Do Islamic banks perform better than conventional banks ? A financial ratio analysis approach

Abstract

The Islamic finance and banking industry have been a successful alternative to conventional banking for the people who seek financial services that comply with Islamic law. The assets of financial institutions that follow the Islamic law nearly doubled from 2008 to 2016 to reach around 1,500 billion USD in 2016. Islamic finance is not only limited to countries with a Muslim majority but has also presence all over the world including the western countries. Luxembourg has introduced bonds that comply with Islamic laws to attract Muslim investors, and several western banks started offering financial products that are compliant with Islamic laws. This paper attempts to compare the difference in performance between Islamic banks and conventional banks in seven countries that have a strong presence of Islamic banks: Bahrain, Kuwait, Malaysia, Qatar, Turkey, Saudi Arabia, and the UAE. The paper covers three periods: pre-financial crisis, the financial crisis, and post financial crisis. The method employed in this paper is the financial ratios analysis (FRA) to measure liquidity, capital adequacy, efficiency profitability, and credit risk. The ratios of Islamic banks and conventional banks were calculated and then the averages were subject to the t-test to determine the significance between those averages. The empirical results suggest that no model has a clear superiority over the other. The notable differences that were observed are that: Firstly, the average Net interest (financing) margin of Islamic banks was higher than the conventional banks’ average thus suggesting that the financing methods of Islamic banks are superior. Secondly Conventional banks had considerably higher profit margins, which implies that they manage better all the expenses and revenues and not only those associated with financing costs and investments revenues. Thirdly conventional banks have a higher level of Non-performing loans, which can also be attributed to the different modes of lending between conventional and Islamic banks.