The discussion in this chapter is based on the results of the conceptual aspects of the research that were gained from the literature review and from data collected and analysed in order to investigate risk management issues in Islamic banking. The available studies on similar subjects are mostly theoretical in nature, considering primary data research only. The results of the current study will therefore fill a significant gap in current scholarship by providing vital empirical information about risk management in Islamic banking.

In the last three chapters, Chapters 7, 8 and 9, the findings of the quantitative and qualitative data analysis were presented. This chapter discusses the implications of the findings in relation to the existing body of knowledge in the field. It aims to achieve the objective of giving greater meaning to the results through an interpretative method. The aim of this chapter, hence, is to combine the main results of the empirical chapters so as to conduct an integrated discussion of the hypotheses identified earlier, whereby it will be possible to highlight the contribution of this study.

For the purpose of clarity and to provide a more clearly structured approach to discussion, the flow of this chapter corresponds to the research hypotheses and to the thematic structure used in the questionnaire and interviews. Thus, the main discussion of the chapter is divided into 10 main sections: Risk Perception in Islamic Banking; Islamic Finance Contracts; Additional Risk Issues Facing IFIs; Capital Adequacy for Islamic Banks; Islamic Banking and the Global Credit Crisis; Risk Management and Reporting; Risk Measurement; Risk Mitigation; Islamic Banking in Practice; and, finally, The Future of Islamic Banking.

RISK PERCEPTION IN ISLAMIC BANKING

This section aims to provide a discussion through further interpretation of the results on the overall risks faced by Islamic banks by responding to the hypotheses set in advance.

• Hypothesis 1: The main risks facing Islamic banks are reputational risk, Shari'ah-non-compliance risk, asset–liability management (ALM) risk, liquidity risk and concentration risk.

In order to identify the main risks facing Islamic financial institutions (IFIs), the findings from the questionnaire and interview analyses were examined side by side, in addition to searching the existing literature review.

The null hypothesis is accepted and the alternative hypothesis is rejected by both quantitative and qualitative analyses.

The descriptive statistics for the entire sample, as in Table 7.5, show that the top five risks facing IFIs according to mean ranking are: liquidity, ALM, reputational, concentration and credit risks. Shari'ah-non-compliance risk followed with a close mean rank of 3.71, while market risk was considered the least risky (2.72). Of note is the proximity of mean values among the top risks.

These findings are no surprise, as liquidity management is far from an easy task for IFIs; it is structurally more challenging for IFIs because there is still a significant shortage of liquid instruments, despite the efforts of the various central banks to provide a variety in which Islamic banks can place their surplus cash. In fact, Tamweel and Amlak would have gone insolvent if not for government help. As discussed in Chapter 3, there have been some efforts to improve liquidity management and to develop an Islamic capital market and tradable Islamic financial instruments, but to date these have been limited.

ALM and liquidity risks are closely correlated, as the former is basically the practice of managing risks that arise due to mismatches between the assets and liabilities of a bank. For IFIs, the limited range of possible funding sources leads to concentrated liabilities, imbalanced funding mixes and stretched capital management strategies. Therefore, IFIs' funding bands usually remain imbalanced and IFIs tend to fill the gaps with capital. However, capital is a very expensive way of funding. This is why Islamic banks, particularly in the Gulf Cooperation Council (GCC), engage in higher risk/high yield transactions to make up for the expensive funding via capital and consequently keep shareholders satisfied with high returns. Those IFIs forced themselves, unintentionally, up the risk curve instead of diversifying their risks. This makes the balance sheet of Islamic banks quite polarised, with high real estate assets, which led to Islamic banks having a high concentration risk, on both sides of the balance sheet. A typical balance sheet structure of many IFIs displays high exposure to properties on the assets side and limited funding sources with high reliance on short-term liabilities and capital on the other side. This is a very unfavourable funding continuum, which has led IFIs into a vicious circle of risks.

Moreover, IFIs tend to have a concentration base of assets and/or deposits; they face high concentration by name and sector, as well as high geographical concentration. The limited scope of eligible asset classes creates asset concentration risk. Focus on tangibles had led to increased property-related financings at IFIs, affected by the relatively undiversified nature of the economies. As real estate markets are highly volatile in the GCC, the concentration risk is magnified because concentrations are even more problematic when they are biased toward high-risk sectors. High lending concentrations to construction and real estate companies are common for many IFIs. Moreover, the construction and real estate sectors are highly cyclical, require high capital-intensity, and typically have a long production cycle, leaving IFIs with high exposures to this sector and vulnerable to shifts in the market environment. According to Smith (2010), the combined exposure to the real estate and construction sector is in some cases higher than 100% of Tier 1 capital for Islamic banks, particularly in the GCC.

Respondents also identified credit risk as being among the top risks that face IFIs. Traditionally, a large part of a bank's profit came from lending businesses. Also, the majority of bank losses were related to this aspect of risk management; hence the focus was primarily on credit risk. Credit risk management for IFIs is further complicated by a number of factors such as contractual complications with Islamic banking products creating additional credit risks; difficulty of foreclosure; and lack of credit assessment models, track record, robust ratings, mitigation techniques, etc.

Furthermore, reputational risk is critically important for Islamic banking, as a growing industry that is built on trust and transparency. Finally, Shari'ah compliance is inherently and systemically significant to Islamic banking. Any divergence from Shari'ah principles exposes the IFI to a wide range of risks at different levels as discussed in previous chapters.

Of note is the political risk. Under Question 8 of the questionnaire, only two respondents added political and country risks as extra risks facing IFIs. However, the lesson from the recent political unrest and revolutions in the Middle East is that political risk – which was previously largely ignored – does matter. Political risks are hard to predict and not recurring. The nature of political risk is that it can strike suddenly and have unpredictable consequences, as has already been witnessed in Tunisia, Egypt, Libya, Syria, Bahrain and Yemen. Political risk has been latent for many years in the Middle East, but has now erupted across most countries in the region. Events just the past few months show that the structural landscape of the region's politics is changing fundamentally. Under these circumstances, long-standing assumptions concerning political risk and its potential economic impact are being challenged. There is no doubt that political change in the Middle East could ultimately be positive as governments that enjoy greater legitimacy tend to be more resilient to economic shocks, which require governments to take tough economic measures. In the short term, however, the process of political change has brought negative economic pressures on the economies of these countries, hence affecting IFIs operating directly or indirectly through the region. On 15 May 2011, Zawya reported that close to USD 1.6 trillion worth of projects were cancelled or on hold in the Middle East and North African (MENA) market, where most IFIs reside and/or operate, because of the recent events.

If the questionnaire was to be redistributed now, after the eruption of the Middle Eastern revolutions, political risk would most likely attract much higher scores given that most Islamic banks are located in, or directly affected by, the Middle East.

Interviewees also indicated that IFIs' unsound risk management architecture is reflected by their concentration risks, poor sector allocation, imprudent liquidity management and imbalanced ALM. In addition, interviews revealed that Shari'ah-non-compliance risk is a significant risk facing IFIs. It is also noticeable that both Islamic and non-Islamic bankers had similar risk perceptions about risk management in Islamic banking. This supports Research Hypothesis 1.

This further confirms the findings from the research conducted by Al-Omar and Abdel-Haq (1996), who identified credit and liquidity risks for Islamic banks as higher than those for conventional banks. Also, Khan and Ahmed (2001) found that IFIs face some risks that are different from those faced by conventional financial institutions. They revealed that some of these risks are considered more serious than the conventional risks. While Moody's (2009c) highlighted that IFIs suffer from liquidity management and stated that “liquidity tends to be a financial crutch for Islamic banks”, the report indicated that the handling of asset–liability mismatches is not a new problem in Islamic banking; it is as old as Islamic banking itself.

Furthermore, breaking down the descriptive statistics among different groups provided significant findings, as summarised in Table 7.6. Three out of the top four risks identified by Islamic bankers are also listed by conventional bankers among the top four risks. In general, risk perceptions among bankers, whether Islamic or non-Islamic, reflected similar patterns. This was emphasised by the frequency distribution and the Kruskall-Wallis (K-W) test of significance in Chapter 8.

Subsequently, further sub-hypotheses were formulated in order to further investigate the impact of various categories of respondents on risk perception. This was done with the objective of exploring if there are trends and correlations among the different control variables.

The sub-hypotheses are as follows:

• H_1-1: There is no statistically significant difference among the respondents in relation to their perception of the various risks facing IFIs according to region.

As can be seen in Table 8.1, at α = 0.05, the null hypothesis is rejected and the alternative hypothesis is accepted, since the tested p-value is lower than the critical p-value for corporate governance risk (p = 0.002), implying that there are statistically significant differences in the risk perception of corporate governance risk among different regions.

The mean rankings for credit, liquidity, corporate governance and concentration risks remain very similar between fully fledged Islamic banks and Islamic subsidiaries, and slightly change when conventional banks are added to the sample; however, the pattern is still obvious. The findings indicate that there is an observed pattern, which can be generalised to most of the risk categories. This can be explained only by market realities. In line with this, Noraini et al. (2009) found no evidence that Islamic bankers in different countries perceived risks differently; that research focused solely on Islamic bankers.

Moreover, the K-W test with ‘Region’ as the control variable for different samples of data in terms of the institutional nature of respondents consistently show that there is a significant difference between regions in risk perception of corporate governance risk. A bank's corporate governance practices can have a material impact on its risk profile, particularly where governance practices are weak.

This was re-emphasised by the K-W test results for Statement 10 in Question 11 of the questionnaire. When asked how strongly they agree or disagree with the statement ‘Corporate governance is generally weak in Islamic banks’, the majority of respondents agreed, and the K-W test had very significant results across various control variables as summarised in Table 8.19.

According to a study by Safieddine (2009), there is a need to give special attention to corporate governance issues in IFIs due to the importance of corporate governance for economic development, the growth of Islamic finance, the critical role of governance in financial institutions, and the unique agency issues faced by these institutions. Most of the Islamic banks surveyed by Safieddine (2009) recognise the importance of incorporating governance mechanisms. Some governance instruments, including the board of directors, Shari'ah Supervisory Boards and internal control departments, appear to have the qualifications and composition that would equip them to mitigate agency issues; however, deficiencies in the actual practices of governance are still observed, leaving agency issues unresolved. The establishment of a governance committee or an audit committee is not common among the banks surveyed, and clear internal audit functions are not properly established. Therefore, the financial reporting process does not appear to be tightly monitored, and this could potentially result in agency problems. Most importantly, investment account holders (IAHs) and other investors still lack access to relevant information, and they continue to lack influence on management decisions, which expands the divergence between their cash flow and monitoring rights.

Khandelwal (2008) also argues that transparency and corporate governance in the Islamic financial services industry should always be developed and adjusted to meet the specific needs of Islamic banks.

As explained in Chapter 3, IFIs do not generally have robust corporate governance frameworks in place. However, in this they are no different from some of their local conventional peers. For instance, family ownership/majority ownership by a core shareholder group is seen in both segments of an Islamic country's banking system. Their prevalence weakens the rights of minority shareholders, could lead to unmerited appointments or promotion of family members, and could give rise to conflicts of interest between shareholders and bondholders. The lack of genuinely independent directors is a shortcoming of emerging markets in general and impairs a board's ability to maintain accountability and provide strategic guidance. As discussed in Chapter 3, the two cases of Ahmad Hamad Algosaibi & Brothers and the Saad Group in Saudi Arabia raised questions about corporate governance in the Middle East as the two conglomerates were, to a certain degree, a family affair.

In fact, weak corporate governance structures are a general feature of Islamic banking. For a number of IFIs, corporate governance systems are opaque, unaccountable and often heavily ‘relationship-based’, as opposed to the predominantly rule-based corporate governance systems of conventional banks in developed markets. Often, Islamic banks' ownership structures are complex and not transparent; in addition, developed corporate governance structures comprising qualified independent board members, effective committee structures, protection of minority shareholder interests, etc., are absent. In many cases, the owners or shareholders hold key management positions and dominate the board of directors, thus making it difficult for the board to manage conflicts of interest between the controlling shareholders' interests and those of the minority shareholders.

Banks in the Middle East in general have traditionally enjoyed a cosy relationship with prominent family-owned businesses. The practice of so-called name lending – extending credit based on the reputation and standing of the company's owners rather than on rigorous examination of its financial health – is prevalent.

According to Zawya, most family businesses in the Middle East are less than 65 years old. Many of them began as trading houses and have now become diversified conglomerates. However, a host of challenges facing many family businesses in the Gulf are worth considering:

1. Succession issues and transferring effective control and knowledge from one generation to the next is a challenge and, as shareholders (family members) become numerous, they impact the efficiency of decision-making.
2. Attracting outside talent and relinquishing control when necessary are always important. Over the years, family groups have grown into multi-billion-dollar conglomerates, sometimes without commensurate skill resources.
3. Family businesses need to shift from being purely operational to thinking in more strategic terms.
4. Separation of management and ownership may be difficult.
5. Diversification into multiple businesses can lead to over-extension beyond the group's core knowledge and competences.

The GCC Board Directors Institute, a Dubai-based non-profit that seeks to improve corporate governance standards, issued a report in 2009 highlighting the need for reform in the six GCC member states – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE). The report Building Better Boards notes that only 55% of GCC companies disclose the main executive positions of board members, compared with 100% in Europe, and only 32% of companies disclose other positions held by board members, compared with 97% in Europe. It urges a reduction in the number of boards on which directors serve; the appointment of strong audit, nomination and remuneration committees; efforts to attract more international directors to the boards of Gulf companies; and the promotion of greater corporate transparency (Townsend, 2009).

Corporate governance risk in the GCC, where most Islamic banks reside, has become publicly exposed. Poor corporate governance imposes heavy costs. The need for additional efforts toward improved corporate transparency is paramount. As long as Gulf companies and banks restricted their activities to largely within the region, there was little pressure to change those opaque practices. But growing links with international markets and financial institutions are generating greater demands for reform. Changing corporate practices, however, would not be easy. Governance reform needs to be addressed against the cultural backdrop in the Gulf, which places great emphasis on reputation and discretion.

The same trend could be established when different K-W tests were conducted with different institutional settings. As discussed in the following hypotheses, it was concluded that three control variables (region, country and nature of financial institution) demonstrate some significant differences about risk perception among respondents, but not for all risks.

Furthermore, although statistically corporate governance risk is the sole significant risk identified by respondents, examining the mean ranking of other risks like concentration, credit and liquidity risks reveals a structural pattern determined by market realities. Also, as depicted by Tables 8.4 to 8.6, the differences between the mean rankings is noticeable among different regions for these risks and when conducting the K-W test for different samples using different institutional settings, which confirms that there is significant difference between regions.

• H_1-2: There is no statistically significant difference among the respondents in relation to their perception of the various risks facing IFIs according to the country in which they operate.

At α = 0.05, the null hypothesis is rejected and the alternative hypothesis is accepted. The K-W test was conducted in a similar manner according to ‘Country’ as control variable; the results confirm those produced by the test conducted according to the ‘Region’.

• H_1-3: There is no statistically significant difference among the respondents in relation to their perception of the various risks facing IFIs according to the respondent's position.

At α = 0.05, the null hypothesis is accepted and the alternative hypothesis is rejected, since the tested p-value is higher than the critical p-value. Therefore, the results suggest that statistically there are no differences in risk perception among respondents according to their position.

• H_1-4: There is no statistically significant difference among the respondents in relation to their perception of the various risks facing IFIs according to accounting standards.

At α = 0.05, the null hypothesis is accepted and the alternative hypothesis is rejected, since the tested p-value is higher than the critical p-value. The results of the K-W test in Table 8.7 show that there are no significant differences among different respondent categories.

• H_1-5: There is no statistically significant difference among the respondents in relation to their perception of the various risks facing IFIs according to nature of the financial institution.

For this hypothesis, the results from the K-W test provided dispersed data. At α = 0.05, liquidity, ALM, Shari'ah-non-compliance, concentration, reputation and displaced commercial risks had significant p-values, while the remaining risks did not. Therefore, the null hypothesis is accepted and the alternative hypothesis is rejected, since the tested p-value is lower than the critical p-value for most risks. Further examination of the mean rankings for risks with significant p-value, as summarised in Table 8.9, confirms the dispersion of data as no trend could be established. In general, fully fledged Islamic banks and conventional banks with Islamic activities have higher mean values than conventional banks alone and ‘Others’, particularly for liquidity, ALM and displaced commercial risks. This trend, nonetheless, slightly changes for concentration and reputation risks. Of note also is the proximity of mean value among fully fledged Islamic banks and Islamic subsidiaries, which reflects the similar perception of risks in Islamic banking. One possible reason for this is the similar knowledge and awareness about Islamic banking products and structures among those professionals with hands-on experience in Islamic banking. This confirms the findings of the descriptive statistics in the section ‘Locating Risk Perception’ in Chapter 7.

Moreover, this coincides with the findings of the qualitative analysis, as on the basis of the interview findings, there is a high degree of correlation between the responses of the two groups. However, differences generally existed between the responses of bankers and non-bankers.

Based on the above hypotheses and the findings from both the quantitative and qualitative analyses, it can be concluded that three control variables (region, country and nature of financial institution) contribute to some significant differences about risk perception among respondents, but not for all risks. In addition, this can also be supported by the fact that there is no significant difference in perception levels between respondents from stand-alone Islamic banks and Islamic subsidiaries. Initially, it was expected that respondents from stand-alone Islamic banks would have stronger perceptions compared to those from Islamic subsidiaries, for two reasons: firstly, stand-alone Islamic banks have been in existence much longer than Islamic subsidiaries, and, secondly, the respondents from stand-alone Islamic banks have the advantage of dealing with only Islamic banking products and services whereas Islamic subsidiaries still need to operate side by side with their respective conventional counterpart in sharing the same operating platforms and buildings. Nevertheless, the results have indicated otherwise. Differences could be spotted between the perceptions of conventional banks and stand-alone Islamic banks, and more noticeably between the perceptions of bankers and non-bankers, the latter being represented by the category ‘Others’. This could be because bankers, whether Islamic or non-Islamic, have hands-on experience and better understanding of the Islamic banking model and its risk architecture than non-bankers, who tend to be more theoretical in their approach.

ISLAMIC FINANCE CONTRACTS

This section aims to provide a discussion through further interpretation of the results on the usage and risk perception of Islamic finance contracts by responding to the hypotheses set in advance.

ADDITIONAL RISK ISSUES FACING ISLAMIC FINANCIAL INSTITUTIONS

This section aims to provide a discussion through further interpretation of the results on additional risk issues facing IFIs by responding to the hypothesis set in advance.

• Hypothesis 4: There is no substantial difference between risk management in Islamic banking and conventional banking.

Descriptive statistics in Chapter 7 indicate that risk management for IFIs is more challenging than it is for conventional banks. Not only do IFIs face some risks that are different from those of their conventional peers, but these risks are also more serious and not well understood. Displaced commercial risk and Shari'ah standardisation are obvious examples of additional challenges facing IFIs. The findings also highlighted that corporate governance is generally weak in Islamic banks, which re-emphasises the findings of sub-hypothesis H_1-1.

In addition, risk management functions in IFIs in many cases lack influence in the bank's decision-making process. They may in some cases appear strong on paper, although the de facto governance behind this is not robust. This could include, for example, a lack of sufficiently senior risk management representation at board level, insufficient powers delegated to risk management, or the presence of strong shareholders or political influences that are able to override or influence decision-making on risk management. Engel (2010) argues that risk managers in IFIs generally lack independence. Rarely can risk managers veto or influence strategy in Islamic banks and they are mostly tasked with managing existing exposures and monitoring disbursed loans, along with other back-office functions.

Furthermore, factor analysis was used in responding to Hypothesis 4. The final outcomes and a detailed discussion of the factor analysis are available in the section ‘Additional Risk Issues Facing IFIs’ in Chapter 7. The factor analysis results suggest that all 11 variables of risk perception are reduced to three components, namely ‘Risk Perception’, ‘Shari'ah Compliance' and finally ‘Rate of Return’.

The findings from the quantitative analysis echo the interview findings which indicate that Islamic banking in its current state can be riskier than conventional banking. There are several risk management areas where improvement can be made to promote and to enhance the functioning of IFIs. Risks in IFIs must be assessed in an integrated manner and risks for IFIs should not be managed using the same techniques as those used in conventional banking.

The following sub-hypotheses were formulated in order to identify whether there are any significant differences across various groups in the respective control variables.

• H_4-1: There are no statistically significant differences among respondents' perceptions about additional risk management issues in Islamic banking according to the nature the of financial institution.

The results in Table 8.18 suggest that the null hypothesis is rejected in favour of the alternative hypothesis, indicating that there are significant differences according to nature of financial institution. In addition, in order to respond to this hypothesis after conducting factor analysis, further analysis was carried out using a one-way between-groups MANOVA test in order to investigate if there is any significant difference between the three component groups identified under factor analysis in relation to same control variables. This helped to locate the impact or significance of each control variable on the established distribution. The results in Table 8.30 signify that 30.1% and 33.6% of the variances in ‘Risk Perception’ and ‘Shari'ah Compliance' scores are explained respectively by nature of financial institution.

• H_4-2: There are no statistically significant differences among respondents' perceptions about additional risk management issues in Islamic banking according to region.

As can be seen in Table 8.19, similar conclusions can be derived from this category analysis, where the statistical results reject the null hypothesis. Similarly, after conducting factor analysis further analysis was carried out using a one-way between-groups MANOVA test in order to investigate if there is any significant difference between the three component groups in relation to the same control variables. This helped to locate the impact or significance of each control variable on the established distribution. The results in Table 8.26 signify 45.9% and 34.4% of the variances in ‘Risk Perception’ and ‘Shari'ah Compliance' scores are explained respectively by the region.

Conducting the MANOVA test according to ‘Region’ and ‘Nature of Financial Institution’ as independent variables provided consistent results. It can be concluded that ‘Risk Perception’ and ‘Shari'ah Compliance' are significant dependent variables and have strong explanatory power, while ‘Rate of Return’ does not follow the pattern.

• H_4-3: There are no statistically significant differences among respondents' perceptions about additional risk management issues in Islamic banking according to the respondent's position.

Similarly for this sub-hypothesis, the results reject the null hypothesis as Table 8.19 depicts. The p-value for Statements 2, 3, 4, 7 and 10 are lower than the critical p-value of 0.05. It can be concluded that the respondent's position plays a statistically significant determining role.

• H_4-4: There are no statistically significant differences among respondents' perceptions about additional risk management issues in Islamic banking according to the nature of activities.

The inferential statistical results in Table 8.19 reject the null hypothesis and accept the alternative hypothesis as the p-value for Statements 2, 4, 7, 8, 10 and 11 are significantly lower than the critical p-value of 0.05.

• H_4-5: There are no statistically significant differences among respondents' perceptions about additional risk management issues in Islamic banking according to the accounting standards used.

Similarly, for the accounting standards control variable, the null hypothesis is rejected in favour of the alternative hypothesis, since the p-value recorded for some statements in the Table 8.19 is lower than the critical p-value limit.

CAPITAL ADEQUACY FOR ISLAMIC BANKS

This section aims to provide a discussion through further interpretation of the results on capital adequacy issues facing IFIs by responding to the hypothesis set in advance.

• Hypothesis 5: Capital requirements levels should be lower in IFIs than in conventional banks.

The frequency distribution in Figure 7.5 shows that 65.3% of respondents believe that IFIs should hold higher capital levels than their conventional peers. Only 8.3% of respondents indicated that IFIs should hold lower capital levels, 18.1% indicated they should hold the same level, while 6.9% indicated they did not know the answer.

In addition, most interviewees believe that IFIs should hold higher capital levels than their conventional counterparts because the Islamic banking business model in its current state carries more risks.

Therefore, the hypothesis stating that capital requirement levels should be lower in IFIs than in conventional banks is rejected by both quantitative and qualitative analyses, which implies that capital requirement levels should be higher in IFIs than in conventional banks.

The responses are against the researcher's expectations, as most literature reviewed suggests that IFIs should have lower capital requirements than their conventional peers. Archer and Abdel Karim (2007), for instance, argue that the risk-sharing characteristic of Profit-Sharing Investment Accounts (PSIAs) in Islamic banking could greatly enhance risk management and mitigation in IFIs provided that proper pricing, reserving and disclosure are maintained. Therefore, IFIs should be subject to lower capital requirements because according to the Islamic Financial Services Board (IFSB) supervisory discretion formula, α represents the extent of total risk assumed by the PSIA, with the remainder absorbed by the shareholders on account of displaced commercial risk. In line with this, Farook (2008) argues that, if IFIs apply the profit and loss sharing (PLS) principle practically, losses will be shared with PSIAs and hence the Islamic bank will be prone to lower risks leading to lower required minimum capital. The IFSB supervisory discretion formula is a step in the right direction, with α representing the extent of total risk assumed by the PSIA, with the remainder absorbed by the shareholders on account of displaced commercial risk. IFIs that implement the risk-sharing technique practically will be keen on proper disclosure in order to enjoy a higher capital relief.

While the researcher agrees with the concepts discussed in the literature review from an academic point of view, the practice remains different (as depicted by the primary research findings). In order to apply the risk-sharing principle practically, the IFSB standards should be made mandatory for Islamic banks to allow for wider implementation, consistency and standardisation of risk management principles across the Islamic financial industry. This requires collaboration between regulators, IFSB, Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), Islamic banks and industry practitioners.

• Hypothesis 6: Basel II was drafted with conventional banking very much in mind. IFIs should follow their own standards, e.g. IFSB principles on capital adequacy.

The frequency distribution in Figure 7.6 shows that the majority of respondents believe that Basel II could be applied to IFIs but with a few amendments. In fact, most IFIs use Basel II capital adequacy standards, with greater use of the basic and standardised approaches rather than the advanced models. This is due to the relative simplicity of their capital requirements. Moreover, 87.5% of respondents believe that Basel II standards should be reviewed after failing to prevent the crisis. As depicted in Figure 7.6, there is an obvious lack of clarity on the applicability of the proposed Basel III standards to Islamic banking, as 65.3% of respondents were ‘neutral’ when asked about the issue, 27.8% either ‘disagree’ or ‘strongly disagree’ that the proposed Basel III rules would be easily applicable to Islamic banks. Around one-third of respondents do not believe that the new standards, with their stricter capital, leverage and liquidity rules, are likely to prevent another financial crisis. The break down between Islamic and non-Islamic bankers reveals the same pattern, as shown in Table 7.15.

Interviewees had varying views about the suitability of Basel II and potentially Basel III to Islamic banking. In general, respondents, particularly bankers and rating agency analysts agree that with a few amendments, Basel II becomes applicable to IFIs in order to ensure a level playing field for all banks. It is interesting to note that despite a general lack of absolute clarity about Basel III and its potential impact on IFIs, most interviewees agreed that Basel III is a fact that is here to stay. There is also a general belief among respondents that although Basel III is more demanding than Basel II with regard to addressing systemic risk, it may not be the last of the Basel series. This is mainly because risk is inherent in the complex global financial markets of increasing sophistication. Basel III cannot work on its own. As the regulators recognise, financial stability is about far more than capital and liquidity ratio. Banks will still fail even if higher ratios are implemented. Regulators need to work on other steps to reduce systemic risk including enhanced transparency, risk-sharing and value creation. All these concepts are rooted in Islamic finance, but unfortunately tend to be neglected.

Therefore, Hypothesis 6 is rejected by both quantitative and qualitative analyses.

Although the result is not as per the expectations of the researcher, it confirms the findings of the research conducted by Noraini et al. (2009), who concluded that Basel II could be applied to Islamic banks but with some adaptations and the IFSB could play an important role in this context. In addition, consideration of the implications of Basel III is at an early stage for most IFIs. While Akkizidis and Khandelwal (2007) argue that Basel II is primarily for conventional banks and thus does not offer great help to IFIs, they believe that although Pillars 1 and 2 of Basel II have limited applicability to Islamic banking, the third Pillar of Basel II on market disclosure is largely applicable to IFIs because social responsibility and transparency are of utmost importance in Islamic finance.

Fitch Ratings (2011) expects Basel III to have little impact on IFIs' capital adequacy, as capital ratios are generally sound and consist largely of core Tier 1 capital. Hybrid capital is negligible in the region. However, new liquidity requirements may be significant, as IFIs have a substantial maturity mismatch: customer deposits are contractually short term (albeit very stable), while IFIs are financing increasingly longer-term assets. This may require some adjustment to their liquidity management.

Subsequently, the following sub-hypotheses were developed to see if there is any significant difference in the perception across different groups of respondents for each control variable.

• H_6-1: There are no statistically significant differences among the respondents' views about capital adequacy for Islamic banks according to region.

At α = 0.05, the null hypothesis is rejected, since the K-W test results for four statements (out of five) recorded a lower significant value than the critical p-value, as depicted in Table 8.31.

• H_6-2: There are no statistically significant differences among the respondents' views about capital adequacy for Islamic banks according to nature of financial institution.

As Table 8.32 shows, at α = 0.05 the null hypothesis is accepted and the alternative hypothesis is rejected for all statements except Statement 5. All statements are statistically insignificant except Statement 5, which shows different views between bankers (whether Islamic or conventional) and non-bankers (p-value = 0.02), which is also evident from the mean ranking. This implies that the nature of financial institution is not a statistically determining factor, and that the opinions of the respondents are rather similar. This coincides with the results of descriptive statistics, in Figure 7.4, as more than 59% of respondents use Basel II standards.

• H_6-3: There are no statistically significant differences among the respondents' views about capital adequacy for Islamic banks according to the nature of activities.

Similarly, for the ‘Nature of Activities’ control variable, the null hypothesis is rejected since the p-value recorded in the testing is lower than the critical p-value limit for three statements, as depicted in Table 8.33.

• H_6-4: There are no statistically significant differences among the respondents' views about capital adequacy for Islamic banks according to respondent's position.

Similar results also can be found for the ‘Respondent's Position’ control variable in Table 8.34. At α = 0.05, the null hypothesis is rejected and this suggests that the alternative hypothesis is accepted since the p-value recorded in the testing is significantly lower than the critical p-value limit for Statement 5 (0.008). Therefore, it can be concluded that, statistically, there is a significant difference in the respondents' perceptions according to their position.

ISLAMIC BANKING AND THE GLOBAL CREDIT CRISIS

This section aims to provide a discussion through further interpretation of the results on the global credit crisis and Islamic banking by responding to the hypothesis set in advance.

• Hypothesis 7: Islamic banking is more resilient to economic shocks than conventional banking but not recession proof.

It is interesting to note that both Islamic and non-Islamic bankers in the questionnaire share the view that Islamic banking is less risky than conventional banking, in theory, due to the naturally inherent conservatism in the Shari'ah principles; however, the theory is a long way from fact in current financial practice. Participants asserted that reform is needed within Islamic banking in order for it to be successful and capable of providing an ethical alternative to the debunked Wall Street banking model. Most respondents also support the view that the recent crisis could have been avoided under a genuine Islamic banking system. Although IFIs were by no means unscathed by the crisis, it had a less severe impact than elsewhere and allowed prominent issues to be brought to the forefront. This supports Hypothesis 7.

Factor analysis was used in responding to Hypothesis 7. The final outcomes and a detailed discussion of the factor analysis are available in the section ‘The Credit Crisis and Islamic Banks’ in Chapter 8. The factor analysis results suggest that all nine variables of perception of the credit crisis and Islamic banking are reduced to two components, namely ‘Resilience of IFIs’ and ‘Risk management must be embedded institutionally’.

Furthermore, most interviewees believe that although IFIs have been more resilient to the ongoing crisis than their conventional counterparts, the shift in the environment did negatively affect some of them. Islamic finance is not an island; it has suffered from the liquidity drought, to the point where a few IFIs have defaulted, but as an industry it now has a track record of resilience (which had not been tested before). While the global crisis gave Islamic banking an opportunity to prove its resilience, it also highlighted the need to address important challenges.

Therefore, Hypothesis 7 is supported by both quantitative and qualitative analyses.

The results further confirm the findings revealed by Moody's (2011a) that while the Islamic financial industry seems to have been resilient to the crisis relative to its conventional counterpart, it is far from being a risk-free segment. The most affected line of business within the industry was undoubtedly investment banking. And yet, until 2007, Shari'ah-compliant investment banks were portrayed by market participants as having significant potential, benefiting from cheap funding, high liquidity, exceptional profits and robust capitalisation. At the time, the combination of these four factors led them to pursue investments in riskier markets and asset classes such as private equity, infrastructure or real estate, mostly in emerging markets ranging from the Maghreb to Southeast Asia.

When the financial crisis erupted in mid-2007, the Islamic finance industry remained relatively healthy and insulated, and recorded robust performance. Some commentators wrongly labelled Islamic finance as a ‘risk-free’ sector. However, the significant defaults of The Investment Dar (TID) and Gulf Finance House (GFH) since early 2009 and the growing difficulties of the rest of the Islamic investment banking community make this assessment dubious, as the structural weaknesses of the Islamic financial industry started to become more obvious. The crisis was a unique opportunity for the industry to prove that it had the capacity and ability to react to and absorb shocks, but not for all its sub-segments. While the commercial banking sector seems to have emerged from the crisis relatively unscathed, the investment banking sector could not have been more different, as it suffered a very sudden and sharp dip in performance as losses mounted (Moody's, 2011a). One of the interviewees for this research, Engel (2010), adds that the structural feature of IFIs' ALM – which was once a benefit when ample liquidity was chasing too few assets – started to turn negative when sudden massive liquidity withdrawals were backed by almost nothing but a high level of impaired assets. In addition, the crisis revealed that IFIs also had heavy concentrations across the board, by name, sector, geography and business line.

In fact, until 2007, IFIs benefited from a very favourable economic and liquidity environment, especially due to the boom in the real estate and infrastructure sectors, and supported by massive government spending within these sectors. Meanwhile, an increasing number of regional investors were attracted by the high yields that IFIs were offering through their recycling of a growing amount of oil wealth into investments that fell outside the remit of their plain-vanilla banking activities. The perception of sound capitalisation was largely artificial in the sense that it underestimated the profound impact of sector-wide concentration risks and inadequate liquidity management. Above all, IFIs registered impressive performance for one main reason: available and cheap liquidity, explains Thun (2010), one of the interviewees for this research. This element was at the heart of the business model, consisting of borrowing short to invest long on behalf of their investment constituencies, while keeping on the balance sheet a portion of the IFI's illiquid investment portfolio that was incommensurate with their liquidity and capital profile.

The interviews also indicated that by the beginning of 2009, operating revenues started to shrink for IFIs, reflecting their struggle to book new transactions (negative volume effect) and declining asset valuations (negative price effect). At the same time, their fixed charges remained stable, while funding costs and expenses escalated. This P&L scissors effect worsened in the second half of 2009, leaving the IFIs with very limited room for manoeuvre. This highlights the very weak diversification of their revenue base, their dependence on a very uncertain transaction flow rather than on an existing stock of cash-flow-generating assets, and the cyclical cost of their funding profiles. Only a few IFIs managed to mitigate this issue.

Above all, the crisis revealed weak risk management architectures among most IFIs. It had the constructive effect of focusing the minds of Islamic practitioners on their core business strategies and operating models, highlighting corporate governance and asset and liability management specifically. According to Moody's (2011a), TID, for instance, (which defaulted in May 2009) did not disclose proper risk management information. Furthermore, in 2007, most IFIs only applied Basel I, which did not make it mandatory for them to adhere to Basel II's Pillar 3 disclosure requirements. Only in the 2008 financial reporting data (released during Q1 2009, i.e. quite late in the cycle given the extreme circumstances at the time) did IFIs start to adopt more transparent approaches to risk management, Basel II guidelines and requirements. Even then, not all the information was clearly and consistently released by the IFIs. However, since 2009, disclosure practices have been improving significantly (Moody's, 2011a).

Traditionally, IFIs have not been heavily leveraged. The primary reasons for conservative financial leverage maintenance are: (i) IFIs have limited incentives to grow debt-like liabilities because their assets tend to be highly profitable; (ii) they needed to set aside extra capital buffers to prepare for expansion; (iii) funding is usually cheap, thanks to easy access to non-remunerated qardh hasan current account deposits; and (iv) the necessity to set aside capital charges for specific risks like displaced commercial risk (DCR), reputation risks and concentration risks as per Basel II's Pillar 2 (Moody's, 2009c). These capital and liquidity buffers, previously criticised by opponents of Islamic finance as a burden on profitability, have perhaps been one of the most important strengths of the IFIs amid the crisis because they provide a financial institution with surplus cash to use as a shock absorber. Under the recent difficult economic conditions, most IFIs have been able to seek out opportunities by using their surplus liquidity to aggressively boost deposit volumes and thus to increase their market shares by growing lending volumes, while maintaining their focus on the retail and corporate sectors. This is a strategy employed by GCC banks to de-couple their retail lending business from global markets by focusing on extending credit locally. According to another interviewee, Damak (2010), with very few exceptions (especially in Dubai), funding has been less of a constraint for IFIs because of the market's perception that these players will be more resilient than their conventional peers to the global credit turmoil.

Hasan and Dridi (2010) argue that IFIs have avoided the subprime exposure, but note that they are subject to the ‘second round effect’ of the global crisis. They explain that, because the global financial crisis originated from subprime mortgage portfolios which were spun off into securitised instruments subsequently offered as investments, IFIs were not affected because Islamic finance is based on a close link between financial and productive flows. However, the protracted duration of the crisis affected IFIs as well, not because these institutions have a direct exposure to derivative instruments, but simply because Islamic banking contracts are based on asset-backed transactions. With the global economic downturn, property markets have seen a decline in a number of countries where IFIs have a significant presence. This carries negative implications for these banks as a large number of contracts are backed by real estate and property as collateral. Hasan and Dridi assert that the crisis highlighted a number of sector-specific challenges that need to be addressed in order for IFIs to continue growing at a sustainable pace. Specifically, the key challenges faced by the Islamic banking industry include (i) the infrastructure and tools for liquidity risk management, which remain underdeveloped in many jurisdictions; (ii) a legal framework, which is incomplete or untested; (iii) the lack of harmonised contracts; and (iv) insufficient expertise (at the supervisory and industry levels) relative to the industry's growth.

In addition, the lack of harmonised accounting and regulatory standards was a key challenge for regulators and market participants during the crisis. This is even more acute for IFIs given the lack of standard financial contracts and products across the various institutions within the same country, as well as across jurisdictions. Local accounting standards used in the Islamic banking sector often consist of a mixture of International Financial Reporting Standards (IFRS), International Accounting Standards (IAS), AAOIFI and other specific standards, complicating the operations of Islamic banking. While full harmonisation might not be possible given the nature of the industry, mutual recognition of financial standards and products across jurisdictions would help limit this problem. It would also reduce transaction costs, help implement efficient regulatory oversight, enhance the process of compliance, and contribute to confidence and industry growth (Hasan and Dridi, 2010). Moreover, Ahmed (2009) identifies the issues and problems behind the crisis at three levels: regulatory level, organisational level and product level. “There is a real role for regulators on the national level to make regulations a fair playing field for Islamic banks” adds Asaria (2011).

In summary, Islamic banks, working within the business cycle of their respective countries, have suffered from the crisis, to the point where a few of the sector's banks have defaulted, but as an industry it now has a track record of resilience (which had not been tested before). Islamic banking is expected to emerge stronger from the crisis, provided some conditions are met: more innovation, enhanced transparency, more robust risk management architecture and culture, and above all, enhanced Shari'ah compliance. In theory, Islamic financial principles contribute to the stability of the financial system. Islamic modes of finance, particularly the profit-sharing principle, provide a loss absorption feature to financial institutions. However, the practice is very different from the theory. All of these deviations between theory and practice mean that the system is not functioning at its full potential and has adapted itself to limited functionality. Even if Islamic finance had been prevailing, in its current state, the crisis could have happened, but at a less severe level. Islamic finance has not yet provided a more principled mode of finance than the debunked Wall Street model because the embedded ethical foundations have not been explored yet (Asutay, 2009b).

Paradoxically, Islamic banks' reputation has generally benefited from the recent crisis. From a conceptual perspective, Islamic banks will probably be the big winners when the crisis ends. As a sub-set of ethical finance, Islamic banking is now considered not so much niche business standing at the margins, but rather as representative of a credible, viable and sustainable alternative business model for sound, ethical and socially responsible banking. Many now believe that mainstream finance has moved too far into excess leverage, meaningless innovation and value-destroying investments. The credit crunch has shaken confidence in the existing Western regulations and created the need for a better, more transparent system; this has opened the door for Islamic bankers to take up the opportunity. Indeed at the 5th World Islamic Economic Forum (WIFE) in Jakarta on 2 March 2009, Muslim leaders including Indonesian President Susilo Bambang Yudhoyono and Malaysian Prime Minister Abdullah Badawi called on the Muslim world to leverage the global financial crisis by turning “adversity into opportunity” (Parker, 2009).

According to the proceedings of the Securities Commission Malaysia (SC) and the Oxford Centre for Islamic Studies (OCIS) Roundtable and Forum (2010), after the recent financial crisis Islamic banks seem to be emerging stronger than conventional banks. According to Ken Eglinton, Director of Banking and Capital Markets at Ernest & Young, who was interviewed for this research, Ernest & Young did a comparison between the top conventional banks and the top Islamic banks. It showed that the aggregate net profits of the commercial banks dropped by USD 42 billion in 2008 from USD 116 billion in 2006. In contrast, the net profits of Islamic banks increased by 9% during the same period.

The following sub-hypotheses were developed to see if there is any significant difference in the level of perception across the different categories of respondents.

• H_7-1: There are no statistically significant differences among the respondents' perceptions about the credit crisis and Islamic banking according to region.

At α = 0.05, the null hypothesis is rejected and the alternative hypothesis is accepted, since seven out of nine statements had significant p-values. Therefore, it is concluded that there are statistically different opinions among the respondents coming from different regions.

In addition, in order to respond to this sub-hypothesis, after conducting factor analysis, further analysis was carried out using a one-way between-groups MANOVA test in order to investigate if there is any significant difference between the two component groups identified under factor analysis in relation to region as the control variable. This helped to locate the impact or significance of each control variable on the established distribution. The results signify that 32% of the variances in ‘Resilience of IFIs’ scores are explained by region.

• H_7-2: There are no statistically significant differences among the respondents' perceptions about the credit crisis and Islamic banking according to the nature of the financial institution.

At α = 0.05, the null hypothesis is accepted and the alternative hypothesis is rejected for all statements except Statement 3, which shows that, statistically, the nature of financial institution does not play a significant role in the difference in perceptions among respondents. This is consistent with the descriptive statistics, which show that most respondents share similar views regardless of the nature of financial institution.

Statement 3: ‘Islamic finance could have solved the global crisis’ produced differences among different categories of respondents. Mean rankings for Statement 3, as depicted by Table 8.36, show that fully fledged Islamic banks are far more aggressive in their belief that Islamic finance could have solved the global crisis than other categories (46.2), followed by Islamic subsidiaries (40.25), then by ‘Others’ and ‘Conventional Banks’.

An attempt was also made to see the effect of ‘Nature of financial institution’ on the components identified in factor analysis through MANOVA. However, no significant results could be established.

• H_7-3: There are no statistically significant differences among the respondents' perceptions about the credit crisis and Islamic banking according to the nature of activities.

As Table 8.37 depicts, at α = 0.05 the K-W test results suggest that the null hypothesis is rejected and the alternative hypothesis is accepted. Therefore, it can be concluded that, statistically, there are significant differences in the level of perception according to the institution's ‘Nature of Activities’.

• H_7-4: There are no statistically significant differences among the respondents' perceptions about the credit crisis and Islamic banking according to accounting standards.

Similarly, for the accounting standards control variable, the null hypothesis is rejected in favour of the alternative hypothesis, since the p-value recorded in the testing is lower than the critical p-value limit as shown in Table 8.38. Therefore, it can be concluded that, statistically, there is a significant difference in the level of perception according to the accounting standards utilised by the institution.

• H_7-5: There are no statistically significant differences among the respondents' perceptions about the credit crisis and Islamic banking according to the respondent's position.

At α = 0.05, the null hypothesis is accepted, suggesting that the alternative hypothesis is rejected since the p-value recorded in the testing is lower than the critical p-value limit. Thus, it can be concluded that, statistically, there are no significant differences according to respondent's position.

The findings from the above sub-hypotheses tests echo the findings from the descriptive statistics and from the qualitative interview analysis. However, the inferential statistical analysis provides a higher level of understanding and knowledge concerning the subject matter. Combining the results of the above five sub-hypotheses tests provides an aggregate trend that can be attributed to prevailing market conditions: retail fully fledged Islamic banks and Islamic subsidiaries, located mainly in the ‘GCC’ and ‘Other’, are more aggressive in their perceptions of the credit crisis and Islamic finance than other categories. These banks tend to use AAOIFI accounting standards or IAS and AAOIFI standards together. This trend could not be established by studying one control variable in isolation; the five control variables had to be examined together in order to see the bigger picture. This pattern is consistent with the findings of Table 7.16, which breaks down the descriptive statistics among Islamic bankers and non-Islamic bankers.

RISK MANAGEMENT AND REPORTING

This section aims to provide a discussion through further interpretation of the results on risk management and reporting issues facing IFIs by responding to the hypothesis set in advance.

• Hypothesis 8: Not many Islamic banks use the more technically advanced risk measurement and reporting techniques.

Findings from quantitative analyses indicate that although IFIs are doing comparatively well in terms of their general risk management and reporting, they are still perceived to use less advanced risk management approaches. Frequency distribution in Table 7.16 shows that IFIs usually use the same risk management techniques as conventional banks for managing risks, in particular liquidity, credit and market risks. Nevertheless, the spread and frequency of utilising these techniques is lower among Islamic banks than among their conventional peers. The most widely used daily report among IFIs is the liquidity risk report, followed by the credit exposure report and the profit rate risk report. Commodity risk and equity mark-to-market reports are the least used by IFIs in this survey. Improving risk management and reporting practices represent a serious challenge to Islamic banking in order to lift itself to the next level. Interviewees also perceived IFIs to use less advanced risk management approaches. Risk management frameworks are not yet fully developed in IFIs. There is still lack of well-functioning system of controls and internal checks and balances. The findings support Hypothesis 8.

Some interviewees indicated that currently there are weaknesses and a serious lack of a robust risk culture among IFIs. However, the financial crisis has raised the profile of risk management within Islamic banks. In the current environment the painful cost of inadequate risk management is being demonstrated every day. Banks seeking to navigate the recession must put a premium on effective risk management. Also, due to limited resources, IFIs are often unable to afford high-cost management information systems or the technology to assess and monitor risk in a timely fashion. Efforts should be made to collaborate among IFIs to develop Islamic risk management systems that are customised to the industry needs. The changes required to institutionalise a strong risk culture are fundamental and far-reaching: risk must become ‘everyone's business’ throughout the organisation. Responsibility and accountability for risk should be intertwined among all stakeholders, from board members to business unit heads and their teams, who must be more actively committed to identifying and mitigating risks. There is a need to introduce a risk management culture among Islamic banks.

These findings contradict those by Shaikh and Jalbani (2009), whose paper optimistically concluded that the equity-based business of Islamic banks posing slightly more risk than conventional banks is well mitigated by Islamic banks through their effective and adequate distinct risk management procedures. The researcher does not agree with the research methodology and the findings of this study by Shaikh and Jalbani. Rosman and Abdul Rahman (2010) surveyed the risk management practices of 28 Islamic banks from 16 different countries. Their findings indicate that Islamic banks are doing comparatively well in terms of their general risk management and operational risk management. In terms of risk reporting, the study found that the majority of Islamic banks produced various types of risk reports and there is a significant improvement in their risk reporting over the last few years. The majority of Islamic banks they surveyed produced all the risk reports except for commodities and equities positions risk reports, and country risk reports. On the other hand, Ahmed and Khan (2007) argue that there is a need to introduce a better risk management culture in Islamic banks. Wilson (2002) also argues that IFIs can learn from conventional banks in the fields of technology and developing infrastructure, as much as conventional banks need to learn from IFIs about staff and client motivation and relationships.

The following sub-hypothesis was developed to see if there is any significant difference in the level of use of risk reporting across different regions.

• H_8-1: There are no statistically significant differences among respondents in the frequency of producing risk management reports according to region.

The results from the K-W test reject the null hypothesis and accept the alternative hypothesis, since there is a significant difference among various regions in the frequency of producing risk reports (p-value < 0.05) except for commodity risk report (0.094), industry concentration risk report (0.129), credit exposure report (0.091) and large exposure report (0.071). Hence, for the rest of the reports there are significant differences in the perceptions of the participants. Thus, for most of the reports ‘Region’ is a significant factor. Repeating the K-W test with ‘Region’ as the control variable for various institutional samples provided an obvious trend: conventional banks, concentrated in Europe and the Americas, produce risk reports more frequently than Islamic banks. In addition, the results reflect the risk management culture difference between Islamic and conventional banks.

RISK MEASUREMENT

This section aims to provide a discussion through further interpretation of the results on risk measurement in IFIs by responding to the hypothesis set in advance.

• Hypothesis 9: The use of risk measurement techniques is less advanced among Islamic banks than among their conventional peers.

In addition to risk management reports, financial institutions use various techniques to measure and analyse risks. Similar to Hypothesis 8, Hypothesis 9 is supported by both quantitative and qualitative analyses. Frequency distribution in Table 7.17 shows that the most common technique used by IFIs as indicated by respondents is maturity matching analysis (22 respondents), followed by reliance on external ratings provided by rating agencies (21 responses), internal-based rating and Gap analysis (19 responses each). Only 14 respondents indicated they use Value at Risk (VaR) models, while simulation techniques are used by just six IFIs in the sample. Interviewees also emphasised the fact that risk measurement techniques in Islamic banking are not as sophisticated as in the conventional banking world.

In line with this, Noraini et al. (2009) also found that more technically advanced risk measurement approaches are perceived not to be widely used by Islamic banks, except for the Internal-Based Rating System and Estimates of Worst Case. The study concluded that most IFIs did not use sophisticated risk measurement approaches as the IFIs are still new and do not have sufficient resources and systems to use the more technically advanced techniques. Supporting this argument is the study by Rosman and Abdul Rahman (2010), who concluded that IFIs are using less technically advanced risk measurement approaches.

Khan and Ahmed (2001), on the other hand, found that the overall risk management processes in IFIs to be satisfactory. They apprehended, however, that this may be because the banks that have relatively better risk management systems responded to the questionnaires. The results for risk management process showed that while Islamic banks have established a relatively good risk management environment, the measuring, mitigating and monitoring processes and internal controls need to be further upgraded. Khan and Ahmed's study also identified the problems that IFIs face in managing risks. These include lack of instruments (like short-term financial assets and derivatives) and money markets. At the regulatory level, the financial institutions apprehend that the legal system and regulatory framework is not supportive to them. Results from a survey of 17 Islamic institutions from 10 different countries revealed that while Islamic banks have established a relatively good risk management environment, the measuring, mitigating and monitoring processes and internal controls need to be further upgraded. The results indicated that the growth of the Islamic financial industry will, to a large extent, depend on how bankers, regulators and Shari'ah scholars understand the inherent risks arising in these institutions and create appropriate policies to cater to these needs.

Subsequently, the following sub-hypotheses were tested to identify whether there is any statistically significant difference in the frequency of producing risk measurement reports across various groups of respondents based on the selected control variables.

• H_9-1: There are no statistically significant differences among respondents in the use of risk measurement techniques according to region.
• H_9-2: There are no statistically significant differences among respondents in the use of risk measurement techniques according to the respondent's position.
• H_9-3: There are no statistically significant differences among respondents in the use of risk measurement techniques according to the nature of the financial institution.
• H_9-4: There are no statistically significant differences among respondents in the use of risk measurement techniques according to the nature of activities.
• H_9-5: There are no statistically significant differences among respondents in the use of risk measurement techniques according to accounting standards.

As Table 8.56 depicts, at α = 0.05 the five sub-hypotheses are declined. This means that statistically all the selected control variables play a role in the difference in utilising risk measurement tools. However, ‘Region’ and ‘Nature of Financial Institution’ are the control variables with the most significant results and hence these two variables are most essential to the difference in risk management techniques among banks. Mean rankings show that conventional banks in relation to their regional location, concentrated outside of the GCC and Middle East, use more advanced risk management techniques than Islamic banks. The region ‘Americas’ is the most advanced across all techniques, followed often by ‘Other’ or ‘Europe’. The rest of the regional samples include mostly Islamic banks; their use of sophisticated risk measurements, however, is not as significant as in conventional banks in the Americas and Europe.

RISK MITIGATION

This section aims to provide a discussion through further interpretation of the results on risk mitigation issues facing IFIs by responding to the hypothesis set in advance.

• Hypothesis 10: Islamic banks use a number of risk mitigation tools that are intended to be Shari'ah-compliant and that are less advanced than those utilised by conventional banks.

Both the descriptive statistics and the qualitative interview analysis clearly reflect that risk mitigation techniques in Islamic banking are less advanced than those in conventional banking. This supports Hypothesis 10.

Risk mitigation is currently one of the most contentious issues in Islamic banking. The unique nature of risks faced by Islamic banks, combined with the restrictions added by Shari'ah, makes risk mitigation for Islamic banks a difficult and complex process. There are risks that Islamic banks, like their conventional counterparts, can manage and control through appropriate risk policies and controls that do not conflict with the Shari'ah principles. However, there are other risks that banks cannot eliminate and that can be reduced only by transferring to or selling those risks in well-defined markets. These risks can generate unexpected losses that need capital insulation, and hedging can help to restrict the impact of unexpected loss. Traditionally in the conventional world risk-transfer techniques include the use of derivatives for hedging, selling or buying of financial claims, and changing borrowing terms. The challenge is, however, that most of the conventional hedging tools so far do not comply with the Shari'ah requirements. This causes IFIs to be faced with an additional array of risks particularly market and credit risks. As explained in Chapter 3, there have been substantial efforts in developing Sharia'ah-compliant hedging instruments; however, much of this progress remains localised with limited scope for cross-border application and further work is still needed.

Until recently, it had been the opinion of most Shari'ah scholars that hedging would fall into the category of speculation and uncertainty. In the last few years, however, the increasing sophistication in Islamic banking products has led some scholars to take the view that Islamic banks may be able to enter into hedging arrangements provided that the hedging tool is in itself structured in a Shari'ah-compliant manner. According to Khan (2010), “there is growing demand for hedging and Shari'ah-compliant derivatives, which would be used merely for hedging and not speculation”. Khandelwal (2008) also asserts that there has been substantial development in finding ways to apply derivatives in Islamic finance to reduce certain risks such as currency and commodity risks. For example, some Shari'ah-compliant hedging instruments, such as profit rate swaps, have been introduced in Malaysia. However, much of this progress remains localised with limited scope for cross-border application and further work is still needed. The empirical study conducted by Rosman and Abdul Rahman (2010) found that IFIs are still lacking in the application of unique Shari'ah-compliant risk mitigation techniques, while Ahmed and Khan (2007) believe that the potential of futures, currency forwards, options and embedded options in risk management in Islamic finance is tremendous.

One of the interviewees, Chowdhury (2010), argues that derivatives are sophisticated instruments that can, if employed with care, enhance efficiency in IFIs through risk mitigation, thereby making them more competitive as well as appealing to customers. However, their application in Islamic finance is surrounded by religious dogma and is highly controversial for reasons of speculation and uncertainty, two practices banned under Shari'ah. There are varying scholarly opinions in the world of fiqh and, due to this judicial fragmentation, the final verdict on the legitimacy of derivatives varies between a total ban in some countries and actual implementation (although on a limited scale) in others (Chowdhury, 2010).

Another interviewee, Engel (2010), adds that the recent financial crisis, in the opinion of many, including Shari'ah scholars, is blamed on the ‘speculative’ use of complex derivative instruments. The economic meltdown was in fact due to a combination of several factors, primarily a lack of proper risk monitoring and quantification mechanisms. The bubble in the derivatives industry was attributed to a copycat phenomenon, whereby banks took on more risk than they could possibly cope with, exceeding their liabilities many times over and building inverted pyramid structures on their balance sheets. The consequential seizure in the market has forced financial institutions to drastically scale back their proprietary risk-taking and to revamp models, which adds to the reluctance of Shari'ah scholars to permit the use of derivatives. Thun (2010) agrees that despite their pivotal function, the use of derivatives in emerging countries in general, and in the Islamic banking sector in particular, has been limited, in part due to the absence of legal provisions, insufficient technical frameworks, underdeveloped capital markets, and/or inadequate accounting, regulatory and disclosure standards. Therefore, the use of derivatives in Islamic banking requires an understanding of the distinction between hedging and speculating.

As risk management and corporate governance in IFIs are already below par relative to the rest of industry, the use of securitisation and derivatives offers considerable scope for reducing IFIs' risk exposures and thus improving their overall risk profile (Smith, 2010).

Recently, highly skilled financial engineers in global conventional banks owning Islamic windows, more advanced Islamic banks, economists and a few Shari'ah scholars have combined efforts to develop Islamic derivative products. For this, jurists have increasingly been working on khiar, arbun and wa'ad concepts to turn them into contracts, as explained in Chapter 3. Although wa'ad is still criticised from a conceptual perspective, in practice this instrument has become a contractual promise, as it offers great flexibility, explains Thun (2010). For instance, it allows for an FX forward profile to be emulated. The writer makes a unilateral promise to buy or sell a particular amount of currency against another currency on a predetermined date and at a predetermined rate. If the promise is contractually agreed not to be binding, then the buyer chooses whether to enforce the wa'ad or not in exchange for a non-refundable fee, which ends up becoming equivalent to a put or call option (Thun, 2010).

Far from having a complete derivative supply, the trend in the Islamic financial industry is therefore to develop explicit Islamic derivative products. Through Shari'ah-compliant engineering, currency forwards, call options on sukuk, securities or commodities, profit rate swaps, cross-currency rate swaps, forward rate swaps and even total return swaps can be copied, at least conceptually, adds Lowe (2010), one of the interviewees for this research. On the other hand, as previously discussed, if IFIs continue to mimic conventional banking products, they will weaken the uniqueness of their value proposition and the powerful nature of their natural factors of differentiation.

Risk mitigation techniques are inherently complex by nature and require a well-thought-out regulatory framework for their management and application. For instance, in order to promote and legalise the use of derivatives, large Islamic banks in Malaysia are stepping forward in collaboration with the Malaysian Financial Market Association to establish standards in Shari'ah-compliant derivatives to enhance liquidity and improve balance sheet management (Moody's, 2011a). This is in addition to the progress made by supervisory bodies like IFSB, IIFM, AAOIFI and others.

It is interesting to investigate the findings further to determine whether there is any statistically significant difference in the use of mitigation techniques according to various control variables. Therefore, the following sub-hypotheses were formulated.

• H_10-1: There are no statistically significant differences among respondents in the use of risk mitigation techniques according to region.
• H_10-2: There are no statistically significant differences among respondents in the use of risk mitigation techniques according to the respondent's position.
• H_10-3: There are no statistically significant differences among respondents in the use of risk mitigation techniques according to the nature of the financial institution.
• H_10-4: There are no statistically significant differences among respondents in the use of risk mitigation techniques according to the nature of activities.
• H_10-5: There are no statistically significant differences among respondents in the use of risk mitigation techniques according to accounting standards.

Table 8.59 shows that at α = 0.05 the five sub-hypotheses are rejected in favour of the alternative hypothesis. This means that statistically all the selected control variables play a role in the difference in utilising risk mitigation techniques among financial institutions. However, ‘Nature of Financial Institution’ is the control variable with the most significant p-value (0.00). Mean ranking in Table 8.60 shows that with the exception of Islamic swaps and Islamic currency forwards, fully fledged Islamic banks fell behind Islamic subsidiaries in using all other risk mitigation techniques. The latter group tends to benefit from the already developed risk mitigation platforms at their conventional parents. However, of notice is that the difference in the value of mean ranking between the two groups is small, which reflects that IFIs are progressing in the use of risk mitigation, but that still the use of risk mitigation techniques in IFIs is not as developed as in conventional banking.

ISLAMIC BANKING IN PRACTICE

This section aims to provide a discussion through further interpretation of the results on practical issues in Islamic banking by responding to the hypothesis set in advance.

• Hypothesis 11: Most IFIs abandoned conservative risk management Shari'ah principles in favour of copying conventional structures.

Descriptive statistics support Hypothesis 11 as most respondents believe that IFIs should stop simply mimicking conventional finance, as the trend seemed to be toward trying to duplicate what conventional banks did. Everyone assumed there was a single model of banking and they were copying the Wall Street model – a model that had more or less collapsed. Before the recent financial meltdown, the Islamic banking industry came under the criticism that it had not been able to match all the existing conventional products with Islamic equivalents. In hindsight, if IFIs continued on the same track as their conventional peers, they would have been prone to the same risks. Hence Islamic banks have been largely spared the subprime crisis.

Likewise, interviewees are of the view that IFIs will not achieve their objectives by simply mimicking conventional products. While the ideals of Islamic finance offer some compelling ideas, the reality is that much of Islamic finance today is focused on replicating the conventional system. This provides support for Hypothesis 11. Chowdhury (2010) argues that this reminds us that IFIs will not achieve their objectives by simply mimicking conventional products. If scholars had allowed simple mimicking without checks, IFIs would have been as exposed to subprime as the conventional banks are.

In theory, the Islamic financial system is definitely more resilient to economic shocks than the debunked Wall Street model, but unfortunately theory is a long way from fact in current financial practice. Practitioners of Islamic finance to date have been mimicking conventional products. This mimicking has resulted in a close correlation between the two systems. “People all over the world have been paying attention to Islamic finance, not necessarily because it would have solutions to all these problems; but because it is institutionalised and has embraced conservative principles” (Warde, 2009). Certainly, Islamic banks have partially ignored this conservatism by simply mimicking conventional banks, but still the fundamental principles of Islamic finance have saved Islamic banks from many of the conventional financial woes.

The crisis created a golden opportunity for Islamic finance to present itself to the world as a better, more sustainable financial system. Dr Mohammed Mahmoud Awan, a leading scholar and Dean at the Malaysia-based International Centre for Education in Islamic Finance (INCEIF), thinks that the recent global crisis has opened many windows of opportunity for Islamic finance as it has the capacity and capability to bring stability to the market (Awan, 2008). However, the defaults of sukuk in the Middle Eastern market, and the frauds that occurred in several IFIs, have downplayed this notion. According to the proceedings of the SC–OCIS Roundtable and Forum (2010), there were failures of credit risk assessment and over-concentration of risks in real estate assets; there was lack of transparency; there were family-owned businesses that were perceived to have government support (in some of the sukuk); in some areas, there was even inadequate regulation; and in a recent case there was also inappropriate use of a legal defence. The industry needs to work together to remove the negative perceptions that are seen to somewhat impact it. So, it is important to subscribe to the values of Shari'ah, to build robust risk management systems and IT systems, and to have greater transparency and greater practice of Shari'ah governance.

The following sub-hypotheses were formulated in order to identify whether there are any significant differences across various selected groups in relation to the respective control variables.

The results of the hypotheses testing can be seen in Tables 8.61 and 8.62.

• H_11-1: There are no statistically significant differences among respondents' perceptions about the current practices in Islamic banking according to the nature of the financial institution.

The results suggest that the null hypothesis is rejected, which implies that ‘Nature of Financial Institution’ is a statistically significant determining factor. Mean rankings revealed that Islamic bankers are more critical of the current practices in the industry than their conventional peers. This could be explained by the fact that Islamic bankers are more educated about the underlying principles of Islamic finance and have a better understanding of current structures than conventional bankers.

• H_11-2: There are no statistically significant differences among respondents' perceptions about the current practices in Islamic banking according to region.

The results suggest that the null hypothesis is rejected and the alternative hypothesis is accepted. There are significant ‘regional’ differences among respondents' views.

• H_11-3: There are no statistically significant differences among respondents' perceptions about the current practices in Islamic banking according to the respondent's position.

For this sub-hypothesis, the test results were unable to reject the null hypothesis, meaning that the impact of respondent's position causes no significant difference.

THE FUTURE OF ISLAMIC BANKING

This section aims to provide a discussion through further interpretation of the results on the future of Islamic banking by responding to the hypothesis set in advance.

• Hypothesis 12: Islamic banking has great potential to become a strong alternative financing system provided that it goes back to its roots.

Evidence from the questionnaire data analysis indicates that Hypothesis 12 is supported. Most respondents reckon that Islamic banking has benign potential provided that it goes back to its roots. Both Islamic and non-Islamic bankers (including Islamic subsidiaries, conventional banks and others) also consider improved risk management and mitigation practices among the top priorities IFIs should focus on in their development plans. The future of Islamic banking will highly depend on risk architecture and how the industry will develop instruments that enhance liquidity; improve ALM and risk management; and develop Islamically acceptable risk-hedging tools. This questionnaire identified the inadequacy of risk management practices by IFIs that may threaten their sustainability especially during financial crises. Adequate resources need to be devoted to risk identification and measurement, as well as risk management techniques, so as to be able to develop innovative risk mitigation and hedging instruments suitable to IFIs.

Interview findings similarly provide strong support to Hypothesis 12, as interviewees almost unanimously agree that there is now an opportunity for Islamic banking to thrive as it has the potential to contribute to a more stable economy. “We have all learnt a lot over the past few years about how to allow the Islamic finance market to mature. There's now an opportunity for Islamic finance to thrive”, says Chowdhury (2010), one of the interviewees. Many interviewees, particularly consultants, researchers and Shari'ah scholars, revealed that in its current form Islamic banking has little to offer in terms of long-lasting solutions. The solution ultimately has to be a moral not a material one. Islamic banking needs to aim for a truly alternative vision based on the ethical and moral safeguards within authentic Islamic concepts, together with improving risk management and mitigation techniques, enhancing liquidity management and reducing concentrations.

The recommendations for the future of Islamic banking provided by both survey respondents and interviewees were numerous; however, this section focuses on the most important ones highlighted by most respondents and those that scored high mean rankings.

The continuing rapid growth of demand for Islamic financial services is clearly good news for Islamic banks. At the same time, it also presents some challenges, as the banks need to invest in upgrading their risk management capabilities in line with the more complex and larger projects into which they are entering. Given the unparalleled market conditions, the risk management process is going through fundamental and significant changes. Islamic banks need to ensure they are prepared for the constantly changing environment, and they also need to get involved in those changes to have their say.

While the Islamic banking model limited the chances of surviving the crisis unscathed, there is still strong growth potential for the industry. “After enduring the recent financial shocks, some IFIs are now conducting internal reviews and looking more deeply into ways to improve and diversify their business model”, explains Engel (2010). For instance, efforts are being made to better organise professional off balance sheet asset-management activities targeting high-net-worth individuals and institutional investors who require Shari'ah-compliant placements, across a wider range of asset classes. Unicorn Investment Bank, for instance, typically focuses on general corporate finance, including advisory, mergers and acquisitions, debt and equity capital markets, structured finance and brokerage. First Energy Bank, an energy finance specialist, will likely follow the same path. The business evolution of Khaleeji Commercial Bank is also relevant as it is trying to consolidate its investment banking services with a more robust commercial banking platform. “Overall, I believe that the strategic move of some IFIs acquiring larger, more diversified and established Islamic banks offers the most promising potential” adds Lowe (2010).

Going forward, it is expected that lower volumes, shrinking margins and deteriorating asset quality will all weigh on IFIs' profitability and ultimately their capitalisation. However, the impact will be more manageable than for their conventional peers. Fortunately, Islamic banks have been very profitable in the past and have therefore accumulated large amounts of capital, making them capable of absorbing these sorts of shocks. As previously discussed, conventional banks have had a greater appetite for exotic asset classes than IFIs. In that sense, asset-quality deterioration at conventional banks may be more pronounced. In addition, conventional peer banks used to be less well capitalised and less liquid, and therefore will find it more difficult to book new business in the current market conditions. “To grow today, a bank must have accumulated excess liquidity and capital in the past: most Islamic banks have, some conventional peer banks haven't”, says Damak (2010) during the interview for this research.

According to the latest findings (Moody's, 2011a; Fitch Ratings, 2011), IFIs are already tightening their belts and using their surplus liquidity deposits to meet their basic financing needs and to replace recent deposit withdrawals. Most IFIs have placed property-based projects on hold because of declining demand in the real estate sector and foreign direct investment. There have been financial stimulus packages supplied by governments to assist IFIs with their liquidity constraints. Those banks that are on the brink of liquidity crunch and that have been unsuccessful in attracting additional deposits will either have to issue more sukuk or merge with their financially stronger counterparts.

Islamic banks, organisations and regulators are working to address these challenges. The rapid developments are likely to continue. Financial institutions in countries such as Bahrain, the UAE and Malaysia have been gearing up for more Shari'ah-compliant financial instruments and structured finance – on both the asset and liability sides. At the same time, the leading financial centres, such as London, New York and Singapore, are making significant progress in establishing the legal and prudential foundations to accommodate Islamic finance side by side with the conventional financial system. Many of the largest Western banks, through their Islamic windows, have become active and sometimes leading players in financial innovation, through new Shari'ah-compliant financial instruments that attempt to alleviate many of the current constraints such as a weak systemic liquidity infrastructure. More conventional banks are expected to offer Islamic products, enticed by enormous profit opportunities and also ample liquidity, especially across the Middle East.

New product innovation is also driven by domestic banks' interest in risk diversification. With a large number of new Islamic banks, especially across the Middle East and Asia, diversification of products enables banks to offer the right product mix to more sophisticated clients. A few banks are already active across different jurisdictions, and this trend is certainly going to continue in the near future, possibly with some consolidation (Moody's, 2011a).

Thun (2010) argues that just before the crisis Islamic banking was on the edge of a new era that would bring Islamic finance closer to the PLS, asset-backed and real-economy financing ideals, with innovations introduced by Shari'ah-compliant investment banking. Sometime before the crisis, institutions like GFH, Arcapita Bank, Unicorn Investment Bank and TID started moving away from pure banking intermediation and into more sophisticated investment/merchant banking lines of business, like private equity, asset-management, brokerage, infrastructure and structured real estate finance, as well as advisory, corporate and project finance – thereby laying the groundwork for innovation within Islamic banking. The industry was on the edge of moving beyond the focus on raising cheap murabahah or wakala deposits (so as to recycle them into safe, stable and expensive retail and corporate loans) and adopting a greater emphasis on risk-taking instead. However, the onset of the financial liquidity crisis prevented the dawning of this new era, adds Thun (2010).

On the regulatory front, whereas the growth history and forecasts are a source of optimism for the Islamic finance industry, the growing regulation in the wake of the recent credit crisis offers a newer set of challenges. There will be material, substantive change to the regulatory environment under which banks and other financial institutions operate (PWC, 2009). Regulators across the world are set to introduce a new era of tightened regulation for the financial sector in general. Central banks and financial regulatory authorities around the world are the subject of intense criticism for failure to predict and check the global financial crisis. Issues are being framed (particularly in the areas of risk management, liquidity and capital requirements), consultation papers drafted, and stakeholders' opinions sought for the introduction of a new and tougher regime of banking and financial regulations. “Islamic banks should get involved and should be proactive”, asserts Lowe (2010). The IFSB has moved ahead with efforts aimed at fostering the soundness, risk management, capital standards and stability of the Islamic financial services industry through more standardised regulation.

According to Khan, S. (2009), as it stands Islamic banking regulations are framed from a conventional base and as long as the conventional yardstick is applied, certain structures, such as the mudarabah and musharakah products, will likely continue to be treated as higher risk. While some of these products may actually have a higher risk profile, concepts of risk-sharing could be ingrained further through the development of more profit- and risk-sharing mudarabah and musharakah products. This should be driven by both regulators and Islamic banking practitioners who, together, need to facilitate a transparent explanation of the risks to the customer as well as enable better risk allocation between Islamic banks and the customer. The current regulatory infrastructure for IFIs is more or less largely voluntary, such that very few penalties apply to institutions that do not follow the AAOIFI Standards, or any other set of Shari'ah-related rules or standards. Until a regulatory system is meaningfully enforced where penalties of non-compliance actually hurt, it is rather futile to expect IFIs to change any of their past patterns of behaviour. Such enforcement is largely dependent on both political will and vision (Khan, S., 2009).

Islamic banking will continue to grow at a faster rate than conventional banking because of the inevitable de-leveraging of the global system but also because the roots of Islamic banking are in the Gulf and South East Asia; these are regions with higher growth rates, expanding populations and abundance of natural resources especially energy (Eedle, 2009). Several IFIs are therefore in a position to gain market share at the expense of conventional peers, which have been weakened by toxic subprime assets. However, for Islamic banking to become a true global alternative to the existing Western system, there are a number of actions that must be considered, as explained earlier. The main issue is the development of products that are more in line with the spirit of Shari'ah and that do not just replicate conventional equivalents.

However, the political and social upheaval throughout the Middle East will undoubtedly have direct and indirect impacts on IFIs in general, and on those located in the Middle East in particular. The ability of local governments to support Islamic banking and to bail out financial institutions remains to be assessed after the scissors effect of rising oil prices and local geo-political unrest.

Subsequently, the following sub-hypotheses were formulated in order to identify whether there are any significant differences across various groups in the respective control variables. The results of the hypotheses testing are summarised in Table 8.63.

• H_12-1: There are no statistically significant differences among respondents' recommended growth strategies for Islamic banks according to region.

The K-W test results suggest that the null hypothesis is accepted and the alternative hypothesis is rejected, which implies that, statistically, there are no significant differences in the respondents' views across various regions.

• H_12-2: There are no statistically significant differences among respondents' recommended growth strategies for Islamic banks according to respondent's position.

Similarly, the results suggest that the null hypothesis is accepted indicating that, statistically, this control variable plays no significant role in impacting the respondents' opinions.

• H_12-3: There are no statistically significant differences among respondents' recommended growth strategies for Islamic banks according to the nature of the financial institution.

For this hypothesis, the testing results decline the null hypothesis, meaning that, statistically, there are significant differences among respondents' views according to the nature of financial institution. ‘Organic growth in home market’ and ‘Standardisation’ had p-values of 0.036 and 0.015 respectively, which are lower than the critical p-value of 0.05. However, examining the mean rankings of these two strategies according to ‘Nature of Financial Institution’, as summarised in Table 8.64, did not identify a particular pattern.

• H_12-4: There are no statistically significant differences among respondents' recommended growth strategies for Islamic banks according to the nature of activities.

The K-W results were unable to reject the null hypothesis, indicating that, statistically, the variable ‘Nature of Activities’ plays no significant role in impacting the respondents' opinions.

• H_12-5: There are no statistically significant differences among respondents' recommended growth strategies for Islamic banks according to accounting standards.

The testing results accept the null hypothesis indicating that this control variable is, statistically, not significant in influencing the respondents' opinions.

• Hypothesis 13: Perceptions of Islamic and conventional bankers differ significantly. Islamic bankers are more biased toward their business model, and vice versa.

Finally, Hypothesis 13 is a general hypothesis not linked to a specific part of the questionnaire. The researcher expected the perceptions of Islamic bankers to be biased in favour of their business model, and those of the conventional bankers to be biased against Islamic banking. Hypothesis 13 is declined as the findings from both the quantitative and qualitative analyses reflected a high degree of correlation between the responses of the two groups. However, differences generally existed between the responses of bankers and non-bankers. Non-bankers have a different risk perception than bankers; this is because bankers, whether Islamic or non-Islamic, have hands-on experience and better understanding of the Islamic banking model and its risk architecture than non-bankers, who tend to be more academic in their approach.

More specifically, the various K-W tests presented in Chapter 8 generally show that there is no significant difference in perception levels between respondents from stand-alone Islamic banks and Islamic subsidiaries. Initially it was expected that respondents from stand-alone Islamic banks would have a stronger perception compared to those from Islamic subsidiaries for two reasons: firstly, stand-alone Islamic banks have been in existence much longer than Islamic subsidiaries, and, secondly, the respondents from stand-alone Islamic banks have the advantage of dealing with only Islamic banking products and services whereas Islamic subsidiaries need to operate side by side with their respective conventional counterpart in sharing the same operating platforms and buildings. Nevertheless, the results have indicated otherwise. Some differences could be spotted between the perceptions of conventional banks and stand-alone Islamic banks, and more noticeably between the perceptions of bankers and non-bankers, represented by ‘Others’. Examining the mean rankings for different questions confirmed that there is an observed pattern, which can be explained by market realities.

CONCLUSION AND SUMMARY

The current chapter is intended to combine, integrate and discuss the main results and findings from all three empirical chapters, combined with knowledge developed from the literature review, and to provide the basis for an overall conclusion.

To render the results in a more systematic manner, Table 10.1 attempts to bring together the results of the testing of all the main hypotheses.

As can be seen in Table 10.1, for the 13 hypotheses, nine null-hypotheses were accepted, while the alternative null-hypotheses were accepted for the remaining four hypotheses.

Based on the decisions of the hypotheses testing, the main findings and implications of this study will be presented in Chapter 11, together with recommendations for areas in which future research appears to be desirable. Chapter 11 also discusses future directions of risk management in Islamic banking.