A critical review of the literature on the rate of return risk in Islamic banks

Purpose - This paper aims to provide a critical review of the literature on the rate of return risk faced by Islamic banks. Design/methodology/approach - Through a thorough review of the literature, this paper presents the discussion among scholars regarding the rate of return risk in Islamic banks. Findings - One of the major issues highlighted is the sensitivity of Islamic banks to the changes in the conventional interest rate due to the fact that many Islamic banking products are benchmarked against the conventional interest rate. Moreover, the limited techniques and instruments available to mitigate the rate of return risk also need serious attention by the regulators. Research limitations/implications - The study relies solely on the literature and highlights important issues in the area but does not provide any empirical evidence of the importance of rate of return risk to Islamic banks as it is beyond the scope of the paper. Practical implications - There are several issues that should be taken into consideration. First, the dearth of empirical research on the identification of the rate of return risk in Islamic banking highlights the need to develop appropriate methodology to enrich the study on the rate of return risk. Second, more focus is needed to determine the impact of rate of return risk on the financial stability and the performance of Islamic banks. Originality/value - This paper highlights several important issues relating to the rate of return risk in Islamic banks that are not widely discussed among researchers. In particular, this paper emphasizes the need to identify, handle and mitigate such risks to ensure the stability of Islamic banks. Therefore, this paper identifies a gap that needs further exploration so as to contribute towards enriching the existing literature in this area.