Riba and Gharar Prohiobited from the Point of View in Islamic Jurisprudence and Economic

1.1 DEFINITION

Gharar has been defined …relatively the same way by both the Muslim’s jurist and the economists. Both scholars have concluded risk as a measure of uncertainty in which the agent cannot assign actual probabilities to the possible alternative occurrences to the unacceptable event (Saati, 2003). Due to the unique characteristics of Islamic banks, which are based, among other things, on mobilising funds through profit-sharing and loss-bearing investment, the level of risk is proved to be higher in Islamic banks than it is in conventional banks (Ahmed, 2005). As stated by Kumar (2008), the survival and success of financial organization depends on the efficiency in which they can manage its risks, hence, risk management is one of the critical factors in providing better returns to the shareholders.

1.2 OVERVIEW OF RISK

Various scholars have commonly classified risk into two components namely systematic and unsystematic risk. While systematic risk is related to the overall market or the economy, unsystematic risk is linked to a specific asset or firm. Asset-specific unsystematic risk can be mitigated in a large diversified portfolio whereas the systematic risk is non-diversifiable. However, parts of the systematic risk can be reduced through the risk mitigation and transferring techniques. Maiya (2009) asserted that although both conventional banks and Islamic banks are exposed to the same type of risks, there are risks that are unique to Islamic banks due to their need to comply to the Shari'ah law. Unlike conventional banks, Islamic banks share business risks with investors and borrowers hence, from a risk perspective, the essential difference between conventional and Islamic banking is in the nature of risk sharing (Cherrak and Touzani, 2008). Common risks include liquidity risk, credit risk, market risk, legal risk, and operational risk (as illustrated in exhibit 1) whereas risks unique to Islamic banks include commodity and inventory risk,...