Operational Risk in Islamic Finance

Abstract

According to the guidelines of the Islamic Financial Services Board (IFSB),¹ financial institutions are exposed to operational risks when losses occur due to failures in their internal controls involving processes, people, and systems. In addition, institutions should also incorporate possible causes of losses resulting from Shariah non-compliance and the failure in their fiduciary responsibilities. A special characteristic in applying Islamic financial contracts is the strong engagement between the institution and the counterparties. In addition, when applying partnership agreements (i.e. in Mushãrakah and Murãbaha), both sides may share profits and losses. There is, therefore, an involvement from all parties (banks, buyers, renters, business partners, etc.) in the cause of the operational risk.