Operational Risk Management in Islamic Banking; a System Thinking Approach

Muhammad Farhan & Hassan Mobeen Alam
Published Online: December 2018
Abstract

This research paper aims to explore the operational risk management structure of Pakistani Islamic banking system by developing a system dynamic model through a novel methodology called system thinking approach. This model has facilitated to understand the interrelationships between various characters of operational risk and its management. In order to develop the system dynamic model, this study has been divided into three stages. In the first stage, the researchers have developed an initial casual loop diagram on the basis of preliminary knowledge and understanding achieved through literature review on causal interconnections between various variables of operational risk management system. In the second stage, semi-structured face to face interviews have been conducted from risk managers to improve, confirm and add risk factors in the preliminary model. In the last stage, a refined system dynamic model has been developed based on interview data analysis. The model indicates that an escalation in the operational risk induces the Islamic banking institutions to proactively develop a framework to manage the operational risk as per the prudential regulations of the central bank. Therefore, the Islamic banking institutions take steps to manage the operational risk by giving training to their staff, making contingency plans, adopting advanced technology for Islamic banking, improving internal control system, confirming disciplined workplace environment and ensuring compliance with Sharīʿah and fiduciary responsibilities.


Keywords

Islamic Banking, Operational Risk, System Thinking, Risk Management.