Impact of Risk Management on Bank Financial

Stability

YUMNA MUGHAL 14-ARID-1684

NOUMAN MEHMOOD 14-ARID-1669
HASHIR ALI 14-ARID-1643
M OMER SULTAN 14-ARID-1660

Supervised by: Mam BUSHRA ZULFIQAR

UIMS-PMAS Arid Agriculture University

Rawalpindi, Pakistan
Introduction
Background
 Pakistan in total has 38 commercial banks with 8400 branches, 19 foreign banks, 4
nationalized, 11 private, 2 privatized and only 2 provisional banks existing.
 Following Basel I (1988) and Basel II (2004), a broad measure of change to strengthen
risk control, oversight and administration within the savings sector.
 The fundamental target of the Basel II Accord is to upgrade the security and soundness of
the worldwide saving money framework; specifically by fortifying danger administration
practices
 The BCBS (Basel committee on banking supervision) has third pillar in unique basal
agreement (basal II) issued in june2004 as a result of market reach, which is consistent
with the Islamic banks.
Problem Identification
 Risk is said to be the insecurity in banks financial positions. It is not only the occurrence of
unhelpful outcomes but unexpected positive outcomes are also a form of risk.
Research Gap
 Main purpose of our research is to examine the effect of different type of risk associated
with banks which are credit, liquidity and operational risk on bank stability.
 Previous researchers take very small size of bank and there time period is also small.

2
 Variables Introduction

A borrower fails to make the required portions.

Bookkeeping based credit scoring framework is another method used to gauge
Credit Risk
the effect of credit risk on bank money related security.

Company or bank may be unable to meet short term financial demands.

The value stays dangerous because of depleted deals conditions, while selling
Liquidity Risk
any of the advantages instantly.

Caused by the genuine misfortunes brought about for insufficient or

fizzled procedures.
How banks can develop a conceptual and practical framework to
Operational Risk cope with operational risk.
The development of causal models and hedging programs for
operational risk.

3
 Variables Introduction

Taiwo(2014) find that bank liquidity has a non-vital negative effect on capital as
a measure of size.
Bank Size
In 1996 to 1998 the equity volatility at large banks is significantly smaller than
(control variable)
at small banks and in 2000 to 2003 the opposite is true.

The asset utilization ratio calculates the total revenue earned for every dollar of
Asset Utilization assets a company owns
Ratio. Higher the benefit use means the bank capacity to reimburse its advances is
higher, which lessens the level of non-performing credits (NPLs).

The ratio between the liquid assets and the liabilities of a bank or other
institution.
Liquidity Ratio
The higher the liquidity scope extent shows the low level of liquidity risk anyway
it may extend the credit and operational danger

4
 Variables Introduction

The loan-to-deposit ratio is used to assess a bank's liquidity by comparing

Loan to Deposit
a bank's total loans to its total deposits for the same period. This number
Ratio
is expressed as a percentage.

The reserve requirement (or cash reserve ratio) is a central bank

Reserve regulation employed by most, but not all, of the world's central banks, that
Requirement sets the minimum amount of reserves that must be held by a commercial
bank.

What is a 'Leverage Ratio' A leverage ratio is any one of several financial

measurements that look at how much capital comes in the form of debt
Leverage ratio
(loans), or assesses the ability of a company to meet its financial
obligations.

5
 Variables Introduction

Provisioning Coverage Ratio (PCR): The ratio of provisioning to gross

Provisioning
non-performing assets. Indicates the extent of funds a bank has kept
Ratio
aside to cover loan losses.

Capital Adequacy Ratio (CAR) is also known as Capital to Risk (Weighted)

Capital Assets Ratio (CRAR), is the ratio of a bank's capital to its risk. National
Adequacy Ratio regulators track a bank's CAR to ensure that it can absorb a reasonable
amount of loss and complies with statutory Capital requirements.

6
 Need of the Study
Due to global financial crisis, investment decisions are considered as the important tasks in daily
life. For this reason, it is necessary to understand various factors which prompt individual
investors to make investment decisions.

Effect of psychological factors along with demographic factors should

(Rana et al., 2011)
be examined to determine their influence on investor behavior.
There should be transparency, timely spread and asymmetry of (Mahmood et al., 2011;
information about all the listed companies for every investor. Wang et al., 2006)

There is a need to examine the impact on investment decisions by (Singh, 2012; Edwards et
varying framing and perceptions. al., 2002)

(Mahmood et al., 2011;

The independent impact of risk propensity and problem Framing on
Rana et al., 2011; Chou et
risk perception should be studied. al., 2010).

Empirical testing of these relationships should be done to determine

(Mahmood et al., 2011)
the true effect of these factors on investment decisions.

7
In the case of Pakistani Stock Market it is observed that while making any financial
decision an investor perceives to invest in those stocks where investor assumes
low risk and high benefits according to his/her own perception and available
information.

much information is available

How it is being presented True intention of this study
the risk is being perceived
Whether willing to take risk

Problem Statement
Although traditional finance theory always suggests that investors’ investment
decisions are based on their objective evaluation of risks and expected
returns, psychological factors towards perception of risk may play critical
role in investors’ investment decisions in Pakistani stock market.

8
Objectives:
The research has following objectives:
 To examine the impact of liquidity risk on Bank financial stability.
 To examine the impact of credit risk on Bank financial stability.
 To examine the impact of operational risk on Bank financial stability.
 To check the relationship between liquidity risk, credit risk and operational risk.

Significance:
 Our study will also beneficial and useful for banking sector of Pakistan, to
view the significance of regulations developed by Basel committee in
relation to achieve efficiency through proper managing and reducing risks.
 Risk management is concepts in which we are find the difference between
credit risk, liquidity risk and operational risk.
 Although this study is based on the determination of risk in the financial
sectors.
 The study is based on the risk management of commercial it is the key
source for the Pakistani Banks to take better steps to decrease the risks in
the Banks.

9
 Literature Review
Relationship Literature Findings
Funfgeld and Wang, 2009; Wood and Zaichkowsky, 2004; Attitudes towards risk can
Risk Propensity and
Rohrmann, 2002; Weber, 2001; East, 1993; Sitkin and Pablo, be quite influential in
Investment
1992; Davis-Blake and Pfeffer, 1989; Schneider and Lopes, 1986; explaining an individual’s
Decisions
Vlek and Stallen, 1980; Brockhaus, 1980; Markowitz, 1952 investment behavior
Singh, 2012; Singh and Bhowal, 2010; Xiao et al., 2003; Edwards
Problem Framing et al., 2002; Kuhberger et al., 2002; Druckman, 2001; Kuhberger, Differences in investor’s
and Investment 1998; Tversky, 1992, 1986, 1981; March and Shapira, 1987; Staw behavior based on
Decisions et al., 1981; Sitkin and Weingart, 1995; Kahneman and Tversky, framed information
1979
Information flowing
Information
Mahmood et al., 2011; Akhtar et al., 2011; Nwezeaku and Okpara, towards the stock
Asymmetry and
2010 ; Baik et al., 2010 ; Wang et al., 2006; Cheng, 2003; markets play a critical
Investment
Warneryd, 2001 role while making
Decisions
investment decisions

Chen and Tsai, 2010; Singh and Bhowal, 2008; Pennings and Investor decision-making
Risk Perception and
Wansink, 2004; Hallahan et al., 2004; Weber, 2001; Slovic, 2000; process is greatly
Investment
Weber and Hsee, 1998; Weber and Milliman, 1997; Adams, 1995; affected by the risk
Decisions
Fischhoff, 1994; Weinstein, 1989; Slovic, 1972 perception

Mahmood et al., 2011; Rana et al., 2011; Okpara, 2010; Lu et al.,

2010; Chang et al., 2008; Singh and Bhowal, 2008; Fischer and Mediator variable strongly
Mediation Impact of
Jordan, 2006; Xiao et al., 2003; Sitkin and Weingart, 1995; Sitkin predict the risky decision-
Risk Perception
and Pablo,1992; Jackson and Dutton, 1988; MacCrimmon and making behavior
Wehrung, 1986; Staw et al., 1981;

10
Theoretical Framework

Independent Variables: Capital Adequacy, Provisioning, leverage, Reserve Req.

Loan to deposit, Liquidity, Asset utilization and Bank size
Dependent Variable: Credit risk, liquidity risk and operational risk.

11
Hypotheses Statements

Main Research Question

 What is the impact of risk management on bank financial stability?
 What is the impact of liquidity risk on Bank financial stability?
 What is the impact of credit risk on Bank financial stability?
 What is the impact of operational risk on Bank financial stability?
 What is the relationship between liquidity risk, credit risk and operational risk?

Hypothesis

 H1 = Credit risk has significant and positive/negative effect on bank financial stability.
 H2 = Liquidity risk has significant and positive/negative effect on bank financial
stability.
 H3 = Operational risk has significant and positive/negative effect on bank financial
stability.

12
Materials and Method

 For this study, the population is the banks listed in State Bank of
Pakistan.
 We are using the sample of 24 listed banks.
 Data is collected from the annual reports of banks for the time
period of 7 years from 2011 to 2017.
 There are total 168 observation in our research.

13
 Instrument And Measures/ Research Tools

Variables Measure Source

Credit Risk Total debts / Total assets

Liquidity Risk Total capital / Total assets

Operational
Net income / Total assets
Risk
Capital Tier1 capital + Tier2 capital / Risk
Adequacy weighted assets
Provisioning
NPLs / Total loans
Ratio
Leverage Elbadry (2016)
Deposits / (Capital + Reserve)
Ratio
Reserve
(Reserve / Deposit) * 100
Requirement
Loan to
Total loans / Total Deposits
deposit Ratio
Liquidity Ratio Liquid assets / deposits
Asset Utilization
Operating income / total asset
Ratio
Bank Size Log of total assets
Correlation

CR LR OR CAD PR LVR RR LD LIQ AS BS

CR 1
LR -0.54860 1
OR -0.29480 0.44406 1
CAD -0.70160 0.82341 0.28610 1
PR -0.10311 -0.10050 0.05277 0.43870 1
LVR 0.35342 -0.43583 -0.21426 -0.37478 0.54730 1
RR 0.10072 -0.08275 -0.03998 -0.08687 -0.01426 0.18730 1
LD -0.07460 0.04391 -0.08095 0.01690 -0.12001 0.01933 0.36920 1
LIQ -0.09705 0.16985 0.10354 0.16199 -0.03478 -0.10330 0.03180 -0.22840 1
AS -0.12203 0.16173 0.62125 0.12446 0.02764 -0.09130 -0.04230 -0.08520 0.32839 1
BS 0.23770 -0.21053 0.33567 -0.29451 -0.20120 -0.00640 -0.06800 0.02051 -0.01120 0.45700 1
 Relationships
• 0 to 0.19 = very weak
• 0.20 to 50 = weak
• 0.50 to 0.80 = strong
• 0.81 to 1 = very strong

15
Regression Analysis of Credit Risk

Model Summary
• 55% of our variables are
defined in our research.
• The value of F-statistic
is 28.32 which model is
significant 16
Regression Analysis of Liquidity Risk

Model Summary
• 39% of our variables are
defined in our research.
• The value of F-statistic is
25.40 which model is
significant 17
Regression Analysis of Operational Risk

Model Summary
• 45% of our variables are
defined in our research.
• The value of F-statistic is
85.63 which model is
significant 18
Discussion and Findings

Findings Support
the positive and significant effect of Capital adequacy ratio on
Credit risk and there are positive and also significant effects of
Elbadry (2018), Eric (2015)
Reserve requirement, Asset utilization and bank size on credit
risk.
the negative and significant effects of provisioning ratio and Loan
to deposit ratio on Credit risk. Higher level of these ratios Masayasu (2015).
weakens the level of Credit risk in Pakistani banks.
the negative and significant effects of Provisioning ratio,
Leverage ratio and Bank size (taking as control variable) on Elbadry (2018), Caroline (2017)
Liquidity risk.
The ratio of Capital adequacy ratio, Reserve requirement and
Eliza (2016), Fauziah (2018).
Liquidity ratio has significant and positive effect on Liquidity risk.
the positive and significant effect of Capital adequacy ratio,
Reserve requirement, Loan to deposit ratio, Asset utilization ratio James E. (2016), McNulty (2016), Souhir
and Bank size on Operational risk and also negative and (2017), Kerstin (2016).
significant effect of Provisioning ratio on Operational risk.

19
Conclusion
 The study explains the effect of the independent variables on the dependent
variables and how they affect the liquidity of Pakistan's banking sector.
 Based on our findings, we conclude that our result has a significant and
positive effect of CAD on CR. There is also an insignificant and positive of LVR
on credit risk.
 We can conclude that there is a significant and positive relationship of the
reserve requirements, the LIQ and the size of the bank on the LR. There is
also significant and negative relationship of LVR on LR.
 Operational risk is the positive and significant effect of solvency ratio (CAD),
reserve requirements, loan-to-deposit ratio, AU and the size of bank on
operational risk whereas provisioning ratio leverage ratio and liquidity ratio has
negative effect on operational risk.
 From all of the above, we can conclude that liquidity ratio, the size of the bank,
RR, LD, and solvency ratio (CAD) have a great impact on our dependent
variables that are CR, LR and OR.

20
Limitation & Future Research Areas

 In this research the data from annual reports of commercial banks is used, only
focus is on commercial banks of Pakistan.

 The study can be further expanded in the future by using Islamic banks and
micro finance banks.

 May examine other variables that can effect the bank financial stability.
 Bank should control its probability of risk by using some proper tools
recommended by State Bank of Pakistan.

21
Thank You !

22