Purpose
This study aims to propose a risk management framework for Islamic banks to address specific risks that are unique to Islamic bank settings.
Design/methodology/approach
A unique methodology has been developed first by exploring the dynamics and behaviors of various risks unique to Islamic banks. Second, it integrates them through a series of diagrams that show how they behave, integrate and impact risk, returns and portfolios.
Findings
This study proposes a unique risk-return relationship framework encompassing specific risks faced by Islamic banks under the ambit of portfolio theory showing how Islamic banks establish a steeper risk-return path under Shariah compliance. By doing so, this study identifies a unique “Islamic risk-return” nexus in Islamic settings as an explanation for the concern of contemporary researchers that Islamic banks are more risky than conventional banks.
Originality/value
The originality of this study is that it extends the scope of risk management in Islamic banks from individual contract-based to an integrated whole, identifying a unique transmission path of how risks affect portfolio diversification in Islamic banks.