RISK MANAGEMENT COMPARISON OF ISLAMIC AND CONVENTIONAL

BANKS IN PAKISTAN

TABLE OF CONTENT
Contents
ABSTRACT........................................................................................................................1
Acknowledgments..............................................................................................................2
Chapter 1: Introduction......................................................................................................3
Background........................................................................................................................3
Research Statement..........................................................................................................5
Purpose of study................................................................................................................5
Objective............................................................................................................................5
Significance of the study....................................................................................................5
Chapter 2: Literature review..............................................................................................6
Risks Management in conventional banks........................................................................6
Risks Management in Islamic bank...................................................................................9
Risks Management comparison of Islamic and conventional banks...............................12
Chapter 3: Methodology..................................................................................................15
Methodology....................................................................................................................15
Sample selection.............................................................................................................15
Data collection and Questionnaire...................................................................................16
Data analysis...................................................................................................................16
Reliability of the measures..............................................................................................17

Chapter 4: Analysis..........................................................................................................18
Awareness of the Risk managers about various type of Risk of the Bank along with
measurement level..........................................................................................................18
Awareness of the different type of the risk identification technique plus it measurement
level..................................................................................................................................23
Exercise of different risks management technique and the frequency of the uses.........26
Awareness regarding risk mitigation approaches & acceptances level..........................29
Awareness of risk mitigation techniques & measurement...............................................31
Attitude of management towards risk management practices........................................33
Conclusion.......................................................................................................................35
References.......................................................................................................................36
Annexure - Questionnaire................................................................................................39

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. Data is collected from ten
banks and one respondent from the risk management department from each
of the selected banks. Frequency tabulation is use for the analysis and
Cronbachs alpha is use for reliability of the collected data. Finding 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. And 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.

Acknowledgments

All praise is due to Almighty ALLAH, the most merciful and the most
beneficent, WHO bestowed upon us health, power of communication and
opportunity to successfully complete our undergraduate studies. Countless
salutation is upon the Holy Prophet Hazrat Muhammad (Peace Be upon
Him), the most perfect and torch of guidance and knowledge for humanity as
a whole.
We feel honored to express our sincere gratitude to Mr. Muhammad Kamran
for his supervision, guidance and encouragement throughout this research.
We always found him very much alive, full of zeal, vitality and intellectual
curiosity. Without his ideas, remarks and endless interest this work could not
have been carried out and completed.

CHAPTER 1: INTRODUCTION
1.1 BACKGROUND TO THE STUDY
Risk management is one of the building blocks for banking sector. Now a
days 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
6

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.
1.1 RESEARCH STATEMENT
To investigate Comparison of Risk Management Practices between Islamic
and conventional Banks in Pakistan.

1.2 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.
1.3 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.
1.4 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

Risks Management in conventional banks
The process by which we first of all identified the risk, then in 2 nd

stage

being financial manager we assessed that identified risk in 3 rd 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,
8

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.
Ninimaki(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
10

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.
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

11

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 risktaking

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
12

sour the Muslim

community prohibit us clearly from gambling, as shown in these verses (AlBaqara, 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 firms 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
13

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.

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 networking 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.
14

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 nonIslamic and Islamic banks. Additionally, risk management practices by the
degree to which managers are implicit to be determined risks and risk
15

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

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 thats why the study select five private conventional
banks out of 17 for maintaining the balance between both of them.
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
16

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.
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

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

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

17

management activity from each of the selected bank is required for data
collection.
Data analysis
Cronbachs 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
Cronbachs Alpha. With the use of Cronbachs Alpha measuring of error is not
a difficult task actually Cronbachs 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

18

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

19

Risk Techniques

Islamic Banks

Conventional Banks

Credit Risk/ Investment Risk

Liquidity Risk
Interest Rate Risk
Foreign Exchange/ Currency

5
5
0
4

100
100
0
80

5
5
5
5

Operational 5

100

Risk
Performance/

Risk
Environmental Risk
5
Rate of Return Risk
5
Sharia non-compliance Risk
5
Price risk
1
Type of Highly
Only
Risk

Aware

Neutral

100
100
100
20
Unaware Not at all

5
5
1
5
aware

Aware

Islami

convention Islami

convention Islami

convention

Islami

con

al

al

al

al

Credit Risk/ 100

100

Investment
Risk
Liquidity

80

100

20

Risk
Interest

100

20

Rate Risk
Foreign

20

100

Performance 60

100

60

20

Exchange/
Currency
Risk

/
Operational

20

20

20

Risk
Environment 40

100

40

al Risk
Rate

of 40

40

Return Risk
Shari'a non- 100

20

compliance
Risk
Price risk

100

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 noncompliance 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:

21

20

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

Risk

Concerned

Concerned

Isla

conve

Isla

conve

Isla

mi

ntiona

mi

ntiona

Credit

10

100

Risk/

20

20

Invest
ment
Risk
Liquidit 80
22

80

Not

Not

at

all

Concerned

Concerned

conve

Isla

conve

Isla

conve

mi

ntiona

mi

ntiona

mi

ntiona

y Risk
Interes
t

100

10

Rate

Risk
Foreign

20

40

60

80

20

80

Exchan
ge/
Curren
cy Risk
Perfor
mance
/
Operat
ional
Risk
Enviro

60

20

20

80

Rate of 60

20

20

60

20

nment
al Risk
20

20

Return
Risk
Shari'a

10

non-

compli
ance
Risk
Price
risk

23

40

60

20

60

20

100

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
Inspection

by

Islamic banks
the 5

Conventional Banks

100

100

100

100

100

100

bank risk manager

Audits or physical 5
inspection
Financial

statement 5

analysis
Risk survey

40

20

Process analysis

20

100

SWOT analysis

80

100

Inspection

by 2

40

100

outside expert
24

Benchmarking
Scenario analysis
Internal

20

20

80

100

40

80

communication
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 2 nd 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
Risk

Neutral

Unaware

Aware

by
25

Not

at

all

aware

Isla conve

Isla conve

mi

ntiona

mi

ntiona mi

ntiona

mi

ntiona mi

ntiona

Inspecti 10
on

Only Aware

100

Isla conve
c

Isla conve

Isla conve
c

the

bank
risk
manag
er
Audits

10

or

100

physica
l
inspecti
on
Financi

10

al

100

statem
ent
analysi
s
Risk

20

20

60

10

20

20

40

20

60

40

40

40

20

20

survey
Process
analysi
s
SWOT

40

60

Inspecti 20

40

40

20

analysi
s

on

by

outside
expert

26

20

40

20

60

Bench

20

20

20

40

20

20

20

Internal 20

40

80

60

20

40

markin
g
Scenari

20

20

o
analysi
s
20

60

20

20

commu
nicatio
n

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
27

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
Gap Analysis
Scenario Analysis

5
5
4

100
100
80

5
4
5

100
80
100

Duration Analysis

100

20

40

100

20

20

Value at risk
5
Simulation 3

100
60

5
5

100
100

techniques
Stress testing
5
Risk
adjusted 1

100
20

4
5

100
100

return on capital
Internal Based 5

100

100

rating system
Credit Scoring
Credit

100
60

5
5

100
100

Maturity 2
Matching
Earning at risk

committees

28

5
3

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

of

Frequently

Neutral

Rarely used

used

Not

at

all

aware

Risk
Isla

conve

Isla

conve

Isla

conve

Isla

conve

Isla

conve

mic

ntiona

mic

ntiona

mic

ntiona

mic

ntiona

mic

ntional

20

20

Credit

10

Ratin

20

80

gs
Gap

20

20

60

60

40

20

20

20

Analy
sis
Scena
rio
Analy

29

60

40

sis
Durati 80

20

20

80

80

80

on
Analy
sis
Matur

20

20

20

20

60

60

20

20

ity
Match
ing
Earni

20

60

40

40

40

80

60

60

40

40

100

80

100

80

ng at
risk
Value
at risk
Simul

20

ation
techni
ques
Stress 60
testin
g
Risk

20

adjust
ed
return
Intern
al
Based
rating
30

20

syste
m
Credit

80

100

20

60

100

40

Scorin
g
Credit
comm
ittees

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

31

Islamic Banks

Conventional Banks

Risk may be avoided

80

20

Risk may be retained

20

100

Risk

may

be 3

transferred
Risk may be shared
Risk may be reduced

5
60
40

2
5

100

100

100

In the table 5(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 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 of Highly

Only

Risk

Agreed

Agreed

Isla conve

Isla conve

mi
32

ntiona mi

Neutral

Diagreed

Highly
Disageed

Isla conve

ntiona mi

Isla conve

ntiona mi

Isla conve

ntiona mi

ntiona

Risk

60

20

20

100

20

40

40

40

20

60

20

60

80

20

20

60

may be
avoided
Risk

20

may be
retaine
d
Risk

40

40

may be
transfer
red
Risk

40

may be
shared
Risk

80

20

may be
reduced

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 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.
33

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

Risk Techniques

Islamic Banks

Conventional Banks

Collateral

100

100

60

80

100

100

80

40

100
20

5
5

100
100

80

100

Arrangement
Third

party 3

enhancement
Loan loss reserves
On

balance

sheet 4

netting
Guarantees
Parallel contracts
Over

the

5
1

Counter 4

derivatives

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
34

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 of Highly
Risk

Neutral

Not Used

Used

Not at all
Used

Isla conve

Collater

Only Used

Isla conve

Isla conve

Isla conve

Isla conve

mi

ntiona mi

ntiona mi

ntiona mi

ntiona mi

ntiona

80

100

20

40

20

20

60

20

20

40

20

20

60

40

20

al
Arrange
ment
Third

20

party
enhanc
ement
Loan
loss
reserve
s

35

On

40

20

60

40

20

20

balance
sheet
netting
Guarant 10
ees

Parallel

20

100

100

80

contrac
ts
Over

20

60

80

60

the
Counter
derivati
ves

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
36

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

Risk

Positive

Positive

Isla conve

Isla conve

Negative

Highly
Negative

Isla conve

Isla conve

Isla conve

mi

ntiona mi

ntiona mi

ntiona mi

ntiona mi

ntiona

Credit

10

100

Risk

Liquidit

10

y Risk

Interest

60

20

20

40

20

40

Rate

10
0

Risk
Foreign

20

40

60

20

40

20

20

80

Exchan
ge Risk
Perform
ance
Risk

37

80

20

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.

38

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44.
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The

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Annexure - Questionnaire

Risk Management comparison of Islamic and Conventional in

Pakistan
Zainab Asif Siddiqui &SumairaAltaf
City University Of Science And Information Technology, Peshawar.

Questionnaire

Respondent Name:

Respondent Designation:

41

Respondent Company:

42

Questionnaire
Question 1-a: Awareness of different types of risk faced by
respondents

a)
b)
c)
d)

Risk Techniques
Credit Risk/ Investment Risk
Liquidity Risk
Interest Rate Risk
Foreign Exchange/ Currency

Islamic

Conventional

e)
f)
g)
h)
i)

Risk
Performance/ Operational Risk
Environmental Risk
Rate of Return Risk
Sharia non-compliance Risk
Price risk

Question 1-b: Level of awareness of respondents as regards various

risks
Highly Aware

Only Aware

Neutral

Unaware

Not

Isla

Conven

Isla

Conven

Isla

Conven

Isla

Conven

aware
Isla Conven

mic

tional

mic

tional

mic

tional

mic

tional

mic

tional

ent Risk
b) Liquidity

Risk
c) Interest

a) Credit

at

Risk/
Investm

Rate
Risk
d) Foreign
Exchang
e/
43

all

Currenc
y Risk
e) Perform

of

ance/
Operatio
nal Risk
f) Environ
mental
Risk
g) Rate
Return
Risk
h) Sharia
noncomplia
nce Risk
i) Price
risk

44

Question 2: Concernedness of the respondents regarding various

types of risks

Highly

Only

Neutral

Not

Not

Concerned
Isla Conven
mic

Concerned
Isla Conven

Isla

Conven

Concerned
Isla Conven

Concerned
Isla Conven

tional

mic

tional

mic

tional

mic

tional

mic

tional

ent Risk
k) Liquidity

Risk
l) Interest

of

j) Credit

at

Risk/
Investm

Rate
Risk
m) Foreign
Exchang
e/
Currenc
y Risk
n) Perform
ance/
Operatio
nal Risk
o) Environ
mental
Risk
p) Rate
Return
Risk
45

all

q) Sharia

noncomplia
nce Risk
r) Price
risk

46

Question

3-a:

Awareness

of

the

respondents

of

the

risk

identification techniques and measurement level (Tick or cross)

Risk Techniques
Islamic
a) Inspection by the bank risk
b)
c)
d)
e)
f)
g)
h)
i)
j)

manager
Audits or physical inspection
Financial statement analysis
Risk survey
Process analysis
SWOT analysis
Inspection by outside expert
Benchmarking
Scenario analysis
Internal communication

Conventional

Question 3-b: Level of awareness of risk identification techniques

Risk

Highly

Techni

Aware

Only Aware

Neutral

Unaware

Not

at

all

aware

ques
Isla

a) Inspecti
on

Conve

Isla

Conve

Isla

Conve

Isla

Conve

Isla

Conve

mic ntional

mic ntional

mic ntional

mi

ntional

mic ntional

by

the
bank
risk
manage
r
b) Audits
or
physica
47

l
inspecti
on
c) Financi

analysis
d) Risk

survey
e) Process

analysis
f) SWOT

analysis
g) Inspecti

analysis
j) Internal

al
statem
ent

on

by

outside
expert
h) Bench
markin
g
i) Scenari
o

commu
nication

48

Question 4-a: Use of risk management techniques

Management Techniques
Credit Ratings
Gap Analysis
Scenario Analysis
Duration Analysis
Maturity Matching
Earning at risk
Value at risk
Simulation techniques
Stress testing
Risk adjusted return on capital
Internal Based rating system
Credit Scoring
Credit committees

Islamic

Conventional

Question 4-b: Frequency of use risk management techniques

a) Credit

Mostly Used

Frequently

Neutral

Rarely Used

Not

at

Isla

Conven

Used
Isla Conven

Isla

Conven

Isla

Conven

used
Isla Conven

mic

tional

mic

tional

mic

tional

mic

tional

mic

tional

Rating
s
b) Gap
Analys
is
c) Scena
rio
Analys
is
d) Durati
on
Analys
is
49

all

e) Maturi

at risk
h) Simula

ty
Matchi
ng
f) Earnin
g

at

risk
g) Value

tion
techni
ques
i) Stress
testin
g
j) Risk
adjust
ed
return

50

Question 5-a: Risk mitigation approaches

Management Techniques
Risk may be avoided
Risk may be retained
Risk may be transferred
Risk may be shared
Risk may be reduced

Question

5-b:

Level

Islamic

of acceptance

Conventional

of

various

risk mitigation

approaches
Highly agreed

Risk

Only agreed

Neutral

Disagreed

Highly

Isla

Convent

Isla

Convent

Isla

Convent

Isla

Convent

Disagreed
Isla Convent

mic

ional

mic

ional

mic

ional

mic

ional

mic

ional

may
be
avoide
d
Risk
may
be
retaine
d
Risk
may
be
transfe
rred
Risk
may
be
shared
51

Risk

may
be
reduce
d

Question 6-a: Awareness of respondents about risk mitigation

techniques

Collateral Arrangement
Third party enhancement
Loan loss reserves
On balance sheet netting
Guarantees
Parallel contracts
Over the Counter derivatives

52

Islamic

Conventional

Question 6-b: Level of using specific risk mitigation techniques

Highly used
Isla Convent

Only used
Isla Convent

Neutral
Isla Convent

Not- used
Isla Convent

Not at all used

Isla Convent

mic

ional

mic

ional

mic

ional

mic

ional

mic

ional

netting
Guarant

ees
Parallel

s
Over the

Collater
al
Arrange
ment
Third
party
enhance
ment
Loan
loss
reserves
On
balance
sheet

contract

Counter
derivativ
es

Question 7: Attitude of Management towards risk management

practices
Highly Positive Only Positive
53

Neutral

Negative

Highly

Isla

Convent

Isla

Convent

Isla

Convent

Isla

Convent

Negative
Isla Convent

Credit

mic

ional

mic

ional

mic

ional

mic

ional

mic

ional

Risk
Liquidit

y Risk
Interest

Rate
Risk
Foreign
Exchan
ge Risk
Perform
ance
Risk

54