Risk Sharing, Transfer and Management

Risk management is a complex discipline with claimed scientific underpinnings. Since 2008 these have been shaken by the global financial crisis, with the result that some of the key paradigmatic assumptions of risk management are now seriously questioned. Major casualties of the crisis have been the views that credit markets are efficient, and that the best way to manage risk is to transfer it to someone else. With these assumptions increasingly in doubt, the current flawed paradigm of risk management is ripe for a rehabilitation that might bring the world’s financial situation more in line with reality. The central question moving forward today is whether the right lessons will be drawn from the recent (2008) experience, and whether enough momentum can be generated to move to a new paradigm, one of risk sharing rather than risk transfer. This article explores the economic and financial dimensions of risk management and risk transfer, and then juxtaposes this review with a step-by-step survey of Islamic Finance’s teachings on the related - and paradigm setting - notion of risk sharing. Risk sharing ensures an efficient allocation of resources and a reduction of waste by providing investors with a powerful incentive - the risk of losses - to exercise due diligence. At the same time, by requiring a greater number of parties to share total risk, risk sharing enhances systemic stability. These constitute compelling reason for utilising risk-sharing contracts in preference to risk transfer modes of risk management.