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Evaluation of bank performance is important for all parties: depositors, the bank

management and regulators. Depositor-investors will decide whether to invest or withdraw

funds from the bank based on the bank performance. From the performance, the bank

management will look up whether to improve its deposit service or loan service or others

services. Regulator is also interested to know for its regulation purposes.

Bank Islam Malaysia Berhad (BIMB) is a single full-fledged Islamic bank in

Malaysia. The important underlying force that led to the establishment of this Islamic bank in

Malaysia was the elimination of riba that is known as interest. With the increase in Muslim

populations and awareness of Islamic values, there was a greater demand for Islamic bank

and interest-free finance by Muslim consumers, traders, investors, and businessman.

BIMB was established in July 1983 to meet these demands and challenges. Since then

BIMB introduced and marketed various interest free products such as Wadiah Yad

Dhamanah, Mudharabah, Musyarakah and others. Bank’s business has expanded over the

years. Its assets and deposits have increased from RM325 mil to RM4, 440 mil in 1997. The

financing of loans and services increased to RM991 mil in 1997. The number of branches

increased to 75 in 1998. However, as time has passed, many new banks had emerged offering

various kinds of financing products, leaving consumers with variety of choices at almost zero

switching cost.

In view of the increasing intensity of competition, coupled with challenging

macroeconomic conditions, it is pertinent to look into the performance of BIMB to see where

the bank stands and how it had performed against its competitors. In Islam, business is an
Ibadah (worship) and is recommended whereas riba (interest) is prohibited. From business

point of view, Islamic bank is not only a firm but also a moral trustee of the depositors where

deposits are trust given to banking firm. It is naturally expected that as a custodian of trust for

the depositors’ deposits, Islamic bank is likely to be more liquid and become more solvent

compared to its counterpart conventional banks. Islamic bank management, according to

Islamic ethics, is accountable to the depositors in this world and the world hereafter for their

failure to keep the trust entrusted upon them. It is, therefore, expected that the liquidity and

solvency ratio of the Islamic bank will be higher than conventional banks. However, it is also

expected that the liquidity ratio of the Islamic bank may decline during the later periods

compared to its early eras. As the bank grows, it acquires more skill and the art of banking

business, it will keep less liquidity and thus the liquidity ratio may decline.

Malaysia were shaken in 2005 by the news that BIMB reported a loss of RM450

million. This was the first time ever that the bank had gone into the red (NST, 2005) but was

a consequence of the financial crisis in 1998, since when the non-performing loans (NPLs)

had been building up. NPLs can be defined as a loan on which the borrower is not making

interest payments or repaying any principal.1 At what point the loan is classified as non-

performing by the bank, and when it becomes bad debt, depends on local regulations. Banks

normally set aside money to cover potential losses on loans (loan loss provisions) and write

off bad debt in their profit and loss account. In some countries, banks that have accumulated

too many NPLs are able to sell them on - at a discount - to specially established asset

management companies (AMCs), which attempt to recover at least some of the money owed.

Danaharta could not take the loans off BIMB’s books then because it could not take the loans

off BIMB’s books then because it could not take Shari’ah compliant loans. Thus, it was also

reported that the NPLs were close to 21 percent, well above the market average of 8 percent.

The financial crisis highlighted the vulnerability associated with fragmented financial

systems and also the risk of banks ignoring even basic risk management which in turn

contributed to economy-wide difficulties.

There is broad agreement that a substantial number of bank failures may destabilize

the system of monetary payments and control, and impair the flow of funds to borrowers

lacking access to capital markets. Because of the perceived link between banks’ financial

stability and the performance of the economy, it is therefore not surprising that the amount of

risk faced by banks is of substantial concern to policymakers. The importance to studying

bank risk is readily reflected in the Basle Committee’s constant and ongoing effort to account

for it in the risk-based capital adequacy guideline.

Even though risk management in banking is not a new activity, the aforementioned

scenarios show that more emphasis should be given to managing major risks such as market,

credit and operational risks. Effective risk management is critical to sustaining business

growth and continued profitability of the banks either conventional or Islamic. Given today’s

challenging financial and economic environment, adopting a balanced risk-return profile is

important in striving for continuing enhancement of shareholders’ value. The supreme

mortgage crisis has though witnessed a number of collapse and near collapse. Credit risk,

high leverage, and liquidity and funding risk are the main factors contributing to the crisis;

hence, lessons should be learned, and prudent risk management should be in place so that

history will not be repeated (Brown and Davis, 2008).

This article review tries to identify the methods and tools used in managing market,

credit and operational risk in BIMB. Studies that are directly directed to risk management of

Islamic banks have been conducted by Khan & Ahmad (2001) and Mohd Ariffin (2005) on

risk reporting and disclosure and Dasuki (2002) on risk exposure.

As for the Islamic financial institutions, Khan & Ahmad (2001) conducted a survey of

17 Islamic banks on risk management issues. Many issues were highlighhted, with the crux of

the problem the inability to manage risks effectively due to a lack of relevant instruments

available in an Islamic banking context. Where risk is concerned, the study highlights that the

rate of return risk (or benchmark risk as referred to in the study) is considered as the most

critical for Islamic banks. In principle, Islamic banks are different from conventional ones

due to prohibition of riba’ and the need to comply with the Shari’ah. As such the nature and

characteristics of risks that Islamic banks are exposed to should be different from

conventional banks. However in practice, Islamic banks offer products which are quite

similar to the conventional bank and emulate the practices of the conventional banks.


The establishment of Bank Islam Malaysia Berhad (BIMB and nowadays known as Bank

Islam) in 1983 was seen as a major leap forward in the development of Islamic banking in

Malaysia. Bank Islam is the first full-fledged Islamic bank in Malaysia, was set up primarily

to assist the financial needs of the Muslim’s country. However, after two decades served

Malaysians in Islamic banking industry, seems that Bank Islam suddenly found itself in the

red when it reported a loss of RM456 million for the first time since its inception. The bank

had to write off some RM2.3 billion after being mired by financial losses in 2005 and 2006.

Datuk Seri Abdullah Ahmad Badawi (Prime Minister at that time) directed BIMB to take

immediate action against those who could have led the bank to record the financial loss. Bank

Islam which is the country’s pioneer in Islamic financial institution seems to be like from

leader to laggard.

To turnaround Bank Islam as the flag bearer of the country’s Islamic financial

institution, a new Managing Director was appointed and a new management team was put in
place to stop the damages and turn around the bank’s fortune. After a year struggling to rise

up the image of Bank Islam, it looks like the bank made an impressive recovery to chart

strong growth and return to profit. After four decades of evolution and expansion, Bank Islam

continues to make history and lift Islamic banking into the high level.


Based on the case study, we can see the downfalls of Bank Islam are contributed by

four (4) major factors:

i. Financial Debacle

ii. Capital Destruction

iii. Bleeding Portfolio

iv. Corporate Outlook

3.1 Financial Debacle

As we can see, Bank Islam had reported losses for two (2) consecutive years as

RM0.48 billion in 2005 and RM1.277 billion in 2006 as shown in Table 2

(Profit / (Loss) Before Zakat and Tax) of the case study. It was heavy provision

for bad financings totaling RM2.3 billion in those two (2) years. Upon the

provision, the losses are from its corporate financing from the Labuan

subsidiary which the bank had realised converting the subsidiary into a branch

made the bank into a financial trouble.

Figure 1.0 Financial Highlights of Bank Islam in 2006

3.2 Capital Destruction

In 2006, the capital deficits to RM278 million based on the Statistical Review as

stated in Balance Sheet as at 30th June 2006 in item Shareholders’ Fund (shown

in Figure 2.0) provided by Bank Islam itself. According to the Financial

Statements in Annual Report 2006 of Bank Islam, the core capital ratio showed

-2.78% and the risk-weighted capital ratio is -2.84% (shown in Figure 3.0). The

core capital defined the financial strength of the bank normally based on the

sum of its equity capital and disclosed reserves. While the function of the risk

weighted capital is to show that all the assets of the bank holds that are

systematically weights for credit risk. Technically, what we can see is Bank

Islam is a defunct financial institution.

Figure 2.0 Statistical Reviews on Shareholders’ Funds

Figure 3.0 Core Capital Ratio and Risk-weighted Capital Ratio

3.3 Bleeding Portfolio

Bank Islam huge delinquent portfolio is the consumer financing, particularly

from the automobile financing. The roots cause are from the weak underwriting

standards and the quality of the business as we can see poor asset quality was

the direct result of the poor credit evaluation, insufficient depth and breadth in

processing financing and the absence of a robust risk management framework.

The bank suffered huge losses due to Non-performing Financing (NFP). It can

be seen in Figure 4.0 as below that shows the provision of the NFP.

Figure 4.0 The provision of the Non-performing Financing

3.4 Corporate Outlook

It was a big mess in how the bank runs the business. It can show by the lack of

technologies’ expertise, human capital development, the plain products and

services provided by the bank and the weakness in marketing. From the human

capital development’s view the turnover of staff is very high and also the work

culture of the staff which very much like a public sector organisation.

Information Technology (IT) provided by Bank Islam is also outdated. How

they want to stay competitive if the core banking system is outdated? They have

no proper system especially in risk management and collection which shows the

absence of key IT Enablers. The products and services provided also did not

much different from the conventional financial institution. They are lack of

products and services innovation which not responsive to marketplace and

customer needs. Bank Islam discovered that their weaknesses on the channel of

delivery. As we knew Bank Islam has limited branch networks and Auto-teller

Machines (ATMs), the location of the premises which is not strategic, the

physical condition of the premises is in poor quality and the bank’s operation

also had a limited capability due to IT constraints.


4.1 Profitability

According to study conducted by Mohamad & Shaza Marina (2011), profitability

position of BIMB has not changed over ten years as the data collected by using

income statements and balance sheets from their annual reports start from 2000 until

2009 (10 years). All three measures of profitability, i.e Return on Asset (ROA),

Return on Equity (ROE) and Profit Expense Ratio (PER), are not statistically

significant. The bank’s profitability remains unchanged between 2000-2004 and

2005-2009 due to the losses made by BIMB in 2005 and 2006. There are various

reasons for lower profitability performance of BIMB. First, BIMB does not have wide

scope for investment in any stock or security because of religious constraints. It can

only invest in Shari’ah approved projects. It cannot invest beyond the Shari’ah Board

approved investments even if it can earn higher rate of returns. In Malaysia, Shari’ah

Board supervises banks’ investments. Secondly, investments in government bond are

major source of earnings for BIMB. The rate of return of government bond is lower

than other types of investments. Thirdly, in order to provide the guarantee of

depositors’ deposits and trust (amanah), BIMB maintains more liquidity than the

conventional banks.

4.2 Liquidity

From the study (year 2000 – 2009), also showed that BIMB maintained its liquid

position. As highlighted earlier, this may be due to the mandate of the bank in

providing guarantee for depositors’ deposits and trust (amanah). BIMB’s investment

is limited by the Shari’ah i.e the Islamic law. Islamic banks are not permitted to invest

in un-Islamic investment opportunities such as gambling, alcohol and related projects

although these investments may be highly profitable. The restricted set of investment

opportunities helps Islamic banks, in particular BIMB, to hold higher liquid assets.

Second, most loans and investments of Islamic banks are of short-term nature.

Murabahah constitutes a shorter term and a lower risk investment for a bank. There is

practically no risk involved in murabahah financing where it is fully collateralized by

the asset. On the other hand, mudarabah and musyarakah financing are of longer term

investment that constitutes only a small percentage of the bank’s total financing.

Thirdly, as a fairly new player in the market as compared to the conventional ones,

the bank cannot afford to incur losses and undermine the general reputation of Islamic

banking system.

The bank’s performance of risk and solvency between 2000-2004 and 2005-2009

revealed that BIMB’s involvement in risky business measured in Debt Equity Ratio (DER),

Debt to Total Asset Ratio (DTA), Equity Multiplier (EM) and Loan Deposit Ratio (LDR)

decreased over years. The reason for the low risk of BIMB can be seen from few angles.
Firstly, BIMB’s investments in government securities are much larger than the conventional

banks. Secondly, it has more equity capital compared to assets shown by its EM. Larger

equity capital indicates a higher shock absorbing capacity for the Islamic bank. It can

withstand more assets or loan losses as opposed to bank(s) which has (have) less capital.


Islamic banks face certain risks that are associated with specific business models and

Islamic contracts. The unique risks arising from compliance with Shari’ah rules and

principles need to be addressed by Islamic banks and included in their assessment or risk

management systems.

5.1 Market risk management

The paper that has been studied by Tafri F.H et al. (2014) showed that in the case of

the Islamic banks, market risk VaR is not extensively used. Although most of the

Islamic banks have used VaR to some degree in calculating the market risk of these

instruments, some are still in the planning stage. Since Islamic finance is either asset-

backed or equity-based, market risk becomes an important part of Islamic banking.

The Islamic Financial Services Board (IFSB) defines market risk as “the risk of losses

in on- and off- balance sheet positions arising from movements in market prices”.

Islamic financial institutions use a benchmark rate to price different financial

instruments. For example, in a murabahah contract, the mark up is determined by

adding the risk premium to the benchmark rate (such as the LIBOR2). The nature of

London Interbank Offered Rate: is a benchmark rate that some of the world’s leading banks charge each
other for short-term loans.
fixed income assets is such that the mark up is fixed for the duration of the contract.

As such, if the benchmark rate changes, the mark up rates on these fixed income

contracts cannot be adjusted.

5.2 Credit risk management

Credit risk is defined as the risk that counter-party fails to meet its obligation in

accordance with agreed terms. Credit risk would take the form of settlement/payment

risk arising when one party to a deal pays money or delivers assets before receiving

its own assets or cash, thereby exposing it to potential loss. The BCBS’s (2004)

proposes two broad methodologies for calculating banks’ capital requirements for

credit risk. One of the alternatives would be to measure credit risk in the standardized

manner, supported by external credit assessments3 while the other alternative is to use

the bank’s internal rating-based method of Basel II subjected to explicit supervisor or

central bank approval. All conventional and Islamic banking windows adopt the

standardized approach while the Islamic banks about 70% use the standardized

approach while other using the foundation approach and advanced internal rating-

based approach (Tafri, Abdul Rahman, & Omar, 2011). Owing to the risk sharing

nature of the modes of financing and a need to separate the capital of current and

investment accounts, Islamic banks need greater capital as compared to the

conventional banks. Thus, Islamic banks are better off using the internal rating-based

approach to derive capital adequacy. Among the many advantages of using this

approach are that: it allows the risk profile of each asset to be mapped individually as

the Islamic modes of financing are diverse; it aligns the actual risk exposure of the

banks with their capital requirement; and it is expected to generate reliable data

Such as Standard and Poor’s or Rating Agency of Malaysia or Malaysian Rating Agency Corporation.
through the integration of external and internal informatin since external credit

assessments need to be used as benchmarks (Chapra & Khan, 2000). The result of

Tafri, Abdul Rahman & Omar (2011) imply that Islamic banks are still low in terms

of usage of the credit risk mitigation methods as compared to conventional banks.

5.3 Operational risk management

The IFSB uses the definition of the BCBS in defining operational risk as “risks arising

from inadequate or failed internal processes, people, and systems, or from external

events”. Due to the fact that Islamic banks are relatively new, operational risk in terms

of personal risk can be acute in these institutions. Operational risk in this respect

particularly, arises as the banks may not have enough qualified professionals (capacity

and capability) to conduct the Islamic financial operations. A study has been

conducted by Tafri F.H et al. (2011) said that the tools and techniques that are mostly

used by the Islamic banks are risk and self-assessment techniques, internal audit

results/scores, internal loss event database, risk mapping, risk indicators, causal event

indicators and external loss event database.

5.4 Adequacy of risk management tools and systems

The findings of Tafri F.H et al. (2014), suggesting that the tools and systems for risk

management practies are barely inadequate for Islamic banks. The three most critical

areas are the lack of “IT professionals with relevant expertise in the process

integration and risk analytics”, “IT systems to cater for each Islamic instrument” and

also the “capactity of human capital in the highly technical areas of risk


Islamic and conventional banks are financial intermediaries that offer similar services to the

public and private sectors. However, in principle, Islamic banks are different from

conventional banks due to the prohibition of riba and the need to comply with the Shari’ah. It

can be concluded that the risk management tools and systems for Islamic banking are seen as

inadequate, particularly in the critical areas of: “IT professionals with relevant expertise in

the process integration and risk analytics”, “IT systems to cater for each Islamic instrument”

and also the “capactity of human capital in the highly technical areas of risk measurement.”

Thus, the Islamic banks should innovate or develop more tools which are Shari’ah compliant

to cater for the sector’s needs, but sufficient expertise in the relevant areas will be essential.

Islamic bank itself must put serious effort in training and educating human resources

that are well versed in Islamic principles as well as the technical disciplines. It may be

difficult, but the integration of this knowledge is important in order to preserve the Islamic

banking industry specifically – and the Islamic financial system generally – from degradation

and being relegated to form only.


Basel Committee on Banking Supervisions (BCBS). (2004). International Convergence of

Capital Measurement and Capital Standards: A Revised Framework. Bank for

International Settlements, Basel.

Abdul Hamid, M., & S.M, A. (2011). The Performance of Banking During 2000 - 2009:

Bank Islam Malaysia Berhad and Conventional Banking in Malaysia. International

Journal of Economics and Management Sciences, Vol.1, No. 1, 9-19.

Brown, C. a. (2008). Risk Management lessons from the sub-prime crisis. The National

Institute of Accountant Tasmania Division Congress.

Chapra, U., & Khan, T. (2000). Regulation and supervision of Islamic banks. Occasional

Paper No. 3, Islamic Research and Training Institute, Islamic Development Bank,


Dasuki, A. (2002). Risk exposure of Islamic banks: An application of the AAOIFI standards.

unpublished Master dissertation, Department of Economics, University of

Loughborough, Leicester.

Khan, T., & Ahmad, H. (2001). Risk Management: An analysis of issues in Islamic financial

industry. IRTI/IDB Occasional Paper No. 5.

Mohd Ariffin, N. (2005). Enhancing Transparency and Risk Reporting in Islamic Banks.

unpublished Doctoral dissertation, School of Management, University of Surrey.

Samad, A., & Hassan, K. (1999). The performance of Malaysian Islamic Bank During 1984-

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Tafri, F., Abdul Rahman, R., & Omar, N. (2011). Empirical evidence on the risk management

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