Credit risk management and Islamic banking

The ongoing development of risk management methods and the increased use of innovative financial products such as securitization and credit derivatives have brought about substantial changes in the business environment faced by credit institutions today. Credit Risk Management is intended to assist practitioners in redesigning banks' systems and processes in the course of implementing the Basel II framework.
Throughout the 2004 and 2005 guidelines appeared on the subjects of securitization, rating and validation, credit approval processes and management, as well as credit risk mitigation techniques. The content of these guidelines were based on current international developments in the banking field and is meant to provide best practices which banks would be well advised to implement regardless of the emergence of new regulatory capital requirements.
Islamic banking is being adopted and popular all over the world in recent years, because it is meant to provide a transparent system of banking. It is expected to have characteristics like Islamic and ethical behaviour, good governance, maintain customer relationships, fair dealings, deduction and provision of zakah, focus on safety and security of staff, balanced goals with environmental protective and friendly projects and doing research and development.
Credit risk is arising in Islamic banking when bank pays money under the salam or istisna contract and deliver goods under the murabaha contract before receiving its own asset or money. Supply of credit is dependent on the change in inflation rate, total deposit and time differences of the variables.
Contractually Islamic bank depositors accept losses or lower rate of interest when assets are under-perform through which the bank manages the risk. In modaraba contract clarity is provided on investment and stimulus to them to accept the associated risk. Islamic banks have enough concentration of long-term assets and cash to set off their floating liabilities.
Credit risk management in Islamic banking is very difficult because the banks are prohibited to charged interest and penalties. Clients delay the payments because they know that banks will not charge any penalty for that. Due to these delays, banks' investments are stuck and banks don't earn profit or any income. As a result, the much trumpeted Islamic banking has miserably failed to deliver anything.
Sharia scholars have profited handsomely for years from sitting on multiple boards, approving Islamic versions of conventional financing, derivative and hedging products-It is disgracefully anti-competitive, counter-productive and there is every likelihood that the government will come to regret it.
Now banks use collateral securities and pledges against the credit risks. Banks can demand additional pledges or securities before the Mudarbah contract due to weak legal rules. Difficulties can be reduced by some ways like looking into banks' policies, which already exist.
There are strategies to manage the credit risk in Islamic banking. To manage the risk, the credit exposures to individuals can be reduced. Working with clients knowing their problems of credit and finding a solution to these problems can be done. And in case of default, carrying out legal actions and calling on guarantees and liquidating collateral securities.
Few suggestions before Islamic banking involve risk management functions to identify the risk first, measurement and assessment of risk, mitigation and control of risk, review and monitoring of risk, reporting the risk. Islamic banking must try to come out of this frustrating time.