Risk management in banks: determination of practices and relationship with performance

A thesis submitted to the University of Bedfordshire in partial fulfilment of the requirements for the degree of Doctor of PhilosophyThe issue of risk management in banks has become the centre of debate after the recent financial crises. Several efforts have been made to improve the risk management and performance of banks including introducing the Basel Accords as well as risk management guidelines by central banks. Consequently, the State Bank of Pakistan has issued risk management guidelines to strengthen the risk management system and to improve the performance of the local banks. However, the available literature in Pakistani context fails to explain the impact of these efforts on the performance of banks. The purpose of this study is to empirically examine the effectiveness of risk management processes and their relationship with the performance of banks. This study reviews the relevant literature on banking risk management from diverse methodological strands and synthesises its conclusions to make an addition to the available knowledge; particularly to address certain research gaps regarding risk management and performance of banks in developing countries, specifically in Pakistan. Owing to its empirical nature, the current research adopts a deductive reasoning approach in terms of theory testing. This study applies a mixed method research strategy by taking the quantitative method as the major component, while the qualitative method plays a supplementary role. The sample is composed of twenty banks in Pakistan and the stratification is performed according to the bank category (public, private and foreign) in respect of different strata. The study collects and analyses primary as well as secondary data. This research is carried out in three phases. In the first phase a qualitative system dynamics model (Causal Loop Diagram) is developed based upon interview data analysis to understand and document the behaviour of risk management systems of Pakistani banks. In the second phase, this research conducts questionnaire data analysis by using ordinary least-squares regression to assess the different aspects risk management practices of banks in Pakistan. Finally, two-stage data envelopment analysis technique has been adopted to examine the relationship between the risk management and performance of the selected banks. This study results reflect that it is very important for Pakistani banks to formulate an active risk management process to identify, measure, monitor and control different risks. These results further reveal that formation of a comprehensive risk management system is not only a useful practice to meet the regulatory requirements but an effective exercise to improve the performance of Pakistani banks also. By employing a pragmatic, embedded, mixed method research strategy, this study has created a new insight into risk management in local banks and extends the existing theoretical literature in the field of banking in various ways