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Risk
Risk management practices of management
conventional and Islamic banks practices
in Bahrain
215
Hameeda Abu Hussain and Jasim Al-Ajmi
Department of Economics and Finance, University of Bahrain, Received September 2011
Sekheer, Bahrain Revised November 2011
Accepted February 2012
Abstract
Purpose – The purpose of this paper is to report empirical evidence regarding the risk management
practices of banks operating in Bahrain.
Design/methodology/approach – A sample of bankers was surveyed through a questionnaire and
the results used to examine if the risk management practices are significantly associated with the type
of bank (conventional or Islamic) and if those practices are positively affected by understanding risk,
risk management, risk identification, risk assessment analysis, risk monitoring and credit risk
analysis. Several statistical and econometric methods were used to the test the hypotheses.
Findings – Banks in Bahrain are found to have a clear understanding of risk and risk management,
and have efficient risk identification, risk assessment analysis, risk monitoring, credit risk analysis
and risk management practices. In addition, credit, liquidity and operational risk are found to be the
most important risks facing both conventional and Islamic banks. Furthermore, the risk management
practices are determined by the extent to which managers understand risk and risk management,
efficient risk identification, risk assessment analysis, risk monitoring and credit risk analysis. Islamic
banks are found to be significantly different from their conventional counterparts in understanding
risk and risk management. The levels of risks faced by Islamic banks are found to be significantly
higher than those faced by conventional banks. Similarly, country, liquidity, and operational, residual,
and settlement risks are found to be higher in Islamic banks than in conventional banks.
Research limitations/implications – The results may have been influenced by the current
economic global crisis. Although the response rate is very high, there is no evidence of non-response
bias, and there is high internal consistency within the responses. The reliance on survey methodology
introduces the possibility that respondents expressed their beliefs and did not necessarily describe
their actions.
Practical implications – Bankers, depositors, investors and regulators are likely to benefit from the
results of the study when taking decisions related to the banking industry.
Originality/value – This is the first published attempt to investigate empirically the risk
management practices of banks operating in Bahrain and to compare the practices of conventional and
Islamic banks.
Keywords Bahrain, Banks, Risk management, Conventional banks, Islamic banks, Perceptions,
Risk management practices
Paper type Research paper

1. Introduction
Effective risk management is accepted as a major cornerstone of bank management by
academics, practitioners and regulators. Acknowledging this reality and the need for a The Journal of Risk Finance
Vol. 13 No. 3, 2012
comprehensive approach to deal with bank risk management, the Basel Committee pp. 215-239
q Emerald Group Publishing Limited
1526-5943
JEL classification – G20, G21, G28 DOI 10.1108/15265941211229244
JRF on Banking Supervision adopted the Basel I Accords, followed by the Basel II Accords
13,3 and recently by the Basel III, to deal with the matter. Moreover, risk management is
found to be one of the determinants of returns of banks’ stocks (Sensarma and Jayadev,
2009). The recent global economic and financial crisis erupted in the USA when
Lehman Brothers Holdings, Inc. filed for Chapter 11 bankruptcy on 15 September 2008.
The spread of this crisis worldwide raised questions about the effectiveness of risk
216 management practices (RMPs) applied by banks, including those applied by
well-established banks. Risk management failure is considered one of the main causes
of the crisis (Bank for International Settlements, 2009; KPMG International, 2009;
Sabato, 2009; Holland, 2010). The US Sarbanes Oxley Act of 2002 was enacted in
response to the boom and bust of the dot.com market and obliges all companies quoted
on the US stock exchanges to spend considerable sums of money in order to maintain
their control systems (Williams et al., 2006). A global survey of 346 financial service
executives conducted in March 2009 by the Economist Intelligence Unit (2010) on
behalf of SAS Inc., aimed to examine how the financial institutions worldwide are
strengthening their risk management capabilities in response to the global crisis.
Approximately half of the survey respondents reported that they had conducted, or
planned to conduct, a thorough overhaul of their risk management, including
improvements to data quality and availability, strengthening risk governance, moving
towards a firm-wide approach to risk and deeper integration of risk within lines of
business. However, only 40 percent of respondents stated that the importance of risk
management is widely understood throughout their company, suggesting that more
needs to be done to embed a strong culture of risk management in financial
institutions.
Risk management is a continuous process that depends directly on changes in the
internal and external environment of banks. These changes in the environment require
continuous attention for identification of risk and risk control. In response to the call to
enhance the effectiveness of risk management, banks in Bahrain, like those in many
other countries, are required to comply with Basel II.
Banks in Bahrain are facing an exceptional challenge in managing their risk
exposure which came as a result of the continual social and political unrest which
erupted on 14 February 2011. The government’s struggle to deal with the democratic
movement resulted in a decline in non-oil economic activities, deterioration of credit
rating and a decline in stability of the banking industry. Among those results are:
.
the estimated growth rate of gross domestic products (constant prices) in 2011
was 1.5 percent, which is lower than IMF prediction of around 4.5 percent before
the uprising;
.
a credit rating cut of two levels by Standard & Poor’s to the second-lowest
investment grade; similar moves were taken by Fitch and Moody’s;
.
the downgrading credit rating increased the yield paid on the recent seven-year
Ijarah sukuk issue to 6.273 percent compared with 5.5 percent yield paid on a
bond maturing in 2020 issued before the uprising; and
.
revision of a Banking Industry Country Risk Assessment by Standard & Poor’s
from groups 5 to 6 (group 1 is the lowest risk while group 10 is the highest risk),
and finally, drop in assets value; for example, the market capitalization of
Bahrain Bourse decline by 19.34 percent from January 2011 to January 2012.
These consequences indicate that banks are facing higher credit and market risks now Risk
when compared with the situation prior to the uprising. management
RMPs have been widely investigated over the years. However, little attention has
been paid to banks operating in emerging markets and, in particular, Islamic banks practices
(Al-Tamimi, 2002; Al-Tamimi and Al-Mazrooei, 2007; Hassan, 2009). Since risk
management failure has been identified as one of the main causes of the financial crisis,
additional study of the subject is warranted. The primary aim of this study is to 217
contribute to the debate about risk management by investigating the RMPs of banks
operating in Bahrain. Specifically, the study’s objectives are threefold:
(1) to investigate empirically the degree to which the conventional and Islamic
banks in Bahrain use effective RMPs and techniques in dealing with different
types of risk;
(2) to identify the most important types of risk facing the Islamic banks in Bahrain;
and
(3) to compare the RMPs of conventional and Islamic banks.

The study extends the work of Al-Tamimi and Al-Mazrooei (2007) and Hassan (2009)
who suggest similar studies in different environments. Although the study is an
extension of these studies, in another context it differs in at least two aspects:
(1) the questionnaire used is similar but not identical, having been revised after
taking into account the environment and the opinions of practitioners who
commented on the earlier version of the questionnaire; and
(2) the present study includes a comparison of the practices of conventional and
Islamic banks.

The remainder of the paper is divided into four sections: Section 2 provides a brief
review of the literature, Section 3 describes the conceptual framework and the
methodology, Section 4 discusses the results and Section 5 presents the main
conclusions, limitations and suggestions for future research.

2. Brief literature review and hypotheses

Unlike studies that deal with risk management in general, published empirical studies
on the RMPs of financial institutions are relatively rare (Fatemi and Fooladi, 2006;
Al-Tamimi and Al-Mazrooei, 2007). Richard et al. (2008) found that banks’ credit risk
management is affected by the environment in which banks operate. This section offers
a brief review of recently published studies that are directly relevant to this endeavor.
In a study of the sensitivity to risk of large domestic banks in the USA, Linbo Fan
(2004) found that profit efficiency is sensitive to credit risk but not to insolvency risk or
to the mix of loan products. Hahm (2004) argues that it is necessary to improve
banking supervision and banks’ risk management to ensure successful financial
liberalization. This is based on a study of interest rate and exchange rate exposure of
Korean banks before the 1997 Asia Pacific economic crisis, which found that the
performance of commercial banks was significantly associated with their pre-crisis
risk exposure (Table I).
Fatemi and Fooladi (2006), after investigating the current practices of credit risk
management in the largest US-based financial institutions, report that identifying
JRF counterparty default risk is the single most important purpose served by the credit risk
13,3 models utilized. However, it should be noted that these results are based on a very low
response rate, i.e. 21 responses to questionnaires sent to 100 banks.
Al-Tamimi and Al-Mazrooei (2007) provide a comparative study of banks’ risk
management in locally incorporated banks and foreign banks in the United Arab of
Emirates (UAE). The results show that the three most important types of risks facing
218 UAE commercial banks are foreign exchange risk, followed by credit risk and
operating risk. However, an earlier study by Al-Tamimi (2002) reports that the main
risk facing UAE commercial banks is credit risk. For risk identification (RI), he reports
that inspection by branch managers and financial statement analysis were the main
methods used; while Al-Tamimi and Al-Mazrooei (2007) report that inspection by the
bank risk manager, audits or physical inspections, financial statement analysis and
risk survey are the main methods used. These results indicate that banks are becoming
more sophisticated in managing their risk. The authors also report that the locally
incorporated banks are fairly efficient in managing risk; however, the variables such as
RI, assessment and analysis have proved to be more influential in the risk management
process. Finally, their results indicate that there was a significant difference between
the UAE national and foreign banks in understanding risk and risk management
(URRM), practicing risk assessment and analysis (RAA), and in risk monitoring
(RMON) and controlling, but not in RI, credit risk analysis (CRA) and RMPs. On
average, they report that foreign banks are better than locally incorporated banks in
dealing with risk exposure. A difference in the quality of the staff is the primary reason
offered by the authors to account for such significant differences. Additionally, one
could add differences in regulatory requirements that banks are subject to as a possible
reason for such results. Branches of foreign banks, such as Citibank, HSBC and
Standard Chartered Bank, are required to comply with the regulatory requirements
that their parent companies are subject to, which might be more rigorous than those
applied by the Central Bank of the UAE.
Al-Tamimi (2008) studied the relationship between the readiness to implement the
Basel II Accord and the resources needed to implement it in UAE banks. The results
revealed that these banks are aware of the benefits, impact and challenges associated
with the implementation of the Basel II Accord. However, the research did not find any
positive relationship between the UAE banks’ readiness to implement Basel II and the
impact of that implementation. Nor was the relationship between readiness and
anticipated cost of implementation confirmed. No significant difference was found in
the level of preparation for the Basel II Accord between the UAE national and foreign
banks. It was concluded that there was a significant difference in the level of the UAE

Risk management aspects Cronbach’s a

URRM 0.892
RI 0.713
RAA 0.834
Table I. RMON 0.850
Internal consistency RMPs 0.872
of the six risk CRA 0.729
management aspects All aspects 0.961
banks in relation to Basel II, based on employees’ educational levels. The results Risk
supported the importance of education for the implementation of the Basel II Accord. management
Hassan (2009) reports that, like the conventional banks, Islamic banks are also
subject to a variety of risks due to the unique range of products offered. He also shows practices
that there was a remarkable understanding of risk and risk management among the
staff working in the Islamic banks of Brunei Darussalam, which proved their ability to
manage risk successfully. The major risks that were faced by these banks were foreign 219
exchange risk, credit risk and operating risk. A regression model was used to develop
the results, which showed that RI, and RAA were the most influential variables, and the
Islamic banks in Brunei needed to give more attention to those variables to make their
RMPs more effective. Understanding the true application of the Basel II Accord can
improve the efficiency of Islamic banks’ risk management systems.
Van Greuning and Iqbal (2008) and Iqbal and Mirakhor (2011) argue that a
comprehensive framework of risk management is equally applicable to a conventional
or Islamic bank. The findings of Hassan (2009) lend further support to this argument.
Khan and Bhatti (2008) observed that Islamic banks face another crucial challenge to
improving their risk management strategies and corporate governance because of their
adherence to Islamic Sharia’a (law). This should have an impact on the risk management
of Islamic banks in terms of certain applications, emphasis and inclusion or exclusion.
Taking into account the above review and the objectives of the study, the research
questions that this study aims to address are:
RQ1. Do bankers understand risk and risk management?
RQ2. Do banks identify the potential risk to which they are exposed?
RQ3. Do banks have in place a system for assessing and analyzing risk?
RQ4. Do banks monitor and control risks efficiently?
RQ5. Do banks have efficient risk management?
RQ6. Do banks analyze credit risk efficiently?
RQ7. What types of RI methods do banks use?
RQ8. What are the types of risks to which banks are exposed?
Based on the above review and the research questions, the following hypotheses,
phrased in a null form, will be tested:
H01. RMPs are not determined by URRM, RI, RAA, RMON and CRA.
H02. There is no significant difference between conventional and Islamic banks
with respect to URRM, RI, RAA, RMON, CRA, RMPs and level of risk.

3. Methodology
3.1 The instrument
A modified version of the questionnaire developed by Al-Tamimi and Al-Mazrooei
(2007) and Hassan (2009) is used to collect the data for this study. It is divided into three
parts: Part I solicits information about the respondents and the bank for which they
work; Part II covers six aspects of risk management:
JRF (1) URRM;
13,3 (2) RI;
(3) RAA;
(4) RMON;
(5) RMPs; and
220 (6) CRA.

This part includes 51 statements to which respondents are invited to indicate their
level of agreement based on an interval scale, where 11 statements correspond to
URRM; five, to RI; seven, to RAA; five, to RMON, 15, to RMPs and eight, to CRA.
Respondents were asked to indicate the extent of their agreement with each of the
questions on a seven-point Likert scale. Part III consists of two closed questions based
on an ordinal scale dealing with the risks facing the sample banks and based on binary
answers about the methods of RI used.

3.2 Sample
In the new banking environment, risk management is not restricted to the
responsibility of the risk management department, but is the responsibility of everyone
working for the bank (KPMG International, 2009). According to KPMG International
(2009), bank staff should understand the organizational risk appetite, and the risk
management system of checks and balances should incorporate three independent
layers of defense against risk: business units, risk management function and internal
audit. Therefore, the target population for the survey is not limited to risk
management specialists but extends to include all staff. Furthermore, the population is
similar to that used in the studies of Al-Tamimi and Al-Mazrooei (2007) and
Hassan (2009).
Banks operating in Bahrain were assigned to students in the Islamic Finance course
in the first semester of 2009/2010. Before approaching the assigned banks, students were
trained to administer the questionnaire. To maintain records of the questionnaires,
students were asked to deposit the returned completed questionnaires soon after
receiving them. Of 700 questionnaires distributed, 560 were returned. In total,
26 questionnaires were excluded because of missing data. The resulting response rate
was 74.9 percent. Although the response is considered very high, testing was conducted
for the possibility of non-response bias.
Evidence of non-response bias was obtained by examining differences between the
responses of 30 early and late 30 respondents. The comparison indicated that there
were no significant differences between the two groups in terms of their responses to
the questions in the questionnaire.
To assess the reliability of the instrument, Cronbach’s a was employed on the six
aspects of risk management included in the questionnaire. This measure consists of
estimates of how much variation in scores of different variables is attributable to chance
or random errors (Selltiz et al., 1976). As a general rule, a coefficient greater than or equal
to 0.7 is considered acceptable and a good indication of construct reliability (Nunnally,
1978). The internal consistency measured by Cronbach’s a ranges between 0.713 for RI
to 0.892 for URRM, indicating that the results are reliable. It is worth noting that all
values of Cronbach’s a reported by Al-Tamimi and Al-Mazrooei (2007)
and Hassan (2009) are below 0.7. This indicates that construct reliability is better for the Risk
results of the current study. management
The characteristics of the respondents are shown in Table II. The questionnaires
were answered primarily by bankers occupying middle management positions or above, practices
and the majority of the respondents (77.5 percent) possess experience of five years or
longer. All respondents held an academic and/or a professional qualification such as
Chartered Financial Analyst, Certified Public Accountant or Financial Risk 221
Management. Of the respondents, 52.5 percent work in conventional banks, while the
rest work in Islamic banks. The majority of the respondents (75 percent) work for locally
incorporated banks. Overall, we can conclude that those who took part in the survey
have adequate knowledge about RMPs operating in their banks. In order to obtain a
measure of response reliability, interviews (lasting between 45 minutes and 1 hour)

Attributes Frequency %

Gender
Female 209 39.9
Male 315 60.1
Length of experience
Less than five years 205 39.1
Five years and less than ten years 201 38.4
Ten years or longer 118 22.5
Position
Executive/managerial 124 23.7
Middle management 171 32.6
Other 229 43.7
Type of job
Audit 60 11.5
Credit 66 12.6
Finance 116 22.1
Investment 63 12.0
IT 27 5.2
Operations 64 12.2
Private banking 32 6.1
Risk 48 9.2
Treasury 44 8.4
Other 4 0.8
Highest qualification
BSc 312 59.5
Professional (accounting, finance) 123 23.5
Graduate degree 60 11.5
Risk management professional qualification 16 3.1
Other 13 2.5
Type of license
Retail conventional 175 33.4
Retail Islamic 166 31.7
Wholesale conventional 100 19.1
Wholesale Islamic 83 15.8
Type of bank Table II.
Locally incorporated 393 75.0 Characteristics
Foreign bank 131 25.0 of the sample
JRF were conducted with four randomly selected respondents approximately six months
13,3 after the questionnaires were received. No inconsistencies were found between the
questionnaire responses and the interview findings.

4. Analysis of the results

4.1 Understanding risk and risk management
222 Appreciation of banks’ risk exposure by board members, executive management and
other employees are of extreme importance for effective risk management. In addition,
banks in Bahrain are required to comply strictly with the requirements pertaining to
managing risk exposure set out in the rule book published by the Central Bank of
Bahrain (CBB), the bank regulator. The CBB is known to be very prudent; and as a
result, one would expect banks in Bahrain to comply strictly with the rules. The roles
of banking regulators are more important as a result of the implementation of the Basel
II Accord and the recent global financial crisis. To capture the URRM aspect of risk
management, 11 statements are included in the questionnaire. The summaries of the
responses are presented in Table III. The mean responses of all groups to the
statements range between 4.95 and 5.78, with an overall average of 5.34. The highest
mean is for the statement, “Managing risk is important to the performance and success
of the bank”. The lowest mean is for the statement, “It is crucial to apply the most
sophisticated techniques in risk management”; followed by “The bank aims is to
extend the application of advanced risk management techniques”. This indicates that
bankers do not perceive those techniques to improve significantly the way risks are
managed and/or those techniques are not understood well by those staff. Overall, these
results indicate that staffs of banks operating in Bahrain have a good understanding of
risk and risk management, which gives an indication of the ability of these banks to
manage risk efficiently in the future. These results are qualitatively similar to those
reported by Al-Tamimi and Al-Mazrooei (2007) and Hassan (2009).
The sample is divided into two groups: those working for conventional banks and
those working for Islamic banks. This makes it possible to compare the perceptions of
the two groups. Table III presents the summary of the responses. The mean responses
of Islamic bankers to all statements exceed the mean responses of the other group. The
test statistics indicate that the mean responses of the two groups to the statements are
not significantly different, with the exception of four statements.

4.2 Risk identification

RI is the first step in managing risk by banks. Failure to identify risk makes it
impossible to manage. To capture the RI function performed by banks, the
questionnaire includes five questions. Table IV provides the results of means and
standard deviations for the answers to the five statements for all respondents and for
the two subgroups. The average of the means is 4.876, which indicates that banks
operating in Bahrain clearly identify the potential risk relating to their declared aims
and objectives. The mean responses of all questions exceed the midpoint (i.e. 4) on the
seven-point Likert scale. This result is also consistent with the conclusion regarding
understanding risk, as the more staff understand risk, the easier they can identify risk.
Furthermore, this result for RI is consistent with those reported by Al-Tamimi and
Al-Mazrooei (2007) and Hassan (2009). The t-statistics indicate that the mean responses
of conventional and Islamic bankers do not significantly differ from each other,
 Frequency of 5-7 % Mean SDa Mean SD Mean SD
No. Questions Whole sample Conventional Islamic tb

1. There is a common understanding of risk 379 72.6 5.42 1.537 5.32 1.512 5.52 1.561 2 1.482
management across the bank
2. Responsibility for risk management is clearly set out 386 73.8 5.29 1.582 5.25 1.589 5.33 1.575 2 0.549
and understood throughout the bank
3. Accountability for risk management is clearly set out 397 75.9 5.37 1.489 5.33 1.513 5.42 1.465 2 0.647
and understood throughout the bank
4. Managing risk is important to the performance and 437 83.4 5.78 1.541 5.68 1.568 5.89 1.507 2 1.515
success of the bank
5. It is crucial to apply the most sophisticated 344 66.3 4.95 1.503 4.77 1.543 5.15 1.434 2 2.873 *
techniques in risk management
6. The bank aims to extend the application of advanced 355 67.7 5.05 1.666 4.89 1.787 5.23 1.505 2 2.349 *
risk management techniques
7. It is important for my bank to emphasize continuous 402 76.7 5.43 1.639 5.25 1.755 5.62 1.479 2 2.600 *
review and evaluation of the techniques used in risk
management
8. Applications of risk management techniques reduce 414 79.3 5.53 1.529 5.51 1.524 5.46 1.439 2 0.457
costs or expected losses
9. Stress testing output is understood by senior 395 75.7 5.38 1.530 5.37 1.524 5.39 1.539 2 0.162
management and board
10. My bank has an effective risk management strategy 385 73.4 5.15 1.530 4.96 1.613 5.37 1.405 2 3.092 *
in place
11. My bank has an effective risk management 392 75.0 5.34 1.573 5.24 1.681 5.46 1.439 2 1.839 * *
framework (infrastructure, process and policies) in
place
Average 5.31 1.074 5.21 1.135 5.43 0.988 2 2.401 *
a b
Notes: Significant at: *5 and * *10 percent; SD – standard deviation; t-statistics
management

Responses to statements
practices

Table III.
223
Risk

about URRM
 JRF
13,3

224

about RI
Table IV.
Responses to statements
Frequency of 5-7 % Mean SDa Mean SD Mean SD
No. Questions Whole sample Conventional Islamic tb

1. The bank carries out a comprehensive and 381 73.1 5.14 1.451 5.07 1.476 5.22 1.421 2 1.242
systematic identification of its risk relating to each
of its declared aims and objectives
2. The bank finds it difficult to identify, and classify its 264 50.4 4.13 1.832 4.31 1.809 3.94 1.843 2.201 *
main risks
3. Changes in risk are recognized and identified by the 363 69.3 5.05 1.479 5.10 1.566 5.00 1.377 0.764
bank’s rules and responsibilities
4. The bank is aware of the strengths and weaknesses 357 68.1 5.09 1.689 5.01 1.702 5.18 1.673 2 1.147
of the risk management systems of other banks
5. My bank has developed and applied procedures for 360 69.0 4.97 1.569 4.97 1.642 4.97 1.488 2 0.07
the systematic identification of investment
opportunities
Average 4.88 1.051 4.899 1.090 4.87 1.007 0.222
Notes: Significant at: *5 percent; aSD – standard deviation; bt-statistics
with one exception as shown in Table IV. Like the results reported by Al-Tamimi and Risk
Al-Mazrooei (2007) and Hassan (2009), these results indicate that banks do not find it management
difficult to identify and classify the main risk they face. However, the conventional
banks in Bahrain appear to face more difficulties in prioritizing their main risks practices
compared with Islamic banks.
Respondents were asked to state whether or not their banks use the RI methods
included in the questionnaire. Table V depicts the frequency and the percentage of the 225
responses that indicate that they used the RI method. The entire sample ranked the
methods inspection by the bank risk staff, audit and physical inspection and financial
statement analysis as the three methods most widely used to identify types of risks.
Although both Al-Tamimi and Al-Mazrooei (2007) and Hassan (2009) report a similar
ranking, their results indicate that more than 90 percent of the respondents indicate the
use of these methods, while the results of the current study indicate that none of the
methods is used by 90 percent of the banks. The least used method is SWOT analysis,
with only 61.7 percent of all respondents indicating their banks use this method.
Similar results are found for the subgroups from conventional and Islamic banks.
Overall, the results show that conventional and Islamic banks in Bahrain use more
traditional methods of RI than sophisticated methods.

4.3 Risk assessment and analysis

Risks are generally identified at both the individual entity and the fully consolidated
levels of an institution on the basis of management policies. While most risks are
identifiable, not all are quantifiable. An example of an identifiable but unquantifiable
risk is legal risk. The next step in risk management, after RI, is to assess and analyze
the identified risks. The mean responses of the entire sample to the seven components
included in the questionnaire to capture this aspect of risk management (Table VI)

Frequency % Rank Frequency % Rank Frequency %

yes yes yes Rank
No. Questions Whole sample Conventional Islamic

1. Inspection by the 426 81.3 1 232 84.2 1 194 77.9 2

bank risk staff
2. Audit and physical 419 80.0 2 220 80.0 2 199 79.9 1
inspection
3. Financial statement 402 77.2 3 211 58.4 8 191 76.7 3
analysis
4. Risk survey 321 62.0 8 157 57.1 9 164 65.9 9
5. Process analysis 386 74.4 4 199 72.4 3 187 75.4 4
6. SWOT analysis 318 61.7 9 169 61.5 7 149 59.8 10
7. Inspection by N/A N/A 178 71.5 5
Sharia’a auditors
(Islamic banks only)
8. Benchmarking 342 66.3 7 177 64.4 6 165 66.3 8
9. Scenario analysis 353 68.1 6 185 67.3 5 168 67.5 7
10. Internal 362 69.7 5 191 69.5 4 171 68.7 6
communication Table V.
Responses regarding
Note: N/A – not applicable RI methods
 JRF
13,3

226

Table VI.

about RAA
Responses to statements
Frequency of 5-7 % Mean SDa Mean SD Mean SD
No. Questions Whole sample Conventional Islamic tb

1. My bank assesses the likelihood of risk occurring 397 76.1 5.21 1.362 5.19 1.376 5.23 1.350 2 0.291
2. The bank’s risk is assessed by using quantitative 378 72.3 5.16 1.507 5.10 1.556 5.22 1.451 2 0.869
analysis methods
3. The bank’s risk is assessed by using qualitative 400 76.5 5.35 1.529 5.27 1.552 5.44 1.502 2 1.273
analysis methods (e.g. high, moderate and low)
4. My bank’s response to analyzing risk includes 400 76.3 5.19 1.496 5.12 1.483 5.27 1.509 2 1.167
assessment of the costs and benefits of addressing
risk
5. My bank’s response to analyzing risk includes 406 77.5 5.37 1.569 5.36 1.558 5.38 1.584 2 0.127
identifying, prioritizing of risk and selecting those
that need active management
6. My bank’s response to analyzing risk includes 398 76.1 5.36 1.504 5.23 1.574 5.51 1.412 2 2.123 *
identifying, prioritizing risk treatments where there
are resource constraints on risk treatment
implementation
7. My bank relies on the output of quantitative data 300 57.3 4.51 1.671 4.50 1.601 4.51 1.749 2 0.084
without human judgment
Average 5.16 1.065 5.10 1.113 5.22 1.001 2 0.208
Notes: Significant at: *5 percent; aSD – standard deviation; bt-statistics
range between 4.51 and 5.37 with an average of 5.16. The lowest mean response is to Risk
the statement “My bank relies on the output of quantitative data without human
judgment”. This indicates that banks give important consideration to human judgment
management
as well as quantitative analysis. Overall, the results indicate that banks in Bahrain are practices
efficient in assessing and analyzing risk. These results are qualitatively similar to
those reported by Al-Tamimi and Al-Mazrooei (2007) and Hassan (2009).
Table V summarizes the responses of conventional and Islamic bankers which 227
indicate that the mean responses to the seven statements by Islamic bankers are higher
than those of their conventional counterparts. To test the hypothesis that the mean
responses of the samples are not significantly different, t-statistics were used. The
results show that the mean responses of the groups to the statements are not
significantly different, with the exception of “My bank’s response to analyzing risk
includes identifying, prioritizing risk treatments where there are resource constraints on
risk treatment implementation”.

4.4 Risk monitoring

The primary components of risk management are internal controls and management
information systems for controlling, monitoring and reporting risks. RMON aims to
determine whether the risk exposures are in line with the desired level and are dealt with
properly. To capture this aspect of risk management, five statements are included in the
questionnaire. Table VII reports the responses of the whole sample, conventional
bankers and Islamic bankers. The mean responses to the five statements range between
5.16 and 5.41, with an overall average of 5.29. These results indicate that bankers believe
that banks operating in Bahrain have efficient RMON and control system.
The mean of the responses of conventional bankers is lower than that of Islamic
bankers. The mean responses of Islamic bankers on the five components of the RI aspect
of risk management are higher than those of conventional bankers. To test the hypothesis
that the mean responses of conventional and Islamic bankers are not significantly
different from each other, we used the t-test. The results of the test are shown in Table VII.
They indicate that there are no significant differences between the mean responses of the
groups, with the exception of the mean responses to the statement “Reporting and
communication processes within my bank support the effective management of risk”.
4.5 Risk management practices
Banks’ boards and staff understanding of the risks faced and having effective risk
management strategies and frameworks (infrastructure, process and policies) in place
do not guarantee that banks manage their risk exposure effectively. The gap between
what is expected from bank staff and RMP is one of the reasons for banking failure. In
total, 15 statements are included in the questionnaire to capture the RMPs. Table VIII
summarizes the responses to those statements. The overall mean response is 5.23, and
means responses range between 4.38 and 5.51. The lowest mean response
(very close to the midpoint of the Likert scale) was that of the statement “Risk
management techniques are used for regulatory purposes only”. These results lend
further support to the responses to the statements that capture URRM, in which the
respondents agreed that effective risk management improves banks’ performances.
These results also indicate that the banks’ staffs are aware of the application of the Basel
Capital Accord, which was introduced to improve the efficiency of banks’ risk
management.
 JRF
13,3

228

Table VII.

about RMON
Responses to statements
Frequency of 5-7 % Mean SDa Mean SD Mean SD
No. Questions Whole sample Conventional Islamic tb

1. Monitoring the effectiveness of risk management is 384 73.3 5.16 1.450 5.14 1.463 5.19 1.438 2 0.432
an integral part of routine management reporting
2. Level of control by the bank is appropriate for the 403 76.9 5.39 1.550 5.20 1.623 5.60 1.439 2 2.977 *
risk that it faces
3. Reporting and communication processes within my 395 75.4 5.24 1.602 5.16 1.688 5.34 1.500 2 1.273
bank support the effective management of risk
4. The bank’s response to risk includes an evaluation of 403 76.9 5.41 1.574 5.38 1.633 5.44 1.510 2 0.432
the effectiveness of the existing controls and risk
management responses
5. The bank’s response to risk includes action plans in 406 77.8 5.26 1.478 5.21 1.526 5.32 1.423 2 0.872
implementation decisions about identified risk
Average 5.29 1.210 5.21 1.274 5.37 1.133 2 1.813 * *
Notes: Significant at: *5 and * *10 percent; aSD – standard deviation; bt-statistics
 Frequency of 5-7 % Mean SDa Mean SD Mean SD
No. Questions Whole sample Conventional Islamic tb

1. The bank’s executive management regularly reviews the 402 76.7 5.40 1.551 5.39 1.613 5.41 1.481 20.070
organization’s performance in managing its business
risk
2. My bank is highly effective in continuous review/ 400 76.3 5.32 1.548 5.32 1.595 5.32 1.498 20.036
feedback on risk management strategies and
performance
3. My bank’s risk management procedures and processes 402 76.7 5.36 1.606 5.31 1.721 5.42 1.471 20.752
are documented and provide guidance to staff about
managing risks
4. My bank’s policy encourages training programs in the 365 69.7 5.02 1.663 4.91 1.748 5.16 1.557 21.730
area risk management as well as ethics
5. My bank emphasizes the recruitment of highly qualified 374 71.4 5.06 1.722 4.92 1.704 5.20 1.733 21.871
people who have knowledge of risk management
pertaining to the type of the bank
6. Effective risk management is one of the objectives of my 418 79.8 5.47 1.470 5.37 1.500 5.57 1.432 21.584
bank
7. It is too risky to invest my bank’s funds in one specific 415 79.3 5.51 1.594 5.37 1.705 5.66 1.451 22.208 *
sector of the economy
8. The application of Basel Accord II improved of 405 78.2 5.49 1.433 5.40 1.499 5.60 1.350 21.562
efficiency and RMPs in my bank in particular
9. My bank’s capital is adequate if the ratio of capital to 356 69.7 5.12 1.359 5.10 1.386 5.15 1.331 20.391
total risk-weighted assets is equal to the CAR prescribed
by the CBB
10. I consider the level of RMPs in my bank to be excellent 380 73.8 5.16 1.448 5.05 1.575 5.28 1.283 22.026 *
11. Risk management is given great importance by my bank 411 78.6 5.50 1.616 5.31 1.780 5.69 1.389 22.741 *
12. Senior management lead risk management from the top 401 77.5 5.37 1.654 5.27 1.770 5.48 1.511 21.448
13. Risk factors are consolidated across all banks operations 312 60.0 4.93 1.483 4.76 1.505 5.10 1.442 22.655 *
14. Risk management techniques are used as management 399 76.4 5.32 1.477 5.26 1.527 5.39 1.419 21.001
tools
15. Risk management techniques are used for regulatory 283 54.0 4.38 1.757 4.50 1.750 4.24 1.759 1.726
purposes only
Average 5.54 1.085 5.46 1.200 5.64 0.934 21.978 *
a b
Notes: Significant at: *5 and * *10 percent; SD – standard deviation; t-statistics

Responses to statements
management
practices

about RMPs
Table VIII.
229
Risk
JRF The responses of those working in conventional and Islamic banks are shown in
13,3 Table VIII. With the exception of the mean response to the statement “Risk
management techniques are used for regulatory purposes only”, the means responses
to the statements by Islamic bankers are higher than those of the conventional bankers.
The t-statistics indicate that the differences between the mean scores of the two groups
are not significantly different from zero, with three exceptions.
230
4.6 Credit risk assessment
Banks face different types of risk. However, credit risk is the most significant of those
risks. This is evident in the calculation of the capital adequacy ratio according to Basel II
requirements. For this reason, eight statements are included in the questionnaire to
capture the perception of the respondents of this risk. Table IX reports the sample’s
responses on these questions. The mean of the responses to the eight questions is 5.34,
which provides evidence about the efficiency of credit risk management by the Bahraini
banking industry. For the whole sample, the most important aspect is the risk rating of
applicants, followed by the specific analysis of the applicant’s character, capacity,
collateral and conditions. The need for applicants to provide sufficient collateral is
considered, based on the mean of the responses, the fifth most important aspects of CRA.
Requiring applicants to adhere to certain covenants as pre-conditions for granting credit
or executing transactions came in seventh place with a mean response rate of 5.35.
Responses to the eight statements range between 5.04 and 5.56. The mean responses to
all questions of respondents working in Islamic banks are higher than those of their
conventional counterparts, but only two are significantly different.

4.7 Types of risks

Banks are exposed to different types of risks. The importance of those types depends on
the asset portfolio, the way they conduct their business lines (i.e. conventional or
Islamic), and regulatory requirements to which banks are subjected. To identify the
importance of the types of risks to which banks are exposed, respondents were asked to
state their perceptions of the level of importance of 15 different types of risks on a
seven-point Likert scale ranging from very important (7) to not important at all (1).
Table X presents a summary of the responses and the t-statistics to test the hypothesis
that the mean responses of the conventional and Islamic bankers do not differ
significantly. The types of risk are shown in terms of relative importance based on the
mean responses of the whole sample. As shown in Table X, the mean responses for all
types of risk, with the exception of residual risk, are higher than 5. The results show that
the most important risk banks face is credit risk. This type of risk has long been
identified as the dominant risk for banking firms and is an inherent part of their core
lending business. Credit extended to customers and customers’ deposits generally
represents the most significant asset and liability classes on a bank’s balance sheet.
Liquidity risk is ranked the second most important risk, while it is ranked fourth in the
study of Al-Tamimi and Al-Mazrooei (2007) and Hassan (2009). The difference in
ranking is probably due to the period during which the data for the study was collected,
which was a year after the beginning of the global financial crisis; the liquidity crunch
was central to that crisis. Operational risk is ranked third by the respondents. This risk is
defined as the risk of direct or indirect loss resulting from inadequate or failed internal
processes, people and systems or from external events. The level of importance of this
 Frequency of 5-7 % Mean SDa Mean SD Mean SD
No. Questions Whole sample Conventional Islamic tb

1 My bank undertakes a credit worthiness analysis 421 80.3 5.33 1.383 5.25 1.411 5.43 1.348 2 1.449
before granting credit or executing transactions
2 Before granting capital or credit my bank undertakes 395 75.7 5.44 1.575 5.22 1.797 5.67 1.204 2 2.298 *
specific analysis including the applicant’s character,
capacity, collateral and conditions
3 My bank’s borrowers are classified according to risk 411 78.7 5.56 1.532 5.29 1.681 5.60 1.433 2 2.405 *
factors (risk rating)
4 It is essential to require sufficient collateral from 393 75.6 5.34 1.495 5.26 1.593 5.42 1.376 2 1.197
small borrowers
5 My bank’s policy requires collateral for granting 412 78.9 5.37 1.465 5.34 1.559 5.41 1.335 2 0.586
capital, extending credit, or making transactions
6 It is preferable to require collateral against some 366 70.1 5.04 1.548 4.99 1.628 5.11 1.454 2 0.918
capital and not all of it
7 The level of capital (credit) granted to defaulting 404 77.8 5.34 1.549 5.33 1.634 5.35 1.451 2 0.090
clients must be reduced
8 The bank requires applicants to adhere to certain 411 78.7 5.32 1.455 5.27 1.528 5.39 1.368 2 0.966
covenants as pre-conditions for granting credit or
executing transactions
Average 5.45 1.142 5.27 1.118 5.43 0.855 2 2.218 *
a b
Notes: Significant at *5 and * *10 percent; SD – standard deviation; t-statistics

Responses to statements
management
practices

addressing CRA
Table IX.
231
Risk
 JRF
13,3

232

Table X.
Risk faced by

Islamic banks
conventional and
Frequency of 5-7 % Mean SDa Mean SD Mean SD
Questions Whole sample Conventional Islamic tb

1. Credit risk 446 85.1 6.01 1.566 5.94 1.600 6.09 1.528 2 1.099
2. Liquidity risk 441 84.2 5.91 1.604 5.80 1.641 6.04 1.555 2 1.715 * *
3. Operating risk 428 81.7 5.78 1.594 5.64 1.706 5.92 1.45 2 2.030 *
4. Legal risk 418 79.8 5.72 1.625 5.61 1.704 5.84 1.526 2 1.645
5. Regulatory risk 412 78.6 5.58 1.504 5.49 1.541 5.68 1.460 2 1.429
6. Reputation risk 402 76.7 5.52 1.592 5.43 1.593 5.61 1.588 2 1.303
7. Strategic risk 397 75.9 5.47 1.67 5.42 1.689 5.52 1.651 2 0.725
8. Solvency risk 399 76.6 5.39 1.613 5.26 1.705 5.53 1.495 2 1.015
9. Interest rate risk (conventional banks only) 213c 77.5 5.31 1.524 5.31 1.524 Not applicable
10. Rate of return risk (Islamic banks only) 188d 75.5 5.48 1.476 Not applicable 5.48 1.476
11. Settlement risk 381 72.8 5.39 1.592 5.24 1.63 5.55 1.537 2 2.291 *
12. Concentration risk 407 77.8 5.31 1.366 5.23 1.387 5.39 1.339 2 1.326
13. Price (equity) risk 387 74.1 5.30 1.534 5.21 1.554 5.41 1.509 2 1.553
14. Foreign-exchange risk 391 74.6 5.28 1.583 5.26 1.644 5.31 1.515 2 0.397
15. Country (political) risk 379 72.6 5.23 1.556 5.08 1.615 5.38 1.474 2 2.215 *
16. Residual risk 288 58.3 4.76 1.666 4.51 1.836 5.04 1.406 2 3.643 *
Average 5.42 1.135 5.34 1.202 5.57 1.062 2 2.256 *
Notes: Significant at: *5 and * *10 percent; aSD – standard deviation; bt-statistics; cout of 275 respondents; dout of 349 respondents
risk stems from the fact that it is part of the capital adequacy ratio calculated Risk
in accordance with the requirements of Basel II. Operational risk includes legal and management
regulatory risks which the respondents ranked third and fourth, respectively.
Foreign-exchange risk, unlike the results of Hassan (2009) which ranked this as the most practices
important risk, was ranked 13th by the respondents. The low ranking of the foreign
exchange risk by the sample is probably due to the fact that the Bahraini dinar is fixed
against the US dollar. Furthermore, the banks’ assets in foreign countries do not use the 233
US dollar or their currencies do not have a fixed rate against the US dollar as of
the August 2011; this represents 20.7 percent of the retail banking assets according to the
CBB (2011).
Those working in conventional and Islamic banks reported and ranked similarly the
same top six types of risk: credit, liquidity, operational, legal, regulatory and
reputational. These results are somewhat similar to those reported by Ariffin et al. (2009);
they found that Islamic bankers perceived credit risk as the most important. However,
those findings contradict Khan and Ahmed (2001), Al-Tamimi and Al-Mazrooei (2007)
and Hassan (2009). The mean responses of all types of risk exceed 5, with the exception of
the mean responses of residual risk by bankers in conventional banks. The mean
responses of the types of risks included in the questionnaire by the Islamic bankers
exceed those of conventional bankers.
The t-test is used to test the hypothesis that the samples perceived the level of
importance of the types of risk similarly. According to the results, the overall risk level
facing Islamic banks is perceived to be significantly higher than that faced by
conventional banks. Furthermore, the t-statistics indicate that there are no significant
differences between the mean responses of the two groups, with the exception of
liquidity, operational, settlement, country (political) and residual risks. With those types
of risks, it is found that Islamic banks face significantly higher risks than their
conventional counterparts. The higher liquidity risk faced by Islamic banks may be the
result of:
. a lack of active money markets for Islamic Sharia’a compliant money market
instruments;
.
restricted access to short-term financing options that are available for
conventional banks, including such funding from the CBB; and
.
maintaining high cash balances out of the balance of current accounts held to
cover clients’ demands for withdrawals from their accounts (Iqbal and Mirakhor,
2011).

As for higher operational risk facing Islamic banks, this is due partly to a unique type
of risk facing Islamic banks; namely, Sharia’a risk, which is a part of operational risk.
This unique risk is due to the need to make their products Sharia’a-compliant. Unlike
conventional bank products, products of Islamic banks lack standardization. In order
to ensure that their products are Sharia’a-compliant, Islamic banks should obtain the
approval of their respective Sharia’a supervisory boards. However, this approval may
not ensure acceptability of those products by other Sharia’a supervisory boards of
other Islamic banks or clients. Another dimension of Sharia’a risk is legal risk. Islamic
banking products can involve a number of separate contracts, giving rise to additional
legal risks. For example, in the case of murabahah[1] transactions, which represent
the dominant investment of Islamic banks, the bank has to buy an item and then sell
JRF it under different payment terms. Each step takes time and involves a new contractual
13,3 agreement, magnifying the scope for disagreements and complications. Sharia’a risk
may lead to a loss of profit generated from non-Sharia’a-compliant sources. The
settlement risk to Islamic banks, as a form of credit risk, arises when an Islamic bank
pays money such as salam[2] or istisna[3] contracts or delivers assets such as
murabahah contracts before receiving its own assets or cash, thereby exposing it to
234 potential loss (Khan and Ahmed, 2001). Such practices make the level of settlement risk
faced by Islamic banks higher than that which faces conventional banks. The residual
risk is the risk that third party claims must be met first before the shareholders receive
any return on capital. Unlike conventional banks, which provide loans fully backed by
the borrower’s assets and thus shift the entire risk to borrowers, some of financial
products of Islamic banks, such as mudharaba[4] and musharakah[5], are structured in
a way that Islamic banks share the risk of the asset with the clients (Ebrahim, 2000). In
addition, Islamic banks, unlike conventional banks, have limited opportunity to charge
clients for the additional risks they face in case of delinquency and loan restructuring.
Consequently, Islamic banks face higher residual risk compared with conventional
banks.
The lack of significant differences between the types of banks regarding credit risk
warrants an explanation. Based on Islamic banking principles of risk sharing and
profit-and-loss sharing, it is expected that the credit risk facing Islamic banks should be
significantly higher than that of conventional banks. One of the most important
explanations is that the murabahah is the dominant investment instrument of the asset
portfolio of Islamic banks (Rosly, 2011), and profit-sharing financing, such
as mudharabah and musharakah has remained negligible in operations of Islamic
banks. As of August 2011, the latter represent not more than 6.12 percent of the assets
managed by Islamic banks in Bahrain (CBB, 2011). Although, theoretically, banks are
exposed to business and credit risks when they enter into contracts of banking
murabahah, in reality such contracts are considered to be akin to loans granted by
conventional banks and as such are gross violations of Sharia’a principles (Khan and
Bhatti, 2008). This is because Islamic banks:
.
insure themselves against the risk of damage to goods, theft and destruction and
levy charges against the clients (Bashir, 1999), or make the necessary
arrangements with asset dealers or charge the client hamish jiddiyah (security
deposit)[6] to eliminate business risks that they may be exposed to during the
ownership period before signing the murabahah contract with clients;
.
use the market interest rate to determine the mark-up (interest rate) charged to
clients;
.
charge higher mark-up on murabahah contracts with longer terms, and higher
credit risk; and
.
use the market interest rate as a benchmark for setting the mark-up they charge
to clients (borrowers).

Overall, the unique risks facing Islamic banks lead them to face higher total risk
compared with conventional banks.
4.8 Testing the hypotheses regarding RMPs Risk
This paper examines the relationship between RMPs and the five aspects of the risk
management process (H01):
management
(1) URRM;
practices
(2) RI;
(3) risk analysis and assessment; 235
(4) RMON; and
(5) CRA.

Following Al-Tamimi and Al-Mazrooei (2007), the function of RMPs is as follows:

RMPs ¼ f ðURRM; RAA; RI; RMON; CRA; bank typeÞ
Unlike Al-Tamimi and Al-Mazrooei (2007), a dummy variable is included in the model
to capture the possible effect of the type of bank (conventional or Islamic) on the RMPs.
Table XI presents the regression results. The variance information factors of the
independent variables are less than 5 and tolerance of more than 0.215 indicates that
multicolinearity does not pose a problem in interpreting these results (Kutner et al.,
2003). Furthermore, the Durbin-Watson statistic of 2.005 indicates no serious
autocorrelation exists. The results show that the constant and coefficients of all
independent variables, including the dummy variable, have a positive sign. Also, the
coefficients of URRM, RAA, RI, RMON and CRA are significant at the 5 percent level
or less. The adjusted R 2 is 81.6 percent and highly significant. These results indicate
that the null hypothesis that states no effect of URRM, RAA, RI, RMON and CRA
on RMPs is rejected. Our results are partially similar to those reported by Al-Tamimi
and Al-Mazrooei (2007) and Hassan (2009) who found that only the coefficient of RI and
RAA are significant. These differences may be attributed to the prudent and vibrant
CBB which follows a risk-based supervision approach (IMF, 2006).
To test H02 the analysis of variance (ANOVA) was applied on each of the six aspects
of risk management and risks facing banks. The results are presented in Table XII.
Using the 5 percent level of significance, the results indicate that there are no significant
differences in any aspect of risk management between conventional and Islamic banks,
with the exception of URRM and level of risk. This is an unexpected result, as both types

Variable Estimates SE Standardized b Tolerance VIF

Constant 0.175 0.135

URRM 0.362 * 0.043 0.359 0.215 4.648
RAA 0.205 * 0.035 0.200 0.338 2.958
CRA 0.275 * 0.036 0.258 0.343 2.918
RI 0.057 * 0.029 0.056 0.481 2.079
RMON 0.118 * 0.033 0.131 0.289 3.459
Bank’s type 0.024 0.043 0.011 0.973 1.028
Adjusted R 2 (%) 81.6%
F-statistics 353.569 * Table XI.
Durbin-Watson 2.005 Regression results:
dependent variable –
Note: Significant at: *5 percent or less RMPs
JRF of bank are subject to the same regulatory requirements and a regulatory system that
13,3 maintains closely aligned prudential regulations for both types of banks to guarantee as
far as possible a “level playing field” (IMF, 2006). However, Islamic banks are exposed to
additional types of risks that are unique to those banks, such as Sharia’a risk, and some
risks arising from profit-sharing investment deposits (Khan and Ahmed, 2001;
Ariffin et al., 2009). Additionally, the structure of some products of Islamic banks make
236 them share asset risks with their clients (borrowers). This explains the findings that
show Islamic banks face higher risk than those of conventional banks because the
conventional banks protect themselves by granting loans fully backed by the borrower’s
assets and thus shift the entire risk to the other party.

5. Conclusions, implications, limitations and further research

The purpose of this paper is to report the results of an empirical study of the RMPs of
conventional and Islamic banks operating in Bahrain. A questionnaire was used to
obtain the information needed to achieve the study’s objectives. The main conclusions
of the study are:
.
bankers in Bahrain are aware of the importance and the role of effective risk
management in reducing costs and improving bank performance;
.
banks in Bahrain have in place effective risk strategies and effective risk
management frameworks (infrastructure, process and policies);
.
the three most important types of risk facing banks operating in Bahrain are
credit risk, followed by liquidity and operating risk;
.
banks are somewhat effective in assessing and analyzing risks, RMPs, RMON
and RI;
.
the quality of RMPs is determined by URRM, RI, RAA and CRA; and
.
the RMPs, RI, RAA and CRA of Islamic banks do not differ significantly from
those of conventional banks, although the types of banks differ significantly
from each other with respect to their URRM.

Overall the results show that Islamic banks face higher levels of risk than conventional
banks. It is found that Islamic banks face higher liquidity, operational, settlement,
country and residual risks than their conventional counterparts. These results are
attributable to differences in the products of both types of banks that lead to unique
risks to Islamic banks.

Aspect F-statistics Significant level

URRM 5.338 0.021 *

RI 3.083 0.080
RAA 0.065 0.800
CRA 1.227 0.268
RMON 2.469 0.117
Table XII. RMPs 3.763 0.053
The results of ANOVA Risk 5.025 0.025 *
for conventional banks
and Islamic banks Note: Significant at: *5 percent or less
The results of the study have implications for clients, banks’ management, investors Risk
and regulators. Depositors should know that they are facing higher risks when they management
deal with Islamic banks, and they would therefore expect to receive a higher rate of
returns. Also, borrowers are expected to pay a higher profit (interest) rate to Islamic practices
banks because those banks share the asset risk with them. However, competition with
conventional banks may put them at a disadvantage, which reduces their ability to
charge a higher profit rate. As for management and regulators, knowledge of the 237
unique types of risk facing each type of bank should lead to the development of special
risk management techniques and monitoring procedures that are suitable for those
risks, in addition to enhancing transparency. Finally, investors holding shares in
Islamic banks are expected to hold stocks with relatively high unsystematic risk
compared with stocks of conventional banks. This is an important result for portfolio
construction and management.
The results of this study should be interpreted in the light of a number of
limitations:
.
the conditions facing banks in Bahrain during the period in which the
questionnaires were distributed might have affected some of the results,
especially the type of risk facing the banking industry; and
. although the response rate is very high, there was no evidence of non-response
bias, and the responses were highly consistent internally, the study relies on
survey methodology which measures the beliefs, but not necessarily the actions,
of bankers.

Therefore, caution should be taken in generalizing the findings.

In summary, additional research is recommended in order to further understanding
of RMPs of conventional and Islamic banks. This could be achieved by studying:
.
risk management techniques used to mitigate risk exposure;
.
the specific risks to which banks are exposed, such as liquidity, market (price)
and operational risk;
.
the role of boards of directors and regulators in enhancing RMPs; and
.
banks’ transparency with regard to risk management.

An important effect of Sharia’a is that all investments are, in effect, backed by a

physical asset, and there cannot be pure speculation in money terms alone. This should
have substantial implications on the way Islamic banks handle their risks. For
example, they should be much less highly geared than traditional banks and should
not be trading in options, which did so much to produce the recent economic and
financial crisis. In the light of those considerations, it was very surprising that
employees of Islamic banks and traditional banks should have such similar views
about some aspects of risk management. This could be another focus for future
research.

Notes
1. A form of financing, often used to finance asset purchases or for consumer loans or
conventional trade finance. The bank buys the asset on a cash basis before selling it to the
client (borrower) on credit.
JRF 2. A sales contract in which the price is paid in advance at the time of contracting against
delivery of the purchased goods/services at a specified future date.
13,3
3. A form of sale in which a commodity is sold before it comes into existence.
4. Mudharabah is venture capital funding of an entrepreneur who provides labor while
financing is provided by the bank so that both profit and risk are shared.
5. In musharakah financing, the Islamic bank contributes the depositors’ funds to a joint
238 enterprise with the client (an entrepreneur). Generally, clients manage all the affairs of a
musharakah business, and they share the profit and loss made on the musharakah
investment with the Islamic bank.
6. A certain amount of money taken from a customer who places an order to purchase as a
security for his/her promise.

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About the authors

Hameeda Abu Hussain is an Assistant Professor of Finance at the University of Bahrain. Her
research interests are international finance, currencies, stock exchange markets, conventional
and Islamic banking. She teaches Corporate Finance, International Finance and Investment
Management. She was chairperson of the Department of Economics & Finance, Department of
Office Management Department, and Dean of the College of Business Administration.
Jasim Al-Ajmi is a Professor of Finance and Corporate Governance at the University of
Bahrain. He has worked in the banking industry and has published extensively in the areas of
corporate governance, financial institutions, investors’ behavior, capital markets, risk
management, financial analysis, Islamic finance and behavioral finance. He served as a Board
Member of the Eskan (Housing) Bank, Chairman of the Remuneration Committee of the Eskan
Bank, and member of the Audit Committee of the Eskan Bank. He is a board member of Bahrain
Competitive Council and MENA-OECD Investment Center. He was a member of the National
Committee of Corporate Governance that drafted the unified corporate governance code.
Jasim Al-Ajmi is the corresponding author and can be contacted at: jasimalajmi@gmail.com

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