Asian Research Thesis Index

Abstract

The basic thrust of current study is to measure the magnitude and to gauge the severity  of financial risk on profitability associated with the Islamic and conventional banking in  Pakistan. To realize the magnitude and enormity of financial risk the credit, liquidity, interest  rate and market risks are considered as major constituent of risk management practices. The  magnitude of credit risk was calculated through conventionally recognized quantitative models  (Z-Score, Altman Z-score, NPL ratio and Distance to Default and Default Probabilities for  Black Schole Merton’s Model) whereas, the enormity of liquidity risk calculated through ratios  including; cash and cash equivalent to total assets, investment to total assets and provision for  net advances to total assets. Likewise, interest rate risk was computed by applying historical  Gap Identification Model. The market risk was estimated through Value at Risk (VaR) Model at  90%, 95% and 99% confidence intervals. To gauge the combined effect of risk management  practices on profitability and to realize the appropriate applicability of fixed or random effect  model the Hauseman test was applied. The computed results of credit risk found Islamic banks  hold more risk whereas the probability of bankruptcy in near future felt more in conventional  banks relative to Islamic banks. The overall findings of liquidity risk revealed conventional  banks possess a sound liquidity arrangement than Islamic banks. The sensitivity of interest rate  on the volatility of interest income and the variability of liabilities as compared with assets were  bit high among conventional banks. By and large, the calculated results of market risk inferred  the volatility and potential to loss investment remained high in Islamic banks. Though, severity  of financial crisis-2008 profusely hit the profitability of both banking systems but the Islamic  banks felt more aggressively. The enormity of the credit risk accentuate management of the  Islamic banks to give more emphasis on the credit risk whereas, the State Bank of Pakistan will  have to keenly think on the changing paradigm of the interest rate sensitivity on the conventional  banks and formulate unified strategies which may widely adopted by the conventional banks and  prevent from future trauma.

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