Risk management of Islamic banks: A search for empirical evidences

Abstract

The objectives of this study are to determine 1) the effect of global economic and financial crisis on risk management, 2) the severity of different types of risk facing Islamic banks, 3) the risk levels of Islamic financial modes, 4) risk assessment techniques, and 5) risk management techniques. The structure of the balance sheet, the nature of Islamic finance instruments and funding sources have a great impact on the level of risk exposure of banks and the instruments. Credit risk is found to be the most serious risk, followed by liquidity risk, market risk and operational risk, in descending order of importance. As for the riskiness of Islamic financing modes, mudarabah is perceived to be the riskiest, followed by musharakah, while murabahah ranked as the least risky mode. Moreover, Islamic banks are found to use traditional risk management techniques more than sophisticated measurements. They also adopt risk mitigation techniques that are used by conventional banks in preference to techniques that are considered to be unique to Islamic banks. This paper is the first to study the risk management practices of Islamic banks operating in Bahrain. It also provides evidence about these practices after the global financial crisis that affected all countries, including Bahrain.