Financial Risk Management: It’s Implications and Compliance with Shari’ah Standards

Abstract

Financial Risk Management (FRM) is an integral to ensuring financial stability and sustainability in both conventional and Islamic finance systems. This article explores the definitions and foundations of Financial Risk Management (FRM), focusing on its implications and compliance with Shari’ah standards. Illustrative, conventional FRM relies heavily on risk-transfer mechanisms such as derivatives, while Islamic finance emphasizes on ethical principles, including the prohibition of Riba (interest), Gharar (excessive uncertainty), and Maysir (gambling). These principles promote risk-sharing, fairness, and asset-backed transactions, aligning financial practices with Islamic ethical values. The study reviews international FRM standards, such as those proposed and evaluates their compatibility with Islamic finance. Shari’ah standards, particularly those outlined by AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions), provide a structured approach to managing financial risks in compliance with Islamic jurisprudence. The research also examines the historical roots of risk management in pre-Islamic Arabia, where mutual cooperation and risk-sharing laid the foundation for modern Islamic financial practices.  Drawing on Quranic verses and Prophetic traditions, the article highlights the Shari’ah-based foundations of FRM, showcasing how principles of justice, trust, and shared responsibility are embedded in Islamic finance. This study contributes that Islamic Shari’ah has not only allows mitigating future risk but emphasizes on the following of best principles for FRM laid down in the Qur’an and Sunnah of the Prophet (PBUH).