Dissertation
A Comparison of the Effectiveness of the Different Risk Management Techniques Employed Within Islamic Banking, Compared to those of Traditional Banking
Abstract
The research has the purpose of studying the comparison of the effectiveness of different risk management techniques employed within Islamic Banking compared to those of traditional or conventional banking. The study researches the topic beyond studying risk management activities and techniques in both banks. Effectiveness is the central attribute that is very important because risk management activities must be effective. The research has studied the topic through a mixed-methods approach so that the benefits of quantitative and qualitative research methods can be enjoyed simultaneously. A rich literature review is part of the study that has reviewed risk management in both types of banks effectively. After the systematic literature review, there are results from responses of employees working in both banks. Results show that there are some differences in the effectiveness of risk management techniques in both types of banks. Findings state that Islamic banks in Pakistan are weak in terms of the understanding of risk, risk management, liquidity risk analysis, risk monitoring, and reporting. The conventional banks are not adequate and effective in terms of risk assessment and analysis. Conclusion and recommendations have been presented in the end. The research recommends adopting a standardized risk management method that has shared and mutual grounds between both sectors of banking.
Chapter 1-Introduction
The banking sector exists in a society with great importance. Every individual or institution has to take banking services to exploit more opportunities for their work. The conventional banking system has almost known risk management techniques that might change slightly from time to time. The basic principles of these activities remain the same that they charge interest to cover the risk. In contrast to conventional or traditional banking, Islamic banks do not charge interest (Syakhroza, Paolella, & Munir, 2019). In recent years, the Islamic banking system has emerged that claim of not charging interest to cover risks. An ordinary person shows interest as to how it is possible. There must be differences in risk management techniques employed by Islamic banks as compared to traditional banking. This research has examined different risk management techniques used by both forms of banks, along with their effectiveness.
Risk and its management have been an essential and fundamental function of any banking organization or system. However, the word of risk has experienced changes over the years, but its fundamental concept remains the same. Naturally, it is the probability of diverging from the expected or desired path. Such divergence might be positive that is called upside risk, and it might be harmful that is called downside risk. Generally, risk means the downside risk that needs proper management. A banking organization guarantees businesses and individuals that they should not be exposed to risks (Alam, Gupta, & Shanmugam, 2017).
In its ordinary and fundamental activities, the banking sector has to deal with various types of risks inevitably. Some notable risks include credit risk, operational risk, liquidity risk, and market risk. These risks differ in terms of their effects and span when it comes to Islamic banking and traditional banking. However, risks do not remain the same because the changing market situation and contextual factors lead to the changing nature of risks (Samad, 2004). These types of risks have one feature in common that their intensity is continuously increasing, which makes them complex. Another common feature is that unknown risks keep emerging. Risks emerge due to increased volatility in the industry and financial market, increasing level of competition, globalization, financial innovation, and changing regulatory environment for banks (Gupta, 2015).
For responding to changes affecting the banking industry, traditional banks and Islamic banks prefer engaging in risk management techniques. It is, however, worth considering how much their efforts are effective in managing the risks they are facing. Different types of the banking system must possess different risk management techniques that can distinguish them from the rest. In the case of this particular research, there must be a difference in risk management techniques adopted by Islamic banks and traditional banks. The presence of an information system for risk management, the mechanism to oversee risks, efficiency in risk management, awareness for risk management, and communication regarding risk management are some techniques adopted by banks. Their effectiveness in each banking system must be studied. It would help to understand the fundamental reason for the difference between the two banking systems.
Background of the Study:
Islamic banking is the industry that has been expanding and growing in recent years, but the main growth comes from the gulf countries. However, due to slow economic conditions in the world, there has been slow growth in 2018 and 2019. Sukuk is one of the instruments for financing in Islamic banking and finance. They have played a central role in the recent wave of growth in Islamic finance and banking (Johnes, Izzeldin, & Pappas, 2014). One of the unique aspects of Islamic banking is that it has a concentration in the Middle East. Outside of the Middle East, some countries are driving its growth. However, the growth of Islamic banking is sustainable and in an upward movement. However, there has been an increase in discussions on different kinds of risks emerging around the industry (Waemustafa & Sukri, 2016).
It is the main objective of risk management to minimize existing risks, and industries like the banking industry cannot be immune to various kinds of risks. It is worth understanding the purpose and main role of the banking sector—banks of any kind act as a financial intermediary between the two parties (Olson & Zoubi, 2008). In the banking industry, lender and depositor are the two parties interested in functions. Traditional and Islamic banks lend loans to parties, and ideally, they receive the whole amount back. Simultaneously, there is the issue of liquidity because parties and clients come to Islamic banks for liquidity (Shawtari, Ariff, & Razak, 2019). In pursuit of these objectives, banks might face risks, and ideally, they should be perfect in risk management practices. In this background, risk management is considered a fundamental part of any kind of banking (Asif, Ahmed, Zahid, & Khan, 2017).
Researchers have noted that there is an increasing need for risk management because banks are exposed to new types of risks today. In the past, banks had risks related to credit and market risks only. However, this situation has changed now as they are going to face many types of risks. Some of the newly emerged risks are financial risks, operational risks, reputational risks, and other types. Therefore, risk management in banks has been an essential topic of research (Doumpos, Hasan, & Pasiouras, 2017).
The background of this research is based on a comparison that seeks the difference between traditional banking and Islamic banking. Indeed, both types of banks are involved in risk management activities, and they adopt different techniques to overcome risks. There must be a difference in the effectiveness of their risk management approach. Amid the growing Islamic banking industry, it has got considerable attention, but comparison with traditional banking would make the case more understandable (Jawadi, Jawadi, Ameur, & Cheffou, 2017).
Problem Statement:
Islamic banking is comparatively new in the banking industry, and one might be more interested in understanding the functions of this particular sector. However, it might not be possible if there is not a comparison with traditional banking. Islamic banks have many instruments and products that are similar to traditional banks, but the main difference is to be interest-free. It also makes Islamic banks exposed to a greater level and degree of risk as compared to conventional banks. Traditional banks charge interest that is at their center of activities. Despite the fact that all conditions are met, both types of banks face risks, and there must be risk management to deal with different kinds of risks.
Literature has found different ways to address risk management, as there are many techniques to do so. The level of understanding and management of risks at banks can be an effective way for risk management. The level of communication and preparedness is also crucial because of the risk management that calls for a proactive approach. However, there must be an active role of the top management and employees in the application of techniques for risk management. But there is also an important role of information system and structure that enables them for risk management effectively. The most important risk faced by banks is credit risk, and this research has considered the risk, especially. Apart from the kinds of different risks, the orientation and approach towards risk management have been the main area of concentration in this research.
Thus, this research has focused on communication and the presence of suitable structures in banks to deal with risks. Traditional and Islamic banks have been studied in terms of the effectiveness of their risk management and the effectiveness of activities in this regard. A good aspect of this research is that employees are respondents in this research.
The rationale of the research:
Banks play a critical role in society, and people remain associated with it for carrying out different activities. Different types of banks include commercial banks, investment banks, microfinance banks, agricultural banks, and others. In this research, these banks have been termed as traditional or conventional banks. In comparison with these traditional banks, there is a new banking sector that is called as the Islamic banking sector. Although Islamic and traditional banks have similar kinds of purpose in banking, they differ greatly in terms of techniques. There has been growing interest in studying the difference between both types of banking systems.
Banks have to deal with many risks because they have to interact with clients and parties for carrying out their activities. This part of their activities has been selected for this research to know how they deal with different kinds of risks and their management. It has helped to understand and become aware of basic differences in this regard. The literature review has noted various kinds of risks, but it confirms that credit risk is the most prominent one. However, in the mitigation and management activities for a risk, there is considerable importance for communication, awareness, and contextual factors in banks. Employees’ views in this regard are critical, and this research has taken this perspective.
The purpose of the research is to help people understand the basics of activities so that they can choose which banking sector is the best for them. Risk management abilities of a bank guarantee faith and trust of its clients; otherwise, they cannot show their complete trust in it. Moreover, it is obvious to have risk management activities in banks, along with techniques to deal with them. Still, the level of awareness, communication, and support within a bank must be studied to realize the difference. This research has taken this perspective to study the difference of risk management techniques in both types of banks.
Significance of the Study:
The study has lots of academic and empirical significance. However, the empirical significance of the research is also prominent. In this primary research, a detailed literature review has set the foundation for hypotheses to be tested, and primary data has worked on whether a hypothesis has been accepted or rejected. As a result, the research is going to help the banking industry. It takes employees’ perspective; therefore, the significance is there with respect to employees as well. Questions asked for views and opinions from employees, and their perspective is useful and helpful for the banking industry (Ali & Farrukh, 2013).
The banking industry plays an integral role in people’s lives and business endeavors. People are interested in risk management capabilities and the effectiveness of different banking organizations and systems. This research addresses their interest in risk management techniques in the banking sector. There are two prominent banking organizations. One category is about traditional banks, and the second category consists of the Islamic banking sector. This research has taken both types of banks and has discussed their risk management activities along with effectiveness. As a result, even clients and general people can understand which banking type is more risk effective for them (Hirst, 2015).
Another important aspect of this research is that respondents of this research are employees. Research on employees’ means they have been considered important in risk management activities and techniques adopted by these banks. Therefore, the research has helped understand employees’ perspectives and has led them to take an interest in risk management activities in a bank. It has strategic significance for the banking industry (Zyphur & Pierides, 2017).
The academic significance of this research is in terms of additions to the existing literature on risk management. This research is of empirical significance that can help banks to conduct activities necessary to mitigate and overcome risks. Research field and literature in this area can help transform the academic research on this significantly important area.
Objectives:
- To explore risk management techniques adopted by traditional and Islamic banks
- To explore the differences between risk management techniques adopted by both banks
- To take the perspective of employees related to the topic
- To draw practical and academic implications of research on risk management techniques and their difference is traditional and Islamic banks
- To conclude and recommend banking sector in terms of risk management activities carried out in these organizations
Research Questions:
- What are the different approaches undertaken by Islamic and traditional banks for risk management?
- What is the difference between risk management techniques by Islamic and traditional banks for risk management?
- What is the employees’ perspective regarding risk management?
- What are the recommendations and conclusions from this research?
Chapter 2-Literature Review
This chapter reviews research studies and articles on the topic of this research. The literature review sets the foundation for the research because primary data has lots of support from this chapter. All statements in the questionnaire have been developed based on research studies on the topic. However, this chapter has significance for findings of the research as well because it ensures whether findings are aligned with existing research studies or not.
Products of Traditional Banks:
Before going into detail of the product of traditional banks, it is worth including their activities and functions here. Traditional banks work under four main activities and their heads. These activities fall under the category of retail banking, corporate banking, treasury or investment banking, and banking support (Lang and Schröder, 2013). There are various activities under each head, and the following figure contains all these activities.
Traditional banks offer many products, but they fall under two broad categories, including liability products and loan products. In the liability product category, a traditional bank offers saving accounts, fixed deposit accounts, and current accounts to its customers (Kocakulah and Komissarov, 2020). For loan products, a traditional bank offers fixed loans, term loans, and trade finance.
Traditional banks are exposed to various risks in offering these services and products to their clients. These risks mainly fall under two categories those are transactional risks and operational risks.
One of the risks faced by traditional banks is credit risk. According to Drzik et al., (1998), commercial banks have to face major risks from credit risk that makes 60 percent of total risks. It simply means defaulting the party that has obtained credit from the commercial bank. Failure to meet contractual obligations is the main cause of this risk (Drzik, Nakada and Schuermann, 1998). Researchers have divided credit risk into components that include default risk, migration risk, exposure risk, loss under the default, and counterparty risk (Van Deventer, Imai and Mesler, 2013).
The second type of risk faced by traditional banks is the market risk that is due to the fluctuations of prices in the market, according to Choudhry (2018). There are various factors leading to market risk, including interest rate risk, basis risk, yield curve risk, reprising risk, and option risk. Other forms of risks under this head include foreign exchange risk, equity risk, and commodity risk (Choudhry, 2018).
Commercial or traditional banks face liquidity risk that is one of the main risks faced by these banks. In light of this risk, a bank has to face a mismatch between assets and liabilities and their maturity. Various benefits lead to the management of liquidity risk because it increases the performance of a bank (Subramoniam, 2015). According to researchers, effective management of liquidity risk leads to various benefits for a bank. It helps increase their confidence in the market, and a bank can ensure good relationships with borrowers. If a bank has enough and substantial liquidity, a bank does not need to sell assets prematurely, so; a bank has to face liquidity risks. These risks include funding risk, time risk, and call risk (Hanmanth N. and Shivaji, 2014).
Another type of risk that traditional banks face is an operational risk that is due to the non-performance of processes and functions in the traditional bank (Arhenful, Yeboah and Tackie, 2019). The risk leads to direct or indirect loss, and it might be from external environmental factors as well. It is an important area for risk management because it involves areas including information systems, reporting systems, monitoring rules and procedures, and other processes in a bank (Gad, 2015). Different levels exhibit operational risk, including human error or fraud, processes, information technology, and technical levels (Schniepp, 2013). Risks at these levels lead to risks to operations and various processes.
Other forms of risks faced by traditional banks include residual risks, reputational risk, compliance risk, country risk, and off-balance sheet risk. Reputational risks relate to the goodwill of a bank, and these risks can affect shareholder value (Baldan, Zen and Rebonato, 2012). Compliance risks relate to legal jurisdiction as any bank might not be involved in legal activities. Country risk arises when a foreign government creates a hurdle in payment of loans by a foreign borrower. In the case of contingent or conditional assets and liabilities, the off-balance-sheet risk arises (Abdullah, Shahimi and Ismail, 2011).
Researchers have noted different types of risks and their significance. Al-Tamimi (2007) has noted that credit risk is the most essential and prominent type of risk, and it is prominent in all types of banks (Al-Tamimi and Al-Mazrooei, 2007). Al-Ajmi (2012) has noted different other prominent risks faced by different banks. These risks include credit risk, operational risk, reputational risk, liquidity risk, regulatory risk, and legal risk. However, research studies have not reached a consensus in terms of prominent risks because different research studies have found other risks as important (Hussain and Al-Ajmi, 2012). Ahmad et al. (2013) have noted prominent risks include operational risk, credit risk, counterparty risk, liquidity risk, and foreign exchange risk (Bilal, Talib and Khan, 2013).
Risks Management by Traditional Banks:
Risk management in banks has been the topic of many researchers. Ardrey et al. (2009) have noted that risk management consists of policies aimed at controlling and monitoring dealings in business. These dealings might affect the business negatively, and proper management calls for mitigation and ultimately removing all negative effects of these risks (Ardrey et al., 2009).
Risk management contains all activities that are present in the risk profile. In general terms, risk management includes some steps like identification and measurement of risk. Then, there is monitoring and control of risk so that it cannot spread and expand to a dangerous level (Sharifi, Haldar and Rao, 2019).
Risk management has the dependence on internal as well as external environment of a bank; therefore, Hussain and Al-Ajmi (2012) suggested a continuous need for monitoring and control of risks. As a result, a bank can decide on the mitigation, transfer, and accept the risk that has been identified. Dynamic, uncertain, and uneven market conditions and macroeconomic environments lead to risk exposure for banks (Hussain and Al-Ajmi, 2012). One such risk for banks is the inability of the local currency to convert in the external market. Researchers have noted this among risks faced by commercial banks that they have to face the volatility of local currency (Guo, 2020).
Talwar (2011) has noted that it is necessary and inevitable for banks to have a risk management process, procedures, and risk appetite that is well-defined and well-developed. In this context, commercial banks should know two perspectives on risk management. They are regulatory requirements for risk management practices and voluntary practices exercised by banks. Both perspectives are necessary because they allow the bank to be proactive in risk management (Talwar, 2011).
So far as risk management techniques are concerned, there are eight steps in the process. These steps include exposure identification, risk quantification and collection of data for risk management, setting objectives for the process, setting guidelines for the product and control, evaluation of risk management, development of a strategy for risk management, planning for the implementation, and evaluation of the performance (Al-Tamimi and Al-Mazrooei, 2007).
Iqbal and Mirakhor (2011) have studied Islamic banks that they should possess a comprehensive risk management process. In this context, two steps are important in the risk management process. These steps include identification of causes and reasons for risks and planning for risk minimization (Iqbal and Mirakhor, 2011).
Research has noted that Islamic banks should also work on risk management practices and reporting processes like commercial banks. They should also have the board of directors and senior management oversight for this purpose (Gebba and Aboelmaged, 2016). Under the risk management process, they should implement Shariah rules and guidelines for reporting risks and their management to the supervisory authority. It increases the importance of top management of banks in the implementation of risk management techniques (IFSB, 2005).
Bank Risk Appetite:
In the risk management literature, an important concept is the bank risk appetite. According to COSO (2017), the concept refers to the amount of risk that is present at a broader level. An organization agrees to pursue with this risk in exchange for value. It means that it is the acceptable amount of risk that is necessary for the value of the organization and its employees. A bank can also accept risks in light of this concept because it helps in resource allocation. It is also valuable for the monitoring and responding to risks faced by an entity because it helps the reorganization of resources in that entity (COSO, 2017). Reorganized resources under this concept are the organization itself, human resources working there, and processes present for proper functioning and working in that entity. As a result, it helps to develop a suitable infrastructure that can absorb and bear risks (Gontarek and Bender, 2019).
The concept of risk appetite might be in contrast to concepts of risk tolerance and risk profile. According to the Institute of Risk Management (2011), risk appetite and risk tolerance are concepts that refer to a bearable amount of risks for an organization. However, risk tolerance denotes the maximum level of risk that is acceptable for an organization (IRM, 2011). According to KPMG (2013), risk tolerance acts as the measure that is there for monitoring, and it performs in comparison with the risk appetite concept. The risk profile is another useful and relevant concept that contains all risks faced by a financial institution, including a bank so that a bank can carry out its activities (KPMG, 2013).
Risk Management Process and Effectiveness of Risk Management Techniques:
Many researchers and research studies have studied the risk management process and its various components. They include steps and techniques needed for proper management of risks in a bank. For instance, Shafiq and Nasr (2010) and Shafique et al. (2013) have conducted research into the process for risk management and practices needed for it (Shafique, Hussain and Hassan, 2013). Among other researchers, they have studied the relationship between practices and process for risk management. Different aspects of risk management and practices include understanding risk and its management, identification and assessment of risk, monitoring of risks, and analysis for credit risk (Shafiq and Nasr, 2010).
Many research studies have studied the effectiveness of risk management techniques in commercial banks. Abdul Rehman et al. (2013) include some practices for risk management, including developing understanding, identification, assessment, analysis, control, and monitor, and contribution to the overall risk management process (Abdul Rahman, Noor and Ismail, 2013). Similarly, research studies have noted that the effectiveness of risk management and process depends on activities including risk governance, assessment of risks, aggregation and quantifying risks, reporting and monitoring of risks, and optimization of control procedures for risk management (Jankensgård, 2019).
Products and Instruments of Islamic Banks:
In the risk management of a bank, there is great importance for products and instruments in a bank. Islamic banks offer many products and instruments that are not similar to traditional commercial banks. Siddiqui (2008) has noted that Islamic banks offer seven different types of instruments and products. These products and instruments include Murabahah, Mudarabah, Musharakah, Salaam and Istisna, Ijarah, and Qard-e-Hasna (Ismal, 2014). In general banking terminologies, Murabahah is called cost-plus mark-up. Mudarabah might be called profit and loss sharing mechanism. Salaam and Istisna are called forward contracts, while Musharakah is like a partnership or joint venture between the parties. Ijarah is the form of leasing in Islamic banking (Gupta, 2015), and Qard-e-Hasna is the form of a loan, but Islamic banks do not charge loan (Khan, Bhatti and Siddiqui, 2008).
Researchers have further classified and divided different instruments and products in Islamic banking, and some of these researchers are El Qorchi (2005) and Chong et al. (2009). According to their classifications, there are debt-creating instruments, and Salaam, Kifalah, Istisna, and Murabahah fall under this category of debt-creating instruments (El Qorchi, 2005). The second category in these instruments is non-debt creating instruments. Under this category, Mudarabah and Musharakah are Islamic banking instruments or products. Some researchers have divided Islamic banking instruments and products into three different categories, and researchers present instruments and products in these three categories. The first category is financing that contains the instruments of Murabahah, Ijarah, Istisna, and Salaam (Chong and Liu, 2009). The second category is investing, which includes instruments and products of Mudarabah and Musharakah. The third category includes the instruments of Takaful, Kifalah, Wakalah, and Qard-e-Hasna. Islamic banks also issue an Islamic bond that is called Sukuk (Borhan and Ahmad, 2018). Khan and Bhatti (2008) have noted Sukuk as a prominent and good source of funding by banks in Pakistan (Khan and Bhatti, 2008).
Risks and the Case of Islamic Banks:
Many researchers have taken the case of Islamic banks and the risks they are facing. Kahef (2006) has cautioned in the research that Islamic banks should adopt risk-free banking practices. According to the research, Islamic banks have specific laws, types, and processes that call for requirements for effective and efficient management of risks (Rosman and Rahman, 2015). For instance, Mudarabah is a known and familiar mode of financing in Islamic banking, and it has lots of risks for parties involved in it. In Islamic banks, the loss is mainly shared by Islamic banks that should be borne by all parties involved in it. Musharakah is considered to be less risky because of the involvement of both parties in the decision-making process (Kahf, 2006).
Like traditional commercial banking, Islamic banks face operational risk, reputation risk, and transparency risk. Other risks in Islamic banking include Shariah risk and fiduciary risk. Broadly, risks in Islamic banking can be divided into four major categories, including financial risks, business risks, operational risks, and Shariah risks.
From financial risks, credit risk is a prominent one that emerges from non-payment from the borrower. In Islamic banking, Murabahah contracts present a higher level of risk due to compliance with Shariah rules and regulations. Hassan and Lewis (2007) provided an explanation in research as to when credit risk emerges in the Mudarabah contract. It happens when a bank cannot take part in the management of the business and acts only as a financier. In Musharakah’s contracts, credit risk emerges when the entrepreneur does not pay profit to the bank, and the bank has to take extra measures for claiming the credit (Hassan and Lewis, 2007).
Market risk in Islamic banking arises when Islamic banks have to face instability and uncertainty in market prices for specific assets. Like other banks, Islamic banks are also exposed to foreign exchange rate risk that emerges from the change in the exchange rate of local and foreign currencies. Another type of risk that confronts Islamic banks is the commodity price risk. According to Akkizidis and Khandelwal (2008), commodity price risk comes into being when banks possess assets of different kinds for the purpose of selling them into the future. There are different instruments and products in Islamic banking that have commodity price risk (Akkizidis and Khandelwal, 2007).
Other notable financial risks are mark-up risk and equity investment risk. Islamic banks are exposed to mark-up risk that is a fixed rate (Zainol and Kassim, 2012). They have to consider LIBOR as the benchmark that goes to decide the profit and loss ratio. The risk associated with it increases when the benchmark rate increases than the previously agreed contract and rate (Ahmed et al., 2018). Another financial risk is the equity investment risk, and it comes into being when monitoring is required to decrease the level of informational asymmetries (Rosman and Rahman, 2015). Islamic banks have to look into the proper monitoring and assessment of Mudarabah and Musharakah contracts.
Islamic banks are exposed to operational risks when they face failure in system or technology in a bank. Internal and external processes might be responsible for operational risks, and Islamic banks have to be careful in understanding these risks (Abdullah, Shahimi and Ismail, 2011).
Islamic banks might be exposed to business risks, and different types of business risks are there. The risk associated with the rate of return is a known business risk that is due to the uncertainty related to the return on investment (Yuksel, 2017). The second business risk might be withdrawal risk that is due to the lower rate of return to clients. In this case, a client might consider withdrawing the amount from Islamic banks and deposit in another bank that has a higher rate of return (Ismal, 2012). The third business risk is the liquidity risk that can hurt Islamic banks very much. In fact, many Islamic banking instruments lack liquidity, and this aspect leads them to face liquidity risk. This risk emerges when there is unavailability or shortage of liquidity (Braima, 2017). Another form of business risk is a reputational risk that arises due to a lack of worth and goodwill of the bank. It might be due to a lack of management seriousness and the ability to offer extraordinary services to its clients (Haron et al., 2015).
The fourth main category of risks faced by Islamic banks is due to Shariah non-compliance risk. Researchers have carried out this form of risk, and there might be two types of risks related to shariah non-compliance (Rosly, Naim and Lahsasna, 2017). First, this risk emerges due to non-standard practices in an Islamic bank. Secondly, these risks arise due to a lack of obeying Shariah rules and regulations.
Risks Management by Islamic Banks:
IFSB issued fifteen principles for Islamic banks for risk management. El Tiby (2010) has noted that these fifteen principles had the aim that Islamic banks have to operate and perform in accordance with Shariah rules and regulations. These include no use and support for Riba, adoption, and use of Shariah-compliant risk mitigation techniques, and rendering help to the Basel Committee on banking supervision. These conditions can ensure that Islamic banks can deal with their unique case for risk management (El Tiby, 2010).
Credit risk is one of the main risks faced by Islamic banks, and they have quite a similar approach in managing credit risk with traditional banks. Islamic banks should review parties involved in obtaining credit, and they should devise a strategy to check the worth of the client (Masood, Suwaidi and Thapa, 2012). Moreover, there must be monitoring, reporting methods, and mitigation techniques for risk management. Diversification of loans, classification of assets, and the presence of an adequate amount of capital are suitable policies for managing credit risk in Islamic banks (Wiryono and Effendi, 2018).
Another head in risk management for Islamic banks is related to liquidity risk management. Research studies have noted that Islamic banks have a lesser degree of threat for liquidity risk. IFSB (2005) has presented guidelines for Islamic banks to deal with liquidity risk (Ali & Farrukh, 2013). These guidelines call for the presence of a liquidity risk management framework and the presence of a sufficient amount that can fulfill the day-to-day needs of the bank. The presence of liquidity risk mitigation techniques, liquidity reserves, and sales of financing instruments are some techniques to manage this form of risk in the Islamic banking system (IFSB, 2005).
Risk management by Islamic banks calls for the management of operational risks. It is the requirement for banks under the Basel Accord 2 that they should maintain and keep capital for operational risk management (Abdullah, Shahimi and Ismail, 2011). Major risks faced by banks are due to the failure of human and machine interaction. There is also the impact of internal and external factors in risk management. Operational risk management allowed dealing with these risks so that a bank can ensure its operations and processes (Hasan, 2014).
The above literature review has noted that banks have different risk management techniques to mitigate and overcome different types of risks. Credit risk and liquidity risk are prominent ones. The literature review has noted that the presence of an information system for risk management, the mechanism to oversee risks, efficiency in risk management, awareness for risk management, and communication regarding risk management is some techniques adopted by banks (Hassan, 2009). These techniques and their implementation in both types of banks have been analyzed, and findings have been drawn. Generally, the literature review has identified the fact that both types of banks carry out risk management activities. There might be a difference in instruments and products in both banks. But the desire and seriousness of risk management remain there in both banks.
Chapter 3-Research Methodology
The research has used a mixed-methods approach to draw results. The mixed-method approach in research is considered very comprehensive and least prone to deficiencies. Researchers use features and attributes of quantitative and qualitative research simultaneously, and as a result, they can enjoy the benefits of both forms of methodologies. This research has also enjoyed benefits because of its ability to use quantitative research that allows the collection and interpretation of primary data. It also allows the use of secondary data from the rich literature on the topic under which hypotheses have been developed and tested. First, the following section discusses the title or topic of the research to suit a suitable methodology. Later sections of the methodology discuss components of the mixed-methods approach. An important part of the methodology is the discussion on ethical considerations. They are very important and play a central role in the reliability of data.
Title of the Research and the Chosen Method:
The topic of the research suggests the use of methodologies useful for this research. The title states that research would compare two banking systems. It has not focused on any organization. Instead, through primary research, this research has taken an Islamic Bank and a traditional or conventional bank. However, the focus of the research is the comparison of two banking systems, and any particular bank would allow this research to happen only. Thus, it is clear that it is not going to be a case study method. Still, it is the mixed-methods research involving primary and secondary ways of data collection and interpretation. The second important aspect of the title is a comparison of both banking systems in terms of the effectiveness of different risk management techniques employed there. Objectives set in the introduction section of this research contain various risk management techniques. However, the questionnaire mainly focuses on awareness, information, and the presence of risk management infrastructure in each banking system. Risks focused on the questionnaire of this research are credit risk and liquidity risk because both risks play a dominant role in the processing and functioning of any banking organization. The very nature of the research and with the aim of meeting objectives has used literature review very much. Therefore, primary data is as important for this research as the importance of secondary data. It is also true for secondary data that is as important for the research as the importance of primary data. The literature review offers a rich literature on variables in the title of this research.
Attributes of quantitative research suitable for this research:
Quantitative research has useful attributes of research because it yields generalized research results. It is objective-based because it uses variables to draw results. As a result, results are adjustable to any condition and situation because of objective results. In the given research, the focus has been made on the comparison of different risk management techniques adopted by Islamic banks and traditional banks. Therefore, the intent and purpose of this research must not be to focus on particular or some organizations merely. Instead, the focus of the research is to focus on the variables of the research. In this research, risk management techniques are going to be studied, and the entire focus has been given to these techniques. The use of quantitative research has enabled to use findings of this research for any Islamic bank and traditional or conventional bank. It is the strong point of this research because the banking industry is in continuous need of research. Primary research goes on to find the original results (Zyphur & Pierides, 2017).
The chosen methods in quantitative research:
The descriptive statistic has been used as part of the quantitative methodology for this research. The descriptive statistics have values of mean, median, mode, as well as diagrams to show responses from respondents of the study. Respondents of the research are employees, and they have offered their responses to questions asked. The use of descriptive statistics helps find results and interpret so that objectives are met. The use of diagrams is an effective method because it instantly helps understand the orientation and tendency of data collected from participants of the study. Participants from Islamic banks and conventional banks have given responses, and the use of SPSS has given meaning to their responses. However, it is worth understanding that it is the mixed-methods approach that uses qualitative results as well. The following section contains the attribute of the qualitative research used in the methodology section of this research.
Attributes of qualitative research suitable for this research:
The second method for research in this thesis is qualitative that reviews the literature on the topic. Literature from secondary sources comes from research articles, books, websites, and online publications. The literature review in this research contains content from a variety of books, websites, and research articles. The rich literature review contains research studies on risk management in each type of banks, i.e., Islamic banks and traditional banks. Within each head of risk management, the literature covers many types of risks. One might note that it was hard to include the entire list of risks in a questionnaire because respondents needed a cohesive and short questionnaire to answer. However, the presence of literature has enabled considering different kinds of risks to make the research perfect. Moreover, the instruments and products of each type of bank, along with associated risks, make the literature perfect. In this context, the decision of mixed research methodology becomes suitable for this research. The rich literature review has also made it possible to test hypotheses in light of the research results. Moreover, aligning the research results has also been possible because of secondary sources (McKim, 2017).
The chosen methods in qualitative research:
The chosen method in qualitative research is the review based research that conducts summation and synthesis of different research studies. There are four main headings in the literature review, and each heading has an explanation of aspects related to risk management. For instance, there is a review of products and instruments in each type of bank. Then, there are research studies on associated risks. It follows the literature on risk management techniques and different frameworks. The whole literature review makes a clear path as a result of the review. When both research methods are combined, it becomes an effective picture of the variables under consideration.
Data Collection:
It is the primary research, and data collection is an important part of the methodology where respondents are from both types of banks. All respondents were employees of a bank, and it has been ensured that they represent equally from the Islamic bank and traditional bank. In the data collection procedure, the instrument that has been used is a questionnaire. The questionnaire has fourteen questions involving different aspects of risk management. Fourteen questions or statements present five options before the respondents ranging from strongly agree to strongly disagree. The target population for the research consists of employees of any scale who work in Islamic or traditional banks. A simple random convenience sampling technique has been identified for selecting respondents from banks. The sample for the research consists of 52 respondents, and the sample is equally divided between Islamic banks and traditional banks. It means that 26 respondents from each type of bank are part of the study sample.
Questions asked from respondents show that respondents have to respond to differences in risk management of banks. Two types of risks have been included in the statements that include credit risk and liquidity risk. Moreover, the focus has been made on the knowledge, awareness, and efficiency of risk management initiatives in both types of banks. Equal representation of respondents from both banks enables the comparison possible on risk management. It is worth considering that respondents are from both banks. They give their views and responses for statements on the state of risk management infrastructure and practices in the banks. Among risk, credit risk and liquidity risk have been included in the questionnaire.
Research Implications:
The use of the chosen research methodology in this research indicates the research can be used for subjective and objective purposes. Primary research and its results have provided results that can be implemented in the whole banking industry. There are some differences in risk management, but overall, it indicates similarity in risk management approach. Moreover, the alignment of the research with the existing literature ensures the validity and credibility of the research. Thus, the research calls for implementing findings on the banking industry so that they can make changes to risk management activities. Academic implications of the research are also substantial, where researchers can choose the risk management construct in the banking industry. Researchers can choose the topic in their research, and this research is there to support their research in this field. The research has been empirical, and banks of any type can get benefit from the research and its practical implications. The use of a mixed-method approach has made it possible to make research empirically strong and worthwhile (Johnes, Izzeldin, & Pappas, 2014).
Limitations:
The limitations of the methodology might also be there. Although these limitations have not affected the research adversely, they indicate areas for improvement in the future. The mixed-methods approach in this research is the strong point of the research, but a small sample size indicates limitations. A larger and more representative research sample could provide more value to the research. In research studies, a sample size of more than 100 respondents also exists. Another limitation of the research methodology is that it has used descriptive statistics. The effectiveness of descriptive statistics is above doubts because it helps find the orientation or pattern of research results from respondents. However, other statistical tests, including correlation and regression, can be used for getting results. Another limitation of the methodology is that the literature review has shorter that could have been expanded. However, these limitations in methodology do not raise concerns over the validity and reliability of the research methodology. It is better to consider these limitations as future research directions for change in methodology. Any change in methodology leads to change in research, and it is advised to consider these limitations in future research so that implications of the research are positive (Taras, Steel, & Kirkman, 2010).
Ethical Considerations:
The methodology has abided by ethical considerations to make it a legitimate effort in academic and empirical research. The data collection process has implemented these considerations by getting consent from the participants of the study. In order to do so, respondents have been provided with the purpose and possible outcomes of the research. They were informed about the objectives of the study and the rationale behind it. As a result, they participated in the research after showing their consent. They were allowed and informed as well that they can withdraw from research any time within the data collection process. However, none of the respondents has declined to provide responses and completed the data collection process. They were informed that their data would be remained confidential. The collected data has been used only for the said research, and it has been protected as well. It has been ensured that data would be disposed of after the completion of the research. There is no intention to keep data after the research is completed. Moreover, it has been ensured that the data is used for this particular research so that it is not available for any third-party researcher. These ethical considerations have been followed in this research, and they have made the research perfect as well. One can understand the level of confidentiality from the fact that respondents have not been asked for any particular bank. They had to inform whether they are working in a conventional bank or an Islamic bank.
Chapter 4-Results, Discussion and Findings
Results
The quantitative analysis is conducted by using the survey tool of close-ended questions based questionnaire. The questionnaire is used to ask questions to the employees of the banks, i.e., both conventional and Islamic banks. The survey questions are Likert scale-based, and the respondents have to select one option for the five given options to show the level of agreement or disagreement with the given statement. The collected data has recorded 26 respondents from conventional banks and 26 respondents from Islamic banks. The results are then tabulated and fed into the SPSS software to get the results of Descriptive statistics.
The questionnaire showed 14 questions in total. Other than this, there is also a question at the start of the survey form, which asks the respondents if they work for a conventional bank or an Islamic bank. The questions asked in the questionnaire are close-ended and asks the respondents about the risk management strategies of their banks. The results of the survey are shown below in terms of each question individually. However, firstly, the descriptive statistics of all the questions altogether are shown and discussed.
The survey results are tabulated and discussed in two separate sections; conventional bank and Islamic bank. The responses of the conventional banks and the Islamic banks have all been separately tabulated to show a comparison of the results. These results will be analyzed along with the results of the literature analysis in the discussion section to show the findings of this study. The questionnaire is attached in the appendix. The Likert scale has values from 1 to 5 in which 1 refers to the strongly disagree, and 5 to the strongly agree.
Conventional Banks Descriptive Statistics:
The results of the SPSS analytical tool of the responses of the questionnaire survey from the respondents that belonged to the conventional banks are presented in the table below.
| Descriptive Statistics | ||||||
| N | Minimum | Maximum | Mean | Std. Deviation | Variance | |
| Q1 | 26 | 1.00 | 5.00 | 3.3462 | .93562 | .875 |
| Q2 | 26 | 2.00 | 5.00 | 3.7308 | .72430 | .525 |
| Q3 | 26 | 2.00 | 5.00 | 4.0385 | .72004 | .518 |
| Q4 | 26 | 2.00 | 5.00 | 4.0769 | .79614 | .634 |
| Q5 | 26 | 2.00 | 5.00 | 3.5769 | .98684 | .974 |
| Q6 | 26 | 2.00 | 5.00 | 3.7308 | .96157 | .925 |
| Q7 | 26 | 2.00 | 5.00 | 3.6923 | .78838 | .622 |
| Q8 | 26 | 2.00 | 5.00 | 3.4231 | .94543 | .894 |
| Q9 | 26 | 2.00 | 5.00 | 3.3846 | .69725 | .486 |
| Q10 | 26 | 2.00 | 5.00 | 3.9615 | .77360 | .598 |
| Q11 | 26 | 3.00 | 5.00 | 4.0385 | .66216 | .438 |
| Q12 | 26 | 1.00 | 5.00 | 3.5000 | .81240 | .660 |
| Q13 | 26 | 1.00 | 5.00 | 3.7692 | .90808 | .825 |
| Q14 | 26 | 1.00 | 5.00 | 3.9231 | 1.01678 | 1.034 |
| Valid N (listwise) | 26 | |||||
The N value in the above table shows that a total of 26 respondents answered the 14 questions presented in the questions. The minimum value here is showing the lowest selected option from the Likert scale, and the maximum is showing the highest selected option. This shows that for Questions 1, 12, 13, and 14, respondents who selected the lowest option were of 1, which means Strongly Disagree. It can be said while looking at these questions that at least one respondent has an opinion that the bank has effectively analyzed the liquid risk management process, and that they are not satisfied with the risk management methods adopted by the bank and the communication about the risks as compared to other banks is not better, and also that the nature of risk in the Islamic banking is different as compared to conventional banks. For question 11, that is, the bank analyzes credit risk management; no one has selected the option of disagreeing or strongly disagree, and the lowest answer selected is Neutral.
| One-Sample Statistics | ||||
| N | Mean | Std. Deviation | Std. Error Mean | |
| Q1 | 26 | 3.3462 | .93562 | .18349 |
| Q2 | 26 | 3.7308 | .72430 | .14205 |
| Q3 | 26 | 4.0385 | .72004 | .14121 |
| Q4 | 26 | 4.0769 | .79614 | .15614 |
| Q5 | 26 | 3.5769 | .98684 | .19353 |
| Q6 | 26 | 3.7308 | .96157 | .18858 |
| Q7 | 26 | 3.6923 | .78838 | .15461 |
| Q8 | 26 | 3.4231 | .94543 | .18541 |
| Q9 | 26 | 3.3846 | .69725 | .13674 |
| Q10 | 26 | 3.9615 | .77360 | .15172 |
| Q11 | 26 | 4.0385 | .66216 | .12986 |
| Q12 | 26 | 3.5000 | .81240 | .15933 |
| Q13 | 26 | 3.7692 | .90808 | .17809 |
| Q14 | 26 | 3.9231 | 1.01678 | .19941 |
The T-Test is then used to show the Mean and Standard deviation values. This is actually quite helpful in understanding the average answer that was selected in terms of each of the questions. For instance, for Q1, the average number of responses is 3.34, which is greater than three, i.e., Neutral towards the agreement. All the questions that were asked about the risk management procedures and strategies of the bank were, on average, mildly agreed to by the respondents as the mean answer for all questions is above 3.
Now each of the answers of the respondents for each of the questions will be shown individually:
| Q1-The nature of risk within the Islamic Banking industry differs from Conventional Banking. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Strongly Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Disagree | 4 | 15.4 | 15.4 | 19.2 | |
| Neutral | 7 | 26.9 | 26.9 | 46.2 | |
| Agree | 13 | 50.0 | 50.0 | 96.2 | |
| Strongly Agree | 1 | 3.8 | 3.8 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The question asked the respondents if they agree that the nature of risk for the conventional banks and Islamic banks differ. Out of 26 respondents, only one completely disagreed with this statement, four disagreed, seven respondents were Neutral, 13, i.e., the majority of the respondents agreed, and one strongly agreed. This shows that around 50% plus 3.8% of the respondents agreed that there is a difference in the nature of risk for both types of banks.
| Q2-You are aware of the risks faced by the bank. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 2 | 7.7 | 7.7 | 7.7 |
| Neutral | 5 | 19.2 | 19.2 | 26.9 | |
| Agree | 17 | 65.4 | 65.4 | 92.3 | |
| Strongly Agree | 2 | 7.7 | 7.7 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
This is the 2nd question that asks the respondents if they are aware of the risks faced by their banks. The answers show that 65% of the respondents agreed, and 7% strongly agreed, while a total of 7% disagreed, and 26% remained neutral. Therefore, most of the respondents of the conventional bank showed that they are aware of the risk factors.
| Q3-The bank where you do the job thoroughly understands the risk it is exposed to. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Neutral | 3 | 11.5 | 11.5 | 15.4 | |
| Agree | 16 | 61.5 | 61.5 | 76.9 | |
| Strongly Agree | 6 | 23.1 | 23.1 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
This is the third question that asks the respondents if they agree that their bank knows the nature and extremity of the risk to which they are exposed to. One person disagreed with this statement, while three remained neutral. Around 61% agreed, while 23% strongly agreed.
| Q4-The bank where I work manages its risks appropriately. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Neutral | 4 | 15.4 | 15.4 | 19.2 | |
| Agree | 13 | 50.0 | 50.0 | 69.2 | |
| Strongly Agree | 8 | 30.8 | 30.8 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The fourth question on the survey asks the employees and Managers of the banks if they agree that their bank manages their risks appropriately. The frequencies of the table show that 50% of the respondents agree, while 30% strongly agree with this statement. Around 19.2% of the respondents either remained neutral or disagreed.
| Q5-The bank where I work effectively communicates risk management practices to its employees. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 5 | 19.2 | 19.2 | 19.2 |
| Neutral | 5 | 19.2 | 19.2 | 38.5 | |
| Agree | 12 | 46.2 | 46.2 | 84.6 | |
| Strongly Agree | 4 | 15.4 | 15.4 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
This question is ranked fifth on the survey and asks the respondents about the communication of the risk management practices with the employees of the bank. Around 19% of the employees do not agree that these communication practices are effective, 19% are unaware of the situation, while 46% agreed, and 15% strongly agreed.
| Q6-The bank is well-prepared to identify risks it is exposed to. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 3 | 11.5 | 11.5 | 11.5 |
| Neutral | 7 | 26.9 | 26.9 | 38.5 | |
| Agree | 10 | 38.5 | 38.5 | 76.9 | |
| Strongly Agree | 6 | 23.1 | 23.1 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
In this question, the respondents are asked if the agreement that the bank is well prepared for the risks it is exposed to. The majority of the respondents agree at 38%, while 23% strongly agree, and 26% were unaware of the situation, and 11% disagreed.
| Q7-The bank has a well-established information system for risk assessment. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 2 | 7.7 | 7.7 | 7.7 |
| Neutral | 7 | 26.9 | 26.9 | 34.6 | |
| Agree | 14 | 53.8 | 53.8 | 88.5 | |
| Strongly Agree | 3 | 11.5 | 11.5 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
This question asks the respondents if their bank has a well-developed information system for the assessment of the risks. 53% of the respondents agree that their bank does have an effective and well-established information system, while 26% remained neutral, and 7% showed disagreement. 11% of the respondents strongly agreed.
| Q8-Controls which are implemented to manage risk are resilient. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 6 | 23.1 | 23.1 | 23.1 |
| Neutral | 5 | 19.2 | 19.2 | 42.3 | |
| Agree | 13 | 50.0 | 50.0 | 92.3 | |
| Strongly Agree | 2 | 7.7 | 7.7 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The bank employees of the conventional banks were asked if enough controls were implemented in their banks to manage the risks. The frequency table and bar chart shows that 50% of the employees agreed, 7% strongly agreed, 19% remained neutral, and 23% disagreed.
| Q9-The monitoring and control mechanism oversees risk management practices as well. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 2 | 7.7 | 7.7 | 7.7 |
| Neutral | 13 | 50.0 | 50.0 | 57.7 | |
| Agree | 10 | 38.5 | 38.5 | 96.2 | |
| Strongly Agree | 1 | 3.8 | 3.8 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The ninth question on the survey asks the respondents about the monitoring and control mechanism of the bank, which oversees the risk management practices. The employees showed that most of them are unaware of this as 50% of the employees selected the option Neutral, 7% disagreed, and 38% agreed, while 3% strongly agreed.
| Q10-The bank has an efficient risk management system. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Neutral | 5 | 19.2 | 19.2 | 23.1 | |
| Agree | 14 | 53.8 | 53.8 | 76.9 | |
| Strongly Agree | 6 | 23.1 | 23.1 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The bank has an efficient risk management system; the respondents are asked in this question if they agree with this statement. 53% of the respondents have agreed, 23% strongly agreed, 19% remained neutral, and 3% have disagreed.
| Q11-The bank effectively analyzes credit risk management. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Neutral | 5 | 19.2 | 19.2 | 19.2 |
| Agree | 15 | 57.7 | 57.7 | 76.9 | |
| Strongly Agree | 6 | 23.1 | 23.1 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
In this question, the survey asks the respondents if the bank is known to analyze its credit risk management strategies and procedures effectively. The respondents in the majority have agreed to it. Only five that make up 19% of the respondents have remained neutral. No one has disagreed, while 57% have agreed, and 23% have strongly agreed.
| Q12-The bank effectively analyzes liquidity risk management. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Strongly Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Disagree | 1 | 3.8 | 3.8 | 7.7 | |
| Neutral | 9 | 34.6 | 34.6 | 42.3 | |
| Agree | 14 | 53.8 | 53.8 | 96.2 | |
| Strongly Agree | 1 | 3.8 | 3.8 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The twelfth question asks the respondents about liquidity risk management procedures and strategies in terms of their effectiveness. Of the 26 respondents, 53% of the respondents agreed, 3% strongly agreed, 34% showed them as neutral while 3.8%, i.e., one person disagreed, and another one person strongly disagreed.
| Q13-You are satisfied with the use of risk management methods adopted by the bank where you do the job. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Strongly Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Disagree | 1 | 3.8 | 3.8 | 7.7 | |
| Neutral | 5 | 19.2 | 19.2 | 26.9 | |
| Agree | 15 | 57.7 | 57.7 | 84.6 | |
| Strongly Agree | 4 | 15.4 | 15.4 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The second last question asks the respondents if they are satisfied with the use of the methods used for risk management by their banks. 57% of the respondents agreed, 15% strongly agreed, while 19% remained neutral. Two individuals showed disagreement with the statement.
| Q14-My bank has better communication about the risks it faces in comparison to other banks in the industry. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Strongly Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Disagree | 1 | 3.8 | 3.8 | 7.7 | |
| Neutral | 5 | 19.2 | 19.2 | 26.9 | |
| Agree | 11 | 42.3 | 42.3 | 69.2 | |
| Strongly Agree | 8 | 30.8 | 30.8 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The last question of the survey to the employees and managers of the conventional banks showed that 42% plus 30% of the respondents agree that the bank has better communication about the risks as compared to the other banks. In comparison, around 20% disagree or remained neutral.
Islamic Banks Descriptive Statistics:
The outcomes of the SPSS analytical tool of the answers of the questionnaire survey from the respondents that belonged to the Islamic banks are presented in the table underneath.
| Descriptive Statistics | ||||||
| N | Minimum | Maximum | Mean | Std. Deviation | Variance | |
| Q1 | 26 | 2.00 | 5.00 | 4.2692 | 1.11562 | 1.245 |
| Q2 | 26 | 3.00 | 5.00 | 4.1923 | .56704 | .322 |
| Q3 | 26 | 2.00 | 5.00 | 4.5000 | .70711 | .500 |
| Q4 | 26 | 2.00 | 5.00 | 4.2692 | .72430 | .525 |
| Q5 | 26 | 2.00 | 5.00 | 4.0000 | .69282 | .480 |
| Q6 | 26 | 2.00 | 5.00 | 4.0769 | .68836 | .474 |
| Q7 | 26 | 2.00 | 5.00 | 3.8077 | .74936 | .562 |
| Q8 | 26 | 2.00 | 5.00 | 3.8462 | .73170 | .535 |
| Q9 | 26 | 3.00 | 5.00 | 4.0769 | .62757 | .394 |
| Q10 | 26 | 3.00 | 5.00 | 4.1154 | .65280 | .426 |
| Q11 | 26 | 3.00 | 5.00 | 4.3462 | .56159 | .315 |
| Q12 | 26 | 3.00 | 5.00 | 4.2692 | .53349 | .285 |
| Q13 | 26 | 3.00 | 5.00 | 3.9615 | .59872 | .358 |
| Q14 | 26 | 2.00 | 5.00 | 4.0000 | .80000 | .640 |
| Valid N (listwise) | 26 | |||||
The chart above here is showing the total N value, minimum value, and maximum value of the responses. While the N value shows that a total of 26 respondents answered the 14 questions presented in the questions, the minimum value here is showing the lowest selected option from the Likert scale and vice versa. This shows not for any of the questions answered by the employees of the Islamic banks, and the respondents have selected the option of strongly disagree.
As done for the conventional bank responses, the T-Test is now used to show the Mean and Standard deviation values. This is an interesting tool that gives the answers that were, on average, selected by the respondents. For instance, for Q1, the average number of responses is 4.426, which is greater than four, i.e., agree and towards strongly agree. All the questions that were asked about the risk management procedures and strategies of the bank were on average agreed to by the respondents as the mean answer for all questions is above 4 or near 3.8.
| One-Sample Statistics | ||||
| N | Mean | Std. Deviation | Std. Error Mean | |
| Q1 | 26 | 4.2692 | 1.11562 | .21879 |
| Q2 | 26 | 4.1923 | .56704 | .11121 |
| Q3 | 26 | 4.5000 | .70711 | .13868 |
| Q4 | 26 | 4.2692 | .72430 | .14205 |
| Q5 | 26 | 4.0000 | .69282 | .13587 |
| Q6 | 26 | 4.0769 | .68836 | .13500 |
| Q7 | 26 | 3.8077 | .74936 | .14696 |
| Q8 | 26 | 3.8462 | .73170 | .14350 |
| Q9 | 26 | 4.0769 | .62757 | .12308 |
| Q10 | 26 | 4.1154 | .65280 | .12803 |
| Q11 | 26 | 4.3462 | .56159 | .11014 |
| Q12 | 26 | 4.2692 | .53349 | .10463 |
| Q13 | 26 | 3.9615 | .59872 | .11742 |
| Q14 | 26 | 4.0000 | .80000 | .15689 |
Now each of the answers of the 26 respondents for each of the question will be displayed separately:
| Q1-The nature of risk within the Islamic Banking industry differs from Conventional Banking. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 4 | 15.4 | 15.4 | 15.4 |
| Neutral | 1 | 3.8 | 3.8 | 19.2 | |
| Agree | 5 | 19.2 | 19.2 | 38.5 | |
| Strongly Agree | 16 | 61.5 | 61.5 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The question inquired the participants if they agree that the nature of risk for the conventional banks and Islamic banks differ. Out of 26 respondents, only one remained neutral with this statement, four disagreed, and 0participantschose Strongly Disagreed, 16, i.e., the majority of the participants strongly agreed, and five agreed. This shows that around 61% plus 19% of the participants agreed that there is a difference in the nature of risk for both types of banks.
| Q2-You are aware of the risks faced by the bank. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Neutral | 2 | 7.7 | 7.7 | 7.7 |
| Agree | 17 | 65.4 | 65.4 | 73.1 | |
| Strongly Agree | 7 | 26.9 | 26.9 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
This is the question that inquires the participants if they are mindful of the risks faced by their banks. The answers show that 65% of the participants agreed, and 26% strongly agreed, while 0% disagreed, and 7% remained neutral. Therefore, most of the participants of the Islamic bank showed that they are aware of the risk factors.
| Q3-The bank where you do the job thoroughly understands the risk it is exposed to. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Agree | 10 | 38.5 | 38.5 | 42.3 | |
| Strongly Agree | 15 | 57.7 | 57.7 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
This is the third question that enquires the participants if they agree that their bank knows the nature and extremity of the risk to which they are exposed to. One person disagreed with this statement, while 0 remained neutral. Around 38% agreed, while 57% strongly agreed.
| Q4-The bank where I work manages its risks appropriately. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Neutral | 1 | 3.8 | 3.8 | 7.7 | |
| Agree | 14 | 53.8 | 53.8 | 61.5 | |
| Strongly Agree | 10 | 38.5 | 38.5 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The fourth question on the survey enquires the employees and Managers of the banks if they agree that their bank manages their risks appropriately. The frequencies of the table show that 53% of the participants agree, while 38% strongly agree with this statement. Around 7% of the participants either remained neutral or disagreed.
| Q5-The bank where I work effectively communicates risk management practices to its employees. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Neutral | 3 | 11.5 | 11.5 | 15.4 | |
| Agree | 17 | 65.4 | 65.4 | 80.8 | |
| Strongly Agree | 5 | 19.2 | 19.2 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
This question is ordered fifth on the survey and asks the participants about the communication of the risk management practices with the employees of the bank. Around 3.8% of the employees do not agree that these communication practices are effective, 11% are unaware of the situation, while 65% agreed, and 19% strongly agreed.
| Q6-The bank is well-prepared to identify risks it is exposed to. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Neutral | 2 | 7.7 | 7.7 | 11.5 | |
| Agree | 17 | 65.4 | 65.4 | 76.9 | |
| Strongly Agree | 6 | 23.1 | 23.1 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
In this question, the participants are inquired if the agreement that the bank is well prepared for the risks it is exposed to. The majority of the participants agree at 65%, while 23% strongly agree, and 7% were unaware of the situation, and 3.8% disagreed.
| Q7-The bank has a well-established information system for risk assessment. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Neutral | 7 | 26.9 | 26.9 | 30.8 | |
| Agree | 14 | 53.8 | 53.8 | 84.6 | |
| Strongly Agree | 4 | 15.4 | 15.4 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
This question inquires the participants if their bank has a well-developed information system for the assessment of the risks. 53% of the participants agree that their bank does have an effective and well-established information system, while 26% remained neutral, and 7% showed disagreement. 11% of the participants strongly agreed.
| Q8-Controls which are implemented to manage risk are resilient. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Neutral | 6 | 23.1 | 23.1 | 26.9 | |
| Agree | 15 | 57.7 | 57.7 | 84.6 | |
| Strongly Agree | 4 | 15.4 | 15.4 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The bank employees of the Islamic banks were asked if enough controls were implemented in their banks to manage the risks. The frequency table and bar chart shows that 58% of the employees agreed, 16% strongly agreed, 23% remained neutral, and 3.8% disagreed.
| Q9-The monitoring and control mechanism oversees risk management practices as well. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Neutral | 4 | 15.4 | 15.4 | 15.4 |
| Agree | 16 | 61.5 | 61.5 | 76.9 | |
| Strongly Agree | 6 | 23.1 | 23.1 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The ninth question on the survey inquires the participants about the monitoring and control mechanism of the bank, which oversees the risk management practices. The employees showed that the majority agree with 61% choosing agree, and 23% selected strongly agree while 15% remained neutral.
| Q10-The bank has an efficient risk management system. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Neutral | 4 | 15.4 | 15.4 | 15.4 |
| Agree | 15 | 57.7 | 57.7 | 73.1 | |
| Strongly Agree | 7 | 26.9 | 26.9 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The bank has an efficient risk management system; the participants are asked in this question if they agree with this statement. 58% of the participants have agreed, 27% strongly agreed, 16% remained neutral, and 0% have disagreed.
| Q11-The bank effectively analyzes credit risk management. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Neutral | 1 | 3.8 | 3.8 | 3.8 |
| Agree | 15 | 57.7 | 57.7 | 61.5 | |
| Strongly Agree | 10 | 38.5 | 38.5 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
In this question, the survey inquires the participants if the bank is known to analyze its credit risk management strategies and procedures effectively. The participants in the majority have agreed to it. The only one that makes up 3.8% of the participants has remained neutral; no one has disagreed, while 58% have agreed, and 38% have strongly agreed.
| Q12-The bank effectively analyzes liquidity risk management. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Neutral | 1 | 3.8 | 3.8 | 3.8 |
| Agree | 17 | 65.4 | 65.4 | 69.2 | |
| Strongly Agree | 8 | 30.8 | 30.8 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The twelfth question inquires the participants about liquidity risk management procedures and strategies in terms of their effectiveness. From the 26 participants, 65% of the participants agreed, 30% strongly agreed, 3.8% showed them as neutral 0 people disagreed or strongly disagreed.
| Q13-You are satisfied with the use of risk management methods adopted by the bank where you do the job. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Neutral | 5 | 19.2 | 19.2 | 19.2 |
| Agree | 17 | 65.4 | 65.4 | 84.6 | |
| Strongly Agree | 4 | 15.4 | 15.4 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The second last question inquires the participants if they are satisfied with the use of the methods used for risk management by their banks. 65% of the participants agreed, 15% strongly agreed, while 19.2% remained neutral. 0 individuals showed disagreement with the statement.
| Q14-My bank has better communication about the risks it faces in comparison to other banks in the industry. | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | Disagree | 1 | 3.8 | 3.8 | 3.8 |
| Neutral | 5 | 19.2 | 19.2 | 23.1 | |
| Agree | 13 | 50.0 | 50.0 | 73.1 | |
| Strongly Agree | 7 | 26.9 | 26.9 | 100.0 | |
| Total | 26 | 100.0 | 100.0 | ||
The last question of the survey to the employees and managers of the Islamic banks displayed that 50% plus 26% of the participants agree that the bank has better communication about the risks as compared to the other banks, while around 23% disagree or remained neutral.
Discussion
The results of the SPSS analysis show two points clear. Firstly, the majority of the respondents of both the banks, conventional as well as Islamic banks, agreed to the statements. Secondly, the respondents from the Islamic banks agreed more as compared to conventional banks. The Strongly Disagree option was not selected even for once by any of the respondents of the Islamic banks. Moreover, most of the respondents of the conventional banks showed Neutral opinion depicting that they are not much aware of the risk management procedures and strategies implemented at their banks.
Looking at the literature review conducted at the initial stage of the study leads to say that the two banking sectors, Islamic banks, and the conventional banks do have different risk management techniques and therefore need different methods to overcome and mitigate these risks. The most important ones that were the most prominent were the liquidity and credit risks. The literature review has shown that by creating awareness of the risk management models, aiding the communication process among the employees and the management, increasing the efficiency of the risk management processes, and making the mechanisms and control systems more effective, the banks have developed and improved the risk management process.
The literature review and the analysis of the Risk Management processes and procedures of the Islamic and conventional banking systems in Pakistan have shown that both banks carry out their risk management activities effectively. There can be differences in the products and instruments of the banks; however, the need and effort for making the risk management procedures and strategies effective and viable remains the same in both types of banks.
The research contains views of employees working in Islamic and conventional banks. The majority of respondents have agreed to statements asked in the questionnaire. The literature review has noted differences in risk management approaches and practices adopted by Islamic and conventional banks. However, there have not been considerable differences in light of the primary research results. It is worth noting that the word considerable is important here that has hidden meaning that there are differences as well.
There has been the effectiveness of risk management processes and activities in both banks. They have been effective in information systems placed for the purpose of risk management as information systems enable employees to be aware of and prepared for risk management activities. However, employees see these processes and activities differently. It is, however, not clear what are the reasons for this response. Control and monitoring mechanisms are crucial for banks and their risk management practices. Respondents have found these practices effective as well, but they have shown concerns on awareness and communication in both banks regarding risk management. Therefore, responses give the impression that respondents agree to statements, but they also highlight areas for improvement in risk management activities in both types of banks.
Looking at the results of survey questionnaire of the employees of both conventional and Islamic banks leads to say that even though the procedures, information systems, control mechanisms, and risk mitigation process implemented in both banks are effective yet different in the eyes of its employees and managers, there is still enough room for better communication and awareness regarding the subject among the employees.
Findings
The findings of the literature review and the quantitative analysis of the survey responses show that the risk identification, assessment, analysis, credit risk analysis, and risk governance techniques has been quite influential and efficient in the Islamic banking sector of Pakistan. However, on the contrary, understanding of the risk management practices, credit risk analysis, as well as the risk governance process, is the most contributing factor in terms of the conventional banks of Pakistan. Literature has revealed that there is a difference between the conventional and Islamic banks in terms of Pakistan with regards to the risk management practices, risk identification process, risk governance, and liquidity risk analysis process. In terms of the Islamic banks in Pakistan, the understanding of risk, risk management, liquidity risk analysis, risk monitoring, and its reporting are weak. While on the other hand, in conventional banks, the risk assessment and analysis are not effective adequate in conventional banks. Both types of banks, therefore, need to analyze why their weak aspects of the risk management process are not effective.
This study shows that the Islamic banks, as well as the conventional banks, need to improve their current risk management procedures to make it effective. The study has highlighted the weaknesses of both of the banking sectors. Looking at the results of the survey questionnaire of the employees of both conventional and Islamic banks leads to the belief that even though the procedures, information systems, control mechanisms, and risk mitigation processes implemented in both banks are effective yet different. In the eyes of its employees and managers, there is still enough room for better communication and awareness regarding the subject among the employees.
Islamic banks should train their employees in terms of Sharia compliance risk management techniques. Other than this, as notified from the quantitative analysis, the awareness, information systems, and communication process of the risk management and control mechanisms should be made effective in the Islamic as well as conventional banks.
Communication and awareness areas regarding risk management in Islamic banks display the area for improvements because the research finds these areas a weak. It is true for Islamic banks they have shown a weaker understanding of risk and weak risk management practices. However, they consider techniques for risk management as effective, but they find these techniques less effective in reality. Moreover, risk monitoring and risk reporting are also weak areas of research that should be the areas of concern.
Findings regarding conventional banks are also important. Conventional banks need improvement in areas of risk assessment and analysis. These risk management techniques are effective, but they are not adequate. It might be a crucial finding of this research because it shows that risk management techniques can be effective, but its practice might not be adequate. Risk assessment and analysis are areas of importance in risk management, and both kinds of banks should work to be good at these practices and techniques. However, conventional banks should focus greatly on these techniques.
Chapter 5-Conclusion and Recommendations
Conclusion
The research concludes that Islamic banks and conventional banks place great importance to risk management because it is an essential activity of the banking sector. Banks act as guarantors for their clients, and they finance their businesses and financial needs. Therefore, banks of any type have to exhibit and display an exemplary approach towards risk management. Risk is the state that is not desired, and it has negative consequences for an organization. The research has taken the case of Islamic and conventional banks simultaneously and compared risk management techniques in both types of banks. It has been noted that the research has contributed to the existing literature very much because Islamic banking is an emerging field. There has been fast growth in the sector over the years that have slowed down in the last couple of years. However, in years to come, it is expected that growth patterns in the Islamic banking sector would continue. It might attract the attention of investors and clients to see the risk management mechanism and procedures in these banks. An effective and straightforward way to do so is to compare risk management practices with conventional banks.
Overall, the research has noted that both banks have risk management procedures and processes, but there is a difference in risk management techniques and practices in both banks. The study has been able to say so because of views from employees on the risk management area. However, the main focus of the research has been to know the level of communication and awareness regarding risk management. The level of preparedness has also been vital, and the research has asked about the level of preparedness. The findings of the research note the difference in both sectors in the banking industry, but there is room for more communication and awareness on the subject in these banks.
The research has achieved the goal in light of the rationale and met all set objectives from the introduction. The first objective aimed at exploring the risk management techniques adopted by traditional and Islamic banks. Techniques adopted by both banks revolve around liquidity risk management, credit risk management, placing the infrastructure for risk management, and communication regarding these activities.
The objective has met its requirement as it is found that Islamic banks show a weak approach in terms of the understanding of risk, risk management, liquidity risk analysis, risk monitoring, and its reporting. So far as conventional banks are concerned, their risk management techniques and process are less effective. It shows the need for improvement in the risk management approach in both types of banks in the Pakistani perspective.
One of the objectives is to take the perspective of employees, and this research is based on their perspectives. Thus, this research objective has been achieved, as well. The last objectives of the research go to draw practical and academic implications of research on risk management techniques and their difference in both types of banks. Later, the research concludes and recommends in this chapter. It is encouraging to know that the research has come up with requirements and met all goals set for it.
There are limitations to the research as well as some of them have been discussed in the methodology section. Moreover, the research should also recommend practical and academic domains of research. These aspects have been covered in the next section.
Recommendations
The research recommends Islamic banks and conventional banks to narrow down the gap between risk management techniques and practice. It is nice to see that this research has covered an important area in the banking industry. However, it is worth considering that there has been a difference in these activities and practices. It is better to align risk management activities in both types of banks so that clients can have a safer banking experience.
Islamic banks have many instruments and products that are different from conventional banks. However, the difference is in terms of approach towards risk management and their performance for clients. The basic principle and purpose of each product are to finance clients and their business needs. Moreover, these products aim at providing credit facilities for clients. Therefore, both sectors in the banking industry should try to align their activities so that there is a common framework for risk management.
The research recommends that both banks should keep offering different products and services. However, risk management is an area that does not need to be different. Despite different products and business models of both banks, each bank has to reduce the risks it faces. Therefore, both sides of the banking industry should coordinate and collaborate with each other so that they can come up with a comprehensive and standardized risk management model.
The research recommends both banks to encourage research in the field of risk management because it is a very crucial area for the industry. Banks should take an interest in devising plans and techniques that can make banking experience safer and more convenient for clients. Islamic banks have presented changes in many products and processes in the banking industry. Conventional banks should learn from the business model of Islamic banks. The reason of the difference between both banks should be noted, and then risk management should be inserted as a common practice in business models of both banks. This is how; the banking industry can have common grounds to meet mutual interest and purpose.
In the end, the research has recommended academic researchers to advance their efforts in this area as risk management is an evergreen area for research. The dynamic and ever-changing environment in the banking industry calls for continuous research and advancement in each area, and minimization of risks is crucial. It has been recommended considering these aspects for future research so that the industry can reach a consensus. Islamic banks and conventional banks should join their hands in the formulation of risk management practices and techniques.
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