Does Sharia governance deter bank risk-taking? Evidence from profit-sharing accounts and board financial expertise

Purpose This study aims to investigate whether Sharia governance mitigates risk-taking in Islamic banks, focusing on two underexplored mechanisms: profit-sharing investment accounts (PSIAs) and the accounting and finance qualifications (AFQs) of Sharia board members. It also examines how these governance features interact with conventional structures, such as board independence, risk committees and ownership concentration, to shape bank stability. This study addresses gaps in the literature by disentangling Sharia governance into its internal components and assessing their discrete and combined effects on multiple dimensions of risk (liquidity, credit, operational and insolvency) in Islamic banks operating in the Gulf Cooperation Council (GCC). Design/methodology/approach The authors construct a unique hand-collected panel of 37 Islamic banks across five GCC countries, covering 296 bank-year observations over more than a decade. To estimate the effects of Sharia and conventional governance mechanisms on risk, the authors use generalized least squares (GLS) random effects as the baseline method, with robustness checks using the two-step system generalized method of moments. Multiple risk proxies, such as loan-to-deposit ratio, loan-loss reserves, non-performing loans, asset return volatility, Z-score, capital adequacy ratios and standard deviation of return on assets, are combined with governance and ownership variables. This dual-governance framework allows us to assess both statistical and economic significance in shaping Islamic banks’ risk-taking. Findings The authors find that Sharia board AFQs significantly reduce liquidity and credit risks, with magnitudes equal to 27% and nearly twice their sample means, respectively. PSIAs also discipline managers, reducing credit risk by almost half its mean. Risk committees and foreign ownership further constrain risk-taking, while government ownership increases insolvency risk. Importantly, the effects of Sharia governance are amplified when combined with strong boards and ownership structures, confirming the value of a dual-governance model. These findings highlight that governance expertise and depositor-based discipline materially improve bank stability and provide evidence that both Sharia-specific and conventional mechanisms are complementary. Research limitations/implications This study is limited to GCC Islamic banks and relies exclusively on quantitative data, which may not fully capture informal governance dynamics. Expanding the sample to include Islamic banks in Southeast Asia, Africa or North Africa would improve external validity. Qualitative or mixed-methods approaches could further explore how boardroom interactions, religious interpretations or institutional contexts influence governance effectiveness. Future research could also examine depositor perceptions of PSIAs and their influence on risk discipline. Despite these limitations, this study provides novel empirical evidence on the economic significance of Sharia governance mechanisms and their integration with conventional governance structures. Practical implications Policymakers and regulators should consider mandating minimum financial expertise standards for Sharia board members, ensuring that Sharia oversight is supported by accounting and finance literacy. Regulatory authorities could also strengthen disclosure requirements around PSIAs, including profit allocation and risk-sharing mechanisms, to protect depositors and enhance transparency. For bank boards, appointing financially qualified Sharia scholars should be viewed as a strategic governance investment, not just a compliance exercise. Risk committees and concentrated ownership further complement Sharia governance in constraining risk-taking. Collectively, these findings offer actionable insights for regulators, bank executives and standard-setting bodies such as AAOIFI and IFSB. Social implications Strengthening Sharia governance has broader societal benefits beyond financial stability. By embedding financial literacy within Sharia supervisory structures, Islamic banks can reinforce public trust, ensure fairness in risk-sharing and align banking practices with the ethical principles of Islamic finance. This contributes to depositor protection, market transparency and resilience against systemic crises. In the long run, these reforms can promote inclusive financial development, particularly in emerging markets where Islamic banking plays a central role in economic growth. Enhancing Sharia governance thus supports both the legitimacy of Islamic finance and its potential as a socially responsible alternative to conventional banking. Originality/value To the best of the authors’ knowledge, this is the first empirical study to jointly assess the effects of PSIAs and Sharia board AFQs on risk-taking in Islamic banks. Unlike prior studies that treat Sharia governance as a monolithic construct, the authors disentangle its internal attributes and evaluate their interaction with conventional governance. This study also demonstrates the economic significance of these mechanisms, not just statistical relevance. By introducing the concept of dual governance in Islamic finance, the paper provides novel insights into how Sharia-specific and conventional structures complement each other. The findings carry important implications for governance design, policy frameworks and international supervisory standards.