A THEORETICAL ANALYSIS OF THE OPERATIONAL RISK FRAMEWORK IN ISLAMIC BANKS

Abstract

In terms of operational risks, Islamic banks have certain similarities with the conventional banking system since they function within a similar financial environment. However, the challenges are more complex for Islamic banks owing to their particular contractual and financial transactions. For this reason, it is understood that operational risks in Islamic banks are perceived to be significantly higher. This is one of the main building blocks from which the paper is developed. The theoretical analysis offered by this paper starts with presenting the arguments as to why Islamic banks have a distinct operational risk aspect, as compared to conventional banks. It also examines operational risk exposures in Islamic banks by mapping such risks. In addition, the paper also sheds light upon operational risk issues from a regulatory point of view, namely Basel and the Islamic Financial Services Board (IFSB). Lastly, the analysis in this paper suggests the need for maintaining capital specifically to mitigate losses caused by operational risk in Islamic banks. This paper, hence, provides a step further in understanding operational risk issues by providing the four dimensions of operational risk in Islamic banks, namely SharE?ah compliance risk, fiduciary risk, people risk, and legal risk.

JEL Classification: G21, G32, Z12

Key words: Islamic banks, Operational risk, Islamic Financial Services Board