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Financial Characteristics And Sustainability Of Islamic Banks: A

Comparative Analysis On Top Five Islamic Banking Countries

Name: Amin Jan

Matrix Id: G02849

Supervisor: Dr. Maran Marimuthu

Department: Management and Humanities

Course: M.PHIL in Management By Research

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INTRODUCTION

After the subprime crisis of (2007-2008) considering sustainability in no more optional.

In line of that, the global Alliance for banking on values GABV started operation in May 2011 with the motive to provide sustainable banking.

Banks performance is very vital for sustainable development in society due to its intermediary role (Jeucken, 1999 ;Brown, 2003)

Internal CAMELS rating techniques (Ravi Kumar, 2008) and external players FSB

100 financial crises in the last four decades (Chapra, 2008)

Financial crisis occur due to short term unstable strategies (Gore et-al 2009)

To avoid crisis businesses have to adopt long term strategies (Jeucken, 1999)

Lacking prudential regulations. Researchers filling the gap

Islamic and conventional are the two competitors in banking.

INTRODUCTION

IBs retain less than 1% of the total global banking assets (Beck, 2013 ;Isaac 2014)

large Islamic banks are financially unstable compared to large conventional banks (Cihak, 2010)

IBs in Europe exists as niche market (Cihak, 2010)

(CAGR 2006-2010 to 2008-2012) for major Islamic banking countries declined significantly (World Islamic bank competitiveness report 2011-2012 and 2013-2014)

The going concern concept (GAAP)

Financial characteristics to evaluate bankruptcy.

Bankruptcy used as a proxy for financial sustainability i.e. (bankrupt banks low sustainability, non-bankrupt banks high financial sustainability.

Source: World Islamic bank competitiveness report (2013-2014)

INTRODUCTION

Country Total IB share Total CB share

Bangladesh 12% 88%

Saudi Arabia 53% 47%

Malaysia 20% 80%

U.A.E 17% 83%

Kuwait 42.3% 57.7%

Qatar 24% 76%

Turkey 5.6% 94.4%

Bahrain 12.8% 87.2%

Indonesia 4.6% 95.4%

Pakistan 8.5% 91.5%

Average country

share

19.98% 80.02%

Table 1.1: Share of Islamic vs. conventional banks in

country total banking assets (2013-2014)

Country CAGR (2006-

2010)

CAGR (2008-

2012)

Decline

Saudi Arabia 19% 11% 8%

UAE 16% 14% 2%

Kuwait 22% 6% 16%

Qatar 39% 31% 8%

Bahrain 22% 2% 20%

Average 23.6% 12.8% 10.8%

Source: World Islamic bank competitiveness report (2011-

2012) and (2013-

Table 1.2: Cumulative asset growth rate of Islamic banks (2006-

2012)

20 % 80 %

11 %

INTRODUCTION

Economic sustainability of banksBroader concept which covers the micro, macro, and structural variables. Economic sustainability refers to the business ability of keeping its high earnings and maintaining business operations successfully in the long run. Economic sustainability checking in general deals with the following queries.

1: where is the business standing today?

2: where is the business going?

3: how is the business going to get there?

4: Evaluating and streamlining key policies i.e. profit, monetary value, leverage, liquidity, productivity etc.

INTRODUCTION

Why sustainability measurement is important?

Going concern concept (GAAP) Achieving the vision and mission.

How to measure sustainability?

Two sets (strong sustainability and weak sustainability) (Rennings, 1997)

Internationally recognized performance indicators (Keeble, 2003).

Literature ReviewAuthors & Year Topic Findings

(Said, 2013) (Smaoui et-al, 2011) (Yudistra ,2004) (Hassan et-al, 2003) (Zaman et-al, 2001)

Islamic bank’s performance on cross country basis

Favorable macro variable has positive relation on profitability

Large bank size has a significant positive relation to the firm’s profitability.

Higher cost to income ratio leads toward lower profitability.

The shorts term funding seems to have a positive relation with the profitability.

Size of the bank has negative impact on the profitability.

(Abduh ,2013) (Husain et-al, 2012) (Saleh et-al, 2006) (Sarker,1999) (Turn, 1996)

Islamic banks performance on the basis of difference in profitability determinants

Market concentration in banks specific factors

banks size in structural variable

And inflation in the macro variable has a positive impact on the Islamic bank’s profitability.

Literature Review

Authors & Year Topic Findings

(Muda et-al, 2013)(Sufian, 2007)(Bashir (2003)

Islamic bank’s performance on the basis of foreign vs. domestic Islamic banks

Domestic Islamic banks performed better then foreign Islamic banks.

higher leverage and large loans to asset ratio has positive impact on Islamic bank’s profitability.

(Qureshi et-al,2012) (Hanif et-al ,2012)(Akhtar (2011) (Ansari et-al ,2011) (Hamid et-al, (2011)(Safiullah, 2010) (Samad , 2004)

Islamic banks performance on the basis of Islamic vs. conventional banks

Profitability and productivity of conventional banks is better than Islamic banks,

Liquidity and solvency Islamic banks performed better than that of conventional banks.

Literature Review

Selection of appropriate bankruptcy model

Earlier work on bankruptcy (Beaver, 1966) ,(Altman ,1968), (Deakin, 1972), (Altman, Haldeman, and Narayanan 1977),(Ohlson, 1980), (Altman, 2000)

Features selection is very important in bankruptcy. Majors features are correlation matrix, t-test, stepwise regression, factor analysis (FA) and principle component analysis (PCA), and neural network (Tsai ,2009)

Ratios are the best in bankruptcy prediction (Pompe et-al, 2005)

Altman model is the best in predicting bankruptcy (Mossman, 1998)

Literature Review

Why to choose Altman model for Islamic banks sustainability?

Altman model is the most famous bankruptcy model and is different from the

rest in a sense that instead of a single feature it provides the blend of all vital

ratios in a single line.

Can Altman model works on Islamic banks?

Altman model can be applied to Islamic banks due to universal applicability

of ratios.

Problem Statement

Identification of Research Gap

(Smaoui et-al, 2011), (Yudistra, 2004) (Hassan et-al, 2003) studied cross country

Islamic banks performance and found that, short term funding's and capital has

positive relation to profitability, while size of banks seems to have negative relation

with Islamic bank’s profitability.

(Abduh,2013), (Husain et-al, 2012) studied the difference in profitability

determinants of Islamic banks and found that, market concentration in banks

specific factors, banks size in structural variable, while Inflation in the macro

variable has a positive impact on the Islamic bank’s profitability

(Muda et-al, 2013) (Sufian, 2007) (Bashir ,2003) studied foreign vs. domestics

Islamic banks performance and found that foreign IBs are more profitable than

domestic IBs.

Problem Statement

(Qureshi et-al , 2012) (Hanif et-al, 2012) (Akhtar, 2011) (Ansari et-al, 2011) (Hamid et-al,

2011) (Safiullah, 2010) (Samad, 2004) studied Islamic vs. conventional banks performance

and found that ,conventional banks are more profitable and more capitalized, while Islamic

banks found better in liquidity and insolvency.

Islamic bank’s performance is studied from a variety of angles and in different contexts as

well, and even some of the studies reported Islamic banks more profitable. But only being

profitable does not guarantee sustainability in long Run (Husna, 2012)

However all the previous studies on IBs are concerned with its ongoing performances only,

sustainability checking is widely neglected in the literature (Klumpes, 2013)

Studies on IBs are limited to testing one or two factors only a holistic approach is missing, as

satisfactory performance in one tested factor can be surpassed by untested factor in shape of

detrimental distress in long run (Husna, 2012)

Problem Statement

Explanation of Research Gap

Sine forty years of Islamic banks operations, still its market share is not significant as

compared to conventional banks (Cihak, 2010)

Additionally the share of Islamic banks even in the major Muslim nations is around

20 % only, compared to 80 % of conventional bank’s (World Islamic bank

competitiveness report 2011-2012 – 2013-2014)Does it mean that Islamic bank can’t

progress?

The CAGR of major Muslim countries' Islamic banks is declining sine 2006 (World

Islamic bank competitiveness report 2011-2012 – 2013-2014). In line of that can

Islamic banks be soothsaid un-sustainable in long run?

To saturate that gap and these questions the sustainability of Islamic banks on a larger

scale has to be checked in order to report it financially sustainable in long run.

Research Questions, Research objectives, and Hypotheses

RQ 1:

What is the bankruptcy rate of top five Islamic banking countries?

RQ 2:

Are there any significant differences among the top five Islamic banking countries

with regard to bankruptcy?

Objective 1:

To perform a comparative analysis among the top five Islamic banking countries on

bankruptcy

Hypothesis 1

H1: Top five Islamic banking countries do differ on bankruptcy.

Research Questions, Research objectives, and Hypotheses

RQ 3:

Do the top five Islamic banking countries differ on financial performance

indicators?

Objective 2:

To perform a comparative analysis among the top five Islamic banking

countries with regard to performance indicators.

Hypothesis 2:

H1: Top five Islamic countries do differ on performance indicators.

Research Questions, Research objectives, and Hypotheses

RQ 4:

Which performance indicators have significant impact on bankruptcy profile?

Objective 3:

To examine the individual performance indicators those have significant impact on

bankruptcy profile of Islamic banks.

Hypothesis 3

H3: H1 Performance indicators are significantly correlated with bankruptcy exposure.

H3a: H1 liquidity is significantly correlated with bankruptcy exposure.

H3b: H1 Profitability is significantly correlated with bankruptcy exposure.

H3c: H1 Productivity is significantly correlated with bankruptcy exposure.

H3d: H1 Insolvency is significantly correlated with bankruptcy exposure.

Novelty

Lens 1:

This study for the first time will diagnose the economic

sustainability of Islamic banks. This signifies that this study will

examine bankruptcy profile of the Islamic banks.

Lens 2:

This study will serve a launching pad in in the process of

developing an Islamic banking sustainability continuum model.

That is yet to be developed

Research model

Methodology

Model Used in this study:

In 1968, Altman applied 22 different ratios to 66 manufacturing firms. To the sample

of bankrupt and non bankrupt firm. Out of those 22 ratios, 5 ratios which caused the

higher variations reputedly were selected and were given high weightage overall

model was reported 95%.

If Public Firms Z = 1.2x1 + 1.4x2 + 3.3x3 + 0.6x4 + .999x5

If Private Firms Z = 0.717x1 + 0.847x2 + 3.107x3 + 0.420x4 + 0.998x5

If service Firms Z = 6.56x1 + 3.26x2 + 6.72x3 + 1.05x4

Z > 2.9 Safe Zone

Z < 1.21 Distress Zone

1.21< Z <2.9 Grey Zone

Methodology

X1: working capital / Total assets

X2: Retained earnings/ Total assets

X3: EBIT / Total assets

X4: Book value of Equity / Total liabilities

Variable Explanation

Liquidity (Theory of bank liquidity ,(Acharya et-al, 2012)

Cumulative profitability (Pecking order Theory , (Myers, 1984)

Productivity (Modern portfolio Theory , (Markowitz,1952)

Insolvency (Theory of banking crisis, Kobayashi, 2003; Deepening Insolvency Theory , Heaton, 2004)

Conceptual framework of Altman’s model

www.themegallery.com

Sampling method

Country Country share (Total:USD1.1 Trillion)

Iran 39.7%

Saudi Arabia 13.7 %

Malaysia 9.8 %

U.A.E 9.1 %

Kuwait 9.0 %

Qatar 4.1 %

Turkey 2.7 %

Bahrain 2.3 %

Indonesia 1.5 %

Egypt 1.3%

Sudan 1.1

Others 5.6%

Source: Global Islamic finance 2012: bridging economies introductory session and GIFF report.

Non-probability Judgmental sampling Technique

Top five countries collectively possess 81% of total IBS

Methodology

Research design Type of study This study is a descriptive in nature, which will describe the sustainability profile of

Islamic banks in top five Islamic banking countries. Sources of data collection All the data related to this study is taken from the annual reports of representative banks

via their official web sites, data from 2009-2013 is used in this study. Statistical techniques• 1: ANOVA (Post hoc test)• 2: correlation • 3: Regression Software:• SPSS, E-view Unit of analysis Unit of analysis are the selected Islamic banks Bankruptcy = βo+ β1Liq+ β2prof+ β3prod+ β4insol+ β5size+ε

Preliminary FindingsS.N Kuwait 2009 2010 2011 2012 2013 Average

1 Al-Ahli Bank 0.13 0.19 0.19 0.22 0.21 0.19

2 Al-Rajhi Bank 2.17 1.85 1.67 -- -- 1.90

3 Boubyan Bank 1.17 2.65 2.44 2.06 1.84 2.03

4 KFH 1.23 1.02 0.91 0.91 1.17 1.053

  U.A.E 2009 2010 2011 2012 2013 Average

5 Abu Dhabi Islamic Bank 1.48 1.68 1.62 1.75 1.37 1.58

6 Al-Hilal Bank 0.81 0.68 0.744 0.85 1.12 0.84

7 Attijari Al Islami 4.40 4.74 4.80 1.87 -- 3.95

8 Dubai Islamic Bank 1.30 1.33 1.07 1.06 2.01 1.35

9 Emirates Islamic Bank 1.54 1.24 1.49 0.99 1.27 1.31

10 Sharjah Islamic bank 2.16 2.11 2.00 1.97 1.70 1.99

  Saudi Arabia 2009 2010 2011 2012 2013 Average

11 AL Baraka Investment and development Co 8.35 8.36 7.44 7.38 6.89 7.68

12 Al Jazeera Bank 1.39 1.28 1.30 1.09 1.05 1.22

  Iran 2009 2010 2011 2012 2013 Average

13 Bank Maskan 0.63 1.12 0.87 0.24   0.71

14 Bank Saderat Iran 0.24 0.18 0.33 0.02 0.65 0.28

15 Karafarin Bank 2.17 5.07 1.95 1.51 1.21 2.38

  Malaysia 2009 2010 2011 2012 2013 Average

16 Affin Islamic Bank Berhad 0.75 0.69 0.55 0.51 0.44 0.59

17 Al Rajhi Banking & Investment Corporation 0.69 0.54 0.40 0.33 -- 0.49

18 Alliance Islamic bank 0.93 0.87 0.76 0.69 0.65 0.78

19 Bank Muamalat 0.81 0.76 0.71 0.55 0.61 0.69

20 CIMB Bank 4.91 4.64 3.59 3.19 3.53 3.97

21 Hong Leong Islamic Bank 0.95 1.04 0.70 0.66 0.65 0.80

22 HSBC Ammnah 0.82 0.96 0.53 0.80 0.82 0.79

23 KFH Malaysia Berhad 1.83 1.18 0.96 0.67 1.19 1.17

24 Public Islamic Bank 0.61 0.72 0.55 0.62 0.53 0.61

25 RHB Islamic Bank 0.77 0.62 0.47 0.54 -- 0.60

26 Standard Chartered Saadiq BHD 0.84 1.17 0.89 0.50 0.003 0.68

27 Bank Islam 0.32 0.63 0.48 0.58 0.55 0.51

Preliminary Findings

Country Status 2009 2010 2011 2012 2013 Mean

Kuwait (4) Bankrupt 20.42% 14.50% 13.82% 19.56% 25.10% 18.68%

  Grey zone 79.58% 85.50% 86.17% 80.44% 74.90% 81.32%

  Non-bankrupt 0% 0% 0% 0% 0% 0%

U.A.E (6) Bankrupt 11.19% 5.98% 15.56% 25.46% 12.00% 14.04%

  Grey zone 88.81% 55.61% 43.89% 32.56% 88.00% 61.77%

  Non-bankrupt 0% 38.41% 40.55% 41.99% 0% 24.19%

Saudi (2) Bankrupt 0% 0% 0% 12.82% 13.22% 5.20%

  Grey zone 14.26% 13.29% 14.89% 0% 0% 8.49

  Non-bankrupt 85.73% 86.70% 85.10% 87.17% 86.77% 86.29%

Iran (3) Bankrupt 3.30% 100% 9.81% 37.23% 42.50% 38.57%

  Grey zone 29.00% 0% 90.18% 62.76% 57.49% 47.88%

  Non-bankrupt 67.68% 0% 0% 0% 0% 13.53%

Malaysia

(12)

Bankrupt 52.75% 66.53% 66.22% 67.04% 60.82% 62.67%

  Grey zone 12.86% 0% 0% 0% 0% 2.57%

  Non-bankrupt 34.38% 33.46% 33.77% 32.95% 39.17% 34.74%

Over all (27) Bankrupt 18% 37% 21% 32% 31% 28%

Grey zone 45% 31% 47% 35% 44% 40%

Non-bankrupt 38% 32% 32% 32% 25% 32%

Bankruptcy profile of selected Islamic banks from 2009-2013 (Altman’s model)

ANOVA resultsCountry Liquidity Profitability Productivity Insolvency Z-score

Kuwait 0.94 0.27 0.21 0.43 1.59

U.A.E 1.16 0.05 0.17 0.38 1.76

Saudi 2.75 0.02 0.18 1.48 4.45

Iran 0.66 0.06 0.34 0.09 1.16

Malaysia 0.49 0.02 0.11 0.35 0.99

P-value 0.000 0.000 0.000 0.000

Post Hoc (Scheffe) Test          

Kuwait - UAE N.S Sig** N.S N.S N.S

Kuwait – Saudi Sig** Sig** N.S Sig** Sig**

Kuwait – Iran N.S Sig** N.S N.S N.S

Kuwait – Malaysia N.S Sig** N.S N.S N.S

U.A.E – Kuwait N.S Sig** N.S N.S N.S

U.A.E – Saudi Sig** N.S N.S Sig** Sig**

U.A.E – Iran N.S N.S N.S N.S N.S

U.A.E – Malaysia Sig** N.S N.S N.S N.S

Saudi – Kuwait Sig** Sig** N.S Sig** Sig**

Saudi – U.A.E Sig** N.S N.S Sig** Sig**

Saudi – Iran Sig** N.S N.S Sig** Sig**

Saudi – Malaysia Sig** N.S N.S Sig** Sig**

Iran –Kuwait N.S Sig** N.S N.S N.S

Iran – U.A.E N.S N.S N.S N.S N.S

Iran – Saudi Sig** N.S N.S Sig** Sig**

Iran – Malaysia N.S N.S N.S N.S N.S

Malaysia – Kuwait N.S Sig** N.S N.S N.S

Malaysia – U.A.E Sig** N.S N.S N.S N.S

Malaysia- Saudi Sig** N.S N.S Sig** Sig**

Malaysia – Iran N.S N.S N.S N.S N.S

0.20

Regression results for Islamic banks bankruptcy

 

ModelUnstandardized

CoefficientsStandardized Coefficients

t Sig.

Collinearity Statistics

B Std. Error Beta Tolerance VIF1(Constant) -.142 .068

 -2.106 .037

   

x1: Liquidity .980 .009 .549 103.539 .000 .671 1.491

x2: Profitability .038 .040 .005 .934 .352 .784 1.275

x3: Productivity 1.048 .022 .208 47.211 .000 .976 1.025

X4: Insolvency 1.055 .012 .531 91.316 .000 .559 1.789

Log T.A .009 .004 .011 2.364 .020 .937 1.067

Dependent Variable: Zcore

R2: 0.99

Adjusted R2: 0.98

Conclusion

As per objective no 1, Z-score results snapshot the bankruptcy rate of top five

Islamic banking countries' five year prior to bankruptcy, i.e. bankruptcy rate is

18.68% for Kuwait, 14.04% for U.A.E, 5.20% for Saudi Arabia, 38.57% for

Iran ,and that of 62.67% for Malaysian Islamic banks.

As per objective no 2, the results of ANOVA shows the comparison, that the top

five Islamic banking countries have a significant relation on performance

indicators like liquidity, profitability, and insolvency, but on the basis of

productivity top five Islamic countries bank’s does not have a significant

relation.

Conclusion

As per objective no 3, the result shows that all the performance indicators

i.e. liquidity, productivity, and insolvency are significantly correlated with

bankruptcy except profitability, hence this result has disapproved the

argument that only profitability is enough to avoid Islamic banks from

bankruptcy. The results are consistent with the findings of (Husna,2012)

Recommendations`

Selected 27 Islamic banks from five countries are lacking very much on

profitability and productivity, which is endorsing the fact of reducing the

CAGR of major Islamic banking countries. In order to stay competitor and

sustainable Islamic banks has to improve its profitability and productivity.

limitations

Limitation of the study

To evaluate sustainability of Islamic banks this study has selected only five countries, the

number of countries can be expanded to further diagnose Islamic bank’s sustainability.

Suggestions for further studies

As this study applied Altman model on predicting Islamic banking bankruptcy, and Altman

uses only micro factors. To further explore Islamic banking sustainability and bankruptcy a

separate bankruptcy continuum model needs to be developed, which is composed of micro,

macro, and Islamic bank’s structural variables. As Islamic bank do not have its own

separate sustainability checking model (Husna, 2012).

Thank You

And have a nice Day