Dissertation-Aleem 1105941 - Copy

A Study Examining Risk Management at

Meezan and Burj Bank in Pakistan

Developed by Aleem Khan

ID:1105941Supervised by

Dr. Blair Logie

Department of Business Management, Leeds Trinity University College

(2011-12)

ACKNOWLDGEMENT

All thanks and gratitude to Allah Almighty for his blessings and guidance throughout

my life, especially during this Research. It was His kindness which has made it possible.

I have been extremely fortunate to have Dr. Blair Logie as my supervisor, who inspite

of his extremely busy schedule was there for me whenever I needed him. I am grateful to him

for his able guidance, intellectual advice, and developing in me an eagerness to gather more

and more knowledge. His invincible attitude and quest for gaining insight into any research

problem is truly admirable and it taught me valuable lesson of life. Thank you Sir!

I am highly obliged by the kind support and help extended by Dr. Blair Logie in my

work. He helped and guided me in a productive and prospective way so that i am able to

accomplish my task successfully.

Last, but not least, the prayers, sacrifices and encouragements of my parents

throughout these years and my whole life cannot be acknowledged in few words. They have

given me so much and asked for so little. Without their support I could not be able to go even

a step ahead. I also cannot pay-off the support and prayers of my family. There are no words

to thank for their efforts.

Abstract

This research is being conducted for unveiling the reasons behind hesitation of people

towards acceptance and adoption of Islamic Banking and Finance. This topic has been

addressed by many researchers but still I feel a gap so .This research is an addition to

the work done before with some additional constraints identified, that need to be

considered for increasing trend of Islamic Banking usage in Pakistan.

The purpose of this study is to understand and bring forth the risks of practicing

Islamic Banking in Pakistan. While taking the interviews of the management of both

Banks for this research, it is to understand the measures being taken by Meezan Bank

and Burj Bank in minimising the effects of risks which they are facing in conducting

Islamic banking system. This paper will help policy makers to take measures for

increasing awareness about Islamic banking through proper adoption of awarness &

educating people. This research study will also open new doors for new upcoming

researchers.

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Table of Contents Page #

Chapter 1: Introduction 51.1 Background 51.2 Research Rationale 51.3 Research Aim 51.4 Research Objectives 61.5 Research Questions 71.6 Research Settings 71.7 Structure of the study 8

Chapter 2: Literature Review9

2.1 Introduction 92.2 Risks 92.3 Sources of Risks 102.4 Risk Management 112.5 Risk Management framework 122.6 Models of strategic Risk management 142.7 Risk Management in context of Islamic banking 192.8 Conclusion 21

Chapter 3: Research Methodology22

3.1 Introduction 223.2 Research Process onion framework 223.3 Ethical Considerations 27

Chapter 4: Findings & Analysis28

4.1 Introduction 284.2 Findings from Interviews 284.3 Analysis of findings 31

Chapter 5: Conclusions & Recommendations36

5.1 Summary of Findings 365.2 Conclusions 365.3 Recommendations 395.4 Limitations of Research 405.5 Recommendations for future research 41References 42

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Title: A study examining Risk management at Meezan and Burj Bank in Pakistan

CHAPTER 1 INTRODUCTION

1.1 BACKGROUND

A bank is a financial institution, which deals with money and credit. It accepts

deposits from individuals, firm and companies at a lower rate of interest and gives at a

higher rate of interest to those who need them. There is a difference between the terms

at which it borrows and those at which it lends from the source of it profit. A bank,

thus, is a profit earning institution. (Siddiqui, 2003)

1.2 RESEARCH RATIONALE

This study is worth doing as it is seeking to conduct research in Pakistan about the

risk management in Islamic banking. This industry is new in market, although the

conventional banks have seen their high and are well settled with their market, Islamic

banking offers a new horizon to the customers and the overall economy. Pakistan is a

very diverse country with ethnic, religious and ever changing and unstable geo-

political situation.

1.3 RESEARCH AIM

The aim of this study is to critically examine the risks faced by and the concept of risk

management at Meezan and Burj Banks in Pakistan.

This research will define and explain the risk management in today’s corporate world

with emphasis on the Islamic banking as the banks in focus that is “Meezan Bank” &

“Burj Bank” both is the fore leaders in Islamic banking concept which is still very

young as compared to the conventional banking. Risk management and its

application, technicalities involved in it, users, SWOT analysis and getting the

broader picture about the topic. The main focus in performance management in

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today’s world is risk management. How the managers handles the risks involved in

their various decisions of banking life. Every decision has its pros n cons. To evaluate

these risks and to choose amongst the best suited is the task for which the managers

are hired and paid for. While evaluating the different options and solutions one has to

keep in mind the strategic aim of the organization and the long term effect of that

decision on the strategic aim. Here comes the strategic risk involvement. There is no

benefit in losing the strategic advantage of the company. And it is the most crucial

thing to choose and evaluate the various strategies keeping in mind the strategic risks

involved in that option.

The purpose of this study is to understand and bring forth the risks of practicing

Islamic Banking in Pakistan. It is to understand the measures being taken by Meezan

Bank and Burj Bank in minimising the effects of these risks.

1.4 RESEARCH OBJECTIVES

The objectives of the research are clear from the word go that it is destined to

highlight the risks involved in the Islamic Banking sector in Pakistan with focus on

two leading banks, Meezan Bank & Burj Bank. The research objectives can be

categorized as following;

1. Firstly we will define in detail the risks in the organizations, the hazards

caused by those risks and how these are critical in the success of the

organizations. We will see the forecasted risks involved in the banking sector,

especially in Islamic banking and this literature study will allow us to see the

importance of risk management in Islamic banking sector.

2. Secondly we will study the techniques and various models of risks

management. That segment will allow us to learn the tools which highlight the

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risks at hand and the tried & tested techniques used by the successful

professionals to cope with them.

3. Lastly with the help of analysis of the data collected from the primary &

secondary sources, we will be able to recommend to the Meezan & Burj bank

as how they could apply the risk management techniques in their respected

organizations to overcome these risks before they can do any damage and

hence improve their performance and ensure their strategic benefits.

1.5 RESEARCH QUESTIONS

1. Risks faced by Islamic banks in Pakistan. How these are the hazards in the success of these organizations?

2. Identification of risk management tools to overcome the risks highlighted in response of the first questions. How to overcome these hazards effectively?

1.6 RESEARCH SETTINGS

Meezan Bank and Burj bank are chosen to represent Islamic banking sector in

Pakistan due to their growth and effective team management. What these two banks

have achieved in the net of conventional banking is eye catching and the research on

these can help develop road map for a successful Islamic bank in Pakistan particularly

and in the world generally.

In year 2002, Meezan Bankt received the license to operate as an Islamic Bank by the

State Bank of Pakistan. The aim of Meezan Bank is to meet its customers commercial

and Islamic Banking needs. The Bank aims to provide a fast, efficient and reliable

service for its customers. (Meezan Bank, 2011)

Burj Bank is a leading Islamic Bank in Pakistan. The banks vision is to be amongst

the top 10 banks of Pakistan. The bank is known for the high quality of Islamic

banking service that it provides to meet the diverse needs of its customers. (Burj

Bank, 2011).

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The state bank of Pakistan has identified the above mentioned risks and informs banks

that in most instances these risks will tend to overlap with each other. Banks can also

face additional risks due to sudden changes in the external market and in the

economic and political conditions of Pakistan. The State bank of Pakistan keeps a

vigilant watch over how the country’s banks are managing these risks. It supports and

provides guidance to banks in effective management of risks (State Bank of Pakistan,

2010).

1.7 STRUCTURE OF THE STUDY

This study is made up of five chapters. The first chapter introduces the topic of the

study, outlines the aims, objectives and research questions. It also brings forth the

setting of the study and states the structure of the study.

Chapter two reviews the literature on risks and risk management. An examination of

the different types of risks a business faces is carried out. It analyses the concept of

risk management in the context of Islamic banking.

Chapter three presents the research methodology. Using the research process onion

framework by Saunders et al (2009), this chapter analyses the key concepts of

research and applies them in the context of this study.

Chapter four presents the findings from the primary research conducted in the study.

It analyses the findings in the light of the views of different research participants and

with past research.

Chapter five concludes the study. It presents the key arguments of each chapter in the

study. It presents the limitations of the study and makes recommendations for future

research.

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Chapter 2: Literature Review

2.1: Introduction

Risk and its effective management have gained significance in organisations as this

world is an ever competitive global village rather than isolated areas any more. Below

is the brief year wise history of Islamic banking as we found from the literature

consulted.

1947: The inception of Pakistan as the first Islamic Republic created in the name of

Islam. 1949 The Objectives Resolution was adopted by the first Constituent Assembly

based on the ideology of a sovereign Islamic state. This was the first step in the

conception towards Pakistan’s Constitution. 1956 The first Constitution defined Islam

as State Religion and all laws to be according to the injunction of the Quran and

Sunnah. 1962 The establishment of Council of Islamic Ideology (CII) was followed

by the conception of the second constitution of Pakistan. 1973 The third constitution

of Pakistan was passed allowing comprehensive legislation on Islamic principles and

establishment of Federal Shariat Court. 1980 CII presents report on the elimination of

Interest genuinely considered to be the first major comprehensive work in the world

undertaken on Islamic banking and finance. In this period President Zia ul Haq

imposed profit and loss sharing accounts as a compulsion instead of interest bearing

accounts, he also started deduction of Zakat from bank accounts in Islamic prospect.

1985 Commercial banks transformed their nomenclature stating all Rupee saving

accounts as interest-free. However, foreign currency deposits in Pakistan and on

lending of foreign loans continued as before. 1991 Procedure adopted by banks in

1985 was declared unIslamic by the Federal Shariat Court (FSC). The Government

and some banks/DFIs made appeals to the Shariat Appellate Bench (SAB) of the

Supreme Court of Pakistan. In 1991 thsese two new Islamic banks started their

operations in Pakistan(State Bank of Pakistan, 2010).

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2.2: Risks

Risk is defined as “the probability of occurring of a destruction” in its simpler form.

Destruction in this situation can be a physical injury or financial loss, in one way or

other always a man is suffered. The quantifiable likelihood of loss or less-than-

expected returns, Examples: currency risk, inflation risk, principal risk, country risk,

economic risk, mortgage risk, liquidity risk, market risk, opportunity risk, income

risk, interest rate risk, prepayment risk, credit risk, unsystematic risk, call risk,

business risk, counterparty risk, purchasing-power risk, event risk”

The simple fact is that risk is always a possibility matter. Possibility is a dual

condition either something is possible. Likelihood reflects the range between absolute

certainty and impossibility. The key thing to keep in mind is that establishing

probabilities is not the same thing as foretelling the future. Risks can be measured by

multiplying impacts with probability.

In risk management, the term hazard is used to mean an event that could cause harm

and the term risk is used to mean simply the probability of something happening

(Charterd Management Institute, 2011)

2.3: Sources of Risk

The risks faced by any organization, including an Islamic bank, are generally of two types;

1. External risks2. Internal risks

External risks are the risks caused from the environment. This will include the

economy situation of the market, political situation change, a strategy change from the

government or the state bank of Pakistan, a disaster caused by nature like earthquake,

flood etc. Also if there is a war situation in the area than the strategies will have to be

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changed and the people will not be feeling safe to keep the money in the banks due to

devaluing of the currency.

Internal risks are like change of the top management, a union issue, a strike form the

workers or a scandal caused by some internal factors. Both of these two types are

equally hazardous though entirely different from one another. The management have

to have a close look at both the ends to detect the risk as it is raising head. These two

types are in general but we will keep our focus on the risks that are more likely to rise

in an Islamic bank, both external and internal risks(Chartered Management Institute,

2011).

2.4: Risk Management

Definition of risk management is that it is a logical process that seeks to eradicate

minimize the level of risk associated with the business. These includes the steps

involved to indicate the risks before they can pose a damage and propose and

implement steps that are necessary to remove these risks in the most practical and

efficient manner in such a way that in future this type of risks is no longer a threat to

the organization. One key to the efficient management of risks is the economical

factor. This means the utilization of existing resources and not incurring cost in

removal of the risk. The organizational strategic aim is to be kept in mind while

developing strategies for the removal of the risks so that every step taken is in

accordance with the overall vision and mission of the organization. This means the

team dealing with the risk management should include the top management.

Risks are not only the occurrence of an incident; it is also detecting the flaws in the

ongoing and seemingly harmless operations that can negatively affect the bank in the

longer run. This is done with various tools of the risk management that are discussed

ahead in this study and it is one of the basic aims of this research project(Chartered

Management Institute, 2011).

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2.5: RISK MANAGEMENT FRAMEWORK

Risk management involves to identify and recognize the risks or threats one can face

and how to eliminate or minimize them. There are five major steps which provide the

basic structure of risk management (Jorion and Khoury 1996).

Risk Management Process

1. Risk Identification

It involves observing risks associated with the particular work. The

identification of risks depends upon the type of work and purpose of company.

Some risks pose short term but severe effects and some pose long term effects

which are less severe. Most commonly it can be a physical injury or fraud etc.

All types of risks are identified. The risk analysis involves source analysis and

problem analysis.

a) Source analysis

Source analysis is recognition of all internal and external risk sources that

are targets of risk management. Examples of risk sources are: stakeholders

of a project, employees of a company or the environmental conditions.

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b) Problem Analysis

Problem analysis is linked with source analysis. Once the source is known

the problem or threat it can be in future is identified. For example,

stakeholders withdrawing during a project may endanger funding of the

project; privacy information may be stolen by employees even within a

closed network or earthquake hitting the area resulting in causalities.

2. Risk Prioritization

It involves analyzing or assessing which of the risks listed will have the most

impact on the company. In addition to prioritizing the risks, the risk manager

will need to determine which risk factors the company has control over and

which ones it does not.

3. Mapping Goals & Objectives

After assessing each risk, they must be evaluated. It requires goals and

objectives of the company and stakeholders so that awareness of all the

outcomes of the possible risks must be known.

4. Mitigation Plan

A treatment plan is then formed which elaborates that which risks are to be

eliminated or reduced depending upon their affect on company’s goals and

objectives. The risk manager must determine what can be done to treat each

risk. Creating a treatment plan will necessitate deciding which risks can be

avoided and which ones can only be lessened. The treatment plan will tell the

steps involves in managing associated risks. It will also tell about those risks

which can only be reduced and which are inevitable.

The risk management plan contains an analysis of likely risks with both high

and low impact, as well as mitigation strategies to help the project avoid being

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derailed should common problems arise. Risk management plan includes risk

strategy. It involves

a) Risk Avoidance

Avoiding a risk simply means not doing any activity which can cause a

damage or loss. If alternative is present and it is economical and

practical then those activities which pose risks are avoided.

b) Risk Reduction

Risk reduction means minimizing the affect of risks which cannot be

avoided.

c) Risk Transfer

The term risk transfer means effect of the risk on the other stakeholders

of the organization that can be affected as a byproduct of the main

segment that is directly being affected by the hazard. This can be

explained as the affect of the harm done by the risk or problem on the

other departments and stake holders

d) Risk Retention

In simple words this can be defined as the harm caused by an un

attended risks which continuously affects the performance of that

particular sufferer and its ongoing affect of risk transfer to other stake

holders.

5. Continual supervision

The final step in the risk management process is ongoing risk monitoring. This

is a step that should occur throughout the lifetime of a company. The

monitoring should occur at each level of the business so as to provide a

complete view of the impact of risk

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2.6 MODELS OF STRATEGIC RISK MANAGEMENT

Risk management tools allow planners to explicitly address uncertainty by identifying

and generating metrics, parameter zing, prioritizing, and developing mitigations, and

tracking risk. These risk management tools include

a) Risk Management Information System

These are computer software program that help risk managers to keep

track of risks. This risk management software allows users to identify

risk and manage the exposure. It is used to support expert advice and

cost-effective information management solutions around key processes

such as:

I. Risk identification and assessment II. Risk control

III. Risk financing

b) Incident Management System

Incident management systems are risk management tools that help risk

managers handle situations when an unfortunate event happens. It

helps the managers to keep check on accidents in organization.

c) Certificate Managers

Certificate management systems can help risk managers keep track of

all their insurance contracts.

d) Business Intelligence Tools

These allow risk managers to mine their wealth of claims and incident

data. This can lead to the detection of patterns and ways to identify risk

before it occurs.

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e) Catastrophe Models.

This risk management software allows risk analysis of an

organization's disaster exposure to such events as hurricanes,

earthquakes, floods, thunderstorms, and winter events. These tools also

allow risk managers to calculate the event probability for a given

disaster

1. Strategic Risk

It is the long term risks evolving from bad business decisions that affect the

profitability in negative manner. This can be either not reading the situation

properly or not implementing the decisions as they should be implemented,

miscommunications or other communication hazards can lead to this but the

overall impact is the long term loss of the organization. The organizational goal

suffers the company move in a direction which is not in compliance with the

vision or mission of the organization and the organization tend to lose its

customers due to this. It might arise from the miss reading of the market situation

or wrong forecast of the current environmental changes which in turns make the

organization suffer in the longer run. This is where the organization need to keep

itself updated on the ongoing changes in the enviromen tin general and keep their

work force up to date through refresher coursed and other workshops an seminars.

(www.dft.gov.uk, accessed on 12.2.2012)

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2.6.1 Collective Level of Strategic Risk Indicators

Below are the three indicators that allow the organization to keep an eye on the

strategic risks that are potential for the company:

1. Low

Risk management is directly proportional to the insurance of the organizations

strategic goals, objectives and survival in the market. Management needs to be update

on the tools and techniques that are efficient, practical and cost beneficial in detecting

and removing the risks.

There should be strong communication systems developed across the organization

both horizontally and vertically so that there should be no information loss when it

comes to planning on coping with the risks. The cost spent on this management

system will pay back the organization in the longer run and the company will benefit

from this.

2. Moderate

These are the decisions or strategies that are directly linked with the short term

achievement of targets and goals that lie in the road map of strategic goals. The risks

involved in these decisions are moderate risks as this can be reversed on the ad-hoc

basis but continuous occurrence of mistakes in this process will lead to overall failure

of the organization. The remedy for this involves moderate cost.

3. High

This level deals with the top management and the board of directors that are involved

in making the strategic goals of the organization. If the destiny is set with an error

then this fundamental mistake will reflect on every step taken by the organization and

will cause greater harm than any other risk level. The main concern with this level is

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that the risks are very rarely exposed in short time and the organization as a whole

doesn’t seem to know unless everything is lost. The cost spent in removal of such

risks should not be compromised at all and every possible step should be taken in

ensuring that the proper pathway is set and every aspect of the risks involved analyzed

before declaring the strategic goals of the organization. The orientation to the

managers should be of the best standard available so that they are clear in their minds.

Any communication hazard will lead to disaster for the organization like an Islamic

bank and the cost of rectification is too high for this and in most of the cases the

turning back is not possible at all.

Now we will propose the process for managing the risks in the organizations. It

defines the roles and responsibilities of the participants. The risk management

activities are defined and the budgets involved and any tools and techniques that are

used therein.

2.7: Risk management in the context of Islamic Banking

Islamic banks, as they are in the mode of developing, face a number of risks which

they need to manage successfully to survive in the market. Real estate equity

marketing is the main market for Islamic banks. There strategic asset is the loyalty of

the customers that are moving towards the Islamic banking due to moral grounds

imposed by their religion. Fiduciary & reputation risks are high as there is a fine line

to hold when it comes to the implementation of Islamic shariah laws in banking and

educating their customers about this so that no one can confuse the customers, at the

same time ensuring their customers to have faith in the Islamic banks to deliver good

in comparison to the conventional banks. (Khan, T., Ahmed, H, 2001)

The risks involved in Islamic banking a little different from those of Conventional

banks, they use both debt and equity to finance their investments, while Islamic banks

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like Meezan bank & Burj Bank, are expected to depend primarily upon equity

financing and customers’ deposit accounts such as current, saving, and investment.

There are four broad categories in which the risks faced by Islamic banks can be summarized;

Financial risk:

Credit risk: It is the risk of the counterparty failure to meet their obligation towards

the bank in a timely manner.

Interest rate risk: It is the risk of the reduction in the value of the fixed-interest asset

such as bonds due to a rise in interest rates. This can be also considered as part of

market risk, unless the asset is in the banking book. Also, interest rate risk is the risk

of an interest rate mismatch between fixed-rate assets and floating-rate liabilities, or

vice-versa, which results in a “squeeze” in both profit and cash flow.

Market risk: It is a risk which affects the class of assets or liabilities to a bank due to

economic changes or external events. It is also considered as a systematic risk such as

changes in stock market, interest rates, currency or commodity markets.

Liquidity risk: It is either a financing liquidity risk which arises from the difficulty of

obtaining funding at a reasonable cost or an asset liquidity risk which arises from the

difficulty of trading an asset.

Settlement risk: The risk that counterparty does not deliver security or its value in

cash as per agreement.

Prepayment risk: The risk of loans being prepaid before maturity date, especially

when it comes to mortgage loans. This can take place due to a drop in interest rates.

Operational risk:

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These are the risks which mainly result from inadequate internal processes and

strategies, people and systems, or from external events. This is associated with the

prospective for systems failure in a given market.

Business risk:

Legal and Regulatory risk: The type of risk that arise due to the changes in the law

and regulations which adversely affect a bank’s position.

Volatility risk: This is the risk which arises from the fluctuations in the exchange rate

of currencies.

Equity risk: This risk is mainly due to stock market dynamics which lead to

depreciation of investments.

Country risk: A political or financial event in a particular country might lead to

potential volatility of those foreign assets.

Event risk:

These are the unpredictable risks due to unexpected events like banking crisis or a

change in the geo-political situation of the country. This type is very high when it

comes to a unstable country like Pakistan.

2.8: Conclusion

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The occurrence of risks is a natural phenomenon in the occurrence of the process of

software development. Risks are incidents and factors which can cause harm, damage

and delay the process of software development.

There are many different types of risks that can occur during the process of software

development. These relate to the industry, the competition in the market, the level of

technology that is being used, the brand, the demands of the customers, operational

risks in the project and stagnation risk.

The management of these risks using a range of different techniques can contribute to

minimising and effectively dealing with the risks that can cause harm to the proper

execution of software projects.

The methodology of this research is examined in the next chapter.

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Chapter 3: Research Methodology

3.1: Introduction

According to Collis an Hussey (2003) research is carried out in a logical and step by

step manner. It is a process of exploration and investigation that aims to uncover

solutions to real life problems, to develop theories and find answers to the research

questions. Research provides a valuable means to increase and develop the knowledge

of the researcher regarding the topic of study. To carry out credible research, a

researcher needs to carefully plan and conduct the research. The researcher needs to

carefully select the data collection methods and interpret the findings (Collis and

Hussey, 2003).

3.2: Research process onion framework

Saunders et al (2009) developed the research process onion framework. This

framework is highlighted in figure 3.1. The significance of this framework is that it

assists researchers in understanding the key concepts that need to be taken into

account when carrying out credible research. The model outlines the different types of

research philosophies, research approaches and research strategies and data collection

methods.

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Figure 3.1 Research Process” Onion’’

Source: Saunders et al, (2009)

3.2.1: Research philosophy

Research philosophy defines the manner adopted by a researcher in the development

and judgement of knowledge that is required to meet the aims and objectives of

research. Saunders et al (2009) has said that there are different types of research

philosophies and these include positivism, realism, interpretivism and pragmatism.

According to Bryman and Bell (20070 Positivism is based on facts, figures and

scientific principles. The end result of positivism is general law-like generalisations

that are similar to those found in physical and natural sciences. Realism is based on

the occurrence of events and social phenomenon in their natural setting. It is

independent of human judgements. Interpretivism is based on the meanings which

human attach to events and social phenomenon. Pragmatism believes in bringing

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together the principles of positivism and phenomenology. It examines a range of

different viewpoints to gather and interpret data (Bryman and Bell, 2007).

The research philosophy used in this study is interpretivism. This is because the

researcher was interested in understanding the viewpoints of managers at Meezan

Bank and Burj Bank about the risks of practising Islamic Banking in Pakistan. The

researcher was also interested in knowing what the managers of these banks were

doing to efficiently managing these risks. Hence the meanings which the banks

managers were associating with risks and their management is the key theme that is

being explored in this study.

3.2.2: Research approach

According to Saunders et al (2009) research approach can be deductive and inductive.

A deductive approach is followed when the aim of the researcher is to examine the

literature on the subject area, then develop appropriate strategy and select data

collection methods to find the answers to the research questions. In an inductive

approach, the data is collected and then theories are developed from it (Bryman and

Bell, 2007).

In this study an inductive approach is followed. This is because the researcher is

looking at understanding the meanings which the managers at Meezan and Burj Bank

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are attaching to risk and risk management. The researcher is looking to develop an in

depth understanding of the research context. He is seeking to collect qualitative data.

3.2.3: Data collection methods

The methodology in a research defines the methods that have been selected to collect

the information that is needed to meet the aims and objectives of the study. The

selection of the appropriate methods for data collection is important as they lead to the

gathering, analysis and compilation of the data. If inappropriate methods are chosen

for data collection, then they can result in errors in data collection (Bryman and Bell,

2007).

Research design is the framework or blueprint for conducting the research project. It

specifies the details of the procedures necessary for obtaining the information needed

to structure and/or solve marketing research problem.

The Research Design of study is mainly Descriptive in nature. Descriptive study is

done in those cases where we want to establish the characteristics of the variables of

interests as in our case where we will developed the Theoretical frame work only on

the brain storming process and we are not very much sure how these variables effect

our dependent variable. This is due to the fact that the Islamic banking is still new to

the market and there are only few players in the market and they too are very

speculative in their approach towards the business.

The descriptive study will help us to define how should the Islamic banks focus on the

creating the brand image for their services and the risks involved therein.

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The secondary data will be collected by the help of various studies done in this

context (Literature review) and also through internet where we will be able to know

the various sale graphs, pricing and other business strategies which will be helpful in

analyzing the data collected.

For the collection of primary data we will use Questionnaires. These questionnaires

will be distributed to various places and people concerned with the Islamic banking.

Developing a good and affective questionnaire will be the major task of our research

team as the entire research success will depend upon the validity of the data collected

from the Questionnaire.

Along with the questionnaire we will be using the following methods for collecting

our data.

Informal interviews

Intercept Surveys

All of the above mentioned methods have their own pros n cons. To make our

research more n more authenticated we will use all of these methods so that our data

analysis will have every ingredient to make it as complete and comprehensive as we

can.

Scales & Measurements

We will use the following scale in our Questionnaire;

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Nominal Scale

Ordinal Scale

Interval Scale

Further in which we used the following techniques of measurement;

“Comparative and non-comparative rating scales”

Sampling Techniques

The population of our research is a not a wide population and we will confine our

research only to the population of Lahore. The various trends about Islamic banking

will be studied by taking the various segments of meezan & Burj bank under

consideration.

For the purpose of sampling we will conduct Non-Probability Sampling further in

which we will do the convenience sampling. Than from the selected samples we will

perform our research.

The interview questions used in this study are as below:

1. What are the risks of practicing Islamic Banking in Pakistan?

2. What are the strategies, measures taken by (name of bank) in minimising the

risks of practising Islamic banking?

3. What is the future of Islamic banking in Pakistan?

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4. What recommendations can you make for improvement in effective

management of risks at (name of bank)?

3.3: Ethical Considerations

The research study kept under consideration all the ethical guidelines that have been

mentioned by Leeds Trinity University. With discussion with the instructor it was

decided that this study does not require us to get ethical endorsement from Meezan

Bank and Burj Bank. Approval was taken from the participants before the beginning

of this study. The participants were told about the purpose of research. The

participants were informed at the start about what they will need to do to take part in

this study. They were also informed about the length of time that will take to conduct

the interviews.

The participants were not forced, nothing was hidden from them and they were

allowed to leave the research wherever they wanted to. The secret information was

treated carefully and no such information was leaked which could cause risks in any

form to the Meezan or Burj Banks. Where the reference was quoted, they were quoted

in accordance with the policy of the Leeds institute and no plagiarism was involved in

that.

There is no harm or professional hazard to any of the direct or indirect participant or

party when they contributed in completion of this study. Everything was kept clear

and consent was taken before mentioning any company info. The conclusion are

drawn only from the literature review and the data collected through research and

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there is nothing that anyone can claim about this research that the information has

been tempered with or altered by the researcher.

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Chapter 4: Findings and Analysis

4.1: Introduction

This chapter identifies the views of the interviewees to the interview questions. It compares the views of the participants with the opinions of different researchers.

4.2: Findings from interviews

The responses given by the participants are highlighted henceforth.

4.2.1: What are the risks of practicing Islamic Banking in Pakistan?

Similar opinions have been presented by the interviews carried out at Meezan bank

and Burj bank. The key arguments given by the participants are that practising Islamic

banking presents credit risks, operational risk, legal risk, fiduciary Risk and

withdrawal risk.

One of the interviewees said that:

‘Practising Islamic banking presents credit risks because at times, there develop

misunderstandings between the two parties. There have been times when one party

has made the payment to the other party by making a bank transfer. The business has

informed the bank about the nature of the transaction. However the other party has

either refused to deliver the goods or the goods delivered have been of poor quality

and have not met the needs of the client. In such a case the first part has incurred

losses.’

One of the interviewees said:

‘Islamic banks face liquidity risks as the Islamic law does not allow them to use

interest in any form. Islamic banks cannot use interest based loans. The problem of

liquidity creates a lot of problems in the conduct of Islamic banking activities.’

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One of the interviewees said:

‘I believe that Islamic banks face a wide range of risks. As I am the operations

manager, the operational risks in planning of and execution of Islamic banking

activities relate to usage of IT systems. We have had to develop a new IT system that

is used to conduct Islamic banking. It was a challenge to get employee commitment to

learn and use the new system.’

One interview said:

‘In my opinion, islamic banks mainly face credit risks and legal risks. Credit risks are

mainly due to the inability of the two parties to meet the contractual agreements laid

down in the contract. There often arise conflicts when one party has paid the other

party for the merchandise or assets and the other party has refused to, delayed or

delivered goods or assets of unsuitable quality.’

One interview said:

‘Islamic banks face liquidity risks. They also face withdrawal risk and fiduciary risk.

The risks faced by Islamic banks tend to vary with the nature of the financial banking

instruments that are being used.’

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4.2.2: What are the strategies, measures taken by (name of bank) in minimising

the risks of practising Islamic banking?

The risk management strategies identified by Meezan Bank and Burj bank related to

carrying out risk assessments. The banks conducted risk assessments to identify the

likely risks that can occur in the conduct of its Islamic banking activities. It was said

that risk assessments required the support of the senior management team of the bank.

The bank minimised risks by having its own in built risk management systems that

helped in reducing risks. The banks actively talked to their customers and sought to

find out what they expect from the bank and how they feel the bank could reduce the

risks it faces.

4.2.3: What is the future of Islamic banking in Pakistan?

All of the interviewees were of the opinion that Islamic banking had a very positive

future in Pakistan. Seven of the interviewees said that this was because people of

Pakistan were muslims and wanted to carry out their banking activities by adherence

to Islamic law. However three of the participants said that it was due to the fact that

Islamic banking was fair.

The interviewees said that there has been rapid growth in the number of Islamic banks

in Pakistan and this trend is likely to continue in the future. Existing Islamic banks

have seen growth in the number of clients they serve.

4.2.4: What recommendations can you make for improvement in effective

management of risks at (name of bank)?

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There was similarity in the viewpoint of the participants. Recommendations made

were in relation to the accurate identification of risks. It was said that banks need to

have systems, processes and procedures that could help them in understanding the

kind of risks that their business is likely to face. Banks needed to conduct detailed

analysis of the possible risks that could affect their operations. Banks needed to have

efficient policies and procedures in place to manage risks caused by Islamic banks.

They can do this by actively engaging with their staff and informing them about the

bank’s risk management strategies. Banks need to entrust the responsibility of

identifying risks to all of their employees so that together all the workers can see what

are the risks the bank is facing and how they can mitigate these risks.

Banks need to understand the underlying causes that lead to the occurrence of these

risks. If banks know the root cause of the risks then they can better tackle the risks.

Participants said that Islamic banks face risks and uncertainties caused by the unstable

political and economic conditions in Pakistan. They need to understand how the

macroeconomic variables are affecting their business operations.

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4.3: Analysis of findings

The findings of this study have shown that practising Islamic bank can present credit

risks. These findings are in agreement with the views of Greuning and Iqbal (2008)

that Islamic banks face credit risks. These credit risks usually occur when one party

makes the payment (for example, in a Istisna contract) or makes delivery of asset (for

example, in a Murabahah contract) before they physically get the goods, assets. This

exposes them to potential loss. The use of profit-sharing methods of financing such as

Mudarabah and Musharakah, the bank faces the risks when the businessmen does not

pay the bank their due share. This creates problems for banks because they do not

have sufficient information about the profit of the organisation. Due to fact that

Murabahah contracts are trading contracts, credit risks occur owing to poor

performance shown by the trading partner (Greuning and Iqbal, 2008)

Akkizidis and Khandelwal (2007) suggest that islamic banks face liquidity risks.

These risks occur because the banks are unable to get cash at a reasonable cost from

borrowings or sale of assets. Islamic banks face problems because they can not use

interest based loans as these are prohibited by Shariah. Islamic banks are unable to

borrow funds to fulfil liquidity needs. Moreover, Shariah (Islamic law) says that

banks cannot sell debt at a price above its face value. Hence Islamic banks cannot

increase their financial resources by disposing off debt-based assets (Akkizidis and

Khandelwal, 2007).

According to Greuning and Iqbal (2008) practising Islamic banking presents

benchmarking risks. This is because Islamic do not with interest rate. This may seem

that they are not influenced by market risks that occur due to changes in interest rate.

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However ups and downs and variations in market interest rate have a direct impact on

earning of Islamic banks. Variations in market interest rate pose risks to Islamic

banks. Banks use a benchmark rate to sell different financial products and services.

This is particularly evident in a Murabah contract because the markup price is set by

summing up the risk premium and benchmark rate. The mark up rates in fixed income

assets stays consistent throughout the period of the contract. If a change occurs in the

benchmark rate, the mark – up rates on the fixed income contracts can not be changed

accordingly. For this reason, Islamic banks incur risks due to changes in market

interest rates (Greuning and Iqbal, 2008).

Akkizidis and Khandelwal (2007) state that Islamic banks face operational risks in

relation to person risk. Banks may not have talented, efficient and highly talented

individuals who have the relevant skills and capabilities to conduct Islamic banking

activities. Information technology in the form of computers and computer systems is

being used by banks. It often occurs that banks conventional banking IT systems are

not suitable to deliver Islamic banking activities. This necessitates Islamic banks to

develop and implement separate system to carry out their Islamic banking activities

(Akkizidis and Khandelwal, 2007).

According to Bessis (2009) Islamic banks face legal risks. This is because there are a

range of different contracts involved in Islamic banking. Islamic banks risks in

relation to the proper documentation and implementation of these contracts. There

exist no standard forms of contracts for different financial instruments. There is no

consistency in the forms developed by different Islamic banks. Different Islamic

banks have developed different ways of enforcing the principles laid down by the

Shariah in relation to practising Islamic banking. Due to a lack of standardised

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contracts and no litigation systems to solve the problems linked with enforceability of

contracts by the counterparty, the legal risks linked with practising Islamic banking

increases (Bessis, 2009).

Saunders and Cornet (2011) state that Islamic banks face withdrawal risk. Islamic

banks offer a variable rate of return on saving and investment deposits. This creates

uncertainty pertaining to the real value of the deposits. There are times when

depositors withdraw their savings and investments from Islamic banking because of

asset preservation regarding reducing of risk owing to lower rate of return. Islamic

banks have termed this risk as withdrawal risk as it is related to lower rate of return in

relation to other financial institutions (Saunders and Cornet, 2011).

According to Greuning and Iqbal (2008) Islamic banks face fiduciary risk. Fudiciary

risks occur because when Islamic banks earn a low rate of return than the market rate,

then depositors and investors believes that the low rate of return is a violation of the

investment contract or a case of mismanagement of funds by the bank. Fudiciary risk

is often a result of a violation of contract by the Islamic bank. At times, fudiciary risks

occur when Islamic banks are unable to accurately interpret and apply the principles

of Shariah to various contracts. Because the reason for the existence of Islamic banks

is to follow the principles of the Shariah, their inability to do so can affect customers

confidence in the ability of the bank to efficiently conduct banking practices

(Greuning and Iqbal, 2008).

According to Sattar (2011) another risk of Islamic banking is the displaced

commercial risk that is in relation to equity holders. This risk occurs when banks have

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to let go of a certain percentage of their profits to pay the depositors to avoid them

from withdrawing owing to the reduction in market rate (Sattar, 2011).

According to the state bank of Pakistan (2011) Islamic banking institutions are

required to carry out meaningful risk assessments based on the principles of Shariah.

Islamic banks face risks in relation to practising Islamic banking. These risks are

affected by changes and developments taking place in the external marketplace.

Islamic banks face risks caused by changes taking place; in the markets they serve, in

the products and services they provide, in Pakistan’s political and economic

environments (state bank of Pakistan, 2011).

According to Sattar (2011) the occurrence of this risk signifies that even though the

bank is following the requirements of the Shariah, thus far they are unable to provide

competitive rates of return in contrast with their competitors and other Islamic banks.

Investors and depositors will want to withdraw their savings and investments from

Islamic banks if this risk occurs. To avoid withdrawals, it becomes necessary for the

senior management team of the bank to give a certain percentage of their own share in

profits to the investment depositors (Sattar, 2011).

The findings of this study are in agreement with state bank of Pakistan (2011) who

state that the practice of conducting risk assessments in relation to a bank’s Islamic

banking practice can only be successful if they have the support and commitment of

the senior management team of the bank. The senior management of a bank needs to

approve the risk management objectives, strategies, policies and procedures of the

bank. The risk management activities need to be aligned with the financial condition,

risk profile and risk tolerance. The bank’s risk management objectives, strategies,

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policies and procedures are to be communicated with all those individuals that have

the responsibility to carry out the bank’s risk management strategy. For the successful

carrying out of risk assessments, banks need to have an effective risk management

structure (state bank of Pakistan, 2011).

The findings of this study are consistent with the views of Akhtar (2007). Research by

Akhtar (2007) suggests that the number and operations of Islamic banks are

increasing at a fast pace. However the use of Islamic banking as compared with

conventional bank is still in its infancy stage. Islamic banks are mainly concentrated

in large cities. However some are now gradually expanding in secondary cities. There

is absence of Islamic banking in rural areas where there is immense potential for their

growth (Akhtar, 2007).

Akhtar (2007) shows that Pakistan is slowly developing its Islamic banking

infrastructure. Investors and depositors are confident in the growth of Islamic

financial system of Pakistan. Pakistan is striving towards achieving a coordinated

approach to development and implementation of Islamic banking activities. Pakistan

is working towards achieving efficient allocation of resources in a fair and consistent

manner (Akhtar, 2007).

According to Calder and Watkins (2006) in today’s intensely competitive and cut

throat corporate world, the occurrence of and management of risks has become an

essential part of the day to day running of a business. An understanding of the risks

faced by a business is very important as it can help companies in looking for ways

following which they can minimise the harmful impact of these risks. Risks are faced

by companies operating in every sector of an economy. However, the nature, scope

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and impact of these risks tend to differ between one company and another. Accurate

identification and management of these risks is vital for organisations to achieve

success and high levels of performance (Calder & Watkins, 2006).

Calder and Watkins (2006) state that there has been a rise in the number of risks

companies face. This has been mainly been due to the rapid and constant changes

taking place in a company’s internal and external environment, globalisation,

changing habits of consumers, recession, rising level of prices of products. Companies

need to understand these risks carefully because they do not effectively manage these

risks; it is possible that their overall productivity and business performance can be

adversely affected (Calder & Watkins, 2006).

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Chapter 5: Conclusion and recommendations

5.1: Summary of findings

This study has examined the different forms of risks that Islamic banks in general and

Meezan and Burj bank specifically face in conducting their Islamic banking activities.

It has done this by critically analysing the risks faced by Islamic banks in chapter 2. It

has identified the risks, tools and techniques to manage risks at Meezan Bank and

Burj Bank in Pakistan. This study has made recommendations for improvement in

risk management of Islamic banks in Pakistan. This research has met the aim and

objectives of the study and has answered the research questions.

The findings of this study have shown that the risks faced by Meezan Bank and Burj

Bank in relation to practicing Islamic banking are credit risks, operational risk, legal

risk, fiduciary Risk and withdrawal risk.

5.2: Conclusions

It can be concluded that the risks faced by Islamic banks are credit risk, liquidity risk,

fiduciary risk, withdrawal risk, operational risk, legal risk and displaced commercial

risk.

It can be concluded that Islamic banks in Pakistan carry out risk assessments to

understand and manage the risks caused by practicing Islamic banking. These risk

assessments should be carried out by qualified personnel. However, it is important for

Islamic banking institutions to understand and assess the overlapping nature of the

risks faced by Islamic banks.

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Islamic banking is still new in the market and not established market segment. So it

has not only vulnerable to the extent that it can vanish completely, on the other hand it

has a wide potential to create a big customer count for itself in a country like Pakistan

with Muslim population touching 150 Million. The problem faced by Islamic banking

in Pakistan and where ever it is implemented is the finance as the people are trend

seekers and generlay the people are not willing to left the conventional ways of

banking. But there is a potential that is the Meezan & Burj bank like other Islamic

banks can educate and convince the clients on the Islamic style of banking then this

issue of financing can be resolved and there will be no problem for them. The

customer is willing to take chance as the conventional banks are working on interest

and the Muslim population doesn’t like it from heart though they didn’t had any

alternative till now.

Secondly there is a big advantage that there will be ample political support available

to these banks to market their services even to the non-muslims by showing the

growth and profits in the balance sheets. Some of the workable conclusions can be

summarized as following;

1. Risk management is a central part of any organization’s strategic management.

It is the process whereby organizations methodically address the risks

attaching to their activities with the goal of achieving sustained benefit within

each activity and across the portfolio of all activities. This, very significantly

applies on the Islamic banks under discussion.

2. Identification of risk and threats is very important as well as their mitigation

and its implementation. It increases the probability of success, and reduces

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both the probability of failure and the uncertainty of achieving the Islamic

bank’s overall objectives

3. Risk management protects and adds value to the organization and its

stakeholders through supporting the organization’s objectives by:

i. Providing a framework for an organization that enables future activity to take place in a consistent and controlled manner improving decision making, planning and prioritization by comprehensive and structured understanding of business activity, volatility and project opportunity/threat.

ii. Contributing to more efficient use/allocation of capital and resources within the organization

iii. Reducing volatility in the non essential areas of the businessiv. Protecting and enhancing assets and company imagev. Developing and supporting people and the organization’s knowledge base

optimizing operational efficiency.

4. Strategic risk management is a means of coordinating, over sighting and modeling the interrelationship of important risk factors across all the functions of the Islamic banks.

5. Strategic risk management embraces both the upside and downside of risk. It seeks to:

i. counter all losses, both from accidents and from unfortunate business judgments, and

ii. Seize opportunities for gains through organizational innovation and growth.

6. Risk management in meezan and burj banks is not just about the review of

risks themselves. Banks need to review their risk management systems to

ensure they are delivering effective and robust risk management that is fit for

the organization’s purposes.

Participatory financing is a unique feature of Islamic banking, and can offer

responsible financing to socially and economically relevant development projects.

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This is an additional service Islamic banks offer over and above the traditional

services provided by conventional commercial banks.

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5.3: Recommendations

It is recommended that Islamic banks in Pakistan strive to develop an organisational

culture in which identification of risks is not the task of one team or department but is

the responsibility of every employee who works in the bank. Every employee should

be encouraged to voice out their concerns about the risks that the bank is facing and

what the bank can do to minimise these risks. The board of directors of the bank

should develop a risk management environment in which every employee is aware of

the risk management strategy of the bank.

Islamic banks in Pakistan should have robust systems, procedures and policies to

efficiently practice Islamic banking and to monitor and manage risks.

Islamic banks in Pakistan should develop and implement an efficient internal control

system. This could assist the bank in monitoring the effectiveness of its Islamic

banking practices.

As far as the risk management is concerned following are the recommendations made

to Meezan & Burj banks to ensure the proper use of the management tools for

improving their performance and ensuring their survival in Pakistan;

1. Risk management should be a continuous and developing process which runs

throughout the Banks strategy and the implementation of that strategy. It

should address methodically all the risks surrounding the banks activities past,

present and in particular, future.

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2. Risk management must be integrated into the culture of the Islamic banks with

an effective policy and a programmed led by the most senior management.

3. It must translate the strategy into tactical and operational objectives, assigning

responsibility throughout the organization with each manager and employee

responsible for the management of risk as part of their job description. It

supports accountability,

4. Strategic risk management should focus on elimination or reduction of the

risks in most sustainable way. Keeping in mind all stakeholders, economic and

social conditions and environment in general.

5. Risk management strategies should make sure at first that the risk is

eliminated with minimum exploitation of resources but if risk cannot be

eliminated then it should concentrate of maximum reduction of risk with less

cost

6. The most important aspect in risk management is transfer of risk to other

party. It is the best strategy to avoid risk as other party has to pay for the

losesAll legal aspects involved in risk management should be known before

formulation of the plan. Otherwise easily avoidable losses have to be paid.

Islamic banks in Pakistan should recruit highly talented individuals who have the

skills to efficiently carry out the bank’s operations. They should be able to work in a

highly competitive working environment. They should have the skills to identify and

manage risks.

Islamic banks in Pakistan should give priority to accurately identify the risks of

practising Islamic banking. The HR team of banks should provide training to

employees in the effective understanding and management of the banks risks.

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Islamic banks in Pakistan should work at developing standard documents to

implement and carry out Islamic banking practices. They should develop Shariah

compatible risk management techniques. Banks should provide training to all key

personnel in the use of these techniques.

5.4: Limitations of research

This research is limited due to a number of reasons. The first reason is that the

researcher faced a very tight timescale in completing this research. He had to

complete this research in a very short period of time. He had to manage his time very

carefully. This posed quite a significant limitation because if the researcher had more

time, he could have further improved conducting and writing this research.

The second limitation is that this research had a very small sample size. This was

because the researcher had less time to plan and conduct this study. The third

limitation is that the researcher did not have the financial resources to travel to

Pakistan and carry out face to face interviews with the relevant managers at Meezan

Bank and Burj Bank. Conducting face to face interviews could have revealed more in

depth answers to the interview questions.

The fourth limitation of this research is that it used only one data collection method

that is semi structured interviews to conduct this study. If the researcher had more

time and financial resources he could have gone to Pakistan and conducted focus

groups with employees who identify and manage risks at Meezan bank and Burj bank.

5.5: Recommendations for future research

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Future research could examine the concept of risks and risk management in different

banks in Pakistan. Future research can seek to identify risks faced by Islamic banks in

different countries of the world. The risk management strategies of different Islamic

banks operating in different countries of the world can be examined in future research.

Future research can conduct comparative researches of the kinds and types of risks

and risk management tools and techniques that are faced and used by Islamic banks in

Pakistan and those by other countries of the world.

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WEBSITES & WEBLINKS

http://www.meezanbank.com/index.aspx

http://www.sbp.org.pk/about/speech/Governors/Dr.Shamshad/2008/Ten-Years-01-July-08.pdf

http://www.investopedia.com/articles/07/islamic_investing.asp

www.burjbankltd.com

www.cmi.com.uk

http://www.dft.gov.uk/ha/standards/pilots_trials/section2/RiskManagementStrategy.htm

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http://www.cmi.com.uk/

http://www.burjbankltd.com/

http://www.investopedia.com/articles/07/islamic_investing.asp



http://www.meezanbank.com/index.aspx

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