risk management is one of the building blocks for banking sector

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ABSTRACT

The study was conduct to find out the comparison of Risk management practices of Islamic and

conventional banks operating in Islamic Republic of Pakistan. Close ended questioner is used for

data collection which covers the following aspects; awareness and measurement level of risk and

risk identification techniques risk mitigation approaches and risk mitigation techniques use of

risk management techniques and management attitude toward practices regarding risk

management. !ata is collected from ten banks and one respondent from the risk management

department from each of the selected banks. "requency tabulation is use for the analysis and

Cronbach#s alpha is use for reliability of the collected data. "inding of the study was that there is

difference between the two banking system awareness regarding different kind of risk risk

identification techniques and risk mitigation techniques and approaches. Islamic banks are less

aware as compared to conventional banks. $nd difference found in the use of mitigation

techniques also. Islamic banks use only traditional techniques and conventional banks use

advance techniques beside the use of traditional techniques. Islamic banks staff are not that much

qualified like conventional banks. The research is beneficial for fund manager depositor and

especially for Islamic banks.



Chapter 1: Introduction

Background

Risk management is one of the building blocks for banking sector. %ow a day#s all the banks

are facing different kind of risk because of the volatility in the environment such as liquidity risk

credit market interest rate and foreign e&change risk so such kind of risks create difficulties in

the successes and survival of the banking sector. Risk management efficiency is absolutely

required .Carey '())*+ says that risks management is very essential for financial institution as

compared to other part of the business environment. The main function of the financial

institution is to ma&imi,e the revenue as well as increase the value of the share for share holder

by providing different financial services and take care of the risk. $s we know that risk is able to

be classified into unsystematic and systematic risk. -ystematic risk is related with on the whole

economy and on the other side unsystematic risk is associated with specifically firm or assets.

-ome part of systematic risk can be compact not completely eliminate with the use of

transmission techniques and mitigation strategies. $ccording to -antomero and ldfield '*//0+

suggest three strategies of mitigation. $void or remove risk by simple business particles; Transfer

risk toward the other participant; 1anage risk actively at the bank level.

The global survey conducted by economist intelligence unit in ()*) whose findings were

based on to e&amine how the financial institutions are going to strengthen their risk management

in response to global crisis. "i&ing the risk management and quality improvement of data helps

to strengthen their risk management to global crisis are the results of that survey. 1oreover the

survey suggests that forty 2 of the respondent are knew that significance of risk management is

3



commonly understood throughout their organi,ation and suggestion was to build and improve

the culture of the risk management.

The effect of ())3 financial crisis was on both financial and non financial sector and because

of this every organi,ation want to increase risk management practices. Initially financial

organi,ation meet regulatory requirement for risk measurement and they were wrong to think

meeting regulatory requirement is the only solution for risk management. In the practices of risk

management there mainly three aspects risk identification; risk measurement and mitigation of

the risk. $ll these aspects are different in interest based banking system and interest free banking

system. 4ecause of one system is totally dependent on interest and other one is totally

independent. In interest free economic system the concept of risk is also different. Risk is viewed

from ( dimensions. 5harar 'uncertainty+ is prohibited and there will be freedom in contract. In

interest based economic system there is no restrictions. $nd depositors are also not bound to

share the risk on the other side the profit and loss will be share which mean share the risk.

Practices of the risk management are widely investigated throughout the world but in the

emerging banking sector like in Islamic bank system is very small or appro&imately ,ero. In

Islamic Republic of Pakistan Islamic banking is also important part of the economy and also in

the development stage. Therefore the researcher needs to find out the gap between both the

Islamic and non Islamic system operating in Islamic republic of Pakistan in term of risk

management practices.

4



Research Statement

To investigate Comparison of Risk 1anagement Practices between Islamic and conventional

4anks in Pakistan.

Purpose of study

The purpose of the study is to compare risk management practices of interest based and

interest free banking operating in Islamic republic of Pakistan.

Obecti!e

To find out the awareness of banks employee facing various types of risk and management

techniques $ttitude of bank personnel toward risk management practices 6evel of risk

management practices along with different methods of identification and mitigation of risk.

Significance of the study

The analysis and Results of the study is useful for banking sector especially for Islamic

banking operating in Islamic Republic of Pakistan and also helpful for the future study.

5



Chapter ": #iterature re!ie$

-tudies have been published about risk and practices of risk management throughout the

world. The number of studies in the area of risk and practice of risk management in financial

institutions of Pakistan is very small and especially the comparison of Islamic and conventional

banks# risk management practice is nil.

Risks %anagement in con!entiona& banks

The process by which we first of all identified the risk then in (nd stage being financial

manager we assessed that identified risk in 7 rd stage we measured that risk and then managed

that risk for creating economical value are called financial risk management. '8orion ()*) +.

-alas 9-aurina '())(+conducted study on credit risk in -panish savings and commercial

banks in which they contributed by providing policy guidance from their study that e&amined the

risk of credit in -panish banks. In the study determinants of problem loan during */3:*//0

were compared take into account together individual banklevel and macroeconomic variables.

The 5ross domestic product growth rate rapid past credit or branch spreading out family

indebtedness firms si,e portfolio composition inefficiency market power capital ratio and net

interest margin are variables that clarify credit risk. -uggestions are bound to increase essential

bank administrative policy issue. <&ercise of bank level variables such as before time notice

indicators and the role of bank competition and personal responsibility in determining credit risk.

6inbon '())=+ conducted a study on risk versus efficiency in large banks of united state of

$merica. >e says that bank efficiency depends on profit creation and its relationship with risk of

6



those banks. >e finds that profitability of a bank is responsive to credit risk along with solvency

risk and not responsive to liquidity risk and with the investment.

>am '())=+ has conducted study on e&change risk and interest rate of ?orea. >e finds that

most of the ?orea commercial 4anks are facing both e&change rate and interest rate risk. >e also

shows that credit policy and the degree of interest rate are the factors which are e&tensively

linked by the efficiency of ?orean 4anks. The outcomes show that improvement in financial

management and risk management practices are very important in support of booming

liberali,ation.

%inima@ki'())=+ mentioned in his article that the attitude of the investor to risk depending on

the structure of the bank in term of risk management. >e also found that if the banks are

competing in loan market only than the deposit insurance effect on risk will be ,ero. n the other

side deposit insurance increases risk taking if 4anks are competing for deposits only. therwise

the banks will pay them high deposit rates.

Aetmore'())=+ checked out the relationship between loantodeposits ratio and liquidity risk

of a large commercial bank. >e found from his study that 6T! ratio had ma&imi,ed over the

period studied because of changes in assetliability management practices. $nd concludes that

from his study that there is always positive relation between loantodeposit and market risk

Bang'())=+ conducted a study on world diversification and foreign e&change risk. <mpirical

results of the study suggested that foreign e&change risk is a high priced. In addition the diverse

world has proven to help global portfolios. These results suggest that e&change rate risk

Taiwanese investment includes valid seek international diversification

7



Tamimi '())(+ e&amines the e&tent to which commercial banks in the nited $rab <mirates

use technical risk management in the treatment of various types of risks. $ccording to the result

of the study the commercial banks of nited $rab <mirates were suffering from credit risk. $

study showed check up by the financial statement analysis and branch manager were the main

methods used to identify risks. $ccording to this study the main technique used in risk

management to establishment of standards credit worthiness analysis credit score collateral and

risk rating the study as well shows the commitment of the nited $rab <mirates commercial

banks to use the most modern techniques of risk management The Committee suggested the

implementation of a conservative credit policy.

$lTamimi 9 $l1a,rooei'())0+ e&amine one of the good studies about risk management in

which they compared the risk management practice of the national and foreign banks of nited

$rab <mirate. The main aim of this study was to measure the quantity to which the nited $rab

<mirate banks e&ercise practices of management along with their techniques to deal with

different kinds of risk and the second aim was to weigh against the practices of risk management

between national and foreign banks of nited $rab <mirate. In this study the authors developed

questioner and divide into ( parts. *st part covers D aspects which are understood risk and risk

management; credit risk analysis; risk assessment and analysis; risk management practices; risk

monitoring and risk identification and first component include close ended forty three questions

on an interval base. The (nd part is based on an ordinal scale and consists of two questions which

are to deal with risk identification and risks facing the sample banks. The findings of the study

were three kinds of risks faced by the nited $rab <mirate commercial banks which are

operating risk credit risk and mostly "oreign <&change risk. In terms of efficiency nited $rab

<mirate banks is very efficient in managing risk and risk identification and risk assessment and

8



analysis are the most influencing variables in risk management practices. Result show that there

is a significant difference between the practices of risk management of nited $rab <mirate

"oreign and %ational 4anks.

-hafiq 9 %asr ' ()*) + e&amine the study about risk management practices of commercial

banks of Pakistan. They find that there is a general understanding of risk management and risks

of employees in the unit for risk management of commercial banks in Pakistan. The study shows

that the maEority of the daily work they do are risky by nature. The main types of risksF "oreign

e&change interest rate operational liquidity and credit risk. The foreign e&change risk is

essential because Pakistan is part of the global market and spills of international financial crises

such as currency fluctuations and inflation affect Pakistan banks drastically. <ach of the

independent variable individually regressed dependent on R1P show encouraging results

Risks %anagement in Is&amic bank

6iterature suggests that different methods of risk management in financial institutions are the

need of the time shortly after the financial crisis of the world in the last decade faced. <specially

the nited -tates require a lot of time to restore their economies with serious regulatory changes.

1any analysts after the crisis differences in relation to the identification and management of

risks in various banks and financial institutions and organi,ation before and during the crisis

which was a selfdestructive thoughts that such a loss for the world economy

Risk 1anagement defines the need to identify the important risks the method of measuring

the risk of the development of consistent and accurate better the importance of risk reduction

prevention and transfer through the calculation of riskweighted return and appropriate control

procedures risk situation of the company. "or banks the regulatory response is not essential to

9



avoid bankruptcy or financial harassment. 4ank staff requires reliable identification risk

measurement and management pursue cultural and monitor the best riskreward ratio.

In Islamic theory the term risk is also common. To understand this concept of Islamic

standpoint we need to pull together the two dimensions of risktaking without any permission

and information of contract without acceptance of Islamic law. ncertainty regarding the facts

should by contractual arrangement results suspects are covered. "or e&ample the contractual

obligation of the supplier where the supplier is to deliver a product but not in the position of the

product means the contract invalid. %evertheless if the obEect is in its essence none&istent at the

time of the contract the contract will be valid in certain specific cases for e&ample 4ai -alam

and IstisnaGa as the delivery address of the obEect. 4ai G-alam refers to a tangible product 'eg

agricultural products+ it is certain that at the time of contract and IstisnaGa Hrelate to the

construction or manufacture if the goods do not e&ist at the time of concluding the contract but

which are detailed specification for engineers. 'smani ())(+

-haring risk is the primary concern of the Islamic financial system which directs the

distribution of the risk not only but also the economic development through the creation of

value. "or e&ample the gambling is forbidden in Islam it brings risks. The reason for such a

rule the gambling is a ,ero sum game and do not contribute to the development of the economy.

>owever taking risk is based on educate analysis and understandings of risks that are inevitably

present where as gambling create a risk that would be none&istent. The uran the one and only

guide line for sour the 1uslim community prohibit us clearly from gambling as shown in these

verses '$l4aqara verse (*/ -ura $l1aGida verse /)+ gambling or game of chance referred to

in$rabic as maysir.

10



$lielgari ' ())7+ argues that the concept of risk of a Eurist in their studies of the theory

identified the Contract has nothing to do with the concept known to risk in modern financial

-tudies. This distinction is important because when lawyers refer to some Hat riskH Contracts

and make the viewpoint -hariah perspective unacceptable some Practitioners of Islamic finance

as a reference to the risk in the Eargon of the financial world. That is not true. Ae should take

great advances in study of risk and technical risk management in the financial sector. In this

study he concludes that >owever we have our own Theory that relates the unique concept of

risk from an Islamic perspective.

$hmed $hmed 9 %aqvi '()**+ conduct a study on liquidity risk of Islamic bank. 4anks as

intermediary try to manage the supply and demand of liquidity for making good relation with

stakeholder and run the business activity safely. This study aims to e&amine the determinants of

firm#s level risk liquid listed Islamic banks in Pakistan. To this end the liquidity risk is being

used as the dependent variable while the age profitability leverage tangibility of assets and

si,e are used as independent variables. The results show that age leverage and profitability are

the important factors to the liquidity risk of Islamic banks are to be defined in Pakistan while

liquidity risk has statistically insignificant relationship with si,e and profitability of Islamic

banks in Pakistan.

>assan '())/+ conduct a study on risk management practice of 4runei !arussalam and The

aim of this study was to determine the e&tent to which Islamic banks of !arussalam use practices

for risk management 'R1P+ and techniques with different types of risk. This study found that the

three main types of risks that Islamic banks 4runei !arussalam face are foreign e&change risk

11



operating risk and credit risk. It also found that Islamic banks are very efficient in managing risk

where R$$ and RI are the most influencing variables in R1Ps. The results show evidence of

efficiency in the treatment of credit risk Islamic banking system in 4runei !arussalam.

?halid 9 $mEad '()*(+ conduct the study about the practice of risk management and

techniques deal with different kind of risk in interest free banks of Pakistan. -tandardi,ed

questionnaire is used covers si& aspects which are understand risk and risk management; credit

risk analysis; risk assessment and analysis; risk management practices; risk monitoring and risk

identification. $ccording to conclusion of the study interest free banks in Pakistan are efficient

in managing risk where understanding risk management risk management and credit risk

management are the most influencing variable in risk management practices of Islamic banks in

Pakistan.

Risks %anagement comparison of Is&amic and con!entiona& banks

$khtar $li 9 -adaqat '()**+ e&amine the compartive study about liquidty risk

management of both the convetional and islamic banks. The obEective of the study was that the

liquidty risk associated with solvency of 4anks for the purpose of to find out the management of

liquidty risk via compartive analysis of interest based banks and interest free banks.This article

describes the significance of the Return on $ssets 'R$+ Capital $dequacy %etworking

capital Return on <quity and -i,e of the firm with the management of liquidity risks in interest

based and interest free banks in pakistan. "our year of -econdary data is used in this study i.e

())D())/. In both model the study give positive but insignificant relationship of networking

12



capital to net assets 9 si,e of the banks with risk of liquidity. In addition capital adequacy ratio

in interest based banks is found to be positive and significant at *)2 significance level on the

other side return on assets in interest free banks is found to be positive 9 significant at *)2

significance level.

Jainol 9-alina '()*)+ conducted a study to find out the dynamic effects of change in interest

rate changes on the rate of return of interest free banks and the of deposits in the interest based

banks and interest free banks. In addition the outcome of the have significant implication on

practices of risk management of interest free banks of 1alaysia. "or healthy growth of interest

free banking system many suggestion are put forward for mitigation of the rate of return.

>asan 9 !ridi '()*)+ e&amine comparative study between interest based and interest free

banking system during the global crisis ())3.The impact of the global crisis ())3 on

profitability assets and credit growth and e&ternal evaluations in a group of countries where the

( banks Islamic and conventional have a significant market share. $ccording to their analysis

the Islamic banks have been differently affected than conventional bank."actors associated with

Islamic banks business model has Hhelped. %egative impact on profitability in ())3 while

weaknesses in risk management practices in some Islamic banks led to a larger decline in

profitability in ())/ compared with conventional banks.

>ussain 9 $l$Emi '()*(+ argued in the study of risk management practices of the interest based

and interest free banking systems in 4ahrain. The reason of this paper was to give e&perimental

13



support for risk management Practices of banks operating in 4ahrain. 4anks working inside

4ahrain are found to have a very plain understanding of risks and risk management and the

classification of appropriate risk assessment risk analysis and risk management. "or the control

of risk they have credit scrutiny and practices regarding risk management. In addition proved

that credit liquidity and operational risks they have different approaches to the main risks for

non Islamic and Islamic banks. $dditionally risk management practices by the degree to which

managers are implicit to be determined risks and risk management wellorgani,ed risk

recognition credit risk analysis risk monitoring and risk assessment analysis. Islamic banks

were considerably different as compared to the conventional banks understand the risk and risk

management. !ifferent levels of risk countered by interest free banks were drastically superior to

the degree of risk faced by conventional banks. -imilarly the country risk liquidity risk and

operational risk and outstanding resolution are to be found advanced in Islamic banks than

conventional banks.

>uq $,ad 9 Rahman ' ()*)+ conduct a comartive study on practices regarding risk

management of in interest based and interest free banking system oparating in 4angladesh.

-elect sample of *= banks seven Islamic and seven non Islamic banks and one respondent select

from every bank for the collection of data. The finding of the study was that there is difference

between the two sets of banking system regarding awareness of risk identification of risk

awareness of mitigation techniques and uses of mitigation techniques. $nd the reason was not

good enough loan recovery lack of information regarding risk.

.

14



15



Chapter ': %ethodo&ogy

%ethodo&ogy

There are five private conventional and five Islamic banks are selected for data collection. %ow

days there are only five fullfledged Islamic banks operating in Pakistan so that#s why I select

five private conventional banks out of *0 for maintaining the balance between both of them.

Samp&e se&ection

There are *0 privates conventional banks operating in Pakistan and for the study we take as

sample five conventional 4anks of *0 banks and in Pakistan only five fullfledge Islamic banks

are operating in Pakistan "or comparison of risk management practices five fullfledge Islamic

banks are selected and for keeping the balance five conventional are also selected and that

selection of conventional was based on random sampling method. nly privates banks are

selected because full fledge Islamic public banks are not yet establish in Islamic Republic of

Pakistan.

The se&ected fi!e fu&&(f&edged Is&amic Pri!ates banks are)

* 1ee,an 4ank

( 4ankIslami 4ank.

7 !ubai Islamic 4ank

= 4urE 4ank limited

: $lbarka Islamic 4ank

16



Interest based or con!entiona& banks are)

* 4ank $lfalah limited

( >abib 4ank limited

7 nited bank limited

= "aysal bank limited

: $llied bank limited

*ata co&&ection and +uestionnaire

Primary data is used for data collection structure closed end questioner is used for the study.

uestioner is take from the study of >uq $,ad 9 Rahman ()*) and questioner contains *)7

closed ended questions design on ordinal and nominal scales and these questions are based to

understand three aspects of risk management practicesF understanding risk and risk management;

risk identification; risk assessment and analysis; risk measurement and risk mitigation practices.

Person involved with risk management activity from each of the selected bank is required for

data collection.

*ata ana&ysis

Cronbach#s alpha is used for evaluating reliability through this deviation will be measured of the

answers of respondents within a scale. se of frequency table is very common beside the

frequency table correlation analysis is also part of the analysis of the study.

17



Re&iabi&ity of the measures

"or measuring the internal consistency of the question the researcher need Cronbach#s $lpha.

Aith the use of Cronbach#s $lpha measuring of error is not a difficult task actually Cronbach#s

$lpha is simply coefficient of reliability 'or consistency+ it is not a statistical test. Coefficient

greater or equivalent to ').0+ is up to standard '%unnally */03+. The questionnaire consists of

*)7 questions and the reliability among them is '.07D+ which is good result mean acceptable

18



Chapter ,: Ana&ysis

The outputs of the questionnaires are sub section in the following heading

A$areness of the Risk managers about !arious type of Risk of the Bank a&ong $ith

measurement &e!e&

Table *'a+ communicate that there are little differences between the two set of the banks as

regards the understanding of different types of risks. The is same awareness of

InvestmentKCredit perationalK Performance 6iquidity <nvironmental and Rate of Return Risks

but regarding other type o risk like interest rate sharia non compliance risk and price risk there

is huge difference between the two different banking system awareness and also little bit

difference e&ist in foreign e&change risk. These results are almost same like the pervious study

>uq $,ad 9 Rahman ()*)

Risk Techni-ues Islamic 4anks . Conventional 4anks .

Credit RiskK Investment Risk : *)) : *))

6iquidity Risk : *)) : *))

Interest Rate Risk ) ) : *))

19



"oreign <&changeK CurrencyRisk

= 3) : *))

PerformanceK perational Risk : *)) : *))

<nvironmental Risk : *)) : *))

Rate of Return Risk : *)) : *))

-hari#a noncompliance Risk : *)) * ()

Price risk * () : *))

Table *'b+ communicate that there is deference in level of awareness also between the two

sets of banks e&cept credit risk or investment and sharia non compliance which is same both of

the sets are highly aware. 6iquidity risk is in Islamic banking is 3)2 are highly aware and

remaining () 2 neutral. "oreign e&change risk awareness level is ()2 highly aware about

performance risk D) 2 are highly aware as regard environmental and rate of return risk =) 2 are

highly aware. 4ut in case of interest rate risk Islamic banks are not aware at all and about price

risk the entire respondent are only aware. n the other side of the coin the level of awareness are

very high about all type of risk e&cept sharia non compliance risk in which they are not aware at

all. Ahich mean that they have nothing to do with sharia non compliance because this the risk

for Islamic banking system and not for interest based banking system. The awareness level in

pervious study >uq $,ad 9 Rahman '()*)+ is low as compared to the finding of this study.

20



Ahich shows that in Pakistan the awareness level is very high as compared 4angladesh Islamic

banks especially in sharia non compliance risk *)) 2 of the respondent are highly aware.

21



Type of

Risk

>ighly $ware nly $ware %eutral naware %ot at all aware

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Credit

RiskK

Investme

nt Risk

*)) *))

6iquidity

Risk

3) *)) ()

Interest

Rate Risk

*)) () 3)

"oreign

<&change

K

Currency

Risk

() *)) D) ()

Performa

nceK

peration

al Risk

D) *)) () ()

<nvironm

ental Risk

=) *)) =) ()

Rate of

Return

Risk

=) =) ()

-hariGa

non

compliance Risk

*)) () *))

Price risk *)) () 3)

22



Concernedness regarding different types of risks

The table '(+ results shows that there is also difference between the two systems of banks about

concernedness of various type of risks. "or Islamic banks all the risk managers are highly

concerned about credit risk which is same like conventional banking system and liquidity risk

concernedness is also same both of the systems 3) 2 of respondent are highly involve and

remaining are only concerned. D) 2 of Islamic respondents are involved in environmental and

rate of return risks. In interest based banking system all respondents are highly concerned about

credit risk and interest risk and 3) 2 respondents are highly concerned about liquidity risks. ()

2 of respondent are highly concernedness about "oreign e&change performance and

environmental risk and in case of price risk =) 2 of respondent are highly concerned regarding

different type of risks. The results are almost same like the pervious study in 4angladesh by >uq

$,ad 9 Rahman '()*)+

$s a result >* There is a difference as to the awareness and concernedness of the different kind

of risks by interest based and interest free banks. $nd thus our hypothesis is proved in our study.

23



Type of

Risk

>ighly

Concerned

nly Concerned %eutral %ot Concerned %ot at all

Concerned

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Credit

RiskK

Investment

Risk

*)) *))

6iquidity

Risk

3) 3) () ()

Interest

Rate Risk

*)) *))

"oreign

<&changeK

Currency

Risk

() =) D) 3)

Performan

ceK

perationa

l Risk

3) ()

<nvironme

ntal Risk

D) () () 3) ()

Rate ofReturn

Risk

D) () () D) () ()

-hariGa

non

complianc

e Risk

*)) *))

Price risk =) D) () D) ()

A$areness of the different type of the risk identification techni-ue p&us its measurement

&e!e&

24



Table 7 'a+ communicate about the awareness of respondents of regarding risk identification and

measuring level. -o all the risk manger of both sets of banks are aware about identification

methods mention in the table check up by the risk manager "-$ and physical inspection or

audit. $bout -AT analysis conventional banks respondents are *)) 2 on the other side 3) 2

are aware. Regarding process analysis inspection by outside e&perts and scenario analysis in

interest based banking are *)) 2 of respondent are aware. -o this show that interest based

banking system are aware about both the traditional and as well as the advance methods of risk

identification methods but Islamic banks are aware about traditional but not that much aware

about advance tools of risk identification.

Risk Techniques Islamic banks 2 Conventional 4anks 2

Inspection by the bank risk

manager

: *)) : *

$udits or physical

inspection

: *)) : *

"inancial statement analysis : *)) : *

Risk survey ( =) *

Process analysis * () : *

-AT analysis = 3) : *

Inspection by outside

e&pert

( =) : *

4enchmarking * () *

-cenario analysis = 3) : *

Internal communication ( =) =

$ccording to the result of table 7'b+ there is difference between the levels of awareness regarding

identification methods. There is similarity somehow like both sets of banks are highly aware

25



about the mention identification techniques like check up by the risk manager "-$ and

substantial inspection or audit. Regarding remaining techniques of risk identification maEority of

the respondents in interest bases banking systems are highly aware as compared to interest free

banking system like -AT analysis D) 2 of respondents are highly aware in conventional and

on the other side only =) 2 are highly aware so same difference e&ist in the remaining

techniques also. Results are almost same like the pervious study by >uq $,ad 9 Rahman

'()*)+. -o with respect of all these result so our (nd hypothesis is also proved.

>( There is a variation between the interests based and interest free banks in the practices of risk

identification.

Type of

Risk

>ighly $ware nly $ware %eutral naware %ot at all

aware

Isla convent Isla convent Isla convent Isla convent Isla convent

26



mic ional mic ional mic ional mic ional mic ional

Inspection

by the bank

risk

manager

*)) *))

$udits or

physical

inspection

*)) *))

"inancial

statement

analysis

*)) *))

Risk survey () () () () =) () D)

Process

analysis

D) *) =) =) =)

-AT

analysis

=) D) =) () () ()

Inspection

by outside

e&pert

() =) () =) () D)

4enchmarki

ng

() () () 3) D)

-cenario

analysis

=) () () () () () () =)

Internal

communica

tion

() =) () D) () ()

/0ercise of different risks management techni-ue and the fre-uency of the uses

Table ='a+ the result shows that there is also difference between the uses of different management

techniques. $s the result show that all the respondents of both sets of the banks use credit rating

27



value at risk internal based rating system and credit scoring "or gap analysis *)) 2

respondents are from Islamic side and 3) 2 are from the conventional and the same

percentages are for stress testing management techniques. 3) 2 of the Islamic banking industry

use scenario analysis and in conventional *)) 2 are use scenario analysis for management of

risk. In case of duration analysis *)) 2 of Islamic banks are use but on the other side only () 2

use duration analysis. $ll of the respondents of Conventional banks use maturity analysis but in

Islamic banking system only =) 2 use maturity matching management techniques. sing of

earning at risk management techniques are same but ratio is very low only () 2 in both of the

sets of the banks. The use of simulation management techniques is very high in conventional *))

2 and on the other side D) 2 of the Islamic banks use simulation management techniques and

the same case for credit committees. The use of risk adEusted return is very high '*)) 2+ also in

conventional banks and very low only () 2 in Islamic banks. The pervious study result

differences are difference in case of duration analysis value at risk gap analysis and Credit

committee use in Pakistan is very high with comparison of 4angladesh study conducted by >uq

$,ad 9 Rahman '()*)+ and remaning variable reluts are almost same.

Type of risk Islamic 4anks 2 Conventional 4anks 2

28



Credit Ratings : *)) : *))

5ap $nalysis : *)) = 3)

-cenario $nalysis = 3) : *))

!uration $nalysis : *)) * ()

1aturity 1atching ( =) : *))

<arning at risk * () * ()

Lalue at risk : *)) : *))

-imulation

techniques

7 D) : *))

-tress testing : *)) = *))

Risk adEusted return

on capital

* () : *))

Internal 4ased rating

system

: *)) : *))

Credit -coring : *)) : *))

Credit committees 7 D) : *))

29



In the (nd table of '=+ is regarding the using frequency of the management techniques in the

previous table ='b+. The results show that the using frequency of both of the banking system is

different. Islamic bank use management techniques most of the time and frequently but in

conventional banks is note case like that they are not stuck to frequently or mostly but they rarely

use most of the techniques e&cept credit scoring and credit committees mostly use by all of the

respondents of the sample. Results are almost same with >uq $,ad 9 Rahman '()*)+.

$ccording to the finding our study there is gap between the two sets of so our 7 rd hypothesis is

also proved >7. There is a gap between the interest based and interest free banks in the

understanding of risk and risk management practices.

Type of

Risk

1ostly used "requently used %eutral Rarely used %ot at all aware

Islami

c

conventio

nal

Islami

c

conventio

nal

Islami

c

conventio

nal

Islami

c

conventio

nal

Islami

c

convention

al

Credit

Ratings

*)) () 3)

5ap$nalysis

() () D) D) () ()

-cenario

$nalysis

=) () () () D) =)

!uration

$nalysis

3) () () 3)

1aturity

1atching

() () 3) 3)

<arning at

risk

() () () D) =)

Lalue at

risk

D) D) =) =)

-imulatio

techniques

() () () 3) D)

-tress

testing

D) D) =) =)

30



Risk

adEusted

return

() *)) 3)

Internal

4ased

rating

system

() *)) 3)

Credit

-coring

3) *)) ()

Credit

committees

D) *)) =)

A$areness regarding risk mitigation approaches acceptances &e!e&

In the table :'a+ the result show that conventional banks are more aware about risk mitigation

approaches as compared to Islamic banking system like in conventional all the respondents

mean *)) 2 of the sample are aware about risk reduction sharing transferring and risk retaining

approaches and only () 2 of respondent are aware about risk avoidance. 4ut in Islamic banks

*))2 of respondents know only the risk reduction approaches 3) 2 are aware about risk

avoidances D) 2 are aware about transferring of risk =) 2 are aware about risk sharing

approaches and () 2 are aware about risk retention approaches. >ence we can say that the

conventional banks awareness regarding risk mitigation approaches are more than that of the

Islamic banks.

$pproaches Islamic 4anks 2 Conventional 4anks 2

31



Risk may be avoided = 3) * ()

Risk may be retained * () : *))

Risk may be transferred 7 D) :

Risk may be shared ( =) : *))

Risk may be reduced :

*))

: *))

In the table :'b+ the result shows that level of use of risk mitigations approach is very high in

Islamic banks as compared to conventional banks like in case risk avoidance D) 2 of Islamic

banks are only agree to use this approach and on the other hand no one use this approach. () 2

of respondent are only agree to use risk retaining approach in conventional banks but not at all in

Islamic banks. In case transferring and sharing the risks =) 2 respondent of the Islamic banks

are highly agree to use but no one from the conventional banks. "or risk reduction mitigation

approach 3) 2 of the respondents use in Islamic banks and only () 2 of the respondent use in

conventional banks are highly agreed. -o the the result show that in Islamic banks the

respondents are highly agreed to use the risk mitigation approaches and the conventional banks

are only agreed to use some of the approaches. The result shows that the pervious study results

are higher than the study conducted in Pakistan the using risk mitigation approaches.

Type of Risk >ighly $greed nly $greed %eutral !iagreed >ighly !isageed

32



Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Risk may be

avoided

D) () () *))

Risk may beretained

() () =) =)

Risk may be

transferred

=) =) =) () D)

Risk may be

shared

=) () D) 3)

Risk may be

reduced

3) () () () D)

A$areness of risk mitigation techni-ues measurement

Table D'a+ communicates regarding the awareness of mitigation techniques. 4oth set of the banks

are *)) 2 aware about collateral arrangement loan loss reserves and guarantees of mitigation

techniques. Third party enhancement techniques of mitigation awareness are 3) 2 in

conventional banks and D) 2 in Islamic banks. n balance sheet netting awareness are 3) 2 in

Islamic banks and =) 2 in conventional banks. Parallel contracts awareness in Islamic banks is

() 2 and in conventional the awareness about parallel contract is *)) 2 which mean that all of

the respondents are aware. ver the counter derivatives techniques of mitigation awareness is

*)) 2 in conventional banks and 3) 2 in Islamic bank. $long with the whole consequence

shows that the interests free banks are less aware regarding the risk mitigation techniques as

compared to the non Islamic banks.

33



Risk Techniques Islamic 4anks 2 Conventional 4anks 2

Collateral $rrangement : *)) : *))

Third party enhancement 7 D) = 3)

6oan loss reserves : *)) : *))

n balance sheet netting = 3) ( =)

5uarantees : *)) : *))

Parallel contracts * () : *))

ver the Counterderivatives = 3) : *))

Table D 'b+ communicate the level of using the risk mitigation techniques. $ll the respondents

highly use collateral arrangement in conventional banks and in Islamic 3) 2 of the respondents

highly use collateral arrangement. Third party enhancement is highly use in interest free banks as

compared to interest based banks along with the same case is for loan loss reserves highly use in

interest free banks as compared to interest based banks. The using level of on balance sheet

netting conventional is neutral and from Islamic side maEority of respondents are not uses on

balance sheet netting. The uses of guarantee in Islamic is very high all of the respondent use it

and on the other hand conventional banks are using it neutrally. Parallel contract are highly use

34



by interest free banks as compared to interest based banks. -o the results suggest that Islamic

banks are not that much aware about risk mitigation techniques as compared to interest based

banks but the interest free banks using level of risk mitigation techniques is more than that of

conventional banks which show that Islamic banks need high awareness about all these

techniques. Results are almost same with the pervious study of >uq $,ad 9 Rahman '()*)+.

Type of Risk >ighly sed nly sed %eutral %ot sed %ot at all sed

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Isla

mic

conventi

onal

Collateral

$rrangement

3) *)) ()

Third partyenhancement

=) () () D) () () ()

6oan loss

reserves

=) () () D) =) ()

n balance

sheet netting

=) () D) =) () ()

35



5uarantees *)) *))

Parallel

contracts

() *)) 3)

ver the

Counterderivatives

() D) 3) D)

Attitude of management to$ards risk management practices

Table '0+ communicates about the management attitude toward the following types of risk. The

entire respondent of both of the banks attitudes toward credit risk is very high. In case of

liquidity from Islamic banks all of the respondents are highly positive but on the other hand

conventional banks management are not that much positive about liquidity risk management. In

case of interest rate conventional banks are positive to manage it for Islamic there is no need of

interest rate management because they are not based on interest they run interest free banking

system. Islamic banks management are highly positive for performance risk 3) 2 of the

respondent are highly positive on the other hand () 2 are only positive for performance risk .

() 2 Islamic banks management attitude toward foreign e&change risk are highly positive and

conventional banks management attitude toward risk management is not that much positive. -o

its mean that the Islamic banks management are more highly positive towards risk management

practice and on the other hand conventional banks management attitude are not that much highly

positive toward risk management practices like Islamic banks. Aith the comparison of pervious

study difference occurred in case of foreign e&change risk in 4angladesh the management

attitude toward foreign e&change risk is high as compared to Pakistan. ther results are same.

36



Type of

Risk

>ighly

Positive

nly Postive %eutral %egative >ighly

%egative

Isla

mic

conven

tional

Isla

mic

conven

tional

Isla

mic

conven

tional

Isla

mic

conven

tional

Isla

mic

conven

tional

Credit

Risk

*)) *))

6iquidity

Risk

*)) D) () ()

Interest

Rate Risk

() =) =) *))

"oreign

<&change

Risk

() =) D) () =) ()

Performan

ce Risk

3) () () 3)

Conc&usion

The finding of the study concludes that there is variation between the two systems in term of

awareness of risk identification mitigation and management techniques. "or risk identification

conventional banks are more aware than Islamic banks and conventional banks use advance

techniques for risk identification beside the the traditional techniques of risk identification and

on the other hand Islamic banks use only traditional techniques for identification of risk and they

need to come up with the advance techniques which is beneficial for future because banking

industry is develop with passage of time and such traditional techniques lead them to failure.

37



Islamic banks need qualified staff also for risk management department because maEority of them

are unaware about the advance techniques. In case of the approaches of risk mitigation the

finding of the study conclude that the conventional banks awareness regarding risk mitigation

approaches are more than that of the Islamic banks. Islamic banks also need awareness regarding

approaches of risk mitigation. They are not aware actually otherwise Islamic banks use the risk

mitigation approaches more than that of the conventional banks. Islamic banks are not that much

aware about risk mitigation techniques also as compared to conventional banks but the Islamic

banks using level of risk mitigation techniques is more than that of conventional banks which

show that Islamic banks need high awareness about all these mitigation techniques. The Islamic

banks management is more highly positive towards risk management practice and on the other

hand conventional banks management attitude are not that much highly positive toward risk

management practices like Islamic banks. which shows that management of Islamic banks want

to manage their practices of risk but they need awareness and for the need of such awareness

they need qualified staff and on the other hand conventional banks management need to focus

also on the practice of risk management for the survival in the market.

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