Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
Profitability Comparison of Islamic and Conventional
Banks
Tariq Alzoubi*
The study examines 33 conventional banks and 10 Islamic banks from Saudi
Arabia, Kuwait, United Arab Emirates (UAE), and Jordan, between 20072013. The research tends to make a comparison between the profitability of
Islamic and conventional banks. The results show that there is no significant
differences between the profitability of Islamic and conventional banks.
Additionally, the results also show that the growth rate of Islamic banks’
assets is more than 170% higher than conventional banks’ assets.
Field of Research: Banking.
Keywords: Islamic Banks, Conventional Banks, Profitability.
1. Introduction
The late financial crisis brought an important question as to whether the current
financial system is adequate and convenient to face such a crisis. Regulators and
researchers tried to find ways and solutions within the current conventional financial
system to solve the financial crisis and prevent future crises from happening. Even
with all efforts made the current financial system and their institutions cannot be
regarded as a perfect solution for the financial crisis.
While regulators and researchers investigated the financial crisis to understand its
reasons and causes, they discovered something very important; some financial
institutions and some corporations have not been affected by financial crisis as much
as others. These institutions and corporations did not depend mainly on the
conventional financial system. Many of these institutions and corporations were using
Islamic financing and Islamic financing tools to finance their operations. Even for
these financial institutions and corporations who did not use Islamic financing and
Islamic financing tools to run their operations, there ways to operate were closer to
Islamic financing than conventional financing. See also, (Čihák and Hesse, 2010;
Hennieand Zamir, 2008; Zamir and Abbas, 2011)
As a result of this investigation, more attention has been brought to Islamic finance
and Islamic finance institutions. Many countries and firms have started to use Islamic
financial tools to finance their needs. As these tools present an alternative source of
financing, this source could help to prevent the financial system from facing financial
crises.
Islamic finance system, institutions, firms and tools based their operations on
interest-free transactions, and profit and losses sharing. Accordingly, all parties share
the risks, returns and losses. As this system and operations present fairness to all
*
Dr. Tariq Alzoubi, Assistant Professor, Department of Finance, Business School, Jordan University,
Amman, Jordan, Email: tariq.alzoubi@gmail.com, +962 79 0680861.
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
parties by rewarding all parities the actual return on their invested capital, as well as,
distributing the losses and risks among all participants.
In spite of the fact that most Islamic finance tools have existed and used even before
Islam, Islamic banks as independent financial institutions started to operate in the
1970s. Islamic banks operate in a way which is significantly different than how
conventional banks operate. As conventional banks provide their clients with direct
credit facilities (Loans) with fixed interest, Islamic banks participates with their clients
in projects and investments; as they finance their clients‟ needs and share the profits,
the risks, and losses with their clients through Islamic financing tools including;
“Musharkah” (Joint Venture contract), “Mudarabah” (A trustee financing contract),
“Murabaha” (cost-plus sale), “Ijara” (Leases), and “Istisna” (manufacturing order).
In this research, we will compare the profitability of Islamic and conventional banks,
after the financial crisis to understand whether Islamic banks perform better than
conventional banks or whether they can survive and compete with these
conventional banks.
The rest of this paper will be organised as follows; section 2, will provide the literature
about the topic. The data and methodology will be presented in section 3. After that,
section 4, will discuss the results and findings of this paper. Subsequently, the
conclusion of this paper will be presented in section 5.
2. Literature Review
Jaffar and Manarvi (2011) examined the performance of conventional and Islamic
banks in Pakistan between 2005 to 2009, based on a sample of 5 Islamic and 5
conventional banks. In accordance with this examination, Jaffar and Manarvi found
that A) conventional banks have a better earning ability and management quality. B)
Islamic banks have a better liquidity position and adequate capital.
Bashir (2000) studied the performance of 18 Islamic banks from Egypt, Bahrain,
Jordan, Kuwait, Qatar, Sudan, Turkey and United Arab Emirates between 1993 to
1998. Using the net non-interest margin, profit before tax to total assets, return on
equities, return on assets, and an external variables, the results showed that for
Islamic banks there is a positive relationship between capital to assets ratio and
banks profitability.
Brown (2003) used a sample of 19 countries between 1998 to 2001 to study the
Islamic banks performance across countries. Using the return on assets and return
on equities to measure the profitability, the results varied among countries each year.
Hassan and Bashir (2004) based on a sample of 43 Islamic banks between 1994 to
2000. They studied determinants of profitability for the Islamic banks. The results
showed that high capital to assets as well as high loan to assets ratios lead to higher
profitability.
Alkassim (2005) used net non-interest margin, return on equities, and return on
assets to measure the profitability of 16 Islamic and 18 conventional banks in the
Gulf Cooperation Council Countries. The results showed that the bank size has
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
positive effect on the profitability of Islamic banks but not conventional. The total
expenses positively impact the profitability of Islamic banks and negatively for
conventional banks, and non-interest expenses assist the profitability for both
conventional and Islamic banks.
Moin (2008) evaluated the performance of one Islamic bank compared to 5
conventional banks in Pakistan between 2003 to 2007. Using return on assets, return
on equity, and operating profit to operating expenses ratio, the results showed that
the average profitability of the 5 conventional banks was higher than the one Islamic
bank.
Samad (2004) compared the performance of Islamic and conventional banks in
Bahrain between 1991 to 2001. The results showed that there were no statistical
differences between the profitability of these two groups.
Onakoya and Onakoya (2013) examine 4 Islamic and 5 conventional banks in the
United Kingdom between 2007 to 2011. The results showed that conventional banks
were more profitable compared to Islamic banks.
Ansari and Rehman (2011) used the data between 2006 to 2009 of 3 Islamic and 3
conventional banks to measure the deferences between these two groups‟
performance. Using the return on assets, return on equity, and profit expense margin
to measure the profitability, the results showed that there was no significant deferent
between the two groups.
Siraj and Sudarsanan (2012) examine 6 Islamic and 6 conventional banks in Gulf
Cooperation Council Countries between 2005 to 2009. The results showed that
Islamic banks were more profitable compared to conventional banks.
The literature provides us with a vary results regarding the differences between the
profitability of Islamic and conventional banks. As some papers showed Islamic
banks were more profitable than conventional banks, other papers showed that
better performance of conventional banks, and there are some paper showed that
there is no significant deferent between the profitability of the these two groups.
H1: Islamic banks are more profitable than conventional banks.
3. Data and Methodology
Based on a sample of 10 Islamic banks and 33 conventional banks, which have been
taken from 4 countries (Saudi, Kuwait, UAE, and Jordan), between 2007 to 2013.
The researcher used ANOVA to compare the differences between the profitability of
Islamic and conventional banks.
We used 3 measures of profitability and the growth of the bank‟s assets, as well as,
growth of the bank‟s equities. The profitably measures were;
Return on Assets (ROA); measured as net income/losses after taxes divided by the
total assets for both Islamic and conventional banks. This ratio measures the bank‟s
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
ability to generate profit for each unit of money invested in assets. As the return on
assets increases, this means the bank is more profitable.
Return on Equities (ROE); measured as income/losses after taxes divided by the
total equities for both Islamic and conventional banks. This ratio measures the bank‟s
ability to generate profit for each unit of money invested by the bank‟s owners. As the
return on equities increases, this shows that the bank is more profitable.
Net Interest Margin (NIM); for conventional banks this ratio measured as interest
income minus interest expenses all divided by total assets. For Islamic banks, this
ratio measured as Income from Islamic financing tools include (Murabaha,
Mudaraba, Ijara and any other Islamic financing tool) minus distribution to depositors
and Sukuk holders all divided by total assets. This ratio measures the bank‟s ability
to generate income from its core business after covering the expenses of money
acquired to operate. As the net interest margin increases, this means the bank is
more profitable.
The growth of the bank‟s assets: measured as the value of assets at time t minus the
value of assets at time t-1 all divided by the value of assets at time t-1.
The growth of the bank‟s equities: measured as the value of equities at time t minus
the value of equities at time t-1 all divided by the value of equities at time t-1.
All variables have been calculated based on annual numbers, taken from annual
reports of banks.
4. Results and Analysis
Table 1 shows the results of Islamic banks between 2007 to 2013.
Table 1
Results of Islamic Banks
The profitability measures for the Islamic and Conventional banks, including: Return
on Assets (ROA); Return on Equity (ROE); Net Interest Margin (NIM); Growth in
Assets (GAssets); Growth in Equities (GEquities). Between 2007-2013. ***, **, * indicate
that coefficients are significant at the 1%, 5% and 10% levels respectively.
Average
Max
Min
Standard deviation
ROA
1.43%
5.16%
-2.09%
1.26%
ROE
9.65%
27.32%
-18.10%
8.36%
NIM
2.92%
6.18%
0.10%
1.04%
GAssets
15.78%
73.45%
-34.39%
17.43%
GEquities
12.87%
86.94%
-17.96%
19.58%
Observations
61
61
61
61
Source: Calculated from banks‟ annual reports, period 2007-2013.
From table 1 we can notice that the research variables are widely range, the most
likely reason for this wide range is that the sample included banks from different
countries, with different sizes, and some of these banks were new while the other
were relatively older.
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
Table 2 shows the results of conventional banks between 2007 to 2013.
Table 2
Results of Conventional Banks
The profitability measures for the Islamic and Conventional banks, including: Return
on Assets (ROA); Return on Equity (ROE); Net Interest Margin (NIM); Growth in
Assets (GAssets); Growth in Equities (GEquities). Between 2007-2013. ***, **, * indicate
that coefficients are significant at the 1%, 5% and 10% levels respectively.
Average
Max
Min
Standard deviation
ROA
1.54%
4.01%
-2.74%
0.94%
ROE
10.17%
22.34%
-34.18%
6.51%
NIM
2.85%
4.96%
0.77%
0.78%
GAssets
9.08%
60.66%
-35.26%
11.94%
GEquities
9.91%
75.00%
-13.08%
11.94%
Observations
195
195
195
195
Source: Calculated from banks‟ annual reports, period 2007-2013.
From table 2 we can notice that the research variables are also widely range, for the
same reason mentioned above.
Table 3 shows the results for both groups between 2007 to 2013.
Table 3
Differences between Islamic and Conventional banks
The profitability measures for the Islamic and Conventional banks, including: Return
on Assets (ROA); Return on Equity (ROE); Net Interest Margin (NIM); Growth in
Assets (GAssets); Growth in Equities (GEquities). Between 2007-2013. ***, **, * indicate
that coefficients are significant at the 1%, 5% and 10% levels respectively.
Islamic Banks Conventional Banks
Different
t-statistics
ROA
1.43%
1.54%
-0.11%
0.7324
ROE
9.65%
10.17%
-0.53%
0.5123
NIM
2.92%
2.85%
0.06%
-0.5144
GAssets
15.78%
9.08%
6.70%
-3.3970***
GEquities
12.87%
9.91%
2.95%
-1.4248
Observations
61
195
Source: Calculated from banks‟ annual reports, period 2007-2013.
Table 3 indicates the ROA for conventional banks is higher than ROA for Islamic
banks by 0.11% but the difference is not significant statistically. The same for ROE,
conventional banks have an average value of 10.17% compare to a value of 9.65%
for Islamic banks, which is also not significant statistically. For NIM, Islamic banks
achieve higher than conventional banks by 0.06%, again the difference is not
significant statistically.
From these results we can conclude that there are no differences between Islamic
and conventional banks from profitability aspect. The most likely reason of this result,
is that Islamic banks operate under the control and monitor of central banks which
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
are conventional banks. Therefore, Islamic banks are still controlled by the
regulations of central banks, which built for conventional banks and conventional
financial systems. This clearly means Islamic banks cannot operate totally according
to Islamic rules.
The growth of assets for Islamic banks was 15.78%, which is 174% greater than the
growth of assets for conventional banks. The difference was statistically significant at
better than 1% significant level. This result can be explained based on the fact that
Islamic banking is relatively new banks, especially if we compare them with
conventional banks. Conventional banks were operated for hundreds of years, while
Islamic banks only started to operate in the last 40 years. This means most of Islamic
banks are still under early stage of their life. This means that Islamic banks still
operate under low profit stage; when these banks start the rapid growth stage, their
profitability will start to increase significantly.
The growth of equities of Islamic banks was about 3% higher than the growth rate of
conventional banks. This different was not significant statistically.
5. Conclusion
The last 40 years witnessed the born of Islamic banks, and since then they have
started to operate as strong competitors to conventional banks. Few papers studied
the performance of Islamic banks and compare their performance with conventional
banks. The results were varying from these researches, mainly because the sample
sizes were small.
This research used a larger sample of 33 conventional banks and 10 Islamic banks
between 2007 to 2013 with 265 observations (195 from conventional banks and 61
from Islamic banks), taken from 4 countries which are Saudi, Kuwait, UAE, and
Jordan.
The results showed that there are no significant statistical differences between the
profitability of Islamic and conventional banks, as Islamic banks are relatively new
compare to conventional banks they still under the low profit stage. This result has
been confirmed by the significance higher growth rate in the Islamic banks‟ assets
compare to conventional banks. From this result, we can predict that Islamic banks
can perform better than conventional banks as soon as they enter their high growth
stage.
The main limitation of this research is the small size of the sample. Another limitation
is related to analysis period as it only covers the period after the financial crisis. It is
recommended to confirm the results of this paper on a sample before the financial
crisis period. It is also recommended to compare Islamic and conventional banks
performance not only from profitability based on large sample size but also from
different performance aspects.
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
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