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Differences in the risk

management practices of Islamic
versus conventional financial
institutions in Pakistan
An empirical study
Owais Shafique

Risk
management
practices
179
Received 13 March 2012
Revised 25 September 2012
Revised 28 October 2012
Accepted 2 November 2012

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 risk
management 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 a
questionnaire survey.
Findings Literature review discovered that the types of risks faced by both types of financial
institutions can be classified under six categories. The research concludes that credit risk, equity
investment risk, market risk, liquidity risk, rate of return risk and operational risk management
practices in IFI are not different from the practices in CFI. Whereas the overall risk management
practices 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 risk
management practices in Pakistani financial system, creating a need for empirical studies for further
discoveries to formulate better frameworks and to prevent an impending financial crisis that might be
unravelling 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 executed
to understand differences in the risk management practices in Pakistan, exclusively among Islamic
financial 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 authors are lost for words to thank Mr Tahir Shafique for his cooperation and help in
producing this research paper.

The Journal of Risk Finance

Vol. 14 No. 2, 2013
pp. 179-196
q Emerald Group Publishing Limited
1526-5943
DOI 10.1108/15265941311301206

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180

1. Introduction
The history of conventional financial institutions (CFI) as well as Islamic financial
institutions (IFI) goes back hundreds of years when excess money was lent out to those
who needed it and then they returned the money. The Holy Quran (n.d.) criticizes Riba
(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 dominated
by Bardi and Peruzzi families who financed the 100 year war against France by
extending extensive loans to Edward III of England. His default led to a primitive
bankruptcy. More recently from late 1980s till 1996 Bankers Trust is accredited with
pioneering various practices, including the discovery of novel risk measurement
methods. The bank faced several lawsuits as derivative deals for few corporate clients
of the bank went sour damaging its reputation. As a result, rumors about huge losses
in its trading books filled the market, which was worth $2 billion from late 1998 to
early 1999. Bankers Trust was sold to Deutsche Bank, a decade before the global
financial crisis of 2008 engulfed the Lehman Brothers as its 1st victim (A Brief History
of 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 the
very forces it had sought to manage. While calling Bankers Trusts mortifying end as
one of the great ironies of modern financial history.
Financial institutions are bestowed with an imperative responsibility to execute in
the economy by acting as intermediaries between the surplus and deficit units, making
their job as mediators of critical significance for efficient allocation of resources in the
modern economy (El-Hawary et al., 2007). The sturdiness of the financial institutions is
of 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. Worlds largest banks announced write-downs of $274 billion in total on the
first anniversary of the credit crunch. While US subprime mortgages and leveraged
loans 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 financial
institutions up and running (BNM, 2008; Blunden, 2005).
A new rulebook by the name of Basel III was formulated as a repercussion of the
2007-2009 financial crises so as to take in a number of measures in order to reinforce
the resilience of the banking sector (BCBS, 2009a). The subprime bubble burst, kicked
off 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 is
in 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 have
remarkably short memories.
Bernstein (1996), in his book, wrote that the revolutionary idea that defines the
boundary between modern times and the past is the mastery of risk. Hence to avert the
chance of history repeating itself we must learn a lesson from the past and we must
come up with a framework that is resilient enough to prevent and most probably bring
an end to a domino collapse of the financial institutions one after the other, which
results in an eventual financial crisis. Therefore, the main purpose of the study is to

examine the current practices and future trends in risk management methodologies of
Islamic versus Commercial Financial Institutions in Pakistan. The study identifies the
practices 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 risk
mitigation between IFI and CFI in Pakistan. This research also provides grounds to
determine the status of the readiness of the financial institutions in their gameness to
adapt Basel III. However, given that in Pakistan no particular comparative surveys
among IFI and CFI have been conducted. This study fills a void by providing an
insight into risk management practices (RMP) in IFI and CFI.
Pakistan practices a dual banking system whereby the Islamic banks operate hand
in hand with the conventional banks, making it interesting to compare and contrast the
way both systems observe risk management. Therefore, it is hoped that this research
will help to enrich the literature in the area of risk management and lay the foundation
to bridge the gap between the two systems. This is first of its kind study that addresses
the unmarked topic of an empirical analysis of the two systems in Pakistan. The
motivation for this research mostly came from the fact that we know so little about this
topic. As only a miniscule amount of literature exists on this topic, hence we set off to
find 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 use
risk management techniques in dealing with different types of risks and are there any
significant differences in the practices of both IFI and CFI in Pakistan. This study also
intends to identify the most rigorously mitigated risk types facing the IFI and CFI in
Pakistan. The paper intends to discover the differences in practice based on the
differences in principle.
2. Literature review
Risk 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 organizations strategic management (ISO-IEC, 2002). It is used
by a firms strategic management in order to make positive contribution to the goals,
objectives and the portfolio of almost all its activities. RMP shields and creates value
for quarter concerned and an organization must integrate organization wide RMP as a
nonstop 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 resources
and is considered an imperative component of enterprise risk management (ERM)
system. This helps bank to establish its overall risk profile, determining how much risk
it is taking and the level of diversification it can achieve by entering in different
business areas (Tschemernjak, 2004). ERM rigors the extent of risk taking and
aversive aptitude to ensure firms goals and objectives (Steinberg et al., 2004).
Every new day unearths the financial benefits of ERM such as a drop in the overall
cost of system ownership and considerable long-term cost savings. However, even for
the most sophisticated organizations ERM is a far-off aspiration still, as it is not
practical yet. Therefore, in order to manage credit, market and operational risk across

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Figure 1.
Capital requirements
under pre- and post-crisis
situations

the enterprise many banks are amalgamating systems, processes and methodologies
on a local level in a specific business unit (Tschemernjak, 2004).
An amended rulebook namely Basel III was worked out as a repercussion of the
2007-2009 financial crises to take in a number of measures to reinforce the resilience of
the banking sector. The fresh capital adequacy framework accentuates immensely on
liquidity 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 whereas
banks had to endure losses far beyond their minimum capital requirements throughout
the modern financial crisis (BCBS, 2009b). The Basel Committee modified bank
regulation at length establishing two supplementary capital requirements, incremental
risk capital charge (IRC) and stressed value-at-risk (VaR), escalating the loss
engrossing capacity of bank capital (BCBS, 2009b, 2010).
Although credit risk was responsible for substantial price changes in the recent
financial crisis but market risk factors like changes in risk premia was the major cause of
price fluctuations (Berg, 2010). The risk premia has considerable effects on bond returns
as compared to the default risk factors. In order to let bank capital suck up sharp
negative price changes in a crisis, the Basel Committee brought into play an additional
capital add-on on top of the IRC whilst VaR model under stressed market conditions is
mainly used to assess price risk (Elton et al., 2001). To put it in a nutshell the total capital
requirements under pre- and post-crisis situations is represented in Figure 1.

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

An empirical study concluded that VaR is time and again erroneous in foreseeing future
portfolio outcomes (Perignon and Smith, 2010a, b). The error was due to the negligible
volatility 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 the
market faces a crisis situation therefore, in order to correct the impending capital short
fall under crisis situations, a stressed VaR was developed using estimates over an earlier
period of stern market distress (Jimenez-Martin et al., 2009). Regardless of the fact that
the incremental credit risk is sizeable to the banks the banks may need ten times more
capital 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 degree
of usage of market VaR between IFI and CFI.
The fresh capital adequacy framework, developed under Basel III, accentuates
immensely on credit risk, liquidity risk and market risk under ordinary and stressed
conditions (BCBS, 2009a). Credit and liquidity risks are the foremost reason of bank
failures in commercial banks ((The) Economist, 1993; Greuning and Bratanovic, 2003;
Bluhm et al., 2003; Kealhofer, 2003). Credit risk causes stern bank collapses amongst the
two risks.
A Brunei Darussalam based study by Hassan (2009) established that Islamic
banks encounter three (most important) types of risk firstly foreign-exchange risk,
second credit risk and third operating risk. Another UAE based study by Al-Tamimi
and Al-Mazrooei (2007) confirms the findings and further adds that above 90 per cent
of the respondents used the four core techniques of risk identification bank risk
managers inspection, audits or physical inspection, financial statement analysis and
risk survey.
The most significant function served by the employed credit risk models was the
recognition 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 risk
policy is part of the company-wide capital management strategy. At the same time it
also established that models proficient in managing counterparty migration risk are
explicitly used by nearly 50 per cent of the responding financial institutions while on
the contrary only a handful of financial institutions use either a proprietary or a
vendor-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 theoretical
argument brought to light by Collier et al. (2007), Soin (2005), Williamson (2004)
and Collier et al. (2004) that management accounting is significant for management and
supports risk management. The study by Rasid et al. (2011) further discovered that
analysis of financial statement was allegedly the largest contributor towards risk
management while budgeting and strategic planning are indispensable players in
managing risk. Management accounting and risk management functions are
anticipated to facilitate decision making in an organization and they are greatly
interconnected (Rasid et al., 2011). A year-to-year cost income ratio, equity to total
assets ratio, total asset growth ratio and ratio of loan loss reserve to gross loans
positively 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 on
German banks by Nuxoll (2003) supports this conclusion.
Chazi and Syed (2010), in their study, claim that capital adequacy and risk for the
banks 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 firms recital. The
objectively calculated misclassification costs and the probability of failure can
effortlessly be acknowledged, two years prior to any real collapse, through the use of
MDA for categorization and assessment of customers hence cutting down banks
non-performing loans and its credit risk exposure considerably (Chijoriga, 2011). The
MDA model developed by Altman (1968) has an overall 94 per cent correct prediction
rate, i.e. 95 per cent correct prediction rate for one year, 72 per cent for two years and
45 per cent for three years before failure. Likewise the linear MDA model outperforms
other models with an accurate percentage range from 95 to 70 per cent for one to five
years 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 variables
affecting risk management system at the operational level.
Operational risk is any possibility of loss arising as of scarce or inferior internal
processes, 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 risk
also consists of legal risk (Djojosugito, 2008; Archer and Abdullah, 2007; Fiennes, 2007;
Sundararajan, 2005; Khan and Ahmed, 2001) and reputational risk (Archer and
Abdullah, 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) Shariah compliance risk.
(3) Legal risks come up either from the Islamic banks operations; or troubles of
legal ambiguity in inferring and implementing Shariah contracts (Archer and
Abdullah, 2007).
The Nolan Company created benchmarks for commercial banks together with
numerous 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 the
primary technique for evaluating their operational efficiency. At first developed by
Charnes et al. (1978), DEA is a linear-programming method used to evaluate the
relative performance of identical organizations. Athanassopoulos and Giokas (2000),
Golany and Storbeck (1999), Berg et al. (1993), Ferrier and Lovell (1990) and
Thanassoulis (1990) espouse DEA as an apparatus to evaluate banking recital. To
compute costs and performance of bank branches DEA was integrated with activity
based-costing by Kantor and Maital (1990). On the contrary, Wei-Shong and
Kuo-Chung (2006) came up with the view that in-house performance measures are more
effective to assess the job recital of employees in lending activities as compared to
DEA, 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 odds
of employee moral hazard behaviors through the use of in-house measure to monitor

the output quality of the employees in a lending department. Therefore, it is crucial to

put into practice a double checks monitoring system from higher level managers
regarding 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 the
implementation of operational risk management (Tafri et al., 2011). Due to the one of its
kind contractual features and general legal environment the debate on operational risk
in Islamic banks in comparison to conventional banking is gaining importance and
turning more complicated (Abdullah et al., 2011).
Islamic banks have been shielded from the modern global financial crisis by and large
for the reason that they operate following the principles of Islamic finance. A reason may
be that Islamic finance prohibits interest (Riba) based dealings as well as undue
uncertainty (Gharar). The paper moreover states that Islamic banks are upholding
superior capital ratio in contrast to conventional banks (Chazi and Syed, 2010).
The most compelling evidence proving that there are significant differences in the
risks 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 the
follows 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 Hypothesis
The following hypotheses have been developed:
H1. There is a significant difference in the extent of usage of credit RMP between
IFI and CFI.
H2. There is a significant difference in the extent of usage of investment RMP
between IFI and CFI.
H3. There is a significant difference in the extent of usage of market RMP between
IFI and CFI.
H4. There is a significant difference in the extent of usage of liquidity RMP
between IFI and CFI.

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H5. There is a significant difference in the extent of usage of rate of return RMP
between IFI and CFI.
H6. There is a significant difference in the extent of usage of operational RMP
between IFI and CFI.

186

Finally, we come up with the final hypothesis that tests weather there is a significant
difference 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 design
A questionnaire survey method was picked as it was most appropriate for this study.
Most of the questionnaires were personally distributed, administered and collected
because this method saves time and the responses are more reliable, while a few
questionnaires 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 October
2011 and were turned in by late December 2011. The questionnaires targeted senior
banking practitioners, i.e. Relationship Associates (Credit Division), credit officers, chief
risk officers, senior risk managers, financial controllers and general/branch managers to
truly analyze the practices of the banks rather than collecting data from the public
relations 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 were
adopted and adapted from Tafri et al. (2011). There were several types of closed-ended
questions with single response and five-point scale questions. The questions in the
questionnaires were divided into seven segments, i.e. one segment collected the data
pertaining 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 the
participants were asked to not only fill the questionnaire but also suggest possible problems
with the phrasing of the questions and statements in order to bring greater clarity and ease
of understanding for the respondents. Once pre-testing was completed, the questionnaire
was amended in light of the suggestions received from pre-testing participants. The final
sample that was selected did not include participants from the pilot sample.
3.1 Sample
SBP is the regulatory authority of all the financial institutions weather Islamic or
Conventional. Recently, SBP made it mandatory for all conventional banks to start an
Islamic Banking Branch or at least an Islamic window in their conventional banking
branches but this has not yet been implemented, therefore we formed two segments IFI
and CFI. The sample size of 69 was finalized using the statistical formula
n 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 not
delivered 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 and
60 from 21 distinctive CFI. As stated earlier the questionnaires were personally

distributed and administered to the financial institutions in Pakistan because a large

number of responses were not necessary. This not only made the process of data
collection swift but more authentic and reliable as well. This also helped us to achieve
an exceptional response rate of 82 per cent.
3.2 Statistical analysis and tools
The data collected under this research was qualitative and we tried to quantify it by
using progressive scale but we have to acknowledge the fact that despite everything
we try we can never quantify qualitative data precisely and therefore statistically we
must study our results and provide a human point of view in the results through the
use of figures and graphs and base our judgments on human experience. Although
there is no statistical test that has been developed, to date, to test such data we still
devised a way to double check our judgment. To comprehend our results with utmost
honestly 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 on
some solid grounds came from the research of Tafri et al. (2011). Although the ANOVA
results cannot be trusted a 100 per cent but still it is the best available tool to analyze
the data and with a little help from an experienced human we are quite hopeful to get
the most accurate results possible.
3.2.1 ANOVA test (F-test). The F-test is simply a test for variances. It is used to test
weather 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 financial
institutions.
4. Analysis/findings
This 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 a
totally different product range, the literature review suggests that both share the same
types of risks, with some variances. Due to their relatively new born and less immune
product types and strict regulatory practices for compliance with the Shariah rules, IFI
are more susceptible to losses, especially operational risk. So, it was generally
anticipated that because of greater risk they would have much strict RMP in
comparison to CFI. The data collected for this research was quite interesting and its
analysis in particular revealed many eye-opening facts.
The mean values (Table I) of both types of financial institutions show that CFI
manage all types of risks, except operational risk, better than IFI but this may not be true
and all the difference can be the result of variance in data which occurred merely due to
the 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 overall
analysis of risk undoubtedly suggests that these minute differences are merely due to
sampling error. To affirm our findings we used the doughnut charts (Figures 2-8).
Figure 2 clearly shows that there is little difference between the frequency
distribution for credit RMP of IFI and CFI. The major two response categories
(frequently practiced and occasionally practiced), which are the most significant for
this 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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Table I.
Produced from the data
collected through
primary research

Risk management practices in conventional and Islamic financial institutions

Conventional financial
IFI
institutions
Average responses (%)
Average responses (%)
Risk type
1 2
3
4
5 Mean 1
2
3
4
5 Mean Mean difference
Credit risk
Equity
investment risk
Market risk
Liquidity risk
Rate of return
risk
Operational risk
Overall 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

0.20

0.0 0.0 3.0 51.5 45.4

2.5 5.8 14.9 24.0 52.9
0.0 2.7 22.7 36.4 38.2

4.42
4.19
4.10

0.0
2.7
2.7

0.0 5.6 44.4 50.0

4.5 6.2 35.2 51.1
2.7 3.0 38.3 53.3

4.44
4.27
4.37

0.02
0.08
0.27

0.0 5.7 18.2 15.9 60.2

2.4 7.9 20.0 22.4 47.3
1.3 5.1 15.9 30.9 46.9

4.31
4.04
4.2

2.5 0.0 0.9 21.3 75.4

8.4 12.1 7.3 39.0 33.1
3.3 4.2 5.1 36.0 51.4

4.67
3.76
4.3

0.36
0.28
0.11

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

Figure 2.

market RMP, as presented in Figures 3 and 4, respectively, is nearly the same for IFI
and CFI for all the five response categories.
Figures 5-7 indicate that frequency distributions for liquidity risk, rate of return risk
and 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 different
from CFI because these differences may be due to sampling error. Therefore, we have
to understand that weather the difference is significant or not.
Figure 8 identifies no significant differences in the frequency distribution of overall
RMP of IFI and CFI for all the five response categories. On average 46.9 per cent
respondents of IFI and 51.4 per cent respondents of CFI believed they frequently
practice risk management, whereas 30.9 per cent IFI respondents and 36 per cent CFI
respondents said they occasionally practice risk management.

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Figure 3.

Figure 4.

To get a richer picture of the situation, we put our data through the ANOVA test
ensuring the resilience of our results. The ANOVA test produced consistent result
throughout, in all the seven hypothesizes, except for trifling difference under equity
investment 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 when
put 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 CFI
proving 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 to
end the debate on the differences in the RMP among IFI and CFI in Pakistan.

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Figure 5.

Figure 6.

Based on the frequency distributions of both IFI and CFI in Table I we come to know that
rate of return risk is the most highly managed and mitigated risk in both IFI and CFI as
60.2 per cent of IFI respondents and 75.4 per cent of CFI respondents claimed that they
frequently practice rate of return risk mitigation. Moreover, based on the highest
frequency 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 equity
investment risk. Whereas IFI frequently practice risk management and mitigation on
rate of return risk, market risk and equity investment risk.
5. Conclusion
Putting the whole study in a nutshell we set out to ascertain the differences in the RMP
of IFI and CFI of Pakistan. We discovered through our literature review that both types
of financial institutions face same types of risks but with different magnitude. The six

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Figure 7.

Figure 8.

categories of risk can classify all the types of risks faced by both types of financial
institutions. It was generally anticipated that IFI may be practicing risk management
more rigorously than CFI especially operational risk management. This study
unearths countless facts regarding the RMP of IFI and CFI of Pakistan.
Despite the various differences in concept, practices, operations and an entirely
different 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 investment
risk, market risk, liquidity risk, rate of return risk and operational RMP in IFI are not
different from the practices in CFI which is contradictory to some of the findings of a
Dominantly 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

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Table II.
Produced from the data
collected through
primary research

Risk type

Risk management practices in conventional and IFI

F-value
p-value
Decision (difference)
Decision after LSD test

Credit risk
Equity investment risk
Market risk
Liquidity risk
Rate of return risk
Operational risk
Overall risk management

0.43
3.61
2.47
0.61
1.62
2.01
1.82

0.85
0.03
0.07
0.72
0.21
0.13
0.24

Not significant
Significant
Not significant
Not significant
Not significant
Not significant
Not significant

Not significant

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

Abdullah et al. (2011). This clearly indicates that a Malaysia based study cannot be
generalized 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 that
our research is better.
The research by Tafri et al. (2011) has provided much valuable learning and
guidance for this research and we appriciate their work and the only reason to mention
the contradiction was to clarify that the research by them most probably represents the
true condetions of Malaysia but it cannot be generalized in Pakistani context and that
our research was necessary to expose this fact to the world. Our research strengthens
the belief that every country must carry out research in its own context as a study
based on one country may not be a true representative of the situation in another
country.
We also discovered that CFI more rigorously manage and mitigate rate of return
risk, liquidity risk, market risk and equity investment risk. Whereas, IFI most
frequently practice risk management and mitigation on rate of return risk, market risk
and equity investment risk.
Signing off on this study we conclude that the RMP of IFI and CFI are alike and any
differences in their mean values are merely coincidence and insignificant. The only
reason that we can find for this similarity is that IFI are a very new business form in
Pakistan as compared to the CFI and because the IFI are in infancy and are developing
slowly 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 about
the 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 and
frameworks to prevent an impending financial crisis that might be unravelling as you
read this paper.
We expect that our research will inspire many more researchers and policy makers
to conduct further research on this topic using a larger sample size and therefore come
up with more accurate results. For now, its a never ending war against risk that we
intend to win through our mastery of risk. Hence, we expect that this study will
provide valuable base for further researches in the future.

5.1 Limitations
One of the limitations of this research is the possible biasness on the part of the
respondents because for any study making use of survey questionnaire a possibility
exists 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 and
all questions asked were related to practices of risk management the researchers
reserves the right to believe that the responses were true and honest to the extent of the
knowledge 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 their
infancy in Pakistan so we had to settle on such a small sample size.
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About the authors
Owais Shafique is the CEO and CFO at Pak Marketing, Bahawalpur, Pakistan. He is pursuing an
MSc in International Accounting and Finance, specializing in Strategic Finance Practice, from The
University 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 prestigious
institutions of Pakistan. He has authored several international books and research papers. His
areas of interest include Islamic banking, crisis management, creative accounting, risk
management, managerial finance, advanced financial statement analysis and investment analysis
& portfolio management. Owais Shafique is the corresponding author and can be contacted at:
owais.shafiq@gmail.com
Nazik Hussain at present works as an Assistant Professor in the Department of Management
Sciences, The Islamia University of Bahawalpur, Pakistan. His qualifications include MBA, MA
Specializing in Economics, Fellow Public Accountant (FPA) and MA Specializing in Islamic
Studies. 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, financial
accounting and managerial finance.

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