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Future Of Risk Management In Islamic Banking Finance Essay

In finance, risk is the chance that an investments actual return will be different than expected. Nothing is better than understanding the risk to be able to manage risks. The way to manage risks in Islamic Banks differs than that in conventional banks. As they build several business models which allow the bank to share risks with lenders and borrowers. But that doesn�t mean they are immune from crisis in global economy. Even though they were protected is the last years, a big question is asked if they will be able to face long term crisis as those happening in Europe and North American countries.


Islamic finance is part of the global financial system. During the recent financial crisis, Islamic financial institutions proved to be an evolving alternative to conventional banks which are operating according to interest-based services. They showed a remarkable growth by 15 to 20 % per year and recently we can see some Islamic institutions or banks operating in non-Muslim countries like USA and UK at a huge range. As demand for Islamic financial services are increasing, conventional banks started to bring Islamic services into action. Of these banks are Deutsche bank, Citibank and Standard and Charted. Thus, such institutions established departments to care specifically about the application of business into Islamic laws or what is known by Shariah. To achieve effectiveness in risk management in Islamic financial institutions, a distinct attention is required. It deals with issues that need to be better researched and understood. In general, it requires some innovative solutions to make risk management smoothly applied with the unique features of services provided by Islamic financial institution.

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During the financial crisis in the past few years many conventional banks closed and many are resisting difficulties. Knowing that few conventional banks are managing difficulties properly, most of the Islamic banks and financial institutions were fully protected from crisis. But in the coming years and as expected to have hard financial situations, how can Islamic banks survive and manage risks.


I aim from this research to show if the risk managerial methods being applied by the Islamic financial institutions were enough to help the growth of this sector. Thus the hypotheses can help prove what were the drivers for this development and what are the main reasons of their success. After, I can show if such factors are sufficient to protect this banking system from future economic downturns in its environment.


The results will help giving strong arguments that maybe in favour for all banks. The research can give new ideas for future implications by Islamic and conventional banks. I hope from the conclusion and the recommendations to give Islamic banks a clear understanding about the future risks and what are the best to manage them. I will try to show some survival characteristics in the Islamic financial system that could be implemented into conventional banks to help face recent crisis.


From many years ago, Risk management has attracted attention by academics and professionals in the financial sector. These days, this topic is requiring new innovations as many banks are suffering from inconsistent financial situation. As looking at the problem from different sides one can rarely guess a solution to escape this vertex. Several reviews argued that the core of the problem is the bad structure of the financial system that all bank are built on and the only way to survive is to take brave decisions and recreate new financial method and implement more regulations. But when we start reviewing all the recent articles and studies especially those issued for Europe and North America, reader has to look deeply on a positive remarkable sign. Unlike conventional banks, Islamic banks were rarely suffering and their business indicators were showing growth and potentials toward development. Many reviews relay this progress for the natural characteristics of Islamic banks which is based on Islamic laws that deprive the interest rate.

Many studies are available to talk about the main causes of current financial crisis. The main cause as most economists agree was the excessive and irresponsible lending. According to a research done by US congress some causes of the financial crisis are the failure of risk management, global financial imbalances and shadow banking system. While we can easily know the causes it�s getting hard to find a solution and escape out the problem. According to western researchers the mentioned causes could be solved by more strict regulations and by improving banking supervision. On the other hand some Muslim researchers claimed about two factors help banks to accept that they will not suffer losses. The first one is security system or what is known by collateral, which is essential and obvious in any kind of financial system to allow risk management and avoid cheating. Collateral is been exposed to risk in which its value could be reduced by the same factor that reduces the borrower�s ability to pay back. Thus their main function is based on avoiding risks through asset backed banking. It�s also argued that the profit and loss system (PLs) may lessen this problem. They added that without PLs, banks can�t carefully evaluate of the collateral and the credit status of a client and will increase financing. The second factor is about protecting from default to the banks is a concept called �too-big to fail�. This means that the central bank or other banks are ready to bail them out when crisis happened. Logically speaking then, banks enjoying such safety measures are ready to take more risks than others.

Some challenges are faced by Islamic banks to build a risk management system which can be an adequate and integrated. Of these challenges we can talk about the inability of the Islamic banks to follow disclosure and uniform reporting standards as required by the AAOIFI. They can allow transparency within the industry and comparability could be allowed across Islamic banks functioning all over the world. Thus controlling, regulatory and supervisory authorities could be easily facilitated. Another challenge is the centralization on Islamic law which has to be ensured. In the future the risk management system needs to well established and accepted by the legal Islamic finance framework. Also, the unskilled human resources working within the Islamic financial institutions are a floating challenge. They have to combine between the product�s understanding and the in-depth knowledge of the Islamic laws. Thus this will help in facilitating finding new innovations and will improve the bank�s ability to manage their service at its best.

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Finally, many think that Islamic banks don�t need new changes in their operation framework, but they have to start thinking about studies and saving achievement to allow development and building new innovative methods in the future. As we live in a highly competitive environment and this growing domain needs to find new markets and means that risks will be increased and thus differentiation is a must. In a rapidly changing financial environment, it should be predictable that risk management is an active area of study which requires unbroken research plans.



To validate the hypotheses I am going to review the latest studies about the studied topic and compare the finding with my arguments. Since nothing is better than number to prove a hypotheses, I am going to get samples from Islamic and non-Islamic banks financial statements during the crisis and compare the number to show the performance of each. Also I will conduct interviews with some professors and professionals following the progress of Islamic banking. Questions will be centered on future strategies to manage risks and what are the main expectations from Islamic banking.

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