Unveiling the Risk Determinants in Islamic and Conventional Banks: Empirical Evidence from Pakistan
Abstract
Abstract Views: 0
This study aims to compare the determinants of the four main risks (credit, liquidity, operational, and regulatory risks) that Islamic and conventional banks face by focusing specifically on Pakistan's regulatory and institutional settings. The study collected unbalanced panel data for the period 2005-2022 and employed the Generalized Method of Moments (GMM-IV) approach to estimate outputs. For the robustness check, the samples were pooled for both groups and the results are re-estimated. The study found that there exist significant differences in the risk determinants of both types of banks. Similarly, there was found a positive and significant association of non-performing loans (NPL) with lag terms for conventional banks (CBs) and an insignificant association for Islamic Banks (IBs). Regarding firm performance, the study found that it does not explain the credit risk for IBs, but reported improved results for CBs. Similarly, the study found significant differences in terms of efficiency for both banks. Additionally, it was determined that derivative contracts increase liquidity and operational risk for CBs, while no such significant association exists for IBs. The findings provide valuable insights for Pakistan's regulatory and standard-setting institutions when developing governing, risk management, and overall operational policies and frameworks for Islamic and conventional banks. The inherent differences in the overall functioning of these banks make their anatomy of risk significantly different. As such, the governing regulations, for example, the Prudential Regulations issued by the State Bank of Pakistan (SBP), need to account for these differences. Although the current literature examines the differences between Islamic and conventional banks from different perspectives, a thorough and holistic comparison is missing. The current study aims to address this gap.
Downloads
References
Abdullah, M., Shahimi, S., & Ismail, A. G. (2011). Operational risk in Islamic banks: Examination of issues. Qualitative Research in Financial Markets, 3(2), 131–151. https://doi.org/10.1108/17554171111155366
Accornero, M., Cascarino, G., Felici, R., Parlapiano, F., & Sorrentino, A. M. (2018). Credit risk in banks’ exposures to non‐financial firms. European Financial Management, 24(5), 775–791. https://doi.org/10.1111/eufm.12138
Ahmed, H. & Khan, T. (2007). Risk management in Islamic banking. In M. K. Hassan & M. K. Lewis (Eds.), Hand book of Islamic banking (pp. 144–158). Edward Elgar Publishing.
Albaity, M., Mallek, R. S., & Noman, A. H. M. (2019). Competition and bank stability in the MENA region: The moderating effect of Islamic versus conventional banks. Emerging Markets Review, 38, 310–325. https://doi.org/10.1016/j.ememar.2019.01.003
Alhammadi, S., Alotaibi, K. O., & Hakam, D. F. (2022). Analysing Islamic banking ethical performance from Maqāṣid al-Sharī ‘ah perspective: Evidence from Indonesia. Journal of Sustainable Finance & Investment, 12(4), 1171–1193. https://doi.org/10.1080/20430795.2020.1848179
Barakat, A., & Hussainey, K. (2013). Bank governance, regulation, supervision, and risk reporting: Evidence from operational risk disclosures in European banks. International Review of Financial Analysis, 30, 254–273. https://doi.org/10.1016/j.irfa.2013.07.002
Basiruddin, R., & Ahmed, H. (2020). Corporate governance and Shariah non-compliant risk in Islamic banks: Southeast Asian evidence. Corporate Governance, 20(2), 240–262. https://doi.org/10.1108/CG-05-2019-0138
Belouafi, A. (1993). Asset and liability management of an interest free Islamic bank [Doctoral dissertation, University of Sheffield]. White Rose eTheses Online. https://etheses.whiterose.ac.uk/id/eprint/4221/
Bhatti, M. (2019). Managing Shariah noncompliance risk via Islamic dispute resolution. Journal of Risk and Financial Management, 13(1), Article e2. https://doi.org/10.3390/jrfm13010002
Bilgin, M. H., Danisman, G. O., Demir, E., & Tarazi, A. (2021a). Bank credit in uncertain times: Islamic vs. conventional banks. Finance Research Letters, 39, Article e101563. https://doi.org/10.1016/j.frl.2020.101563
Bilgin, M. H., Danisman, G. O., Demir, E., & Tarazi, A. (2021b). Economic uncertainty and bank stability: Conventional vs. Islamic banking. Journal of Financial Stability, 56, Article e100911. https://doi.org/10.1016/j.jfs.2021.100911
Bitar, M., Naceur, M. S. B., Ayadi, R., & Walker, T. (2017). Basel compliance and financial stability: Evidence from Islamic banks (Working Paper No.17/161). International Monetary Fund. https://www.imf.org/en/Publications/WP/Issues/2017/07/18/Basel-Compliance-and-Financial-Stability-Evidence-from-Islamic-Banks-45040
Boukhatem, J., & Djelassi, M. (2020). Liquidity risk in the Saudi banking system: Is there any Islamic banking specificity? The Quarterly Review of Economics and Finance, 77, 206–219. https://doi.org/10.1016/j.qref.2020.05.002
Butt, A. A., Rizavi, S., Nazir, M. S., & Majid, A. (2021). Corporate derivatives use and firm value: Evidence from Pakistan stock exchange. International Journal of Management, 12(3), 1197–1203. https://doi.org/10.34218/IJM.12.3.2021.113
Butt, M. A., Ayub, H., Latif, B., Asif, F., Shabbir, M. S., & Raja, A. A. (2022). Financial risks and performance of conventional and Islamic banks: Do reputational risk matters? Journal of Islamic Accounting and Business Research, 13(4), 581–595. https://doi.org/10.1108/JIABR-10-2020-0336
Chaffai, M., & Hassan, M. K. (2019). Technology Gap and Managerial Efficiency: A Comparison between Islamic and Conventional Banks in MENA. Journal of Productivity Analysis, 51(1), 39–53. https://doi.org/10.1007/s11123-019-00544-x
Chamberlain, T., Hidayat, S., & Khokhar, A.R. (2020), Credit risk in Islamic banking: Evidence from the GCC. Journal of Islamic Accounting and Business Research, 11(5), 1055–1081. https://doi.org/10.1108/JIABR-09-2017-0133
Cheng, M., & Qu, Y. (2020). Does bank FinTech reduce credit risk? Evidence from China. Pacific Basin Finance Journal, 63, Article e101398. https://doi.org/10.1016/j.pacfin.2020.101398
Elamer, A. A., Ntim, C. G., Abdou, H. A., & Pyke, C. (2020). Sharia supervisory boards, governance structures and operational risk disclosures: Evidence from Islamic banks in MENA countries. Global Finance Journal, 43, Article e100488. https://doi.org/10.1016/j.gfj.2019.100488
Elshandidy, T., Fraser, I., & Hussainey, K. (2013). Aggregated, voluntary, and mandatory risk disclosure incentives: Evidence from UK FTSE all-share companies. International Review of Financial Analysis, 30, 320–333. https://doi.org/10.1016/j.irfa.2013.07.010
Esposito, J. L., & Delong-Bas, N. J. (2018). Shariah - what everyone needs to know. Oxford University Press.
Fakhri, U. N., & Darmawan, A. (2021). Comparison of Islamic and conventional banking financial performance during the Covid-19 Period. International Journal of Islamic Economics and Finance, 4(SI), 19–40. https://doi.org/10.18196/ijief.v4i0.10080
Fan, J. P. H., Wei, K. C. J., & Xu, X. (2011). Corporate finance and governance in emerging markets: A selective review and an agenda for future research. Journal of Corporate Finance, 17(2), 207–214. https://doi.org/10.1016/j.jcorpfin.2010.12.001
Farooqi, M. F., & O’Brien, J. (2019). A comparison of the impact of the Basel standards upon Islamic and conventional bank risks in the Gulf state region. Journal of Islamic Accounting and Business Research, 10(2), 216–235. https://doi.org/10.1108/JIABR-10-2016-0125
Ghenimi, A., Chaibi, H., & Omri, M. A. B. (2021). Liquidity risk determinants: Islamic vs conventional banks. International Journal of Law and Management, 63(1), 65–95. https://doi.org/10.1108/IJLMA-03-2018-0060
Government of Pakistan. (2007). Draft companies regulations. https://www.secp.gov.pk/document/sro-423-i2017-draft-companies-incorporation-regulations-2017/?wpdmdl=28551
Grassa, R., Moumen, N., & Hussainey, K. (2020). Is bank creditworthiness associated with risk disclosure behavior? Evidence from Islamic and conventional banks in emerging countries. Pacific-Basin Finance Journal, 61, Article e101327. https://doi.org/10.1016/j.pacfin.2020.101327
Grassa, R., Moumen, N., & Hussainey, K. (2021). What drives risk disclosure in Islamic and conventional banks? An international comparison. International Journal of Finance and Economics, 26(4), 6338–6361. https://doi.org/10.1002/ijfe.2122
Gull, M., & Khan, A. U. (2023). Impact of the Islamic modes of finance on the profitability of Islamic banking sector in Pakistan. Islamic Banking & Finance Review, 10(1), 1–23. https://doi.org/10.32350/ibfr.101.01
Handayani, B. D., Rohman, A., Chariri, A., & Pamungkas, I. D. (2020). Corporate financial performance on corporate governance mechanism and corporate value: Evidence from Indonesia. Montenegrin Journal of Economics, 16(3), 161–171. https://doi.org/10.14254/1800-5845/2020.16-3.13
Hankins, K. W. (2011). How do financial firms manage risk? Unraveling the interaction of financial and operational hedging. Management Science, 57(12), 2197–2212. https://doi.org/10.1287/mnsc.1090.1068
Hasan, B. M., Rabbani, R. M., Sarker, T., Akter, T., & Hasan, S. M. (2022). Role of risk disclosure on creditworthiness and driving forces of risk disclosure of banks: Islamic vs conventional banks. International Journal of Islamic and Middle Eastern Finance and Management, 16(5), 892–909. https://doi.org/10.1108/IMEFM-01-2022-0008
Hassan, M. K., Khan, A., & Paltrinieri, A. (2019). Liquidity risk, credit risk and stability in Islamic and conventional banks. Research in International Business and Finance, 48, 17–31. https://doi.org/10.1016/j.ribaf.2018.10.006
Hassan, S. G. (2021). The Funding Liquidity Risk and Bank Risk: A Review on the Islamic and Conventional Banks in Pakistan. Hamdard Islamicus, 43(1), 83–101. https://doi.org/10.57144/hi.v43i1.38
Heflin, F., Shaw, K. W., & Wild, J. J. (2011). Credit ratings and disclosure channels. Research in Accounting Regulation, 23(1), 20–33. https://doi.org/10.1016/j.racreg.2011.03.004
Hoque, H., & Liu, H. (2023). Impact of bank regulation on risk of Islamic and conventional banks. International Journal of Finance & Economics, 28(1), 1025–1062. https://doi.org/10.1002/ijfe.2462
Huan, X., & Parbonetti, A. (2019). Financial derivatives and bank risk: Evidence from eighteen developed markets. Accounting and Business Research, 49(7), 847–874. https://doi.org/10.1080/00014788.2019.1618695
Hussain, K., Sheikh, R., Qayyum, A., & Abbasi, S. N. (2024). Macroeconomic conditions as determinants of profitability and risk: A comparison of Islamic and conventional banks in Pakistan. Islamic Banking & Finance Review, 11(1), 1–21. https://doi.org/10.32350/ibfr.111.01
İncekara, A., & Çetinkaya, H. (2019a). Credit Risk Management: A Panel Data Analysis on the Islamic Banks in Turkey. Procedia Computer Science, 158, 947–954. https://doi.org/10.1016/j.procs.2019.09.135
İncekara, A., & Çetinkaya, H. (2019b). Liquidity risk management: A comparative analysis of panel data between Islamic and conventional banking in Turkey. Procedia Computer Science, 158, 955–963. https://doi.org/10.1016/j.procs.2019.09.136
Jedidia, K. B., & Hamza, H. (2024). Does PLS in Islamic banking limit excessive money creation? Journal of Islamic Accounting and Business Research, 15(3), 422–442. https://doi.org/10.1108/JIABR-02-2022-0047
Julia, T., & Kassim, S. (2020). Exploring green banking performance of Islamic banks vs conventional banks in Bangladesh based on Maqasid Shariah framework. Journal of Islamic Marketing, 11(3), 729–744. https://doi.org/10.1108/JIMA-10-2017-0105
Keffala, M. R. (2021). How using derivative instruments and purposes affects performance of Islamic banks? Evidence from CAMELS approach. Global Finance Journal, 50, Article e100520. https://doi.org/10.1016/j.gfj.2020.100520
Khalid, S., & Amjad, S. (2012). Risk management practices in Islamic banks of Pakistan. The Journal of Risk Finance, 13(2), 148–159. https://doi.org/10.1108/15265941211203198
Khan, N., Ramzan, M., Kousar, T., & Shafiq, M. S. (2023). Impact of bank-specific factors on credit risk: Evidence from Islamic and conventional banks of Pakistan. Pakistan Journal of Humanities and Social Sciences, 11(1), 580–592. https://doi.org/10.52131/pjhss.2023.1101.0375
Khawaja, R., Nawaz, U., & Aman, D. (2023). Evaluating the impact of bank distress on the financial performance of commercial vs Islamic banks in Pakistan. Social Science Research Network. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4382721
Koju, L., Koju, R., & Wang, S. (2020), Macroeconomic determinants of credit risks: Evidence from high-income countries. European Journal of Management and Business Economics, 29(1), 41–53. https://doi.org/10.1108/EJMBE-02-2018-0032
Kunz, J., & Heitz, M. (2021). Banks risk and management control systems: A systematic literature review. Journal of Management Control, 32, 439–493. https://doi.org/10.1007/s00187-021-00325-4
Lahrech, N., Lahrech, A., & Boulaksil, Y. (2014). Transparency and performance in Islamic banking: Implications on profit distribution. International Journal of Islamic and Middle Eastern Finance and Management, 7(1), 61–88. https://doi.org/10.1108/IMEFM-06-2012-0047
Linsley, P. M., & Shrives, P. J. (2006). Risk reporting: A study of risk disclosures in the annual reports of UK companies. The British Accounting Review, 38(4), 387–404. https://doi.org/10.1016/j.bar.2006.05.002
Mas'ud, M. K. (1975). Recent studies of shāṭibī's al-muwāfaqāt. Islamic Studies, 14(1), 65–75.
Mohammad, S., Asutay, M., Dixon, R., & Platonova, E. (2020). Liquidity risk exposure and its determinants in the banking sector: A comparative analysis between Islamic, conventional and hybrid banks. Journal of International Financial Markets, Institutions and Money, 66, Article e101196. https://doi.org/10.1016/j.intfin.2020.101196
Mondello, G., & Smaoui, N. B. A. (2021). Agency theory and bank governance: A study of the effectiveness of CEO's remuneration for risk taking. HAL-SHS. https://shs.hal.science/halshs-03502607/document
Mutamimah, M., & Saputri, P. L. (2023). Corporate governance and financing risk in Islamic banks in Indonesia. Journal of Islamic Accounting and Business Research, 14(3), 436–450. https://doi.org/10.1108/JIABR-09-2021-0268
Naili, M., & Lahrichi, Y. (2022). The determinants of banks’ credit risk: Review of the literature and future research agenda. International Journal of Finance and Economics, 27(1), 334–360. https://doi.org/10.1002/ijfe.2156
Neifar, S., Salhi, B., & Jarboui, A. (2020). The moderating role of Shariah supervisory board on the relationship between board effectiveness, operational risk transparency and bank performance. International Journal of Ethics and Systems, 36(3), 325–349. https://doi.org/10.1108/IJOES-09-2019-0155
Oahn, T. T. K., Nguyen, D. V., Le, H. V., & Duong, K. D. (2023). How capital structure and bank liquidity affect bank performance: Evidence from the Bayesian approach. Cogent Economics & Finance, 11(2), Article e2260243. https://doi.org/10.1080/23322039.2023.2260243
Ofori-Abebrese, G., Pickson, R. B., & Opare, E. (2016). The effect of bank specific factors on loan performance of HFC bank in Ghana. International Journal of Economics and Finance, 8(7), 185–192. http://dx.doi.org/10.5539/ijef.v8n7p185
Oyewo, B. (2022). Enterprise risk management and sustainability of banks performance. Journal of Accounting in Emerging Economies, 12(2), 318–344. https://doi.org/10.1108/JAEE-10-2020-0278
Paltrinieri, A., Dreassi, A., Rossi, S., & Khan, A. (2021). Risk-adjusted profitability and stability of Islamic and conventional banks: Does revenue diversification matter? Global Finance Journal, 50, Article e100517. https://doi.org/10.1016/j.gfj.2020.100517
Purwanto, P., Bustaram, I., Subhan, S., & Risal, Z. (2020). The effect of good corporate governance on financial performance in conventional and Islamic banks: An empirical study in Indonesia. International Journal of Economics and Financial Issues, 10(3), 1–6. https://doi.org/10.32479/ijefi.9139
Radzi, R. M. & Lonik, K. A. T. (2016). Islamic banks’ risks: Its rating methodology and shariah assessment solutions. Journal of Islamic Banking and Finance, 4(2), 48–60.
Rahahleh, N. A., Ishaq Bhatti, M., & Najuna Misman, F. (2019). Developments in risk management in Islamic finance: A review. Journal of Risk and Financial Management, 12(1), Article e37. https://doi.org/10.3390/jrfm12010037
Ratnasari, N. G., Hati, S. R. H., & Chalid, D. A. (2021). Full-fledged vs Islamic bank windows: Which one do Muslim consumers know better and prefer more? IQTISHADIA, 14(2), 301–311. https://doi.org/10.21043/iqtishadia.v14i2.9967
Rizvi, S. A. R., Arshad, S., & Lahsasna, A. (2014). Derivatives in Islamic finance: The need and mechanisms available. International Journal of Financial Services Management, 7(3/4), 177–195. https://doi.org/10.1504/IJFSM.2014.065572
Safiullah, M. (2021). Financial stability efficiency of Islamic and conventional banks. Pacific Basin Finance Journal, 68, Article e101587. https://doi.org/10.1016/j.pacfin.2021.101587
Saiful, S., & Ayu, D. P. (2019). Risks management and bank performance: The empirical evidences from Indonesian conventional and Islamic banks. International Journal of Economics and Financial Issues, 9(4), 90–94. https://doi.org/10.32479/ijefi.8078
Salem, R., Usman, M., & Ezeani, E. (2021). Loan loss provisions and audit quality: Evidence from MENA Islamic and conventional banks. Quarterly Review of Economics and Finance, 79, 345–359. https://doi.org/10.1016/j.qref.2020.07.002
Sharifi, S., Haldar, A., & Rao, S. V. D. N. (2019). The relationship between credit risk management and non-performing assets of commercial banks in India. Managerial Finance, 45(3), 399–412. https://doi.org/10.1108/MF-06-2018-0259
Siddiqui, O., Khaleequzzaman, M., & Afzal. M. S. (2022). Accounting for Ijarah–Reviewing the need for exclusive accounting standards. Journal of Islamic Business and Management, 12(2), 198–217.
Siddiqui, O., Khan, N., & Sohail, M. K. (2024). The three ESG pillars, firm value and financial performance: A comparison of developed and emerging markets. NICE Research Journal, 17(2), 1–14. https://doi.org/10.51239/nrjss.v17i2.446
Siddiqui, O., Sohail, M. K., & Niazi, B. (2023). Setting CEO remuneration in Pakistan: Comparing theory and practice. Journal of Innovative Research in Management Sciences, 4(1), 18–34. https://doi.org/10.62270/jirms.v4i1.41
Smaoui, H., Salah, I. B., & Diallo, B. (2020). The determinants of capital ratios in Islamic banking. Quarterly Review of Economics and Finance, 77, 186–194. https://doi.org/10.1016/j.qref.2019.11.002
State Bank of Pakistan. (2023a). Prudential regulations. https://www.sbp.org.pk/publications/prudential/index.htm
State Bank of Pakistan. (2023b). SBP regulated institutes. https://www.sbp.org.pk/f_links/f-links.asp
The Pakistan Code. (1962). The banking companies ordinance. https://pakistancode.gov.pk/english/UY2FqaJw1-apaUY2Fqa-cJ%2BV-sg-jjjjjjjjjjjjj
Us, V. (2017). Dynamics of non-performing loans in the Turkish banking sector by an ownership breakdown: The impact of the global crisis. Finance Research Letters, 20, 109–117. https://doi.org/10.1016/j.frl.2016.09.016
Usmani, T. M. (2005). An introduction to Islamic finance. Idara Isha’at-E-Diniyat (P) Ltd.
Vuillemey, G. (2019). Bank interest rate risk management. Management Science, 65(12), 5933–5956. https://doi.org/10.1287/mnsc.2018.3125
Widarjono, A. (2020). Stability of Islamic banks in Indonesia: Autoregressive Distributed lag approach. Jurnal Keuangan Dan Perbankan, 24(1), 40–52. https://doi.org/10.26905/jkdp.v24i1.3932.
Zainuldin, M. H., & Lui, T. K. (2020). Earnings management in financial institutions: A comparative study of Islamic banks and conventional banks in emerging markets. Pacific Basin Finance Journal, 62, Article e101044. https://doi.org/10.1016/j.pacfin.2018.07.005
Copyright (c) 2024 Ozair Siddiqui, Naveed Khan, Zaheer Abbas
This work is licensed under a Creative Commons Attribution 4.0 International License.
Authors retain copyright and grant the journal right of first publication with the work simultaneously licensed under a Creative Commons Attribution (CC-BY) 4.0 License that allows others to share the work with an acknowledgement of the work’s authorship and initial publication in this journal.
