mareyah mohammad ahmad, dayanand pandey

8/3/2019 Mareyah Mohammad Ahmad, Dayanand Pandey

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10th Global Conference on Business & Economics ISBN : 978-0-9830452-1-2

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.

October 15-16, 2010Rome, Italy

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ABSTRACT

This paper analyzes the comparative performance of Conventional Banks vis--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 risk-

sharing 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 Banks

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 ofAllah. 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, orconsensus 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 QuranandSunnah. 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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http://en.wikipedia.org/wiki/Holy_scripturehttp://en.wikipedia.org/wiki/Godhttp://en.wikipedia.org/wiki/Islamic_Prophethttp://en.wikipedia.org/wiki/Muhammadhttp://en.wikipedia.org/wiki/Companionshttp://en.wikipedia.org/wiki/Consensushttp://en.wikipedia.org/wiki/Ayahhttp://en.wikipedia.org/wiki/Qur'anhttp://en.wikipedia.org/wiki/Qur'anhttp://en.wikipedia.org/wiki/Sunnahhttp://en.wikipedia.org/wiki/Sunnahhttp://en.wikipedia.org/wiki/Godhttp://en.wikipedia.org/wiki/Islamic_Prophethttp://en.wikipedia.org/wiki/Muhammadhttp://en.wikipedia.org/wiki/Companionshttp://en.wikipedia.org/wiki/Consensushttp://en.wikipedia.org/wiki/Ayahhttp://en.wikipedia.org/wiki/Qur'anhttp://en.wikipedia.org/wiki/Sunnahhttp://en.wikipedia.org/wiki/Holy_scripture


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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 clients 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 bankings 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

Bankers annual report, the worlds largest Islamic banks by assets are concentrated in

only five markets: Iran, Kuwait, Malaysia, Saudi Arabia and the UAE. In three


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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 (taawun), efficiency, stability

and growth. Also, it is Islams 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 Banks 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 Muajjal (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), Istisnaa (forward contract), and Joalah (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 banks 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 banks 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)

Istisnaa 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 Istisnaa comes

into existence. An important aspect for the validity of Istisnaa 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-Joalah (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 vice-

versa, 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: 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 banks 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.

Siddiquis (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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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

countrys 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, its termed as economic depression. If it leads to

a breakdown of economy, it is referred to as economy collapse.

Recessions affect the countrys 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 2002-

2004. 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, DellAriccia 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 DellAriccia, 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. Its 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 Irans 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 banks 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: are ratios related to the measurement of the quality of

banks assets which are mainly loans and leases by the Banks credit standards, and the

liquidity of securities held. As a matter of fact, one of the main components of a Banks

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

Banks capital is considered as a cushion for potential losses, which protect the banks

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 ofbankruptcy 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 (DHulster, 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 Banks 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--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 banks 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, its 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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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 istisnaa (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. 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

kind of marketable features into them. This is one of the major elements that maintains

Islamic banking, Al-Monayea said (Jamaldeen, 2010).


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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 inter-

bank 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 Net Interest Margin

R6 Operating Efficiency Ratio = Cost to Income Ratio = operating expenses/operating incomeR7 Income from financing activities/Average

financing receivables (or assets)

Interest Income on Loans/Average Gross

Loans

R8 Asset Turnover: Income from financing

activities/Average Earning Assets

Asset Turnover: Interest Income/Average

Earning Assets

R9 Customer Deposits share of profit/ funded

Liabilities

Interest Expense/Average Interest-

bearing Liabilities

R10 Net Income from financing activities/Average

Earning Assets

Net Interest Income/Average Earning

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


R12 Financing Receivables Loss Reserves/Gross

Financing Receivables

Loan Loss Reserves/Gross Loans

R13 Impaired Financing Receivables/Gross


Impaired Loans/Gross Loans

Table (3): List of Liquidity Ratios using Islamic Banks and Conventional Banks related terms


R18 Net financing receivables/Total Assets Net Loans/Total Assets

R19 Net financing receivables/Total Deposit and

Short-Term Funding

Net Loans/Total Deposit and Short-Term

Funding


Borrowing

Net Loans/Total Deposit and Borrowing


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Table (4): List of Ratios


Growth of Assets and Liabilities

R1 Growth of Total AssetsR2 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 Net Interest Margin

R6 Operating Efficiency Ratio = Cost to Income Ratio = operating expenses/operating income

R7 Income from financing activities/Average

financing receivables (or assets)

Interest Income on Loans/Average Gross

Loans

R8 Asset Turnover: Income from financing

activities/Average Earning Assets

Asset Turnover: Interest Income/Average

Earning Assets

R9 Customer Deposits share of profit/ funded

Liabilities

Interest Expense/Average Interest-

bearing Liabilities

R10 Net Income from financing activities/Average

Earning Assets

Net Interest Income/Average Earning

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

R13 Impaired Financing Receivables/Gross


Impaired Loans/Gross Loans

Capital Adequacy Ratios

R14 Tier 1 Ratio

R15 Total Capital Ratio

Leverage RatiosR16 Equity/Total Assets

R17 Equity/Total Liabilities

Liquidity Ratios

R18 Net financing receivables/Total Assets Net Loans/Total Assets


Short-Term Funding

Net Loans/Total Deposit and Short-Term

Funding


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Borrowing

Net Loans/Total Deposit and Borrowing


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