Risk Management in
Islamic Financial Instruments
62
CHAPTER 4: COMPARATIVE ANALYSIS OF RISK MATRICES
FOR ISLAMIC AND CONVENTIONAL BANKS
This section begins with a brief description of the risk matrices that are used in analyzing the
risk management of conventional and Islamic banks from different geographic regions. Later, a
brief discussion is provided on the methodology of sample selection. Then, the following
section presents a comparative analysis of risk management for conventional and Islamic
banks across the geographic regions. Finally, similar comparative analysis of risk management
for conventional and Islamic banks is provided for five major Islamic finance markets:
Malaysia, Turkey, United Arab Emirates, Kingdom of Saudi Arabia and Bangladesh.
4.1 BRIEF DESCRIPTION OF RISK MATRICES
Risk matrices provided by the BankScope Database can be broadly categorized into four major
types: a) Asset quality ratios, b) Capital Adequacy ratios, c) Operational efficiency ratios, and d)
Liquidity ratios. While 35 risk matrices are computed in process of risk analysis, only the
major risk matrices under each category are presented in this report. The following discussion
is a brief overview of the risk matrices used later.
Asset Quality Ratios24
 Loan Loss Res/Gross Loans: The loan loss reserve over gross loan ratio indicates
how much of the total portfolio has been provided for, but not charged off. It is a
reserve for losses expressed as percentage of total loans. Given a similar charge-off
policy, the higher the ratio, the poorer will be the quality of the loan portfolio.
 Loan Loss Prov / Net Int Rev: Loan loss provision over net interest revenue
presents the relationship between provisions in the profit and loss account and the
interest income over the same period. Ideally, this ratio should be as low as
possible. In a well-run bank, if the lending book is higher in risk, this would be
reflected by higher interest margins. If the ratio deteriorates, this means that risk
is not being properly remunerated by margins
 Loan Loss Res / Impaired Loans: The loan loss reserve over impaired loans
(non-performing loans) ratio relates loan loss reserves to non-performing or
impaired loans. The higher this ratio, the bette the bank is and the more
comfortable we will feel about the assets quality.
 NCO / Net Inc Bef Ln Lss Prov: Net charge-off over net income before loan loss
provision ratio is measured similarly to charge-offs, but against income generated
in the year. The lower this ratio, the better, other things being equal.
Capital Adequacy Ratios
 Equity / Tot Assets : This ratio measures the ability of the bank to withstand
losses. A declining trend in this ratio may signal increased risk exposure and
possibly capital adequacy problem.
24 All definitions of Asset Quality, Capital, Operations and Liquidity were obtained from the BankScope database