Risk Management in
Islamic Financial Instruments
120
Figure 5.12: Risk Management Framework of Islamic Banks
Overall, the study finds that operating risk is the most important risk for IFIs. The second most
important risk is credit risk, which is followed by liquidity risk and mark-up risk. Among many
problems, the lack of understanding of the Islamic financial system has been the most
important problem in IFIs. A number of studies conducted in various Islamic countries report
that credit risks and operating risks are the major risks in IFIs (Khan & Ahmed 2001; Rosman
2009). Liquidity risk is sometimes more acute in markets with no secondary backup for banks
(Rosman 2009). However, more importantly, IFIs found varied levels of risks were associated
with various modes of financing. As stressed by the IFSB (2005), IFIs may face more credit risk
in Mudurabah or Musharakah kind of partnership contracts, whereas the market rate of return
problem can be associated with the Ijarah mode of financing.
A study by Hassan (2009) on IFIs of Brunei Darussalam and by Al-Tamimi and Al-Mazrooei
(2007), conducted on the foreign IFIs of United Arab Emirates, reported that credit risk and
operational risks are among the top challenges for the selected banks. Quite contrary to these
studies, Khan and Ahmed, (2001) in their cross-country study, reported mark-up and
operational risk as most important, while credit risk as not very important.
This study has the largest sample thus far, covering 18 banks from 14 countries. Khan and
Ahmed (2001) covered 17 banks from 10 countries. Khan and Ahmed (2001) reported a lack
of understanding is the primary problem that risk managers face in IFIs. Two important
conclusions can be drawn from these two cross-cultural studies. Firstly, a number of countries
have basic problems with Islamic finance infrastructure, which, when addressed, can help
International authority
Central Bank
Shari'ah Supervision
Internal Auditor
Internal Control
Shari'ah
Principles