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Risk Management Practices Followed by the Commercial Banks in Pakistan

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 International Review of Business Research Papers
Volume 6. Number 2. July 2010 Pp. 308 – 325

Risk Management Practices Followed by the

Commercial Banks in Pakistan
Afsheen Shafiq1and Mohamed Nasr
Risk management is one of the most important practices to be used especially in
banks, for getting assurance about the reliability of the operations and procedures
being followed within them. In today’s dynamic environment, nothing is constant
but risk. Even banking is not deprived of risk and all banks are exposed to a variety
of risks including credit risk, liquidity risk, foreign exchange risk, market risk and
interest rate risk. An efficient risk management system is the need of time.
Managing risk is one of the basic tasks to be done, once it has been identified and
known. The risk and return are directly related to each other, which means that
increasing one will subsequently increase the other and vice versa.

The purpose of this study is to explore the current risk management practices that
are being followed and exercised by the banks, specifically, commercial banks in
Pakistan. Primary and secondary data sources are used to serve the purpose.
Results reveal a significant difference in the application of risk management
aspects among the pubic sector commercial banks and local private banks. Also
the financial soundness indicators differ in value for each type of commercial bank.
Although there is a general understanding about risk and its management among
staff of commercial banks, still there is a need for commercial banks to devise
training courses tailored to the needs of Banking Personnel in Risk Management.

This study has been conducted to estimate the average returns on investment
portfolio and risk involved in the return on investment of portfolio in each of
selected insurance companies before and after GATS membership. Descriptive
statistics, correlation analysis, Paired samples statistics and multiple comparisons
have been used to evaluate the insurance investment activities.

The study concludes that there is a significance difference between the average
return of investment of each of the Pakistani insurance companies before and after
GATS. Risk involved in this investment before membership was 1.74 % and
increased to 12.869 % after this membership. Even after performing well, there is
an intensive increase in the risk involved in investment after GATS membership.
The study is expected to provide a useful reference for Insurance managers as well
as the ministry of Finance and Securities & Exchange Commission of Pakistan in
their efforts to control and improve the performance of insurance in Pakistan.

Field of Research: Financial Risk Management, Financial Modeling.

1. Introduction

Risk is defined as anything that can create hindrances in the way of achievement
of certain objectives. It can be because of either internal factors or external

1
Afsheen Shafiq is a Graduate of MS leading to Ph.D. in CIIT, Islamabad, Pakistan, e.mail: afshin.shafiq@gmail.com
2- Mohamed Nasr is HEC Canadian Professor of Finance and Applied Statistics at Comsats Institute of
Technology in Islamabad, Pakistan
 Shafiq & Nasr

factors, depending upon the type of risk that exists within a particular situation.
Exposure to that risk can make a situation more critical. A better way to deal with
such a situation; is to take certain proactive measures to identify any kind of risk
that can result in undesirable outcomes. In simple terms, it can be said that
managing a risk in advance is far better than waiting for its occurrence.

The idea of risk differs from that of probability and uncertainty. Risk is said to be
absent within a situation where a person is 100% certain about the outcome. This
idea also brought the rise of insurance with its origin. Insurance is the basis upon
which people show a good deal of willingness to take risk; it creates the
foundation of the security where fortune has been ousted by an active
engagement with the future. On the other hand, the practice of Risk Management
is a measure that is used for identifying, analyzing and then responding to a
particular risk. It is a process that is continuous in nature and a helpful tool in
decision making process. According to the Higher Education Funding Council for
England (HEFCE), Risk Management is not just used for ensuring the reduction
of the probability of bad happenings but it also covers the increase in likeliness of
occurring good things. A model called “Prospect Theory” states that a person is
more likely to take on the risk than to suffer a sure loss.

Risk exists as a part of an environment in which various organizations operate

(Tchankova, 2002). Banking is a business mostly associated with risk because of
its large exposure to uncertainty and huge considerations. Risk management is
one of the most important practices to be used especially in banks, for getting
assurance about the reliability of the operations and procedures being followed.
In today’s dynamic environment, all banks are exposed to a large number of risks
such as credit risk, liquidity risk, foreign exchange risk, market risk and interest
rate risk, among others – the risks which may create some source of threat far a
bank's survival and success (Al-Tamimi and Al-Mazrooei, 2007).

Due to such exposure to various risks, efficient risk management is required.

Managing risk is one of the basic tasks to be done, once it has been identified
and known. The risk and return are directly related to each other, which means
that increasing one will subsequently increase the other and vice versa. And,
effective risk management leads to more balanced trade-off between risk and
reward, to realize a better position in the future (Fatemi and Fooladi, 2006).

It is also realized recently that Risk Management is essentially more important to

be carried upon in the financial sector than any other part of the economy. It
makes more sense when it is known that the main purpose of the financial
institutions is to maximize revenues and offer the maximum value to the
shareholders by facilitating them with a variety of financial services especially by
administering risks (Al-Tamimi and Al-Mazrooei, 2007). The prime reason to
adopt risk management practices is to avoid the probable failure in future. But, in
realistic terms, risk management is clearly not free of cost. In fact, it is expensive
in both resources and in institutional disruption. But the cost of delaying or

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avoiding proper risk management can lead to some adverse results, like failure of
a bank and possibly failure of a banking system (Meyer, 2000).

The banking industry recognizes that an institution needs not do business in a

manner that unnecessarily imposes risk upon it; nor should it absorb risk that can
be efficiently transferred to other participants. Rather, it should only manage risks
at the firm level that are more efficiently managed there than by the market itself
or by their owners in their own portfolios. In short, it should accept only those
risks that are uniquely a part of the bank's array of services.

Banking is one of the most sensitive businesses in any economy since it acts as
a life-blood of modern trade and commerce to provide them with the major
sources of finance. Pakistan is one of the key emerging markets of South Asia
and its banking sector consists of Commercial Banks and Specialized Banking
Institutions, regulated by the State Bank of Pakistan. Pakistan is one of few
developing countries, where the public sector banks were privatized within a
limited time span. The Federal Government is now left with only the National
Bank and First Women Bank, while the State Province owned banks are the
Bank of Khyber and Bank of Punjab. The Banking Sector has significantly
improved its performance during the last few years as more foreign banks have
also started their operations in this region.

The time period between “2002-2007” proved to be of significant growth for the
banking sector of Pakistan. Classified as Pakistan’s and region’s best performing
sector, the banking industry’s assets increased over $60 billion, its profitability
remains high, non-performing loans (NPLs) are low, credit is fairly diversified and
bank-wide system risks are well-contained. Almost 81% of banking assets are in
private hands. It shows that privatization of the major portion of the banks has
increased competition among them and resulted in the continuous increase in
performance to retain their customers through efficient means. Currently, it is
more obvious that increased competition in consumer banking has increased the
need for effective and efficient risk management for the banks to gain a
competitive edge.

The risk arises from uncertainty of a particular situation and certainty of being
exposed to that situation. Risk Management as commonly perceived does not
mean to minimize risk; in fact, its goal is to optimize the risk-reward trade off.
And, the role of risk management is to assure that an institution does not have
any need to engage in a business that unnecessarily imposes risk upon it. Also, it
should not absorb any such risks that have the tendency to be transferred to
other participants. Rather it should only accept those risks that are uniquely a
part of the array of bank’s services. In this regard, risk management aspects
such as Understanding risk and risk management, risk identification, risk
assessment and analysis, risk monitoring, risk management practices and credit
risk analysis of the banks have to be considered for assessing their risk
management approach.

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2. Literature Review

Within the last few years, a number of studies have provided the discipline into
the practice of risk management within the corporate and banking sector. An
insight of related studies is as follows:

Amran, et al. (2009), explored the availability of risk disclosures in the annual
reports of Malaysian companies. The study was aimed to empirically test the
characteristics of the sampled companies. The level of risk faced by these
companies with the disclosure made was also assessed and compared. The
findings of the research revealed that the strategic risk came on the top, followed
by the operations and empowerment risks being disclosed by the selected
companies. The regression analysis proved significantly that size of the
companies did matter. The stakeholder theory explains well this finding by stating
that “As company grows bigger, it will have a large pool of stakeholders, who
would be interested in knowing the affairs of the company.” The extent of risk
disclosure was also found to be influenced by the nature of industry. As explored
within this study, infrastructure and technology industries influenced the
companies to have more risk information disclosed.

Hassan, A. (2009), made a study “Risk Management Practices of Islamic Banks

of Brunei Darussalam” to assess the degree to which the Islamic banks in Brunei
Darussalam implemented risk management practices and carried them out
thoroughly by using different techniques to deal with various kinds of risks. The
results of the study showed that, like the conventional banking system, Islamic
banking was also subjected to a variety of risks due to the unique range of
offered products in addition to conventional products. The results showed that
there was a remarkable understanding of risk and risk management by the staff
working in the Islamic Banks of Brunei Darussalam, which showed their ability to
pave their way towards successful risk management. The major risks that were
faced by these banks were Foreign exchange risk, credit risk and operating risk.
A regression model was used to elaborate the results which showed that Risk
Identification, and Risk Assessment and Analysis were the most influencing
variables and the Islamic banks in Brunei needed to give more attention to those
variables to make their Risk Management Practices more effective by
understanding the true application of Basel-II Accord to improve the efficiency of
Islamic Bank’s risk management systems.

Al-Tamimi (2008) studied the relationship among the readiness of implementing

Basel II Accord and resources needed for its implementation in UAE banks.
Results of the research revealed that the banks in UAE were aware of the
benefits, impact and challenges associated in the implementation of Basel II
Accord. However, the research did not confirm any positive relationship between
UAE banks readiness for the implementation of Basel II and impact of the
implementation. The relationship between readiness and anticipated cost of
implementation was also not confirmed. No significant difference was found in

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the level of Basel II Accord’s preparation between the UAE national and foreign
banks. It was concluded that there was a significant difference in the level of the
UAE banks Basel II based on employees education level. The results supported
the importance of education level needed for the implementation of Basel II
Accord.

Al-Tamimi and Al- Mazrooei (2007) provided a comparative study of Bank’s Risk
Management of UAE National and Foreign Banks. This research helped them to
find that the three most important types of risks facing the UAE commercial
banks were foreign exchange risk, followed by credit risk and then operating risk.
They found that the UAE banks were somewhat efficient in managing risk;
however the variables such as risk identification, assessment and analysis
proved to be more influencing in risk management process. Finally, the results
indicated that there was a significant difference between the UAE National and
Foreign banks in practicing risk assessment and analysis, and in risk monitoring
and controlling.

Koziol and Lawrenz (2008) provided a study in which they assessed the risk of
bank failures. They said that assessing the risk related to bank failures is the
paramount concern of bank regulations. They argued that in order to assess the
default risk of a bank, it is important considering its financing decisions as an
endogenous dynamic process. The research study provided a continuous-time
model, where banks chose the deposit volume in order to trade off the benefits of
earning deposit premiums against the costs that would occur at future capital
structure adjustments. Major findings suggested that the dynamic endogenous
financing decision introduced an important self-regulation mechanism.

3. Research Methodology and Design

This study aims to investigate the awareness about risk management practices
within the banking sector of Pakistan. This study is comprised of data collected
through both, primary as well as secondary sources. The purpose of using
primary source data is to check the extent to which different risk management
practices have been followed by the commercial banks in Pakistan. Primary data
is collected through the use of a questionnaire. The questionnaire comprises a
number of statements under one macro-statement (variable). The questionnaire
is comparable to one provided in a study by Al-Tamimi and Al-Mazrooei (2007). It
includes Risk Management Practices (RMP) as the dependent variable, and
different aspects of risk management as the independent or explanatory
variables. Whereas, the objective to use secondary data is to link the risk
weighted Capital Adequacy Ratio (CAR) to the different financial indicators of the
commercial banks that are used to measure their soundness.

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3.1 Study Sample

Out of the total 36 of commercial banks in Pakistan 15 commercial banks were

approached; however, the commercial banks that responded timely and
positively were 12 in total. A total of 7 questionnaires were distributed in each of
the bank approached to be filled by the staff working specifically in the Risk
Management department. After the elimination of the erroneous responses the
effective response rate obtained was around 58% of the total sample. An attempt
is made to collect data from each of the sampled commercial bank’s risk
management department in the major cities of Pakistan including Islamabad,
Rawalpindi, Lahore and Karachi.

The secondary data is collected and assembled from the different quarterly
reports on “performance review of the banking system. The available data covers
a period of total 9 years from 2000-2008. The data is mainly related to the Risk
Weighted Capital Adequacy Ratio (RWCAR) and its impact on different financial
indicators of the commercial banks that are used to measure their soundness.
The data mainly related to the commercial banks in Pakistan is decomposed into
three main categories: Public sector commercial banks, local private banks and
foreign banks.

3.2 Variables

This study is mainly related to the risk management practices being followed by
the commercial Banks in Pakistan. The questionnaire is used as a main tool to
collect primary data and check the extent to which the risk management
practices are being carried upon by the commercial banks in Pakistan. The six
important aspects of risk management process are categorized as one
dependent and five explanatory variables.

Dependent Variable: The dependent variable of this study is risk management. It

is measured with the help of risk management practices and specifically their
degree of usage within the commercial banks of Pakistan.
Independent or Explanatory Variables: The explanatory variables include the five
main aspects of risk management. These variables are as follows:
 Understanding Risk and Risk Management.
 Risk Identification
 Risk Assessment and Analysis
 Risk Monitoring
 Credit Risk Analysis

3.3 Financial Soundness Indicators: The secondary data is comprised of four

main financial soundness indicators, each of which is evaluated through a
number of sub-indicators are to aimed to evaluate the performance of the banks
within a span of a year. Their division is shown as follows:
i. Capital Adequacy Ratio

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ii. Asset Quality

iii. Earning
iv. Liquidity

3.4 Hypothesis Testing

Based on the research questions and problem of the study, a set of hypotheses
are developed and tested to show the degree of relationships between risk
management practices and each of the five aspects of risk management process.
Each of the alternative hypotheses formulated is stated below:

H11 There is a positive relationship between risk management practices and

understanding risk and risk management, risk identification, risk assessment and
analysis, risk monitoring and credit risk analysis.

H21 There are significant differences between Pakistan’s public sector and private
local banks in the use of understanding risk and risk management, risk
identification, risk assessment and analysis, risk monitoring and controlling, risk
management practices and credit risk analysis.

Based on the secondary data, the following alternative hypothesis is formulated

to check the difference between the values of all the financial soundness
indicators among the three separate groups of commercial banks in Pakistan.

H31 There is significant difference between the financial soundness indicator’s

values between Pakistan’s public sector, local private and foreign banks for all of
the nine years ranging from 2000-2008.

3.5 Data Analysis Methods

A regression model is applied to estimate the relationship between one

dependent variable and the five explanatory variables. The model is as follows:

RMP = ƒ (URM, RI, RAA, RM, CRA)

Where:
RMP = Risk Management Practices;
URM = Understanding Risk and Risk Management;
RI = Risk Identification;
RAA = Risk Assessment and Analysis;
RM = Risk Monitoring; and
CRA = Credit Risk Analysis

This model is adopted to test the second hypothesis of the study. For the
purpose of testing rest of the hypotheses developed specifically for analyzing the
primary data, ANOVA test is run. Its purpose is to check the differences among
various Pakistan’s public sector and local private banks in use of all the six major

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aspects of the Risk Management Process. Another tool used to determine

whether a linear relationship exists between the variables is Product Moment
Correlation, r. For the purpose of testing the secondary data analytically, Analysis
of Variance test is used for each of the major financial soundness indicator
separately.

4. Data Analysis

4.1 Primary Data Analysis

The reliability of the scales used within the questionnaire is evaluated using
Cronbach’s alpha. It allows measuring the reliability of different variables. The
questionnaire adopted for this study contains 43 statements representing each of
the six aspects of risk management. It is used to estimate how much variation in
scores of different variables is attributable to chance or random errors (Selltiz et
al., 1976). There is a general rule that a coefficient greater than or equal to 0.7 is
considered acceptable and a good indication of construct reliability (Nunnally,
1978). The overall Cronbach’s alpha (  , for the six aspects of risk management
process is 0.771 as shown below in table 4.1. It means that there is an
acceptable degree of consistency among the responses against each item.

Table 4.1: Overall Reliability Statistics for six Aspects of Questionnaire

Cronbach's N of
Alpha Items
.771 6

Multiple-Regression Model:
The regression model is applied to estimate the relationship between Risk
Management Practices and the five explanatory variables as follows:

RMP = ƒ (URM, RI, RAA, RM, CRA)

Product moment correlation is used to analyze correlations among the

explanatory variables, namely understanding risk and risk management (URM),
risk identification (RI), risk assessment and analysis (RAA), risk monitoring (RM),
and credit risk analysis (CRA). Table 4.2 reveals the correlation coefficients
between all the variables.

This table of bi-correlations is useful to detect any potential case of

multicollinearity. An examination of the results of correlations presented in Table
4.2 shown below suggests that there is no problem of multicollinearity among all
explanatory variables.

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 Shafiq & Nasr

Table 4.2: Correlation Coefficients between Explanatory Variables

RMP URM RI RAA RM CRA

Pearson
Correlatio 1
RMP n
Sig. (2-
.
tailed)
Pearson
Correlatio .269 1
URM n
Sig. (2-
.062 .
tailed)
Pearson
Correlatio .361(*) .439(**) 1
RI n
Sig. (2-
.011 .002 .
tailed)
Pearson
Correlatio .322(*) .403(**) .184 1
RAA n
Sig. (2-
.024 .004 .207 .
tailed)
Pearson
Correlatio .305(*) .575(**) .413(**) .470(**) 1
RM n
Sig. (2-
.033 .000 .003 .001 .
tailed)
Pearson
Correlatio .249 -.015 .255 .253 -.089 1
CRA n
Sig. (2-
.084 .919 .077 .079 .541 .
tailed)
Notes: * Correlation is significant at the 0.05 level (2-tailed).
** Correlation is significant at the 0.01 level (2-tailed).

Table 4.3 below shows the regression results. It can be seen from the results
provided in Table 4.3 that R2 is 0.351. This indicates that the five explanatory
variables explain 35.1 percent of the variations in risk management practices.

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 Shafiq & Nasr

Table 4.3: Model Summary for all explanatory variables

Adjuste
Model R R2 F Sig
d R2
1 .592(a) .351 .275 4.645* 0.002*
Predictors: (Constant), CRA, URM, RI, RAA, RM * significant at  =
1%

The estimated coefficients of all the explanatory variables are insignificant but
still show a positive impact on risk management practices except URM that is
slightly negatively correlated with RMP. These results obtained using the study
multiple-regression model is displayed in Table 4.4.:

Table 4.4: OLS Regression Result for all Explanatory Variables

Coefficients(a)

Beta t Sig.

(Constant) 1.293 1.164 .251

URM -.004 -.023 .982
RI .158 1.219 .230
RAA .213 1.259 .215
RM .265 1.794* .080*
CRA .151 1.000 .323
a. Dependent Variable: RMP * Significant at  = 10%

4.2 Linear Regression Model

Since the results shown on table 4.2 reflect mild multicollinearity, each of the
explanatory variable is regressed alone to check its impact on RMP. All the
results are summarized in two tables, one of which shows the Model summary
for checking the impact of each of the explanatory variables upon RMP. The first
explanatory variable is URM and it shows that the value for R2 is .097, which
means that URM explains only 9.7 percent of the variation in risk management
practices.

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 Shafiq & Nasr

Table 4.5: Model Summary of Linear Regression for all Independent or

Explanatory Variables

Model R R2 Adjusted R2 F Sig

URM .312(a) .097 .078 5.071* 0.029**

RI .395(a) .156 .138 8.699* 0.005*
RAA .451(a) .204 .187 12.016* 0.001*
RM .511(a) .261 .245 16.567* 0.000*
CRA .297(a) .088 .069 4.533* 0.039**
a. Predictors: (Constant), URM, RI, RAA, RM, CRA * Significant at  = 1% **
Significant at  = 5%

The second explanatory variable whose impact is checked in relation to RMP is

RI. Table 4.5 shows that the value for R 2 is .156, which means that RI explains
15.6 percent variations in the risk management practices. Similarly the model
summary for RAA shows that the value for R 2 is .204, which means that RAA
explains 20.4 percent variations in the risk management practices. Likewise, the
values depicted in the table 4.5 for R2, for RM and CRA are .261 and .088
respectively and thus explain 26.1 percent and 8.8 percent of the risk
management practices respectively.

The table 4.6 below depicts the individual estimated coefficient of linear
regression of the independent or explanatory variables on RMP. URM is showing
positive and significant impact on risk management practices. It shows a positive
relation between both the variables. It means that results are significant and with
one degree change in URM, RMP will also change by 0.327 degrees in the same
direction.

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 Shafiq & Nasr

Table 4.6: Regression Coefficient Results for all Independent or

Explanatory Variables

Independent
or Explanatory Beta t Sig.
Variables
(Constant) 3.627 4.373* .000*
URM .327 2.252** .029**
(Constant) 3.759 6.359* .000*
RI .350 2.949* .005*
(Constant) 3.943 3.988* .000*
RAA .478 3.466* .001*
(Constant) 2.965 4.752* .000*
RM .463 4.070* .000*
(Constant) 3.650 4.213* .000*
CRA .324 2.129** .039**
a. Dependent Variable: RMP * Significant at  = 1% ** Significant at 
= 5%

The estimated coefficient of linear regression for RI is showing positive and

significant impact on risk management practices. It shows a positive relation
between both the variables. It means that results are significant and one degree
change in RI will change the value of RMP by 0.35 degrees. Likewise, the
estimated coefficients of linear regression for RAA, RM and CRA show positive
and significant impact on risk management practices. A positive relationship is
shown between each of these variables with RMP. It means that results are
significant and one degree change in RAA, RM and CRA will bring a significant
change in the value of RMP by 0.478, 0.463 and 0.324 degrees respectively.

The results from all the linear regression lines between five explanatory variables
and the study dependent variable RMP show that there are significant
relationships between them. This result is obtained when each of the explanatory
variables is regressed alone on RMP. All the results are highly significant and
show the positive relation between each of the five explanatory variables and risk
management practices.

4.3 Analysis of Variance

To test rest of the other hypotheses ANOVA is used. The main purpose is to
show the difference in the risk management and all the six aspects of risk
management process among the public sector commercial banks and local
private banks of Pakistan.

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Table 4.7 shows the ANOVA results and the difference among the risk
management aspects followed by public sector commercial banks and local
private banks of Pakistan.

Table 4.7: Analysis of Variance

Sum of Mean
d.f. F Sig.
Squares Square
URM Between Groups 1.987 1 1.987 6.302** .016**
Within Groups 14.822 47 .315
Total 16.809 48
RI Between Groups .508 1 .508 1.037 .314
Within Groups 23.056 47 .491
Total 23.564 48
RAA Between Groups .597 1 .597 1.764 .191
Within Groups 15.911 47 .339
Total 16.508 48
RM Between Groups 5.239 1 5.239 14.234* .000*
Within Groups 17.298 47 .368
Total 22.537 48
RMP Between Groups .850 1 .850 2.264 .139
Within Groups 17.650 47 .376
Total 18.500 48
CRA Between Groups .292 1 .292 .904 .347
Within Groups 15.209 47 .324
Total 15.501 48
 Significant at  = 1% Significant at  = 2%

The above ANOVA table clearly shows that only two of the explanatory variables
namely URM and RM are practiced differently in public sector commercial banks
and private local banks in Pakistan. There is a significant difference between the
groups in case of these two variables as shown in the above table 2.25.

The secondary data analysis consists of both descriptive and analytical analysis.
This data type is used for the purpose of showing various facts and figures
related to the risk management of the commercial banks in Pakistan. The
secondary data is composed of three separate groups of commercial banks. The
three types of commercial banks are as follows: Public Sector Commercial
Banks, Local Private Banks and Foreign Banks.

The data is related to all the three bank types within the SBP’s quarterly
performance review reports for banking system. The secondary data is
comprised of four major financial soundness indicators.

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 Shafiq & Nasr

1- Capital Adequacy Ratio: Capital Adequacy Ratio is the amount of risk-based

capital as a percent of risk-weighted assets. It further contains the risk
weighted items and sub-indicators such as Risk Weighted CAR, Tier I Capital
to Risk Weighted Assets and capital to total assets.

2- Asset Quality: This financial soundness indicator contains the items related to
Non-Performing Loans, which are loans and advances whose mark-
up/interest or principal is overdue by 90 days or more from the due date. It
contains four sub indicators all related to NPLs.

3- Earning: It contains return on assets before and after tax and return on equity
before and after taxes as well. Return on assets measures the operating
performance of an institution. It is a widely used indicator of earning and is
calculated as net profit as percentage of average assets. Net Interest Income
is included under the same earnings indicator that it is the total interest
income less total interest expense. This residual amount represents most of
the income available to cover expenses other than the interest expense.

4- Liquidity: The final financial soundness indicator is liquidity. It comprises all

the liquidity ratios and it is used to represent the bank’s ability to efficiently
and economically accommodate decreases in deposits and to fund increases
in loan demand without negatively affecting its earnings. In the same way,
liquid assets are those assets that are easily and cheaply convertible to cash.

The commercial banks are divided into three main types of public sector
commercial banks, local private banks and foreign banks. The ANOVA results
are shown in tables 4.8, 4.9, 4.10, and 4.11 below. The table 4.8 below shows a
significant difference between all sub-indicators of financial soundness related to
CAR among the three groups of commercial banks in Pakistan.

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Table 4.8: Analysis of Variance Results for CAR

Capital Sum of Mean

d.f. F Sig.
Adequacy Ratio Squares Square
Between
Risk Weighted 16839.870 2 8419.935 182.472* .000*
Groups
Capital
Within Groups 1107.451 24 46.144
Adequacy Ratio
Total 17947.321 26
Between 1179.087
Tier I Capital to 22245.443 2 11122.721 .000*
Groups *
Risk Weighted
Within Groups 226.400 24 9.433
Assets
Total 22471.843 26
Between
558.314 2 279.157 29.702* .000*
Capital to Total Groups
Assets Within Groups 225.564 24 9.399
Total 783.879 26
* Significant at  = 1%

Table 4.9: Analysis of Variance results for Asset Quality

Sum of Mean
Asset Quality Squares d.f. Square F Sig.
Between
687.380 2 343.690 13.282* .000*
NPLs to Total Groups
Loans Within Groups 621.047 24 25.877
Total 1308.427 26
Between
23454.279 2 11727.139 179.214* .000*
Groups
Provision to NPLs
Within Groups 1570.473 24 65.436
Total 25024.752 26
Between
22548.732 2 11274.366 98.230* .000*
Net NPLs/Net Groups
Loans Within Groups 2754.609 24 114.775
Total 25303.341 26
Between
49467.205 2 24733.603 13.639* .000*
Groups
Net NPLs/Capital
Within Groups 43522.538 24 1813.439
Total 92989.743 26
* Significant at  = 1%

Table 4.9 above shows a significant difference between all sub-indicators of

Asset Quality among each of the three groups of commercial banks in Pakistan.

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Table 4.10 below is a good indication that at there is a significant difference

between all sub-indicators of financial soundness related to Earnings among
each of the three groups of commercial banks in Pakistan except ROA after tax.

Table 4.11 below shows that there is a significant difference between all sub-
indicators of financial soundness related to Liquidity among each of the three
groups of commercial banks in Pakistan except for the ratio of ROA after taxes
which clearly shows the drastic impact of taxes on Pak banks.

Table 4.10: Analysis of Variance results for Earning

Sum of Mean
Earning Squares df Square F Sig.
Between 13401.32
2 6700.664 6.733* .005*
Groups 7
Within Groups 23884.24
ROA before Tax 24 995.177
7
Total 37285.57
26
4
Between
1.676 2 .838 .099 .906
Groups
ROA after Tax
Within Groups 202.622 24 8.443
Total 204.299 26
Between
2561.659 2 1280.829 28.316* .000*
Groups
ROE before Tax
Within Groups 1085.589 24 45.233
Total 3647.247 26
Between
2922.183 2 1461.091 14.202* .000*
Groups
ROE after Tax
Within Groups 2469.124 24 102.880
Total 5391.307 26
Between 14342.05
2 7171.027 69.162* .000*
Groups 4
NII/Gross Income Within Groups 2488.442 24 103.685
Total 16830.49
26
6
Between 13648.09
2 6824.046 60.438* .000*
Groups 2
Cost/Income
Within Groups 2709.831 24 112.910
ratio
Total 16357.92
26
3
* Significant at  = 1%

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Table 411: Analysis of Variance results for Liquidity

Sum of Mean
Liquidity d.f. F Sig.
Squares Square
Between
2034.367 2 1017.184 13.460* .000*
Liquid Assets/Total Groups
Assets Within Groups 1813.711 24 75.571
Total 3848.079 26
Between
1372.005 2 686.003 12.390* .000*
Liquid Assets/Total Groups
Deposits Within Groups 1328.778 24 55.366
Total 2700.783 26
Between
1180.476 2 590.238 5.449* .011*
Groups
Advances/Deposits
Within Groups 2599.584 24 108.316
Total 3780.061 26
* Significant at  = 1%

From all the results, it can be interpreted that there is a significant difference
among all the each of the three groups of commercial banks in Pakistan as
shown by the values from the financial soundness indicators; the ratio of
Advances : Deposits is almost at the same level of significance.

5. Conclusion

From the descriptive and analytical results, it is concluded that there is a general
understanding of risk and risk management among the staff working in the risk
management department of the commercial banks of Pakistan. The study reveals
that most of the daily operations that they perform are risky by nature. The most
critical types of risk are: Credit risk, liquidity risk, interest rate risk foreign
exchange risk, and operating risk. The foreign exchange risk is important since
Pakistan is part of the Global Village and spills of international financial crises
such as fluctuations in foreign exchange rates and inflation affect the Pak banks
drastically. Each of the independent variable is regressed separately on the
dependent RMP; and show encouraging results.

Results of ANOVA regarding the financial rations are encouraging except for
ROA after taxes which means that either the government of Pakistan has to
reduce its corporate taxes to improve performance of the Pak Banks or another
study is needed with extended period of time and including the Pak Islamic
Banks who are less risk taking that the conventional Pak Banks in order to
corroborate or refute this finding.

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5.1 Study Limitations and Future Research

Islamic Banks were not included in the sample since their structure and type of
operations are quite different from those of Conventional Banks; so they were not
included in the study. Since Islamic Banks form a growing segment in Pak
Banking and are here to stay, the conventional banks need to cooperate with
them and study their specific types of risk and risk management to improve
theirs. Other studies are needed for specific type of risk and method of
management at the Islamic Banks in Pakistan according to Islamic Shari’ah.

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