The Transformation of Risk Management Practices in Islamic Banking

Abstract

Like their conventional counterparts, Islamic banks are subject to various risks associated with their everyday activities that require proper management. However, the types of risk and their measurement and management may vary. The objective of this chapter is to compare several aspects of risk management in conventional and Islamic banks, including the concept of risk, type of risk, risk approaches to risk measurement and management, and capital adequacy. The findings reveal that unlike the conventional banking model, Shariah considers some conditions for risk to be acceptable, including the objective of taking risk, the value that taking risk would add to the economy, and the degree of risk taken. Consequently, a number of conventional risk measurement and management approaches are available to Islamic banks as they are also Shariah-compatible instruments. However, adopting and developing tools that serve unique risks associated with the nature of Islamic methods of finance is crucial. For example, alongside the implementation of international capital adequacy guidelines, there are special calculation guidelines available to Islamic banks issued by the Islamic Financial Service Board (IFSB) and the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI).