 In this module, we shall look at the definitions of major risks faced by Islamic banks or the major risks inherent in Islamic modes of finance. It is important to look at the nature of these risks, their definitions before we start citing them heavily in the subsequent modules. Credit risk, we said, is one of the major risks faced by Islamic banks because of some of the Islamic modes of financing used by them. Actually, credit risk is relevant to all the Islamic modes of finance. In fact, if I tell you, credit risk is relevant to all modes of financing, whether they are conventional or Islamic. Whenever you are extending a loan or whenever you are extending a finance facility to someone, there is always a chance that the person would either not pay at all or would delay. That is actually called credit risk. So, credit risk is the loss of income arising as a result of the counterparty. It could be a borrower. It could be someone who has got financing on credit basis or someone has bought a commodity and has to pay for it in the payment or time or in full as a contractually agreed. So, this is actually credit risk. When someone does not pay in time, in time means when the person was required to pay or does not pay at all, credit risk arises. And as I said, this exists in all modes of financing. Market risk. Market risk may arise due to several macroeconomic and transaction-specific factors. It is a risk associated with the overall market. Because of any changes in the market, if there are some relevant factors which have affected a transaction, that would give rise to market risk. It ranges from equity risk to a lot of other risks. In case of equity risk, for example, if the stock market has crashed, there is a huge drop in the stock market and the bank, Islamic bank is actually listed on that stock market. Of course, its stock market valuation or market capitalization would go down, which would have a huge impact on its risk profile. Market risk may also be transaction-specific. For example, in Salem transactions, it may be related to the price of the commodity to be delivered. Third risk is markup risk. Markup risk is also known as benchmark rate risk. It is relevant to fixed return kind of modes of financing, which are like Muraabha, Salem, and in some cases, it would be Ijara as well, if it's not a variable rate Ijara. But primarily, Muraabha and Salem-based transactions or Muraabha as a mode of financing and Salem as a mode of financing would have relevance to markup risk. It is also relevant to other modes of finance, but is more manageable in case of Ijara, Musharaka, and Mudarabha. Commodity, asset price risk. This risk arises due to movement in the prices of the assets or commodities to which Islamic banks have exposure because of use of a certain mode of finance. In case of Ijara, Musharaka, Mudarabha, and Salem, it is quite evident. In case of Muraabha transactions, it is more manageable. Why? As we would see, in case of Muraabha, the first purchase and the second sale, they are quite close to each other. Hence, the exposure of the bank to the commodity asset price is rather limited. Liquidity risk. Liquidity risk arises from either difficulties in obtaining cash at reasonable cost from borrowings. This is known as funding liquidity risk or sale of assets called asset liquidity risk. Basically, when the bank loses money for any reason, we call it liquidity risk. If the bank is not able to get financing on reasonable rates, and hence it faces certain restrictions in its doings, in its business, that is an example of liquidity risk. Or if the bank has got assets, but it is not able to sell these assets in the market for the price it is looking for, that would give rise to liquidity risk as well. So, in the absence of possibility of securitization of several portfolios, Islamic portfolios, liquidity risk is quite paramount in Islamic banking and finance. Operational risk. Operational risk as I said earlier, this is extremely relevant to Islamic banking and Islamic modes of financing because Islamic modes of finance and their applications are quite complicated. Hence, the chance of making a mistake is higher in case of Islamic modes of finance as compared to the conventional modes of finance. Operational risk as I said earlier, can be the fault of an employee. It can also be a problem in the system of a computer. This is an example of operational risk, that you have to send someone 10,000 rupees or say AX0 or Lagaad. Operational risk includes employees risk, sometimes it is known as people risk. It is also relevant to technology risk and of course anything which may affect the reputation of an institution, reputation of an Islamic bank, that could be an example of an operational risk as well. And this is relevant to all Islamic modes of finance. Legal risk. Risk of adverse interpretation of Islamic contracts by a court. The judge does not know about Islamic law. He had a case of Islamic banking. He interpreted that contract according to his thought and his understanding and gave the decision carefully. And that decision actually created a lot of legal risk for an Islamic bank. And by the way, this is a major risk faced by Islamic bank. In a lot of jurisdictions, the judges, they do not know anything about Murabaha. And I can tell you certain cases where the judge would not be able to pronounce even Murabaha. Murabaha, Mozorba, whatever they call it. Especially if the first language of the judge is not Urdu or Arabic or Farsi, they come up with very funny pronunciations of these Islamic modes of finance. Now again, legal risk is relevant to all the Islamic modes of finance. Withdrawal risk. This is relevant to profit sharing investment accounts. In case the rate of return on profit sharing investment accounts is lower than the return offered by other banks, then this risk becomes quite relevant. There could be a switch of business away from an Islamic bank. And this is relevant to some of the Islamic modes of finance. Fiduciary risk. The contract requires Islamic bank to behave like this in this way. However, the bank's employees, they have not been able to fulfill the requirements of that contract. This would give rise to fiduciary risk. And it is relevant to quite a number of practices and products in Islamic banking and finance. Displaced commercial risk. This is the amount of provisions an Islamic bank should keep in the wake of fluctuations, decrease or increase, especially decrease in the performance of a portfolio held by an Islamic bank. This is a risk which is related with withdrawal risk. And we shall be looking at one example of displaced commercial risk in the context of profit sharing investment accounts.