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Risk Management Assessment Systems: An Application to Islamic Banks

Risk management is central in operations of financial institutions, both from business and regulatory perspectives. Risk management is not only about identifying and mitigating risks, but involves a strong risk management system that includes establishing appropriate risk management environment, maintaining an appropriate risk management process, and instituting adequate internal controls. This paper provides a measurable tool to assess the risk management framework in Islamic banks. The structured assessment methodology provide indices that gives a quantitative assessment of not only the overall risk management system of a financial institution, but also indicates the strengths and weaknesses of various aspects of this system. The assessment process can be used by Islamic banks and regulatory authorities to identify the weaknesses and improve upon the risk management framework. The paper provides examples of how the assessment method outlined can be used to estimate the status of risk management system for two Islamic banks.