Study Shows Islamic Banks Perform Best During Economic Crisis

Study Shows Islamic Banks Perform Best During Economic Crisis

New Research from The British University in Dubai Shows GCC-based Islamic Banks Performed Better During the Recent Recession than Conventional Banks.

July 6, 2010 3:16 by Rasha Reslan

Islamic banking practice performed better and showed greater resilience during the recent economic crisis than conventional banking practice, according to new research released today by The British University in Dubai (BUiD), the Middle East’s leading research-based postgraduate university.

The study, carried out by Mareyah Mohammed Ahmad, who has just graduated with a distinction in BUiD’s MSc in Finance and Banking course, analysed the profitability, asset-quality, capitalisation and leverage and liquidity ratios between 2006 and 2009 for 12 Islamic banks and 12 conventional banks based in the GCC.

Findings show that during the study period the Islamic banks were more profitable in terms of Return on Average Asset (ROAA), their assets grew much faster and higher, their net income from financing activities was higher, they had higher capital ratios, were less leveraged and had higher liquidity ratios compared with conventional banks.

“My study supports other literature that shows Islamic banking is a better banking practice than conventional banking during an economic crisis. The most recent global downturn, which was linked to asset management, demands and concepts of risk management, proved this point. Assets are the cornerstone of Islamic banking, they have to be real, have value and some marketable features, making them more profitable in terms of generating revenues even during a crisis,” explained Mareyah.

“Another key reason why Islamic banks’ profits remain high is because they enjoy a built-in stabiliser to help them cope with economic downturns, as instead of paying interest to depositors those with investment mudaraba accounts share in the bank’s profits. So if profits decline depositors simply receive lower returns. This differs to conventional banking where depositors generate returns through interest rates, which are not linked to profits,” Mareyah explained.

However, other findings of Mareyah’s study suggest that in general Islamic banks are less cost-efficient than conventional banks, possibly due to a lack of economies of scale or because customers are predisposed to Islamic products regardless of the cost.

The study concludes that despite the Islamic financial system’s success during the recent economic crisis, the industry is still in its infancy and faces tough challenges ahead. Lack of uniform religious principles, central regulation, risk management tools, long-term finance, sound accounting procedures, skilled Islamic banking personnel, an established inter-bank money market and profit-sharing finance are all key problems which need addressing to ensure future growth.

Dr Dayanand Pandey, Senior Lecturer in Finance and Banking at BUiD, and Mareyah’s supervisor for this research, said, “Mareyah’s research which she undertook as the dissertation- a key element of the MSc programme- is a real value addition in the area of Finance and Banking. It supports the widely held belief that Islamic banking is a better banking practice than conventional banking, particularly in times of crisis. The in-built stabilizers and risk management practices in the Islamic banking products make it the most secured banking practice in the world. The study supports the robustness of the fast-growing Islamic assets across the globe in recent times.”

Entitled ‘Are Islamic Banks Better Immunised than Conventional Banks in the Current Economic Crisis?’, Mareyah’s research has now been accepted for presentation at the 10th Global Conference on Business and Economics to be held in Rome, Italy, October 15-16, 2010.