Download Are Islamic banks better immunized than Conventional banks in the

10th Global Conference on Business & Economics
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Are Islamic banks better immunized than Conventional
banks in the current economic crisis?
By
Mareyah Mohammad Ahmad
Faculty of Business
The British University in Dubai, Dubai
Contact Number: +971506544744
&
Dr. Dayanand Pandey
Faculty of Business
The British University in Dubai, Dubai
Contact Number: +971508698035
May 2010
Acknowledgment
I would like to thank my family for their support and patience during the two-and-a-half
years it has taken me to graduate. As well, I would like to thank my friend, Maheen
Kamali, for her understanding. I would also like to thank Dr. D.N. Pandey for his help
and for his direction with this thesis. Also, I would like to thank Ajay Rai for assisting me
in finding the right data to be used for the methodology of this thesis.
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ABSTRACT
This paper analyzes the comparative performance of Conventional Banks vis-à-vis Islamic
Banks during the period of the recent economic crisis. Utilizing bank level data, the
research examines the performance indicators of Islamic Banks versus Conventional
Banks in the Gulf Cooperation Council (GCC) region, using financial ratios during the
quarters of 2006-2009. Islamic banks operate under different principles, such as risksharing and the prohibition of interest, yet both types of banks face similar type of
economic and competitive conditions. Such analysis would lead to a conclusion whether
Islamic banks perform better than Conventional banks, and whether Islamic Bank’s
inherent risk management is better than Conventional banks. The main purpose of this
thesis was to answer the question whether Islamic Banking is a better banking practice
than Conventional Banking in the times of economic crises?
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LIST OF DEFINITIONS

Sharia: “refers to the sacred law of Islam”.

Quran: “The Quran is the holy scripture of Islam, believed by Muslims to be the
direct and unaltered word of Allah”. It is a primary source of Sharia.

Sunnah: “The Sunnah consists of the religious actions and quotations of the
Islamic Prophet Muhammad and narrated through his Companions”.
It is a
primary source of Sharia.

Ijma: “The Ijma, or consensus amongst Muslim jurists on a particular legal issue,
constitutes the third source of Islamic law. Muslim jurists provide many verses of
the Quran that legitimize Ijma as a source of legislation”. It is a primary source of
Sharia.

Qiyas: “Qiyas is the process of legal deduction according to which the jurist,
confronted with an unprecedented case, bases his or her argument on the logic
used in the Quran and Sunnah. Qiyas must not be based on arbitrary judgment,
but rather be firmly rooted in the primary sources”.

Fatwa: “A Fatwa is a legal pronouncement in Islam, issued by a religious law
specialist on a specific issue”.

Zakat: “Zakat is one of the Five Pillars of Islam. It is the giving a small
percentage (2.5%) of surplus wealth to the poor and needy”. (Wikipedia. 2009).
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INTRODUCTION
1.1-Problem statement
Islamic banks operate under different principles which are based on Islamic Sharia Law.
They are obliged to take active part in the business and opt for sharing profits as well as
losses since interest based investments and borrowings are not permitted in Islam. Since,
Islamic banks can not charge a fixed return unrelated with their client’s operations, it may
seem that Islamic banks face more risk and hence, will have more volatile returns on their
assets as they have to own the asset before they sale or lease it to their clients and take on
the market risk which conventional banks do not take in financing. During the recent
economic crisis, claims were raised by economists, journalists, and analysts whether
Islamic banks are the answer to any economic crisis. According to a survey conducted by
MTI Consulting, Islamic Financial Institutions have been less affected by the global
recession. Around 62 percent of the survey respondents cited they had experienced little
or no impact from the crisis which has affected the banks and financial institutions
worldwide. The results of this survey were presented at the 16th Annual World Islamic
Banking Conference 2009-10 in the Kingdom of Bahrain on December 2009
(A1saudiarabia, 2009). As a result, this paper probes into whether Islamic banks are
better off in terms of performance and financial position than conventional banks during
the current economic recession through the examination of various type of financial
ratios.
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1.2-Fundamentals of islamic banking
Introducing the profit-sharing concept as an alternative to interest-based banking is the
main principle of the Islamic banking.
With a very young history comparative to
Conventional banking system, Islamic banks managed to grow significantly in terms of
assets worldwide, and to prove their presence in non – Muslim countries. It has been
noticed that International banks have opened Islamic windows, due to the increasing
demand for such types of products and services. During the growth stages of Islamic
banks, many claims have been made about the performance and risk level of Islamic
banks, and it has been highlighted immensely during the current economic crisis. Turen,
(1995), Chapra (1982 and 1985), Kahf (1982), Mohsin (1982), Pervez (1990), Siddiqi
(1983) and Zarqa (1983) are main researchers which support the concept that the
principle of profit sharing system (PLS) of Islamic banks and that its intrinsically more
stable than a system which is based on interest, therefore, leading to excessive
fluctuations in rates of return, inflation, and other economic issues.
On the other hand, some researches examine the structure, operation and management of
banks in the GCC region through [Turen (1995), Murjan and Ruza (2002), Islam (2003),
Essayyad and Madani (2003)], while another strand of literature explains general Islamic
financial principles to the non-Muslim reader [Siddiqui (1981), Bashier (1983), Khan
(1985)]. Karim and Ali (1989) and Rosly and Abu Bakar (2003) have examined the
financial ratios of Islamic banks. Karim and Ali (1989) suggest that Islamic banks prefer
to obtain funds from depositors rather than shareholders during expansionary periods in
an economy. When combined with the requirement for risk sharing, return on equity
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should be higher for Islamic than for conventional banks. Rosly and Abu Bakar (2003)
show that profitability was statistically higher for Malaysian Islamic banks during the
period 1996-1999 than for mainstream banks.
This research provides background of Islamic banking’s origin and growth as well as the
details of Islamic Sharia Law and concept along with the types of financial contracts
available in Islamic banks. After which it sets a stage for a discussion of the risk issues
pertaining to Islamic banks. Further, we highlight the theory of economic and banking
crisis with certain facts and figures. This is followed by the examination of 24 Islamic
and conventional banks using (20) financial ratios from different categories in order to
compare which type of bank is better of during the quarters of 2006 – 2009 with the
current economic condition. The conclusion summarizes the findings followed by issues
which act as problems and challenges faced by Islamic banks.
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LITERATURE REVIEW
2.1-Islamic banking: origin, scope and growth
Islamic banks are established to reorganize the Muslims financial contracts and activities
which complement the principles of Shariah (the Islamic Law) and enable them to
conduct it without interest, usury, or ‘riba’ . Zaher and Hassan, (2001) mentioned that
Islamic finance was practiced predominantly in the Muslim world. As a matter of fact,
the term “Islamic Financial system” started to appear only in the mid 1980s, where it is
not limited to banking, but covers financial instruments, financial markets, and all types
of financial intermediation.
The main factor which is supporting the dramatic growth of
Islamic finance for the last couple of years is the spread of the Islamic religion globally.
Siddiqui (2008) mentions that International banks around the globe considered it as a
profit opportunity to cater the increasing demand for Sharia compliant products, which
changed from a normal deposit to creating new products in hedging, investments, and
derivatives. Also, (Brooks, 1999) concludes that some non-Muslims are participating in
Islamic banking because they consider it to be commercially sound. On the other hand,
Zaher and Hassan (2001) rationalized that the growth of Islamic finance and banking is
influenced by factors including the introduction of broad macroeconomic and structural
reforms in financial systems, the liberalization of capital movements, privatization, the
global integration of financial markets, and the introduction of innovative and new
Islamic products.
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As per the studies made by Hassan and Mervyn (2007) and Chapra (1995), Islamic banks
main objective is to achieve the socio-economic goals of the Islamic Religion which are
reaching full-employment, a high rate of economic growth, equitable distribution of
wealth and income, socioeconomic justice, smooth mobilization of investments and
savings while ensuring a fair return for all parties involved. Badreldin (2009) and Zaher
and Hassan (2001) and note that Islamic financial system brings the most benefit to
society in terms of equity and prosperity rather than having a Conventional system with
an aim of profit maximization principles or creating maximum returns on capital.
Islamic Banks have recorded high growth rates both in size and number around the world
even in non-Muslim countries such as Western Europe, North America, and Asia.
Islamic banks operate in over 100 countries worldwide, most of them in the Middle East
and Asia, with over 300 Islamic financial institutions in operation which manage assets
worth $500 billion. Islamic banking industry has increased its share of total bank assets
from 8.8% in 2002 to 13.4% in 2008 (Islamicbanker.com).
Olson and Zoubi (2008)
observed that there were Multinational banks which have introduced Islamic windows
and divisions to offer Islamic products and services within their Conventional banking or
have substantial dealings in the field, such as HSBC, BNP Paribus, Commerzbank,
Standard Chartered, Citicorp, Bank of America, Deutsche Bank, Merrill Lynch, ABN
AMRO, Pictet & Cie, UBS, Barclays, Royal Bank of Canada, American Express,
Goldman Sachs, Kleinwort Benson, ANZ Grindlays and Flemings.
As per Asian
Banker’s annual report, the world’s largest Islamic banks by assets are concentrated in
only five markets:
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Iran, Kuwait, Malaysia, Saudi Arabia and the UAE.
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countries, Iran, Pakistan and Sudan, the entire banking system has been converted to
Islamic Banking, and they are considered as the pioneers of full Islamization. In other
countries, the banking systems are still dominated by Conventional banking institutions
operating alongside Islamic banks. Molyneux and Iqbal (2005) estimate that Islamic
banks in the GCC Region held about 74% of Islamic Banking system assets in 2002.
Appendix (1) lists the top 20 Islamic Banks worldwide as per asset size in terms of
country rank and world rank, as at 31/12/2009:
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2.2-Islamic law and concepts (sharia law)
Many of the legally recognized business arrangements and contracts in Islamic Finance
and Banking have been derived from the four main sources of Islamic Law (or Sharia),
which are: The Quran, the Sunnah, the Ijma, and the Qiyas. Islamic law prohibits the
payment and receipt of interest or usury (riba). Legally, riba is defined as a “contractual
increase arising from a loan (qard), whether in money or barter” (Rosly and Abu Bakar,
2003). The Holy Quran indicates that interest is an unfair business transaction as profits
realized from loans are risk-free with no evidence of value-addition by lenders, which is
considered as an ethical concern. The rationale behind the prohibition of interest or usury
(riba) is based upon values of justice (‘adl), cooperation (ta’awun), efficiency, stability
and growth.
Also, it is Islam’s response to resolve social imbalances arising from
inequitable distribution of income created by the credit system. Even though the interest
(riba) system has its benefits which are confined and restricted only to the lenders, the
borrowers stands to bear the costs which is unethical.
Zaher and Hassan (2001) have included in their research that Islam is against making
money or demands that Muslims revert to an all-cash or barter economy; however it
means that all parties to a financial transaction share the risk and profit or loss of a
venture, and that no one party to a financial contract gets predetermined return. Such a
system or framework will cut down the credit transactions and expand genuine trade and
commercial activities in finance and banking.
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Regarding the efficiency of capital allocation, interest based lending with adjustments for
risk capital tends to result in serving the more creditworthy borrowers and not necessarily
the most productive projects. On the other hand, the Islamic profit and loss sharing
(PLS) system allocates financing to the most productive business ventures, as the share in
returns is more promising.
Banning of interest and activating the (PLS) system in Islamic finance is supported by
economic rationales which are described by the International association of Islamic banks
(1995, pp3-4), as per the points listed below:
1- Based on (PLS) banking system, the allocations of funds will be primarily based
on the soundness of the project, and the return on capital will depend on
productivity. This will result in improving the capital allocation efficiency.
2- The (PLS) system will ensure more equitable distribution of wealth and the
creation of additional wealth to its owners more than the credit system which
depends on interest. As a result, this would definitely lead to reduction of unjust
distribution of wealth under the interest system.
3- The (PLS) system may increase the volume of investments and hence create more
jobs. On the other hand, the interest system would make feasible and acceptable
only to those projects whose expected returns are higher than the cost of debt, and
therefore filter out projects which would have been accepted under the (PLS)
system.
4- Islamic finance and banking reduces the size of speculation in financial markets,
but will allow for a secondary market for trading stocks and investment
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certificates based on profit sharing principles. This will bring sanity back to the
financial markets and promote liquidity to equity holders.
5- In the (PLS) system, the supply of money is not allowed to overstep the supply of
goods and would reduce inflationary pressures it has in the economy.
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2.3-Islamic financial contracts
There are basic financing contracts which are Sharia compliant and have been developed
for the usage of Islamic Banks. The Islamic modes of financing are divided into two
groups, which affect both the assets and liabilities sides of the Bank’s balance sheets
(Zaher and Hassan, 2001) and (Siddiqui, 2008) and (Sundararajan and Errico, 2002) and
(Islamic Finance, 2010):
(1) Core modes which are based on the profit-and-loss-sharing (PLS) principle and
include: Mudaraba (trustee finance), Musharaka (equity participation).
(2) Marginal modes which are based on mark-up principle and are (non-PLS) based,
such as, Qard Al Hasanah (beneficence loans), Bai’ Mua’jjal (credit sales or
deferred payments sales), Bai’ Salam or Bai’ Salaf (purchase with deferred
delivery), Ijara and Ijara wa iqtina’ (leasing and lease-purchase), Murabaha
(mark-up), Istisna’a (forward contract), and Jo’alah (service charge).
The literature below will provide a brief overview of some widely used Islamic banking
contracts which are commonly used to provide sharia compliant products covering
savings, trade, real estate, investment and many more, as Islamic banks offer a range of
financials services and products:
2.3.1-Murabaha (trade with markup or cost plus sale)
A Murabaha transaction is a cost plus profit financing contract in which the asset is
purchased by the Islamic Bank at the request of its customer from a supplier. The Islamic
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Bank then sells the asset to its customer on a deferred sale basis with a mark-up, which
reflects the bank’s profit, which cannot be changed during the life of the contract.
2.3.2-Musharaka (partnership or joint venture)
It is considered as a form of equity participation contract where is usually employed to
finance long-term investment projects. If the customer (debtor) does not seek full bank
financing of the project (100%) but contributes some of his own equity capital, then such
a contract is referred as a Musharaka. The bank is not the sole provider of the funds in
order to finance the project, as the customer, whose considered as a partner, contributes
to the join capital of an investment. The two parties are involved in a (PLS) agreement
where the profits are shared in accordance with pre determined ratios while the losses are
borne in proportion to equity participation.
2.3.3-Mudaraba (trustee finance contract)
Under this financing contract, the Bank provides the entire capital required for the
project, while the customer (or entrepreneur) offers his labor and expertise. Being a PLS
mode, the profits from the project are shared between the bank and the customer at a
certain fixed ratio. Financial losses are borne exclusively by the bank, where the liability
of the customer is only limited to his time and efforts.
Only in the event of
mismanagement or negligence is the customer held liable for the losses.
The Mudaraba contract is reflected in the balance sheet of the bank on both the asset and
liability side. On the liability side, the contract between the bank and the depositors is
known as unrestricted Mudaraba in which the depositors agree that their funds to be used
by the bank’s discretion, to finance an open-ended list (unrestricted) of profitable
investments and expect to share with the bank the overall profits accrued and earned.
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2.3.4-Ijara or ijara wa iqtina' (leasing contract)
Ijara is similar to a conventional operating lease, where when an Islamic bank (lessor)
leases the asset to a customer (lessee) with an agreement on lease payments for a
specified period of time, but with no option of ownership for the customer (lessee). On
the contrary, Ijara wa Iqtina’ is similar to the conventional financial or capital lease,
where the Islamic bank (lessor) purchases the asset such as a building, equipment or even
an entire project and leases it to the customer for an agreed lease rental payment, together
with the customer agreement to make lease payments towards the purchase of the asset
from the lessor at the end of the leasing period. For information, Zaher and Hassan
(2001) mentioned in their study that many investor, especially Islamic banks, have been
attracted to Islamic leasing with the promise of higher yields than Murabaha, which
accounts for the bulk of Islamic banks financial contracts.
2.3.5-Istisna'a (leasing contract)
Istisna’a can be used for financing the manufacture or construction of houses, plant,
projects, and the building of bridges, roads and highways. It is a sale contract in which
the commodity or product is transacted before it comes into existence. It means to order
a manufacturer to manufacture, construct or make something according to the
specifications provided. If the manufacture undertakes to manufacture the goods for the
purchaser, then the transaction of Istisna’a comes into existence. An important aspect for
the validity of Istisna’a is that the price is fixed with the consent of the parties and that
necessary specification of the commodity (intended to be manufactured) is fully settled
between them.
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2.3.6-Qard-e-hasna (benevolent loan or interest free loan)
Islamic banks provide such a facility with a zero return loan and are allowed to charge the
borrowers a service fee to cover the administrative expenses for handling the loan. These
types of loans are negative net present value investments to Islamic banks and are only
limited to the poor sections of society such as needy students or small rural farmers.
2.3.7-Jo’alah (service charge)
This mode usually applies to transactions such as consultations and professional services,
funds placements and trust services. It is defined as when a party undertakes to pay
another party a specified amount of money as a fee for rending a specified service in
accordance to the terms of the contract stipulated between the two parties.
In addition to mark-up and profit sharing instruments, two more Islamic instruments are
used in future trading or contracts:
2.3.8-Bay bi-thaman ajil or bai' mua'jjal (credit sale or deferred payment sale)
(Bay Bi-thaman ajil) – credit sales or deferred payment sale, in which the seller can sell a
product on the basis of deferred payment in installments or in a lump sum payments. The
price of the product is agreed upon between the buyer and the seller at the time of the sale
and cannot include any charge for deferring payments. Islamic banks can add a certain
percentage to the purchase price or additional costs associated with the transaction as a
profit margin, and the purchased product/asset will serve as a guarantee to the bank.
2.3.9-Bai' salam or bai' salaf (future sales contract – purchase with deferred delivery)
It is a sale of a commodity where the buyer pays the seller the full negotiated price of a
product, which the seller promises to deliver at a future date. The quality and the
quantity of the product sold should be fully specified at the time the contract is made.
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Practices and interpretations of Shariah law vary widely between Islamic institutions, as
well as between the various juristic schools in Islam or Schools of thoughts, hence the
acceptability of these techniques is not always agreed upon. As a matter of fact, there has
been various opinions among Islamic Scholars about the meaning of Shariah Compliant
the permissibility of Islamic futures, derivatives and options which have been adopted in
Pakistan and the Middle East.
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2.4-Risks associated with islamic banks
Conventional banks use both debt and equity to finance their investments, while Islamic
banks are expected to depend primarily upon equity financing and customers’ deposit
accounts such as current, saving, and investment (Karim and Ali, 1989).
Grais and Kulathunga (2007) have outlined through their research the main risks that any
bank might face under four broad categories:
1-Financial risk:
a- Credit risk: It is the risk of the counterparty failure to meet their obligation
towards the bank in a timely manner.
b- Interest rate risk: It is the risk of the reduction in the value of the fixed-interest
asset such as bonds due to a rise in interest rates. This can be also considered as part of
market risk, unless the asset is in the banking book. Also, interest rate risk is the risk of
an interest rate mismatch between fixed-rate assets and floating-rate liabilities, or viceversa, which results in a “squeeze” in both profit and cash flow.
c- Market risk: It is a risk which affects the class of assets or liabilities to a bank
due to economic changes or external events. It is also considered as a systematic risk
such as changes in stock market, interest rates, currency or commodity markets.
d- Liquidity risk: It is either a financing liquidity risk which arises from the
difficulty of obtaining funding at a reasonable cost or an asset liquidity risk which arises
from the difficulty of trading an asset.
e- Settlement risk: The risk that a counterparty does not deliver security or its
value in cash as per agreement when the security is traded after other counterparty have
delivered security or cash as per agreement.
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f- Prepayment risk:
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The risk of loans being prepaid before maturity date,
especially when it comes to mortgage loans. This can take place due to a drop in interest
rates.
2-Operational risk: are risks which mainly result from inadequate internal processes and
strategies, people and systems, or from external events. This is associated with the
potential for systems failure in a given market.
3-Business risk:
a- Legal and Regulatory risk: The type of risk that arise due to the changes in the
law and regulations which adversely affect a bank’s position.
b- Volatility risk: This is the risk which arises from the fluctuations in the
exchange rate of currencies.
c- Equity risk: This risk is mainly due to stock market dynamics which lead to
depreciation of investments.
d- Country risk: A political or financial event in a particular country might lead
to potential volatility of those foreign assets.
4-Event risk: Unpredictable risks due to unforeseen events such as banking crisis.
Siddiqui’s (2008) research included that Islamic Banks face similar risk to those
encountered by their conventional counterparts, however, with some variations as they
are required to comply with the Islamic Law (Sharia). The following list includes the
specific risks facing Islamic Banks:
1- Commodities and Inventory risk: This type of risk arises from holding items in
inventory either for resale under a Murabaha contract or for leasing under Ijara. For
information, the collateral under Islamic banking is established at the time of financing
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and the borrower becomes the owner of the assets to be purchased through financing and
if default occurs, the bank can confiscate those collateral assets, which it owns for the
tenor of the contract.
2- Rate of return risk: This type of risk is similar to the interest rate risk in the banking
book, even though Islamic banks are not exposed to interest rate risks. They are only
exposed to a “squeeze” resulting from holding a fixed-return asset such as the Murabaha
that are financed by investment accounts in the liabilities.
3- Legal and Sharia compliance risk: There are operational risks in failing to ensure
Sharia compliance and risks associated with the potential of systems failure resulting
from inadequate internal processes and strategies, people, and external events. As a
result, this includes legal and Sharia Compliance risk.
4- Equity position risk in banking book:
This arises from the equity exposure in
Mudaraba and Musharakah financing contracts.
5- Mark-up risk (benchmark risk): As Islamic banks do not use interest, they use market
rates as benchmarks in pricing their financing contracts and products. As a result, the
risk will arise from any change that will happen to the benchmark rates used, and is also
interrelated to the risk of rate of return that is mentioned earlier.
Khan and Ahmed (2001) have presented a survey of risk management of 17 Islamic
financial institutions in 10 countries and have ranked the risk perceptions resulted from
the survey. While credit risk is the predominant risk that both conventional and Islamic
banks deal with, however, the surveyed Islamic financial institutions do not perceive it as
being as severe as most other risks they identify. In contrast, the most critical risk they
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perceive is the mark-up risk or rate of return risk, followed by operational risk and
liquidity risk, credit risk, and lastly market risk.
The types of financial contracts which are used by Islamic banks as earlier explained
change the nature of risks that an institution might face. An important information to
know is that Islamic banks are constrained in using some types of risk mitigation tools or
techniques as they are not complied with the Islamic Law (Sharia). The Basel Committee
has stipulated higher minimum capital requirements for Islamic Banks. Furthermore,
researchers find that as Islamic banks use profit-loss sharing (PLS) as the primary mode
of financing, they carry much higher risks as it does not guarantee the principal of various
financing contracts, thereby should result in having a higher capital adequacy
requirement (Errico and Farahbaksh, 1998). Such capital requirements would impart
greater solvency and protect the principal liabilities of depositors and investors. In
addition, Ainley (2000) expressed that Islamic banks deal in new and unfamiliar forms of
finance where assets are long-term and illiquid. In response, regulators should impose
higher capital requirements on Islamic banks, particularly during the early years of an
Islamic bank operation.
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2.5-What happens during recessions, crunches and busts?
Banks play a vital role in the economy, and that is through matching the supply of capital
with demand. As a result, knowing how an economic downturn affects businesses and
organizations is important to understanding business cycle dynamics. The current global
economic meltdown has affected almost all countries. The strongest effect was measured
in America, Europe, and Japan due to the severe crisis of liquidity and credit. As a matter
of fact, all economies are interlinked to each other as any major fluctuation in trade
balance and economic conditions causes problems for all other economies.
In macroeconomics, recession is defined as “a distinct decline in any particular
country’s Gross Domestic which is also called as GDP” (Choudhary, 2010). A recession
can also be considered when a country faces negative real economic growth, for two or
more successive quarters of a year. According to the ‘The National Bureau of Economic
Research’ recession is defined as a “significant decline in economic activity spread
across the economy, lasting more than a few months”. When recession continues for a
long duration with severe implications, it’s termed as economic depression. If it leads to
a breakdown of economy, it is referred to as economy collapse.
Recessions affect the country’s overall economic activities such as investments,
employment rates, companies’ profits, and can lead also to sharp increase in price of
commodities.
It implies inflation or deflation, foreclosures, bankruptcies and banks
lending less money. Also, Consumers lose confidence in the growth of the economy and
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spend less. This leads to a decreased demand for goods and services, which in turn leads
to a decreased in production, lay-off, thereby a sharp rise in unemployment.
Furthermore, investors spend less as they fear stocks values will fall and thus stock
markets fall negatively. Stock markets and a recession of the economy are closely
related.
Recessions, crunches and economic downturns may affect banks leading to low profits,
poor capitalization, and high incidence of non-performing loans during the period.
Demirguc-Kunt and Detragiache and Gupta (2006) have defined the banking crisis as the
“a period in which significant segments of the banking system become illiquid or
insolvent”. The literature research conducted has mostly focused on the determinants of
the crises and the early warning indicators. It covered what happens to the economy and
to the banking sector after a crisis breaks out, and that comes from both macroeconomic
and bank level data.
According to Portes (2009), global macroeconomic imbalances were the major
underlying cause of the crisis. The ongoing global financial crisis is largely attributed to
extended periods of excessively loose monetary policy in the US over the period 20022004. Additionally, very low interest rates during this period encouraged an aggressive
search for yield. This resulted in abundant liquidity in the advanced economies generated
by the loose monetary policy which found its way to large capital inflows to emerging
markets. All these factors boosted asset and commodity prices, including oil, thereby
providing a boost to consumption and investments. Global imbalances resulted from
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such monitory policy and the boost in aggregate demand in the US over the aggregate
supply.
This period coincided with lax lending standards, in appropriate use of
derivatives, credit ratings and financial engineering, and excessive leverage. As inflation
reached its highest levels since 1970s, this lead to tightening the monetary policy all of a
sudden. The housing prices started to witness some correction. Lax lending standards,
excessive leverage and weaknesses of banks’ risk models and stress testing were exposed
which lead to the wiping off capital of major financial institutions (Mohan, 2009).
Herrala (2009) has made a research which highlights on the recent International
economic crisis that has been in partially due to credit policies. It has been observed that
lending was too lenient during the pre-crisis period, which lead to the accumulation of
credit risk. When the crisis hit, credit policy tightening further choked the economy. In
this paper, the researcher examines the hypothesis that banks’ credit policies are lenient
during boom periods and tight during busts. As a matter of fact, financial liberalization
during booms can affect the process of credit screening and contribute to a boom of bad
credit.
In addition, Dell’Ariccia and Marquez (2006) propose that the collateral
requirement is lenient during booms and tight during economic downturns.
Peter (2009) specifies that macroeconomic instability refers to the instability of the price
level and of output where financial instability is associated with collapsing financial
institutions at the system level, and it depends on bank behavior in response to asset
prices and bank losses.
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The major cause of the crisis is the “originate-to-distribute” model of securitization as
financial institutions did not follow the business model of securitization. Securitization
allowed lenders to pass through the loan and so reduced their incentive to screen and
monitor the mortgage loans, thereby reduction in loan quality. A number of academic
papers have covered this point such as Dell’Ariccia, Igan, and Laeven (2008); Berndt and
Gupta (2008); and Keys, Mukherjee, Seru, and Vig (2008). Also mortgage lenders sold
very sophisticated products to unsophisticated investors who may not have understood
what they were buying. Banks had the major shareholding of the market which lead to
the crisis to happen:
Commerzbank has undergone an economic, interest rates and exchange rates research in
February/March 2009 which included a couple of analysis of its economists (Kramer,
2009). For instance, the Chief Economist mentioned in the research that both North
America and West Europe are hit by the deepest recession since the end of the World
War II. This will lead in having both economies contract until mid of 2009 as the heavy
recession will not be followed by the classic strong upswing due to the ongoing decline in
the house prices. This would lead to a shrinkage in the GDP in both economies by 2% in
the USA and 2% - 3% in the Eurozone, sharp falls in inflation leading to negative rates,
and rise in unemployment, such as to a high 9% by end of 2009 in the USA. In addition,
the yields of 10-year government bonds have already fallen to a very low level, and the
equity markets are expected to continue to suffer, as companies are reporting
disappointing profits and earnings as a result of the recession. In the USA, the Fed has its
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key interest rate close to 0 %, whereas The European Central bank (ECB) was inducing
to cut the key interest rate to 1% by spring 2009 due to the sharp fall in inflation.
As per the World Economic Situation and Prospects 2010 issued by the United Nations,
which provides an overview of recent global economic performance and short-term
prospects. It’s noticed that after the sharp global downturn in late 2008 and early 2009,
credit conditions are still tight in major developed economies, where many major
financial institutions need to continue the process of deleveraging and cleansing their
balance-sheets. In addition, consumption and investment demand remain weak, low
inflation levels, along with continuous rise of unemployment rates (WESP, 2009).
As the GCC countries were affected by the economic crisis, The GCC credit growth fell
sharply in 2009 main due to tight liquidity and banks being risk averse in the face of
rising Non-performing loans (NPLs) and deflated asset prices.
The next page
demonstrates Table (6) with regards to some of the macroeconomic indicators and
forecasts for each country in the GCC Region covering the period 2006-2010:
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RESEARCH METHODOLOGY
3.1-Data
The evaluation of both Islamic and conventional banks is made through the analysis of
widely used financial ratios which are used for measuring banking performance. The
study covered a sample of 24 banks, comprising of 12 Conventional banks and 12 Islamic
Banks, extracted from the Bankscope database1 over the quarterly period of 2006 – 2009.
To mitigate biasness in the findings, the sample included banks in the GCC countries as 3
out of 5 major markets of Islamic Banking are located in the GCC Region: Kuwait,
Kingdom of Saudi Arabia and the United Arab Emirates. This would also ensure that all
the Banks in the sample have undergone similar levels of economic shocks. The sample
covers countries like Kingdom of Saudi Arabia, United Arab Emirates, Kingdom of
Bahrain, State of Qatar, and Kuwait. As a matter of fact, every Islamic bank included in
the sample from a particular country was selected along with a Conventional Bank of a
similar size in terms of Assets in order to ensure neutral affect of factors on the sample,
thereby more accurate results and findings.
For information, Iranian banks were
excluded from the sample due to the nature of Iran’s closed economy, even though they
are considered to be on the top of the list of Islamic banks in terms of asset size. Refer to
(Appendix 2) for the list of the Islamic and Conventional banks selected for this study.
The limitations faced while collecting the data is the unavailability of some of the
quarterly data for most of the banks, especially when it comes to Islamic Banks. Even
though with the wide range of Islamic banks, some banks statements were not updated till
1
www.bankscope.com
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end of year 2009 which limited the sample to GCC countries instead of covering
worldwide.
3.2 Methodology and financial ratios
Financial ratios are widely used by academic researchers, financial analysts, lenders, and
small business managers. As a result, 20 different types of financial ratios which fall
under 6 general categories are used to analyze the performance and position of Islamic
banks compared to Conventional banks based on the quarterly period from 2006 to 2009,
as explained below:.
3.2.1 – Growth of Assets and Liabilities:
R1: Growth of Total Assets
R2: Growth of Total Liabilities
3.2.2 - Profitability ratios: are used to measure how well a firm is performing in terms of
its ability to generate earnings as compared to its expenses and other relevant costs
incurred during a specific period of time. Profitability measures are important to both
Banks’ managers and owners whereby having a higher value of such ratios relative to
competitors’ or compared to a previous period is indicative that the firm is doing better.
Rosly and Abu Bakar (2003), Siddiqui (2008), and Olson and Zoubi (2008) have
indicated that the following ratios can be used to measure profitability:
R3: Return on Average Equity (ROAE): shows net earnings per unit of equity of capital.
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R4: Return on Average Assets (ROAA): shows how a bank can convert its assets into
profits and net earnings.
Olson and Zoubi (2008) have indicated that based on previous studies, profitability ratios
should be higher for Islamic banks.
3.2.3 - Efficiency ratios: are simply defined as expenses as percentage of revenue. The
lower the ratio the better, since it indicates that expenses are low and earnings are high,
whereby it can also be related to operating leverage. As a matter of fact, efficiency ratios
will measure how effectively the company utilizes these assets, as well as how well it
manages its liabilities internally.
Demirguc-Kunt and Hizinga (1999), Essayyad and
Madani (2000), Siddiqui, A., (2008), and Olson, D. and Zoubi, T., (2008) have indicated
the following ratios for the measurement of the bank’s efficiency level (Refer to Table 1):
The Cost to Income ratio is the commonly used efficiency indicator in the financial
sector. The lower the cost/income ratio, the better as it measures how costs are changing
compared to income. Based on Rosly and Abu Bakar (2003), Yudistira (2003), and
Olson and Zoubi (2008), Islamic banks are expected to be less efficient than conventional
banks. The inefficiency may be due to the lack of economies of scale or it may arise
because customers of Islamic banks are pre-disposed to Islamic products regardless of
cost.
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3.2.4 – Asset quality ratios:
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are ratios related to the measurement of the quality of
bank’s assets which are mainly loans and leases by the Bank’s credit standards, and the
liquidity of securities held. As a matter of fact, one of the main components of a Bank’s
management is asset management. Bank managers are concerned with the quality of their
loans since that provides earnings for the bank. Siddiqui (2008), and Olson and Zoubi
(2008) have indicated the following ratios which can be used for such categories (Refer
to Table 2):
3.2.5 – Capital Adequacy ratios: are the ratios which regulators in the banking system
use in order to monitor the bank's health, specifically bank's capital towards its risk. A
Bank’s capital is considered as a cushion for potential losses, which protect the bank’s
depositors or lenders, thereby maintaining confidence and financial stability in the
banking system. Siddiqui (2008) indicates that the higher the capital adequacy ratio the
more solvent the bank. The list of capital adequacy ratios are as follows:
R14: Tier 1 Ratio
R15: Total Capital Ratio
3.2.6 – Leverage ratios: indicates the financial health of the Bank. In general, financial
leverage indicates the methods of financing used by the Bank and its ability to meet its
financial obligations. It basically measures the level of risk taken by a bank as a result of
its capital structure since it relates to how much debt it has on its balance sheet. Banks
that are highly leveraged may be at risk of bankruptcy if they are unable to make
payments on their debt. They may also find it difficult to find new lenders in the future.
Since Islamic banks do not use debt financing, it is expected to have shareholder equity
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as a larger source of funds relative to Conventional banks (D’Hulster, 2009). The types
of ratios which will be used under this category are:
R16: Equity/Total Assets
R17: Equity/Total Liabilities
3.2.7 – Liquidity ratios:
is the Bank’s ability to meet its short-term debt obligations.
The higher the value of the ratio, the larger the margin of safety that the Bank maintains
to cover the short-term debts. For information, bankruptcy analysts frequently use the
liquidity ratios to determine whether an institution will be able to continue as a going
concern. Siddiqui (2008) used some of the following as liquidity ratios (Refer to Table
3).
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FINANCIAL RATIO ANALYSIS & RESULTS
4.1-Introduction
For each of the listed ratios in Table (4), the analysis will include the following:
-
A table which demonstrates the ratios for each assigned quarter for each type of
the 12 listed banks, along with the averaged ratios and standard deviations
-
A graph of the Averaged Ratios, representing one ratio for each quarter for each
type of banks.
-
A graph representing the Standard Deviation for each ratio at a quarter level for
each type of banks.
-
Analysis and findings of ratio under examination.
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Each ratio within the categories mentioned above will be analyzed separately as it will be
averaged off to arrive to a single figure for each quarter using the (AVG) function in
Excel, for the each of the 12 Islamic banks and the 12 conventional banks of that quarter.
In addition, the (STDEV) function of standard deviation in Excel will be used in order to
track the volatility of the assigned ratio for the specific quarter of the sample period.
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4.2-Analysis and results
The results of this study indicate that measures of banks characteristics and financial
ratios such as profitability, efficiency, asset-quality, capitalization, leverage and liquidity
ratios are good performance indicators between Islamic and Conventional banks in the
GCC regions in the recent economic crisis. Due to the nature and risk type of Islamic
banks, it was clearly illustrated through the financial analysis that Islamic banks are more
volatile than Conventional banks through out most of the financial ratios being under
examination.
The main purpose of this thesis was to answer the question whether Islamic Banking is a
better banking practice than Conventional Banking in the times of economic crises. The
financial analysis of comparative performance of Islamic banks vis-à-vis Conventional
banks during the period of the recent economic crisis can be concluded as per the
following:

Growth of Assets and Liabilities: The percentage growth of Islamic bank’s assets
compared to Conventional banks was much faster and higher, even during times
of slow economy and recession when banks were conservative in lending and
financing activities. Conventional banks’ booked higher liabilities growth rates
compared to assets, which explains the reason for higher cost of funds.

Profitability: Islamic banks are more profitable than Conventional banks in terms
of Return on Average Assets (ROAA) which means that Islamic banks’ assets are
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more profitable in generating revenues, and that Islamic banks’ management are
more efficient in using its assets to generate earnings. The Return on Average
Equity (ROAE) for Conventional banks being more than Islamic banks for most
of the time in the sample period, due to the affect of the net income.

Efficiency: Conventional banks are better off than Islamic banks in terms of
generating interest income from their Earning Assets or Loans in addition to non
interest income as a source of non-funded income; thereby reducing
capitalization, risk and improving diversification for Conventional Banks’ sources
of revenue. However, it’s clear that Conventional banks are incurring higher cost
of funds compared to Islamic banks. This resulted in affecting the Net Interest
Margin (NIM), as the Net Income from financing activities for Islamic banks are
higher than conventional banks which reflect the efficiency level in the lending
activities and managing the lending expenses (or cost of funds) involved.
However, Islamic banks from a macro level are less efficient in terms of
managing their overall costs which include other operating and non operating
expenses, and that is reflected in the cost to income ratio graph.

Assets Quality: It is generally observed that Islamic banks have booked more
impaired loans and Loan reserves than conventional banks, which can indicate
that the credit policy of Conventional banks in reserves and provisioning is more
conservative than Islamic banks especially when considering the issue of
volatility for Islamic banks.
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
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Capitalization Ratios: Islamic banks are more capitalized in terms of their risk
weighted assets compared to Conventional banks. As high capital ratios would
act as a cushion for the bank against any shocks, however, it would negatively
affect the profitability and earnings generated by the bank as more funds is
booked under equity.

Leverage Ratios: Conventional banks are more leveraged than Islamic banks in
terms of depending more on debts and liabilities than Islamic banks.
This
explains the reason as to why interest expenses are higher for Conventional banks.
Furthermore, a lower equity capital ratio is associated with higher returns for
Conventional banks and puts Islamic banks under pressure as equity increases the
Weighted Average Cost of Capital (WACC).

Liquidity Ratios:
Islamic Banks are highly dependant on their investment
deposits in their financing activities leading to high level of liquidity ratios
compared to Conventional banks. This is mainly due to the nature of Islamic
banks and the shortage of supply in money market activities from a sharia
compliance perspective. Also, this is reflected in the Net Income Margin from
Financing Activities of the Islamic banks as it is cheaper to depend on customer
deposits as a source of funding based on (PLS) system compared to Conventional
banks which sources through other channels such as money market, inter-bank
activities. High level of Net Financing Receivables to Total Deposit and Short-
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term funding can trigger liquidity and withdrawal risk. Therefore, it should be
monitored closely by Islamic Banks’ management due to nature of the bank and
limited sources of funding.
Most findings are consistent with the literature and previous academic researches made
on the effectiveness of Islamic banks as a banking practice, except for the profitability
and asset quality ratios. This is mainly due to the affect of Islamic banks earning lower
net income than Conventional banks. In addition, one of the reasons is due to the
aggressive strategy of Islamic banks of booking higher impaired loans than conventional
banks compared to their gross loans. As a matter of fact, this point requires further
examination in order to differentiate between both credit and provisioning policies for
both types of banks.
The findings of the research are in consistent with the literature made on Islamic banks’
performance compared to Conventional banks’, especially that the sample is covering a
period of economic crisis. For instance, there was an examination made through previous
studies such as Karim and Ali (1989) which suggests that GCC Islamic banks may be
more profitable than other GCC banks. On the other hand, it may be possible that
shareholders in Islamic banks are willing to accept a lower return on equity.
Furthermore, Rosly and Abu Bakar (2003) concluded that six profitability ratios confirm
the work of the researchers done where the profitability of Islamic banks is higher than
conventional banks, as both researchers have reported a higher ROA for Islamic banks.
In addition, it was concluded that Islamic banks are less efficient that conventional banks.
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Also, Yudistira (2003) examined 18 Islamic Banks, some which are located in GCC
countries, are slightly less cost efficient than conventional banks. This is due to the lack
of economies of scale as Islamic banks can be smaller in terms of size, or it may arise
because customers of Islamic banks are pre-disposed to Islamic products regardless of
cost.
Olson & Zoubi (2008) have concluded that Islamic banks are more profitable than
Conventional banks but not as efficient. Islamic banks which are of higher profitability
may be due to risk, while the remainder may be due to the greater reliance on deposits for
providing capital. Islamic banks voluntarily hold more cash relative to deposits than
conventional banks due to the risk of withdrawal of deposits, but they also maintain
lower provisions for possible loan losses (or losses from Ijara leasing and investments for
Islamic banks) than conventional banks.
Current critics of Islamic financial practices such as Rosly and Abu Bakar (2003),
Meenai (2000) suggest that Islamic banks have often just repackages conventional
products based on semantics instead. It is suggested that Islamic banks have to promote
ethical banking via partnership arrangements such as mudarabah (trustee partnership) and
musharakah (joint ventures), salam and istisna’a (sale by order) instead of focusing
primarily on non PLS financing contracts such as murabaha and Ijara. Such arrangement
will lead to greater efficiency, and can generate the much-needed scale and scope
economies to increase profitability and efficiency further more as well as impacting the
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well-being of society.
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Islamic banks can provide efficient banking services to the
economy only if they supported with appropriate banking laws and regulations.
Islamic banks enjoy a built-in stabilizer to help them cope with economic downturns, as
instead of paying interest to depositors, those with investment mudaraba accounts share
in the banks profits. Thus, if profitability declines in an economic downturn, depositors
receive lower returns, but if profits rise they enjoy higher returns (Wilson, R., 2009 ).
On the hand, financial experts and Bankers support the phenomenon of Islamized Banks.
For instance, Sir Andrew Cahn, UK Trade & Investment's Chief Executive Officer
remarks: "Despite its origins overseas, Islamic finance has found a natural home in the
UK. Though no sector is immune to the global financial crisis, Islamic finance has shown
great resilience. It is important we continue to work with our Islamic finance partners to
maintain our position as the leading western centre for Islamic finance service
providers." (Ranigee, 2009).
Talking to the Kuwait Times on the sidelines of a conference about the affect of the
economic crisis on Islamic banks, Emad Yousef Al-Monayea, Chairman and Managing
Director of Liquidity House, a KFH subsidiary, said that one of the major elements that
has enabled Islamic banking to resist the economic crisis were the assets that back the
structures developed in Islamic banking: “Most of these structures have to be backed by
these assets; these assets have to be actual, should have a value and have to have some
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kind of marketable features into them. This is one of the major elements that maintains
Islamic banking,” Al-Monayea said (Jamaldeen, 2010).
The crisis was largely linked to asset management, demands and the concepts of risk
management, which contributed to the growth of the crisis. Through the findings of this
research, previous academic findings, and opinions of financial experts and bankers;
Islamic banking is considered a better banking practice than Conventional Banking in the
times of economic crises.
Islamic Banks have still further room for growth and
improvement, and it is vital to study and resolve a lot of outstanding issues that Islamic
banks are facing in the current banking structure and environment.
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Problems and Challenges of Islamic Banking
Iqbal and Ahmad and Khan (1998) and Zaher and Hassan (2001) have included in their
research the problems and challenges which Islamic banks and markets are facing, as it
has to be addressed in order to ensure growth. There are two types of challenges:,
Institutional and operational:
1-Uniform regulatory and legal framework that is supportive of an Islamic financial
system has not yet been developed. As a matter of fact, existing banking regulations in
Islamic countries are based on the conventional or western banking models which narrow
the scope of activities of Islamic banking within conventional limits.
Enhancing
regulation and supervision would lead to more of corporate governance and increasing
the information available to investors, ensures the soundness of the financial system, and
improves the control of monetary policy in addition to Sharia supervision for Islamic
banks.
2-In a conventional credit system, interest rates play a key role in managing liquidity,
pricing risk and allocating credit. As a result, the risk manager of an Islamic bank would
face a greater challenger than the risk manager of a similar size conventional bank due to
the absence of risk management tools and hedging instruments especially that the interbank market mainly depends on interest rates. In addition an Islamic inter-bank market
can be developed, as currently Islamic banks are obliged to hold higher levels of liquidity
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than conventional banks, which will negatively affect their profitability and ability to
compete.
3-Another point is the lack of equity institutions which is related to the point mentioned
previously. Islamic Banks face a need for long-term finance. As Islamic banks do not
deal with interest-bearing bonds, there have been a nourishing market in the last couple
of years to create a new products under the name of ‘Sukuk’. However, there is still no
special market available for Islamic banks.
4-There is a need for a sound accounting procedures and standards that are consistent
with the Islamic Laws.
International accounting procedures which are based on
western/conventional models are not adequate due to differences in the nature and
treatment of financial instruments. However, some Islamic banks with the guidance of
the Islamic Development Bank, have established the ‘Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI), which is functional and based
in the Kingdom of Bahrain. It still requires time and enforcement to see any perceptive
change as the AAOIFI is a voluntary organization and has not binding powers to
implement its standards.
5-Islamic banks and financial Institutions face a fierce competition in human capital as
there is a shortage of trained personnel who can analyze and manage portfolios, and
develop innovative products according to Islamic financial principles. Also, there is a
shortage of scholars who possess even a working knowledge of both Islamic fiqh and
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modern economics and finance as it is currently observed that a scholar is a Sharia board
member for more than one Islamic bank due to this issue.
6-There is a lack of uniformity in the religious principles of Sharia Law applied in
Islamic countries. Such differences in interpretation of Islamic principles are due to
having different schools of thought. As a matter of fact, each Islamic bank should have a
Sharia board (and committee) for advice and guidance and to consult their Sharia
advisors to seek approval for new products and instruments. Due to the different schools
of thought in Islamic law and not having a universally accepted central Islamic religious
authority, a product or financial instrument created may not be acceptable in all countries.
7-Even though Islamic banking has testified huge growth since the last couple of years,
but still a lot of banks which are created are considered small in size and cannot play as a
serious player especially when it comes to attracting large international banks with
Islamic windows. In order to compete globally in an effective manner, small Islamic
banks have to merge. Also, they might need to decide on which area to specialize in. For
example, in Africa the focus might be on agriculture, and in Asia the focus could be on
industrial, service sectors, and trade, whereas inn Europe and USA, Islamic banks can
specialize in capital and financial leasing.
8-Islamic banks would face a problem when it comes to the issue of liquidity and ‘lender
of last resort’ function in many Muslim economies, with exception to Malaysia as it
maintains an active inter-bank money market and an Islamic clearing system that is run
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by the central bank. Currently, the Central bank in many Muslim economies are based on
conventional systems, where when it comes to the ‘lender of last resort’, the Central bank
would stand behind the banking system to offer liquidity lending to banks if there is a
shortage of funds in the system. Islamic banks may not be able to use this facility
because of the interest payments due on the loans.
9-A lot of argument is taking place especially from regulators in Western countries,
highlighting that the market of Islamic banking is relatively new and their assets are
mostly long-term and illiquid, which entitles them to carry more, rather than less capital.
10-The development of an inter-bank market for Islamic banks is one of the biggest
challenges. Also, the secondary market for Islamic products is extremely weak and
illiquid, and money markets are almost nonexistent, since viable instruments are not
currently available.
11-Lack of Financial Engineering in Islamic Banks for designing financial products,
especially in a fast changing market environment and increasing competition. Until now,
the Islamic financial products and contracts have been limited to classical modes.
12-Lack of Profit-Sharing Finance where Islamic economists built up their hopes on
Islamic banks to provide more significant amount of profit-sharing finance than fixed
charge on capital. If well implemented, this would have economic consequences similar
to direct investment and produce a strong economic development impact. However, in
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practice, profit-sharing finance has remained minor or negligible in the operations of
Islamic Banks as most of the assets are between murabaha and leasing modes of
financing.
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TABLES
Table (1): List of Efficiency Ratios using Islamic Banks and Conventional Banks’ related terms
Ratios for Islamic Banks
Ratios for Conventional Banks
R5
Net Income Margin from financing Activities
R6
Operating Efficiency Ratio = Cost to Income Ratio = operating expenses/operating income
R7
Income from financing activities/Average Interest Income on Loans/Average Gross
financing receivables (or assets)
R8
Asset Turnover:
Loans
Income from financing Asset Turnover: Interest Income/Average
activities/Average Earning Assets
R9
Net Interest Margin
Earning Assets
Customer Deposits’ share of profit/ funded Interest
Liabilities
Expense/Average
Interest-
bearing Liabilities
R10 Net Income from financing activities/Average Net Interest Income/Average Earning
Earning Assets
Assets
R11 Non financing Income/Gross Revenues
Non Interest Income/Gross Revenues
Table (2): List of Asset Quality Ratios using Islamic Banks and Conventional Banks’ related
terms
Ratios for Islamic Banks
Ratios for Conventional Banks
R12 Financing Receivables Loss Reserves/Gross Loan Loss Reserves/Gross Loans
Financing Receivables
R13 Impaired
Financing
Receivables/Gross Impaired Loans/Gross Loans
Financing Receivables
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Table (3): List of Liquidity Ratios using Islamic Banks and Conventional Banks’ related terms
Ratios for Islamic Banks
Ratios for Conventional Banks
R18 Net financing receivables/Total Assets
Net Loans/Total Assets
R19 Net financing receivables/Total Deposit and Net Loans/Total Deposit and Short-Term
Short-Term Funding
Funding
R20 Net financing receivables/Total Deposit and Net Loans/Total Deposit and Borrowing
Borrowing
Table (4): List of Ratios
Ratios for Islamic Banks
Ratios for Conventional Banks
Growth of Assets and Liabilities
R1
Growth of Total Assets
R2
Growth of Total Liabilities
Profitability Ratios
R3
Return on Average Equity (ROAE)
R4
Return on Average Assets (ROAA)
Efficiency Ratios
R5
Net Income Margin from financing Activities
R6
Operating Efficiency Ratio = Cost to Income Ratio = operating expenses/operating income
R7
Income from financing activities/Average Interest Income on Loans/Average Gross
financing receivables (or assets)
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Rome, Italy
Net Interest Margin
Loans
47
10th Global Conference on Business & Economics
R8
Asset Turnover:
ISBN : 978-0-9830452-1-2
Income from financing Asset Turnover: Interest Income/Average
activities/Average Earning Assets
R9
Earning Assets
Customer Deposits’ share of profit/ funded Interest
Liabilities
Expense/Average
Interest-
bearing Liabilities
R10 Net Income from financing activities/Average Net Interest Income/Average Earning
Earning Assets
Assets
R11 Non financing Income/Gross Revenues
Non Interest Income/Gross Revenues
Asset Quality Ratios
R12 Financing Receivables Loss Reserves/Gross Loan Loss Reserves/Gross Loans
Financing Receivables
R13 Impaired
Financing
Receivables/Gross Impaired Loans/Gross Loans
Financing Receivables
Capital Adequacy Ratios
R14 Tier 1 Ratio
R15 Total Capital Ratio
Leverage Ratios
R16 Equity/Total Assets
R17 Equity/Total Liabilities
Liquidity Ratios
R18 Net financing receivables/Total Assets
Net Loans/Total Assets
R19 Net financing receivables/Total Deposit and Net Loans/Total Deposit and Short-Term
Short-Term Funding
October 15-16, 2010
Rome, Italy
Funding
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R20 Net financing receivables/Total Deposit and Net Loans/Total Deposit and Borrowing
Borrowing
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