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The Impact Of Financial Risks To The Profitability Of Islamic Banks

1. Introduction

The effectiveness defined for risk management can be experienced by measuring the bank’s profitability whereby any such financial organization has to set the profitability as an essential purpose to be achieved. While superior risk managing practices could be very good at the base line. Besides, the impact devised for the financial risks are intended as interest rate risk, liquidity risk, and credit risk, which set an agenda to the financial institution (Amba and Almukharreq, 2013). However, an increase in the interest rate might trigger the credit risk because this may lead to the increase in loan defaults while the increase defined for interest rate may also lead to the liquidity problems. Thus, it is very important that the impact defined for the financial risk on Islamic banks has good profitability, and this is the reason for depositors and owners to maximize it (Usman and Khan, 2012). Accordingly, awareness for the profitability feature helps the policy makers to formulae the regulations and policies in the banking industry.

1.1. Statement of Research Question

The current research intends on How to measure the impact of the financial risks being occurred because of the profitability of the Islamic Banks.

1.2. Proposed Objectives

  • To inspect the impact of crisis area on the Islamic banks profitability for the GCC Countries
  • To identify whether its impact defined for crisis differ with the difference on the determinant of the Islamic banks on the profitability measure for GCC Countries
  • To assess the financial risks that are being occurred with the proponents of the profitability of the Islamic Banks

2. Relation to previous research

According to Siraj and Pillai (2012), from the previou ........

e. Besides, the impact devised for the financial risks are intended as interest rate risk, liquidity risk, and credit risk, which set an agenda to the financial institution (Amba and Almukharreq, 2013). However, an increase in the interest rate might trigger the credit risk because this may lead to the increase in loan defaults while the increase defined for interest rate may also lead to the liquidity problems. Thus, it is very important that the impact defined for the financial risk on Islamic banks has good profitability, and this is the reason for depositors and owners to maximize it (Usman and Khan, 2012). Accordingly, awareness for the profitability feature helps the policy makers to formulae the regulations and policies in the banking industry.

1.1. Statement of Research Question

The current research intends on How to measure the impact of the financial risks being occurred because of the profitability of the Islamic Banks.

1.2. Proposed Objectives

  • To inspect the impact of crisis area on the Islamic banks profitability for the GCC Countries
  • To identify whether its impact defined for crisis differ with the difference on the determinant of the Islamic banks on the profitability measure for GCC Countries
  • To assess the financial risks that are being occurred with the proponents of the profitability of the Islamic Banks

2. Relation to previous research

According to Siraj and Pillai (2012), from the previous studies, it is been analyzed about the identification of factors affect the achievement of the predictable financial institutions. This is very important areas of the research in the financial area because most researchers do identify the internal/external factors that significantly make an effect in the success area of most financial institutions. Besides, most researchers have also tried to analyze the effect on few factors on Islamic banks profitability. In fact, as opined by Schaeck and Cihák (2014), most researchers have tried to decide on some theories on the determinants of the Islamic banks profit. From this, the team that focused on the internal factors may have a huge affect to the profitability area in Malaysia on Islamic banks. However, these factors included capital sufficiency, liquidity risk, credit risk, and management expense (Rosman, Wahab and Zainol, 2014). Meanwhile it could also be said that in Malaysia while operating in Islamic banks, it is analyzed that the bank size is efficient for determining bank’s profit but other factors like the capital adequacy, liquidity risk, credit risk, and the management expense were not found.

The study also has a correlation where it is analyzed that the Islamic bank’s size is imperative to describe the wide difference in profitability measure for the non-interest banks been used in Malaysia (Petria, Capraru and Ihnatov, 2015). Whereby, it is also seen that large bank size would have better risk that is accessible to the capital markets, which would have cheap borrower cost to generate the earnings. Besides, it is been investigated on the major determinants of Jordanian Islamic bank’s profitability where the return on assets (ROA) and the profit margin could express profitability of the banks. This could also pose a linear regression in order to decide effects related to bank-specific determinants in terms of profitability.

According to Mirzaei, Moore and Liu (2013), it is also important that the result devised from the credit risk also have a positive impact on profitability of Islamic Banks. Besides, Islamic banks also have increase in exposure to the credit risk area, and this is quite higher because of its profit measure. This would also define about the equity value to the total asset ratio, investment in the total deposits and the capital adequacy. Another study analyzed from Pakistan where the internal factors mainly include the bank’s asset, loans, and deposits (Masood and Ashraf, 2012). It is indicated that in Pakistan, the banks have large size and network might suffer from the managerial effectiveness and the bottlenecks.

Meanwhile, a research also analyzed an effective relation between profitability of Islamic banks and financial risks in Malaysia (Mansoor Khan and Ishaq Bhatti, 2008). This is where the proxies were meant to study the return on equity (ROE), net interest/income margin (NIM) and return on assets (ROA). Meanwhile, it is also discussed that the interest rates also affects bank’s return on equity but this is insignificant for the banks. Reference also shows Ukraine bank’s profitability where it is analyzed that the Macroeconomic indicators such as the GDP, exchange rate, inflation, foreign ownership, and financial crisis are mainly used on a wide scale (Farooq and Zaheer, 2015). It is also investigated that the banks owned by most foreigners also have a huge impact to South Eastern Europe’s bank performance.

3. Proposed methods

The methodology section will mainly include the data sources and model specifications that are being defined with the profitability area for GDP growth in major Islamic banks. Besides, this section gives a detail review of the Profitability, Financial Risks and the Controlled Variables used.

3.1. Data Sources:

As opined by Bourkhis and Nabi (2013), the data here would be obtained from the bank’s annual reports that are derived from the Bankscope file. The period for this study is about 8 years (2010-2017). In order, the Panel data consists of a full-fledge global Islamic banks that are been employed on a wide scale. With respect to the macroeconomic variables, it is also intended that the inflation rate and GDP growth rate can be attained from the Euromonitor International portal.

3.2. Model conditions

The main model that is been used to conduct the previous studies are analyzed as below:

PROFITABILITY=F (RISKS, BANK, MACROECONOMIC)

The Risks here are mainly represented by the rate of return risk, liquidity risk and credit risk. While MACROECONOMIC and BANK are defined as the controlled variables, which would represent size of the bank, inflation and GDP growth rate. However, the precise model used here is defined as:

Iijt = α0 + γt CD + αi Bijt + βjMjt + δjCj+ ε ijt

Iijt= Measure of the profitability for the bank (i) in country (j) at time (t)

CD= Dummy variable =1 if there is a crisis and = 0 or else

Bijt= Column vector for the internal variable for the bank (i) in respect to country (j) at time (t)

Mjt= Column vector of the external variable for the country (j) at time (t)

Cj= Column vector for the country dummy variables

γ t, αi, βj and δj= Row vectors of the slope coefficients of the regressors

α0= Constant

εij= Error term

3.3. Profitability

From previous studies, it could be analyzed about the determinants for the bank’s profitability with the financial risk, bank size and operating efficiency. As opined by Ariffin (2012), it is intended that the bank’s profitability can be the return of assets, financial ratios and return on equity. Besides, the reason for taking return of the asset over the return of equity is that financing was defined by the Islamic banks from the early deposits than the capital.

3.4. Financial Risks

As the study is analyzed on the credit risk, liquidity risk and rate of the return risk, it is quite eminent that financial risks are mostly related to each other. For example, enhance in the interest risk for the Islamic banks might cause a heavy increase in the loan provisions, and this might have an effect to the liquidity of bank (Andrikopoulos, Samitas and Bekiaris, 2014). Similarly, in case of the credit risk, it is analyzed that the main business defined for most of the financial institutions is very prominent because this may affect bank’s performance heavily from all areas. While in case of Rate of return risk, it is analyzed by the equation as:

Gap = Rate sensitive assets – Rate Sensitive Liabilities

3.5. Controlled variables

According to Masood and Ashraf (2012), there are many variables intended such as the GDP growth, inflation, bank capital and bank size, which affects the profitability of banks. As per Mirzaei, Moore and Liu (2013), it is fore-mentioned that the natural log defined with the total bank’s asset is analyzed with variable bank size and intended with the positive side of bank’s profitability. The controlled variables however include Rate of Return Risk (ROR), GDP Growth Rate (GDP), Inflation (INF), Bank Size (BSIZE), etc.

3.6. Data Analysis

The data analysis in the findings part would be done with the help of descriptive statistics that summarizes mean, SD and variance on the return of assets, controlled variables and the financial risks (Bourkhis and Nabi, 2013). This would also work with the correlation matrix, Panel Unit Root Test and with the Multivariate Result.

4. Reflections

On conducting the research on “The impact of financial risks to the profitability of Islamic banks”, I have faced some of the major challenges and barriers, which included mainly on the time factor and the topic was out of my subject area. I had to go for in-depth research to find the materials so that there could be uniqueness to the research area intended. At first, I tried to configure with my analytical and personal skills to develop the topic’s literature and the methods area so that everything matches to the criteria. For the introduction part, I took help from the secondary journals and books from web, which gave me a highlight on what was to be conducted empirically. I introduced the topic at first and then develop the statement of the research question along with the objectives so that everything matches with a good relevance to the theme. Besides, I have also defined a broad literature from the previous researches for the topic intended and this is followed with a method section where I have used descriptive statistics to analyze the variables, which would be done in the findings section.

It has been noted that Islamic banks provides the banking activities apart from the borrowing and the lending based on the interest to be given. On such liabilities, I found it a critical from banks of other countries in an increasing scale. I have also realized that the Islamic banks mainly prohibit collection of the payment in terms of the bank’s deposits and the loans. This is where the depositors share the profits as per the bank accordingly with a predetermined ratio. On following this, I have also seen a mechanism for the Islamic banks while researching that it maintain its net worth in order to avoid deterioration of the balance sheets on different economic conditions. On going with the flow of research, I have availed a scenario where I can justify that there could be a negative relation for Islamic bank’s profitability and liquidity. This is the situation where huge amounts of liquid cash will be provided for the banks to overcome the investment opportunities and define a quick access to liquid as well.

On defining ethics, I can conclude from the assessment that for the Islamic banks profitability, they represent something very different unlike the other banks. A practice could also be shown where the practices of the Islamic banking are not been achievable to analyze the goals on the moral values of Islam to enhance social well-being, justice, and equitability. Moreover, with the application to this research, I have evaluated a financial research that could be unique when defined with the participatory action intended in the ongoing research.

5. Timetable

The timetable analyzed for this research would be done with the help of a Gantt chart on following the activities that are highlighted as follows:

Activities

Week 1-2

Week 3-4

Week 5-6

Week 7-8

Week 9-10

Week 11-12

Developing Research Ideas

 

 

 

 

 

 

Introducing the Topic

 

 

 

 

 

 

Defining Research Objectives 

 

 

 

 

 

 

Analyzing Literature Review

 

 

 

 

 

 

Working with Definitions/ terms

 

 

 

 

 

 

Developing Methods section

 

 

 

 

 

 

Findings on Descriptive Analysis

 

 

 

 

 

 

Results

 

 

 

 

 

 

Reflection for the topic

 

 

 

 

 

 

Final Submission

 

 

 

 

 

 

 

Table 1: Gantt chart

(Source: Author)