An Exploratory Examination into the Relationship between Corporate Governance and Risk Management in Islamic Banks: Disclosure and Survey Analysis

Abstract

Whenever corporate and financial failures and crises arise in the world, issues of corporate governance and risk management are always highlighted as major causes of the event. In order to substantiate such claims, it is first important to specify which factors, in either corporate governance or risk management, actually cause these failures. Furthermore, if such factors were identified, might these failures be avoided in the future? This line of questioning provides the rationale behind this research.

This study thus aims to explore and examine corporate governance and risk management practices as well as the potential relationship between the two variables in the case of Islamic banks in various countries. In doing so, the research explores corporate governance and risk management practices by employing disclosure analysis through annual reports, by using content analysis, with the objective of identifying the state of Islamic corporate governance and risk management practices in Islamic banks. To achieve this, the study analyses 181 annual reports from 53 Islamic banks. In addition, the corporate governance and risk management practices of Islamic banks were also explored through perceptions analysis, based upon the responses obtained by questionnaire survey from Islamic bankers and financiers from 28 Islamic banks from 6 countries and locations. An attempt was also made to locate the correlation between corporate governance and risk management with both data sets as it is expected that good corporate governance practices should moderate risk exposure and establish a better risk management process. Thus, this study is predicated on the notion that if banks have good corporate governance practices, the risk management practices should then be efficient.

By using qualitative and quantitative methods of data analysis, including correlation analysis, this study found that the relationship between corporate governance and risk management is not incredibly strong in the case of the Islamic banks involved in the period that this study covers. However, in examining the type of relationship, it was established that there was a positive relationship between the two. Thus, it can be said that with regards to bank failures, if corporate governance is the aforementioned trigger, it is also partly due to risk management – based on the fact that a positive relationship exists between the two. The findings of the study reveal two important results: corporate governance and risk management do not have a strong correlation between them. The findings show that most Islamic banks have very poor scores in Shari’ah compliance and Shari’ah governance. Poor scores are also revealed in other dimensions such as ethics, audit and board composition.

However, in determining which aspect of corporate governance has the stronger propensity for creating problems, it is important to establish the actual dimension which affects corporate governance and risk management the most. This study reveals that Shari’ah-related dimension has the highest bearing on the overall corporate governance positions. Risk management, on the other hand, depends very highly on reporting and disclosure.

A further aspect to consider is that not all dimensions positively affect corporate governance. For instance, the structure, committee and senior management has a negative impact on corporate governance. For risk management, all dimensions had positive impacts except for primary key areas, which are market and liquidity risk and operational risk.