The effect of economic policies on risk management in Islamic finance
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- NGN 5000
Background of the Study
Islamic finance has grown rapidly in recent decades, driven not only by increased global demand for Shariah compliant products but also by evolving economic policies designed to stabilize financial markets. Recent economic policies—both domestic and international—have introduced regulatory reforms that influence risk management practices within Islamic financial institutions (Al-Rashid, 2023). These policies affect capital adequacy, liquidity management, and the mitigation of credit, market, and operational risks. The emergence of Basel III–inspired frameworks, modified to suit Islamic principles, has underscored the need for tailored risk management strategies. As regulators tighten policies to ensure financial stability, Islamic banks must reconcile conventional risk management tools with the ethical imperatives and profit loss sharing models of Shariah law (Hussein, 2024).
Scholars have noted that economic policy changes can both enhance and constrain risk management. On one hand, tighter regulations and mandatory disclosures provide transparency and may foster a culture of accountability (Khan, 2023). On the other hand, rapid policy shifts may impose operational challenges on Islamic institutions that traditionally rely on distinct financial instruments. The dynamic interplay between state economic policies and Islamic finance risk practices has spurred debate regarding the adaptability of traditional risk models. Recent empirical studies highlight that while Islamic financial institutions have innovated in risk management, there remains a lag in fully integrating policy changes into operational frameworks (Abdul, 2024).
Furthermore, economic policies affecting interest rate benchmarks, foreign exchange fluctuations, and commodity prices indirectly shape the risk profile of Islamic banks. The integration of macroprudential measures, as observed in several Gulf Cooperation Council (GCC) countries, has led to new standards for capital buffers and asset quality reviews (Farooq, 2023). As these institutions strive to align with both global standards and religious ethics, the contextual influence of national economic strategies becomes paramount. This study, therefore, examines how contemporary economic policies influence risk management practices and whether current regulatory frameworks adequately support Islamic financial principles. Insights drawn from this analysis are critical for policymakers and industry leaders seeking to fortify financial stability while upholding Shariah integrity.
Statement of the Problem
Despite the expansion of Islamic finance, there is growing concern that existing economic policies may not fully address the unique risk challenges faced by these institutions. Traditional risk management models often fail to capture the complexities of profit loss sharing arrangements and the prohibition of interest, leading to potential mismatches in regulatory expectations and operational realities (Ibrahim, 2023). Economic reforms that work well in conventional banking sometimes prove inadequate or even counterproductive in Islamic finance contexts. For instance, regulatory measures designed for interest based systems can inadvertently marginalize the risk sharing mechanisms central to Islamic banking, thus increasing vulnerability during economic downturns (Suleiman, 2024).
Furthermore, rapid policy adjustments—implemented in response to global financial instability—can impose significant compliance burdens on Islamic banks. These institutions must invest heavily in technology, training, and advisory services to realign their risk management frameworks with new regulatory mandates. There is also a risk that these adjustments might not be fully compatible with Shariah requirements, thereby forcing banks to choose between regulatory compliance and religious adherence (Rahman, 2025). Such a dilemma raises critical questions about the efficacy of current economic policies in safeguarding both financial stability and the ethical dimensions of Islamic finance.
Moreover, limited empirical research has systematically explored the link between economic policy changes and risk management outcomes in Islamic financial institutions. This gap in the literature hinders the development of effective, context specific strategies that integrate modern economic policy imperatives with traditional Islamic finance principles. Consequently, the study seeks to uncover whether these policies are robust enough to mitigate risks while fostering an environment conducive to ethical banking practices.
Objectives of the Study
• To analyze how contemporary economic policies shape risk management practices in Islamic finance.
• To assess the effectiveness of current regulatory frameworks in addressing Shariah specific risk challenges.
• To recommend policy enhancements that align risk management strategies with Islamic financial principles.
Research Questions
• How do current economic policies impact risk management in Islamic financial institutions?
• What are the challenges in harmonizing conventional risk frameworks with Shariah principles?
• Which policy modifications can better support risk mitigation in Islamic finance?
Research Hypotheses
• H1: Economic policy reforms significantly influence risk management practices in Islamic finance.
• H2: There is a positive relationship between regulatory transparency and effective risk mitigation in Islamic banks.
• H3: Tailored economic policies improve the operational resilience of Islamic financial institutions.
Scope and Limitations of the Study
This study focuses on selected Islamic financial institutions across GCC and Southeast Asia. It examines the influence of economic policies introduced between 2023 and 2025. Limitations include potential regional bias and the difficulty of isolating policy effects from global economic trends. Data constraints and rapidly evolving regulatory frameworks may affect generalizability.
Definitions of Terms
• Economic Policies: Government measures affecting financial markets, including regulatory reforms and fiscal adjustments.
• Risk Management: Strategies to identify, assess, and mitigate financial risks.
• Islamic Finance: A financial system adhering to Shariah law, emphasizing ethical and profit loss sharing practices.
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