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This article examines whether Islamic financing can explain three important bank risks in Malaysia. Because of the perceived link between banks' financial stability and the performance of the economy, it is not surprising that the amount of risk faced by banks is of substantial concern to policymakers. The article focuses on three important bank risks: credit risk, interest-rate risk, and liquidity risk. It studies these risks by studying a sample of 23 commercial banks in Malaysia over the period 1988-1996. The focus is on the Malaysian banking system, as it is unique in having both conventional and Islamic interest-free mechanisms operating side by side. Also, Malaysia has developed the most sophisticated and successful transition of its banking sector to accommodate Islamic banks. Despite the growing interest in Islamic banking and finance in both the international business and academic communities, Islamic financial markets are deficient in both liquidity and risk management tools. There has been a broadening and deepening of the financial structure in Malaysia as the economy grew in size, complexity, and sophistication and the demand for new financial services and instruments arose.