Differences in the risk

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Differences in the riskmanagement practices of Islamic

versus conventional financialinstitutions in Pakistan

An empirical study

Owais Shafique Management School, University of Liverpool,

Liverpool, UK and Department of Management Sciences, The Islamia University of Bahawalpur,

Bahawalpur, Pakistan, and

Nazik Hussain and M. Taimoor Hassan Department of Management Sciences, The Islamia University of Bahawalpur,

Bahawalpur, Pakistan

Abstract

Purpose – The purpose of this paper is to provide an insight into the differences in the riskmanagement practices of Islamic financial institutions (IFI) and conventional financial institutions(CFI) in Pakistan.

Design/methodology/approach – The study makes use of primary data collection method using aquestionnaire survey.

Findings – Literature review discovered that the types of risks faced by both types of financialinstitutions can be classified under six categories. The research concludes that credit risk, equityinvestment risk, market risk, liquidity risk, rate of return risk and operational risk managementpractices in IFI are not different from the practices in CFI. Whereas the overall risk managementpractices of IFI and CFI are alike in Pakistan.

Research limitations/implications – Further research with a larger sample size is recommended.

Practical implications – The paper opens our eyes to the fact that much is unknown about the riskmanagement practices in Pakistani financial system, creating a need for empirical studies for furtherdiscoveries to formulate better frameworks and to prevent an impending financial crisis that might beunravelling at the time this paper is being read.

Originality/value – This is the first empirical study of its kind that addresses the unmarked topic of RMP in IFI and CFI in Pakistan. The research was conducted because few studies have been executedto understand differences in the risk management practices in Pakistan, exclusively among Islamicfinancial institutions. This study is expected to expand the existing literature by providing novel

empirical evidence.

Keywords Islam, Financial institutions, Risk management, Risk management practices,Islamic financial institutions, Pakistan, Conventional financial institutions, Empirical, Credit risk,Operational risk, Rate of return risk

Paper type Research paper

The current issue and full text archive of this journal is available at

www.emeraldinsight.com/1526-5943.htm

The authors are lost for words to thank Mr Tahir Shafique for his cooperation and help inproducing this research paper.

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Received 13 March 2012Revised 25 September 2012

Revised 28 October 2012Accepted 2 November 2012

The Journal of Risk FinanceVol. 14 No. 2, 2013

pp. 179-196q Emerald Group Publishing Limited

1526-5943DOI 10.1108/15265941311301206


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1. IntroductionThe history of conventional financial institutions (CFI) as well as Islamic financialinstitutions (IFI) goes back hundreds of years when excess money was lent out to thosewho needed it and then they returned the money. The Holy Quran (n.d.) criticizes Ribâ

(usury) severely and at several occasions.Modern banking practices can be traced to the Medieval Italian cities of Florence,

Venice and Genoa. During the fourteenth century banking in Florence was dominatedby Bardi and Peruzzi families who financed the 100 year war against France byextending extensive loans to Edward III of England. His default led to a primitivebankruptcy. More recently from late 1980s till 1996 Bankers Trust is accredited withpioneering various practices, including the discovery of novel risk measurementmethods. The bank faced several lawsuits as derivative deals for few corporate clientsof the bank went sour – damaging its reputation. As a result, rumors about huge lossesin its trading books filled the market, which was worth $2 billion from late 1998 toearly 1999. Bankers Trust was sold to Deutsche Bank, a decade before the globalfinancial crisis of 2008 engulfed the Lehman Brothers as its 1st victim ( A Brief Historyof Modern Banking , 2011).

A paper written by Guill (2009), a former Bankers Trust employee, illustrates how a“well-capitalized and highly profitable wholesale financial institution fell victim to thevery forces it had sought to manage.” While calling Bankers Trust’s mortifying end as“one of the great ironies of modern financial history.”

Financial institutions are bestowed with an imperative responsibility to execute inthe economy by acting as intermediaries between the surplus and deficit units, makingtheir job as mediators of critical significance for efficient allocation of resources in themodern economy (El-Hawary et al., 2007). The sturdiness of the financial institutions isof vital significance as observed during the most modern US financial crisis of 2008(BNM, 2008). The IMF (2008) anticipated total losses to reach $945 billion globally by

April 2008. World’s largest banks announced write-downs of $274 billion in total on thefirst anniversary of the credit crunch. While US subprime mortgages and leveragedloans may reach $1 trillion according to some estimates of July 2008 (Kollewe, 2008).The stability of the entire economy is affected by a crumple of the financial institutions,as a result a robust risk management system is mandatory to keep the financialinstitutions up and running (BNM, 2008; Blunden, 2005).

A new rulebook by the name of Basel III was formulated as a repercussion of the2007-2009 financial crises so as to take in a number of measures in order to reinforcethe resilience of the banking sector (BCBS, 2009a). The subprime bubble burst, kickedoff by a reprehensible crash of the Lehman Brothers, is a tragic reminder of the past.With the formulation of new rules and revisited customer bank relationships, the ball isin our court, either we come up with a “new normal” or leave them to their own devices,

notes Richard J. Herring (Professor, Wharton Finance), “the financial markets haveremarkably short memories.”

Bernstein (1996), in his book, wrote that the revolutionary idea that defines theboundary between modern times and the past is the mastery of risk. Hence to avert thechance of history repeating itself we must learn a lesson from the past and we mustcome up with a framework that is resilient enough to prevent and most probably bringan end to a domino collapse of the financial institutions one after the other, whichresults in an eventual financial crisis. Therefore, the main purpose of the study is to

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examine the current practices and future trends in risk management methodologies of Islamic versus Commercial Financial Institutions in Pakistan. The study identifies thepractices and techniques used among IFI and CFI to manage credit, equity investment,market, liquidity, rate of return and operational risk. The research also seeks to

discover whether there is an association in the practice of risk management and riskmitigation between IFI and CFI in Pakistan. This research also provides grounds todetermine the status of the readiness of the financial institutions in their gameness toadapt Basel III . However, given that in Pakistan no particular comparative surveysamong IFI and CFI have been conducted. This study fills a void by providing aninsight into risk management practices (RMP) in IFI and CFI.

Pakistan practices a dual banking system whereby the Islamic banks operate handin hand with the conventional banks, making it interesting to compare and contrast theway both systems observe risk management. Therefore, it is hoped that this researchwill help to enrich the literature in the area of risk management and lay the foundationto bridge the gap between the two systems. This is first of its kind study that addressesthe unmarked topic of an empirical analysis of the two systems in Pakistan. Themotivation for this research mostly came from the fact that we know so little about thistopic. As only a miniscule amount of literature exists on this topic, hence we set off tofind out the facts and to develop a platform for future researchers.

The core purpose of this research is to examine the degree to which IFI and CFI userisk management techniques in dealing with different types of risks and are there anysignificant differences in the practices of both IFI and CFI in Pakistan. This study alsointends to identify the most rigorously mitigated risk types facing the IFI and CFI inPakistan. The paper intends to discover the differences in practice based on thedifferences in principle.

2. Literature reviewRisk may be defined as the inconsistency of returns associated with a particular asset(Gitman, 2008). Risk, thereof, is also defined as an amalgamation of the probability of the occurrence of an event and its consequence (ISO-IEC, 2002).

RMP are vital for an organization’s strategic management (ISO-IEC, 2002). It is usedby a firm’s strategic management in order to make positive contribution to the goals,objectives and the portfolio of almost all its activities. RMP shields and creates valuefor quarter concerned and an organization must integrate organization wide RMP as anonstop and developing process in order to accomplish its goals.

Banks must integrate market, credit and operational risk into a single steam of capital measurement to have a comprehensive picture of their entire capital resourcesand is considered an imperative component of enterprise risk management (ERM)

system. This helps bank to establish its overall risk profile, determining how much riskit is taking and the level of diversification it can achieve by entering in differentbusiness areas (Tschemernjak, 2004). ERM rigors the extent of risk taking andaversive aptitude to ensure firm’s goals and objectives (Steinberg et al., 2004).

Every new day unearths the financial benefits of ERM such as a drop in the overallcost of system ownership and considerable long-term cost savings. However, even forthe most sophisticated organizations ERM is a far-off aspiration still, as it is notpractical yet. Therefore, in order to manage credit, market and operational risk across

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the enterprise many banks are amalgamating systems, processes and methodologieson a local level – in a specific business unit (Tschemernjak, 2004).

An amended rulebook namely Basel III was worked out as a repercussion of the2007-2009 financial crises to take in a number of measures to reinforce the resilience of

the banking sector. The fresh capital adequacy framework accentuates immensely onliquidity risk, credit risk and market risk under ordinary and stressed conditions(BCBS, 2009a). It has been made mandatory for banks to maintain a minimum level of capital to cover up losses and to run operating activities as a going concern whereasbanks had to endure losses far beyond their minimum capital requirements throughoutthe modern financial crisis (BCBS, 2009b). The Basel Committee modified bankregulation at length establishing two supplementary capital requirements, incrementalrisk capital charge (IRC) and stressed value-at-risk (VaR), escalating the lossengrossing capacity of bank capital (BCBS, 2009b, 2010).

Although credit risk was responsible for substantial price changes in the recentfinancial crisis but market risk factors like changes in risk premia was themajor cause of

price fluctuations (Berg, 2010). The risk premia has considerable effects on bond returnsas compared to the default risk factors. In order to let bank capital suck up sharpnegative price changes in a crisis, the Basel Committee brought into play an additionalcapital add-on on top of the IRC whilst VaR model under stressed market conditions ismainly used to assess price risk (Elton et al., 2001). To put it in a nutshell the total capitalrequirements under pre- and post-crisis situations is represented in Figure 1.

Figure 1.Capital requirementsunder pre- and post-crisissituations

Source: BCBS, 2009b, p. 18, paragraph 718 LXXXVII-1-

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An empirical study concluded that VaR is time and again erroneous in foreseeing futureportfolio outcomes (Perignon and Smith, 2010a, b). The error was due to the negligiblevolatility in the pre-crisis situations where VaR models were used to estimate risk(Acharya and Schnabl, 2009). The argument is supported by the fact that the VaR was

initially developed to assess risk under stable market conditions and not when themarket faces a crisis situation therefore, in order to correct the impending capital shortfall under crisis situations, a stressed VaR was developed using estimates over an earlierperiod of stern market distress ( Jiménez-Martin et al., 2009). Regardless of the fact thatthe incremental credit risk is sizeable to the banks the banks may need ten times morecapital under stressed situations to absorb market associated risk (Varotto, 2011).

A study by Tafri et al. (2011) claims that a substantial disparity exists in the degreeof usage of market VaR between IFI and CFI.

The fresh capital adequacy framework, developed under Basel III , accentuatesimmensely on credit risk, liquidity risk and market risk under ordinary and stressedconditions (BCBS, 2009a). Credit and liquidity risks are the foremost reason of bankfailures in commercial banks (( The ) Economist , 1993; Greuning and Bratanovic, 2003;Bluhm et al., 2003; Kealhofer, 2003). Credit risk causes stern bank collapses amongst thetwo risks.

A Brunei Darussalam based study by Hassan (2009) established that Islamicbanks encounter three (most important) types of risk firstly foreign-exchange risk,second credit risk and third operating risk. Another UAE based study by Al-Tamimiand Al-Mazrooei (2007) confirms the findings and further adds that above 90 per centof the respondents used the four core techniques of risk identification – bank riskmanager’s inspection, audits or physical inspection, financial statement analysis andrisk survey.

The most significant function served by the employed credit risk models was therecognition of the counterparty default risk. A study conducted on the largest US based

financial institutions concludes that 90 per cent of respondents agreed that credit riskpolicy is part of the company-wide capital management strategy. At the same time italso established that models proficient in managing counterparty migration risk areexplicitly used by nearly 50 per cent of the responding financial institutions while onthe contrary only a handful of financial institutions use either a proprietary or avendor-marketed model for credit risk management (Fatemi and Fooladi, 2006).Furthermore, evidence suggests that a substantial disparity exists in the degree of usage of credit risk mitigation methods between IFI and CFI (Tafri et al., 2011).

The study conducted by Rasid et al. (2011) empirically supports the theoreticalargument brought to light by Collier et al. (2007), Soin (2005), Williamson (2004)and Collier et al. (2004) that management accounting is significant for management andsupports risk management. The study by Rasid et al. (2011) further discovered that

analysis of financial statement was allegedly the largest contributor towards riskmanagement while budgeting and strategic planning are indispensable players inmanaging risk. Management accounting and risk management functions areanticipated to facilitate decision making in an organization and they are greatlyinterconnected (Rasid et al., 2011). A year-to-year cost income ratio, equity to totalassets ratio, total asset growth ratio and ratio of loan loss reserve to gross loanspositively influences the likelihood of financial distress in the coming year however,macroeconomic information shows little impact on the possibility of financial distress

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on UAE based financial institution (Zaki et al., 2011) and a similar study conducted onGerman banks by Nuxoll (2003) supports this conclusion.

Chazi and Syed (2010), in their study, claim that capital adequacy and risk for thebanks can be effortlessly recognized using leverage and gross revenue ratios while also

claiming that Islamic banks demonstrate better leverage and gross revenue ratios.Financial ratios are good taxonomy and predictor variables of firm’s recital. Theobjectively calculated misclassification costs and the probability of failure caneffortlessly be acknowledged, two years prior to any real collapse, through the use of MDA for categorization and assessment of customers hence cutting down bank’snon-performing loans and its credit risk exposure considerably (Chijoriga, 2011). TheMDA model developed by Altman (1968) has an overall 94 per cent correct predictionrate, i.e. 95 per cent correct prediction rate for one year, 72 per cent for two years and45 per cent for three years before failure. Likewise the linear MDA model outperformsother models with an accurate percentage range from 95 to 70 per cent for one to fiveyears before failure (Coats and Fant, 1993).

A recent study by Woods (2009) unearthed that central government policies,

information and communication technology and organizational size are the variablesaffecting risk management system at the operational level.

Operational risk is any possibility of loss arising as of scarce or inferior internalprocesses, people, and systems or from external events is called operational risk (BCBS,2001). Referring to this definition it is implicit that in Islamic banks, operational riskalso consists of legal risk (Djojosugito, 2008; Archer and Abdullah, 2007; Fiennes, 2007;Sundararajan, 2005; Khan and Ahmed, 2001) and reputational risk (Archer andAbdullah, 2007; Fiennes, 2007; Akkizidis and Bouchereau, 2005).

Islamic banks may face three types of operational risks:

(1) Operational risks that are consequential upon a range of banking activities.

(2) Sharia’h compliance risk.

(3) Legal risks come up either from the Islamic bank’s operations; or troubles of legal ambiguity in inferring and implementing Sharia’h contracts (Archer andAbdullah, 2007).

The Nolan Company created benchmarks for commercial banks together withnumerous top performing banks in order to ascertain drivers of soaring performance(Grasing, 2002).

In the 1990s data envelopment analysis (DEA) was espoused by banks as theprimary technique for evaluating their operational efficiency. At first developed byCharnes et al. (1978), DEA is a linear-programming method used to evaluate therelative performance of identical organizations. Athanassopoulos and Giokas (2000),Golany and Storbeck (1999), Berg et al. (1993), Ferrier and Lovell (1990) andThanassoulis (1990) espouse DEA as an apparatus to evaluate banking recital. Tocompute costs and performance of bank branches DEA was integrated with activitybased-costing by Kantor and Maital (1990). On the contrary, Wei-Shong andKuo-Chung (2006) came up with the view that in-house performance measures are moreeffective to assess the job recital of employees in lending activities as compared toDEA, benchmark and productivity measures. One of the primary objectives of Basel II is to alleviate the lending operational risk which is made possible by sinking the oddsof employee moral hazard behaviors through the use of in-house measure to monitor

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the output quality of the employees in a lending department. Therefore, it is crucial toput into practice a double checks monitoring system from higher level managersregarding the aptness of any loan to muddle through employee fraud.

As compared to conventional banks, Islamic banks are not using operational risk

management tools a reason being that they are in the early phase of theimplementation of operational risk management (Tafri et al., 2011). Due to the one of itskind contractual features and general legal environment the debate on operational riskin Islamic banks in comparison to conventional banking is gaining importance andturning more complicated (Abdullah et al., 2011).

Islamic banks have been shielded from the modern global financial crisis by and largefor the reason that they operate following the principles of Islamic finance. A reason maybe that Islamic finance prohibits interest (Riba) based dealings as well as undueuncertainty (Gharar). The paper moreover states that Islamic banks are upholdingsuperior capital ratio in contrast to conventional banks (Chazi and Syed, 2010).

The most compelling evidence proving that there are significant differences in therisks faced and the RMP of IFI and CFI comes from the Malaysian based study of Tafri et al. (2011).

Basel II identifies three categories of risk in conventional banking setup:

(1) credit risk;

(2) market risk; and

(3) operational risks (Chapra and Khan, 2000).

The Risk Management Guidelines for Islamic Banking Institutions by the State Bank of Pakistan (SBP) classifies risk in six categories; therefore we will analyze RMP on thefollows six categories:

(1) credit risk;

(2) equity investment risk;(3) market risk;

(4) liquidity risk;

(5) rate of return risk; and

(6) operational risk (SBP, 2008; IFSB, 2005).

2.1 HypothesisThe following hypotheses have been developed:

H1. There is a significant difference in the extent of usage of credit RMP betweenIFI and CFI.

H2. There is a significant difference in the extent of usage of investment RMPbetween IFI and CFI.

H3. There is a significant difference in the extent of usage of market RMP betweenIFI and CFI.

H4. There is a significant difference in the extent of usage of liquidity RMPbetween IFI and CFI.

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H5. There is a significant difference in the extent of usage of rate of return RMPbetween IFI and CFI.

H6. There is a significant difference in the extent of usage of operational RMP

between IFI and CFI.Finally, we come up with the final hypothesis that tests weather there is a significantdifference in the overall RMP of IFI as compared to CFI serving the actual purpose of the research:

H7. The risk management tools practiced by IFI are significantly different from CFI.

3. Research designA questionnaire survey method was picked as it was most appropriate for this study.Most of the questionnaires were personally distributed, administered and collectedbecause this method saves time and the responses are more reliable, while a fewquestionnaires were sent out to the respondents through email but were followed in and

administered to a reasonable extent. The questionnaires were sent out in early October2011 and were turned in by late December 2011. The questionnaires targeted seniorbanking practitioners, i.e. Relationship Associates (Credit Division), credit officers, chief risk officers, senior risk managers, financial controllers and general/branch managers totruly analyze the practices of the banks rather than collecting data from the publicrelations officers who have the least knowledge of the RMP of the bank.

The survey questionnaire was self-developed, in the widely used English language,based on the variables discovered under literature review. A few questions wereadopted and adapted from Tafri et al. (2011). There were several types of closed-endedquestions with single response and five-point scale questions. The questions in thequestionnaires were divided into seven segments, i.e. one segment collected the datapertaining to the employs and the financial institutions while the other six segments

collected data regarding the six major risk categories.After designing the questionnaire, it was pre-tested with a pilot sample of seven

participants. The method used for pre-testing was participative pre-testing whereby theparticipantswere asked to notonly fillthe questionnaire butalso suggest possible problemswith the phrasing of the questions and statements in order to bring greater clarity and easeof understanding for the respondents. Once pre-testing was completed, the questionnairewas amended in light of the suggestions received from pre-testing participants. The finalsample that was selected did not include participants from the pilot sample.

3.1 SampleSBP is the regulatory authority of all the financial institutions weather Islamic orConventional. Recently, SBP made it mandatory for all conventional banks to start anIslamic Banking Branch or at least an Islamic window in their conventional bankingbranches but this has not yet been implemented, therefore we formed two segments IFIand CFI. The sample size of 69 was finalized using the statistical formulan ¼ P (1 2 P )( Z / E )2, at a desired confidence level of 90 per cent. We sent out a total of 100 questionnaires, 75 printed and 25 through e-mail out of which 15 were notdelivered to the senior risk mangers therefore we later sent another 15 through post.We received a total of 82 completed questionnaires; 22 from six exclusive IFI and60 from 21 distinctive CFI. As stated earlier the questionnaires were personally

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distributed and administered to the financial institutions in Pakistan because a largenumber of responses were not necessary. This not only made the process of datacollection swift but more authentic and reliable as well. This also helped us to achievean exceptional response rate of 82 per cent.

3.2 Statistical analysis and toolsThe data collected under this research was qualitative and we tried to quantify it byusing progressive scale but we have to acknowledge the fact that despite everythingwe try we can never quantify qualitative data precisely and therefore statistically wemust study our results and provide a human point of view in the results through theuse of figures and graphs and base our judgments on human experience. Althoughthere is no statistical test that has been developed, to date, to test such data we stilldevised a way to double check our judgment. To comprehend our results with utmosthonestly and to compensate for biasness we opted to bring into play the ANOVA test.The idea to use ANOVA test as a tool to conform our findings and base our results onsome solid grounds came from the research of Tafri et al. (2011). Although the ANOVAresults cannot be trusted a 100 per cent but still it is the best available tool to analyzethe data and with a little help from an experienced human we are quite hopeful to getthe most accurate results possible.

3.2.1 ANOVA test (F-test). The F-test is simply a test for variances. It is used to testweather two samples are from populations having equal variances (Lind et al., 2008).Therefore, we can use the F-test also known as the ANOVA test for this research to see if there is significant difference in the variance of the RMP of the two types of financialinstitutions.

4. Analysis/findingsThis study discovered several facts on the subject of the RMP of IFI and CFI in

Pakistan. Despite the various differences in the concept, practices, operations and atotally different product range, the literature review suggests that both share the sametypes of risks, with some variances. Due to their relatively new born and less immuneproduct types and strict regulatory practices for compliance with the Sharia’h rules, IFIare more susceptible to losses, especially operational risk. So, it was generallyanticipated that because of greater risk they would have much strict RMP incomparison to CFI. The data collected for this research was quite interesting and itsanalysis in particular revealed many eye-opening facts.

The mean values (Table I) of both types of financial institutions show that CFImanage all types of risks, except operational risk, better than IFI but this may not be trueand all the difference can be the result of variance in data which occurred merely due tothe element of chance. It is evident from the data in Table I that differences in the mean

values of both IFI and CFI are barely noticeable for all categories of risk and an overallanalysis of risk undoubtedly suggests that these minute differences are merely due tosampling error. To affirm our findings we used the doughnut charts (Figures 2-8).

Figure 2 clearly shows that there is little difference between the frequencydistribution for credit RMP of IFI and CFI. The major two response categories(frequently practiced and occasionally practiced), which are the most significant forthis research, have almost the same average frequency of responses for IFI as CFI.At the same time the average frequency distribution for equity investment risk and

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market RMP, as presented in Figures 3 and 4, respectively, is nearly the same for IFIand CFI for all the five response categories.

Figures 5-7 indicate that frequency distributions for liquidity risk, rate of return riskand operational RMP of IFI are not the same as of CFI but a detailed analysis reveals

that despite these visible differences the RMP of IFI may still not be much differentfrom CFI because these differences may be due to sampling error. Therefore, we haveto understand that weather the difference is significant or not.

Figure 8 identifies no significant differences in the frequency distribution of overallRMP of IFI and CFI for all the five response categories. On average 46.9 per centrespondents of IFI and 51.4 per cent respondents of CFI believed they frequentlypractice risk management, whereas 30.9 per cent IFI respondents and 36 per cent CFIrespondents said they occasionally practice risk management.

Risk management practices in conventional and Islamic financial institutions

IFIConventional financial

institutionsAverage responses (%) Average responses (%)

Risk type 1 2 3 4 5 Mean 1 2 3 4 5 Mean Mean difference

Credit risk 2.9 8.3 16.5 35.1 37.2 3.95 3.3 6.1 7.6 37.7 45.4 4.16 0.20Equityinvestment risk 0.0 0.0 3.0 51.5 45.4 4.42 0.0 0.0 5.6 44.4 50.0 4.44 0.02Market risk 2.5 5.8 14.9 24.0 52.9 4.19 2.7 4.5 6.2 35.2 51.1 4.27 0.08Liquidity risk 0.0 2.7 22.7 36.4 38.2 4.10 2.7 2.7 3.0 38.3 53.3 4.37 0.27Rate of returnrisk 0.0 5.7 18.2 15.9 60.2 4.31 2.5 0.0 0.9 21.3 75.4 4.67 0.36Operational risk 2.4 7.9 20.0 22.4 47.3 4.04 8.4 12.1 7.3 39.0 33.1 3.76 0.28Overall risk 1.3 5.1 15.9 30.9 46.9 4.2 3.3 4.2 5.1 36.0 51.4 4.3 0.11

Notes: Response 1 – not in business portfolio, 2 – not practiced, 3 – considering for practice,4 – occasionally practiced, 5 – frequently practiced

Table I.Produced from the datacollected throughprimary research

Figure 2.

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To get a richer picture of the situation, we put our data through the ANOVA testensuring the resilience of our results. The ANOVA test produced consistent resultthroughout, in all the seven hypothesizes, except for trifling difference under equityinvestment risk which eventually proved to be consistent with the rest of the results

after the application of LSD test. This ensured that our results are accurate.The ANOVA test results (Table II) conclude that there are no significant differences

between IFI and CFI in all types of risk except the equity investment risk which whenput through the LSD test also shows no significant difference as well. At the same time,no significant difference was discovered among the overall RMP of IFI and CFIproving that any differences in the mean values are merely a result of coincidence.Therefore, the ANOVA test results prove to be the last nail on the coffin of reality toend the debate on the differences in the RMP among IFI and CFI in Pakistan.

Figure 3.

Figure 4.

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Based on the frequency distributions of both IFI and CFI in Table I we come to know thatrate of return risk is the most highly managed and mitigated risk in both IFI and CFI as60.2 per cent of IFI respondents and 75.4 per cent of CFI respondents claimed that theyfrequently practice rate of return risk mitigation. Moreover, based on the highestfrequency distribution and mean values, the data in Table I shows that CFI rigorously

manage and mitigate rate of return risk, liquidity risk, market risk and equityinvestment risk. Whereas IFI frequently practice risk management and mitigation onrate of return risk, market risk and equity investment risk.

5. ConclusionPutting the whole study in a nutshell we set out to ascertain the differences in the RMPof IFI and CFI of Pakistan. We discovered through our literature review that both typesof financial institutions face same types of risks but with different magnitude. The six

Figure 5.

Figure 6.

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categories of risk can classify all the types of risks faced by both types of financialinstitutions. It was generally anticipated that IFI may be practicing risk managementmore rigorously than CFI – especially operational risk management. This studyunearths countless facts regarding the RMP of IFI and CFI of Pakistan.

Despite the various differences in concept, practices, operations and an entirelydifferent product range the similarities in the RMP of IFI and CFI are quite astonishing,as well as awakening. On the whole we can conclude that credit risk, equity investmentrisk, market risk, liquidity risk, rate of return risk and operational RMP in IFI are notdifferent from the practices in CFI which is contradictory to some of the findings of aDominantly Malaysian based research by Tafri et al. (2011). Only the results of operational RMP are somewhat consistent with the findings of Tafri et al. (2011) and

Figure 8.

Figure 7.

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Abdullah et al. (2011). This clearly indicates that a Malaysia based study cannot begeneralized in Pakistani context maybe due to the fact that Islamic Banking is in its

infancy in Pakistan, whereas it is a well-established business enterprise in Malaysia.We in no way refuse to accept the results of Tafri et al. (2011) or in any way claim thatour research is better.

The research by Tafri et al. (2011) has provided much valuable learning andguidance for this research and we appriciate their work and the only reason to mentionthe contradiction was to clarify that the research by them most probably represents thetrue condetions of Malaysia but it cannot be generalized in Pakistani context and thatour research was necessary to expose this fact to the world. Our research strengthensthe belief that every country must carry out research in its own context as a studybased on one country may not be a true representative of the situation in anothercountry.

We also discovered that CFI more rigorously manage and mitigate rate of return

risk, liquidity risk, market risk and equity investment risk. Whereas, IFI mostfrequently practice risk management and mitigation on rate of return risk, market riskand equity investment risk.

Signing off on this study we conclude that the RMP of IFI and CFI are alike and anydifferences in their mean values are merely coincidence and insignificant. The onlyreason that we can find for this similarity is that IFI are a very new business form inPakistan as compared to the CFI and because the IFI are in infancy and are developingslowly it might take some time for Pakistani IFI to reach the level of performance of Malaysian IFI.

This opens our eyes to the fact that there is still much unknown aboutthe RMP in Pakistani financial system, which still holds many secretes to itself creating a need for empirical studies to dig out all its secretes that are waiting to be

discovered so that this knowledge can be used to formulate better policies andframeworks to prevent an impending financial crisis that might be unravelling as youread this paper.

We expect that our research will inspire many more researchers and policy makersto conduct further research on this topic using a larger sample size and therefore comeup with more accurate results. For now, it’s a never ending war against risk that weintend to win through our mastery of risk. Hence, we expect that this study willprovide valuable base for further researches in the future.

Risk management practices in conventional and IFIRisk type F -value p-value Decision (difference) Decision after LSD test

Credit risk 0.43 0.85 Not significant –

Equity investment risk 3.61 0.03 Significant Not significantMarket risk 2.47 0.07 Not significant – Liquidity risk 0.61 0.72 Not significant – Rate of return risk 1.62 0.21 Not significant – Operational risk 2.01 0.13 Not significant – Overall risk management 1.82 0.24 Not significant –

Notes: Response 1 – not in business portfolio, 2 – not practiced, 3 – considering for practice,4 – occasionally practiced, 5 – frequently practiced

Table II.Produced from the datacollected throughprimary research

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5.1 LimitationsOne of the limitations of this research is the possible biasness on the part of therespondents because for any study making use of survey questionnaire a possibilityexists at all times that the answers from the respondents for all questions are not true;

this study is no exception. Because the questioners were personally administered andall questions asked were related to practices of risk management the researchersreserves the right to believe that the responses were true and honest to the extent of theknowledge of the respondent and contain minimum level of biasness.

The second limitation, the sample size, was finalized based on the number of financial institutions listed in the Karachi stock exchange and because IFI are in theirinfancy in Pakistan so we had to settle on such a small sample size.

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About the authorsOwais Shafique is the CEO and CFO at Pak Marketing, Bahawalpur, Pakistan. He is pursuing anMSc in International Accounting and Finance, specializing in Strategic Finance Practice, fromTheUniversity of Liverpool, UK. He holds a BBA (Hons), Specializing in Finance, from The Islamia

University of Bahawalpur, Pakistan. He is an exceptional scholar and was thus awarded with“Academic Excellence” at The Sadiq Public School of Bahawalpur, one of the most prestigiousinstitutions of Pakistan. He has authored several international books and research papers. Hisareas of interest include Islamic banking, crisis management, creative accounting, riskmanagement, managerial finance, advanced financial statement analysis and investment analysis& portfolio management. Owais Shafique is the corresponding author and can be contacted at:[email protected]

Nazik Hussain at present works as an Assistant Professor in the Department of ManagementSciences, The Islamia University of Bahawalpur, Pakistan. His qualifications include MBA, MASpecializing in Economics, Fellow Public Accountant (FPA) and MA Specializing in IslamicStudies. His areas of interest include Islamic banking, risk management, managerial finance,advanced financial statement analysis and investment analysis & portfolio management.

M. Taimoor Hassan is a Lecturer in the Department of Management Sciences, The Islamia

University of Bahawalpur, Pakistan. His qualifications include MBA and ACMA (Professionalist).His areas of interest include Islamic banking, project finance, risk management, financialaccounting and managerial finance.

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