Risk Management in
Islamic Financial Instruments
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widen the knowledge of Islamic risk management frameworks. Secondly, little has been done
over the last thirteen years in these countries.
Risk management and reporting is highly context-dependent. Reporting of risky activities is
sensitive to ownership and the country of operation. Most of the earlier studies reported that
IFIs did not fully report their country risk (see Khan and Ahmed 2001). This study has similar
findings. Hence, IFIs have not diversified their operation through cross-border arrangements.
This might be a contributing factor that saved IFIs from the global financial crisis. However,
increasing financial diversity and the needs of customers will push IFIs beyond their region of
origin. Consequently, a set of cross-border risk will emerge.
5.11 CONCLUSION
Risk is the uncertainty that must be considered carefully, as banks deal with future
uncertainties. Various types of risk also affect IFIs. Some of these risks are similar to those of
the conventional banks. Studies on various countries and banks report that credit risk,
operational risk, mark up risk, and liquidity risk are the major financial risks affecting IFIs. The
magnitude of the impact of each of these risks varies across the type of financing contracts the
IFIs engage in. For instance, Mudarabah, Musharakah and Murabahah are the financing modes
mostly influenced by these risks, when compared to Ijarah, Salam and Ijtisna.
This study is aimed at exploring the dimensions and determinants of efficient risk
management in IFIs. The participants are selected from OIC member countries. An online
questionnaire method was utilized to collect data from the risk management officials across
regions. A total of 18 bank managers from 14 countries replied within the stipulated time,
which is quite profound given the limited time for responding. This study crossed the
benchmark set by the past studies, especially the one by Khan and Ahmed (2001) that had
covered 13 countries.
There were a number of sections in the questionnaire. The questions were related to overall
perceptions about four categories of risk across six modes of financing. This section was
followed by questions on internal control system, core problems behind inefficient risk
management systems, the basic necessity to establish an efficient risk management system,
and the types of risk management instruments available to IFIs, among many. There were
questions using both dichotomous (yes or no) and scale properties (five and three point scale).
The study further categorized the sample into four regions: MENA, South Asian, Southeast
Asian, and others.
The study reports that operating risk is the most important risk for the IFIs in the sample. By
operating risk, we mean the lack of system, human capital and cutting edge technology in
handling customers’ demands. Credit risk is the second most important risk. Credit risk is the
uncertainty that the customer would fail to pay their loan payments back to the IFI, due to a
number of economic and social factors. The other two important risks are liquidity risk and
mark up risk. Liquidity risk has always been a threat for IFIs. The services offered by Islamic
money markets to solve the liquidity problem are extremely limited to certain countries.
Among the six modes of financing, these risks influence the three primitive levels of Islamic