Performance at Risk- Another Approach to Value at Risk for Islamic Finance

Basel Accords promote Value at Risk (VaR) that is the most used method as the preferred one to measure and report market risks of financial institutions. Using VaR usually requires having asset valuation models and identifying their risk factors as model input parameters, allowing thus to stress them and calculate valuations (mark-to-market or mark-to-model). The previous requirements will make VaR calculation - roughly adapted from conventional finance - complicated for Islamic finance as there are not well-known valuation models and the risk factors may not be easily identified. Moreover, Islamic finance induces specific risk considerations like pricing market risks in ijarah contracts in which they pertain to leased asset's residual value. Such data might be either inexistent or uneasy to exploit in usual financial activities. Although difficult to achieve, the regulators will expect an Islamic financial institution (IFI) to be able to measure and report such risks.