Managing Equity Investment Risk and Rate of Return Risk in Islamic Banking: A System Thinking Approach

Abstract

This study aims to examine and explore the risk management practices with respect to Rate of Return Risk (RORR) and Equity Investment Risk (EIR) in the Islamic Banking Institutions (IBIs) of Pakistan through a systematic model which is called System Dynamic Model (SDM) by using system thinking methodology. This study has been conducted in three sequential phases to develop the qualitative System Dynamic Model for Rate of Return Risk Management and Equity Investment Risk Management. Firstly, the researchers developed preliminary Causal Loop Diagrams (CLD) based on the initial understanding achieved from the causal interconnections between various RORR and EIR characters through extensive literature review. Secondly, the researchers conducted semi-structured interviews with the experts to ratify, endorse and refine the initial CLD. Lastly, the data collected through interviews was analyzed to develop the final refined qualitative SDM. The study's findings indicate that the identification and measurement of the RORR and EIR in IBIs in Pakistan need to be strengthened by developing appropriate methodology. Moreover, the practices adopted by these financial institutions to mitigate and control the exposures of RORR and EIR are good and effective. This Qualitative SDM provides practical, constructive and productive understanding to the managers, policy-makers, regulators, shareholders and scholars regarding the RORR and EIR management mechanism of IBIs of Pakistan.