Risk Management Practices in Islamic Banking: A Comparative Analysis

Abstract

Islamic banking, operating under the principles of Sharia law, presents a unique paradigm in the global financial landscape, necessitating distinct approaches to risk management compared to its conventional counterparts. This research undertakes a comparative analysis of risk management practices employed within Islamic banks, highlighting the commonalities and divergences from traditional banking models. It identifies specific risks inherent to Islamic financial instruments and contracts, such as Sharia non-compliance risk, displaced commercial risk, and the unique challenges associated with profit-and-loss sharing (PLS) modes of financing (Mudarabah and Musharakah). The study explores how Islamic financial institutions integrate conventional risk management tools, where permissible, with Sharia-compliant strategies rooted in principles of risk sharing, asset-backed financing, and ethical considerations. By contrasting these practices, the research illuminates the strengths and weaknesses of current risk mitigation frameworks in Islamic banking, assessing their effectiveness in maintaining financial stability, ensuring Sharia adherence, and promoting sustainable growth within the industry. This analysis provides valuable insights for regulators, practitioners, and scholars interested in enhancing the robustness and resilience of the rapidly expanding Islamic finance sector.