Islamic Justification of Credit Default Swap for Managing Credit Risk in Islamic Banking

Abstract

Due to use profit-sharing modes in Islamic banks, the nature of risks in these institutions has changed and the return of investments or deposits isn’t predetermined. Because the return of investors settles based on profit-loss sharing, they are also contributed to risk of banking operations. In accordance with studies conducted in some Islamic financial institutions credit risk is one of the main risks that puts in danger Islamic banks. Conventional banks use commonly credit derivatives to reduce credit risk exposure. They can hedge themselves against any imposed credit event from counterparty through transferring risk to other party in credit derivatives. This is a principal question about possibility of applying credit derivatives for managing credit risk in Islamic banks considering the Islamic jurisprudence principals.Conventional institutions utilize commonly credit derivatives to reduce credit risk exposure. They can hedge themselves against any imposed credit events by counterparty. There is a permanently question about the possibility of applying credit derivatives to reduce credit risk in Islamic financial institution regarding the sharia principles.This article firstly considers credit risk and introduces different types of it. Then specified types of credit risk which exposure in Islamic credit institutions (especially Islamic banks) will be presented. The nature of Islamic banks appears special risks more than what commonly conventional banks face with them. Finally we look at jurisprudence possibility of applying credit derivatives for managing credit risk in Islamic banks. In this regard we review one of the most common types of credit derivatives (Credit Default Swap) according to sharia principals.