Risk management in Islamic financial institutions:the case of Islamic Development Bank

Abstract

This research explores how Shariah compliancy is impacting risk management techniques by studying the case of the Islamic Development Bank. The research identifies the type of financial instruments and products that are used by Islamic financial institution, the major risks it faces in its operation and the risk management techniques it uses for each of those risks. A comparative analysis is then carried out to compare case of Islamic development bank with a conventional financial institution of similar kind that is the World Bank. The results of the analysis revealed that there is a consistency in fin , ancial products and services of Islamic and conventional financial institutions and the risks they usually face are also similar but because of the underlying Shariah principles which structures the Islamic financial transactions in a modified way considering the ethical perspective behind it, so the risk mitigation techniques are accordingly taking a different shape that is free from any unlawful deal or transaction in financial product, resulting in a fair shariah compliant risk management. Hence there is a difference observed between the risk management techniques used by conventional and Islamic financial institutions. In addition to the difference in risk management techniques of common risks, Islamic Fl has a unique Shariah compliant or Shariah reputational risk that is due to consideration of Shariah (Spirituality) and Islamic development bank also addresses this risk. However, as Islamic Development Bank is a non-profit organization, it faces less Shariah-risk than for-profit institutions and IDB is committed to Shariah rulings and adopts only Islamic modes of finance. Therefore the impact of Shariah risk is less than in case of for-profit organizations.