For distinct features of Islamic management in Islamic banking, they are provides financing which is backed by assets. Islamic banks cannot deal in documents and it is due to the asset backed nature results in productive economic activities. Additionally, Islamic banks need to comply with conventional regulatory standards as well as Shariah standards. Islamic banks do not conduct business with tobacco, alcohol and other harmful toxic producing companies. Islamic banks are not merely interest-free.
Islamic banking transactions need to avoid other elements of fraud, deceit and uncertainty. It is implied from the Gharar-free nature of Islamic banking transantions that such complex conventional instruments like options, swaptions are not allowed in Islamic banking. Moreover, clean borrowing is not allowed in Islamic banking. Islamic banks provide financing to create assets. Therefore, Islamic banks do not offer credits cards, personal loans and running finance/overdraft. Islamic banking also does not permit transactions in most derivatives.
However, Salam (advance sale/purchase) and Istina (project financing) are close alternatives for Forward contracts in conventional banking. Based on the above discussion, an effort will be made to decline a conceptual framework among the different concepts discussed thus far. There are two dependent variables and both are equally important. Although, adequate risk management procedures will get reflected in commercial success in the long-run, but the commercial success is not only criterion of risk management procedures.
It is due to the fact that commercial success depends upon the quality of product, its USPs, its effective marketing, its simplicity and besides the cultural, political and macroeconomic context in which the product is launched and marketed. Therefore, an effort is made to separate both concepts to avoid suggesting the overhaul of an effective risk management system when it does not get reflected in profitability in the short-run due to the other reasons. The hypothesis testing is to compare profitability of Islamic and conventional banks. Null hypothesis is Ho: r > 0. 5 and Ha: r < 0. 5.
From this, ‘r’ is the Pearson’s co-relational coefficient for Return on Equity (ROE) in conventional and Islamic banks. As return on Equity cannot be negative, a one-tail test is performed. ‘r’ is taken to be 0. 5, as risk management alone is not expected to define more than 50% of the relationship. Descriptive statistics show a significant difference in mean. Average ROE in Islamic banks is almost half of that of conventional banks. This is partly due to the fact that Islamic banks are new entrants in the industry and are booking their preliminary and capital expenditures initially for tax purposes.
This is supported by the fact that they have more liquidity than conventional banks. But, they are yet to fully convert their equity base into revenue generating assets. For Risk Management analysis, the more important statistics are deviation statistics. If the standard deviation are similar, conventional banks are more favourable co-efficient of variation. Currently, conventional banks are more profitable due to the learning curve effect, mature product cycles and market share, but Islamic banks are also profitable in their own respect and have the liquidity to turn things around for themselves.
It is support the null hypothesis that presented the opportunities in the environment; Islamic banks having adequate risk management procedures are able to tap opportunities and be profitable like conventional banks and their risk management procedures are adequate enough to not make them fall too behind conventional banks. for the conclusion, this paper concludes that equity-based business of Islamic banks posing a slightly more risk than conventional banks is well mitigated by Islamic banks through their effective and adequate distinct risk management procedures.