European Journal of Banking and Finance, Finance Vol.10 2013 ISSN (paper) 2668-3156 ISSN (online) 2668-3458 www.BellPress.org
Pakistan’s Islamic Banks Risk Management Practices Ejaz Ahmad is the principal auther. Assistant Professor of Economics at Karakoram International University, Gilgit-Baltistan, Gilgit Baltistan, Pakistan. Ejaz Ahmad can be contacted at Email:
[email protected] Dr. Dilawar Khan (Assistant Professor) Department of Economics,Kohat Kohat University of Science & Technology,Kohat, Khyber Pakhtunkhwa Pakistan. Nazia Akbar Department of Elementry & Secondary Education, Education Government vernment of Khyber Pakhtunkhwa, Pakistan. Muhammad Shoaib(Lecturer) Department of Economics, Kohat University of Science & Technology, Kohat, Khyber Pakhtunkhwa Pakistan. Kifayat Ullah(Lecturer) Department of Economics, Karakouram International Islamic University, Uni Gilgit- Biltistan, Pakistan Abstract The study is conducted to investigate an empirical analysis of risk management practices of Islamic banks in Pakistan, with objectives to find whether Islamic banks working in Pakistan are efficient enough in risk identification, risk assessment analysis and its efficiency in credit risk management and policy recommendation for risk management in general. For the said purpose Khyber Pakhtunkhwa is taken as sample and data from 135 respondents was collected through ugh proportionate sampling procedure from Bank Al-Barka Al Barka (Pakistan) Limited, Bank Islami Pakistan, Burj Bank Limited, Dubai Islamic Bank Pakistan Limited and Meezan Bank Limited in Khyber Pakhtunkhwa. For reliability of the data, Cronbach’s Alpha is used, and and its results confirm that the data is reliable. Further VIF test for detection of multicollinearity and Breusch Pagan LM test for hetroskedasticity detection are carried out and their results confirm that the data is free from multicollinearity and hetroskedasticity skedasticity problems. Regression results shows that 67.97 percent variation in risk management practices is due to understanding of risk management, risk monitoring, risk assessment analysis, credit risk analysis and risk identification. The estimated coefficient coefficient of the three independent variables i.e. risk identification (RI), risk monitoring (RM) and understanding of risk management (URM) are positive and statistically significant at 1 percent level of significance. While risk assessment analysis (RAA) and and credit risk analysis (CRA) have positive insignificant effects on risk management practices (RMP). On the basis of these results it is suggested that Islamic banks should concentrate on risk assessment and credit risk analysis for the purpose of risk management. ma Keywords; Risk Management Practices, Understanding of Risk Management, Risk Monitoring, Risk Assessment Analysis, Risk Identification, Credit Risk Analysis, Khyber Pakhtunkhwa Introduction Islamic banking is an alternative to the conventional, interest interest based banking system. The system was introduced in the early 1970s with the aim of provision of Shariah compatible financial services such as investment, financing and trade prospect. In its short life period, it has gained a tremendous growth. Now-a-days financial institutions are doing their operational activities in a very risky environment. The risks faced by the banks can be classified as financial and non-financial non financial risk. Financial risk is generally associated to the leverage of the risk which obligations and liabilities can’t meet to the available assets. It is further classified as market risk and credit risk. The non-financial non financial risks faced by banks include legal, regulatory and operational risk. The risk exists in instrument and an asset in the the market is known as market risk and is further classified as systematic risk and unsystematic risk. Systematic market risk is due to over all movement in the prices and policies of the economy, while unsystematic risk is the change in the prices of specific fic assets or instrument. Credit risk occurs when counterparty can’t fulfill its obligation in specified time fully with terms and conditions of the agreement. This risk leads to uncertainty of nonpayment and delay payment of the principal amount and the interest i payable Gorman, T. (2000). Operational risk can’t be defined properly. It occurs due to technical and human error or accident in day to day operation of the bank. Human risk is due to the inefficiency and fraud, while technological risk is due to telecommunication elecommunication system and program failure. Processing risk is due to various reasons such as specification of the model, execution of incorrect transaction and crossing the limits of operational control (Crouhy et al., 2001). Legal risk is the un-enforceability ability in financial contract. It is related to statutes, legislation and regulations which have effects on the requirements of transaction and contract. It is external i.e. regulations that have effects on business activities and internal i.e. violation of rules and regulation and fraud etc. It is considered as a part of operational risk. Due to changes in the regulatory framework of the country regulatory risk occurs (BIS, 2001). Distinctive Characteristic of Risk Faced by Islamic banks There is difference nce between the theoretical formulation and the practical practices of Islamic banks. Theoretically, Islamic banking is aspired by the Islamic economist, that the liability of the bank should be
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European Journal of Banking and Finance, Finance Vol.10 2013 ISSN (paper) 2668-3156 ISSN (online) 2668-3458 www.BellPress.org limited only to its investment. While on the assets side of the the bank, the funds would be used in profit and loss sharing agreements. Thus any shock on the assets side will be absorbed by the nature of risk sharing agreement of investment. By this way Islamic banks have more stable alternatives as compared to the conventional con banks (Hassan, 2009). The risk associated with the business of banks is shared with its account holders. Islamic banking has unique feature of profit and loss sharing which have changed the nature of risk faced by it. Beside those risks faced by conventional banks, Islamic banks face some other types of risks which are because of the unique characteristics of Islamic banks. The risk faced by Islamic banks includes credit risk, bench mark risk, liquidity risk, operational risk, legal risk, withdrawal al risk and fiduciary or Shariah risk (Khan & Ahmad, 2001). Risk Management The major elements in management of risk are its identification, measurement, monitor and management of different kind of risks. These can be effectively implemented through broader broad process and system. The risk management of individual financial institution is dependent upon the size of the institution, its nature of business and the sophistication of the institute (Jorion, 2001). According to Basel II, credit risk is measured by standardized standardized approach (SA) and internal rating based (IRB) approach. By IRB banks are able for the usage of internal estimation of credit worthiness of customer in order to estimate losses in future. In IRB two possibilities of varying complexity are possible. possib In the foundation of IRB banks estimate the probability of default customers and then the supervisors of the region combine the estimation with other suitable inputs. In advanced IRB banks use default exposure and maturity for the calculation of credit risk (BIS, 2006). State Bank of Pakistan Risk Management Guide Lines for Islamic Banks The guide lines issued by the SBP for Islamic banking are summarized as followings. ( www.sbp.org.pk ) 1. Islamic banks are required to have a comprehensive process of risk reporting and management, which include proper board and senior management over-sight over sight for identification, measurement, monitoring, reporting and controlling. 2. Islamic banks are required to develop financing strategies which which are compatible to teaching of Shariah. 3. Islamic banks should develop suitable methodologies for assessment of credit risk associated with every instrument of Islamic financing. 4. Islamic banks should have suitable policy for risk management equity investment invest like Musharakah and Mudarabah. 5. Islamic banks should adopt valuation methodologies, which are suitable for assessment of potential impact on calculation and allocation of profit. Both the Mudarib and or Musharakah partner and Islamic banks should mutually mutu agree on the method used. 6. Islamic banks are to establish policies for equity investment activities such as Musharakah and Mudarabah under the gaudiness of the Shariah advisor of the bank. 7. For the assets, Islamic bank should have market risk management framework for its assets. 8. Islamic banks should develop appropriate policies for the liquidity management. 9. Islamic banks should ensure for having sufficient resources of Shariah compliant funds to reduce risk, and to meet liquidity liability. 10. Islamic banks should have comprehensive risk management process for the assessment of potential impact of market factor that affect return rate on assets and comparison with the expected rate of return on Profit and Loss Sharing (PLS) accounts. 11. Islamic banks are required ed to have framework for management of displaced commercial risk, where needed. 12. Islamic banks are required to have adequate systems and control including Shariah advisor for the purpose of meeting the teaching of Shariah. 13. Islamic banks are required to keep the interest safeguard of all of its depositors/customers. The Islamic banks should ensure the bases for assets, revenue expense and profit allocation should established, applied and reported in a manner consistent with the Islamic banking fiduciary responsibilities. respo Significance of the Study Islamic financial industry consists of commercial and investment Islamic banks, Islamic insurance companies, windows of interest based banks providing Shariah compatible financial services, mutual funds and index funds, nds, Ijarah (Leasing) and Mudarabah companies. During the short period of life i.e. from 1970s the Islamic banking has gained a reputable status in banking industry. But Islamic banking industry is more expose to risk as compared to conventional banking industry. industry. This study is conducted to assess the level of risk faced by
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European Journal of Banking and Finance, Finance Vol.10 2013 ISSN (paper) 2668-3156 ISSN (online) 2668-3458 www.BellPress.org Islamic banking industry of Pakistan and to suggest policy recommendations for risk management in Islamic banks in general and particularly in Pakistan. Objectives of the Study ives of this study are to find answer of the following questions: The objectives i. To examine whether Islamic banks working in Pakistan are able enough in risk identification. ii. To examine whether Islamic banks working in Pakistan are efficient in risk assessment analysis. iii. To analyze and discuss challenges faced by Islamic banking related to risk management. iv. To examine whether Islamic banks working in Pakistan have efficiency in credit risk management. v. To present in general policies for development of risk management in Islamic banking. Hypotheses of the Study The following hypotheses are developed based on the mentioned questions: i. There is positive relationship between risk management practices and understanding of risk management. ii. Risk assessment and analysis have positive positive relationship with risk management practices. iii. Risk identification and risk management practices have positive relationship. iv. Risk management practice and risk monitoring have positive relationship. v. Credit risk analysis and risk management practices have hav positive relationship. Review of Literature Rosman (2009) conducted a study on risk management practices and procedure. And fouud a positive relation between risk management practices and risk management process aspects. Shafiq and Nasr (2010) conducted a descriptive and analytical study on risk management in commercial banks of Pakistan. Primary and secondary data of banking sector was used for the said study. The results of the study showed a difference between private local and commercial banks of public public sector regarding its application of risk management. The study shows that staff working in the management of risk departments of the commercial banks has knowledge and skills of risk management and risk understanding. The study recommended further training trai for banking staff in generally and especially for those who work in risk management departments of the banks. Akther et al. (2011) conducted a study on comparison of liquidity risk management between conventional and Islamic banks of Pakistan, for the study 2006 to 2009 data was used. The study explored the importance of firm size, capital networking, ROE (return on equity) adequacy capital and ROA (return on assets) for liquidity risk management both in conventional as well as Islamic banks. The study showed an insignificant positive relation between bank size and capital networking to net assets with liquidity risk in both conventional and Islamic banks. Further capital adequacy ratio in conventional banks was positive and significant at 10 percent significance gnificance level, and at the same level return on assets (ROA) in Islamic banks was positive and significant. Misman and Bhatti (2011) conducted a study on Islamic bank risk exposure, for the said study Bank Islam Malaysia empirical analyses were studied. For the risk and return analysis two approaches were used, first the financial ratio analysis approach and second the stock ratio analysis. The results of the study showed that Islamic banks were not efficient in performance as compared to conventional banks banks on the basis of financial ratio analysis and had high risk than the risk of conventional banks. The stock analysis of the bank also showed that the bank had high risk as compared to its conventional counterpart. The researchers concluded that for the survival rvival of the Islamic bank, risk management is very important. RESEARCH METHODOLOGY Universe of the Study The study is conducted in Pakistan. Pakistan is Muslim country where both conventional baking and Islamic banking systems exists. Islamic banking in Pakistan was initiated with islamization process of General Zia-ul-Haq. Haq. Now Islamic banking is one of the fast growing industries of the country. Its total assets are more than Rs.644 billion which are 7.7 percent of the banking industry (SBP, 2012). Due to time and financial constraint, it is difficult to collect data from the Islamic banks of the whole country, so Khyber Pakhtunkhwa province of the country is chosen as sample. Description of the Data Primary data is used for the study. The data is collected through structured questionnaire from 135 sampled respondents. The following research questions are asked by the researcher, and are answered by the staff of the Islamic banks of the sample. Q1. Do the Islamic banks in Pakistan staff understand risk and a risk management? Q2. Do the Islamic banks in Pakistan efficiently assess and analyze risk? Q4. Do the Islamic banks in Pakistan have an efficient risk monitoring and controlling system? Q5. Do the Islamic banks in Pakistan manage the risk efficiently?
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European Journal of Banking and Finance, Finance Vol.10 2013 ISSN (paper) 2668-3156 ISSN (online) 2668-3458 www.BellPress.org Q6. 6. What are the methods used in risk management in general? Sampling Due to time and financial constraint the study is limited to Islamic banks of Khyber Pakhtunkhwa province of Pakistan. There are five main banks which are completely Islamic banks i.e. Al-Barka A Bank (Pakistan) Limited, Bank Islami Pakistan Limited, Burj Bank Limited, Dubai Islamic Bank Pakistan Limited and Meezan Bank Limited working in Khyber Pakhtunkhwa. Total branches of all Islamic banks operating in the province are forty five. Collection ction of data from all the banking staff of these banks is not possible, so proportionate sampling procedure is adopted. The formula used for proportionate sampling is as under (Chaudhry and Kamal, 2001). (3.1) Where, is the number umber of branches of each bank N is number of branches of the sampled is the number of respondents is the sample proportion in kth bank. Sample Size From the above formula the following sampled size is obtained. Table 3.1 Sample size Sr. No Bank Name
No of branches
1
Al-Barka Barka Bank (Pakistan) Limited
09
No Respondents 27
2
Bank Islami Pakistan Limited
05
15
3
Burj Bank Limited
02
06
4
Dubai Islamic Bank Pakistan Limited
03
09
5
Meezan Bank Limited
26
78
Total
45
135
of
Source; State Bank of Pakistan, Islamic banking bulletin Jan-March Jan 2012 3.1
Variables of the Study The following variables are used in this study. Risk Management Practices Understanding Risk Management Risk Identification Risk Assessment and Analysis Risk Monitoring Credit Risk Analysis Analytical Techniques Analytical techniques of this study include reliability test of the data, detection of multicollinearity and hetroskedasticity problem in data and multiple regression models.
Reliability of the Data For the reliability eliability of data Cronbach’s alpha (α) is used, the formula for estimation of Cronbach’s alpha (α) is as under (Stelltiz et al., 1976). (3.2) N --Shows Shows the numbers of items/questions asked. Ĉ --Shows the average inter-items/questions items/questions covariance co among the items. --Shows the average variance. The formula shows that as inter-item inter m correlation Ĉ increases, the value of Cronbach’s alpha (α) increases that indicate reliability of the scale of the data collection, and as inter-item inter item correlation Ĉ decreases, the value of Cronbach’s alpha (α) decreases which indicate unreliability of the scale of the data collection. If the Cronbach’s alpha (α) Value is 0.7 or greater than 0.7 then the data is considered as reliable. Diagnostic Tests Before going to analyze the results from the collected data, it is considered necessary to carry diagnostic diagnost tests on the data for the purpose of validity of the results of the regression model, obtained from the data.
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European Journal of Banking and Finance, Finance Vol.10 2013 ISSN (paper) 2668-3156 ISSN (online) 2668-3458 www.BellPress.org Variance inflation factor (VIF) test for multicollinearity problem detection and Breusch-Pagan Breusch Pagan LM for detection of Hetroskedasticity are carried out. Multicollinearity Detection When more than two independent variables are used, it is suggested that there exists the problem of multicollinearity among the variables. In order to check the problem of multicollinearity in independent variables of the study, VIF test is used. (3.3) Here
is
the
auxiliary
regression
coefficient
of
on
explanatory
variables
(3.4) In this equation the second term i.e.
is known as Variance ariance Inflation Factor (VIF) of the Xj. (3.5)
If
value is equal to zero then VIF value is equal to 1, which is the lowest value of VIF, and there is no
multicollinearity problem in the data, and if
value increases then the value of VIF increases at increasing
rate and reaches to infinity. In case of perfect multicollinearity, the value is equal to 1. If the VIF value is greater than 10 than, there exist the serious problem of multicollinearity among the independent variables. Hetroskedasticity The data used in the study is cross sectional, and generally the problem of hetroskedasticity is common in cross sectional data, so before going to regression analysis it is considered necessary to check this problem in the date, for the said purpose Breusch-Pagan Breusch LM test is carried out. Breusch-Pagan LM Breusch and Pagan (1979) have developed a test for hetroskedasticity known as Langrange Multiplier (LM). + (3.6) The variance of is equal to . Following steps are involved in Breusch-Pagan Pagan LM for detection of Hetroskedasticity problem. of the equation. 1. Run regression on equation 3.6 for obtaining the residuals 2. Following auxiliary regression sion is run: (3.7) Where is variable set and it determine variance of error term. 3. Null and alternative hypothesis is formulated. Homoskedasticity null hypothesis is as under =0 (3.8) Alternative hypothesis is that hat at least one of the value is not equal to zero and it least one of the Zs value have effects on the variance of the residuals and that will be different for t. 4. Compute LM statistic by LM=n , here n is the number of observation and regression coefficient determination. LM test follows distribution with degree of freedom of ρ-1. 5. If statistical value of LM is higher than critical value i.e. LM-stat> LM the null hypothesis is rejected and there exist the problem of hetroskedasticity. Alternatively if ρ value is less than the level of significance α (usually 0.05) reject the null hypothesis. Econometric Model In order to test the Ho, the following regression model is employed: RMP = f (URM, RI, RAA, AA, RM, CRA). (3.9) ● RMPs – Risk Management Practices ● URM – Understanding Risk Management
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European Journal of Banking and Finance, Finance Vol.10 2013 ISSN (paper) 2668-3156 ISSN (online) 2668-3458 www.BellPress.org ● RI – Risk Identification ● RAA – Risk Assessment and Analysis ● RM – Risk Monitoring. ● CRA –Credit Risk Analysis Findings Table 4.1: Reliability statistics Variables Cronbach's Alpha No of Items Understanding of risk management 0.943 8 Risk assessment and analysis 0.964 6 Risk identification 0.808 5 Risk monitoring 0.969 5 Credit risk analysis 0.851 4 Risk management practices 0.96 9 Sourse: Researcher own findings The estimated coefficient for Cronbach’s alpha (α) for every aspect of risk addressed by the questionnaire is greater than 0.7 i.e. URM 0.943, RAA 0.964, RI .808, RM 0.969 CRA 0.851 and RMP 0.960 as shown in the tables, so on the basis asis of the value of Cronbach’s alpha it is concluded that every aspect of risk of the study is reliable and allows us for further steps of data analysis. Understanding Risk Management Table 4.2: Understanding risk management Questions Mean Max Min St. Dev 1. There is common understanding of 4.58 5 4 0.494 risk management across IB. 2. Risk management responsibility is 4.5 5 3 0.591 clearly set out and understood throughout the bank. 3. Risk management accountability is 4.47 5 3 0.643 clearly set out and understood throughout the bank. 4. Risk management is important for 4.54 5 3 0.575 the success of the bank. 5. It is crucial to apply the most 4.3 5 0.818 sophisticated techniques in risk 2 management. 6. The objective of Islamic bank is to 4.41 5 3 0.65 expand the application of the advanced risk management techniques. 7. It is important for your bank to 4.32 5 3 0.591 emphasize on continuous review and evaluation of the techniques used in risk management. 8. Application of risk management 4.38 5 2 0.646 techniques reduce cost and expected losses. . Average 4.44 0.355 Source: researcher’s own findings Table 4.2 presents the response of the eight questions, addressing understanding understanding of risk management. The table shows that average mean of the respondents is 4.44 on URM which is the evidence that banking staff of Islamic banks of Pakistan have enough knowledge of URM.
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European Journal of Banking and Finance, Finance Vol.10 2013 ISSN (paper) 2668-3156 ISSN (online) 2668-3458 www.BellPress.org Table: 4.3: Risk assessment analyses Questions 1. Islamic banks assess the likelihood of occurring risk. 2. Islamic banks risk is assessed by using quantitative analysis methods. 3. Islamic banks risk is assessed by using qualitative analysis methods. 4. Your Islamic banks response to analyses risk includes assessment of costs and benefits of risk. 5. Your IB response to analyze risk includes prioritizing of risk and selecting those that need active management. 6. Your IB response to analyze risk includes prioritizing risk treatment where there are resource contains on risk treatment implementation. Average Source: Researcher’s own findings
Mean 4.43
Max 5
Min 2
St. Dev 0.627
4.33
5
2
0.871
4.1
5
2
0.73
4.34
5
3
0.61
4.31
5
2
0.679
4.28
5
3
0.605
4.3
0.467
The respondents’ nts’ responses on these questions have average mean of 4.30. Table 4.4: Risk identification Questions 1. Islamic bank carries out a comprehensive and systematic Identification of its risk relating to each of its declared aims and objectives. 2. Prioritization of risk is difficult for IB. 3. Changes in risk are recognized and identified with the Islamic banks rules and responsibilities. 4. Islamic banks have enough knowledge ledge of SWOT in risk management of other banks. 5. Islamic banks have developed and applied procedures for the systematic identification of investment opportunities. Average Source: Researcher’s own findings
Mean 4.56
Max 5
Min 3
St. Dev 0.559
4.46
5
2
0.759
4.26
5
1
1.067
4.41
5
3
0.571
4.31
5
3
0.575
4.4
0.559
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European Journal of Banking and Finance, Finance Vol.10 2013 ISSN (paper) 2668-3156 ISSN (online) 2668-3458 www.BellPress.org The average mean of the respondents is 4.40, which shows that Islamic banks of Pakistan have identification of risk about their objective and mission. Table 4.5: Risk monitoring Questions Mean Max Min St. Dev 1. Monitoring the effectiveness of risk 4.33 5 2 0.708 management is an integral part of routine management reporting. 2. Level of control by Islamic banks is 4.4 5 3 0.583 appropriate for the risk that it faces. 3. Reporting and communication 4.42 5 2 0.664 process with in your Islamic mic banks support effective management of risk. 4. Islamic banks response to risk 4.14 5 3 0.505 includes an evaluation of effectiveness of the existing control and risk management responses. 5. Islamic banks response to risk 4.34 5 2 0.733 includes ncludes action plans in implementing decision about identified risk. Average 4.33 0.421 Source: Researcher’s own findings The table shows that the average mean of the five questions of the sample is 4.33, which show that Islamic I banks of Pakistan have efficiency in risk monitoring and controlling. Table 4.6: Credit risk analysis Questions 1. Islamic banks undertake a credit worthiness analysis before transaction. 2. Before granting capital pital your Islamic banks undertakes specific analysis including the Mudarib (Entrepreneur) character, capacity, collateral capital and conditions. 3. Islamic banks customers are classified according to risk factors (Risk rating). 4. It is necessary to require sufficient collateral from small customers. Average Source: Researcher’s own findings
Mean 4.52
Max 5
Min 3
St. Dev 0.530
4.40
5
2
0.693
4.34
5
1
0.775
4.41
5
1
0.932
4.42
0.494
Respondents’ responses on these questions are summarized in Table 4.6. The table shows average mean of the four questions that is 4.42.
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European Journal of Banking and Finance, Finance Vol.10 2013 ISSN (paper) 2668-3156 ISSN (online) 2668-3458 www.BellPress.org Table 4.7: Risk management practices Questions 1. Islamic bank executive management regulatory reviews the organization performance in managing its business risk. 2. Your Islamic bank highly effective in continuous review/feedback on risk management strategies and performance. 3. Your Islamic bank risk management procedures and processes are documented and provide guidance to staff about managing risk. 4. Your Islamic bank Policy encourages training programs in the area risk management as well as Islamic ethics. 5. Your Islamic bank emphasizes the recruitment of highly qualifies persons having Islamic knowledge in risk management. 6. Effective risk management is one of the objectives of IB. 7. It is easy to invest your IB funds in one specific sector of the economy. Your IB capital is adequate. 8. Level of risk management practice of your IB is excellent. Average Source: Researcher’s own findings
Mean 4.66
Max 5
Min 3
St. Dev 0.508
4.33
5
2
0.708
4.45
5
3
0.589
4.48
5
3
0.656
4.23
5
3
0.511
4.21
5
2
0.644
3.8
5
2
0.88
3.91
5
2
0.907
4.39
5
2
0.672
4.28
0.374
Table 4.8: Detection of multicollinearity Variables
R-Squared
VIF
RI
0.5729
2.34137
CRA
0.1257
1.14377
RAA
0.5724
2.34027
URM
0.5033
2.01328
0.4627
1.861157
RM Source: Researcher’s own findings
The Table 4.8 shows that VIF value for all variables is less than 10. This shows the problem of multicollinearity doesn’t exist among the variables used in the data. 4.3.2 Hetroskedasticity Test For the detection of hetroskedasticity problem in the data, Breusch-Pagan Breusch LM is carried out and results of which, appears in the following Table 4.9 Table 4.9: Breusch-Pagan Pagan LM Test Results F-statistic 1.38437 Prob. F(5,118) 0.2351 Obs*R-squared 6.87079 Prob. Chi-Square(5) 0.2304 Scaled explained SS 5.53291 Prob. Chi-Square(5) 0.3544 Source: Researcher’s own findings The table shows that value of ρ is greater than 0.05 indicating that there is no problem of hetroskedasticity in the data.
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European Journal of Banking and Finance, Finance Vol.10 2013 ISSN (paper) 2668-3156 ISSN (online) 2668-3458 www.BellPress.org CONCLUSIONS For achievement of the objectives of the study, the researcher first tested reliability of the data through Cronbach’s alpha, which confirms that the data is reliable, and then diagnostics test for the detection of the problem of multicollinearity and hetroskedasticity are carried out. The results of these tests confirm that there is not the problem of multicollinearity as well as the problem of hetroskedasticity. For checking the relationship between the dependent and nd independent variables of the study, OLS multiple regressions is run on the data and the results are obtained. The regression results show 67.97 percent variation in the dependent variable (RMP) is due to independent variables of the model (URM, RI, CRA RM and RAA). The estimated coefficient of the three independent variables i.e. risk monitoring (RM), risk identification (RI) and understanding of risk management (URM) are positive and statistically significant at 1 percent of significance level, which is the evidence that Islamic banks working in Pakistan are efficient enough in RM, RI and URM. While risk assessment analysis (RAA) and credit risk analysis (CRA) have positive insignificant effects on risk management practices (RMP). The study hypothesis is that, there is a positive relationship between RMPs and understanding risk management (URM), risk assessing and analyzing (RAA), risk identification (RI), risk monitoring (RM) and credit risk analysis (CRA). The regression results support the hypothesis i.e. i.e. it confirms statistically significant positive relation of risk management practices with understanding of risk management (URM), risk monitoring (RM) and risk identification (RI). The results also confirm statistical insignificant positive relationship relationshi of risk assessment analysis (RAA) and credit risk analysis (CRA) with risk management practices (RMPs). The importance of the risk assessment analysis (RAA) and credit risk analysis (CRA) in risk management practices (RMP) are not ignorable, but from the result we conclude that the staff of the Islamic banks have not sufficient knowledge in risk assessment analysis (RAA) and credit risk analysis (CRA) that is the reason that the results of the study shows insignificant effects of the two independent variables varia (RAA and CRA) on the dependent variable (RMP). So regression results are reliable because the data is free from both multicollinearity and hetroskedasticity. Table 4.10: Regression Results Variable
C RAA RI CRA RM URM
Coefficient
Std. Error
t-Statistic
Prob.
0.454264 0.005622 0.201970 0.080427 0.271296 0.317309
0.241475 0.071865 0.060383 0.087155 0.073156 0.075946
1.881200 0.078229 3.344844 0.922807 3.708476 4.178101
0.0622 0.9378 0.0011 0.3578 0.0003 0.0001
R-squared
0.679671
F-statistic
54.74212
Adjusted R-squared
0.667255
Prob(Fstatistic)
0.000000
Source: Researcher’s own findings
The table shows that R-squared squared value is 0.679671 that indicate that 67.97 percent variation in the dependent variable riable (RMP) is due to independent variables of the model (URM, RI, CRA RM and RAA). According to the expectation of the hypothesis, estimated coefficient of the three independent variables i.e. Risk Monitoring (RM), Risk Identification (RI) and Understanding Understanding of Risk Management (URM) are positive and statistically significant at 1 percent of significance level. While Risk Assessment Analysis (RAA) and Credit Risk Analysis (CRA) have positive insignificant effects on risk management practices (RMP). CONCLUSIONS For achievement of the objectives of the study, the researcher first tested reliability of the data through Cronbach’s alpha, which confirms that the data is reliable, and then diagnostics test for the detection of the problem of multicollinearity and hetroskedasticity are carried out. The results of these tests confirm that there is not the problem of multicollinearity as well as the problem of hetroskedasticity. For checking the relationship
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European Journal of Banking and Finance, Finance Vol.10 2013 ISSN (paper) 2668-3156 ISSN (online) 2668-3458 www.BellPress.org between the dependent and independent variables of the study, study, OLS multiple regressions is run on the data and the results are obtained. The regression results show 67.97 percent variation in the dependent variable (RMP) is due to independent variables of the model (URM, RI, CRA RM and RAA). The estimated coefficient coefficie of the three independent variables i.e. risk monitoring (RM), risk identification (RI) and understanding of risk management (URM) are positive and statistically significant at 1 percent of significance level, which is the evidence that Islamic banks working king in Pakistan are efficient enough in RM, RI and URM. While risk assessment analysis (RAA) and credit risk analysis (CRA) have positive insignificant effects on risk management practices (RMP). The study hypothesis is that, there is a positive relationship relationship between RMPs and understanding risk management (URM), risk assessing and analyzing (RAA), risk identification (RI), risk monitoring (RM) and credit risk analysis (CRA). The regression results support the hypothesis i.e. it confirms statistically significant significant positive relation of risk management practices with understanding of risk management (URM), risk monitoring (RM) and risk identification (RI). The results also confirm statistical insignificant positive relationship of risk assessment analysis (RAA) and credit risk analysis (CRA) with risk management practices (RMPs). The importance of the risk assessment analysis (RAA) and credit risk analysis (CRA) in risk management practices (RMP) are not ignorable, but from the result we conclude that the staff of o the Islamic banks have not sufficient knowledge in risk assessment analysis (RAA) and credit risk analysis (CRA) that is the reason that the results of the study shows insignificant effects of the two independent variables (RAA and CRA) on the dependent variable (RMP). RECOMMENDATIONS On the bases of research finding, the following recommendations are forwarded: i. Comprehensive risk management process is recommended for Islamic bank, in order to assess potential impact of market factor that affect assets return r rate. ii. For the purpose of reducing risk and meeting the liquidity liability, Islamic banks are required to have sufficient resources of Shariah compatible funds. iii. Policies are required for equity investment activities such as Musharakah and Mudarabah, under the gaudiness of the Shariah advisor of the bank. iv.
Islamic banks are recommended to classify it’s customers on the basis of risk factor, and before the grant of capital and making transaction to the barrower the bank should collect sufficient collateral collate from those customers, whom risk factor is high.
v.
Islamic banks should develop suitable methodologies for assessment of credit risk associated with every instrument of Islamic financing.
LIMITATION OF THE STUDY The study is limited to risk factor of Islamic Islamic banks only, conventional banks and their risk factors have not been studied in the research. Further due to financial and time constraint it was not possible to study the risk factor of all Islamic banks operating in Pakistan, rather it was limited to Islamic banks of Khyber Pakhtunkhwa province of Pakistan. SCOPE OR RECOMMENDATIONS FOR FUTURE RESEARCH As stated earlier that the study is limited to Islamic banks risk factor and conventional banks have not been studied, it will be interesting to conduct conduct research on conventional banking risk factor and make comparison between conventional and Islamic banks risk factors. Additionally, cross-country country comparisons for the assessment of banking sector development and its impact on corporate sector under the perspective perspective of monetary, economic and market variety and difference would be an inspiring subject for further research. References: 1. Akhtar, F.N., Ali, K., & Sadaqat, S. (2011). Liquidity risk management: A comparative study between conventional and Islamic banks of Pakistan interdisciplinary. Journal of Research in Business, 1(1), 3544. 2. Bank for International Settlement (2001). Basel Committee on Banking Supervisory. The new Basel capital accord: An explanatory note. 3. Bank for International Settlement (2006). (2006). Basel Committee on Banking Supervisory. Internal convergence of capital measurement and capital standard: A revised framework. Comprehensive Version. June 2006.
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Breusch, T., & Pagan, A. (1979). A simple test for hetroskedasticity and random coefficient variation. Studies in Econometric, 47(1), 1278-94. 1278 Chaudhry, S.M., & Kamal, S. (2001). Introduction to statistical theory part II. Ilmi Katab Khana, Urdu Bazar, Lahore Pakistan. Gorman, T. (2000). The complete idiot’s guide to MBA basics, (3rd ed.) Palgrave Palgr Macmillan, Hound Mills, Basingstoke, Hampshire, New York. Hassan, A. (2009). Risk management practices of Islamic banks of Brunei Darussalam. The Journal of Risk Finance, 3(3), 23-37. Misman, F.N., & Bhatti, M.I. (2011). Risk exposure in Islamic banks: banks: A case study of bank Islam Malaysia Berhad. School of Economics and Finance, Faculty of Law and Management, La Trobe University Kingsbury Drive, 3086, Victoria, Australia Rosman, R. (2009). Risk management practices and risk management processes of Islamic Isla banks: A proposed framework. Faculty of Business Administration, Tun Abdul Razak University, Malaysia State Bank of Pakistan (2012) Bulletin on Islamic banking Shafiq, A. & Nasr (2010). Risk management practices followed by the commercial banks in Pakistan. Paki Journal of Risk Finance, 5(2), 212-226. 212 State Bank of Pakistan (2012) Bulletin on Islamic banking http://www.sbp.org.pk
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