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Comparing Between Islamic and Non-Islamic Bank Performance

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July 24, 2016
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Comparing Between Islamic and Non-Islamic Bank Performance
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Introduction
The banking sector is one of the important institutions in the economy. Economic development, stability, and growth majorly depend on the stability of its banking industry. The industry operates as a liaison connecting surplus and deficit units, facilitating funding for productive purposes, and encouraging savings as a basis for investment in future. Thus, the banking sector plays an important role in economic development of a nation or an economic block (Beck et al., 2013). Banks are part of the larger financial institutions encompassing investment banks, finance companies, investment managers among others. Banks act as financial intermediaries by taking money from depositors and advancing loans to borrowers for investment. In some countries, both Islamic and non-Islamic banks operate and offer various products and services to the market. Non-Islamic banks operate on the basis of interest rates in the economy. On the other hand, Islamic banking operates on the basis of profit-and-loss sharing model that is interesting free (Riba free) as stipulated in the Islamic religion (Hanif, 2014). The Islamic banking that is riba-free aims at eliminating interest based transaction as it is seen as usury in the Islamic religion.
However, the paper compares the performance of both Islamic and non-Islamic banks in the economy. The paper uses a qualitative approach to bring out the comparison between the Islamic and non-Islamic banks operating in the economy.
Literature Review
There are quite some studies undertaken in this area of study. Different scholars have raised different opinions about Islamic and non-Islamic banking operation in the economy. Most of the empirical studies concerning this subject used a descriptive approach that focuses on the simple financial ratios.
According to Zeitun (2012), Islamic banking is based on the principle of Islamic finance. That is, banking should focus on the notion that loans should be given free of interest for charitable purposes and organizations. On the same note, loans should be advanced on the basis of profit and loss sharing for commercial purposes. The concept of profit and loss sharing in the advancement of loans stipulates that Islamic banks are not supposed to charge interest. Instead, the banks should be entitled to the yield resulting from the utilization of the loan.
The origin of non-Islamic banks and Islamic bank approach to business are different, and its principles are traced to specific focus groups. Non-Islamic banking originated from western banking (Hanif, 2014). On the other hand, Islamic banking began in the Middle East. Islamic banking has not been on the market for long. However, its conventions and principles are gaining popularity at a fast rate and today Islamic banking is widespread across the globe.
Different researchers used different approaches to finding out the comparing Islamic and Conventional Banks. Toumi et al. (2011), used the comparison of leverage and profitability, Ansari & Rehman (2011) adopted the comparison of profitability and performance. On the same note, Johnes et al. (2014) adopted comparison of the operational framework and finally, Ahmed et al. (2011) adopted the comparison of customer satisfaction.
Scholars have established that the increasing popularity of Islamic banking might be as a result of its resilience to financial shocks and crisis. This notion does not imply that Islamic banks do not feel financial crisis but rather less susceptible to a financial crisis as pointed out by (Ansari & Rehman, 2011).
In Islamic Banking System, any transaction undertaken should be “asset-backed” and thus prohibits generation of interest from the capital. According to Ahmad et al. (2011) money in Islamic religion is just but a medium of exchange that depicts the purchasing power of the owner and that money in itself has no value. This notion confirms the Islamic banking ideology that money becomes capital generating when it is endowed in a productive venture. This notion is different in the non-Islamic banking as that regularly adopt tools such as future contracts, forward contracts and currency derivatives that involve non-asset secured business contacts.
It is imperative to note that non-Islamic banking system is secular in their orientation whereas Islamic banking is founded on Sharia’a principles on all their business dealings. Hanif (2014), noted that in Islamic banks only contracts that are sharia’a approved that are accepted and that any activity that is prohibited by the Islamic religion is not financed. As such, all Islamic banks have a Sharia’a Supervisory Board (SSB) for scrutiny of the transaction in conformity with Sharia laws.
Methodology
This piece of research tries to evaluate and compare non-Islamic and Islamic banks operating in the economy. To achieve this objective, the paper has adopted the use of secondary sources of data that are readily available from previous research, historical data, and information as well as web information.
To ensure that confidentiality of data and ethical consideration, all the secondary data used to prepare this research paper is properly cited. Consent is also requested for permission to use internet sources to collect data about the research topic. The data is then analyzed using the appropriate qualitative analysis method and appropriate conclusion made on the topic.
Findings
A most important tool used to assess the performance of a bank is its profitability. Profitability of an organization can be understood by using various financial indicators such as Net Profit Ratio (NPR), and Return on Share Capital (ROCA) (Toumi et al., 2011). On the same note, Operating Profit Ration and Return on Total Equity (ROE) can be used to determine profitability and performance of an organization. Secondary sources indicate that Islamic banks performed better in terms of capital adequacy, better liquidity position and ability to withstand financial crisis in the economy (Zeitun, 2012). Islamic banks are less affected by the financial crisis in banking as compared to non-Islamic banks. However, Islamic banks have weaknesses in management quality and profitability. On the other hand, non-Islamic banks outperformed Islamic banks in earning ability and management efficiency.
Profitability is higher in non-Islamic banks as compared to Islamic banks. This is because non-Islamic banks are profit oriented and charge interest on each and every loan that they advance. On the other hand, Islamic banks follow the Quran teachings and do not charge interest on loans they advance. However, in terms of operating expenses, Islamic banks reported a higher growth rate of operating expenses as compared to non-Islamic banks operating in an economy (Beck et al., 2013).
The empirical studies reveal that Non-Islamic banks outperform Islamic banks in terms of liquidity management. Islamic banks face challenges in terms of excess liquidity because they always have surplus cash and assets as compared to non-Islamic banks that operate in the economy (Johnes et al., 2014). Non-Islamic banks is controlled by the central banks of their respective banks and the amount of loans advanced depend on the reserve such banks have on their respective central bank in the economy. This concept of reserve requirement ratio help non-Islamic banks to improve its liquidity management and rarely do they face the problem of liquidity.
In terms of customer deposits, non-Islamic banks have to pay interest expense at a stipulated rate. On the other hand, Islamic banks give a share of profit as a percentage of customer deposit. It is evident that Islamic banks provide more profit to customer deposits as compared to non-Islamic banks. Previous research established that profit as a percentage of customer deposit is valued at 17.57% between the periods of 2005 to 2010 as compared to 2.90% for non-Islamic banks (Toumi et al., 2011).
In terms of loan loss ratio, Non-Islamic banks have a slightly smaller loan loss ratio as compared to Islamic banks. Both Islamic and non-Islamic banks exhibited high loan to asset ratio. This ratio indicates that there are high debt and risk of default. However, Islamic banks have a lower loan to asset ratio as compared to non-Islamic banks. This indicates that Islamic banks ought to pay lesser for a loan settlement as compared to non-Islamic banks reflecting that Islamic banks have a higher liquidity as compared to non-Islamic banks.
Conclusion
As mentioned earlier, the banking sector plays an important role in economic development of a country and that stability and growth of an economy depend on the banking sector. Be as it may, Islamic banking is considered as an alternative to the traditional conventional banking. Islamic banking is founded based on the concept of profit-and-loss and risk sharing as compared to non-Islamic banks that use the traditional interest-based deposit and lending method.
It is evident that Islamic banks are performers in terms of possessing the adequate capital to finance their business operations and are having a better liquidity position because of a lower default rate of loans as compared to non-Islamic banks. On the other hand, non-Islamic banks are better performers in management quality and the profitability ratio.
In terms of asset quality, both modes of banking exhibit similar traits. Non-Islamic banks have a smaller loan loss ratio as compared to Islamic banks. Both modes of banking have improved in terms of loan recovery policy and nominal performance. However, Islamic banks have a lower loan to asset ratio as compared to non-Islamic banks. This indicates that Islamic banks ought to pay lesser for a loan settlement as compared to non-Islamic banks reflecting that Islamic banks have a higher liquidity as compared to non-Islamic banks (Zeitun, 2012).
However, it is imperative to note that Islamic banks are gaining more popularity around the globe. The banks have continued in its operations and have received a tremendous growth over the years. Be as it may, the future of Islamic banking is bright, and chances are these banks may roll out its services to other non-Islamic individuals and expand its operation to cover all aspects of banking and other financial services.

References
Beck, T., Demirgüç-Kunt, A., & Merrouche, O. (2013). Islamic vs. conventional banking: Business model, efficiency and stability. Journal of Banking & Finance, 37(2), 433-447.
Johnes, J., Izzeldin, M., & Pappas, V. (2014). A comparison of performance of Islamic and conventional banks 2004–2009. Journal of Economic Behavior & Organization, 103, S93-S107.
Hanif, M. (2014). Differences and similarities in Islamic and conventional banking. International Journal of Business and Social Sciences, 2(2).
Zeitun, R. (2012). Determinants of Islamic and conventional banks performance in GCC countries using panel data analysis. Global Economy and Finance Journal, 5(1), 53-72.
Ansari S., & Rehman K., (2011) Comparative Financial Performance of existing Islamic Banks and Contemporary Conventional Banks in Pakistan, Proceedings 2nd International Conference on Economics, Business and Management, IPEDR 22.
Toumi K., Viviani J.L. and Belkacem L., (May 11-13, 2011). A comparison of leverage and profitability of Islamic and Conventional Banks, International Conference of the French Finance Association (AFFI).
A. Ahmad A., Rehman K., and Safwan N., (2011). Comparative study of Islamic and conventional banking in Pakistan based on customer satisfaction, African Journal of Business Management, 5(5), 1768-1773.

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