An Appraisal of Credit Risk Management in Islamic Banks
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Background of the Study
Credit risk management is essential for maintaining financial stability in any banking system, and Islamic banks face distinct challenges due to the prohibition of interest and the reliance on asset-backed financing. Effective credit risk management in Islamic banking involves unique instruments such as profit-and-loss sharing, murabaha, and ijara contracts that require rigorous risk assessment and monitoring (Mustafa, 2023). With advances in digital technologies and data analytics, Islamic banks are increasingly adopting innovative risk management tools to enhance their credit assessment and minimize defaults. These tools allow for more precise modeling of credit risk while ensuring compliance with Shariah principles. In recent years, regulatory reforms and market pressures have further emphasized the importance of robust credit risk management practices in Islamic finance, as institutions strive to balance profitability with ethical obligations (Al-Hassan, 2024). The continuous evolution of these practices is critical for safeguarding the stability of Islamic banks and protecting stakeholder interests (Ibrahim, 2025).
Statement of the Problem
Despite progress in credit risk management, Islamic banks still struggle with challenges that undermine their risk mitigation efforts. A significant issue is the difficulty in quantifying credit risk in a manner that aligns with Shariah principles, often leading to reliance on conventional models that may not fully capture the nuances of Islamic financing structures (Mustafa, 2023). Additionally, the integration of advanced analytics into traditional credit evaluation processes is hampered by data quality issues and legacy system constraints. Regulatory pressures and evolving market conditions further complicate credit risk management, sometimes resulting in inconsistent risk assessments and increased non-performing loans (Al-Hassan, 2024). These challenges create a gap between the theoretical risk management framework and its practical implementation, thereby affecting the overall financial stability and performance of Islamic banks.
Objectives of the Study
– To evaluate the effectiveness of current credit risk management practices in Islamic banks.
– To identify challenges in aligning risk assessment models with Shariah principles.
– To propose strategies for enhancing credit risk management through technological integration.
Research Questions
– How effective are current credit risk management practices in Islamic banks?
– What challenges exist in quantifying credit risk within a Shariah-compliant framework?
– What measures can improve the integration of advanced analytics in risk management?
Research Hypotheses
– Robust credit risk management reduces non-performing loans.
– Misalignment between conventional models and Shariah principles increases risk.
– Technological integration enhances the accuracy of credit risk assessments.
Scope and Limitations of the Study
This study focuses on credit risk management practices in Islamic banks within emerging markets. Data will be sourced from internal risk reports, regulatory documents, and expert interviews. Limitations include data quality issues and variations in risk assessment practices.
Definitions of Terms
– Credit Risk Management: The process of identifying and mitigating the risk of default.
– Islamic Banks: Financial institutions that operate under Shariah law.
– Non-Performing Loans: Loans in which the borrower is not making interest or principal payments.
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