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Differences in the risk management practices of Islamic versus conventional nancial institutions in Pakistan
An empirical study
Owais Shaque
Management School, University of Liverpool, Liverpool, UK and Department of Management Sciences, The Islamia University of Bahawalpur, Bahawalpur, Pakistan, and

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Received 13 March 2012 Revised 25 September 2012 Revised 28 October 2012 Accepted 2 November 2012

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 nancial institutions (IFI) and conventional nancial 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 nancial institutions can be classied 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 nancial system, creating a need for empirical studies for further discoveries to formulate better frameworks and to prevent an impending nancial crisis that might be unravelling at the time this paper is being read. Originality/value This is the rst 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 nancial 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 nancial institutions, Pakistan, Conventional nancial institutions, Empirical, Credit risk, Operational risk, Rate of return risk Paper type Research paper

The authors are lost for words to thank Mr Tahir Shaque 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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1. Introduction The history of conventional nancial institutions (CFI) as well as Islamic nancial 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 nanced 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 lled 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 nancial 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 protable wholesale nancial 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 nancial history. Financial institutions are bestowed with an imperative responsibility to execute in the economy by acting as intermediaries between the surplus and decit units, making their job as mediators of critical signicance for efcient allocation of resources in the modern economy (El-Hawary et al., 2007). The sturdiness of the nancial institutions is of vital signicance as observed during the most modern US nancial 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 rst 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 nancial institutions, as a result a robust risk management system is mandatory to keep the nancial 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 nancial 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 nancial markets have remarkably short memories. Bernstein (1996), in his book, wrote that the revolutionary idea that denes 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 nancial institutions one after the other, which results in an eventual nancial 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 identies 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 nancial 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 lls 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 rst 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 nd 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 signicant 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 dened as the inconsistency of returns associated with a particular asset (Gitman, 2008). Risk, thereof, is also dened 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 rms 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 prole, determining how much risk it is taking and the level of diversication it can achieve by entering in different business areas (Tschemernjak, 2004). ERM rigors the extent of risk taking and aversive aptitude to ensure rms goals and objectives (Steinberg et al., 2004). Every new day unearths the nancial benets 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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the enterprise many banks are amalgamating systems, processes and methodologies on a local level in a specic business unit (Tschemernjak, 2004). An amended rulebook namely Basel III was worked out as a repercussion of the 2007-2009 nancial 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 nancial crisis (BCBS, 2009b). The Basel Committee modied 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 nancial crisis but market risk factors like changes in risk premia was the major cause of price uctuations (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.

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

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 nez-Martin et al., 2009). Regardless of the fact that period of stern market distress (Jime 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 rstly foreign-exchange risk, second credit risk and third operating risk. Another UAE based study by Al-Tamimi and Al-Mazrooei (2007) conrms the ndings and further adds that above 90 per cent of the respondents used the four core techniques of risk identication bank risk managers inspection, audits or physical inspection, nancial statement analysis and risk survey. The most signicant function served by the employed credit risk models was the recognition of the counterparty default risk. A study conducted on the largest US based nancial 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 procient in managing counterparty migration risk are explicitly used by nearly 50 per cent of the responding nancial institutions while on the contrary only a handful of nancial 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 signicant for management and supports risk management. The study by Rasid et al. (2011) further discovered that analysis of nancial 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 inuences the likelihood of nancial distress in the coming year however, macroeconomic information shows little impact on the possibility of nancial distress

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on UAE based nancial 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 rms recital. The objectively calculated misclassication 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 ve 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 denition 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 efciency. At rst 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 nancial crisis by and large for the reason that they operate following the principles of Islamic nance. A reason may be that Islamic nance 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 signicant 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 identies 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) classies 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 signicant difference in the extent of usage of credit RMP between IFI and CFI. H2. There is a signicant difference in the extent of usage of investment RMP between IFI and CFI. H3. There is a signicant difference in the extent of usage of market RMP between IFI and CFI. H4. There is a signicant difference in the extent of usage of liquidity RMP between IFI and CFI.

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

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Finally, we come up with the nal hypothesis that tests weather there is a signicant 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 signicantly 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 ofcers, chief risk ofcers, senior risk managers, nancial controllers and general/branch managers to truly analyze the practices of the banks rather than collecting data from the public relations ofcers 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 ve-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 nancial 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 ll 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 nal sample that was selected did not include participants from the pilot sample. 3.1 Sample SBP is the regulatory authority of all the nancial 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 nalized using the statistical formula n P(1 2 P)(Z/E)2, at a desired condence 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 nancial 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 gures 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 ndings 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 signicant difference in the variance of the RMP of the two types of nancial institutions. 4. Analysis/ndings 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 nancial 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 afrm our ndings 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 signicant 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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Risk management practices in conventional and Islamic nancial institutions Conventional nancial 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 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 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 3.95 4.42 4.19 4.10 4.31 4.04 4.2 3.3 0.0 2.7 2.7 6.1 7.6 37.7 45.4 0.0 5.6 44.4 50.0 4.5 6.2 35.2 51.1 2.7 3.0 38.3 53.3 4.16 4.44 4.27 4.37 4.67 3.76 4.3 0.20 0.02 0.08 0.27 0.36 0.28 0.11

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Table I. Produced from the data collected through primary research

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

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 ve 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 signicant or not. Figure 8 identies no signicant differences in the frequency distribution of overall RMP of IFI and CFI for all the ve 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 triing 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 signicant 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 signicant difference as well. At the same time, no signicant 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 cofn 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 nancial 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 nancial 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 ndings of a Dominantly Malaysian based research by Tafri et al. (2011). Only the results of operational RMP are somewhat consistent with the ndings of Tafri et al. (2011) and

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Risk type

Risk management practices in conventional and IFI F-value p-value Decision (difference) Decision after LSD test 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 signicant Signicant Not signicant Not signicant Not signicant Not signicant Not signicant Not signicant

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Table II. Produced from the data collected through primary research

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

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 insignicant. The only reason that we can nd 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 nancial 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 nancial 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 nalized based on the number of nancial 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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