CHAPTER 1

INTRODUCTION

1.1 Background to the Study

Risk management is one of the building blocks for banking sector. Now 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 exchange risk so such

kind of risks create difficulties in the successes and survival of the banking sector.

Risk management efficiency is absolutely required .Carey (2001) 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 maximize

the revenue as well as increase the value of the share for shareholder by providing

different financial services and take care of the risk. As we know that risk is able to be

classified into unsystematic and systematic risk. Systematic risk is related with on the

whole economy and on the other side unsystematic risk is associated with specifically

firm or assets. Some part of systematic risk can be compact not completely eliminate

with the use of transmission techniques and mitigation strategies. According to

Santomero and Oldfield (1997) suggest three strategies of mitigation. Avoid or

remove risk by simple business particles; Transfer risk toward the other participant;

Manage risk actively at the bank level.

The global survey conducted by economist intelligence unit in 2010 whose findings

were based on to examine how the financial institutions are going to strengthen their

risk management in response to global crisis. Fixing the risk management and quality

improvement of data helps to strengthen their risk management to global crisis are the
results of that survey. Moreover the survey suggests that forty % of the respondent are

knew that significance of risk management is commonly understood throughout their

organization and suggestion was to build and improve the culture of the risk

management.

The effect of 2008 financial crisis was on both financial and non-financial sector and

because of this every organization want to increase risk management practices.

Initially financial organization 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 are mainly three aspects risk

identification; risk measurement and mitigation of the risk. All these aspects are

different in interest based banking system and interest free banking system. Because

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 2 dimensions. Gharar (uncertainty) is prohibited and there will be freedom in

contract. In interest based economic system there are no restrictions. And 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 approximately zero. 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.
1.2 RESEARCH STATEMENT

To investigate Comparison of Risk Management Practices between Islamic and

conventional Banks in Pakistan.

1.3 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.

1.4 OBJECTIVE

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

management techniques, Attitude of bank personnel toward risk management

practices, Level of risk management practices along with different methods of

identification and mitigation of risk.

1.5 SIGNIFICANCE OF 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.
Chapter 2

LITERATURE REVIEW

1.1 Risks Management in conventional banks

The process by which we first of all identified the risk, then in 2nd stage being

financial manager we assessed that identified risk in 3rd stage we measured that risk

and then managed that risk for creating economical value are called financial risk

management. (Jorion, 2010 ).

Salas &Saurina (2002)conducted study on credit risk in Spanish savings and

commercial banks in which they contributed by providing policy guidance from their

study that examined the risk of credit in Spanish banks. In the study determinants of

problem loan during 1985-1997 were compared take into account together individual

bank-level and macroeconomic variables. The Gross domestic product growth rate,

rapid past credit or branch spreading out, family indebtedness, firms, size, portfolio

composition, inefficiency, market power, capital ratio and net interest margin are

variables that clarify credit risk. Suggestions are bound to increase essential bank

administrative policy issue. Exercise of bank level variables such as before time

notice indicators and the role of bank competition and personal responsibility in

determining credit risk.

Linbon (2004) conducted a study on risk versus efficiency in large banks of United

states of America. He says that bank efficiency depends on profit creation and its

relationship with risk of those banks. He found that profitability of a bank is

responsive to credit risk along with solvency risk and not responsive to liquidity risk

and with the investment.

Ham(2004) has conducted study on exchange risk and interest rate of Korea. He

found that most of the Korea commercial Banks are facing both exchange rate and

interest rate risk. He also shows that credit policy and the degree of interest rate are

the factors, which are extensively linked by the efficiency of Korean Banks. The

outcomes showed that improvement in financial management and risk management

practices are very important in support of booming liberalization.

Ninima¨ki(2004) mentioned in his article that the attitude of the investor to risk

depending on the structure of the bank in term of risk management. He also found that

if the banks are competing in loan market only than the deposit insurance effect on

risk will be zero. On the other side, deposit insurance increases risk taking if Banks

are competing for deposits only. Otherwise, the banks will pay them high deposit

rates.

Wetmore(2004) checked out the relationship between loan-to-deposits ratio and

liquidity risk of a large commercial bank. He found from his study that LTD ratio had

maximized over the period studied, because of changes in asset-liability management

practices. And concludes that from his study that there is always positive relation

between loan-to-deposit and market risk

Yang(2004) conducted a study on world diversification and foreign exchange risk.

Empirical results of the study suggested that foreign exchange risk is a high priced. In

addition, the diverse world has proven to help global portfolios. These results suggest

that exchange rate risk Taiwanese investment includes valid seek international

diversification

Tamimi (2002) examines the extent to which commercial banks in the United Arab

Emirates use technical risk management in the treatment of various types of risks.
According to the result of the study, the commercial banks of United Arab Emirates

were suffering from credit risk. A study showed check up by the financial statement

analysis and branch manager were the main methods used to identify risks. According

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 United Arab Emirates commercial banks, to use

the most modern techniques of risk management, The Committee suggested the

implementation of a conservative credit policy.

Al-Tamimi, & Al-Mazrooei(2007) examined one of the good studies about risk

management in which they compared the risk management practice of the national

and foreign banks of United Arab Emirate. The main aim of this study was to measure

the quantity to which the United Arab Emirate banks exercise 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 United Arab Emirate. In this study the authors developed

questionnaire and divided into 2 parts. 1st part covers 6 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 2ndpart 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 United Arab Emirate commercial banks, which were

operating risk, credit risk, and mostly Foreign Exchange risk. In terms of efficiency

United Arab Emirate banks is very efficient in managing risk, and risk identification

and risk assessment and analysis are the most influencing variables in risk
management practices. Result showed that there is a significant difference between

the practices of risk management of United Arab Emirate Foreign and National

Banks.

Shafiq & Nasr ( 2010 ) examine the study about risk management practices of

commercial banks of Pakistan. They found 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 majority of the daily work

they do are risky by nature. The main types of risks: Foreign exchange, interest rate,

operational, liquidity and credit risk. The foreign exchange 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. Each of the

independent variable individually regressed dependent on RMP show encouraging

results.

1.2 Risks Management in Islamic bank

Literature suggested 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. Especially the United States require a lot of time to restore their

economies with serious regulatory changes. Many analysts after the crisis, differences

in relation to the identification and management of risks in various banks and

financial institutions and organization before and during the crisis, which was a self-

destructive thoughts that such a loss for the world economy

Risk Management defined 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 risk-
weighted return and appropriate control procedures risk situation of the company. For

banks, the regulatory response is not essential to avoid bankruptcy or financial

harassment. Bank staff requires reliable identification, risk measurement and

management, pursue cultural and monitor the best risk-reward 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 risk-taking without

any permission and information of contract without acceptance of Islamic law.

Uncertainty regarding the facts should by contractual arrangement results suspects are

covered. For example, 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.

Nevertheless, if the object is in its essence non-existent at the time of the contract, the

contract will be valid in certain specific cases, for example, Bai Salam and Istisna'a as

the delivery address of the object. Bai 'Salam refers to a tangible product (e.g.

agricultural products), it is certain that at the time of contract and Istisna'a "relate to

the construction or manufacture, if the goods do not exist at the time of concluding the

contract, but which are detailed specification for engineers. (Usmani, 2002)

Sharing 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. For example, the gambling is forbidden in Islam, it brings risks. The

reason for such a rule, the gambling is a zero sum game and do not contribute to the

development of the economy. However, taking risk is based on educate analysis and

understandings of risks that are inevitably present whereas gambling create a risk that

would be nonexistent. The Quran, the one and only guide line for sour the Muslim

community prohibit us clearly from gambling, as shown in these verses (Al-Baqara,

verse 219 Sura Al-Ma'ida verse 90) gambling or game of chance referred to inArabic

as maysir.

Alielgari ( 2003) argues that the concept of risk of a jurist in their studies of the theory

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

financial Studies. This distinction is important, because when lawyers refer to some

"at risk" Contracts and make the viewpoint Shariah perspective unacceptable, some

Practitioners of Islamic finance as a reference to the risk in the jargon of the financial

world. That is not true. We should take great advances in study of risk and technical

risk management in the financial sector. In this study, he concluded that However, we

have our own Theory that relates the unique concept of risk from an Islamic

perspective.

Ahmed, Ahmed, & Naqvi, (2011) conducted a study on liquidity risk of Islamic bank.

Banks 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

examine 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 size 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 size and profitability of Islamic banks in

Pakistan.

Hassan (2009) conducted a study on risk management practice of Brunei Darussalam

and the aim of this study was to determine the extent to which Islamic banks of

Darussalam use practices for risk management (RMP) and techniques with different

types of risk. This study found that the three main types of risks that Islamic banks
Brunei Darussalam face are foreign exchange risk, operating risk and credit risk. It

also found that Islamic banks are very efficient in managing risk where RAA and RI

are the most influencing variables in RMPs. The results show evidence of efficiency

in the treatment of credit risk Islamic banking system in Brunei Darussalam.

Khalid & Amjad (2012) conduct the study about the practice of risk management and

techniques deal with different kind of risk in interest free banks of Pakistan.

Standardized questionnaire is used covers six aspects which are understand risk and

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

practices; risk monitoring and risk identification. According 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.

1.3 Risks Management comparison of Islamic and conventional banks

Akhtar, Ali, & Sadaqat (2011) examined the compartive study about liquidty risk

management of both the convetional and islamic banks. The objective of the study

was that the liquidty risk associated with solvency of Banks 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 theReturn on Assets

(ROA), Capital Adequacy, Networking capital , Return on Equity and Size of the firm

with the management of liquidity risks in interest based and interest free banks in

pakistan. Four year of Secondary data is used in this study, i.e 2006-2009. In both

model the study had given positive but insignificant relationship of net-working

capital to net assets & size of the banks with risk of liquidity. In addition, capital

adequacy ratio in interest based banks is found to be positive and significant at 10%
significance level on the other side return on assets in interest free banks is found to

be positive& significant at 10% significance level.

Zainol &Salina (2010)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

Malaysia. For healthy growth of interest free banking system many suggestion were

put forwarded for mitigation of the rate of return.

Hasan & Dridi (2010) examined comparative study between interest based and

interest free banking system during the global crisis 2008.The impact of the global

crisis 2008 on profitability, assets and credit growth and external evaluations in a

group of countries where the 2 banks Islamic and conventional have a significant

market share. According to their analysis, the Islamic banks have been differently

affected than conventional bank. Factors associated with Islamic banks business

model has "helped. Negative impact on profitability in 2008, while weaknesses in risk

management practices in some Islamic banks led to a larger decline in profitability in

2009 compared with conventional banks.

Hussain & Al-Ajmi (2012) argued in the study of risk management practices of the

interest based and interest free banking systems in Bahrain. The reason of this paper

was to give experimental support for risk management Practices of banks operating in

Bahrain. Banks working inside Bahrain 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. For the control of risk they have credit scrutiny

and practices regarding risk management. In addition, they proved that credit,
liquidity and operational risks they have different approaches to the main risks for

non-Islamic and Islamic banks. Additionally, risk management practices by the degree

to which managers are implicit to be determined risks and risk management, well-

organized 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. Different levels of risk countered by

interest free banks were drastically superior to the degree of risk faced by

conventional banks. Similarly, the country risk, liquidity risk and operational risk and

outstanding resolution are to be found advanced in Islamic banks than conventional

banks.

Huq, Azad, & Rahman, ( 2010) conducted comartive study on practices regarding

risk management of in interest based and interest free banking system oparating in

Bangladesh. Select sample of 14 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 were 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. And the reason was not good enough loan

recovery, lack of information regarding risk.

Chapter 3

METHODOLOGY

There are five private conventional and five Islamic banks are selected for data

collection. Now days there are only five full-fledged Islamic banks operating in

Pakistan so that’s why the study select five private conventional banks out of 17 for

maintaining the balance between both of them.

1.2 Sample selection

There are 17 privates conventional banks are operating in Pakistan and for the study

take as sample five conventional Banks of 17 banks and in Pakistan only five full-

fledge Islamic banks are operating in Pakistan For comparison of risk management

practices five full-fledge 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. Only privates banks are selected because full fledge Islamic public

banks are not yet establish in Islamic Republic of Pakistan.

1.3 The selected five full-fledged Islamic Privates banks are;

1. Meezan Bank,

2. BankIslami Bank.

3. Dubai Islamic Bank

4. Dawood Islamic Bank

5. Al-barka Islamic Bank

1.4 Interest based or conventional banks are;

1 Bank Alfalah limited

2 Habib Bank limited

 3 United bank limited

4 Faysal bank limited

5 Allied bank limited

1.4 Data collection and Questionnaire

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

study. Questioner is take from the study of Huq, Azad, & Rahman, 2010 and

questioner contains 103 closed ended questions design on ordinal and nominal scales

and these questions are based to understand three aspects of risk management

practices: 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.

1.5 Data analysis

Cronbach’s alpha is used for evaluating reliability through this deviation will be

measured of the answers of respondents within a scale. Use of frequency table is very

common beside the frequency table correlation analysis is also part of the analysis of

the study.

Reliability of the measures

For measuring the internal consistency of the question the researcher need Cronbach’s

Alpha. With the use of Cronbach’s Alpha measuring of error is not a difficult task

actually Cronbach’s Alpha is simply coefficient of reliability, (or consistency) it is not

a statistical test. Coefficient greater or equivalent to (0.7) is up to standard (Nunnally,

1978). The questionnaire consists of 103 questions and the reliability among them is

(.736) which is good result mean acceptable

Reliability Statistics

Cronbach's Alpha N of Items

.736 103
 Chapter 4: Analysis

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

Awareness of the Risk managers about various type of Risk of the Bank along

with measurement level

Table 1 communicate that there are little differences between the two set of the

banks as regards the understanding of different types of risks. There is same

awareness of Investment/Credit, Operational/ Performance, Liquidity, Environmental

and Rate of Return Risks but regarding other type o risk like interest rate , sharia

noncompliance risk and price risk there is huge difference between the two different

banking system awareness and also little bit difference exist in foreign exchange risk.

These results are almost same like the pervious study Huq, Azad, & Rahman, 2010

Table 01: Awareness of different types of risk faced by respondents

Risk Techniques Islamic Banks % Conventional Banks %

Credit Risk/ Investment Risk 5 100 5 100

Liquidity Risk 5 100 5 100

Interest Rate Risk 0 0 5 100

Foreign Exchange/ Currency Risk 4 80 5 100

Performance/ Operational Risk 5 100 5 100

Environmental Risk 5 100 5 100

Rate of Return Risk 5 100 5 100

Shari’a non-compliance Risk 5 100 1 20

 Price risk 1 20 5 100

Type of Highly Only Aware Neutral Unaware Not at all

Risk Aware aware

Isla conve Isla conve Isla conve Isla conve Isla conve

mic ntional mic ntional mic ntional mic ntional mic ntional

Credit 100 100

Risk/

Investm

ent

Risk

Liquidit 80 100 20

y Risk

Interest 100 20 80

Rate

Risk

Foreign 20 100 60 20

Exchan

ge/
Currenc

y Risk

Perform 60 100 20 20

ance/

Operati

onal

Risk

Environ 40 100 40 20

mental

Risk

Rate of 40 40 20

Return

Risk

Shari'a 100 20 100

non-

complia

nce

Risk

Price 100 20 80

risk

Table 1.2 communicate that there is deference in level of awareness also between the

two sets of banks except credit risk or investment and sharia non-compliance which
is same both of the sets are highly aware. Liquidity risk is in Islamic banking is 80%

are highly aware and remaining 20 % neutral. Foreign exchange risk awareness level

is 20% highly aware, about performance risk 60 % are highly aware, as regard

environmental and rate of return risk 40 % are highly aware. But in case of interest

rate risk Islamic banks are not aware at all and about price risk the entire respondent

are only aware. On the other side of the coin the level of awareness are very high

about all type of risk except sharia non-compliance risk in which they are not aware at

all. Which 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 Huq, Azad, & Rahman, (2010) is low as compared

to the finding of this study. Which shows that in Pakistan the awareness level is very

high as compared Bangladesh Islamic banks especially in sharia non-compliance risk

100 % of the respondent are highly aware

Table 1.2: Level of awareness of respondents as regards various risks:

Concernedness regarding different types of risks

The table (2) results shows that there is also difference between the two systems of

banks about concernedness of various type of risks. For 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 80

% of respondent are highly involve and remaining are only concerned. 60 % 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 80 % respondents are highly concerned about liquidity risks. 20 % of

respondent are highly concernedness about Foreign exchange, performance and

environmental risk and in case of price risk 40 % of respondent are highly concerned

regarding different type of risks. The results are almost same like the pervious study

in Bangladesh by Huq, Azad, & Rahman, (2010)

As a result, H1 There is a difference as to the awareness and concernedness of the

different kind of risks by interest based and interest free banks. And thus our

hypothesis is proved in our study.

Table 2: Concernedness of the respondents regarding various types of risks

Type of Highly Only Neutral Not Not at all

Risk Concerned Concerned Concerned Concerned

Isla conve Isla conve Isla conve Isla conve Isla conve

mic ntional mic ntional mic ntional mic ntional mic ntional

Credit 100 100

Risk/

Investm
ent

Risk

Liquidit 80 80 20 20

y Risk

Interest 100 100

Rate

Risk

Foreign 20 40 60 80

Exchan

ge/

Currenc

y Risk

Perform 80 20

ance/

Operati

onal

Risk

Environ 60 20 20 80 20

mental

Risk

Rate of 60 20 20 60 20 20

Return
Risk

Shari'a 100 100

non-

complia

nce

Risk

Price 40 60 20 60 20

risk

Awareness of the different type of the risk identification technique plus its

measurement level

Table 3 communicate about the awareness of respondents of regarding risk

identification and measuring level. So all the risk manager of both sets of banks are

aware about identification methods mention in the table check up by the risk manager,

FSA and physical inspection or audit. About SWOT analysis conventional banks

respondents are 100 % on the other side 80 % are aware. Regarding process analysis,

inspection by outside experts and scenario analysis in interest based banking are 100

% of respondent are aware. So 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.

Table 3: Awareness of the respondents of the risk identification techniques and

measurement level
Risk Techniques Islamic % Conventional %

banks Banks

Inspection by the bank risk 5 100 5 100

manager

Audits or physical inspection 5 100 5 100

Financial statement analysis 5 100 5 100

Risk survey 2 40 1 20

Process analysis 1 20 5 100

SWOT analysis 4 80 5 100

Inspection by outside expert 2 40 5 100

Benchmarking 1 20 1 20

Scenario analysis 4 80 5 100

Internal communication 2 40 4 80

According to the result of table 3.2 there is difference between the levels of awareness

regarding identification methods. There is similarity somehow like both sets of banks

are highly aware about the mention identification techniques like check up by the risk

manager, FSA and substantial inspection or audit. Regarding remaining techniques of

risk identification majority of the respondents in interest bases banking systems are

highly aware as compared to interest free banking system like SWOT analysis 60 %

of respondents are highly aware in conventional and on the other side only 40 % are
highly aware so same difference exist in the remaining techniques also. Results are

almost same like the pervious study by Huq, Azad, & Rahman, (2010). So with

respect of all these result so our 2nd hypothesis is also proved.

H2 There is a variation between the interests based and interest free banks in the

practices of risk identification.

Table 3.2: Level of awareness of risk identification techniques

Type of Highly Only Aware Neutral Unaware Not at all

Risk Aware aware

Isla conve Isla conve Isla conve Isla conve Isla conve

mic ntional mic ntional mic ntional mic ntional mic ntional

Inspecti 100 100

on by

the

bank

risk

manage

Audits 100 100

or

physical
inspecti

on

Financi 100 100

al

stateme

nt

analysis

Risk 20 20 20 20 40 20 60

survey

Process 60 10 40 40 40

analysis

SWOT 40 60 40 20 20 20

analysis

Inspecti 20 40 20 40 20 60

on by

outside

expert

Benchm 20 20 20 80 60

arking

Scenari 40 20 20 20 20 20 20 40

analysis
Internal 20 40 20 60 20 20

commu

nication

Exercise of different risks management technique and the frequency of the uses

Table 4 the result shows that there is also difference between the uses of different

management techniques. As the result show that all the respondents of both sets of the

banks use credit rating, value at risk, internal based rating system and credit scoring,

For gap analysis 100 % respondents are from Islamic side and 80 % are from the

conventional and the same percentages are for stress testing management techniques.

80 % of the Islamic banking industry use scenario analysis and in conventional 100 %

are use scenario analysis for management of risk. In case of duration analysis 100 %

of Islamic banks are use but on the other side only 20 % use duration analysis. All of

the respondents of Conventional banks use maturity analysis but in Islamic banking

system only 40 % use maturity matching management techniques. Using of earning at

risk management techniques are same but ratio is very low only 20 % in both of the

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

conventional 100 % and on the other side 60 % of the Islamic banks use simulation

management techniques and the same case for credit committees. The use of risk

adjusted return is very high (100 %) also in conventional banks and very low only 20

% 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 Bangladesh study conducted by Huq, Azad, & Rahman,

(2010) and remaning variable reluts are almost same.

Table 4: Use of risk management techniques

Type of risk Islamic Banks % Conventional Banks %

Credit Ratings 5 100 5 100

Gap Analysis 5 100 4 80

Scenario Analysis 4 80 5 100

Duration Analysis 5 100 1 20

Maturity Matching 2 40 5 100

Earning at risk 1 20 1 20

Value at risk 5 100 5 100

Simulation 3 60 5 100

techniques

Stress testing 5 100 4 100

Risk adjusted return 1 20 5 100

on capital

Internal Based rating 5 100 5 100

system

Credit Scoring 5 100 5 100

Credit committees 3 60 5 100

In the 2nd table of (4) is regarding the using frequency of the management techniques

in the previous table 4.2. 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 except credit

scoring and credit committees mostly use by all of the respondents of the sample.

Results are almost same with Huq, Azad, & Rahman, (2010).

According to the finding our study there is gap between the two sets of so our 3rd

hypothesis is also proved H3. There is a gap between the interest based and interest

free banks in the understanding of risk and risk management practices.

Table 4.2: Frequency of use risk management techniques

Type Mostly used Frequently Neutral Rarely used Not at all

of Risk used aware

Isla conven Isla conven Isla conven Isla conven Isla conven

mic tional mic tional mic tional mic tional mic tional

Credit 100 20 80

Rating

Gap 20 20 60 60 20 20

Analys

is

Scenar 40 20 20 20 60 40

io

Analys

is
Durati 80 20 20 80

on

Analys

is

Maturi 20 20 80 80

ty

Matchi

ng

Earnin 20 20 20 60 40

g at

risk

Value 60 60 40 40

at risk

Simula 20 20 20 80 60

tion

techni

ques

Stress 60 60 40 40

testing

Risk 20 100 80

adjuste

d
return

Interna 20 100 80

Based

rating

system

Credit 80 100 20

Scorin

Credit 60 100 40

commi

ttees

Awareness regarding risk mitigation approaches & acceptances level

In the table 5 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 100 % of the sample are aware about risk reduction, sharing,

transferring and risk retaining approaches and only 20 % of respondent are aware

about risk avoidance. But in Islamic banks 100% of respondents know only the risk

reduction approaches 80 % are aware about risk avoidances, 60 % are aware about

transferring of risk, 40 % are aware about risk sharing approaches and 20 % are aware
about risk retention approaches. Hence we can say that the conventional banks

awareness regarding risk mitigation approaches are more than that of the Islamic

banks.

Table 5: Risk mitigation approaches

Approaches Islamic Banks % Conventional Banks %

In
Risk may be avoided 4 80 1 20
the
Risk may be retained 1 20 5 100
tabl
Risk may be transferred 3 60 5
e
Risk may be shared 2 40 5 100
5(b)
Risk may be reduced 5 5 100 the
100 resu

lt 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 60 % of Islamic banks

are only agree to use this approach and on the other hand no one use this approach. 20

% 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 40 %

respondent of the Islamic banks are highly agree to use but no one from the

conventional banks. For risk reduction mitigation approach 80 % of the respondents

use in Islamic banks and only 20 % of the respondent use in conventional banks are

highly agreed. So 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.

Table 5.2: level of acceptance of various risk mitigation approaches

Type Highly Only Agreed Neutral Diagreed Highly

of Risk Agreed Disageed

Isla conven Isla conven Isla conven Isla conven Isla conven

mic tional mic tional mic tional mic tional mic tional

Risk 60 20 20 100

may be

avoide

Risk 20 20 40 40

may be

retaine

Risk 40 40 40 20 60

may be

transfe

rred

Risk 40 20 60 80

may be

shared
Risk 80 20 20 20 60

may be

reduce

Awareness of risk mitigation techniques & measurement

Table 6 communicates regarding the awareness of mitigation techniques. Both set of

the banks are 100 % aware about collateral arrangement, loan loss reserves and

guarantees of mitigation techniques. Third party enhancement techniques of

Risk Techniques Islamic Banks % Conventional Banks %

Collateral Arrangement 5 100 5 100

Third party enhancement 3 60 4 80

Loan loss reserves 5 100 5 100

On balance sheet netting 4 80 2 40

Guarantees 5 100 5 100

Parallel contracts 1 20 5 100

Over the Counter derivatives 4 80 5 100

mitigation awareness are 80 % in conventional banks and 60 % in Islamic banks. On

balance sheet netting awareness are 80 % in Islamic banks and 40 % in conventional

banks. Parallel contracts awareness in Islamic banks is 20 % and in conventional the

awareness about parallel contract is 100 % which mean that all of the respondents are
aware. Over the counter derivatives techniques of mitigation awareness is 100 % in

conventional banks and 80 % in Islamic bank. Along 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.

Table 6: Awareness of respondents about risk mitigation techniques

Table 6.2 communicate the level of using the risk mitigation techniques. All the

respondents highly use collateral arrangement in conventional banks and in Islamic 80

% 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 majority 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 by interest free banks as compared to interest based banks. So 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 Huq, Azad, & Rahman, (2010).
Table 6.2: Level of using specific risk mitigation techniques

Type Highly Used Only Used Neutral Not Used Not at all

of Risk Used

Isla conve Isla conve Isla conve Isla conve Isla conve

mic ntional mic ntional mic ntional mic ntional mic ntional

Collate 80 100 20

ral

Arrang

ement

Third 40 20 20 60 20 20 20

party

enhanc

ement

Loan 40 20 20 60 40 20

loss

reserve

On 40 20 60 40 20 20

balanc

e sheet

netting

Guaran 100 100

tees

Paralle 20 100 80

contrac

ts

Over 20 60 80 60

the

Counte

derivat

ives

Attitude of management towards risk management practices

Table (7) 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 80 % of the respondent are

highly positive on the other hand 20 % are only positive for performance risk . 20 %

Islamic banks management attitude toward foreign exchange risk are highly positive
and conventional banks management attitude toward risk management is not that

much positive. So 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. With the comparison of pervious study difference

occurred in case of foreign exchange risk in Bangladesh the management attitude

toward foreign exchange risk is high as compared to Pakistan. Other results are same.

Table 7: Attitude of Management towards risk management practices

Type of Highly Only Neutral Negative Highly

Risk Positive Positive Negative

Isla conve Isla conven Isla conven Isla conven Isla conven

mic ntion mic tional mic tional mic tional mic tional

al

Credit 100 100

Risk

Liquidit 100 60 20 20

y Risk

Interest 20 40 40 100

Rate

Risk

Foreign 20 40 60 20 40 20

Exchan
ge Risk

Perform 80 20 20 80

ance

Risk

Conclusion

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. For

risk identification conventional banks are more aware than Islamic banks and

conventional banks use advance techniques for risk identification beside 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. Islamic

banks need qualified staff also for risk management department because majority 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.

Recommendations

It is recommended there is variation between the two systems in term of awareness of

risk identification, mitigation and management techniques. For risk identification
conventional banks are more aware than Islamic banks and conventional banks use
advance techniques for risk identification beside 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. Islamic banks need qualified staff
also for risk management department because majority of them are unaware about the
advance techniques.

It is also recommended for the researchers to develop or find out those relative things
that affects the risk management factors in conventional and Islamic banking. How
these two banking system survive in the market to bear at high level risk. Also find
out different ways to overcome the risk management factors.

It is recommended for the researchers to discover more important factors of risk

management. 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.