The speedy and active changes in the global financial countries different risks to banking institutions. All the activity business with conventional banks and Islamic banks are equally for face their risks. Yemen's Islamic financial institutions in future will depend on how well they can manage the credit risks. In this paper investigates how the factors affecting credit risk, being with the first risk faced in banking institutions with systematically identifies the key factors affecting credit risk knowledge in Yemen's Islamic banking operations. A comparison of these factors that affect credit risk between conventional and Islamic banking operations is highlighted. And also there is many policy implications are addressed to promote in Islamic banking industry for risk management.
CHAPTER ONE
1-0) Introduction:
According of the last ten years, the products of Islamic banking and finance has high demand and grown strongly. The Islamic financial markets had more than $263 billion from 265 banks with their assets and more than $400 billion of investments (IOSCO, 2004)[1]. of mode profit and loss sharing (PLS) Islamic savings, savings account and investment products that have proceeded to hedge bonds, derivatives and funds. Islamic banking products now proliferation to longer than 50 countries, including Europe and USA is comprehensible as international banks that can get a lot of profit opportunity by needs of the Muslim population in Asia, Middle East and somewhere else for banking services.
The active and rapid changes in the global financial markets give to banking system traditions various risks. The conventional banks, Islamic banks are not same but equally for exposures to risks. The exception in Islamic banking in Yemen is unique due the nature of risks that facing them. This uniqueness came from its assets and liabilities of the banking system in Yemen. On the asset side of Islamic bank, all the funds that invest with Shari'ah, can be commenced in the form of profit and lose sharing modes of financing like (Mudarabah and Musharakah), Salam /Istisna (object to deferred sale in future or prepaid for sale) and leasing (Ijarah), installment selling (medium or long term murabahah), Murabahah financing modes as fixed-income (cost-plus profit). On other side, of liability side, the deposits in Islamic banking can be in the form of investment account or in current account. In Islamic bank for the depositors that deposits in investment account can get rewarded with the opportunity to share the profits or losses of investment project with the bank, but for depositors in current account can get their deposits on demand. And the different character of its liability and assets composition and the loss and profit sharing basis will change always the character of risks that Islamic banks face.
One of the leading risks that affect seriously of bank's viability is the credit risk as evident from the wave of Bank's bankruptcies in the globe. Khan and Ahmed (2001) realize opinion of some bankers that there is misunderstanding of risks concerned in Islamic banking. Further, Sarker (1999) found in Islamic banking that the amount of bad debts is growing. This different supports the new productions to study as to why increasing the bad loans and high credit risk in Islamic banking experiences, also including an investigation on credit risk's factors that affect Islamic banking. For guarantee of Islamic banks' sustainable growth and viability are maintained, better to recognize these factors early to ensure preventions and necessary precautions are taken. It is attempts' modest in this research to (1) study the factors of credit risk that affect Islamic banking in Yemen (ii) identify if there is any difference among credit risk determinants of conventional banks and Islamic banking in Yemen.
1-1) Background of Islamic Banking Systems in Yemen
The Islamic Bank of Yemen for Finance and Investment, a Yemeni shareholding corporation (YSC) (The Bank), was incorporated on 25 April 1995 pursuant to the Minister's of Trade and Supply Command No. 138 of 1995. The Bank started operations on June 8 1996. In accordance with article no. (26) Of Law no. (21) For the year 1996 with regard to Islamic banks, the Bank is authorized to the privileges, and exceptions stipulated in the Investment Regulation. The Banks was substantiated for the purposes of covering the social and economic needs in investment, finance and banking services in conformity with the principles of the Islamic Shari a.
In 1996, start Islamic finance and banking in Yemen with the establishment many of Islamic Banks of Yemen. The Islam worldwide has covered by growth of Islamic banking services and products, many people intentionally seeking to do their business accordance with the Shariah. Side by side with the global trend, Yemen's Islamic banking has achieved a speedy expansionary appearance since it's established in 1996. The attendance and it's good performance make Islamic banking as an alternative for banking system with well growth potential, in current time, Islamic banking become trademark among many countries.
The number of Islamic banks has increased since 1996 to become four Islamic banks at the end of 2006, with allowing foreign banks to offer Islamic banking window to provide products and services accordance with shariah. Financing of Islamic banking grew from YR 290 billion in 2000 to YR 753 billion of the total deposits by December 2005, also for the stock market (represented increase of loans percentage over the total loans of banking system) from 0.3% in 1996 to 9.7% in 2005.
with increase the establish of a second Islamic bank and players, the Islamic banking become more stable for the growth's future and competing strongly with the conventional banking, especial in provide financing to customers. These moneys will improve the different economy's sectors in the country.
In bank's conventional, increased the funds are loan, financing or advances to customers. These are credit risk and interest-based is come completely from conventional bank. But in Islamic banking, the activity business provide to customers is base on modes al-murabahah and ijara wa iqtina that mostly as credit sale, which mean islamic bank will buy goods on a cash and sell on credit to customers. more than 90 percent of the total assets in Yemen is base on mode of financing known as (cost-plus profit) accounts. And financing of profit sharing (Mudarabah and Musharakah) represent the second largest financing in Yemen. The profit and loss sharing between the Islamic bank and his depositors try to absorb the credit risk, not like conventional banks.
1-2) Problem statement:
In ancient communities, they knew well the meaning of risk in their lives. even when they make their financial decisions, a lot of people know that lending money to somebody who is bankrupt will get high probability of losing the money but different position will be if debtor in good position. Nevertheless, making decision became possible with tool's risk because possible to measure it and to assign values with different circumstances.
Previous studies have concentrated on factors of risk that affect financial institutions in the conventional banking system (Hassan, 1993.1994, Khan and Ahmed, 2001, Berger and DeYoung, 1997; Angbazo et al., 1998 and Ahmad, 2003).
Trustee of public funds is the bank; it must use these funds to defend the rights of holders of these funds. Therefore, the risks underlying Islamic modes of financing are very important in Islamic banking base on the comparative studies.
And its importance for achieving good risk management in an Islamic banking sector, like these factors still not widely studied and documented. Some previous attempts to research on Islamic finance in other countries like Malaysia evolve mainly on conceptual issues underlying the interests of the free system (Bashir and hassan, 2002).
And the question of Islamic bank's viability does not have a lot of attention. Thus, the Islamic finance and banking with it's the unique nature and dynamic for develop of global financial markets, which get many risks that can face them, so will be important to identify the key factors that affect the information of risks in Islamic banks- a that has not been widely studied
1-3) Research Questions:
What is the credit risk among the Yemeni Islamic banks?
What are the factors that affecting the credit risk management in Yemen?
How much he Yemeni environment affecting the Non- performing loan in the Islamic Banks?
1-4) Research Objectives:
To determine the credit risk among the Islamic banks in Yemen.
To study credit risk's factors that can affect the Islamic banking.
To investigate if certain factors (Top Management, Non-Accounting, organizational size, IT, and product diversity) have any influence in the
Islamic banks in Yemen for credit risk.
CHAPTER TWO
2-0) Literature Review:
With increase for developed phenomenally of Islamic banking in current years not just for Muslim countries, but also for others countries (Wilson, 2007). Even with continued growth of Islamic banking, but still there some skepticism if it's be able to manage and control with standards of international banking in the world. They will be needed to comply for risk measurement and capital competence with standardized approach in Islamic banking as in the Basel II accord.
On the one hand, the existence complacent in Islamic banks are perceived, because the believing in Muslim masses as captive market which will come to Islamic banking on religious grounds to avoid riba, but for non-Muslim customers interested to invest their money in organizations that conceded as ethical in their activities the Islamic banks will lose them (Haniffa and Hudaib, 2007). On the other hand, as we note in general, there is lacking professionally of identification processes for managed risk and approaches of credit risk management in Islamic banks, which make the Islamic banks move slowly, that let the activities to be in short-term loans instead of long-term activities (Hassan and Dicle, 2006).
Credit risk activities are an everyday thing to every person, firm or organization. No business can operate successfully in a free society without taking in their business some risks. Financial intermediaries play very an important role in almost of the business country and often serve as strong indicators of its economic development.
Along with the fast growing banking condition and environment, both externally and internally, Islamic banks as intermediary institutions will always face various risk factors at varying complexities inherent in their business activities. Risk in the context of banking represents probable events. Whether or not the events can be anticipated, they have the potential to impact adversely to income and the capital of the bank.
In search of Islamic financial institutions in 28 countries and Ahmed Khan (2001) found in Musharkah is higher of credit risk (3.68 from 5) and the second high credit risk come from Mudarabah (3.24 of 5). Some bankers show results of higher credit risks come from profit and loss sharing modes. And with mark-up risk is more from contracts Istina (3.57) in deferred revenue. Errico and Sundararajan (2002) show the profit and lose sharing modes in Islamic banks for credit risk can move direct to their investment depositors, they can also increase in the bank asset side that associated with the level of risk, because the property is uncollaterised under this mode. In the total assets should normally riskier assets be higher ratio in an Islamic bank than traditional banks, this is deductive intuition.
Sam ad and Hassan 1998) examine in Malaysia about Islamic banking showed that the risk performance from 1984 to 1997 measured in the risky business by the debt to total assets (DTA), debt ratio (DR) and multiplier gain (MG) over the years has risen. EM and DER are importantly for get more profit.
In study for conventional banks, with the Bank Pertanian Perwer Affin Bank, show in Islamic bank the risk is lower. Because in Islamic bank the risk is low than conventional banks in its government securities investment is higher. As for conventional banks, Brewer, Jackson and Mondschean (1996) come upon the risk that connected with loan sectors. Investment in service corporations, real estate loans and Fixed-rate mortgage loans are found to be meaningful but with risking of the negatively position. But for the mortgage loan that non-fixed rate is, nevertheless, important and positively related to risking.
the Islamic banking in Iranian in a study over 1984-1994 years, found the supply of loan in total deposits dependent on the modifications, that change the period of delay the variables and change the inflation rate, but with different economic sectors the change that expected to get return on loans it is not related to that variables. Makiyan (2003)
Rose, 1996:196) with provision loan loss to measure the average of the outstanding loans found in banking literature is as agent for credit risk. Ahmed (1998) fined the meaningfully and positive loan loss provision is associated with net profit loss, the reason when loan loss provision is higher, its increase in breakdown in loan quality and risk. Ortiz, Fishe and Gueyie (2001) get the similar results for loan loss provision to be total loans that will give us risking with positively related to it. Also have been recognised the size of (LOGTA), and get significantly and negative related to risking.
CHAPTER THREE
3-0) Research Design:
This chapter described the research methodology of study and it divided into three, namely (a) Data collection (b) the frame work (c) the model use (d) Research hypothesis
3-1) Data collection:
The data that we collect come from conventional banks and Islamic banks in Yemen. the annual reports is the data that we will collect from Islamic banking as Tadhamon International Islamic Banks (Yemen ) and financial statements of four other banks - Saba'a Bank, Yemen and Bahrain Islamic bank, Islamic Bank of Yemen. But the data of balance sheets and income statements come from six conventional banks in Yemen: Yemen International Bank, al-arabi Bank, Calyon Bank, Yemen and Kuwait Bank. The data is from 1999 to 2005.
3-2) The Frame works:
Earning assetsIndependent variables Dependent variable
Tier 2 capital to tier 1 capital
Risky sector loans (RSEC)
Non-performing loan
Property loans
Loan loss provisions.
3-3) the model:
We use in this research the equation as follow:
CRit = 0 + 1MGTit +2RSECit + 3REGCAPit + 4LEVit +5LLPit +Eit
For dependent variable there is one:
CRit = in the current year there is non-performing loan
Independent variables:
MGTit = in the total assets get earning assets to the bank in the year t
RSECit = the total loans' bank get risky loans' sector (RSEC) in year t.
PSECT = loans' property (non-residential property loans + real estate loans + residential properties loans + construction loans) + loans for purchase of security + loans for consumption credit.
LEVit =the level two of capital to level one of capital in bank for i in the year t.
LLPit = provisions of loan defeat in the year t for bank's total loans.
3-4) the Hypothesis:
In the non-performing loan and the earning assets show negative relationship.
There is positive relationship that credit risk will expect to have with LNTA and ERGCAP.
Earning assets' managing with lower efficiency will probably lead to make credit risk very high.
4) Conclusion:
By surveying between credit risk of Islamic banking and specific factors of conventional banks there is close relationship, in this study try to contribute with existing research about Islamic banks in different ways. First, in this research select many characteristics risk of the conventional banks that provides Islamic bank by descriptive statistics. Second, determine the fundamental factors that affect the risk by regression analysis in Islamic banking.
The analysis will lead us to find the critical factors that affect credit risk in Yemen for Islamic banking. The results in this analysis will provide information about which of the above variables should pay attention in the banking industry, for improve the management risk in Islamic banks. Third, this research will contribute to existing literature; for give new knowledge on the differences and similarities between conventional banking and Islamic banking for credit risk.
