Risk Management:Our Taste Version (1)

The Impact of Credit Risk Transfer on Islamic
Banks Lending Behavior and Financial Stability
Abd elrahman Elzahi Saaid Ali
Rajab 15, 1433H | June 5, 2012


7. Conclusions and Policy Implications

This study investigated the impact of credit risk transfer on Islamic banks lending
behavior and financial stability. The recent financial crisis has further increased the
interest to investigate credit risk management techniques in banks in general and Islamic
banks in particular. The behavior of credit risk transfer of the commercial banks has been
thoroughly studied in the conventional banks’ framework but little attention has been
paid to the credit risk transfer behavior of Islamic banks. Therefore, this research was to
fill the gap. Data collected from 60 Islamic banks was analyzed in a panel-pooled
framework to investigate the behavioral impact of credit risk transfer.
Most of the estimated variables such as the Islamic banks’ total lending (TL/A),
equity capital to assets ratio (CAP/A), liquidity to assets ratio (LIQ/A), profitability ratio
(ROA), and credit risk transfer (CRI) proxy by dummy variables, gross domestic product
(GDP) and the exchange rate (EXR) were significant either at 1% level or 5% level, with
the expected signs.

The research found that Islamic banks with low capital might adjust its lending by
reducing its assets up to the required level rather than raising it. This is due to the cost of
acquiring additional capital. Likewise, Islamic banks might reduce its lending portfolio
when fall short in liquidity level to maintain its liquidity equilibrium in order to meet the
expected obligations. However, this might shrink their volume of lending.
As explained before, the study has attempted to capture the impact of credit risk
transfer on the lending behavior of Islamic banks through a proxy of dummy variables
which have been found to be positively related. Credit risk transfer and banks’ lending
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behavior shows that those Islamic banks would show risk averse when some sorts of
credit risk management techniques are used. These results were consistent with previous
findings regarding conventional banks which behaved more aggressively by granting
more loans when it used advanced risk management techniques. Hence this study
concludes that there is no significant difference between Islamic banks’ behavior and that
of its conventional counterparts when both use modern risk management. Since, Islamic
banks were using less modern credit risk transfer techniques at the time when the
financial crisis hit the entire globe; therefore, they remained relatively stable during the
recent financial crisis.

8. Lessons learned:
1. Using more risk management techniques might lead to more credit risk as the banks
become less risk averse in lending by granting more loans.
2. Banks whether conventional or Islamic need to pay more attention and behave rationally
when they use modern risk instruments to manage their credit risk.
3. Islamic banks have shown resilience and stood relatively stable during the recent
financial crisis because they seldom use modern credit risk management instruments like
financial derivatives which have been found as one of the causes of the crisis.
4. Islamic banks need to be very selective when chose one or more credit risk management
tools to mitigate their risk.
5. To avoid the risk of financial instability, bank regulators are advised to monitor Islamic
banks more closely when they use modern risk management instruments.