Risk Mitigation in an Interest Free and Non- Speculative Financial System: A Critical Review and Regulatory Framework for Shari'ah Compliant Risk Management

Abstract

This paper critically and systematically reviews previous literature on Risk Mitigation in an interest free banking system. The paper, through a study of literature,identifies different forms of risks that are general to all financial institutions and are largely systematic. The review highlights unique risks and unique risk management practices which are specific to Islamic Banking and Financial system. The review enables us by highlighting the importance of the Islamic financial system in the form of real economic activity it performs, unlike the conventional financial system. The Islamic banking system does not permit the use of conventional risk management practices and therefore require risk mitigation practices that are distinctive and particular to Islamic Financial Institutions. A conceptual framework is proposed based on the review of literature proposing three main regulatory variables comprising of Shari'ah Compliant Prudent investing, financing and transactions, Separate Advisory of Scholars and, Integrated Accounting, Auditing and Financial Systems. All these three variables,when implemented, results inadequate capital for absorbing risks,Shari'ah Compliant business practices and monitoring and,identification and controlling of risk factors. This leads to managing unique risks particular to Islamic Financial System through policies and regulations, resulting in sustained profits of the business by avoiding adverse effects on institutions, thus ensuring long term stability and growth. Furthermore, methodology and directions for future research are discussed.