A comparative study of credit risk management in conventional and Islamic banks (A Case Study of Habib Bank Ltd And Meezan Bank)

Abstract

Good financial decisions require effective analysis of all types of risks. When a person set his target, foremost important thing is to understand and evaluate the factors that can deviate the set path to achieve goals. The expectations about future have their impact on financial decisions. These expectations will only be realized if events happen in the expected manner. The study of these possible deviations from the expected events is actually studying the risk. Risk cannot be fully eliminated; therefore, the objective is to identify ways and means to minimize it. Measurement of risk is important for accurate information about risk because without it, better risk management cannot take place. Credit risk management is a topic of great interest given its importance for banks profitability and solvability and, hence, for the smooth functioning of the financial system. Banks face many types of risks like market risk, interest rate risk, liquidity risk etc; but, the most important one is the credit risk because it is related not only to bank’s profitability but also to economy as a whole. Conventional banks have a relationship of creditor and debtor in all their transactions; therefore, they face this risk in every function. On the other side, Islamic banks are exposed to this risk in their financing contracts for example, Salam, Murabaha are sales with deferred payments thus generating debt, and this debt generation leads to credit risk. Musharka, Mudarba etc also involve credit risk in indirect manner.1997 and 2008 financial crisis made it evident that main factor for sustainability and stability of whole system is to manage credit risk. The amount of bad-debts in banks is growing (as depicted in their financial statements).Conventional banks have their deep roots in the economic system of Pakistan, whereas, Islamic banking is still in the phase of growth. There has been a lot of