Review of Risks and Risk Management Systems in the Largest Islamic Banks of the Arabian Peninsula

Abstract

Theoretical background: The specificity of Islamic principles, on the basis of which Islamic banking was created, as well as the nature of its financial instruments, means that Islamic banks may be exposed to greater risks than conventional banks.

Purpose of the article: The aim of the article is to define key risks identified by Islamic banks and to define risk management systems in the 13 largest banks of the Arabian Peninsula region. The article analyses the annual reports submitted by the supervisory boards of the largest Islamic banks of the Arabian Peninsula for 2018, so that common elements in their risk management processes can be found.

Research methods: Analyses of annual reports of the banks of the Arabian Peninsula region.

Main findings: Supervisory boards of Islamic banks identify risks and implement strategies and risk management structures. The most important risks identified by banks are credit risk, liquidity risk, reputational risk, as well as operational risk, understood as the risk of direct or indirect loss, resulting from inadequate or faulty internal processes, errors of employees or systems and external events. Islamic banks may be exposed to increased credit risk, due to the application of the principle of profit and loss sharing (PLS), which is one of the pillars of Islamic finance. An analysis of the financial reports of the largest Islamic banks of the Arabian Peninsula shows that all supervisory boards are aware of the importance and role of an effective risk management system in reducing costs and increasing banks’ results. Most of them use the principles described by the Islamic Financial Services Board (IFSB). All banks have implemented appropriate risk management processes and policies, and have units in their structures responsible for the risk management process, which means that they apply the first IFSB principle. The institutions declare that they identify and monitor risks, and implement risk mitigation measures.