Corporate Governance, Accounting and Risk Management in Islamic Banking and Finance

Posted on February 5, 2022 by Cheapest Assignment

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Islamic Banking is considered as the banking system that is carried on in accordance with the Shariat. In Islamic terms, money has no inherent value, as such, it cannot be sold at a profit and it is also allowed to be utilized as per Shariat only (The Conversation Media Group Ltd, 2020). The Islamic law or Shariat prohibits paying any fee for renting money also called riba for particular periods of time. Under Islamic laws, rather than providing interests to traditional accounts, Islamic banks generate accounts that provide profit or loss. The bank in turn buys assets with people’s money which then generate a return for the banks. Charging a high-interest rate is considered unscrupulous under Islamic Law. The Islamic banking industry is growing swiftly near the beginning of the 2000s. The Islamic Banking sector possesses total assets of $195B in the year 2000 to $1451 in the year 2015 and it will further increase to $2716B by the end of 2021 ( Safullah & Shamsuddin 2018, p.129). This fast progress of Islamic Banking has prompted academic interest in determining corporate governance, accounting and risk management in Islamic Banking and Finance. The main purpose of this study is to provide the readers a wide aspect of the topic and derive certain implications from the same.

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Literature Review

Risk management is defined as the process of managing the risk by determining the risk, assessing the risk, controlling and mitigating, monitoring and review of risk disclosure and risk coverage. In the study by Saifullah & Shamsuddin (2018, p.129) the authors stated the past experiential research has assessed accounting-based measured of credit risk and insolvency risk for Islamic as well as conventional banks. The liquidity risk of any financial institution like a bank is the likelihood of the consumer’s need for cash extractions exceeding the bank’s source of money. This risk essentially strengthens in case the banks get challenges either in their borrowing capitals at the rational cost of marketing the assets at their current price to meet the liquidity requirements. As compared to conventional banking can possess more liquidity risk which can be due to their religious limitations on acquiring interest-based funds received from the money market. As a result of religious restrictions for using convention mitigation tools like credit derivatives, there is also greater exposure of credit risk in Islamic Finance (El-Hawary et al., 2007). Additionally, Shariah restrains portfolio diversification, interest-based comprehensive funding and also use of predictable risk hedging tools, thus, making Islamic Banks riskier. As per the agency theory, the board size of an organization determines the capability of the board to assess and give advice to the management. 

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Akkizidis & Khandelwal (2008) stated that Islamic banking institutions have various orientations regarding risks. In addition to operational, market and credit risk Islamic Banks are also facing equity investment risk which is generally dependent on the kind of contracts structured among the binding parties. Such risks are particular to the contract type which is named as Musharkah and Mudarbah. Islamic banks are also exposed to performance risks called Salaa, Ijarah and Isitisna Islamic product and compliance risks in the Murabahah contract. Considering all these risks, Islamic Banking management tools comprise of net income simulation, risk thresholds, scenario analysis, potential loss limits, counterparty limits, credit rating system, and stress test. The Board of directors in the bank needs to summarize the overall credit risk strategies by demonstrating the willingness of the bank’s credit for different sectors, profitability, geographical location and maturity. While doing so, the bank will recognize the objectives of credit quality, growth, earnings and the risk-reward tradeoff for the activities. Islamic banks need to use stress testing by setting limits while monitoring by evaluating the interest rate, business cycles and other market movements. Islamic banks are required to have a system for ongoing administration of different credit risk-bearing portfolios. 

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Islamic banks need to have self-governing ongoing credit reports for the board of directors as well as senior management for ensuring the bank’s exposure to risk. This need to be managed within the strictures as set by the provident standards as well as limits. Senior management of the bank needs to ensure that the bank follows certain strategies as well as measures that facilitate the managing of interest rate risk. Islamic banks need to have essential internal controls to encourage their effective performance and lastly consistent supervisory and financial reporting and compliance with applicable rules, guidelines and official strategies. In terms of managing the liquidity risk, the senior management of the organization as well as the board of directors needs to make sure those objectives and priorities of the respective banks regarding liquidity management are comprehensible. Islamic banks also need to have by issuing different forms of guidelines, rules, regulations etc. For doing so, the management is required to create an operational risk catalogue where the banks can be able to process outlines for each business or department of the institution. Conceptual studies reveal some significant aspects of managing risk that Islamic banks need to follow. It is essential for the management of the Islamic banks to understand the aspects of risk in the banking system and manage those risks by using modern tools and strategies (Rosman, 2009).

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Corporate governance is the accumulation of different kinds of rules, processes and laws through which businesses are operated, controlled and regulated. This term comprises the internal as well as external factors that potentially impact the interests of the organization’s stakeholders that including customers, shareholders, suppliers, management and different government regulators. It is an error to presume that Islamic banks do not need prudential corporate governance as they operate through an Islamic value system that impartially safeguards the rights of the respective stakeholders. It is a fact that Islamic banks equitably position themselves differently than the conventional banks regarding losses, failures etc. which can lead to corporate governance violations. Stakeholders of Islamic banks possess the right as well as the responsibility to determine the meaning of abiding by Shariah and the task that can effectively govern and risks being limited. Saffieddine (2009) premised that there are certain corporate governance concepts that are not accounted for within the background of Islamic banking, even though they possess severe challenges and have significant inferences.

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There are some severe issues relating to the stakeholders of Islamic banks which justify the use of corporate governance concentration. These comprise of agreement with the shariah in actions, defending the interest of the accounting holders, calculation of mudarib’s share of profit, resolving the issues linked with the misuse of funds and unobstructed investment for the account holders along with ensuring transparency in the total profit distribution method (Almutairi & Quttainah 2017, p.23). Thus, it can be said that Sharah’s government is the overall system that potentially manages the traditional values of the Islamic Banks as well as IFIs to the insight of the Shariah using the profitable transactions in all the actions. Uddin (2018, p.55) determined there was variation in Shariah governance procedures among IFIs in more than 11 countries which is generally different.  In this case, they recommended the establishment of comprehensive shariah governance practices that can essentially promote good corporate governance. 

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Grassa & Matoussi (2014, p.346) stated that the governance of Islamic Banks needs to be different from the conventional banks. It is essential for the Islamic banks to undertake their actions on the basis of Shariah law. IBS is also featured by the existence of the investment accounts that actually complicate their entire governance framework. Further, institutional environment IBs are featured on the basis of the existence of the investment accounts which actually complicate the bank’s corporate governance systems. All these make the corporate governance of Islamic banks different from that of their conventional banks and the purpose of corporate governance in these banks are quite different from that of normal banks.


Research methodology is an integral part of the research which can be defined as the process to determine, select, and process as well as analyze the information regarding the topic. In this research secondary qualitative research has been conducted by taking proper assistance from past scholarly articles. Secondary research is the method of research that involves already existing data. Current/existing data is summarized as well as collated to enhance the overall effectiveness of the research. Qualitative research potentially involves collection as well as analysis of data that are not numerical in nature for successfully understanding the concepts, opinions or any sorts of experiences. This can be used for gathering in-depth perceptions of the corporate governance and risk management issues that are faced by Islamic Banks. In this study, initially, 14 articles were chosen for gathering data, however, out of those articles 6 articles failed to meet the criteria and thus they were rejected. Finally, 8 articles were chosen that met all the possible criteria and all these articles were significantly used to derive information on the topic. All these articles were selected by ascertaining ethical consideration and maintaining transparency. Ethnographic qualitative research has been done in this research which usually focused on interpreting the data gathered to observe the implications that can be formed from the data which has been collected from all the literature.

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Findings and Discussion

Safiullah, & Shamsuddin (2018) have examined the risk in Islamic and conventional banks and concluded three aspects of Islamic bank that is size, qualifications and finally reputations of Shariah board members as the primary drivers of risk. The study has shown some major policy suggestions for practical regulators as well as global controlling necessary for the Islamic Banks. The study also concluded that there is a dual domination structure with a wide SSB that is extravagantly signified by refined followers in lowering the risk. Similarly, the study by El-Hawary et al. (2006, p.778) contrasted the risk as well as regulations that are essential in case of the financial intermediation and Islamic banking face some significant challenges in future. Findings of the study revealed that regulators need to conduct two prolonged strategies that are running current practices and also shaping the transition on the basis of efficient intermediation.  Rosman (2009) in his study showed the use of a conceptual model in determining relationships among risk management practices and four aspects of the risk management process: understanding risk, identifying risk, risk analysis and assessment, risk monitoring. The findings of the study revealed that empirical kinds of literature and conceptual model have succeeded in explaining relationships among the risk management processes.

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The study by Safieddine (2009) provided the perception that agency structures in Islamic banking can increase trade-offs among Sharia compliance as well as the mechanism protecting the rights of the investors. Similarly, the findings of Almutairi, & Quttainah (2017, p.23) reveals a robust as well as the significant relationship among Shariah supervisory board (SSB) and Islamic Bank performance by collecting a sample from 82 banks in 15 countries from the period of 1993-2014. The finding of Uddin (2018, p.55) reveals that vast knowledge on Islamic Banking products, customers and attitudes of the employees poses some major challenges in managing and assessing commercial risk. Similarly, Grassa & Matoussi (2014, p.346) used a descriptive analysis approach by collecting data from 83 Islamic banks and observing them from 2002 to 2011. The findings of the paper revealed that there are major differences as well as divergence of corporate governance structures of Islamic banking in the Gulf countries along with South Asian nations. The paper also provided some crucial guidelines for the future development of corporate governance for Islamic banks.

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In conclusion, it can be said that though all the banks are exposed to risks, Islamic banks are generally exposed to Shariah risks which are actually related to the function and operation of the Shariah board. Islamic banks need to have an improved risk monitoring structure by having progressive internal control along with risk mitigation approaches. In this respect, the Shariah board along with the management of different Islamic banks needs to create new rules which abide with their religious values. Corporate Governance helps to structure the division of responsibilities within the business for managing different kinds of risks in Islamic

. This also helps to assess the means through which the risk management system can be implemented in the respective department of the organization. Islamic banks are currently required to have sound corporate governance that will ensure periodically yet accurate disclosure of the performance of the banks which will help customers and investors to know the position of the bank in the market.

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Akkizidis, I., & Khandelwal, S. (2007). Financial risk management for Islamic banking and finance. Springer.

Almutairi, A. R., & Quttainah, M. A. (2017). Corporate governance: evidence from Islamic banks. Social Responsibility Journal, vol.23, no.34, pp.23-78.

El-Hawary, D., Grais, W., & Iqbal, Z. (2007). Diversity in the regulation of Islamic financial institutions. The Quarterly Review of Economics and Finance46(5), 778-800.

Grassa, R., & Matoussi, H. (2014). Corporate governance of Islamic banks. International Journal of Islamic and Middle Eastern Finance and Management. Vol.7, no.3, pp.346-362.

Rosman, R. (2009). Risk management practices and risk management processes of Islamic banks: a proposed framework. International Review of Business Research Papers5(1), 242-254.

Safieddine, A. (2009). Islamic financial institutions and corporate governance: New insights for agency theory. Corporate Governance: An International Review17(2), 142-158.

Safiullah, M., & Shamsuddin, A. (2018). Risk in Islamic banking and corporate governance. Pacific-Basin Finance Journal47, 129-149.

The Conversation Media Group Ltd. (2020). Explainer: how does Islamic finance work?

Uddin, M. A. (2018). Can Shari’ah Governance Framework be the Way Forward for Islamic Finance?. In The Name of Allah, The Most Beneficent, The Most Merciful, 55.

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