IRTI Working Paper Series

0 downloads 277 Views 819KB Size Report
Increasingly corporate financial institutions are realizing the importance of ... disruptions or to prevent accounting s
IRTI Working Paper Series WP/2016/14

Risk Management Practices in Islamic Banking Institutions: A Comparative Study between Nigeria and Malaysia Aliyu Dahiru Muhammad

08 Safar 1438H | November 08, 2016

Islamic Economics and Finance Research Division

0

IRTI Working Paper 2016-14 Title: Risk Management Practices in Islamic Banking Institutions: A Comparative Study between Nigeria and Malaysia Author(s): Aliyu Dahiru Muhammad

Abstract

Increasingly corporate financial institutions are realizing the importance of risk management. This leads to innovation of financial products to mitigate the risk. Islamic banking institutions face similar risks as conventional banking institutions. However, the later has additional Shariah noncompliance risk. The objective of this study is to compare risk management practices in Islamic banking institutions between Nigeria and Malaysia. The study employs survey technique to collect data from the respondents and analyze it using various techniques. Specifically, t-test and analysis of variance as well as multiple regressions were used to analyze the data. Findings show that there is significant differences in terms of understanding risk management and risk assessment and analysis between Nigeria and Malaysia with the later taking the lead. This is due to maturity and robust legal and regulatory framework. However, the result exhibits relative competition in RMP between Nigeria and Malaysia as out of five dimensions three are not significant (RMP, RI, RCM). While Malaysia leads in some aspects of risk management, Nigeria has huge potential to change the landscape of Islamic finance in the country. This implied that risk management processes in Islamic banks require additional legal and regulatory framework to strengthen their existing condition. Further research should focus on the details of risk management techniques employed by Islamic banks in the study area. JEL Classification: G20; G21; G28. Keywords: Risk Management Practices, Islamic banking, Nigeria, Malaysia _____________________________________________

Suggested citation: Muhammad, Aliyu Dahiru (2016). Risk Management Practices in Islamic Banking Institutions: A Comparative Study between Nigeria and Malaysia, IRTI Working Paper No. WP/2016/14, Jeddah: Islamic Research and Training Institute.

IRTI Working Paper Series has been created to quickly disseminate the findings of the work in progress and share ideas on the issues related to theoretical and practical development of Islamic economics and finance so as to encourage exchange of thoughts. The presentations of papers in this series may not be fully polished. The papers carry the names of the authors and should be accordingly cited. The views expressed in these papers are those of the authors and do not necessarily reflect the views of the Islamic Research and Training Institute or the Islamic Development Bank or those of the members of its Board of Executive Directors, Management or its member countries.

Islamic Research and Training Institute 8111 King Khalid St. Al Nuzlah Al Yamania Dist., Jeddah 22332-2444 Kingdom of Saudi Arabia 1

Risk Management Practices in Islamic Banking Institutions: A Comparative Study between Nigeria and Malaysia Aliyu Dahiru Muhammad1

1.

Introduction

Risk management is about how firms actively select the type and level of risk that it is appropriate for them to assume (Crouhy, Galai and Mark, 2006). A comprehensive risk management system include maintaining a risk management review process, appropriate limit on risks taking, adequate systems of risk measurement, a comprehensive reporting system and effective internal controls. In doing so, functions should be divided on risk management, monitoring and control as well and risk mitigation. The conventional risk management has not been able to, consistently prevent market disruptions or to prevent accounting scandals due to weak corporate governance. Risk management is a broad term for business discipline that ‘protects assets and profit of an organization by reducing the potential for loss before it occurs, mitigating the impact of the loss if it occurs, and executing a swift recovery after the loss occurs’ (Coffin, 2009, p. 4). It comprises risk identification, measurement and evaluation exposures, risk mitigation, risk reporting and risk transfer. On the other hand, Enterprise Risk Management (ERM) represents much wider scope in terms of covering the risk. It is risk management strategy in an organization that goes beyond physical and financial exposures to risk but also include long-term strategies, competitor response, human capital and operational exposures among others. It includes every significant component of the risk in the organization comprehensively and systematically (Coffin, 2009). Regardless of the definition, risk management system should be comprehensive, embodying all departments and units of the institution to create a risk-management culture (Ahmed, 2009). Meanwhile, in the contemporary financial market, there is increasing trend in financial innovations particularly in the derivatives and liberalized markets. Thought these innovative financial products enhance returns and lower transaction cost and they are creating vulnerabilities 1

Visiting Scholar, Islamic Research and Training Institute, Islamic Development Bank, Jeddah and Lecturer, International Institute of Islamic Banking and Finance, Bayero University Kano. E-mail: [email protected]. This paper is part of the Research conducted as a visiting scholar and supported by Islamic Research and Training Institute (IRTI), Islamic Development Bank Jeddah. Special thanks to Prof. Abdul Ghafar Ismail, Manager Research Division (IRTI) and many other personalities that supported me in this research. 2

instead of protection of the assets through the complex risks that are difficult to comprehend (Ahmed, 2009). This is largely caused by the practical disconnect between derivatives market and real asset transaction (LiPuman and Lee, 2005). For instance, the derivatives market expanded rapidly before the financial crisis. The notional value of Over the Counter (OTC) Transaction was USD596 trillion in 2007. The corresponding global GDP was USD54.3 trillion (Ahmed, 2009). In 2014 however, the corresponding figure increased to USD629 trillion and USD77.9 trillion respectively (IBS 2016, WDI, 2014). Currently there has not been any published study that examines risk management practices in Islamic banks in Nigeria, albeit, there are few related studies on Malaysia. This is despite the growth of Islamic banks and the seeming convergence between Islamic and conventional banks. The motivation of the study therefore is to bridge the gap in the literature by comparing the two countries. Risk management practice is not only one of the crucial areas in finance but also one of the least studied areas especially in Islamic finance. For instance since the establishment of Islamic banking and finance in Nigeria, there is virtually no studies conducted that examine risk management practices. Even in Malaysia, where the practice is more than three decades now, there has been limited studies on the area. Samad and Hasan (2000), Arif (1989), and Dirrar (1996) are either focusing on performance, evaluations or the study is far from risk management practice except Abdul Rahman et al. (2014) that compares Risk management practice in Malaysia and Jordan. Thus, the objective of this study is to investigate risk management practices in Islamic banks in Nigeria and Malaysia. The paper spreads into five sections. Section two reviews the related literature including the general overview of risk management and related development. While section three focuses on the methodology in the study, section four consists of results and discussion of the study. Finally section five forms the conclusion of the study.

2.

Related Literature Review

Risk management has assumed more importance than before in financial institutions due to capital exposure globally. It is evidently that corporation must take risk if they are to survive and prosper. The primary functions of risk management is to understand the portfolio of risk that the company takes or taking in the future. It is a known postulation that there is a trade-off between risk and

3

expected return. The expected return is the weighted average of the possible returns, which is estimated from the historical data. The consequences of poor risk management could cause institutional failure and by extension loss of values to the investors. In the United States between 1980 and 1990, there were over 1000 banks` failures. This is related to poor risk management practices and existence of deposit insurance that allowed the bank to follow risky strategies (Abdul Rahman et al. 2014). There are different types of risks that financial institutions face. These include credit risk, operational risks, market risk, liquidity risk and systematic risk. Islamic financial institutions however, face additional risk, which is sharia non-compliance risk. Credit risk is the risk that counterparties in loan transaction and derivatives transactions will default. This constitutes the greatest risk facing a commercial bank and which most of the regulators capital is required (Hull, 2012). Market risks however, arise from the banks trading operations. This is related to the value of the instrument, which declines or rises. The time horizon for considering losses from credit risks or operational risk is one year while ten days are considered for market risks. Operational risk is the risk that losses are incurred because internal systems fail to work as they supposed to or because of external events. Shari’ah compliant requires that all activities in IFIs conform to the principles and values of Islam. Shariah non-compliance risk therefore could be avoided if the principles of Islamic finance are fully adopted. Some specific operational issues affecting compliance or otherwise include treatment of interest-based calculations, discounting, early and late payments, defaults and ethical practices. Shariah guidelines are developed to ensure sharia compliance of all these issues (Zafar, 2012). Izhar (2010) categorizes Shariah compliance into products, activities and contract documentation aspects. Inadequate attention to the whole process of Shariah compliance will expose an Islamic bank to Shariah non-compliance risk. Much related to the above is reputational risk, which arises form failure of governance, business strategy and process. Once reputation of an IFI drops, the profitability could be at stake if there is negative publicity about its business practice particularly relating to Shariah noncompliance on the products and services. This alone, can trigger bank failure, systematic risk and instability (Zafar, and Qattan, 2006 cited in Ahmed, 2009). Hence, credibility and trust will also be lost by the banks. Addressing them will lead the bank to achieve its objectives via increase in net income of shareholders or else it can fail to achieve the objectives. 4

The objective of risk management tools and mechanisms is to reduce risks that are inherent to tolerable levels so that the residual risks meet the risk appetite of stakeholders that encourages them to invest in growth-enhancing wealth creating activities (Ahmed, 2009, p. 9). Thus, risks can either be avoided if identified, transferred or managed if it happens. In Islam, there are a number of lessons on risk mitigation in business transactions and other aspect of life. For instance, Surat Yusuf verse, 67 taught us to manage risk by taking precaution through understanding risk, identifying risk, analyzing risk and risk control. In the tradition, when the Bedouin came to the messenger (p.b.u.h.) and asked him: “O the Messenger of Allah…Should I leave my camel untied and trust in Allah, or should I tie it?” The Holy Prophet (p.b.u.h.) replied: “Tie your camel and then trust in Allah” (Al-Tirmidhi, 1998). Given the vital role of risk management in finance, there is need for effective measurement techniques of risk. Scholars have developed a measure of risks such as Value-at Risk (VaR), arbitration method, Capital Asset Pricing Model (CAPM). These measures give bank a measure of portfolio`s largest expected loss during a specific period for a given level of probability (Tariqullah and Dandang, 2005, p.378). Markowitz (1952) and Sharpe (1964) have developed the CAPM which is widely used in risk management analysis. Ross (1976) developed Arbitrage Pricing Theory (APM) which is an extension of CAPM and these provide insights to manager and academicians in risk management. In terms of risk mitigation, Islamic finance is constrained due to the non-availability of some instruments such as hedge funds. However, the nature of Islamic finance products portrays different type of risk that has to be tailored to the product. Asutay and Turkistani (2015) argue that risk management in Islamic finance is built on the foundation that risk must be shared between parties unlike in the conventional finance where risk is assumed by one party or the other. Ahmed (2009) identifies the failure of risk mitigation in conventional finance at three different levels as the cause of the recent financial crisis: at institutional level, organizational level and product level. He opines that the current practice of Islamic finance might not be helpful as it mimics conventional counterpart. This, however, could be avoided if principles of Islamic finance have been observed. According to him, such risks can be mitigated at these three levels. Thus, the paper argues that the recent financial crisis reveals misunderstanding and mismanagement of risks at institutional, organizational and product levels. The implication of which is that Islamic finance could fall into the same trap unless appropriate measures are taken as at when due. Interestingly, 5

the author argues that, building trust is an essential element in making the Islamic financial sector a viable and resilient alternative. Interestingly, the 2008-2009 financial crisis was seen as an opportunity for Islamic finance to portray its strengths in the market and attract investment and subsequently serve wider consumers. According to Chapra, (2008) and Siddiqi (2008), the crisis was due to lack of market discipline arising from lack of using profit and loss sharing modes of financing as well as the increasing gambling and speculation through derivatives market. In view of this, Ahmed (2009) cautions that unless Islamic finance restraint itself from mimicking conventional products, it is susceptible to a similar episode. He advocates for proper observance of Islamic financial principles that will lead to genuine economic activities and subsequently improvement in the welfare of the people. Moreover, Hassan (2009) identifies three types of risks namely essential risk; forbidden risk and tolerable risks. In the case of essential risk, which is considered as part of business undertakings, it justifies gain on investment. Forbidden risk however, entails excessive risk that actually can be avoided such as gambling and gambling-like transactions and finally tolerable risks that can be transferred or shared in a sharia compliant manner. Increased risk exposure has become a major issue of concern for researchers particularly after the 2008-2009 financial crisis, which exposes the weaknesses in risk management of the major financial institutions. Financial institutions therefore are expected to manage their observed risks efficiently. It is argued that the Islamic financial institutions are exposed to the same conventional risk and are always subject to the specific risks associated with the Islamic financial products and operations. Asutay and Turkistani (2015) further argued that Islamic finance risks sphere seems to be larger than the conventional banking despite the fact that the underlying features of Islamic finance aim at reducing excessive risk taking and speculation. In fact, due to increasing financial uncertainties there is need to examine risk management practices between Islamic banks with the aim to explore the exposure and managing risk in the institutions. Ali and Naysary (2014) examine risk management practices in Kuwait. Their finding reveal that the practice of risk management in Islamic banks is similar to the conventional banks in terms of risk process, measurement of risks and techniques adopted to measure risks. Hassan (2009) studied Kuwait using survey technique, and regression method, the author investigates risk management practices in Islamic banks in Brunei Findings from this study show that as the products of Islamic banks and conventional banks differ, so the risk exposure also 6

differs. Similarly, there is dilemma in terms of managing foreign exchange risk, credit risk and operational risk. Nazir, Daniel and Nawaz (2012) investigated risk management practices of conventional and Islamic Banks in Pakistan. The authors gathered data from the survey of 300 respondents based on the regression and analysis of variance it was found that Pakistani banks are efficient in credit risk analysis, risk monitoring and understanding risk. Moreover, there is significant difference in risk management practices of the Islamic and conventional banks in Pakistan. Ali and Naysary (2014) used qualitative research using in-depth interview and thematic data analysis to explore the risk management practices in Islamic banks in Kuwait. Their finding reveals that the practice of risk management in Islamic banks is similar to the conventional banks in terms of risk process, measurement of risks and techniques adopted to measure risks. Rashidah et al. (2012) studied risk management practices in Malaysian and Indonesia and found that Islamic banks in Malaysia were using techniques that are more sophisticated in risk identification compared to Indonesian Islamic banks. Similarly, Samad and Hassan (2000) compares Islamic bank and a group of conventional bank in terms of risk and insolvency measure. Their finding reveals that Islamic bank in less risky using some selected risk measures. In general, Islamic banks have to deal with challenging environment, yet they have to understand potential risk within the environment they operate as well as internal risk such operational risk to avoid failure on one hand and to take opportunity on the other hand. Based on these and similar similar studies, the following hypotheses are proposed: Kia and Darrat (2003) based on Iranian banking system find that demand for profit sharing deposits possesses inherent stability features and tend to be policy invariant as compared to conventional fixed deposit. The former suggests that profit sharing banking system could help to insulate the monetary system from interest rate fluctuations. However, finding from Kassim, Majid and Yousuf (2009) from Malaysian data shows contrary to this assertion. This supports the claim by Ahmad (2009) that, unless Islamic banks are well rooted and firmly follow the Islamic principles of finance, they would face the same consequence with the conventional finance.

3.

Research Methodology

This section covers the data collection, instruments used and its reliability test, population and sample of the study and data analysis techniques. The instrument used to generate the data is a 7

modified questionnaire developed by Al Tamimi and Mazrooei (2007), Hassan (2009) and Abdul Rahman et al. (2014). Using questionnaire for this kind of study is acceptable due to paucity of secondary in the area. The questionnaire comprises five sections: respondents profile; the company`s profile; the risk management process- understanding risk management, risk identification, risk assessment and analysis risk control and monitoring as well as the general risk management practices. The instruments uses 7-point likert scale and respondent were asked to indicate their level of agreement (ranging from 1 =strongly disagree to 7=strongly agree) their perceptions about the total of 40 closed-ended questions relating to risk management process and risk management practices. Questionnaire was distributed to three banks that are licensed to operate Islamic banking in Nigeria by the Central Bank of Nigeria. The samples of the population were drawn from Abuja, Kano, Kaduna and Katsina. A total of 200 questionnaires were distributed among staff of the branches of the three banks, one full fledge Islamic bank and two Islamic banking windows. These are Jaiz Bank, Stanbic IBTC, Sterling Bank respectively. The response rate was 52 percent which was considered good for this kind of study. Similarly, in the case of Malaysia, the data was collected from 17 Islamic banks identified by Bank Negara Malaysia (BNM). A total 255 questionnaire was distributed, while 136 usable were used for the study representing 53 percent response rate. The data was collected by trained research assistants in both countries. Thus, given the new banking environment where holistic approach to risk management is applied not only risk management department, the respondents were also drawn from various departments (Rahman, 2016). According KMPG International (2009), risk appetite of the bank should be understood by the bank staff and the three independent layers of defense against risk should be incorporated in risk management system vis-à-vis business units, risk management function and internal audit. A battery of statistical techniques were employed to analyse the data. However, cronbach`s alpha was used to test the reliability of the instrument. The measure shows estimate of how much variation in scores in the variables used is due to random error (Stelltiz et al. 1976). The estimated result shows that the instrument and the variables are reliable both in Nigeria and in Malaysia. In addition, t-test and Analysis of Variance (ANOVA) were used to examine if there is significance difference between the samples of the study. Multiple regressions technique was employed to examine the relative impact of the independent variables on the dependent variables. The rationale for adopting this is due to its predictive power and accuracy compared to simple correlations 8

(Robert, 2016). Similar techniques were found in Hassan (2009), Al-Tamimi and Maqroozei (2007) and Abdul Rahman et al (2014) that studied risk management practices in various jurisdictions. Based on the previous studies in the area, the following hypotheses were considered in this study.

H1. There is significant difference between the level of risk management practices of Islamic Banks in Nigeria and Malaysia. H2. There is significant difference between the level of understanding risk management and the techniques used in Islamic Banks in Nigeria and Malaysia. H3. There is significant difference between the level of risk identification in Islamic Banks in Nigeria and Malaysia. H4. There is significant difference between the level of risk assessment and analysis practice of Islamic Banks in Nigeria and Malaysia. H5. There is significant difference between the level of risk control and monitoring of Islamic Banks in Nigeria and Malaysia. H6. The is positive relationship between risk management practices and understanding risk management, risk identification, risk assessment and analysis and risk monitoring and control.

4.

Results and Discussions

This section presents the results of the study and discusses its relevance in the context of risk management in general and the study areas specifically. Table 1. Reliability Test Cronbach Alpha No.

Risk Management Aspects

Nigeria

Malaysia

Overall (Both)

1

Risk management practices

0.909

0.903

0.905

9

2

Understanding risk management

0.857

0.814

0.837

3

Risk identification

0.769

.500

0.629

4

Risk assessment and analysis

0.853

0.871

0.867

5

Risk control and monitoring

0.859

0.885

0.873

Source: author’s own computation Before carrying the analysis, preliminary test were conducted to ensure reliability and validity of the data. Table 1 shows the result of the instrument used in the research. Cronbach`s alpha was employed to measure the reliability of the variables. The measure shows estimate of how much variation in scores in the variables used is due to random error (Stelltiz et al., 1976). According Nunnaly (1978) the value of the alpha of 0.7 and above are acceptable. In this research, most of the values in RM, URM, RAA and RCM are above 0.8 except RI, which has the lowest value of 0.76 in Nigeria, 0.50 in Malaysia and 0.63 for the overall. In general, the result is reliable and is similar to that of Hussain and Al-Ajmi that reported high cronbach`s alpha in their studies. Table 2. Level of Risk Management Practices between Nigeria and Malaysia through t-test Nigeria Malays Significant No. Risk management practices mean ia Difference mean Executive management of your Islamic Bank regularly 6.02 5.91 0.417 1 reviews the bank’s performance in managing its business risk 2 Your Islamic Bank is highly effective in continuous 5.76 5.65 0.373 review/feedback on risk management strategies and performance 3 Your Islamic Bank’s risk management procedures and 5.68 5.81 0.369 processes are documented and provide guidance to staff about managing risks Your Islamic Bank’s policy encourages training programs 5.32 5.68 0.014 4 in the risk management and Islamic ethics areas 5 Your Islamic Bank emphasizes the recruitment of highly 5.57 5.36 0.206 qualified people having Islamic knowledge in risk management 6 One of the objectives of your Islamic Bank is ‘effective risk 5.74 5.93 0.183 management’ Your Islamic Bank finds that it is too risky to invest funds in 5.56 5.67 0.515 7 one specific sector of the economy Your Islamic Bank is successfully implementing the IFSB 5.69 5.64 0.732 8 and Central Bank guidelines/principles in regard to risk 10

9 10 11

Management Application of Basel II Accord will improve of efficiency and RMPs in the Islamic banking in general I consider the level of RMPs of my Islamic Bank to be excellent I consider my Islamic Bank has a shariah compliance Risk Management Practices Overall

5.51

5.84

0.019

5.47

5.68

0.134

5.87

5.96

0.488

5.66

5.74

0.440

Source: author’s own computation

With regard to specific indicators of risk management practices, it was observed that Malaysian Islamic banks encourage more training to the staff on risk management and ethics. This is not a surprising because of high level of government involvement and the maturity of Islamic banks in Malaysia as compared to Nigeria. Furthermore, it is found that there is significant difference in terms of the application of Basel II and efficiency of Islamic Banking with the higher mean from Malaysian Islamic banks. This finding is similar to Nazir, Daniel and Nawaz (2012) in the case of Pakistan. Basel II accord provides the basis for implementing the internal ratingsbased (IRB) approach to measuring a bank’s capital adequacy. According to Grenuing and Iqbal (2008) IRB approach brings additional sensitivity to risk which is more sensitive to the drivers of credit risk and economic loss in a bank’s portfolio. Subsequently it will create incentives for the bank to enhance its internal risk management practices. Table 3. Level of Understanding Risk Management between Nigeria and Malaysia through t-test No. 1 2 3

Understanding Risk management

Nigeria mean

Malaysia mean

Significant Difference

There is a common understanding of risk management across Islamic bank

5.63

5.98

0.023

Responsibility for risk management is clearly set out and understood throughout the bank Accountability for risk management is clearly set out and understood throughout the bank Managing risk is important to the performance and success of the bank

5.51

5.90

0.006

5.56

5.85

0.047

6.19

6.35

0.166

It is crucial to apply the most sophisticated techniques in risk management

5.97

5.90

0.588

The objective of Islamic bank is to expand the applications of the advanced risk management technique It is important for your Islamic bank to emphasize on continuous review and evaluation of the techniques used in risk management Application of risk management techniques reduce costs or expected losses

5.62

5.82

0.137

5.91

6.03

0.335

5.90

6.06

0.216

I understand that the risk management practices in Islamic banks must be according to Shariah

6.16

6.26

0.503

4 5 6 7 8 9

11

Overall Score

5.83

6.01

0.032

Source: author’s own computation The result of Table 3 shows that there is significant difference between understanding risk management across Islamic banks understudied. The mean value in the case of Malaysia (5.98) is higher than that of Nigeria (5.63). The result further reveals that there is significant difference with regard to the setting out risk management responsibility and its understanding in the bank with Malaysian Islamic banks having the higher mean (5.90). Similarly, there is significant difference between setting out risk management accountability and its understanding in the bank equally taking the lead by Malaysian Islamic banks. Table 4. Level of Risk Identification between Nigeria and Malaysia through t-test Nigeria Malaysia No. Risk Identification mean mean The Islamic bank carries out a comprehensive and systematic 5.80 5.86 1 identification of its risk relating to each of its declared aims and objectives 2 Changes in risk are recognized and identified with the 4.43 3.25 Islamic Bank’s rules and responsibilities 3 The Islamic Bank is aware of the strengths and weaknesses 5.38 5.73 of the risk management systems of the other banks. Islamic Bank has developed and applied procedures for the 5.43 5.36 4 systematic identification of investment opportunities In the process of identifying risk, your Islamic Bank always 5.54 5.66 5 take shariah compliance issues into consideration Overall Score 5.41 5.31

0.664

0.00 0.016 0.639 0.408 0.344

Source: author’s own computation

Table 4 shows that there is significant difference between change in risk profile and policy adjustment to respond to the changes in Islamic Banks in the studies area. In fact, Malaysian Islamic banks has the lowest response to this question probably due to bureaucratic procedures in the bank. On the other hand, there is significant difference between awareness on the strengths and weaknesses of the risk management system of other banks. In this case, Malaysia leads with slightly higher mean as compared to Nigeria. This could be due to vibrant existence of Islamic interbank money market in the country as compared to very new but emerging Islamic interbank money market in Nigeria. In the case of Nigeria, there is single full fledge Islamic bank with additional Islamic banking windows offered by the conventional banks. 12

Table 5. Level of Risk Assessment and Analysis between Nigeria and Malaysia through t-test Nigeria Malaysia Significant N

Risk Assessment and Analysis

mean

mean

Difference

o. 1

Islamic Bank assesses the likelihood of occurring risk

5.68

6.01

0.027

2

Islamic Bank’s risk is assessed by using quantitative analysis methods Islamic Bank’s risk is assessed by using qualitative analysis methods (e.g. high, moderate, and low) Your Islamic Bank analyses and evaluates the opportunities that it has to achieve objectives Your Islamic Bank's response to analysis risk includes assessment of the costs and benefits of addressing risk Your Islamic Bank’s response to analyze risk includes prioritizing of risk and selecting those that need active management. Your Islamic Bank’s response to analyze risk includes prioritizing risk treatments where there are resource constraints on risk treatment implementation Your Islamic Bank has applied a shariah compliance risk assessment and analysis Overall Score

5.27

5.79

0.00

5.49

5.79

0.025

5.68

5.85

0.205

5.58

5.83

0.054

5.64

5.88

0.066

5.41

5.88

0.008

5.83

5.77

0.389

5.57

5.86

0.003

3 4 5 6

7

8

Source: author’s own computation Interestingly, when it comes to measurement of risk, it is apparently very clear that Malaysia leads in many respects. For instance, there is significance difference in assessing the likelihood of risk occurring in Islamic banks with mean value of 6.01 in Malaysia and 5.68 in Nigeria. There is also significance difference in Islamic banks techniques in measuring risk quantitatively (5.79 in Malaysia and 5.27 in Nigeria) and qualitatively (5.79 in Malaysia and 5.49 in Nigeria); cost and benefits of addressing the risk (5.83 in Malaysia and 5.58 in Nigeria); prioritizing risk (5.88 in Malaysia and 5.64 in Nigeria) and risk treatment due to resource constraints (5.88 in Malaysia and 5.83 in Nigeria). Overall, there is significant difference between Islamic banks in Nigeria and Malaysian Islamic bank in terms of risk assessment and analysis. Malaysia was found to lead this aspect which shows relative leadership and maturity of the country`s Islamic banks compared to that of Nigeria. This finding confirms hypothesis 3 and the result is confirmed.

13

Table 6. Level of Risk Control and Monitoring between Nigeria and Malaysia through t-test Nigeria Malaysia Significant Risk Control and Monitoring No. mean mean Difference 1 2 3 4

5 6

Monitoring the effectiveness of risk management is an integral part of routine management reporting Level of control by the Islamic Bank is appropriate for the risk that it faces In your bank, reporting and communication processes support the effective management of risks The Islamic Bank's response to risk includes an evaluation of the effectiveness of the existing controls and risk management responses The Islamic Bank's response to risk includes action plans in implementing decisions about identified risk The existing control and monitoring process in your Islamic Bank has always consider shariah compliance issues Overall Score

5.97

6.08

0.348

5.65

5.74

0.501

5.76

5.75

0.946

5.65

5.87

0.097

5.70

5.89

0.191

5.94

6.10

0.213

5.78

5.90

0.217

Source: author’s own computation In terms of some specific questions on risk control and monitoring, there is significant difference in bank`s response using effective evaluation of the existing control and risk management responses. The mean difference for Nigeria is slightly lower than Malaysia with 5.65 and 5.87 respectively. However, most of the question the researchers could not establish any significant difference in them.

In order to test H1, the following regression model was specified; Model Specification 𝑅𝑀𝑃 = 𝑓(𝑈𝑅𝑀, 𝑅𝐼, 𝑅𝐴𝐴, 𝑅𝑀) Where: 𝑅𝑀𝑃 = 𝑟𝑖𝑠𝑘 𝑚𝑎𝑛𝑎𝑔𝑒𝑚𝑒𝑛𝑡 𝑝𝑟𝑎𝑐𝑡𝑖𝑐𝑒𝑠 𝑈𝑅𝑀 = 𝑢𝑛𝑑𝑒𝑟𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑟𝑖𝑠𝑘 𝑚𝑎𝑛𝑎𝑔𝑒𝑚𝑒𝑛𝑡 𝑅𝐼 = 𝑟𝑖𝑠𝑘 𝑖𝑑𝑒𝑛𝑡𝑖𝑓𝑖𝑐𝑎𝑡𝑖𝑜𝑛 𝑅𝐴𝐴 = 𝑟𝑖𝑠𝑘 𝑎𝑠𝑠𝑒𝑠𝑠𝑚𝑒𝑛𝑡 𝑎𝑛𝑑 𝑎𝑛𝑎𝑙𝑦𝑠𝑖𝑠) 𝑅𝑀 = 𝑟𝑖𝑠𝑘 𝑚𝑜𝑛𝑖𝑡𝑜𝑟𝑖𝑛𝑔

Table 7. Correlations Coefficients between independent variables

RMP

RMP 1

URM

RI

RAA

RCM

14

URM .691** 1 ** RI .635 .666** ** RAA .592 .593** RCM .651** .539** Source: author’s own computation

1 .585** .524**

1 .654**

1

Before furthering the research, a multicolllinerity test was carried out to assess the degree of correlation among the variables. Pearson`s correlation was employed to examine the correlations among the independent variables vis-à-vis understanding risk management (URM), risk identification (RI), risk assessment and analysis (RAA) as well as risk control and monitoring (RCM). Table 10 reveals the correlation coefficients between the independent variables. According to Camm et al. (2016, p.327) any correlation coefficient that exceeds (0.7) suggests a potential problem of mulitocollinearity. The analysis in table 10 shows there is absence of multicollinearity among the independent variables. Existence of multicollinearity, may suggest weak predictive power of the model. Moreover, result of Durbin Watson test (1.67) shows that the data is normal and further analysis could be carried out. The value is 1.72 in Nigeria and 1.96 in Malaysia respectively. Table 8. Comparative Regression Result Variables

Nigeria Coefficient

Constant Understanding risk management (URM) Risk identification (RI) Risk assessment and analysis (RAA) Risk control and monitoring (RCM) Adj. R2 F-value Sig. Durbin Watson N

Sig.

Malaysia Coefficient

Overall Sig.

Coefficient

Sig. .713

.561

.000

.065

.411

.351

.000

.251

.003

.042

.591

.200

.001

-.020

.811

.314

.000

.058

.328

.152

.071

.494

.000

.319

.00

.694 59.464 .000 1.72

.624 57.108 .000 1.96

.612 9.741 .000 1.67

104

136

240

Source: author’s own computation 15

Nigerian Model 𝑅𝑀𝑃 = 𝑓(𝑈𝑅𝑀. 561 + 𝑅𝐼. 251 − 𝑅𝐴𝐴. 02 + 𝑅𝑀. 152 + 𝑒) Malaysian Model 𝑅𝑀𝑃 = 𝑓(𝑈𝑅𝑀. 065 + 𝑅𝐼. 042 + 𝑅𝐴𝐴. 314 + 𝑅𝐶𝑀. 494 + 𝑒) Overall Model 𝑅𝑀𝑃 = 𝑓(𝑈𝑅𝑀. 351 + 𝑅𝐼. 200 + 𝑅𝐴𝐴. 058 + 𝑅𝐶𝑀. 319 + 𝑒)

Based on the result of regression, the adjusted R-squares are found to be high with value 0.69 and 0.64 in Nigeria and in Malaysia respectively. The overall value also stands at 0.612. Using F-statistics, it was discovered there are significant difference between the two (2) countries with 59.46 in Nigeria and 57.10 in Malaysia. The overall F-statistics was also found to be significant. While in Nigeria, understanding risk management (URM) and risk identification (RI) were significant predictors; in Malaysia, only risk assessment and analysis (RAA) as well as risk control and monitoring (RCM) were significant. The overall result shows that understanding risk management, risk identification and risk control and monitoring were all significant predictors of risk management practices. This is consistent with the findings of Abdul Rahman et al. (2014) in the case of Malaysia and Jordan except that risk identification is not statistically significant in their study. While understanding risk management is the most important factor that influences risk management practices in Nigeria, in the case of Malaysia risk control and monitoring stands as the most influential factor of risk management practices. Overall, however, understanding risk management carries the highest value among all the variables. Meanwhile the result indicate, Nigeria starts Islamic banking practice with good footing and it can compete with Malaysia as times goes on. However, the country needs to pay attention to understanding risk and risk identification. Malaysia on the other hand needs to pay more attention to risk assessment and analysis as well as risk control and monitoring regardless of the country.

5.

Conclusion and Implications

This study examines the differences in risk management factors in the countries under study. It was found that there is significant differences in terms of understanding risk management and risk assessment and analysis between Nigeria and Malaysia with the later taking the lead. This might 16

be due to maturity and robust legal and regulatory framework. However, the result exhibits relative competition in RMP between Nigeria and Malaysia as out of five dimensions three are not significant (RMP, RI, RCM). Based on regression analysis, it was observed that there are significant differences in terms of understanding risk management and risk assessment and analysis between the two countries. While in Nigeria, it was found that understanding risk management (URM) and risk identification (RI) were significant predictors; in Malaysia, only risk assessment and analysis (RAA) as well as risk control and monitoring (RCM) were significant. However, overall, understanding risk management, risk identification and risk control and monitoring were all significant predictors of risk management practices. While in Nigeria, understanding risk management is the most important factor that influences risk management practices, in the case of Malaysia risk control and monitoring stands as the most influential factor of risk management practices. In terms of policy implications, the management board of Islamic banks in both countries should introduce regular training and research on risk management to create risk management culture. This will increase efficiency and effectiveness of risk management and resource allocations. Consequently it will boost confidence of the clients of the Islamic banks. Similarly, sound legal reforms are highly desirable in the growth and development of Islamic banking. In Nigeria, Islamic banking is based on some sub-sections of the constitutions and guidelines of the central bank of Nigeria. Thus, a proper legal environment helps in ensuring robustness of the system as well checkmating the market behaviors. There is also the need for more facilities’ from the lender of last resort with regard to liquidity management of Islamic banks in Nigeria. At the moment, Islamic banks are at disadvantaged positions due to lack of facilities that will attract returns other than interest rate. This will go a long way in ensuring shariah compliance.

17

References Abdul Rahman, Rashidah, Alsmady, Ahnaf, Ibrahim, Zuraeda Muhammad, A.Dahiru (2014). Risk Management Practices in Islamic Banking Institutions: A Comparative Study Between Malaysia and Jordan, Journal of Applied Business Research, 30(5): pp. 1295-1304. Abdulmanap, A. (2015). Overview: Government Initiatives and Policies in the Development of Islamic Finance in Malaysia. Malaysia Islamic Finance Report 2015, Jeddah: Islamic Research and Training Institute, Jeddah Abikan, A. (2012). The Legal Framework for Islamic Banking in Nigeria, Journal of Islamic Banking and Finance, Volume 29 Oct – Dec. 2012 No. 4, pp. 20. Abikan, A. (Undated) Interest-Free Window Of The Defunct Habib Nigeria Bank: A Test-Run for Islamic Banking System in Nigeria available at http://unilorin.edu.ng/publications/abikan/Habib%20Bank%20paper.pdf downloaded on 7/6/2016 Abu-Hussain, H. and Al-Ajmi, J. (2012). Risk Management Practices of Conventional and Islamic Banks in Bahrain, The Journal of Risk Finance, 13(3), pp. 1-26 Agha S. E. and Sabirzyanov, R. (2015). Risk Management in Islamic Finance: An Analysis from Objectives of Shari’ah Perspective, International Journal Of Business, Economics and Law, Vol. 7, Issue 3: pp.46-52 Ahmed, H. (2009). Financial Crisis: Risks and Lessons for Islamic Finance, ISRA International Journal of Islamic Finance, 1(1): pp. 7-32. Al Tamimi, H. and Mazrooei, F. (2007). Banks` Risk Management: a Comparison Study of UAE National and Foreign Banks, The Journal of Risk Finance, Vol.8 Issue 4: pp. 394-409. Alford, Duncan (April 19, 2010). Nigerian Banking Reform: Recent Actions and Future Prospects Available at SSRN: http://ssrn.com/abstract=1592599 or http://dx.doi.org/10.2139/ssrn.1592599. Ali H. and Naysary B. (2014). Risk Management Practices in Islamic Banks in Kuwait, Journal of Islamic Banking and Finance, 2(1): pp. 123-148. Arif, M. (1989). Islamic Banking in Malaysia: Framework, Performance and Lesson, Journal of Islamic Economics, 2(2): pp. 67-78. Bank for International Settlement (November, 2015) Statistical release OTC derivatives statistics at end-June 2015 Monetary and Economic Department available at www.bis.org/publ/otc_hy.htm.

18

Bank Negara Malaysia (2016) Overview of Islamic Finance in Malaysia available at http://www.bnm.gov.my/index.php?ch=fs_mfs&pg=fs_mfs_bank. BIS (2015). Statistical release OTC derivatives statistics, at end-June 2015, Monetary and Economic Department access at http://www.bis.org/publ/otc_hy1511.htm on 23rd June, 2016. Camm, J. Cochran, J.Fry, M. Ohlmann, J. and Anderson, D. (2016). Essentials of Business Analytics, Cengage Learning, UK. Chapra, U. (2008). The Global Financial Crisis and the Islamic Financial System. Paper presented at the Forum On The Global Financial Crisis, Islamic Development Bank, Jeddah. Cihák, M. and H. Hesse, (2010). “Islamic Banks and Financial Stability: An Empirical Analysis”, Journal of Financial Services Research, vol. 38(2), 95–113 Coffin, B (2009.The 2008 Financial Crisis: A Wake-up call for Enterprise Risk Management, Risk Insurance Management Society, New York. Crouhy, M. Galai, D. and Mark, R. (2006). The Essentials of Risk Management, 2nd Edition. McGraw-Education, US. Crouhy, M., Galai, D. and Mark, R. (2006). The Essentials of Risk Management. McGraw-Hill. US. Dirrar E. E (1996). Economics and Financial Evaluation of Islamic banking Operations: A Case of Bank Islam Malaysia 1983-1995, unpublished project submitted to International Islamic University Malaysia. Hassan, H. (2009). Basic Sharia Principles Governing Risk management, paper presented at Harvard-LSE Workshop on Risk Management, London School of Economics. IRTI (2015). Malaysia Islamic Finance Report 2015, Jeddah: Islamic Research and Training Institute. Izha, H. (2010) Identifying Operational Risk Exposures in Islamic Banking, Kyoto Bulletin of Islamic Area Studies 3-2 (March 2010), pp. 17-53. Kassim, S. H. Abd. Majid, M. S. and Yusof (2009). Impact of Monetary Policy Shocks on the Conventional and Islamic Banks in A Dual Banking System: Evidence from Malaysia. Journal of Economic Cooperation and Development, 30(1): pp. 41-58. Khan, T. and Dandang, M. (2007). Islamic financial Architecture: Risk Management and Financial Stability. Jeddah: Islamic Research and Training Institute.

19

LiPuma, E., and Lee, B. (2005). Financial Derivatives and the Rise of Circulation. Economy and Society, 34(3): pp. 404-427. Lo, C. W. and Leow, C. S. (2014). Islamic Banking in Malaysia: A Sustainable Growth of the Consumer Market, International Journal of Trade, Economics and Finance, 5(6): pp. 526529. Nazir, M. Daniel, A. and Nawaz, M. (2012) Risk Management Practices: A Comparison of Conventional and Islamic Banks in Pakistan, American Journal of Scientific Research, Issue 68: pp. 114-122. Ngalim, S. Ismail, A. and Yaakub, N. (2015). A comparative analysis of the maqasid shariah of Islamic banks in Malaysia, Indonesia and the Gulf Cooperation Council Countries edit (Islamic Finance, Political Economy, values and Innovation, Volume 1, edit Mehmet, A, and Abddullahi, Turkistani, Gerlach Press. Nunnally, J. C. (1978). Psychometric Theory (2nd ed.). New York: McGraw-Hill. Rollert, B. (2016). What advantages does multiple regression analysis have over more sophisticated machine learning methods? McGrill University, accessed at https://www.quora.com/What-advantages-does-multiple-regression-analysis-have-overmore-sophisticated-machine-learning-methods on 6th September, 2016. Ross S. A. (1976). The Arbitrage Theory of Capital Asset Pricing, Journal of Economic Theory, 13: pp. 314-360. Salah, Z. (2016). Risk Management: Case of Islamic Development Bank, a presentation at Advanced Risk Management training organized by Islamic Research and Training Institute, Jeddah, 3rd – 5th May, 2016. Samad A. and Hassan, K. (2000). The Performance of Malaysia Islamic Bank During 1984-1997: An Exploratory Study, International Journal of Islamic Financial Services, Vol. 1 No. 3, pp. 1-15. Sanusi, L. S. (March, 2011). Banks in Nigeria and National Economic Development: A Critical Review. Being a keynote address at the seminar on “Becoming an Economic Driver While Applying Banking Regulations,” organized by the Canadian High Commission in Joint Collaboration with the Chartered Institute of Bankers of Nigeria (CIBN) and the Royal Bank of Canada (RBC). Siddiqi, M. N. (2008). Current Financial Crisis and Islamic Economics. Mimeo, October 31. Stelltiz, C. Wrightsman, L. S. and Cook, S. W (1976). Research Methods in Social Relations, 3rd edition, New York: Holt, Rinehart and Winston. The Banker (Nov 2013) Special Report: Top Islamic Fin Institutions & Global Private Banking Awards 2013, USA. 20

The Economist (October, 2009). Nigeria`s Banking Clean-Up: Invasive Surgery: A Dramatic Stocktaking at Some of Nigeria’s Biggest Banks. Turkistani, A. and Asutay, M. (2015). Islamic Finance: Risk, Stability and Growth, Volume 2, Gerlach Press, US. World Development Indicators (2016). GDP at Market Prices available at http://data.worldbank.org/indicator/NY.GDP.MKTP.CD Zafar,

F. (2012). Risk Management in Islamic Banking available at http://www.slideshare.net/fahadzaf/risk-management-islamic-banking?next_slideshow=1

21