The impact of credit risk management on profitability of Al Hilal Bank
Literature Review: The impact of credit risk management on profitability of
Al Hilal Bank.”
You must write 10 review for each link and I specified the topic that should write about it
of each link. Of each paragraph first write a small introduction and conclusion . and please
REVIEW OF RELEVANT SOURCES
At least 10 relevant sources including 3 Journals: I already choose the journal, use it when you
write.
The full ten relevant sources including 3 journal articles are reviewed.
Each review is minimum 200 words and has includes an introductory and concluding sentence.
The content of each source is fully discussed including why the source was chosen and how
relevant it is to your research. The Literature Review shows evidence of extensive in depth
research
CONCLUSION
Summary of all evidence from the literature reviews implications for the research stated.
Conclusion shows a full detailed summary of the findings from all sources reviewed and
discusses the suitability and implications for the research question.
Total words 2000
Solution
Introduction
It is clear that banks have been facing one of the major challenges of credit risk that has
impacted their performance negatively. Customers have failed to pay back the loan that the
banks lend them hence increasing the credit risk facing banks. There is the need to understand
the sources of credit risk and available strategies to address them in various banks. The study
will focus on the literature review to understand the concept of credit risk, its impact on Islamic
bank’s performance, the Basel and how the relationship between credit risk and bank’s
profitability.
Literature Review
1-Key factors influencing credit risk of Islamic bank in Malaysia
From a more general view, credit management can be considered as the type of financial
risk that most banks will face in the event they have given out a loan to a customer and that
particular customer fails to pay. This risk is incurred by the bank as loss since the money given
to the client will not be recovered. It is clear that most Islamic banks are equally vulnerable to
the various financial risks. The authors analyzed the credit risk management for a bank loan
portfolio and focused specifically on banks found in Malaysian Islamic bank. The author argues
that credit risk management and its measurement is believed to be one of the areas that
differentiate the theories from practice among the Malaysian banks. The author went on to argue
that the limited data available has made it impossible for banks to implement one of the most
standard models for credit risk. The paper therefore has focused on a simple approach that can be
implemented by banks to measure credit risks and examine factors that would affect credit risk.
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The strategy takes into consideration the correlation between borrowers and the recovery rates.
The study used a key method of research of grouping borrowers in a specific homogeneous class
in terms of risks. The study thus found out that through simulation approach, the banks are in a
better position to obtain their distribution of loan loss and further account for loan concentration
in various identified class of risks (Ahmad & Ahmad, 2004, p. 65). The study was selected
because it highlights the importance of credit risk measurement and management in the Islamic
banks in Malaysia. It further provides an effective strategy that these banks should adopt and
implement to understand their credit risk level and how to manage the risks involved.
2-Financial crisis risks and lessons for Islamic finance
The author focused on the credit risk management in terms of their trends and
opportunities. The failures of risk mitigations have been highlighted as the major cause of the
crisis. It is argued that most financial institutions across the globe are subject to various risks
including credit risk and liquidity risk. In the recent financial crisis, much attention has been
focused on the concept of credit risk. It is argued that following the set principles of Islam
finance would have prevented credit risks in banks. The available risks management approaches
have been argued to be full of shortcomings that should be addressed. The second recession has
been argued that it will make the situation worse hence the need for banks to make risk
management their top priority. It can therefore be argued that banks are continuously finding
new innovative methods that will enable them to manage their credit risk. There is the need to
develop a holistic approach that will take into consideration various factors that might affect the
banking sector. The author has argued that despite credit risk being the primary concern for most
THE IMPACT OF CREDIT RISK MANAGEMENT ON PROFITABILITY OF
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banks, they have not been managed effectively as it should be over the years. There is the need
for the people concerned to come together and develop a strategy that will address credit risk to
enhance the banking profitability (Ahmed, 2009, p. 8). This study was chosen because it outlines
the potential risks that Islamic banks might face and the need for the banks to establish the most
efficient risk management approach to address credit risks in future.
3-How the financial crisis affect the banking sector
A study carried by Investopedia, (2015), argues that financial crisis affects most of the
banking sectors. It is argued that the financial crisis had a greater effect on the banking sector.
Most of the banks lost huge money on the mortgage defaults. Further, credit that was available
for consumers dried up, and lastly, there was the freezing of interbank lending. The long terms
effect on the banking sector can be argued to be related to the established new regulations and
rules. Through Basel iii in the US, it is evident that the financial crisis experienced led to the
huge loss, people lost their confidence in the economy and the share price on the stock exchange.
There have been calls for poly makers to develop strategies and policies that will caution the
banking sector in the second economic crisis. There is the need for strategies that will enable
banks to be prepared in the event of a financial crisis since it has been associated with huge loss
to the banks and loss of confidence in the economy. This study is important and therefore was
selected because it tries to analyze how a financial crisis can impact the banking sector in the
economy either negatively or positively focusing particularly on the Islamic banks.
4-Credit Risk Management in the Indonesian Islamic Banking
The article by Chusaini & Ismal, (2013, p.41), focuses on the credit risk management in
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the Indonesia Islamic banks who are key participants in the financial markets. For over the year,
banks have continued to play a key role in the financial management of the nation. The main role
of the banks is to connect various borrowers to the finance lenders, maintain some significant
level of stability in the market. Most of the banks enter the market mainly to create value. The
author argues that banks will look for approaches that will enable them to manage their risks
while at the same time improve their productivity to create value. The bank will be at risk in case
of default while giving credit to its customers. Credit granting is considered one of the main
sources of the bank’s profitability. To enhance this process, a good credit risk management
would be required to create a balance between the risk of default and profitability. The study
used both qualitative and quantitative methodology. The research found out that credit risk
management plays a key role when the banks are carrying out their lending activities. It was also
found out that the techniques of credit risk management significantly carry from one bank to
another. There is the need for banks to value all the available information about a given customer
because given information that has been neglected can turn out to be the root cause of credit risk.
This paper is important for this study because it focuses on how Indonesian Islamic banks carry
out their risk management activities to enable them remain competitive in the market despite the
high level of credit risk that most banks are facing across the world.
5-Framework for Islamic risk management and Credit Risk Management in Murabahah
Financing
Credit risk management is one of the key processes among various banks across the
globe. This risk management is further managed based on the baseline credit framework
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standards. The authors argued that credit risk is a universal problem to all banks and financial
organizations and can arise from either lending or even investing or even through activities
believed to be off balance sheet. It has been argued that credit risk can also occur from
derivatives. Therefore, with the various sources of credit risk, it is the duty of the business
director to establish a strategy that will be used to manage credit risks within the organization.
According to Academia.edu,. (2016), to control credit risks, there are a number of strategies that
a firm can use depending on its suitability to the firm. They include credit rating system, lending
guidelines, counterparty limits, contraction risk, credit portfolio model, and even monitoring of
the rating systems. The bank can decide to use either of the credit risk control available
depending on their environment and circumstances. It is argued that credit management
techniques that are used by banks are different because the banks have various sources of credit
risks hence the need to adopt and implement a suitable credit control technique to address the
same. This study was selected because it highlights the baseline framework within which credit
risk are managed in the Islamic bank in Indonesia. This framework will be helpful in the
mitigation of risks among banks.
6-Impact of monetary policy shocks on the Islamic banks in a dual banking system and
credit risk management
Credit risk for years has been one of the major challenges that most banks have been
forced to experience. The result of this study therefore showed that there is a positive
relationship between credit risk and profitability. Monetary policy shocks therefore have been
found to have a greater impact on the banking sectors in terms of credit risks. It can therefore be
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argued that most banks in Malaysia tend to enjoy significant profitability despite the existence of
high credit risks. The government often uses monetary policy to control the economy by
reducing the amount of money in circulation. This is very different from various studies that
were conducted in other countries. It can be argued that this is so because of the prohibitive
strategy on lending rates, fees and the commissions that are charged. According to Kassim,
Majid & Yusof, (2009, p.41), it is evident that despite the growing rates of credit risk, a bank can
continue making profits in the economy. This will depend on the charges that the bank will
impose in terms of commission, fees, and the lending rates. This will thus ensure that banks
continue to be competitive in the market irrespective of the economic crisis that would increase
the credit risks in the country. The study is vital since it attempts to highlight the existing
relationship between the rates of profitability and the credit risks of several banks in Malaysia
and how monetary policy can impact Islamic banks.
7-Basel and type of Basel related to credit risk in the bank
According to Investopedia (2007), Basel is considered as a set of international banking
regulation that was established by Basel committee that was in charge of bank supervision. It
thus set out the financial sectors’ minimum capital requirements with the aim of reducing the
level of credit risk. The minimum credit requirement plays a key role when it comes to ensuring
that banks are cautioned in the event of credit risk hence can turn on these amounts to service the
credit risk incurred. Based on this, it was passed that banks should be in a position to operate on
a minimum amount of 8 percent of its capital, and this will be based on the percentage of risk-
weighted assets. Base I is thus the one that is related to the credit risk. The base I was established
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in the year 1988 and was aimed at focusing on the credit risk. Therefore, it was responsible for
creating a classification system for bank asset. The classification system further was used to
group banks into five categories. There is thus the need for banks to maintain a capital (Tier 1
and Tier 2) that is equal to approximately 8 % of the total risk-weighted assets. The study was
chosen because it provides background on Basel and its importance in the control of credit risk
effect. It further highlights the impact of Basel policy and how it has affected the banks in terms
of credit risks.
8-Credit Risks and Profitability of Islamic Banks:
It is argued that credit risks have great effect on the bank’s performance in terms of
losing money to customers who could not pay back, but it has no effect on the banks’
profitability. It has been argued that credit risk might lead to huge loss of money from the
banking sector since the money that was lend to customers will not be recovered. However,
studies have shown that in other countries with better credit rates and fees the bulk of the profits
that are made by most commercial banks are not influenced by credit risk. Banks under Basle II
have been asked to control their level when it comes to nonperforming loans to enable them to
reduce their credit risk. There is the need for the commercial bank to put more emphasis on other
factors that might have an impact on their level of profitability rather than focusing critically on
the credit risk. The bank can increase its profitability by focusing more on the interest charged on
loans, the fees and commission that they will charge. This will ensure that banks continue to
make profits despite the high rates on credit risks (Sundararajan, 2007, p. 121). This was selected
because it aims at understanding the impacts that a credit risk might have on the banks
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profitability. It shades light on how the credit risk that is often faced by most banks affect their
profitability.
9-Risk Management Strategy in Islamic Banks
The study by Asian Institute finance (2016), focused on research using an empirical
investigation that analyzed the quantitative effect of banks credit risk. It is argued that credit
risks had a tremendous effect on the bank performance in Asia. Further, the study used the
traditional profit theory to formulate profits for these banks. The result from the study showed
that the effect of credit risk is significantly a cross-sectional invariant. This implies that the credit
risk effect is similar to all the banks in the country. There is the need for the banks in Asia to
enhance their capacity when focusing on the credit risk analysis in addition to the loan
administration. Further, there is also the need for the regulatory authority in Asia to pay closer
attention to what can be defined as the bank compliance to the provisions provided in the Bank
and other financial institution of the year 1999. Therefore, it can be argued that credit risk is a
universal problem across all banks, and further the effect of the risk is similar to all banks.
Therefore, there is the need for the policy makers to come up with a strategy to ensure that the
banks comply with the provision and set guidelines for their operation. This study is vital since it
highlights the various credit risk management strategies used in the Asian banking sectors and
further, how successful they have been addressing the risks.
10-Islamic modes of finance, associated liquidity risks and mitigation steps
Mitigation of the credit risk is one of the great aims of most banks in the world. There is
the need for firms to come up with an effective procedure when it comes to mitigation of credit
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risks. It is argued that loan portfolio often has a greater impact on the risk profile of a bank.
Therefore, there is the need to develop strong credit cultures that enhance the productivity of the
banks and its level of competition in the market. The first step is written credit policies that will
address both the residual and inherent risks when it comes to lending. Standardized credit
packages should be developed and ensures that they are uniform. The third step is experienced
underwriting when it comes to credit policy and the risk guidelines for the firm to understand the
degree of risk. Loan approval authority and well-managed credit risk rating also promote the
safety of the banks since they will facilitate what can be considered as informed decision-
making. Accurate loan documentation should be adhered to in addition to monitoring of the loan
performance in the economy. There is the need for banks to have adequate loan loss reserve that
will aid in covering for any potential loss. Lastly, there is the need for banks to have an
independent loan audit to track the credit risk and impact over time (Ali, 2004, p. 14). This study
is believed to be crucial since it tries to set out effective steps that banks should follow when
mitigating their credit risks. It thus focuses on key steps that Islam banks should adopt in order to
remain competitive and continue making profits.
Conclusion
From the above analysis of literature review, it can be argued that credit risk is one of
the main problems that have been facing most banks and financial sectors globally. Research has
shown that credit risk has an impact on the banks operation and productivity, but this has very
little impact on the banks profitability. Basel I was established to focus on the credit risk hence it
sets out a minimum capital requirement for commercial banks. Therefore, it is evident that credit
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risk has an impact on the bank performance hence the need for banks to develop a credit risk
management strategy that will fit the bank. The credit risk effect is similar to all banks hence the
need for policy makers to come up with the most effective strategy that will fully address the
impact on banks.
References
Ahmad, N. H., & Ahmad, S. N. (2004). Key factors influencing credit risk of Islamic bank: A
Malaysian case. The Journal of Muamalat and Islamic Finance Research, 1(1), 65-80.
https://www.researchgate.net/profile/Shahrul_Nizam_Ahmad/publication/228423667_Key_facto
rs_influencing_credit_risk_of_Islamic_bank_A_Malaysian_case/links/02bfe50e900fe6e53b0000
00.pdf
Ahmed, H. (2009). Financial crisis, risks and lessons for Islamic finance. ISRA International
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https://www.researchgate.net/profile/Habib_Ahmed3/publication/228337197_Financial_crisis_ri
sks_and_lessons_for_Islamic_finance/links/5553204208aeaaff3bf01354.pdf
Academia.edu,. (2016). The current risk management framework in use by Islamic Banks can be
improved. Improvements made are essentially beneficial to the global financial system.
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global_financial_system
Asian Institute f finance. (2016)Risk Management In Islamic Banks. Retrieved 13 February
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Ali, S. S. (2004, February). Islamic modes of finance and associated liquidity risks. In
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http://www.sbp.org.pk/departments/ibd/lecture_6_islamic_modes_finance_liquidity.pdf
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Kassim, S. H., Majid, M. S. A., & Yusof, R. M. (2009). Impact of monetary policy shocks on the
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