RISKS EXPOSURE IN ISLAMIC BANKS: A CASE STUDY OF BANK ISLAM

MALAYSIA BERHAD (BIMB)

Faridah Najuna Mismanab

School of Economics and Finance
Faculty of Law and Management
La Trobe University
Kingsbury Drive, 3086, Victoria, Australia
Phone: +613 94795318; Fax: +613 94791654;
E-Mail: fnmisman@students.latrobe.edu.au

M. Ishaq Bhatti
School of Economics and Finance
Faculty of Law and Management
La Trobe University
Kingsbury Drive, 3086, Victoria, Australia
Phone: +613 94792715; Fax: +613 94791654;
E-Mail: i.bhatti@latrobe.edu.au

___________________
a.
Corresponding author.
b.
Faculty of Business and Management, Universiti Teknologi MARA, Malaysia.
This paper is a preliminary draft. Comment and suggestions welcomed. Version 1.01
The author thanks Heidi Ryoo and others for helpful comments. The usual disclaimer applies.

1
 ABSTRACT

The growth and changes in the global financial markets pose various risks to
the financial pectoral over the world. Risk cannot be avoided as it is part and
parcel of its operations. Banking institutions are likewise exposed to risks. As
conventional banks have to face three major risks; i) credit risk, ii) market
risk, iii) operational risk, similarly Islamic banks also face the same. The
perception that Islamic banks are risk free is not correct and can be an
understatement. This paper explores the risk involved in Islamic banks and
risk management practices by the Islamic banks. The focus of this paper is on
risk and return in Bank Islam Malaysia Berhad (BIMB). The study examines
the risk level in BIMB by using two approach; Financial Statement Analysis
and Stock Analysis. Apart from that, this study also predicts the Islamic banks
amount of financing for each concept in Malaysia for year 2010. The findings
of this paper will assist Islamic banks as it will give a clear understanding
about various types of risk in general and more particularly credit risk and
market risk.

Fields of Research: Risk; Return; Islamic banking

JEL Classification: G21

2
1.0 Introduction

Islamic banking and finance have shown a tremendous growth from year to year. This

growth has been supported by the demand for alternative products that are not only Riba free

but may also prove to be ways and means to reduce the risk of a financial catastrophe. In the

early years of its establishment, the main objective of the Islamic Banks was to provide

Shariah compliant products to Muslim Community but now it is being accepted by the Non-

Muslim Community as well who look at it as a saviour from the risk of financial catastrophe

posed by conventional banking. The ever changing global financial markets pose various

risks to the financial institutions all over the world including Islamic banks. Risk cannot be

avoided as it is part and parcel of banking operations. As conventional banks have to face

five major risks; i) credit/default risk, ii) interest rate risk, iii) liquidity risk, iv) underwriting

risk and v) operating risk, similarly Islamic banks also face the same. The perception that

Islamic banks are free from risk is not entirely correct and can be an understatement.

This study discusses the risks that the Islamic banks are exposed to and also evaluates

the level of those risks. As in financial theory, risk and return will have a direct relationship

which means that high level of risk will require a high return and vice versa. Refer to Capital

Asset Pricing Model (CAPM), a firm should try to generate a return that can compensate the

risk.

This study explores the risks that Malaysian Islamic Banks are exposed to in general

and the Bank Islam Malaysia Berhad (BIMB) in particular. Malaysia has been selected as a

sample for this study because firstly, Malaysia is the first country in the South-East Asia to

implement Shariah based Islamic financial institutions (Venardos, 2006) and secondly, the

growth of Islamic banks in Malaysia is phenomenal as compared to other countries. The legal

basis for the establishment of Islamic banks in Malaysia was the Islamic Banking Act (IBA),

which came into effect on 7 April 1983. The IBA provides Central Bank of Malaysia (BNM)
3
with powers to supervise and regulate Islamic banks, similar to the case of other licensed

banks.

Malaysia offers a wide range of Islamic financial products through its various Islamic

financial institutions namely Islamic banks, Islamic capital markets and Takaful (Islamic

Insurance). With a total population of 28.310 million 1 and Muslim population is about 54%,

the Islamic financial institutions are being supported either from the government and public

tremendously. The establishment of Pilgrimage Board (commonly known as Lembaga

Tabung Haji) in 1963 was the stepping stone for the development of Islamic financial

institutions in Malaysia. Later in 1983 Islamic Banking Act was enacted which was followed

by the establishment of first Islamic bank, Bank Islam Malaysia Berhad (BIMB) in the same

year. BIMB officially offer the Islamic banking services to the public on 1 July 1983. The

objective of its establishment is to cater the specific financial needs of Muslims. In line with

BIMB objectives, the banking activities of the bank are based on Shariah principles. After

more than a decade in operations, BIMB has proved to be a viable banking institution with its

activity expanding rapidly throughout the country with a network of 93 branches and 656

terminals nationwide. The bank was listed on the Main Board of the Kuala Lumpur Stock

Exchange on 17 January 1992. BIMB was the flag-bearer to the Malaysia Islamic banking

and finance services industry. The paid up capital swelled to RM1.73 billion from only RM80

million as at June 2009. Along the way of its establishment, BIMB were received

acknowledgement from national and also international level. The latest achievement, BIMB

was the winner of The BrandLaureate Award 2009-2010 for best brands in Corporate

Branding, Best Brands in Banking-Islamic Banks by The Asia Pacific Brands Foundation

(APBF)

1
See (http://en.wikipedia.org/wiki/Malaysia)
4
 Malaysia is the key player as a country, outside the Middle East, with market share of

about 10% in Islamic banking (Swee-Hock & Wang, 2008). For the period ended March

2010, 17 Islamic banks were operating in Malaysia, comprising 11 local Islamic banks and 6

foreign Islamic banks (www.bnm.gov.my). Table 1 summarized the wide range of Islamic

financial products are being offered by Islamic financial institutions in Malaysia. The

government of Malaysia is truly supporting the development of Islamic Financial Institutions;

as such the establishment of Malaysia Islamic Financial Centre (MIFC) in August 2006. The

objective of establishment Malaysia Islamic Financial Centre (MIFC) is to promote Malaysia

as a major hub for International Islamic finance. In the Financial Sector Master Plan (FSMP)

the Islamic banking and finance also become one of the major issues to be looked at seriously

are a proof to that matter.

The objective of the study is to determine risks and returns in BIMB by making

comparison with all commercial and Islamic banks because BIMB was the pioneer of Islamic

banking in Malaysia. Second objective is to evaluate the risk and return by doing stock

analysis and BIMB was the only one full fledge Islamic banks that were listed in Bursa

Malaysia Berhad (formerly known as Kuala Lumpur Stock Exchange or KLSE).

Table 1: Islamic Financial Institutions in Malaysia

Islamic Islamic Islamic Capital Islamic Money Takaful Fund

Financial Banking Market Market Management
Institutions
-17 Islamic - 58% of - IMMM - 8 Takaful - 9 Licensed
banks outstanding - Diverse Operators Islamic fund
- 16 Islamic bond are short-term - 4 Retakaful management
Diversity of windows Sukuk Islamic money operators companies
players and -3 International - 88% Shariah market - 1 International - 35 fund
range of Islamic banks approved instruments Takaful management
products -14 counters Operator companies
International - 143 Islamic - 7 International with Islamic
currency unit trust funds currency mandates
business unit business units

Source: Kadir(2009)

5
2.0 Literature Review

2.1 Definition of Risk

Risk arises when there is a possibility of more than one outcome and the ultimate

outcome is unknown or not clear. According to Jorion and Khoury (1996) risk is the

variability or volatility of unexpected outcome. Risk can be measured by the standard

deviation of historic outcomes, and risk can be divided into two types: systematic risk and

unsystematic risk 2. Systematic risk is the risk that arises from macroeconomic factors such as

changes in economy, political & social issues, business environment, interest rates, inflation,

war and international incidents. Systematic risk cannot be controlled and is undiversified. It

can however be mitigated by risk transfer techniques i.e. hedging. Oldfield and Santomero

(1997) define systematic risk as risks of asset value change associated with systemic factor,

as such that it can be hedged but cannot be diversified completely. Systematic risk includes:

interest rates risk, foreign exchanges risk, commodity prices risk and industry concentration

risk.

Unsystematic risk is a risk that is unique to a firm or an industry. It is associated with

random causes that can be eliminated through diversification and controlled through good

governance. The examples of unsystematic risk are regulatory action, mismanagement of a

firm, labour difficulties, consumer preferences, loss of key accounts and labour strikes. All

business or investment activities will be exposed to different type of risks or uncertainty. As

risk appears to be present in all the business activities, it should be managed with due

diligence and it requires management due attention by keeping in mind the risk return trade

off model.

2
See Gitman & Joehnk (2005).

6
2.2 Risks in Islamic Banks

Islamic banks operations are based on the Shariah principles. What primarily

differentiates Islamic banks from conventional banks is the prohibition of Riba 3. In

comparison to a conventional bank an Islamic bank offers similar products and services such

as deposit accounts, various types of financing, credit cards and mortgage. However Islamic

bank products are based on concept of profit and loss sharing, while conventional banks are

not. Like other financial institutions, risk is among the main challenges and likewise it needs

to be addressed properly by Islamic banks to make sure that they operate efficiently.

Khan and Ahmed(2001) discuss that Islamic banks not only face risks that

conventional bank face but they also have to deal with the new and unique risk as a result of

their unique asset and liability structure. According to them, this new risk exists due to the

compliance of Shariah requirement. Among the nature of operations in Islamic financial

institutions majority are based on profit and loss sharing, as such it is perceived that such

transactions pose lower risk. While profit and loss sharing contracts expose Islamic financial

institutions to a specific risk related the each type of contract and Qureshi (1984) claims that

equity based financing will increase the exposure of the Islamic bank to risks.

According to Sundararajan and Errico (2002), Islamic financial institutions can be

riskier than conventional financial institutions due to several reasons including the specific

nature of risk and unlimited number of ways to finance a project using either profit & loss

sharing or non-profit & loss sharing contracts. Lack of standardisation in each type of contract

is also another factor that is why Islamic financial institutions are riskier than its companion.

3
Riba is interest or any ex ante return derived on a loan/debt. Islamic banks will not take or give any loan or
enter into contracts seeking any increase over the principal of loans or debts created as a result of any credit
transaction. Buying/selling goods, both on cash payment and credit, for the purpose of earning profit is
permissible (Ayub, 2007).
7
Akkizidis and Khandelwal (2008) explains that the scarcity of hedging instrument,

undeveloped inter-bank money markets and a market for government securities which are

Shariah compliant, make Islamic financial institutions more vulnerable to unfavourable events

than conventional financial institutions. Cihak and Hesse (2008) also argues that Islamic

financial institutions pose risk to the financial system that in many regards differ from those

posed by the conventional financial system.

In the case of Islamic banks, risks will vary depending upon the types of instruments

used in the transactions either in deposit or financing. Sundararajan and Errico (2002) and

Venardos (2006) argue that Islamic banks will face greater challenges in identifying and

handling risk than conventional banks because of the complexities arising from the nature of

the risk for each contract and profit loss sharing concept of certain financing product. While,

Rosly and Zaini (2008) and Hassan and Dicle (2005) discuss that, the nature of risk faced by

the capital owners in an Islamic bank varies and is unique in accordance to the types of

financial instruments it uses, the people it hires to manage the bank and its degree of

transparency. Rosly and Zaini (2008) explain that risk associated with each single product can

further be broken down into major and non-major risk. Major risk means the risk that

dominates the product in use. Due to the unique nature in each product offered by Islamic

banks, Kahf (2005) argues Islamic banks need variant risk identification processes,

different risk management approaches & techniques and require different kind of supervision

as well. Table 2 identifies major risk for each type of contracts or instruments used in Islamic

banks.

8
 Table 2: Major Risk faced by Islamic Banking Products

Types of Contract Major Risks Risk Classification

Murabahah Credit risk Unsystematic risk
Musharakah Market risk Systematic risk
Agency risk
Mudarabah Market risk Systematic risk
Agency risk
Ijarah Thumma Al-Bay Credit risk Unsystematic risk
Ijarah Wa Iktina Operational risk Unsystematic risk
Payment risk
Salam Delivery risk Systematic risk
Istisna Delivery risk Systematic risk
Bay Al-Enah Credit risk Unsystematic risk
Tawarruq Credit risk Unsystematic risk
Commodity Murabahah Credit risk Unsystematic risk
Source: Rosli and Zaini (2008)

Turen (1996) classify that there are three factors that will influence total risk faced by

the Islamic banks; i) risk originates from the new classification of the deposit holders, ii) risk

in Islamic banks will depend on the level of the coverage of the interest charges ratio(net

operating income over interest charges), and iii) risk related to the new status of the loans

given by Islamic banks. Basically the first and second factor will tend to lower the risk level

in Islamic banks, however third factor which is related to the status of the loans given by the

banks, since Islamic banks also offering loan or financing based on profit sharing it will

increase the risk to the banks.

9
2.3 Credit and Market Risk in Islamic banks

Credit and market risk are the main concern of this paper, because it has been

identified as the main risks that influence banks performance and banks failure. Credit and

market risk fall under financial risk groups in Islamic financial institutions (Iqbal & Mirakhor,

2007).

2.3.1 Credit Risks

Arunkumar and Kotreshwar (2005) found out that credit risk contributes 70% of the

total risk in banks and another 30% is shared by market and operational risk. Commercial

banks managers were aware that credit risk is the big gorilla, completely dominating other

risk types as a source of bank insolvencies (Carey & Stulz, 2005). Khan (2003) claims that

credit risk is the most important source of banking instability and capital is widely recognized

as an effective safeguard against the insolvency of banks. Basel Committee, the international

banking supervisory body also claim that the largest source of serious banking problems is

credit risk, the risk of counter party default.

Credit Risk is defined as risk that the value of portfolio may change due to the

unexpected changes in the credit quality of issuer or trading partner (McNeil, Frey, &

Embrechts, 2005). Marrison (2002), Hull (2007) and Arunkumar and Kotreshwar (2005)

defined credit risk as the possibility of the borrower, bond issuers or counter-parties

defaulting or being unable to meet the contractual obligation and repay back the promised

amount. However, Marrison (2002) groups credit risk into the following groups: i) default on

a loan, ii) a bond issuer who fails to make payment promised to the bondholder and iii) in

trading operation.

Credit risk will exist in almost all of the instruments or products offered by the banks,

the only difference is the degrees of the exposure and how the banks mitigate it. For

10
traditional banking, lending activities is considered as a credit risk business. However, for

Islamic banks, since the lending operations have been replaced with investment and

partnership contracts, credit risk management becomes more important and critical. IFSB 1

(2005) defined credit risk as potential that a counterparty fails to meet its obligations in

accordance with agreed terms. This definition applicable to Islamic Financial Services (IIFS)

managing the financing exposure of receivables and leases (for example, Murabahah,

Diminishing Musharakah and Ijarah) and working capital financing transactions or projects

(for example, Salam, istisna and Mudarabah). For Islamic banks, each type of contract will

result in a different credit risk to the banks profit. IFSB 2 (2005), credit risk exposures in

Islamic financing arise in connection with accounts receivable in Mudarabah contract,

counterparty risk in Salam contract, account receivable and counterparty risk in Istisna

contract and lease payment receivable in Ijarah contract and Sukuk held to maturity in the

banking book. Credit risk management in Islamic banks is more complicated not only due to

the nature of the contract but also due to some additional externalities. For example, Islamic

banks cannot charge a penalty due to default in payment by the counterparty as traditional

banks can charge penalty or overdue interest. This limitation can be misused by the

counterparty and they may purposely default in payment since they know Islamic banks will

not charge anything to them. According to Khan (2003), in the case of Islamic banks

counterparty default risk is the most significant risks and the non existence of financial

remedy for a default except for liquidation and other administrative measures, which do not

compensate the bank, adds a unique dimension to credit risk management in Islamic banks.

Khan and Ahmed (2001) using the judgemental ranking procedures in identify risk

perception by the Islamic bankers to different modes of financing in Islamic banks, it appears

that profit sharing modes of financing; i) Musharakah, ii) Dimishing Musharakah and iii)

11
Mudarabah are perceived to have higher credit risk by the bankers 4. In profit sharing modes

of financing, credit risk appears in the case of counterparties do not pay the banks their due

profit share.

2.3.2 Market risk

Market risk is a risk that a bank may experience due to unfavourable movements in

market price (Greuning & Iqbal, 2008) and it will arise from the changes in the prices of

equity instruments, commodities, fixed income securities and currencies. Refer to IFSB 1

(2005) market risk is defined as the risk of losses in on and off-balance sheet positions arising

from movements in market prices i.e. fluctuations in values in tradable, marketable or leasable

assets (including sukk) and in off-balance sheet individual portfolios (for example restricted

investment accounts). The risks relate to the current and future volatility of market values of

specific assets (for example, the commodity price of a Salam asset, the market value of a

sukk, the market value of Murbahah assets purchased to be delivered over a specific

period) and of foreign exchange rates. Islamic banks are restricted to invest or involved in the

business that has high profile of risks. This limitation will affect the returns of investment for

Islamic banks.

4
Khan (2003) argue that judgemental ranking procedures is an acceptable measure of risk. Indeed most
regulatory parameters such as minimum capital requirement of 5% core capital and 8% total capital and risk
weighting of asset are all based on judgemental.

12
3.0 Research Methodology

Bank Islam Malaysia Berhad (BIMB) has been taken as a sample case for this study.

The reason why BIMB was chosen because BIMB was the first Islamic bank established in

Malaysia, availability of data and BIMB survived through the financial crisis in year 1997 and

the recently in the year 2008.

In order to analyze the risk and return relationship this study used two approaches.

First is financial ratio approach. Return on assets (ROA), return on equity (ROE) and the ratio

of non-performing loan to total loan (CR) and their risk levels are calculated for BIMB and

other conventional and Islamic banks. Standard deviation and coefficient of variation were

used as a proxy to measure risk level. Second approach is stock analysis. In stock analysis,

average annual return, standard deviation and coefficient of variations for BIMB and other

stocks of financial sector listed at Bursa Malaysia (Malaysia Stock Exchange) are calculated

by referring to (Bodie, Kane, & Marcus, 2007)

For prediction analysis, Autoregressive (AR) time series forecasting has been used to

predict the amount of financing for each concept in Malaysia Islamic banks. Three years

monthly data for All Islamic banks in Malaysia are collected from year 2007 to 2009. This

study tries to predict the amount of financing for year 2010.

For financial ratio and stock analysis study, data are gathered for the period of ten

years from 1999 to 2008. The data for financial ratio analysis are collected from Bankscope

database, Malaysia Central Bank Bulletin and annual report of BIMB. In Malaysia there are

23 commercial banks and 17 Islamic banks but due to certain data restrictions only 22

commercial banks and 11 Islamic banks are used as a sample in this study. While for stock

analysis the data are collected from the Datastream advance 4.0. There are 41 stocks of

finance sector are listed at Bursa Malaysia but due to unavailability of stock price data only

28 stocks are selected as sample.

13
4.0 Empirical Result

4.1 Risk and Return of Bank Islam Malaysia Berhad (BIMB)

Three ratio; ROA, ROE and CR have been calculated for BIMB and all commercial

and Islamic banks operated in Malaysia as an industry average. Later the standard deviation

and coefficient of variations are calculated to measure the systematic risk exposure.

Table 3 summarizes the result for ROA, ROE and CR. For ROA the results show that

commercial banks have a higher return on asset (ROA) as compared to Islamic banks, while

BIMB on average showed a negative return on asset. This performance is influenced by the

loss in the year 2005 and 2006. The standard deviation and coefficient of variations (C.V) is

high as compared to commercial banks industry.

As for return on equity (ROE), BIMB and Islamic banks industry have negative

average return on equity and this happen due to the performance of the anchor Islamic bank in

Malaysia which is BIMB. BIMB having huge losses during 2005 and 2006 resulted its total

equity entering into negative zone. It is believed that this loss was due to drop in the real

estate market prices as most of the transactions were being backed by the real estate assets in

absence of effective risk management tools.

The ratio of non-performing loans to the total loans (CR) is calculated to measure the

credit risk level. The higher non-performing loans (NPLs) relative to total loans portfolio will

increase the credit risk exposure in the banks. In table 3, the results show a contradictory

finding with respect to ROA and ROE, even though BIMB has higher ratio of non-performing

loans to total loans as compared to commercial banks, total risk is low as the coefficient of

variations is low. This may be due to the types of loans that BIMB offer and requires another

study to answer the situation.

14
 Table 3: Return on Assets, Return on Equity and Credit Risk Level of Bank Islam Malaysia
Berhad (BIMB), All Commercial Banks and Islamic Banks in Malaysia

ROA ROE CR
Years
All CB All IB BIMB All CB All IB BIMB All CB All IB BIMB
1999 0.94 0.78 0.78 4.95 4.82 4.82 13.98 10.57 10.57
2000 1.06 0.28 0.28 10.44 2.18 2.18 12.51 17.13 17.13
2001 1.03 0.27 0.27 8.57 2.53 2.53 13.41 15.94 15.94
2002 0.94 0.30 0.30 9.29 3.36 3.36 14.16 14.15 14.15
2003 1.09 0.33 0.60 10.84 4.14 7.26 11.50 12.89 15.31
2004 1.27 0.12 0.57 13.94 0.22 6.62 8.07 12.48 15.52
2005 1.19 -1.04 -3.53 13.59 -11.18 -53.64 5.63 10.90 19.94
2006 1.15 -0.57 -8.52 12.74 -57.65 -573.30 5.04 8.74 22.57
2007 0.93 0.75 1.38 11.29 13.94 63.15 4.39 7.50 22.25
2008 1.23 0.64 1.80 15.27 8.45 33.07 3.79 4.22 18.64
Mean 1.08 0.18 -0.61 11.09 -2.92 -50.40 9.25 11.45 17.20
Std.
0.13 0.58 3.13 3.03 20.25 186.00 4.28 3.93 3.73
Deviation
C.V 0.12 3.22 5.13 0.27 6.93 3.69 0.46 0.34 0.22

4.2 Risk and Return Analysis of Bank Islam Malaysia Berhad (BIMB) Stock

Risk and return analysis of stock is another method used to examine the performance

of the banks. Financial statement analysis only gives us a basic overview about bank

performance and risk involved. Turen (1996) explains that banks stock price movements can

be analyzed to access a banks performance and the risk involved. This study determine the

risk and return characteristic of BIMBs stock and then compare it with other stocks of

finance sector listed at Bursa Malaysia(Malaysian Stock Exchange). The average annual

return of each stock was calculated for a period 10 years from1999 to 2008. The average

annual return is calculated by using the following formula 5.

Ri = [(Pt Pt-1) + Ct] / Pt-1 (Equation 1)

5
Gitman & Joehnk (2005)

15
 Where : Ri = Rate of return on common stock (i)

Pt = Market price at the end of period (t)

Pt-1 = Market price at the end of period (t-1)

Ct = Cash flow income received during the (t) period

From the average annual return, standard deviation and coefficient of variations for each stock

are calculated in order to determine the risk and return and the results are exhibited in Table 5.

The results also assign ranking to each stock based on average annual return, standard

deviation and coefficient of variations.

Referring to the average annual return and coefficient of variation performance of

BIMB stock is ranked 25 out of 28 stocks. For the period of ten years, the average return was

just only 5.4% as compared to other commercial banks and companies in the finance sector

that can generate a double digit average annual return. This lower return might be due to the

lower risk activities in the BIMB. As it can be seen from the ranking of standard deviations,

BIMB was in 8th ranking out of total market. Refer to the basic financial theory, lower risk

activities or investment will only generate a lower rate of return. Thus this theory is proven by

the result of this study of the risk and return in BIMB, however referring to the ranking based

on coefficient of variation, BIMB has higher risk in comparison to other companies. The

results suggest that BIMB needs more efficiency in running its operations and managing the

risk involved.

16
 Table 5: Average Annual Returns, Standard Deviations and Coefficient of Variations of
BIMB and Finance Sector Stocks Listed in the Bursa Malaysia Berhad

Stock in Average Coefficient Ranking

Ranking Standard Ranking
Finance Annual of of
of AAR* Deviation of SD**
Sector Return Variations C.V***
AFFIN 0.135 19 0.388 13 2.868 17
AMMB 0.226 10 0.464 16 2.055 13
BIMB 0.054 25 0.296 8 5.482 25
CIMB 0.432 2 0.765 25 1.769 9
EON 0.171 15 0.295 7 1.726 8
HLB 0.311 6 0.481 18 1.545 4
MAYBANK 0.200 13 0.312 10 1.560 5
PUBLIC
0.299 7 0.286 6 0.958 2
BANK
RHB 0.312 5 0.558 21 1.788 10
APEX
0.079 24 0.543 20 6.899 26
EQUITY
ECM
0.271 8 0.948 27 3.495 20
LIBRA
HWANG-
0.146 18 0.480 17 3.284 19
DBS
INSAS 0.094 23 0.495 19 5.242 24
JOHAN 0.044 27 0.579 22 13.242 27
K&K
0.337 3 0.904 26 2.679 16
KENANGA
KAF 0.172 14 0.320 11 1.859 11
LPI
0.259 9 0.281 5 1.084 3
CAPITAL
MBF 0.206 12 0.964 28 4.687 23
OSK 0.313 4 0.749 23 2.391 14
MBSB 0.156 17 0.660 23 4.218 22
BURSA 1.115 1 0.406 15 0.364 1
ALLIANZ 0.208 11 0.332 12 1.595 6
JERNEH 0.050 26 0.148 2 2.949 18
KURNIA -0.113 28 0.054 1 -0.481 -
MAA 0.096 22 0.403 14 4.199 21
MANULIFE 0.113 21 0.224 3 1.984 12
MNRB 0.163 16 0.266 4 1.631 7
TAKAFUL 0.117 20 0.307 9 2.622 15
* AAR (Average annual return).
** SD (Standard deviation).
*** C.V (Coefficient of variations)

17
 Table 6: BIMB and Industry Risk and Return

Descriptive Investment
Banking Insurance BIMB
Statistic Company
Mean 0.230 0.276 0.091 0.054
Standard Error 0.035 0.089 0.039 0.099
Median 0.213 0.206 0.113 0.028
Standard
0.110 0.295 0.103 0.296
Deviation
Sample Variance 0.012 0.087 0.011 0.088
Kurtosis -0.042 8.034 2.723 0.176
Skewness 0.299 2.681 -1.394 0.250
Range 0.378 1.071 0.322 0.964
Minimum 0.054 0.044 -0.113 -0.377
Maximum 0.432 1.115 0.208 0.588
Count 10 11 7 9
Coefficient of
0.478 1.068 1.132 5.481
Variations

From the 28 stocks of finance sector listed at Bursa Malaysia, three industries can be

identified: i) Banking (10 stocks), ii) Investment Company (11 stocks) and iii) Insurance (7

stocks). Table 6 above, summarizes the risk and return for each industry and compare it with

BIMB. From the result, BIMB is having a low average annual return if compared to the

banking, investment companies and insurance. However in terms of standard deviation the

risk is high and is comparable to the investment companies and yet the return is much lower

for BIMB. When we compare in terms of the profit maximization (it can be explained by the

coefficient of variations value), BIMB profit level is not in the maximum level. It probably

due to two factors; first, BIMB has not fully utilized the assets and second, the risk has not

been properly managed.

4.2 Prediction Results for Islamic banks Amount of Financing in 2010

Time series prediction has been used to predict the amount of total financing by

Islamic banks in Malaysia. The sample used for this prediction is monthly amount of

financing for each concept from year 2007 to 2009. The test of unit root using Augmented

18
Dickey Fuller (DF) has been done for all the series and all the series have stationary data.

Then the prediction has been done by using the following equation:

Yt = Yt-1 + (Equation 2)

It is assume that there are no constant value and trend lines in the prediction. Table 4 below

summarizes the result from the prediction. All predications are significant at 95% significant

level. The coefficient value explains the percentage increase in the amount of financing for

each concept. For example, the amount for BBA will increase by 1.0244 for every million

ringgit. Detail amount of prediction for the period of 2010 is in appendix I.

Table 4: Prediction Results

t-
Variable Coefficient Std. Error Prob.
Statistic
BBA(-1) 1.0244 0.0103 99.6221 0.0000
IJA(-1) 1.0418 0.0164 63.4527 0.0000
IJAT(-1) 1.0306 0.0117 88.0247 0.0000
ISTISNA(-1) 1.0155 0.0150 67.7338 0.0000
MBH(-1) 1.0348 0.0145 71.4921 0.0000
MDH(-1) 0.9959 0.0387 25.7582 0.0000
MSY(-1) 1.0746 0.0083 129.0009 0.0000
OTHERS(-1) 1.0287 0.0208 49.5181 0.0000

From the prediction results it indicates that, the amount of all concepts of financing for

Islamic banks in Malaysia will increase in 2010. Musyarakah is one of the concept that

predicted will have very tremendous increase in amount of financing followed by Ijarah and

Murabahah. This prediction results, give a signal that the amount of risk related to that

financing will also increase. Thus it will require Islamic banks to have a better risk

management in order to make sure that the risk is in the minimum level. The risk management

is very important to ensure the survival of Islamic banks in the future.

19
 Figure 1: Prediction Graph for Each Concept of Financing of Islamic Banks in Malaysia

5.0 Summary and Conclusion

Risks in Islamic banks basically will be influenced by three factors. First is due to the

nature of concept of the instruments or products offered by them. For example equity based

financing increases the risk exposure to the Islamic banks. Second is due to the compliance of

Shariah. As Islamic banks operations are bound to the Shariah principle, certain risk

management instrument cannot be used by the Islamic banks such as hedging and credit

derivatives. Lack of standardization and regulations among the countries offering Islamic

banking has also been identified as one of the factor that increases the level of risk in Islamic

banks.

20
 This study has conducted the empirical analysis for BIMB and Islamic banks in

Malaysia by doing risk and return analysis using two approach; financial ratio and stock

analysis. This study also predicts the amount of total financing for each concept for 2010.

From the result of first approach, BIMB are underperforming in comparison to conventional

banks based on their ROA and ROE while also perceive higher risk.

As for stock analysis the results are consistent with the financial ratio analysis, out of

28 stocks of finance sector listed at Bursa Malaysia, BIMB is ranked 25 in terms of average

return for the period of ten year i.e. from 1999 to 2008. The coefficient of variations is also

ranked 25 and it shows that BIMB risk is higher as compared to other stocks. This result is

contradicted with Turen (1996) where he finds that Islamic bank in Bahrain is better than

other banks. This difference might be due to different time period of the study and also

different economic position of both the countries.

The empirical result gives a signal not only to BIMB but also to other Islamic banks in

Malaysia about the risk to be faced by them in future. The forecast for financing show an

increasing trend for each concept and it means that Islamic banks need proper risk

management to cater the increasing demand. Proper risk management is important to make

sure the survival of Islamic banks in the future.

Further study should be done to empirically identify the risk exposure for each

concept of financing in Islamic banks. It is because each concept of financing will have

different type of risk exposure.

21
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23
 Appendix 1: Prediction Amount of Financing for All Islamic Banks in 2010
obs BBAF IJAF IJATF ISTISNAF MBHF MDHF MSYF OTHERSF TFF
2007M01 16144.1 524.764 9520.91 472.828 3385.072 166.412 162.931 6400.671 36777.68
2007M02 15811.77 530.512 9410.573 469.647 3497.779 169.627 162.403 6547.779 36600.09
2007M03 16443.19 1301.008 9420.526 465.256 3701.165 170.543 165.865 6615.272 38282.82
2007M04 16419.53 600.515 10109.38 464.077 3895.402 172.249 202.13 6952.339 38815.62
2007M05 16299.96 616.634 10453.57 464.387 4139.202 116.929 202.92 6850.271 39143.87
2007M06 17682.03 769.223 10595.1 704.267 4747.1 117.363 224.989 4864.53 39704.6
2007M07 17813.15 800.826 10725.4 714.311 4971.668 104.224 178.246 4940.027 40247.85
2007M08 17699.59 810.883 11119.19 717.059 5439.297 106.121 182.785 5091.227 41166.16
2007M09 17914.22 901.465 11277.68 711.707 5661.047 103.179 184.197 5344.003 42097.5
2007M10 18175.93 853.36 11459.92 720.587 5683.135 289.474 189.255 5533.053 42904.71
2007M11 18424.15 968.299 11577.05 769.343 5904.278 335.211 225.547 5622.89 43826.77
2007M12 18478.32 1059.251 11553.1 804.102 8060.085 109.804 314.622 5747.297 46126.58
2008M01 28387.59 1292.888 17710.12 769.222 6789.772 108.582 329.044 12048.44 67435.66
2008M02 27574.23 1362.376 18161.77 1299.731 7419.076 108.087 331.034 12413.29 68669.6
2008M03 27992.26 1440.627 18604.15 1347.993 7600.794 133.442 450.582 12414.36 69984.21
2008M04 27258.72 1459.906 19467.75 1374.356 12229.85 168.23 479.555 11090.43 73528.8
2008M05 27446.22 1521.056 19868.88 1426.37 12714.72 145.688 510.156 11147.49 74780.57
2008M06 27513.25 1570.964 20196.47 1397.829 12881.2 161.133 544.092 11129.5 75394.44
2008M07 27614.19 2008.464 20614.7 1492.668 13751.16 134.06 568.182 11307.42 77490.83
2008M08 29082.04 2260.333 21142.12 1539.578 15390.5 310.207 630.95 12486.92 82842.64
2008M09 29687.19 2409.982 21678.46 1531.949 15127.09 315.069 694.964 12876.52 84321.23
2008M10 30849.85 2455.28 22171.38 1378.534 15267.19 329.302 739.035 13536.58 86727.16
2008M11 33471.92 2672.553 30557.97 1397.398 15603.85 336.427 773.204 15449.33 100262.6
2008M12 34308.14 2741.364 31847.2 1384.229 15847.7 313.987 804.124 16797.85 104044.6
2009M01 35278.33 2809.521 32275.77 1410.41 19556.59 325.18 855.194 12646.15 105157.1
2009M02 35333.69 2883.838 33267.47 1430.244 19170.47 386.71 915.739 13644.59 107032.7
2009M03 35528.49 2945.443 33697.11 1477.293 18580.2 389.292 943.112 13835.61 107396.5
2009M04 36200.44 3025.033 34162.35 1463.387 18100.08 385.691 1018.87 14117.6 108473.5
2009M05 36200.44 3025.033 34162.35 1463.387 18100.08 385.691 1018.87 14117.6 108473.5
2009M06 36667.04 3163.498 35398.93 1468.033 18853.62 442.868 1122.588 15830.68 112947.3
2009M07 38547.38 3188.158 36183.01 1517.591 20235.99 402.985 1198.627 16484.89 117758.6
2009M08 39191.96 3269.413 37538.36 1506.645 20547.08 378.593 1430.613 16930.07 120792.7
2009M09 39184.01 3394.815 37992.68 1421.481 20376.93 376.234 1544.345 17507.18 121797.7
2009M10 39982.44 3368.786 38596.36 1486.106 20759.07 373.025 1657.22 18127.34 124350.3
2009M11 41488.5 3775.543 39084.01 1478.045 23035.31 378.427 1766.749 18547.28 129553.9
2009M12 42732.89 4017.365 38953.25 1486.511 23016.89 375.651 1875.777 20349.61 132807.9
2010M01 43775.98 4185.332 40145.19 1509.482 23818.79 374.0982 2015.666 20933.04 136757.6
2010M02 44844.54 4360.322 41373.6 1532.807 24648.64 372.5518 2165.988 21533.19 140831.6
2010M03 45939.17 4542.628 42639.6 1556.493 25507.39 371.0118 2327.52 22150.55 145034.4
2010M04 47060.53 4732.556 43944.34 1580.545 26396.07 369.4782 2501.099 22785.61 149370.2
2010M05 48209.26 4930.426 45289.01 1604.968 27315.71 367.9509 2687.622 23438.88 153843.8
2010M06 49386.03 5136.568 46674.82 1629.77 28267.38 366.4299 2888.056 24110.88 158459.9
2010M07 50591.52 5351.329 48103.03 1654.954 29252.22 364.9152 3103.437 24802.14 163223.5
2010M08 51826.44 5575.069 49574.95 1680.527 30271.36 363.4068 3334.881 25513.22 168139.9
2010M09 53091.5 5808.164 51091.91 1706.496 31326.01 361.9046 3583.586 26244.69 173214.3
2010M10 54387.44 6051.005 52655.28 1732.866 32417.41 360.4086 3850.838 26997.13 178452.4
2010M11 55715.02 6303.999 54266.49 1759.643 33546.83 358.9188 4138.02 27771.14 183860.1
2010M12 57075 6567.571 55927 1786.834 34715.59 357.4351 4446.62 28567.34 189443.4

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