Do governance factors affect the effectiveness of risk management disclosure in UAE banks?

Figures & data

Figure 1. The effectiveness of risk management disclosures in UAE banks.

Note: This figure determines detailed principles, standards, and regulations related to the effectiveness of risk management disclosures from the “Basel Accords,

Financial Reporting Standards (IFRS), Islamic Financial Standards (AAOIFI Bahrain), and Risk Management standards from UAE Central Bank”. The overall measurement scores rely on the bank’s completeness regarding the principles and standards, Thus, if the compliance to risk element is disclosed, then the scoring procedure scores 1, and if the bank does not disclose it, the procedure scores 0.

Table 1. Descriptive statistics for dependent, independent, and control variables

Variables	Observations	Mean	Median	Std. dev.	Min	Max
Dependent variables:
CRR%	80	82.70	83.72	5.96	69.77	93.02
MRR%	80	77.63	77.77	9.23	59.26	96.30
OPR%	80	88.69	90.47	4.69	76.19	100.00
AGR%	80	82.58	83.51	5.52	72.53	94.51
Bank-governance variables:
BSZ	80	19.69	20.00	6.35	8.00	29.00
BID %	80	48.68	47.49	17.72	20.69	87.50
SIZE	80	10.81	10.67	0.55	0.55	11.96
Bank-control variables:
BETA	80	0.67	0.71	0.43	−0.76	1.43
LEV	80	0.52	0.45	0.51	0.00	2.36
ROE %	80	5.76	9.29	18.61	−89.57	77.38
NPLR %	80	8.42	6.24	8.65	2.12	58.13
LDR %	80	84.10	85.00	9.81	63.00	102.00

Notes: This table explains the descriptive analysis of dependent variables (credit risk, market risk, operational risk, aggregate risk), independent variables (BSZ and BID), and control variables (bank size, beta, leverage, ROE, non-performing loans, loan to deposit ratio). The description of all variables is described in Appendix 2.

Table 2. Correlation matrix

Title	CRR	MRR	OPR	AGR	BSZ	BID	SIZE	ROE	LEV	BETA	LDR	NPL
CRR		0.480***	.670***	0.879***	0.223**	−0.224**	0.447***	0.272**	0.015	−0.078	−0.339***	−.349***
MRR	0.485***		.412***	0.821***	0.428***	−0.214	0.603***	0.230***	0.344***	0.070	−0.366***	−.355***
OPR	0.704***	0.483***		0.741***	0.070	−0.024	0.316***	0.120	0.123	−0.077	−0.175	−.178
AGR	0.886***	0.816***	.762***		0.339***	−0.225**	0.589***	0.276**	0.202	−0.020	−0.389***	−.389***
BSZ	0.230**	0.310***	.042	0.315***		−0.864***	0.318***	0.232**	0.167	0.183	−0.495***	−.204*
BID	−0.228**	−0.180	.057	−0.236**	−0.886***		−0.069	−0.098	0.063	−0.063	0.447***	.077
SIZE	0.458***	0.611***	.359***	0.590***	0.381***	−0.196*		0.445***	0.496***	0.500***	−0.278**	−.453***
ROE	0.211*	0.253**	.157	0.271**	0.200*	−0.196*	0.691***		0.066	0.392***	0.029	−.729***
LEV	0.121	0.443***	.238**	0.280**	0.128	0.105	0.614***	0.276**		0.293***	0.088	−.258**
BITA	−0.054	0.082	−.107	0.000	0.236**	−0.134	0.504***	0.535***	0.325***		0.147	−.266**
LDR	−0.347***	−0.350***	−.180	−0.403***	− 0.459***	0.495***	−0.255**	−0.030	0.107	0.160		.078
NPLR	−0.422***	−0.296***	−.237**	−0.389***	− 0.152	0.182	−0.641***	−0.674***	−0.328***	−0.358***	0.047

Notes: Table 2 shows the correlation analysis for all regression variables, measuring the incentives factors (governance and bank control attributes). The numbers in the table above the diagonal are the linear Pearson coefficients; the numbers in the table below the diagonal are the Spearman coefficients; significant coefficients are highlighted in bold. The descriptions of all variables are noted in Appendix 2.

Table 3. Regression analysis for the influence of governance factors on credit risk, market risk, operational risk, and aggregate risk disclosures (H1 and H2)

	Dependent variable=
	CRR		MRR		OPR		AGR
Independent variables	Model 1	Model 2	Model 1	Model 2	Model 1	Model 2	Model 1	Model 2
BSZ	−0.337	−0.002*	0.725**	0.005***	−0.125	−0.001	0.027	0.000
	(0.106)	(0.073)	(0.017)	(0.007)	(0.531)	(0.471)	(0.878)	(0.911)
BID	−0.163**	−0.001**	0.120	0.001	−0.041	0.000	−0.051	0.000
	(0.019)	(0.014)	(0.220)	(0.142)	(0.536)	(0.495)	(0.381)	(0.362)
SIZE	8.075***	0.043***	10.183***	0.056***	4.279***	0.021***	7.825***	0.041***
	(0.000)	(0.000)	(0.000)	(0.000)	(0.006)	(0.007)	(0.000)	(0.000)
BETA	−5.476***	−0.029***	−6.390***	−0.038***	−3.352**	−0.016**	−5.257***	−0.028***
	(0.001)	(0.000)	(0.004)	(0.003)	(0.024)	(0.026)	(0.000)	(0.000)
LEV	−2.413*	−0.012	−0.208	−0.003	−0.153	0.000	−1.237	−0.006
	(0.090)	(0.103)	(0.918)	(0.417)	(0.911)	(0.971)	(0.301)	(0.320)
ROE	−0.019	−9.123	−0.095***	−0.001	−0.010	−4.463	−0.039	0.000
	(0.694)	(0.721)	(0.000)	(0.708)	(0.835)	(0.846)	(0.333)	(0.354)
NPLR	−0.173*	−0.001*	−0.235*	−0.001*	−0.048	0.000	−0.162**	−0.001**
	(0.072)	(0.070)	(0.090)	(0.079)	(0.602)	(0.611)	(0.047)	(0.039)
LDR	0.003	8.779	0.013	1.463	0.002	−7.637	0.006	2.764
	(0.965)	(0.983)	(0.902)	(0.982)	(0.976)	(0.983)	(0.925)	(0.935)
Intercept	16.171	1.199***	−46.805	0.620***	49.485**	1.084***	5.173	1.470***
	(0.429)	(0.000)	(0.114)	(0.001)	(0.014)	(0.000)	(0.765)	(0.000)
Year-fixed effects	Yes	Yes	Yes	Yes	Yes	Yes	Yes	Yes
Adj. R-squared	0.399	0.401	0.481	0.482	0.091	0.086	0.498	0.502
F-statistics	7.549***	7.611***	10.158***	10.206***	1.987*	1.930*	10.806***	10.966***
Observation	80	80	80	80	80	80	80	80
Average VIF	3.167	3.167	3.167	3.167	3.167	3.167	3.167	3.167

Notes: Table 3 shows the regression coefficient and model summary OLS regression for the impact of governance and bank control attributes on each type of risk disclosure. It examines the hypotheses related to H1 and H2. All Model 1 results describe the effect on bank-specific and governance variables before employing log transformation. In addition, Model 2 results indicate the impact after transforming disclosure scores for each type of risk disclosure to the log. The table also shows the number of observations and F-statistics to indicate that all our models are significant and adjusted R-squared present adding additional independent variables to a model to improve explaining the dependent variables. Furthermore, the average variance inflation factor (VIF) tests the multicollinearity problem. Significant coefficients are highlighted in bold *, **, ***Significance levels at 10%, 5%, 1%, respectively. The descriptions of all variables are presented in Appendix 2.

Table 4. Comparison between Islamic and conventional banks

	Conventional		Islamic		Difference test
	(N = 60)		(N = 20)		(Conventional=Islamic)
	Mean	Std. dev.	Mean	Std. dev.	Mann-Whitney test	T-test
CRR	82.20%	5.86%	84.18%	6.15%	0.242	0.201
MRR	79.62%	8.69%	71.66%	8.34%	0.000***	0.000***
OPR	88.57%	4.73%	89.04%	4.66%	0.627	0.697
AGR	82.91%	5.59%	81.59%	5.34%	0.462	0.359

Notes: Table 4 shows the differences across Islamic and Conventional banks in the effectiveness of risk management disclosures and bank value deviation between these two types of banks. ^{*, **, ***}Significantly levels at 10%, 5%, 1%, respectively. The descriptions of all variables are found in Appendix 2.

Table

Year	Islamic banks	Conventional banks	Total observations	Missing data
2016	4	12	16	0
2017	4	12	16	0
2018	4	12	16	0
2019	4	12	16	0
2020	4	12	16	0
Total	20	60	80	0

Table

Variable	Measures	Source
Credit risk (CRR)	Compliance with the Basel Accords, Financial Reporting Standards (IFRS), Islamic Financial Standards (AAOIFI Bahrain), and Risk Management standards from UAE Central Bank. Dichotomous method, if the compliance to risk element is disclosed, the scoring procedure scores 1; the bank does not disclose, it scores 0. Compliance disclosure index for each bank is calculated as the ratio of the total compliance items disclosed.	Annual Report, manual calculation
Market risk (MRR)	Compliance with the Basel Accords, Financial Reporting Standards (IFRS), Islamic Financial Standards (AAOIFI Bahrain), and Risk Management standards from UAE Central Bank. Dichotomous method, if the compliance to risk element is disclosed, the scoring procedure scores 1; the bank does not disclose, it scores 0. Compliance disclosure index for each bank is calculated as the ratio of the total compliance items disclosed.	Annual Report, manual calculation
Operational risk (OPR)	Compliance with the Basel Accords, Financial Reporting Standards (IFRS), Islamic Financial Standards (AAOIFI Bahrain), and Risk Management standards from UAE Central Bank. Dichotomous method, if the compliance to risk element is disclosed, the scoring procedure scores 1; the bank does not disclose, it scores 0. Compliance disclosure index for each bank is calculated as the ratio of the total compliance items disclosed.	Annual Report, manual calculation
Aggregate risk (AGR)	Compliance with the Basel Accords, Financial Reporting Standards (IFRS), Islamic Financial Standards (AAOIFI Bahrain), and Risk Management standards from UAE Central Bank. Dichotomous method, if the compliance to risk element is disclosed, the scoring procedure scores 1; the bank does not disclose, it scores 0. Compliance disclosure index for each bank is calculated as the ratio of the total compliance items disclosed.	Annual Report, manual calculation
Board size (BSZ)	The total number of directors	Annual report, Eikon Datastream,
Board independence (BID)	Non-executive member divided by board size	Annual report, Eikon Datastream,
Bank size (SIZE)	The log of bank total assets	Eikon Datastream
BETA	Risk factor that reflects the systematic risk between bank and market returns	Eikon Datastream
Leverage (LEV)	Total liabilities divided by total assets	Eikon Datastream
Return on equity (ROE)	Net income divided by shareholders’ equity	Eikon Datastream
Non-Performing loans ratio (NPLR)	Divide non-performing loans by total loans	Eikon Datastream
Loan to deposit ratio (LDR)	Divide total loans by total deposits	Eikon Datastream

Table

(1) Compliance with UAE central bank regulations
Risk type	Risk Index (RI)
Credit	1. Managing credit risk
	2. Proper Method to measure credit risk
	3. Amount of regulatory capital for credit risk
	4. Maximum credit exposure by currency
	5. Information about the credit quality of financial assets
	6. Adequately describes how credit risk management occurs
	7. Credit risk mitigation strategy
	8. Full disclosure
Market	1. Interest rate risk
	2. Market risk management strategy
	3. Currency risk.
	4. Equity risk.
	5. VAR (value-at-risk).
	6. Commodities risk
	7. Amount of regulatory capital for market risk (pillar 1 capital).
	8. full disclosure
Operational	1. Amount of regulatory capital for operational risk (pillar 1 capital).
	2. Operational risk Measurement approach.
	3. Operational risk transfer/mitigation/hedging techniques.
	4. Legal risks.
	5. Compliance.
	6. Competition/proprietary/copyright.
	7. Internal audit function
	8. Full disclosure
Notes: Risk Disclosure Total 24. The scoring procedure proceeded as follows: 0: Risk item not disclosed by bank. 1: Risk item disclosed by bank.
(2) Compliance with Basel principles related to risks
Principle	Risk index (RI)
Principle 8	1. Supervisory approach
Principle 9	2. Supervisory techniques and tools
Principle 11	3. Corrective and authorizing powers of supervisors
Principle 14	4. Corporate governance
Principle 15	5. Risk management process
Principle 16	6. Capital adequacy
Principle 17	7. Credit risk
Principle 19	8. Concentration risk and large exposure limits
Principle 20	9. Transactions with related parties
Principle 21	10. Country and transfer risks
Principle 22	11. Market risks
Principle 23	12. Interest rate risk in the banking book
Principle 24	13. Liquidity risk
Principle 25	14. Operational risk
Notes: Risk Disclosure Total 14. The scoring procedure occurred as follows: 0: Risk item not disclosed by bank. 1: Risk item disclosed by bank.
(3) Compliance with international financial reporting standards (IFRS)
IFRS	Risk index (RI)
IFRS 7	Financial Instruments: Disclosures
IFRS 9	Financial Instruments
Notes: Risk Disclosure Total 2. The scoring procedure occurred as follows: 0: Risk item not disclosed by bank. 1: Risk item disclosed by bank.
(4) Compliance with Islamic financial standards (AAOIFI Bahrain)
Islamic financial standards	Risk index (RI)
Sharia’s Standard No. (1)	Trading in Currencies
Sharia’s Standard No. (5)	Guarantees
Sharia’s Standard No. (8)	Murabaha
Sharia’s Standard No. (33)	Waqf
Sharia’s Standard No. (45)	Protection of Capital and Investments

Notes: Risk Disclosure Total 5. The scoring procedure proceeded as follows: 0: Risk item not disclosed by bank. 1: Risk item disclosed by bank.

Table

1. Basel principles related to risks
Principle 8	Supervisory Approach	The supervisor must design and maintain a forward-looking appraisal of the risk characteristics of independent banks and groups that are suited to their structural system, and banks must identify, analyze, control, and monitor the total bank risk.
Principle 9	Supervisory Techniques and Tools	Using an appropriate instrument to assess the risk and an adequate variety of methods and instruments to execute the supervisory strategy.
Principle 11	Corrective and Authorizing Powers of Supervisors	Acting at an early stage to detect any risks to the banking system with adequate tools. When a supervisor identifies harmful, illegal behaviors or actions that potentially put banks or the financial system at risk, they have the authority to take appropriate action, including the imposition of sanctions. All necessary supervision techniques are at the supervisor’s disposal, allowing for quick corrective actions to be carried out.
Principle 14	Corporate Governance	To be sure banks have strong corporate governance, the supervisor assures that banks have solid corporate governance procedures and guidelines. These guidelines and procedures cover areas like business strategy, group and management structure, internal control, roles of the bank’s Board of Directors and senior executives, and renumeration. These policies and procedures are in line with how risky the bank is and how important the corporate governance is to their entire system.
Principle 15	Risk Management Process	The risk management process should be aligned with the bank’s risk profile. The supervisor decides that banks have a complete risk management workflow (which includes and Effectively Board and Executive supervision) to recognize, examine, assess, supervise, disclose, and govern or mitigate all material risks in a timely manner and determine if the capital and liquidity are enough for their risk level and economic and financial conditions. This process includes making and reviewing plans for what to do in case of an emergency, such as solid and trustworthy contingency planning that considers taking the bank’s situation into account. The risk management process is in line with how risky the bank is and how important that bank is to the whole system.
Principle 16	Capital Adequacy	The banks represent appropriate capital adequacy requirements that reflect that those risks have been considered. A bank’s capital adequacy standards are established by the regulator and should be reasonable and suitable, given the industry and economic circumstances under which the bank operates and the risks it faces. The regulator establishes the kind of capital with loss-absorbing capacity in mind. Capital requirements are not lower than the relevant Basel criteria, at least for those banks with a significant worldwide presence.
Principle 17	Credit Risk	The banks have acceptable credit risk considering risk appetite, risk profile, and macroeconomic conditions. In addition, each bank is considered to have a proper credit risk management procedure that takes into consideration their risk tolerance, creditworthiness and industry and global situations. This process is comprised of reasonable rules and methods to discover, measure, assess, timely observing, reporting, and management of credit risk (particularly collateral requirements). The whole credit cycle is addressing covering of credit underwriting, credit assessment, and the continual engagement of the bank’s credit and stock portfolios.
Principle 19	Concentration Risk and Significant Exposure Limits	The banks should have adequate policies and procedures in place for detecting, assessing, managing, reporting, and controlling or mitigating risk swiftly. Subsequently, the regulator has concluded that the bank has sufficient procedures and guidelines in place to promptly discover, analyze, assess, supervise, monitor, manage, or reduce exposures to risk. Prudential restrictions are those guidelines established by regulators to limit banks’ exposure to certain individuals or groups of related counterparties.
Principle 20	Transactions with Related Parties	Enter related parties into any transactions on an arm’s length basis. Then, to avoid abuse deriving from operations with parties involved and identify the threat of potential conflicts of interest, the supervisors of the financial institutions are required to enter into operations with associated parties on an agreed fixed basis, supervise these transaction records, take necessary steps to manage or minimize the risks, and write off associated risk related entities in in compliance with standard procedures and guidelines.
Principle 21	Country and Transfer Risks	As part of their global lending and investment transactions, banks must ensure they have the appropriate procedures in place to identify, evaluate, and manage the risks associated with several other countries. Furthermore, the regulator assesses that banks have suitable guidelines and procedures to promptly detect, quantify, investigate, analyze, disclose, and manage or reduce risk level, and transfer risk in their global financing and investment operations.
Principle 22	Market Risks	Consequently, the market risk management processes of banks are adequate. Moreover, the banks’ risk appetite, risk level, industry and economic circumstances, and the danger of a material decline in stock market are all considered as part of the supervisor’s determination that the banks’ market risk management approach is appropriate. This process comprises responsible policies and procedures to detect, measure, analyze, monitor, report, and manage or reduce potential losses on a reasonable timeframe.
Principle 23	Interest Rate Risk in the Banking Book	A proper technique in banking book to mitigate interest rate risk.
Principle 24	Liquidity Risk	Sets a careful and appropriate liquidity requirements strategy.
Principle 25	Operational Risk	Banks have an acceptable operational risk management framework. Moreover, a bank’s functional risk-management system is deemed acceptable by the regulator if it is shown to reflect the institution’s risk appetite, risk tolerance, and the state of the marketplace and the entire economy. That’s why it’s important to have sound rules and procedures in place to promptly detect and analyze risks in operations; then they may be reported on and used to limit or eliminate threats
Principle 28	Disclosure and Transparency	Banks and banking groups declare the information related to risk management strategies, risk exposures, performance, and financial condition clearly and on a solo basis. The regulator should conclude that the banking institutions and banking groups routinely reveal details that are both widely available and fairly represent their financial position, activity, risk exposures, risk management practices, and governance practices rules and procedures on an aggregated and then relevant, but separate basis.
2. International financial reporting standards (IFRS)
IFRS 7	Financial Instruments: Disclosures	Requires firms to provide full disclosures on their financial statement nature and the extent of risks arising from those financial instruments, both in qualitative and quantitative terms. Specifies information that must be disclosed to assist the main consumers of financial statements in assessing the materiality, risks, and controls associated with a company’s use of financial instruments. Disclose the material accounting rules used to manage financial instruments. It is required that when hedge account is being used, comprehensive details on the methodology, the volume, timeliness, and unpredictability of the future cash flows, and the impacts of hedging instruments on financial standing and performance be reported.
IFRS 9	Financial Instruments.	The necessities for hedging Instruments: Recording, Measuring, Impairment, and derecognition. The provisions pertaining to hedge accounting are voluntary. If the necessary conditions are satisfied, a business may use hedge accounting to record the results of its risk management in the financial statements by offsetting the results of its profits or losses on hedging instruments against those for the risks they are trying to mitigate.
3. Risk management regulations in UAE (central bank)
Article 2	Risk Governance Framework	The existence of a reliable risk governance model to aid in identifying, evaluating, monitoring, and controlling potential threats. Credit risk, Market risk, Liquidity risk, and Operational risk should be covered as a bare minimum.
Article 3	Risk Management Function	The Chief risk officer must be of sufficient seniority and stature within the bank to credibly challenge the heads of business lines and functions.
Article 4	Risk Measurement and Use of Models	The implementation of risk measurement tools by a bank must be tailored to the bank’s risk profile, business, size, and complexity.
Article 5	Stress Testing of Material Risks	A bank must have a forward-looking stress testing program that addresses credit, market, and operational risk with the bank by considering that its risk profile is likely to require capital in excess of the minimum capital requirements.
Article 6	Information System and Internal Reporting	Depending on the risk profile, nature, size, and complexity of the bank’s business and structure, several types of data aggregation and reporting tools will be required by the bank’s risk management framework.
Article 7	Strategic and Operational Decisions	All new products, significant modifications to existing products, and strategic or considerable operational initiatives, such as new systems, business models, or acquisitions, require prior approval from the bank.
Article 8	Group Risk Management.	A bank for which the Central Bank is the primary regulator is required to meet the objectives of the Regulation and Standards on a single and group-wide basis.
Article 9	Disclosures	A Bank should fulfill the disclosure needs and have a Board-approved disclosure policy. A bank must describe in its disclosures its risk management objectives and policies.
Article 10	Islamic Banking	The Board offering Islamic financial services safeguards that the comprehensive approach to risk management ensures full compliance with Sharia’s provisions.
4. Islamic financial standards (AAOIFI Bahrain)
Sharia’s Standard No. (1)	Trading in Currencies	It is permissible to trade in currencies if done in compliance with Sharia’s rules and precepts. To elaborate, before dividing the countervalues, both parties must assume real or constructive ownership of them, and any two items denominated in the same currency must be equivalent in value. Also, future currency contracts are not allowed.
Sharia’s Standard No. (5)	Guarantees	The lessee holds the leased property in trust for the lessor, who is responsible for any risks that may be linked with the property.
Sharia’s Standard No. (8)	Murabaha	Before a purchase can be made, two categories of risk must be identified and separated.
Sharia’s Standard No. (33)	Waqf	It is permissible to invest in Waqf income through acceptable methods, such as Modaraba, Musharakah, Murabahah, Ijarah, Salam, and low-risk investments.
Sharia’s Standard No. (45)	Protection of Capital and Investments	With this Standard, which seek to simplify the understanding of the fundamentals of banking and investing with Islamic financial institutions. In addition, it seeks to clarify the Shariah grounds for what is permitted and what is not. In order to protect the investment, the use of equipment and practices that contradict Sharia law is prohibited.