Risk management practiced tools in the MENA region: A comparative study between Islamic and conventional banks.
Mokni, Rim Ben Selma ; Echchabi, Abdelghani ; Rajhi, Mohamed Taher 等
ABSTRACT
The purpose of the study is to investigate the current risk
management practices of Islamic and conventional banks in the MENA
region. The study is based on a survey of 47 banks, including 24
conventional and 23 Islamic banks. The collected data were analysed
using descriptive statistics and t-tests. The findings indicate that
banks in MENA region have effective risk strategies and effective risk
management frameworks in place. Furthermore, the findings reveal that
credit risk is considered the most important for both conventional and
Islamic banks followed by liquidity risk. Finally, both conventional and
Islamic banks continue to rely on traditional credit risk mitigation
tools. These findings have significant contributions to the literature
by comprehensively clarifying and critically analysing the current state
of risk management among the Islamic banks and conventional banks
located in the MENA region.
JEL Classifications: G20, G21, G28,
Keywords: risk management; MENA; Islamic banking; Islamic finance;
VaR
I. INTRODUCTION
Risk management in the financial sector is very important since the
ultimate goal of the institution is to maximize revenues and
shareholders value. Moreover, the recent financial crisis was marked by
market volatility, lack of liquidity in many financial markets and
increased systemic risk (Delloitte, 2011). This crisis has forced banks
to take a critical look at how they manage risk and has exhibited some
significant weaknesses in risk management in financial industry (KPMG,
2009). This difficulty has highlighted the importance of risk
management; as a result many institutions have reviewed their risk
management models. An active role was undertaken in re-examining their
approaches of risk management, the establishment of risk management
policy and approval of risk appetite.
Solid practices risk management in the banking sector is important
for financial stability and economic development. A robust framework of
risk management can help banks to reduce their exposure to risks, and
enhancing their ability to compete in the market (Mirakhor and Iqbal,
2007). Reducing the exposure will reduce systemic risk. Thus, it is
necessary for banks to put in place a comprehensive risk management to
identify, measure, monitor, manage, and report the various categories of
risk.
Risk management is a key element of the strategic management of the
organization. This is the process whereby organizations methodically
address the risks their activities with the goal of achieving sustained
benefit. In this regard, CBSB (2011) forces authorities to ensure that
banks have in place a comprehensive risk management. The process of risk
management is a structured and consistent approach to identify and
understand the potential risk factors and evaluation of consequences and
uncertainties associated with these risk factors identified. Based on
this information, the best plan of action is evaluated and selected to
address identified risks and achieve the desired objectives.
This study extends the work of Tafri et al. (2011) but differ in
some aspects. Firstly, the questionnaire is similar but not identical;
in fact it investigates the liquidity risk, which has not been examined
by Tafri et al. (2011). Secondly, this study explores the risk
management tools practiced in Islamic and conventional banks in a
different environment (MENA-Middle Eastern and North Africa region).
The main purpose is to examine the current practices in risk
management methodologies of Islamic and conventional banks in the MENA
region. It discusses and analyses the tools and methods used in managing
credit risk, market risk, liquidity risk and operational risk among
Islamic and conventional banks in the aim to identify the convergence in
the practices of risk management and risk mitigation between Islamic and
conventional banks.
The remainder of the paper is divided into four sections: Section
II provides a brief review of the literature, Section III describes the
methodology along with research hypotheses, Section IV discusses the
main empirical results and Section V presents the main conclusions,
limitations of the research.
II. LITERATURE REVIEW
This section presents a brief review of recent literature
discussing risk management tools practiced in banks. Unlike researches
published about risk management in general, the area of risk management
practices in financial institutions is still under-researched. While
some empirical studies examined risk management practices and the
various aspects of risk management process in the conventional banking
(Al-Tamimi and Al-Mazrooei, 2007; Al-Tamimi, 2002; Alam and
Masukujjaman, 2011), few studies only analysed risk management practices
in Islamic banking (Hassan, 2009; Khalid and Amjad, 2012). Hence, the
number of empirical studies on risk management practices in Islamic
banks is still relatively small and risk management in Islamic banks
still under-researched (Abdul Rahman et al., 2013). Another line of
research has been focused on the comparison between the practices of
risk management in Islamic banks and conventional banks (Hassan, 2011;
Hussain and Al-Ajmi, 2012; Tafri et al., 2011; Nazir et al., 2012).
Hassan (2011) provided a comparative study of banks' risk
management of Islamic and conventional banks in the Middle East region.
The multi-regression model and ANOVA test prove that there is a positive
relationship between risk management practices and understanding risk,
risk management, risk identification, risk assessment, risk monitoring,
and credit risk analysis in Islamic and conventional banks.
In the aim to compare the risk management practices between the
Islamic and conventional banking system in Bahrain, Hussain and Al-Ajmi
(2012) introduced a new modified dummy variable i.e. bank type to make
the optimum comparison. The result showed that understanding of risk and
risk management, risk identification, risk assessment analysis, risk
monitoring, credit risk analysis have a positive and significant effect
on risk management practices in Islamic and conventional banking of
Bahrain. The comparative study indicated that the levels of risks faced
by Islamic banks are found to be significantly higher than those faced
by conventional banks. Similarly, country, liquidity, and operational,
residual, and settlement risks are found to be higher in Islamic banks
compared to conventional banks. Using a regression model, Nazir et al.
(2012) explored the current risk management practices adopted by
commercial and Islamic banks in Pakistan. The findings revealed that
there is significant difference in risk management practices of the
Islamic and conventional banks of Pakistan.
Tafri et al. (2011) provided a comparative analysis of the risk
management tools practiced in Islamic and commercial banks in Malaysia
and selected Islamic banks outside Malaysia. The investigation of the
current practices of market risk, credit risk and operational risk
management reported that there are significant differences between
Islamic and conventional banks in the extent of the usage of market
value at risk, stress testing results, credit risk mitigation methods
and operational risk management tools. This present study analyses the
differences and similarities between conventional and Islamic banks in
the practice of managing credit risk, market risk, liquidity risk and
operational risk. Thus, the objective is to compare the method the two
bank types use in managing their risk. Furthermore, this research aims
to ascertain the perceptions of Islamic and conventional bankers about
the importance of transparency and public disclosure in the
understanding of the bank's risk profile.
III. METHODOLOGY
This study covers the main Islamic and conventional banks located
in the MENA region using a questionnaire survey to unravel the
perceptions of risk managers about some of the issues associated with
risk management in Islamic banks and conventional banks.
The questionnaire was developed with reference to works of Arrifin
et al. (2008), Tafri et al. (2011), Khan and Ahmed (2001), Deloitte
(2004. 2007, 2009, and 2011), and KPMG (2004). The questionnaire
consists of close-ended questions and five-point scale questions. The
questionnaire was sent to the respondents in March 2012 and the deadline
for receiving the completed questionnaire was September 2013.
A total of 47 survey questionnaires were collected from banks risk
managers whose 24 were received from conventional banks and 23 from
Islamic banks. The questionnaire was distributed using different
methods, namely, online and self-administered. It is noteworthy that the
MENA countries covered in the study are Bahrain, Jordan, Kuwait,
Lebanon, Qatar, Saudi Arabia, United Arab Emirates, Algeria, Tunisia and
Egypt.
IV. RESEARCH FINDINGS
A. Risk Management System and Process
Table I deliberates some aspects of establishing a risk management.
The table indicates that the percentages to the five statements by
conventional bankers are higher than those of their Islamic
counterparts. From the table, it can be seen that 83.3 per cent of
conventional banks have a formal risk management system in place in
their institutions as compared to Islamic banks (62.5 per cent). On the
other hand, 87.5 per cent of conventional banks have a committee/section
responsible for identifying, monitoring, and controlling different risks
compared to 58.3 per cent only for Islamic banks. Furthermore, 100 per
cent of the conventional banks believe that managing risk is important
to the performance and the success of the banks; against 82.6 per cent
for Islamic banks. In addition, 91.7 per cent of conventional banks
think that the application of risk management techniques reduces costs
and expected losses average and 83.3 per cent for Islamic banks. This
finding indicates that there is a difference in the establishment of an
appropriate risk management environment between Islamic and conventional
banks.
B. Risk Types
Banks are exposed to a variety of risks. The importance of those
types depends on the asset portfolio, the way they conduct their
business lines (i.e. conventional or Islamic), and regulatory
requirements (Abu Hussain and Al-Ajmi, 2012). Table 2 presents the
descriptive statistics of the importance of the risks in the surveyed
banks as perceived by the bankers. The types of risk are shown in terms
of relative importance based on the mean responses of the whole sample.
From the results shown in Table 2, it can be seen that on average, as
indicated by mean values, the conventional bankers rank credit risk as
the most important, followed by liquidity risk and market risk. Foreign
exchange risk is rated on average as the least important risk in
conventional banks by the survey respondents. On the other hand, the
results show that the most important risk Islamic banks face is
liquidity risk followed by credit risk. Operational risk is ranked third
by Islamic bankers. This finding may be explained by the inclusion of
operational risk in the Basel II capital framework that made it a higher
priority, and many institutions have created or expanded their programs
for managing operational risk.
Bankers in conventional and Islamic banks reported and ranked
credit risk and liquidity risk as the most important risks they face.
This result may be explained by the fact that credit risk has long been
identified as the dominant risk for banking firms and is an inherent
part of their core lending business also credit risk cause cash flow
problems and subsequently affect the liquidity of the bank. Furthermore,
the introduction of the liquidity framework Basel III mandates
institutions to comply with quantitative and qualitative liquidity
standards. These results are somewhat similar to those found by Arrifin
et al. (2009) who reported that Islamic bankers perceived credit risk as
the most important. However, those findings contradict those of Khan and
Ahmed (2001) and Al-Tamimi and Al-Mazrooei (2007).
The t-test is used to test the hypothesis that the risk perceptions
are different between conventional and Islamic bankers. According to the
results, there is no significant difference in risk perception between
conventional and Islamic banks in terms of liquidity risk, foreign
exchange risk and operational risk. However, the results indicate that
there difference is significant at 10% for both credit risk and market
risk, whereby conventional banks consider these two types of risks to be
more important compared to their Islamic counterpart.
C. Credit Risk
Credit risk is the most important risks faced by banks, since the
default may cause other risks such as liquidity risk, interest rate
risk. For this reason, credit risk is the main cause of bank failures.
The goal of credit risk management is to maximize a bank's
risk-adjusted rate of return by maintaining credit risk exposure within
acceptable parameters (BCBS. 2000). It is noteworthy that the global
financial crisis led to large credit losses that expedite an increased
focus on managing credit risk.
Risk managers were asked which tools their institutions used for
measuring counterparty credit exposure. The results in Table 3 indicate
that the means range between 3.11 and 3.50. The lowest mean response is
allocated to the principal/notional technique. The mean responses to the
first two statements (principal/notional and assessing potential
counterparty/issuer exposure by simulation) by conventional bankers are
relatively higher than those of their Islamic counterparts.
Nevertheless, for the third statement (Sum of potential exposure for
individual transaction), the mean for Islamic banks is higher compared
to the conventional counterpart. However, none of these differences is
statistically significant.
Stress testing is one method that financial institutions can employ
to upgrade their capacities to assess risk in stressed market conditions
and adverse economic. Table 4 shows that the majority of Islamic banks
use "Default rates by underlying factor such as
obligator/sector/rating/geography/vintage" technique for stress
testing (a mean value of 4.36). For Islamic banks, the lowest mean
response was "Do not have stress tests specially designed for risks
affecting the credit portfolio". For conventional banks, the
highest response was "Default rates by underlying factor such as
obligator/sector/ rating/geography/vintage" and
"correlation", and the lowest mean was "Recovery
rates". For the full sample, results show that banks use somewhat
stress testing for Default rates by underlying factor such as
obligator/sector/rating/geography/vintage. The differences in using
these tools between conventional and Islamic banks are significant for
the first three types (Default rates by underlying factor such as
obligator/sector/rating/geography/vintage, Recovery rates, and interest
rate changes), whereby the Islamic banks apply these instruments more
than the conventional banks. However, the difference is not significant
for the last three types (con-elation, spreads by underlying name, and
do not have stress tests specially designed for risks affecting the
credit portfolio).
As credit risk is the most important type of risk, banks use many
tools to mitigate this risk. The survey also asked risk managers about
their institutions' tools used in credit risk mitigation. Table .5
provides information about the sample's responses on this item. It
can be seen from the inspection of the table that the majority of
surveyed banks (Islamic and conventional banks) use extensively
guarantees (a mean of 4.40) and collateral (a mean of 4.31), and plan to
use the other tools in the future. This finding indicates that the
surveyed banks continue to rely on traditional methods to mitigate
credit risk. This result is consistent with the findings of Tafri et al.
(2011). Furthermore, there is a significant difference between
conventional and Islamic banks in terms of on balance sheet netting,
whereby the conventional banks are more extensively applying it.
The non-significant difference between Islamic and conventional
banks in the use of tools for measuring counterparty credit exposure
across the two types of banks and the partial differences for stress
testing used for risk factors affecting the credit portfolio and the
credit risk mitigation tool indicate that there is no overall difference
in the usage of credit risk management tools between Islamic and
conventional banks.
D. Market Risk
Since the financial crisis, an important origin of losses and
build-up of leverage occurred in the trading book. Thus, financial
institutions shall have in place an appropriate framework for market
risk management.
In response to the financial crisis, the BCBS introduce the Basel
Market Risk Amendment in 1996 codified regulatory expectations, and
helped propel the implementation of internal models, illustrated by the
development of Value at Risk methodologies initiated by the larger banks
through the mid through late 1990s. In this regard, the results in Table
6 indicate that 52.2 per cent of conventional banks use VaR. while just
35 per cent of Islamic banks apply it, which implies that market VaR is
not extensively used by Islamic banks.
Table 7 depicts that the majority of conventional banks use market
VaR for foreign exchange and fixed income instruments. This result is
similar to Tafri et al. (2011). For Islamic banks, market VaR is lightly
used. This finding suggests that Islamic banks do not use the more
technically advanced risk measurement approaches as those used by their
conventional counterparts, due to the fact that Islamic banks are still
developing and face serious challenges, also some Islamic banks are
small in size and the lack of ratings or external sources of credit
assessment for the clients of most Islamic banks (Arrifin et al., 2008).
Given the complexity of the market risks assumed by financial
institutions, VaR become insufficient. In fact, VaR does not calculate
the potential impact of low frequency events that could be considerable.
Stress tests are an important supplement to VaR since they take account
of possible events by considering potential large moves in market
prices, volatility, leverage and time needed to liquidate assets. Stress
testing has become increasingly popular as a tool that financial
institutions can employ to assess their ability to withstand extreme but
rare events (Deloitte. 2012).
Table 8 exhibits the frequency of responses for the usage of stress
tests through banks. For conventional banks, stress testing is used to
report to senior management (a mean of 3.96), report to the board of
directors (a mean of 3.83), understand the institution's risk
profile (a mean of 3.79), set limits (a mean of 3.63), conduct strategic
planning (a mean of 3.46), in response to enquiries from rating agencies
and regulators (a mean of 3.45), and to trigger further analysis (a mean
of 3.42).
In the case of Islamic banks, the stress testing results are
extensively used for reporting to senior management, reporting to the
board of directors, and understanding the institution's risk
profile (a mean of 4.04), followed by its use in response to enquiries
from rating agencies and regulators (a mean of 4), for triggering
further analysis (a mean of 3.50), conducting strategic planning (a mean
of 3.25), and setting limits (a mean of 3.21). Hence, Islamic banks
extensively use the stress testing results compared to conventional
banks. This finding contradicts the findings of Tafri et al. (2011).
However, none of these differences is statistically significant.
E. Operational Risk
Financial institutions had traditionally focused their risk
management programs on market and credit risk. The recent breakdowns
resulting from enforcement actions, major losses from failed investment
strategies, misuse of client funds, computer malfunctions, have
highlighted the need to upgrade operational risk management at many
institutions.
The inclusion of operational risk in the Basel II capital framework
made it a higher priority; furthermore many financial institutions have
created or expanded their programs for managing operational risk. To
capture the progress of the implementation of aspects of operational
risk management, six statements are included in the questionnaire. The
summaries of the responses are presented in Table 9. The mean responses
of all groups to the statements range between 3.57 and 4.23, with an
overall average of 3.91. The highest mean is for the statement,
"Identifying risk type" followed by "gathering relevant
data", then "Standardizing documentation of processes and
controls". The lowest mean is for the statement "Creating
metrics for monitoring each type of operational risk". This
indicates that most banks have implemented some of the basic steps in an
operational risk management program by identifying risk type and
gathering relevant data. Similar results are found for the subgroups of
conventional and Islamic banks.
To assess the extent of development of operational risk
methodologies at the banks' organizations, 11 statements are
included in the questionnaire. Table 10 reports the responses of the
whole sample, conventional bankers and Islamic bankers. The mean
responses to the twelve statements range between 3 and 4.13 with an
overall average of 3.56. It can be seen that the tool which is
extensively used by the whole sample is key risk indicators (a mean of
4.13), risk assessment techniques (a mean of 3.96), internal loss event
database (a mean of 3.92), risk mapping (a mean of 3.68), internal audit
results/scores (a mean of 3.59), balanced scorecard (a mean of 3.55),
scenario analysis (a mean of 3.52), causal event analysis (a mean of
3.42), external loss event analysis (a mean of 3.36), and TQM techniques
(a mean of 3.07). It is worth noting that the banks do not use the
Six-Sigma method (a mean of 3).
Islamic banks extensively use three tools, namely, key risk
indicator (a mean of 4.29), risk assessment techniques (a mean of 4.08),
internal loss event database (a mean of 3.96). The least employed tools
are external loss event analysis (a mean of 3.08), causal event analysis
and Six Sigma (a mean of 3.21), TQM techniques (a mean of 3.22), and
internal audit results/scores (a mean of 3.25).
For conventional banks, the mostly used techniques are key risk
indicator (a mean of 3.96), internal audit results/scores (a mean of
3.92), internal loss event database (a mean of 3.88), risk assessment
techniques (a mean of 3.83), and causal event analysis and external loss
event analysis (a mean of 3.63). Moreover, conventional banks gave
indications that they are planning to use Six-Sigma (a mean of 2.79) and
TQM techniques (a mean of 2.91).
The results of Tables 9 and 10 provide evidence that there is no
significant difference in the usage of operational risk management
methods between Islamic and conventional banks.
F. Liquidity Risk
The market turmoil that began in mid-2007 highlighted the
importance of liquidity for the functioning of financial markets and the
banking sector. Furthermore, financial innovation and global market
developments have transformed the nature of liquidity risk in recent
years (BCBS. 2008). These factors force banks to maintain adequate
liquidity and to improve their liquidity risk management and control
their liquidity risk exposures.
To capture the response of banks to the changed liquidity
environment 9 settlements were developed. Table 11 indicates that the
mean responses to the nine statements by Islamic bankers are generally
higher than those of their conventional counterparts. To test the
hypothesis that the mean responses of the samples are not significantly
different, t-statistics were used. The t-statistics indicate that the
mean responses of conventional and Islamic bankers are significant for
"Revise contingency funding plan (CFP)", and "Treasury
and ALM systems" (at 5% level of significance), and "Integrate
treasury function with risk management function", "Enhance
liquidity stress testing", and "Maintain liquid asset
portfolios" (at 10% level of significance).
The need for stronger liquidity management has been recognized
since the global financial crisis. Basel III introduced a liquidity
framework that mandates institutions to comply with quantitative and
qualitative liquidity standards. To meet the new challenges and
requirements, institutions are asked to enhance their liquidity risk
management tools, procedures and policies. In this context, surveyed
Islamic banks have taken a wide array of actions.
To identify the procedures/practices used for managing liquidity
risk, bankers were asked to state their perceptions of nine settlements
on closed-ended questions. From Table 12, it can be seen that all banks
mostly analyse type of depositors, withdrawing factor (81.3 percent) and
weakly concentrate financing on short-term debt based financing (48.9
percent). The proportion of affirmative responses to the nine statements
by Islamic bankers is higher than those of their conventional
counterparts, except for the last statement i.e. "Preferring SME
(small and medium enterprises) that have low record of non-performing
financing (NPF)".
Banks have several liquid instruments to employ. Underscoring this
point, the survey findings are summarised in Table 13 above. The results
shown in the table indicate that instruments mostly used by the most of
the banks are funds in central banks (77.1 per cent), cash reserves (75
per cent), and money market instruments (62.5 per cent). Tools that are
used to a lesser extent are emergency liquidity facility from the
central bank or the government (47.9 per cent) and funds in other
Islamic banks (58.3 per cent).
On the other hand, the conventional banks use extensively funds in
the central bank (87.5 per cent), followed by cash reserves (75 per
cent) and money market instruments (66.7 per cent). The least used
instruments are funds in other banks (45.8 per cent). Instruments used
by Islamic banks are cash reserves (75 per cent), funds in other Islamic
banks (70.8 per cent), funds in central banks (66.7 per cent), and the
least used instrument is emerging liquidity facility from central
bank/government (41.7 per cent).
G. Transparency and Market Discipline
Transparency has become more challenging in recent years as
banks' activities have become more complex and dynamic in the sense
that many banks have in addition to traditional banking activities a
large-scale international operations and significant participation in
securities and/or insurance businesses. Thus, their product lines
changed rapidly and included well-sophisticated transactions, and they
have complex legal and managerial structures.
These banks present direful challenges to market participants and
supervisors who need to formulate on-going assessments of banks'
activities and risks. At the same time the potential benefits of
disclosure for supervisors have grown as the scope of banks' market
activities has expanded, thereby increasing the potential for market
discipline to function as a complement to supervision (BCBS, 1998).
Hence, transparency is one of the key points for establishing market
discipline. To achieve transparency, a bank must provide timely,
accurate, relevant and sufficient disclosure of qualitative and
quantitative information that enables users to make proper assessment of
the institution's activities and risk profile.
Bankers are asked to give their perceptions about market discipline
and transparency. Table 14 reports the responses of the whole sample,
conventional bankers and Islamic bankers. Roughly 79.2 percent of
conventional surveyed bankers believe that transparency is essential for
achieving market discipline. The same percentage was recorded to the
statement that effective disclosure permits that market participants
have better understanding of the banks' risk profile. For Islamic
banks, the higher percentage is associated with the statement that
Enhanced public disclosure allows market discipline to work earlier and
more effectively (87.5 per cent) followed by the two statements that
"Transparency in financial reports on risks allow to more
accurately assess a banks' financial strength and performance"
and "Public disclosure can reinforce specific supervisory measures
designed to encourage banks to behave prudently" (83.3 per cent).
Consequently, Islamic and conventional banks in the MENA region
appreciative the role of transparency and market discipline and
encourage the disclosure of risk information.
V. DISCUSSIONS AND CONCLUSIONS
The global financial and economic crisis has created a new dynamic
environment for financial institutions. This unsettled market has
underscored the importance of well-designed financial safety,
particularly crisis prevention strategies to ensure the soundness and
stability of the financial system. Prevention strategies will be
promoted by risk management, public disclosure and supervisory
information.
The purpose of this paper is to report the results of an empirical
study of the risk management tools of conventional and Islamic banks
operating in the MENA region. A questionnaire was used to obtain the
information needed to achieve the study's objectives. The main
conclusions of the study are:
* Bankers in MENA region are aware of the importance and the role
of effective risk management in reducing costs and improving bank
performance.
* Banks in MENA region have in place effective risk strategies and
effective risk management frameworks (infrastructure, process and
policies).
* Credit risk is the most important in the conventional and Islamic
banks followed by liquidity risk. There is no significant difference in
risk perception between conventional and Islamic banks in terms of
liquidity risk, foreign exchange risk and operational risk
* There is difference between conventional and Islamic bank in the
usage of stress testing results, the market VaR, the operational risk
management and the liquidity risk management tools. These divergences
may be due to the different nature of the two banks and the obligation
of Islamic banks to be compliant to Islamic law (Shariah), which,
prohibited interest rate in banking transactions, which might have some
effect on the operation of that organization.
* Conventional banks and Islamic banks continue to rely on
traditional credit risk mitigation tools.
* Banks perceive the role of transparency and market discipline and
encourage the disclosure of risk information with reference to Basel II.
These findings have significant contributions to the literature by
comprehensively clarifying and critically analysing the current state of
risk management among the Islamic banks and conventional banks located
in the MENA region. This would subsequently have significant
implications to the practitioners, as well as to the policy makers and
regulators to whom the findings provide important insights on the
possible areas to be strengthened for a more effective and efficient
management of risk for the financial institutions in general.
Hence, the further extension of this research can be focused on a
comparative study between banks and insurance firms in the fast growing
MENA region. The study may be conducted in another region; thereby
interesting results may be expected, because risk management practices
are mainly affected by specific factors such as economic conditions,
competition and regulations. Further research may also consider
analysing equity investment risk and rate of return risk.
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beyond the Credit Crisis, KPMG International, Berne.
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KPMG International.
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Prudential Regulation and Supervision." IMF Working Paper, No. 30.
Nazir, M.S.. A. Daniel, and M.M, Nawaz, 2012, "Risk Management
Practices: A Comparison of Conventional and Islamic Banks in
Pakistan," American Journal of Scientific Research, 68, 1 14-122.
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Evidence on the Risk Management Tools Practiced in Islamic and
Conventional Banks," Qualitative Research in Financial Markets,
3(2), 86-104.
Rim Ben Selma Mokni (a), Abdelghani Echchabi (b), Mohamed Taher
Rajhi (c)
(a) Faculty of Management Sciences and Economics El-Manar
University, Tunis, Tunisia
[email protected]
(b) College of Business, Effat University Jeddah 21478, Saudi
Arabia abdelghani.
[email protected]
(c) Faculty of Management Sciences and Economics El-Manar
University, Tunis, Tunisia mt.
[email protected]
Table 1
Establishing appropriate risk management environment
Items Full sample
Yes (%)
Do you have a formal Risk management 72.9
system in place in your institutions'?
Is there a committee/section responsible for
identifying, monitoring, and controlling 72.9
different risks?
Is the internal Auditor responsible of reviewing
and identifying the risk management analysis 77.1
systems, guidelines and risk reporting?
Do you think that Managing risk is important 91.5
to the performance and success of the bank?
Do you believe that the application of risk
management techniques reduces costs and 87.5
expected losses average?
Items Conventional banks
Yes (%)
Do you have a formal Risk management 83.3
system in place in your institutions'?
Is there a committee/section responsible for
identifying, monitoring, and controlling 87.5
different risks?
Is the internal Auditor responsible of reviewing
and identifying the risk management analysis 79.2
systems, guidelines and risk reporting?
Do you think that Managing risk is important 100
to the performance and success of the bank?
Do you believe that the application of risk
management techniques reduces costs and 91.7
expected losses average?
Items Islamic banks
Yes (%)
Do you have a formal Risk management 62.5
system in place in your institutions'?
Is there a committee/section responsible for
identifying, monitoring, and controlling 58.3
different risks?
Is the internal Auditor responsible of reviewing
and identifying the risk management analysis 75.0
systems, guidelines and risk reporting?
Do you think that Managing risk is important 82.6
to the performance and success of the bank?
Do you believe that the application of risk
management techniques reduces costs and 83.3
expected losses average?
Table 2
The importance of risks
Items Full sample Conventional banks Islamic banks
Mean SD Mean SD Mean
Credit risk 4.25 0.79 4.46 0.59 4.04
Market risk 3.98 0.96 4.25 0.61 3.70
Liquidity risk 4.27 0.79 4.29 0.69 4.25
Foreign exchange risk 3.71 1.06 3.67 0.87 3.75
8Operational risk 4.00 0.91 4.13 0.74 3.88
Items
SD t
Credit risk 1.00 1.79 (*)
Market risk 1.30 1.73 (*)
Liquidity risk 0.90 0.19
Foreign exchange risk 1.26 -0.28
8Operational risk 1.08 0.84
(***). (**), and (*) refer to significance at 10%. 5%. and 1%.
respectively
Table 3
Credit risk exposure techniques
Items Full sample Conventional banks
Mean SD Mean SD Mean
Principal/notional 3.11 1.35 3.43 1.34 2.78
Assessing potential
counterparty/issuer exposure by 3.50 1.14 3.55 1.14 3.45
simulation
Sum of potential exposure for 3.39 1.25 3.18 1.40 3.59
individual transaction
Items Islamic banks
SD t
Principal/notional 1.35 1.46
Assessing potential
counterparty/issuer exposure by 1.14 0.26
simulation
Sum of potential exposure for 1.10 -1.20
individual transaction
Table 4
Types of the stress testing used for risk factors affecting the credit
portfolio
Items Full sample Conventional banks
Mean SD Mean SD
Default rates by underlying
factor such as 3.89 1.29 3.32 1.14
obligator/sector/rating/geogr
apliy/vintage
Recovery rates 3.07 1.26 2.61 1.31
interest rate changes 3.20 1.21 2.78 1.32
Correlation 3.84 1.30 3.32 1.43
Spreads by underlying name 3.00 1.27 2.64 1.37
Do not have stress tests
specially designed for risks 3.31 1.15 2.86 1.41
affecting the credit portfolio
Items Islamic banks
Mean SD t
Default rates by underlying
factor such as 4.36 1.44 -2.47 (**)
obligator/sector/rating/geogr
apliy/vintage
Recovery rates 3.39 1.20 -2.27 (**)
interest rate changes 3.83 1.10 -3.11 (***)
Correlation 2.95 1.18 1.19
Spreads by underlying name 2.95 1.16 -0.70
Do not have stress tests
specially designed for risks 2.52 0.89 0.69
affecting the credit portfolio
(***). (**). and (*) refer to significance at 10%, 5%. and 1%.
respectively
Table 5
Credit risk mitination tools
Items Full sample Conventional banks
Mean SD Mean SD
Collateral 4.31 1.00 4.33 1.09
Guarantees 4.40 0.97 4.29 1.16
On balance sheet 3 31 1 02 3 61 1 03
netting
Off balance sheet 3.16 0.96 3.35 0.98
netting
Syndication and 3.38 0.67 3.33 1.17
participation
Credit insurance 3.12 1.08 3.17 1.13
programs
Asset sccuritisation 2.98 1.15 2.88 1.19
vehicles
Credit derivatives 2.55 1.15 2.67 1.24
Items Islamic banks
Mean SD t
Collateral 4.29 0.91 0.14
Guarantees 4.50 0.78 -0.71
On balance sheet 3 00 1 00 2.18 (**)
netting
Off balance sheet 2.96 0.93 1.48
netting
Syndication and 3.42 0.18 -0.28
participation
Credit insurance 1 46 1 02 -1.00
programs
Asset sccuritisation 3.08 1.10 -0.74
vehicles
Credit derivatives 2.42 1.06 0.86
(***), (**). and (*) refer to significance at 10%. 5%, and 1%,
respectively
Table 6
VaR usage for monitoring market risk
Items Full sample Conventional bank Islamic banks
Usage (%) Usage (%) Usage (%)
VaR usage 44.2 52.2 35.0
Table 7
Extent of usage of market risk VaR
Items Full sample Conventional banks
Mean SD Mean SD
Fixed income 3.11 1.05 3.64 1.01
Foreign exchange 3.50 1.05 3.86 0.95
Equity 3.22 1.12 3.57 1.28
Asset backed 2.93 1.20 3.21 1.25
securities
Credit derivatives 2.97 1.19 2.93 1.07
Commodity 2.72 0.95 2.64 1.01
Catastrophe or other
events driven 2.40 0.94 2.50 1.16
instruments
Items Islamic banks
Mean SD t
Fixed income 2.57 1.09 2.79 (***)
Foreign exchange 3.14 1.14 1.74
Equity 2.86 0.95 1.93 (*)
Asset backed 2.64 1.15 1.42
securities
Credit derivatives 3.00 1.30 -0.16
Commodity 2.79 0.89 -0.38
Catastrophe or other
events driven 2.29 0.73 0.56
instruments
(***), (**). and (*) refer to significance at 10%. 5%. and 1%,
respectively
Table 8
Level of usage of stress testing tools
Items Full sample Conventional banks Islamic banks
Mean SD Mean SD Mean SD
Report to senior 4.00 1.17 3.96 1.30 4.04 1.04
management
Report to the board of 3.94 1.04 3.83 1.27 4.04 0.81
directors
Understand the
institution's risk 3.92 1.05 3.79 1.29 4.04 0.81
profile
In response to enquiries
from rating agencies 3.73 1.22 3.45 1.41 4.00 1.02
and regulators
Trigger further analysis 3.46 1.21 3.42 1.35 3.50 1.06
Set limits 3.42 1.25 3.63 1.28 3.21 1.22
Conduct strategic
planning 3.36 1.29 3.46 1.29 3.25 1.29
Items
t
Report to senior -0.28
management
Report to the board of -0.76
directors
Understand the
institution's risk -0.97
profile
In response to enquiries
from rating agencies -1.34
and regulators
Trigger further analysis -0.21
Set limits 1.07
Conduct strategic
planning 0.49
(***), (**), and (*) refer to significance at 10%, 5%, and 1%.
respectively
Table 9
Extent of implementing operational risk management
Full sample Conventional banks
Items Mean SD Mean SD
Identifying risk type 4.23 0.88 4.17 1.01
Gathering relevant data 4.11 0.98 4.00 0.98
Developing
methodologies to 3.88 0.81 3.58 0.97
quantify risks
Standardizing
documentation of 3.94 1.01 3.96 1.00
processes and controls
Roll-out of a formal
operational risk training 3.75 0.97 3.79 0.98
program
Creating metrics for
monitoring each type of 3.57 0.99 3.63 0.88
operational risk
Islamic banks
Items Mean SD t
Identifying risk type 4.29 0.75 -0.46
Gathering relevant data 4.21 0.98 -0.59
Developing
methodologies to 4.17 0.64 -2.23 (**)
quantify risks
Standardizing
documentation of 3.92 1.02 0.13
processes and controls
Roll-out of a formal
operational risk training 3.71 0.96 0.28
program
Creating metrics for
monitoring each type of 3.50 1.10 0.45
operational risk
(***), (**). and (*) refer to significance at 10%, 5%, and 1%,
respectively
Table 10
Extent of development of operational risk management methodologies
Items Full sample Conventional bank
Mean SD Mean SD
Risk assessment 3.96 0.91 3.83 1.09
techniques
Key risk indicators 4.13 0.80 3.96 1.04
Internal loss event
database 3.92 1.17 3.88 1.08
Scenario analysis 3.52 1.04 3.58 1.21
Causal event analysis 3.42 1.01 3.63 1.21
External loss event 3.36 1.02 3.63 1.17
analysis
Internal audit 3.59 1.09 3.92 1.21
results/scores
Balanced scorecard 3.55 1.19 3.48 1.16
Risk mapping 3.68 1.07 3.57 1.08
Six Sigma 3.00 1.00 2.79 0.93
TQM techniques 3.07 1.02 2.91 0.95
Items Islamic banks
Mean SD t
Risk assessment 4.08 0.73 -0.84
techniques
Key risk indicators 4.29 0.56 -1.36
Internal loss event
database 3.96 1.26 -0.21
Scenario analysis 3.46 0.87 0.43
Causal event analysis 3.21 0.82 1.48
External loss event 3.08 0.86 1.92 (*)
analysis
Internal audit 3.25 0.97 2.23 (***)
results/scores
Balanced scorecard 3.61 1.22 -0.34
Risk mapping 3.78 1.05 -0.72
Six Sigma 3.21 1.07 -1.39
TQM techniques 3.22 1.09 -1.00
(***), (**), and (*) refer to significance at 10%. 5%, and 1%.
respectively
Table 11
Usage of tools in managing liquidity risk
Items Full sample Conventional bank
Mean SD Mean SD
Strengthen liquidity
risk management 4.21 0.94 4.04 1.16
function
Policy 3.85 1.20 3.65 1.47
Revise contingency 3.46 1.15 3.00 1.47
funding plan (CFP)
Diversified funding
sources 3.81 1.15 3.54 1.29
Decrease position
limits ( liquidity risk 3.61 1.18 3.75 1.19
tolerance)
Treasury and ALM
systems 3.87 1.14 3.39 1.44
Integrate treasury
function with risk 4.00 1.14 3.61 1.44
management function
Enhance liquidity 3.78 1.19 3.42 1.47
stress testing
Maintain liquid asset 3.75 1.07 3.46 1.29
portfolios
Items Islamic banks
Mean SD t
Strengthen liquidity
risk management 4.38 0.71 -1.12
function
Policy 4.04 0.93 -1.06
Revise contingency 3.92 0.83 -2.58 (*)
funding plan (CFP)
Diversified funding
sources 4.08 1.02 -1.48
Decrease position
limits ( liquidity risk 3.46 1.18 1.02
tolerance)
Treasury and ALM
systems 4.35 0.83 -2.80 (**)
Integrate treasury
function with risk 4.39 0.84 -2.08 (*)
management function
Enhance liquidity 4.13 0.9. -1 98 (*)
stress testing
Maintain liquid asset 4.04 0.86 -2.02 (*)
portfolios
(***), (**), and (*) refer to significance at 10%, 5%, and 1%.
respectively
Table 12
Procedures/practices used to manage liquidity risk
Items Full sample Conventional banks
Usage (%) Usage (%)
Anal} sing type of deposits.
tenor, etc. for financing
purposes 72.3 58.3
Analysing type of
depositors, withdrawing
Factor, etc. 81.3 66.7
Retaining profit and
allocation for risk
investment reserves 68.8 58.3
Preferring liquid, profitable.
and highly returnable
economic sectors 75.0 66.7
Concentrating financing on
short-term debt based
financing 48.9 34.8
Financing short-term
projects with more funds
available in short-term 70.8 62.5
deposits
Cooperation and
communication with
entrepreneurs 64.6 58.3
financing monitoring and
evaluation 77.1 75.0
Preferring SME ( small and
medium enterprises) which
nave low record of non-
performing financing (MPF) 52.1 58.3
Items Islamic banks
Usage (%)
Anal} sing type of deposits.
tenor, etc. for financing
purposes 87.0
Analysing type of
depositors, withdrawing
Factor, etc. 95.8
Retaining profit and
allocation for risk
investment reserves 79.2
Preferring liquid, profitable.
and highly returnable
economic sectors 83.3
Concentrating financing on
short-term debt based
financing 62.5
Financing short-term
projects with more funds
available in short-term 79.2
deposits
Cooperation and
communication with
entrepreneurs 70.8
financing monitoring and
evaluation 79.2
Preferring SME ( small and
medium enterprises) which
nave low record of non-
performing financing (MPF) 45.8
Table 13
Instruments used for managing liquidity risk
Items Full sample Conventional banks Islamic banks
Usage (%) Usage (%) Usage (%)
Cash reserves 75.0 75.0 75.0
funds in the
central bank 77.1 87.5 66.7
funds in other banks 58.3 45.8 70.8
Using emergency
liquidity facility from
central bank/government 47.9 54.2 41.7
Using the money market
instruments 62.5 66.7 58.3
Table 14
Perceptions of the issue of market discipline and transparency in banks
Items Full sample
Usage (%)
Transparency is essential for achieving
market discipline 75.0
Effective disclosure permit that market
participants have better understanding of
the banks' risk profile 77.1
Enhanced public disclosure allows market
discipline to work earlier and more
effectively 81.3
Market discipline based on adequate
public disclosure encourage banks to
maintain sound risk management systems
and practices 64.6
Transparency in financial reports on risks
allow to more accurately assess a banks'
financial strength and performance 79.2
Public disclosure can reinforce specific
supervisory measures designed to
encourage banks to behave prudently 70.8
If the performance of the bank is great,
the bank tend to disclose more
information to the market on its risks and
risk management practices 75.6
Items Conventional banks
Usage (%)
Transparency is essential for achieving
market discipline 79.2
Effective disclosure permit that market
participants have better understanding of
the banks' risk profile 79.2
Enhanced public disclosure allows market
discipline to work earlier and more
effectively 75.0
Market discipline based on adequate
public disclosure encourage banks to
maintain sound risk management systems
and practices 62.5
Transparency in financial reports on risks
allow to more accurately assess a banks'
financial strength and performance 75.0
Public disclosure can reinforce specific
supervisory measures designed to
encourage banks to behave prudently 58.3
If the performance of the bank is great,
the bank tend to disclose more
information to the market on its risks and
risk management practices 71.4
Items Islamic banks
Usage (%)
Transparency is essential for achieving
market discipline 70.8
Effective disclosure permit that market
participants have better understanding of
the banks' risk profile 75.0
Enhanced public disclosure allows market
discipline to work earlier and more
effectively 87.5
Market discipline based on adequate
public disclosure encourage banks to
maintain sound risk management systems
and practices 66.7
Transparency in financial reports on risks
allow to more accurately assess a banks'
financial strength and performance 83.3
Public disclosure can reinforce specific
supervisory measures designed to
encourage banks to behave prudently 88.3
If the performance of the bank is great,
the bank tend to disclose more
information to the market on its risks and
risk management practices 79.2
