Project Proposal
A Comparison of the Effectiveness of the Different Risk Management Techniques Employed Within Islamic Banking, Compared to those of Traditional Banking
Abstract
The proposed research serves the purpose of studying Islamic banking and conventional banking, as both have clear differences. Risk management is one of the most prominent activities in the banking sector. Islamic banking is different from conventional banking, where the contrast lies in the disparity is in risk management and credit risk. The proposed research seeks to explore differences in both banking systems. Various dimensions can be under study to find differences, but the proposal calls for studying the difference in risk management. A mixed-methods approach is going to be used, and other salient features of the proposed study have been considered. In the end, a timeline for the research has been provided.
Introduction:
Banking has become a significant system in today’s society, and everyone has to deal with the sector. It offers liquidity, profitability, and risk management facilities to people. Businesses and individuals grow their financial activities through the banking sector. The recent emergence of Islamic banking has changed the structure and practices of the banking sector. It started from the Middle East, the growth of Islamic mode of banking in countries beyond the Middle East calls for research on it. There is a need to investigate and explore its uniqueness and difference from conventional banking principles and practices (McKim, 2017). In 2014 alone, Islamic banks grew in their assets by 34 percent, and the total number of financial services reached worth USD 1.88 trillion. Thus, according to an IMF report in 2017, Islamic banking and finance have become a prominent market in the Middle East and Asian countries.
Islamic banking has some evident differences that distinguish it from conventional banking. It follows the teachings and sources of information from the Shariah Law. Shariah Laws prohibits making money from money, making it impossible to earn through interests. Conventional banking has interest at its center. It increases concerns of ordinary people to know how Islamic banking manages risks when there is no interest in covering it. In simple, Islamic banking has a profit and loss sharing mechanism to manage risks. In this context, it becomes an essential question as to how it has a different tool from conventional banking and its risk management.
Aims and Objectives:
The proposed study has the following aims and objectives:
- To investigate and explore the financial performance of conventional and Islamic banking system
- To examine the features of Islamic banking and finance that makes it unique from conventional banking
- To measure and investigate the differences in terms of profitability, efficiency, liquidity, solvency, credit risk, liquidity risk, operational risk, market risk and other risk management practices in Islamic banking
Literature Review:
Islamic banking and the financial system follow the commerce law that is known as Fiqh al-muamalat, meaning the laws about matters in society. Commerce law is about social justice, fairness in dealings, equity in financial issues, and promotion of entrepreneurship and business in society. It puts emphasis on transparency and meeting contractual obligations between parties, following the teachings of Islam. Islamic banking and financial systems offer Shariah approved products. These products are riba or interest-free, gharar or uncertainty free, maisir or gambling free (Syakhroza, Paolella, & Munir, 2019), and clean from non-halal or prohibited activities (Alam, Gupta, & Shanmugam, 2017). Islamic teachings allow a profit and loss method in commerce and business, but a predetermined amount is not permitted in Islam. There must be a risk of loss and variability of profits in Islam because a profit should be real and the result of actual business transactions.
The literature has studied banking under conventional and Islamic perspectives applied in the world. Islamic banking is asset-based banking that banks own goods and assets. They earn a profit from transactions of products physically. They do not operate on speculations or transactions based on fixed profits. On the other hand, traditional banks earn a profit on money as well. It is in the form of interest. The difference in interest is shared among clients and banks. These banks also earn profit by offering loans and credit available for interest (Waemustafa & Sukri, 2016).
The State Bank of Pakistan has said in a report that the number of Islamic banks and financial institutions is greater than 300 those are working across around 70 countries. The World Economic Forum website explains the basic characteristics of Islamic banking. It does not allow interest or riba. There is no permission for gambling or maysir, and excessive level of uncertainty or gharar. Transactions have to show the economic purpose in a real manner. Islamic finance offers banking services, and the Islamic equivalent of a bond market called the Sukuk market. The report has mentioned the top nine countries in the Islamic banking industry, including Saudi Arabia, Malaysia, UAE, Kuwait, Qatar, Turkey, Indonesia, Bahrain, and Pakistan (Hirst, 2015). It is not necessary that Islamic banking and financial institutions are only working in Islamic countries, as many western countries also allow and promote Islamic banking (Khan & Bhatti, 2008). In the Pakistani context, some banks have capitalized on opportunities emerging from Islamic financial and banking principles. However, some traditional banks have started offering Islamic banking and financial services (Asif, Ahmed, Zahid, & Khan, 2017).
In recent years, Islamic banking has been under research increasingly because there are only a few extant research studies available. However, it is going to be a progressively interesting topic to study its differences in comparison with conventional banking. Here, one can find a gap in research because the Islamic banking and financial sector require extensive research because of the scarcity of available literature. One of its reasons is that the results of the existing studies appear to be diverging and do not end at a precise and specific point. Therefore, there is a need for more research to bring more trustworthy and authentic findings of Islamic banking and finance (Doumpos, Hasan, & Pasiouras, 2017). For instance, in one of the research studies, researchers studied Islamic banks and conventional banks under different perspectives and aspects. They took ten banks in both categories each. In this comparison, they failed to get reliable results that may find a comparison of both types of banks (Jawadi, Jawadi, Ameur, & Cheffou, 2017).
Samad (2004) has researched the comparison of both types of banking systems in Bahrain and found differences in Islamic and traditional commercial banks. The researcher compared Islamic and conventional banks based on profitability, credit risk, and liquidity. However, they concluded that Islamic banks stand different in comparison with conventional banks in terms of credit performance. However, Islamic banks do not have a considerable difference from conventional banks in terms of liquidity and profitability. Despite the fact, Islamic banks are less profitable because of the lack of network compared to traditional banking (Ali & Farrukh, 2013). Lack of trained and experienced staff is also responsible. However, Islamic banks have higher liquidity than traditional banks, which is because of restricted investment opportunities under the Sharia Law (Shawtari, Ariff, & Razak, 2019). Another reason is engaging in shorter-term and low-risk investment strategies of these banks. However, with no risk involved in credit management, Islamic banking has a considerable difference from traditional banking. Mudarabah and Musharakah call for financing with the collateral of the asset (Samad, 2004).
In terms of operational efficiency, a study by Johnes, Izzeldin, and Pappas (2014) has found that Islamic banks are not as efficient as conventional banks. It is a unique study that highlights notable attributes of Islamic banks that may affect the profitability of these institutions negatively (Johnes, Izzeldin, & Pappas, 2014). In another similar research by Olson and Zoubi (2008), Islamic banking is not efficient enough in comparison with conventional banks. It alarms the industry in terms of its sustainability and long-term profitability because it may hurt the profitability of consumers (Olson & Zoubi, 2008).
The literature review indicates that there is a lack of consistent and substantial research on the topic of differences in conventional and Islamic banking. The main component of any bank is risk management because clients prefer to be protected against loss and uncertainties. It would be beneficial for understanding how Islamic banks have different attributes in the area of risk management. A study has already revealed that Islamic banks differ based on credit risk (Samad, 2004). According to the study, modes of Modarabah and Musharakah change credit management completely. They work with having collateral of assets behind the financing. It has advantages as clients and banks can be safe from excessive uncertainty (Hirst, 2015). However, it may limit the expansion of Islamic banks as well. This is the area that requires research to know how and why credit management is different between the two types of banking sectors.
Research Methodology:
The proposed research follows a mixed-methods approach. In a mixed-methods approach, primary and secondary data form the foundation of research. The benefits of both forms of data are there because they increase the significance and effectiveness of the research. The nature of the research is to explore the problem of differentiating risk management in two different banking systems. It certainly makes it mandatory to collect as much literature and data as possible through an extensive literature review. It is also called a literature survey because there is productive research work on Islamic banking. Recent years have seen the challenges and shortcomings of the conventional banking system, as many businesses have gone bankrupt. In this context, the literature survey can offer a solid foundation for the research. It is qualitative research that employs a literature survey for exploring a phenomenon (McKim, 2017).
On the other hand, primary data makes the research unique and generalized. Primary research falls under quantitative research, and it generalizes research results. It is a basic characteristic of quantitative research that its results can be generalized. The use of statistical tests is based on variables. A researcher applies tests on variables to get objective results that are generally applicable (Zyphur & Pierides, 2017).
It is more effective because the comparatively new field of Islamic banking needs investigative research. A study on specific financial institutions would make results applicable to the Islamic banking industry. From this, it becomes clear that the proposed research is going to follow an explanatory and exploratory research design. It explores differences, and it is due to the effectiveness of the exploratory research design that new differences can come to the surface. An explanatory research design would explain the phenomenon under research. It would enable the research to explain how and why there are differences in the area of risk management in both forms of banks.
Managers and executives in Islamic banks would offer their responses against questions in the questionnaire. The methodology proposes using SPSS software to process and interpret data. However, the literature review would make the context, and in the backdrop of the literature survey, these results would be explained and discussed. It would help explore new insights and facts about the Islamic banking system and its difference with the conventional banks.
Data Collection:
In the methodology section, data collection is a crucial step that defines the authenticity of the research. The above discussion has noted that the proposed study is going to use secondary research. For the secondary research, journal articles from reputed databases, books, and authentic reports and material from credible sources would be collected. A clear review of these secondary sources would help find new perspectives and aspects of differences in both banking systems. An extensive literature survey would help develop the questionnaire that is the data collection method.
The questionnaire would collect data from participants of the study; those include managers and executives working in Islamic banking and financial institutions. They would respond to questions on risk management. Notable aspects of the banking sector would relate to profitability, solvency, liquidity, credit risk, and efficiency in the sector. A five-point Likert scale would be used and possible respondents would be around 100 respondents.
These numbers of participants are appropriate for the validity and credibility of a study. It is worth mentioning here that participants would belong only to Islamic banking and financial institutions because this sector is under research mainly. There is enough and extensive literature on conventional banking. It contains both primary and secondary research studies. Therefore, in comparison with information from secondary sources would be enough for this study. A mixed-methods approach would help relate responses to the literature on these variables.
Implications of Research in Practical Sphere:
The business and managerial spheres of the corporate world can have enough benefit from the research. It addresses a burning issue in the banking industry where Islamic banking is growing. Conventional banking does not take Islamic banking as a threat or a competitor because conventional banks are also going to offer Islamic banking services. Therefore, the difference between the two different types of banks would help the industry grow in the future. Managers in the industry would also know about the main differences, and in light of these differences, they can make appropriate decisions (Johnes, Izzeldin, & Pappas, 2014).
Limitations:
The proposed research study is using a mixed-methods approach that gives little room for limitations in the selection of suitable methodology. However, the methodology section has indicated that the proposed study would collect information and data only form Islamic banking and financial institutions. It raises one question about why there is no data collection from the conventional banking sector. However, there is a justification for taking data from one banking system only. It is the only prominent limitation of the proposed research study. The data collection instrument, a questionnaire, can also have limitations. For instance, it consists of close-ended questions. It gives limited information from respondents. However, it is widely used; therefore, it is the data collection tool (Taras, Steel, & Kirkman, 2010).
Ethical Considerations:
The proposed study knows that it is going to fetch responses and data from the banking and financial sectors. Information with these institutions is usually sensitive, and clients of these institutions call for privacy and security of the information. Therefore, this study would not ask for confidential and private information related to banks and their clients. It will focus on its purpose only, to gather more information and evidence about risk management in Islamic banking and conventional banking. Moreover, the purpose of the research would be communicated to participants, and their responses and information would be kept protected.
Conclusion:
The proposal concludes that banks have been offering their services to the public for decades, and they are playing an inevitable part in individual and public life. Recently, the Middle East and some Asian countries have seen an increase in Islamic banking. Islamic banking and financial institutions have been growing because of some fundamental differences from conventional banking. Early research into the topic indicates the scarcity of research, and it leads to further research in the field. Risk management is one of the prominent activities of a bank, and this proposed research seeks to find the difference in risk management between both forms of banking spheres.
Research Timeline:
The following is the timeline of the proposed research divided into weeks.
References
Alam, N., Gupta, L., & Shanmugam, B. (2017). Prohibition of Riba and Gharar in Islamic banking. Islamic Finance. Palgrave Macmillan, Cham , 35-53.
Ali, S., & Farrukh, F. (2013). Islamic Banking: Is the Confidence Level of Being an Islamic Banking Employee Better Than Conventional Banking Employee? An Exploratory Study Regarding Islamic Banking. Journal of Business Studies Quarterly, 4 (3), 27-42.
Asif, M., Ahmed, U., Zahid, M., & Khan, A. (2017). Motives Behind the Transfer of a Bank From Conventional Banking to Islamic Banking in Pakistan. Journal of Business and Tourism, 3 (2), 225-234.
Doumpos, M., Hasan, I., & Pasiouras, F. (2017). Bank overall financial strength: Islamic versus conventional banks. Economic Modelling, 64, 513-523.
Hirst, T. (2015). These are the top 9 countries for Islamic finance. Retrieved April 27, 2020, from https://www.weforum.org/agenda/2015/07/top-9-countries-islamic-finance/
Jawadi, F., Jawadi, N., Ameur, H. B., & Cheffou, A. I. (2017). Does Islamic banking performance vary across regions? A new puzzle. Applied Economics Letters, 24 (8), 567-570.
Johnes, J., Izzeldin, M., & Pappas, V. (2014). A comparison of performance of Islamic and conventional banks 2004–2009. Journal of Economic Behavior & Organization, 103, 93-107.
Khan, M. M., & Bhatti, M. I. (2008). Islamic banking and finance: on its way to globalization. Managerial Finance, 34 (10), 708-725.
McKim, C. A. (2017). The value of mixed methods research: A mixed methods study. Journal of Mixed Methods Research, 11 (2), 202-222.
Olson, D., & Zoubi, T. A. (2008). Using accounting ratios to distinguish between Islamic and conventional banks in the GCC region. The International Journal of Accounting, 43 (1), 45-65.
Samad, A. (2004). Performance of Interest-free Islamic banks vis-à-vis Interest-based Conventional Banks of Bahrain. International Journal of Economics, Management and Accounting, 12 (2), 1-15.
Shawtari, F. A., Ariff, M., & Razak, S. H. (2019). Efficiency and bank margins: a comparative analysis of Islamic and conventional banks in Yemen. Journal of Islamic Accounting and Business Research, 10 (1), 50-72.
Syakhroza, M. A., Paolella, L., & Munir, K. (2019). Holier than Thou? Identity Buffers and Adoption of Controversial Practices in the Islamic Banking Category. Academy of Management Journal, 62 (4), 1252-1277.
Taras, V., Steel, P., & Kirkman, B. L. (2010). Negative practice-value correlations in the GLOBE data: Unexpected findings, questionnaire limitations and research directions. Journal of International Business Studies, 41 (8), 1330-1338.
Waemustafa, W., & Sukri, S. (2016). Systematic and unsystematic risk determinants of liquidity risk between Islamic and conventional banks. International Journal of Economics and Financial Issues, 6 (4), 1321-1327.
Zyphur, M. J., & Pierides, D. C. (2017). Is Quantitative Research Ethical? Tools for Ethically Practicing, Evaluating, and Using Quantitative Research. Journal of Business Ethics, 143 (1), 1-16.
