Comparison of Islamic and Conventional Banks

8/2/2019 Comparison of Islamic and Conventional Banks

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Hassan Mohammed/ Master of Finance/ 2011

Comparative Study of Islamic and Conventional Banking

performance: a case study from Pakistan

By:

Hassan Mohammed

A Dissertation Submitted In Fulfilment of Partial Requirement of

Master of Finance

Glasgow Caledonian University

August 2011

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Acknowledgement

I want to thank many people without their help and support this research would

not be possible to complete on time.

First and foremost I want to thank Almighty ALLAH without his blessings

and help this study which requires constant hard work cannot be achievable to

complete during the due time.

I am really thankful to my family for their guidance, support and love. They

always understood me and supported me in every part of my life, in particular my

parents and brothers.

In addition I would like to thank my colleague and friend from Pakistan Mr.

Inam-ul-haq, for his consistent support and guidance helped me in completing mystudy. Data collection was also not possible without his help.

Last but not the least; it is a great pleasure for me to thank my supervisor Mr.

Dr. Kazem Falahati for his consistent support, enthusiasm, supervision, advices and

corrections in completing my dissertation at the time frame. He was always there for me

to help and provided the main fundamentals to complete my dissertation.

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Abstract

Islamic Banking and its finance division started its operations in Pakistan in

the year 1977-1978; this was after the abolition of interest which is according to the

Islamic rules under the Shariah. The amendments in the financial instruments which

were then made free from the interest portion was incorporated in the corporate

financing and also the promulgation of the ordinance for starting the Mudraba

company and issuance of Mudaraba certificate and starting of CTFS (Commission for

Transformation of financial System) and also Islamic Banking division by the

Pakistan’s State Bank is the important moves occupied through the Government of

Pakistan.

Study by the researcher looks into success and the operations of the Islamic

Bank, Meezan Bank Limited which is the first and superior Islamic bank of Pakistan.

The study also looks into the comparison of performance of the Meezan Bank with a

typical Conventional Bank. The comparitative study is done with the help of 12

financial ratios namely Return on Assets (ROA), Return On Equity(ROE), Loan to

Assets Ratio(LAR), Loan to Deposits ratio(LDR), Income to Expense Ratio(IER),

Asset Utilisation(AU). The findings of the study reveal that the Meazaan Bank to be

less profitable and less efficient in comparison to the Conventional Bank although in

case of liquidation of the banks Mezaan Bank is stronger. The conventional bank have

been in the business for a substantial amount of time and also the banks operate into

various sectors giving it a wide range of control over the assets and also the funds

under the management of the conventional bank is huge and generate considerable

income for them.

Although the study found Meezan bank to be less profitable and less efficient

than the Conventional bank, however in case of Liquidation the Meezan bank races

ahead of the conventional Bank. The period under consideration is 2006 to 2010. The

improvement and performance of the Islamic Banks have been good considering the

fact that they have been in operation for a shorter period in comparison to the

conventional bank and therefore Islamic banking holds a promising future.

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Table of Contents

Page No.

Acknowledgements ----------------------------------------------------------- 2

Abstract ------------------------------------------------------------------------- 3

Chapter -1 Introduction ------------------------------------------------------- 6

1.1 Aim ---------------------------------------------------------------- 7

1.2 Limitations -------------------------------------------------------- 8

1.3 Outline ------------------------------------------------------------- 8

Chapter – 2 Background ------------------------------------------------------ 9

2.1Islamic banking and finance ------------------------------------ 9

2.2Islamic banking in a historic perspective --------------------- 11

2.3 Differentiation among conventional and Islamic banking -- 12

Chapter – 3 Pakistan’s banking sector -------------------------------------- 14

3.1Islamic banking sector --------------------------------------------- 15

Chapter – 4 Theoretical framework -------------------------------------------- 18

Chapter – 5 Methodology ------------------------------------------------------- 23

5.1Profitability Ratio -------------------------------------------------- 23

5.2Liquidity Ratio ----------------------------------------------------- 24

5.3Efficiency Ratio ---------------------------------------------------- 26

5.4Risk and Solvency Ratio ------------------------------------------ 27

Chapter – 6 Findings ------------------------------------------------------------ 29

6.1 Profitability Ratio -------------------------------------------------- 29

6.2Liquidity Ratio ----------------------------------------------------- 32

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6.3Risk and Solvency Ratio ------------------------------------------ 35

6.4 Efficiency Ratio ---------------------------------------------------- 38

Chapter – 7 Conclusion ---------------------------------------------------------- 42

Chapter – 8 References ----------------------------------------------------------- 45

8.1 websites --------------------------------------------------------------- 48

Chapter – 9 Appendix ------------------------------------------------------------ 50

9.1 Appendix –A ---------------------------------------------------------- 50

9.2 Appendix – B --------------------------------------------------------- 54

9.3 Appendix – C ---------------------------------------------------------- 56

9.4 Appendix – D ---------------------------------------------------------- 57

9.5 Appendix – E ----------------------------------------------------------- 58

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Chapter:-1

Introduction

Intensifying competition in banking worldwide and constant improvement in

providing suitable financial services requires measuring the performance of all banks.

This is also true for Islamic banking.

The performance estimation of banks is significant for bank managers,

regulators, investors and depositors. Bank performance gives the clear idea to the

investors and depositors of investing and withdrawing funds from the bank inextremely competitive market. Depositors have an interest in measuring the

performance of the banks as there is no guaranty of deposits nominal value and also

they are not guaranteed fixed returns. Bank regulators observe the performance of

the bank to identify the problems as they are responsible for protection and

dependability of the banking system and also to safeguard public confidence.

Managers verifies the results of management decisions taken before and also to

estimate in improving its finances by providing loan services and deposit services.

Samad and Hassan (2000), Hassan and Bashir (2003) stated that the consistent

observing of performance is significant as current problems can be stay behind

which leads to the financial breakdown in the future.

Islamic banking started around three decades ago in Pakistan with a

proposal of removing interest from the process of specialized organization and

conventional banks in 1977-1978; however the serious efforts were made in January

2000. State Bank of Pakistan (SBP) composed a Commission for Transformation of

financial System (CTFS) to introduce Shari’ah obeying modes of financing and in

September 2003 when the State Bank of Pakistan (SBP) established the Islamic

Banking Section. This results in performing significant role in fulfilling various

sectors of the country with the values of Islamic shariah.

In January 2002 State bank of Pakistan approved Meezan bank limited as the

first Islamic bank of Pakistan to increase the process of Islamic banking. Meezan

Bank Limited is the first and foremost full-fledge Islamic bank of Pakistan.

In Pakistan there are just six Islamic banks and the majority of the banks have

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started operating in recent times except Mezzan Bank Limited which is operating from

over nine years. Whereas on other side conventional banks are large in numbers and also

in volume and they are operating from more than 10 years.

Current literature on Islamic banking releases a variety of studies completed

on performance of Islamic banks like “Sufian (2007), Bashir (2000), Saleh and Rami

(2006), Hassan and Bashir (2003), Samad (2004), Samad (1999), Rosly and Abu

bakar (2003), Samad and Hassan (2000)”. On one side the studies on evaluating

Islamic banks and conventional banks financial performance in various countries is

confine by the active studies on Islamic banking. However there is no study available

for qualified examination on financial performance of Conventional and Islamic

banks of Pakistan.

1.1 Aim:-

The researcher in this study aims to study the evolution of Islamic banking

and this would be done by researching into the case of Meezan Bank Limited and

this would in turn lead to performance measurement of Islamic bank in comparison

with Conventional bank in the state of Pakistan.

The early establishment of Meezan Bank Limited would give us the

opportunity of thorough and deep understanding of ways of functioning of Islamic

Banks and also give understanding of performance of other Islamic Banks

The one more main reason for choosing Meezan Bank Ltd as Islamic bank is

accessibility of information and also the reality is MBL is a single private Islamic

bank that is working from over nine years in Pakistan. As Meezan Bank Limited is

the private sector bank, the other conventional bank taken for the study is (Habib

Bank Ltd.) which is also a private sector bank. Additionally this conventional bank is

selected on the largely merit bases in private sector banking of Pakistan. This study

excludes the government owned and private banks as these banks are reasonably

have large volume compared with the private banking sector in Pakistan. Foreign

Islamic and conventional banks are also ignored in this study as this study is

completely focused on the performance of domestic banks. Different Authors used

different methods and techniques to evaluate the performance. Financial ratios are

used to a certain extent in literature. We used financial ratios in this study to evaluate

the performance of Islamic bank and conventional bank in the form of profitability,

risk and solvency, liquidity and efficiency.

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1.2 Limitations:-

There are total 35 conventional banks operating in Pakistan in which six are

full-fledged Islamic banks. There are five private banks and one foreign bank in those

six Islamic banks. Meezan Bank Limited is the only mature, experienced and large

private Islamic bank functioning from more than a decade. Excluding AIB (Albaraka

Islamic Bank of Bahrain) this is an overseas Islamic bank and all other banks have

started functioning recently. AIB is functioning since 1991 and it is small in size. The

reason behind for not selecting this bank is as our research is based on the

comparative performance of conventional bank and Islamic bank of Pakistan. There

are many commercial banks available but data availability and time is the main

limitation restricting us to select the Habib Bank Limited (HBL) to evaluate the

performance in comparison with Islamic bank.

1.3 Outline:

The study mainly comprises of the discussion about the assessment performance of

the banks, methods used for calculating the performance, Aim and objectives of the

research and also the research limitations. The study discuss the background of

Islamic banking and also a historic perspective in chapter 2 also the distinguish

between conventional bank and Islamic bank. In chapter 3 it discuss about the

Pakistan’s banking sector along with the Islamic bank. The chapter 4 is literature

review which contains some review about the previous studies about the comprising

performances of conventional bank and Islamic bank. In chapter 5 discuss about the

data collected for this study and methods used to analyse the performance of Islamic

bank compared with conventional bank. Chapter 6 discuss about the findings and

chapter 7 contains the conclusion of the study. The study ends with the references

used for this research and the data collected from the websites and links and lastly the

appendices for the desertation in which it has principals of Islamic banking,

introduction to Meezan bank, data used for calculating the performance of two banks

and the output results.

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Chapter:-2

Background

Islamic Bank was first opened in Egypt in 1963 and then there were many

branches opened across Middle East and Asian region. Islamic Banking has spread

across the globe in both geographic terms as well as on the basis of Asset under

Management which are currently worth $ 1 trillion. Iran and Sudan transformed their

complete system of banking into Islamic banking system. Their operations currently

run in 60 countries and in rest of economies conventional banking systems are in place. (Aggarwal and Yousaf, 2000). The growth rate of Islamic Banking is around

10% to 15% and currently there are 160 Islamic financial institutions worldwide.

The rise of Islamic banking has been steady and emerging markets in Muslim

countries have accepted it in a big way. The credit market of Islamic Banking has

increased its market share in Muslim countries from 2% in 1970’s to 15% in recent

times. (Aggarwal and Yousuf, 2000). Banking system like Islamic banking is

reaching popularity all over the world. Yudistira (2003) also refers to the growing

number of Islamic banking products being issued by the Multinational Banks in the

Middle Eastern and developing countries.

The liberalization and globalization have produced tests for the Islamic Banks

and they have to face tough competition from the innovative products from

Multinational Banks in designing Islamic products that match the same expectations

and returns.

Islamic finance is based on the rules of Shariah which is the guiding principle

for all kinds of investment permitted in the form of Law which also includes Sociable

dependent Investment. There is no distinction between religious and secular in Islam

and therefore has been able to guide the financial products.

2.1. Islamic Banking and Finance:

The Islamic Banking can be described like banking based on rules as well as

ethical principles of Islam which covers good Governance and risk management

techniques. Islamic Banking deplores the use of interest bearing instruments and

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condemns the financial products that give interest. This feature has its roots in the

Shariah which is like a guiding rule book for Islamic Banking. Internet Banking is not

allowed under the Islamic Banking law and also does the unethical practices are

completely deplored.

Islamic Economics can be also be understood as a body of text that promotes

the allocation of resources and also looks into the well being of human race without

any creation of economic imbalances and macroeconomic problems (Chapra, 1996).

The main feature of Islamic Banking is the impartial importance to various factors of

productions. Islamic Banking is in favour of equitable distribution of money and

counters the flow of money into few hands and supports free flow of money in the

economy, therefore equality and social goals lie at the core principles of Islamic

Banking. . (Source: Bank Alfalah).

Islamic Banking is based on the principles of Islamic Principles and it is a

given thing for the entire activities of banks will pursue the same. Islamic principles

can be said to be the principles for culturally driven and ethical form of banking. The

two guiding principles of Islamic Banking are Sharing of Profit and Loss, Exclusion of

Usury. The amount of interest is referred as Riba inside Islamic law.

The rules of Islamic banking favour the desire to accept the divine Instructions

on all the transactions and more specifically in transactions that involve money.

Islamic banking cannot be relegated to only elimination of Riba, but it also mentions

about Gharar (risk and Uncertainty) and Oimar (speculation). These are couple of

features from a wide array of features that Islamic Banking covers.

Various explanations are given by scholars in regards to interest with some of

quotes are that when does gift something to the other bearing an intention such gifting

would help you in getting some sort of benefit is not in good side of Gods value and if

one does donate in good intentions and in name of Allah one definitely succeeds. The

taking of Riba (usury) which are deplored in the rule of Islam and therefore is liable to

punishment from Allah.

There have been some voices in support of interest bearing loans on

commercial projects and they say that interest is prohibited in retail loans that are

meant for consummative purposes; however such arguments go against the

understanding of rules 278 and 279 of Surah Albaqra

The sermons in the holy Quran warns the subjects to be afraid of Allah and to

forego whatever is remaining from the recievement of Riba (usury). The sermons say

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to avoid any kind of Usury and therefore fear Allah and his messengers who are not

in favour of Usury.

Islamic Banking does not rule out interest completely as it says that profit is

the reward for the capital and therefore when there is profit on the invested projects

then that profit is the right of the owner of the capital. In the same way the loss of the

venture would also have t be borne by the capital provider and also it mentions that

the profit can be claimed only when the investment is done after acknowledging its

risks. The gain made by the lender of the capital and the wages provided to the

labourer. The depositor is compensated in the following 3 ways

1. Return on the capital provided

2. Receiving the profit of the investment in a partnership

3. Rental Earning on the asset being partially by his capital.

2.2. Islamic Banking in a Historic Perspective:

The beginning of Islamic finance can be traced reverse at the period of

Prophet Mohammed and Quran which is the behavioural guide and also is bedrock

faith of billions of Muslims worldwide. The prophet Mohammed was a businessman

working on the behalf of Khadija and his business working has been epitome of fair

Trade which includes transparency in transactions and total honesty.

In Muslim countries the banking concept dates back to time when individuals

deposit their wealth with The Prophet and Abu Bakar Sidique who is Khalifa in

Islam.

In the year 1963 the first Islamic Bank was established in Egypt and it did not

create any Islamic Image of itself. Mr. Ahmad EL NAJJAR was monumental in

creation of the institution and it was on gain division in town of Egypt of Mit Ghamir.

The number of such banks increase to 9 by 1967 and these banks were not

paying any interest and engaged in trading activities and also the profit and loss

sharing with the depositors was done based on the results of projects (Siddiqui, l988).

Nasir social bank confirmed as an interest free commercial bank (Arif, 1988).

There were many Islamic banks opened in 1970’s especially in the Middle

East like, The Dubai Islamic Bank (1975), The Faisal Islamic Bank of Egypt (1977),

Faisal Islamic Bank of Sudan and Bahrain Islamic Bank (1979). There were banks

opened in the Asia Pacific region, the Philippine Amanah Bank was opened in 1973

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and it had no mention of Islamic character in the Banks Charter although efforts were

made to convert the PAB into Islamic Bank. The operations that had interest giving

transactions were followed according to Shariat rules. PAB functioned with two

functionaries conventional and Islamic. Islamic Banking arrived in Malaysia to help

the Hajj Pilgrims. MPSC was created into BANK ISLAM MALAYSIA BERHAD

and opened in 1983 and had RM 80million in assets (Arif, 1988).

The OIC (Organization of Islamic Countries) recognized I DB ( Islamic

Development Bank) in the year l973 towards helping the member nations and also to

promote social welfare of the Muslim Community based on the principles of Shariah.

The IDB is involved in fee based financial services and also in profit sharing based

for the member countries. (Source: IDB).

There was an attempt for Islamic Banking during the 1970’s for interest free

saving loans and savings (Siddiqui 1988). The Islamic Banking System based in

Luxembourg in 1978 was first attempt in western country and there is Islamic Bank

International in Copenhagen (Denmark) and Islamic finance company set up in

Australia (Melbourne) (Arif 1988). A large number of Islamic Banks were established

in late 20th century to cater to the growing needs.

2.3. Differentiation among Conventional and Islamic Banking:

The Islamic Banking is like Conventional bank with difference being that here

the profit and loss is shared with the depositors and is mutually consented (Dar and

Presley, 2000). Islamic banking favours profit and loss sharing whereas conventional

bank favours interest being paid (Arif, 1988).

Islamic finance is the financial system where the teachings of Quran are

followed in a strict manner and in confirmation of Islamic Ethics. The financial

transaction is all based on the principles laid down by the Shariah. Islamic Banking is

based on the principle of “free” and “fair” system. Islam participants are free to enter

in contracts but it doesn’t encourage rampant and misleading transactions and also

exclusion of Gharar and Riba

Association of Islamic bank with depositor resting on individual part and the

Entrepreneurs on other side as compared to conventional bank that only acts as lender

and borrower. The governance structure also forms basis of difference. Islamic banks

have to obey the rules under the holy book Quran and congregate the prospect of the

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Muslim society and their financing models. (Suleiman, 2001).

There are certain similarities with the conventional banks in a Way that both

of them offer financial services and contribute to the growth of the economy in their

own ways. Islamic Banking norms completely restrict the use of Riba (interest) or the

inequitable agreements which occupy speculation or risk.

The Islamic bank in comparison to other conventional banks follow the principle of

fairness and is based on the tenets of shariah and function within the boundaries of

Islam and this was said by Siddiqi(1985). The four rules that govern investment

behaviour (Suleiman 2001) are:

1. Noninterest bearing transactions (RIBA)

2. Avoiding speculative transactions (GHARAR).

3. The application of Islamic Tax (ZAKAT)

4. Discouraging the production of goods and services which are not in confirmation

of rules of Islam (HARAM).

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Chapter: - 3

Pakistan’s Banking Sector

Financial sector act as an main part in the nation’s economy and efficient

financial sector also is important determinant in growth of economy and also in the

living standard of the nation. The greater the assets in the financial sector greater

will be its stability and therefore the nation will have a growing economy. The

Pakistan banks dominated (95%) of the financial sector and so fine strength of these

banks is vital for the economy of Pakistan and also form vital form of lending

mechanisms to the organization which then invests in their projects and therefore the

infrastructure of the country develops and leads to the growth of the nation.

Pakistan economy has 53 banks, 30 commercial banks, 4 specialized banks,Islamic Banks and 6 Micro financing banks in the banking sector. The number of

Government banks is 9, Private banks is 22, foreign banks is 5, development

institutions is 8, banks which are non associate are 5, and Small and medium

enterprise forms 3 banks, However, market share of Big four banks is 44.2% and

while other 8 second tier banks account for further 35% of market. Banks of Pakistan

are looking after the funding of Pakistan Government which then invests in the

infrastructure of the country and in other developmental and socially welfare

schemes. The role of the bank is also in Subsidizing the fiscal deficit which arises as

a result of spending more than the earning, doing trade financing and financing huge

businesses. Tiny and average ventures, the housing sector and Agriculture which is

one of the top employment sources in the rural Pakistan are the major job creators

and play vital role in development of economy of Pakistan and its financial sector.

The politicians play important role in the lending decisions and appointment of

managers of the banks in Pakistan. This clearly shows the nexus between the lenders

and politicians.

Patti and Hardy(2005) have observed that in the past 15 years there has been

liberalization and therefore number of private banks have increased and also due to

privatization of public sector banks nearly 80% of banking space is guarded by the

classified banks as divergent to 1990’s when only 10% was under private sector.

The assets have crossed 180 billion dollars with the GDP of 113% and the share of

the banking sector is around 95% and also constitutes 40% of stock market

capitalisation. Growing financial intermediation has increased banks profitability to

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1.9 billion dollars. The foreign stake is 48% of total capital paid under the regulation

of State Bank of Pakistan (SBP and Shamshad, 2007).

3.1. Islamic Banking Sector:The president of the Pakistan on 01/07/1948 had in his speech at the opening

ceremony of State Bank of Pakistan had said that the state of Pakistan needs to

develop its financial sector on its own and needs to be based n Islamic Concept and

equality of subjects and should be on justice. The message of Shariah and muslim

world needs to be shown and depicted in its actions and therefore such a thing would

help in establishment of humanity and fairness.

Islamic Banking in Pakistan was established in late 1970’s and did not have

interest component and it formed the core value of Islamic Banking and its

commercial arms. On June 26 1980 efforts were made to introduce new instruments

that were interest free and were called “participation Term Certificate” (PTC). In

same time rising risk based capital Ordinance was issued in order to establish

Mudaraba companies and issuance of its certificates. Rupee in Pakistan in July 1 1985

was made interest free by the all banks and they were with or without buy back

agreement., however it was declared Un Islamic by the Federal Shari at Court(FSC).

(Source IIFM).

The commission for Transformation of Financial System (CTFS) was created

in 01/01/2000 by the State Bank of Pakistan and it was done in order to ensure that all

the operations and the transaction of the Islamic Banks was in accordance with

Shariah and Muslim Rules. And educating the banker in regards to development in

finance and also general public at large to educate them also makes them understand

the banking products. This is in accordance with the basic principle that is fairness

and transactions in all the trading activities as was mentioned in the Shariah law

(Source IIFM).

The state of Pakistan tries to move in shifting of financial market into interest

free transactions and also gave a thought into the setting of subsidiaries in State

Bank of Pakistan so that they follow the shariah rules and transactions are according

to Islamic Law, also specifying Commercial branches which are for Islamic products

and also the commercial banks which are fully fledged can do the dealing with the

Islamic product. (Source IIFM).

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Meezan bank limited was approved an authorization of Islamic Banking by the

State Bank of Pakistan in January 2002 and on 15/09/2003 State bank of Pakistan

recognized the Islamic Banking unit and its objective included the monitoring of

Islamic Banking industry and bring to the notice any of the wrongdoings in the

transactions and promote it based on the Shariat laws and transparency and thus make

Islamic Banking the first choice for the users and the providers. Shariat compliant

Islamic banking was the main objective of creation of the Islamic banking Division

and parallel and compatible banking system, the departments included

1. Policy division.

2. Shariah compliance division.

3. Business support division.

The group of directors have specialists on the various divisions of finance and

they are in operations at the SBP, these include the division of Risk sharing and

Compliance and also Marketing department looking after the promotions part and

they are the important departments in SBP.

The following banks are operating and below are mentioned with year of

establishment.

Dubai Islamic Bank Pakistan Limited (2005), Meezan Bank Limited (modernized as

Islamic bank in 2002), Emirates Global Islamic Bank Limited (2007), Dawood Islamic

Bank Limited (2007) , Bank Islami Pakistan Limited (2003), Al-Baraka Islamic Bank

Pakistan (1991).

Al-Baraka is a foreign Islamic bank and has branches functioning all over

Pakistan from 1991. Meezan Banking Limited is the only domestically grown

Commercial bank given license by the State Bank of Pakistan in January in 2002.

Islamic bank share of banking sector is 6.1% at the end of June 2010 which

has increased from 5.1% in June 2009. The number of branches increased to 350 from

289 in the previous years. The Islamic Banks hope to capture 7% of the market share.

The Growth of the Islamic Bank has been good and it is also including various

financial concepts. Meezan Bank Limited remains at the top of Islamic Banks and

Alfalah as foremost foreign Owned Islamic Bank (Source SIMB)

The growth of Islamic Banking has been commendable; however need of

infrastructure, support and specialized Islamic Bankers has controlled thedevelopment. The above mentioned obstructions have hampered the growth of the

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Islamic bank and therefore the solutions to the above problems will help in the growth

of the Islamic banks

Chapter:-4

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Theoretical Framework

The first experiment of Islamic banking was started in the year 1963 in a small

town of Egypt and it was commenced as small size banking. This experiment succeeded

and released different ways for separate market of Islamic banking and finance. In

1970s Islamic banking started various number of full-fledge Islamic banking at a

reasonable size in Asian and Arabic countries. Large amount of these Islamic banks

were in Islamic countries. Islamic banking and non banking associations of finance are

operating on high demanding level even though these banks started in small size. At

present Islamic banking is operating in more than sixty counties and the assets are in

excess of 165 billion dollars at a growth rate of 15% annually. Aggarwal and yousaf

(2000) stated that “In the credit market, market share of Islamic banks in Islamiccountries has risen from 2% in the late 1970s to 15% till today”.

To hold on the teachings of Islamic law (shari’ah) one should follow the

principals of Islamic law like staying away from giving and accepting Gharar and Riba,

empowering in sharing profit businesses, avoiding investment within the unprincipled

businesses, also creating the investments collectively dependable for the personal

benefits as well as achieving the goals of Islamic banks. There are several questions the

researchers, stakeholders and scholars have as how well the Islamic financial

institutions are performing and also how well they are achieving their goals.

On one side Islamic banking is consider the same as a highest developing

market but also on opposite part Islamic banking be surrounded with the problems,

issues and challenges. Several studies carried out because of the commencement of new

Islamic banking and finance. Previous studies of Islamic banking is mainly focus on the

Interest free financing (Ahmad 1981, Karsen 1982). There is not enough exposure in

literature about the capability of Islamic banks and organise savings, group risk and

making easy transactions (Hassan and Basheer, 2003). But there are only some studies

which focus on making the policy of removing interest payments (Khan and Mirakhor,

1987).

Even though the fact of Islamic banking and finance become visible recently

and large development of Islamic banking, the studies focus on the competence of

Islamic banks are in very few quantity (Yudistira, 2003 and Sufian, 2007). There are

many studies generally conducted for calculating the performance of Islamic banks in

relation to the profitability and qualities of bank. Hassan and Basheer (2003)

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determine the fundamental performance of Islamic banks by collecting banks data and

using regression analysis. Samad and Hassan (2000) use financial ratios in order to

analyse the performance of UAE Islamic banks and Malaysian Islamic bank. In the

same way Sarker (1999) measure the competence of Islamic banks in Bangladesh by

using Banking efficiency model and declared that Islamic banks can be active in a

usual banking manner where the profit and loss sharing manner of finance is less

controlled. Moreover Sarker (1999) declared products of Islamic finance have

diverse sorts of Risk, as a result altered characteristic rules must exist.

Samad and Hassan (2000) assess the performances in Liquidity, Risk and

Solvency, Profitability of interbanks and also society participation in BIMD (Bank

Islamic Malaysia Berhad) from 1984 to 1997. It contrasts the performance of Bank

Islamic Malaysia Berhed of two periods one is from 1984 to 1989 and the second is

from 1990 to 1997. Elyasiani (1994) stated this method is not new to assess the

performance banks. To appraise interbank performances the research contrasts BIMB

with a small and large conventional bank with BIMB and also through eight

conventional banks. It uses financial ratios to measure the performances and also used

F test and T test to verify the consequence. The result from this study shows that

BIMB make an important development in profitability for the period of 1984 to 1987.

Though, development in profitability is lagging behind in comparison with

conventional banks due to numerous reasons. This outcome is constant with the

Samad and Hassan (1999). The study exposes that BIMB is comparatively less risky

and more solvent compare to the conventional banks. Its results confirm to risk return

profile that the BIMB is comparative less risky and less profitable. BIMB performance

appraisal specifies it as a most liquid compare to other eight conventional banks.

Bankers identify the causes of Mudarabah and Musharka be not accepted inside

Malaysia by gathering primary data by surveying up to 70% banks. The considerable

causes are lack of knowledge to select, appraise and manage profitable projects.

Samad (2004) calculate the relative performances of conventional banks and

interest free Islamic banks of Bahrain from 1991 to 2001. By using financial ratios to

examine the difference in performance in terms of profitability, credit risk, liquidity

risk and relating the t-test with these ratios. His study concludes with the major

differentiation in credit performances among these banks. But in his study there is no

major difference in profitability and liquidity among conventional and Islamic banks.

Kader and Asarpota (2007) make use of bank level data to appraise the performance of

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Islamic banks of UAE. Income statements and balance sheets of three Islamic banks

and five conventional banks for the time period 2000-2004 are used to gather data for

study. To examine the performance of Islamic banks they applied financial ratios in

profitability, Risk and solvency, efficiency and liquidity. From the findings of the

research Islamic banks of UAE are reasonably more profitable, less risky, less liquid

and more efficient compared to other conventional banks of UAE. Kader and Asarpota

concluded with the two significant suggestions associate with the findings. Firstly the

key reason for the rapid growth in Islamic banking in UAE is due to the quality of

Islamic profit and loss sharing concepts in banks. Secondly Islamic banking in UAE

should be supervise and regulate in different ways as they are different from the

conventional banks of UAE.

Saleh and Rami (2006) assess the performance of Islamic banks in Jordon.

They analyses and examine the experience of Jordon’s first Islamic bank Jordan Bank

for Finance and Investment (JIBFI) and second Islamic bank Islamic International

Arab Bank (IIAB). There are things to see in the study like domestic and global

challenges face by this division. The paper finds some interesting results by

conducting capital structure, profit maximization and liquidity test as performance

appraisal methodology. Firstly the ability and efficiency of both banks have improved

and both banks enlarge their activities and investments. Secondly these banks play a

significant role in financing the projects in Jordon. Thirdly they are focused on short

term investments. Fourthly profitability of the Jordon Bank for Finance and

Investment (JIBFI) is higher. Finally profitability and credit facilities have a higher

growth in Islamic banks.

Bashir (2000) examine some factors of Islamic banking performances from 8

countries of Middle East during 1993-1998. The study gathered data like income

statement and balance sheet of fourteen Islamic banks from 8 Middle East countries

for each year from 1993 to 1998. The study also looks on the relationship between the

banking characteristic and profitability. The study shows some very significant results

after the control of financial composition indicator like macroeconomics background,

taxation and finance markets. Firstly Islamic banks profitability measures respond

optimistically to the boost in loan and capital ratios that are spontaneous and reliable

by the earlier findings. Secondly the research underlines the practical responsibilities

where sufficient loan portfolio and capital ratio plays while discussing the Islamic

banks performance. Thirdly non interest earnings, customer and short term funding

20 | P a g e




and overheads are important for promoting profits of the banks. Fourthly the foreign

owned banks are more profitable as compared to the domestically owned. Fifthly by

keeping other things stable there is fact that open and hidden taxes affect the banks

performance negatively. Sixthly performance measures of the banks have positive

effect of encouraging macroeconomic conditions. Finally the study shows that the

stock markets are praising to bank financing.

Hassan and Bashir (2003) perform a similar study which examines how the

Islamic banks performance is affected by the quality of bank and by a large financial

environment. Their study used data of Islamic banks from 21 countries from 1994 to

2001 in order to look at the performance of Islamic banks. They find their research as

a factor of consistency in profitability of Islamic banks compare to previous

researches. The research shows the factors lead to higher profitability. The factors

like controlling macroeconomics environment, the high capital and loan to asset

ratios, financial market structure and taxation. The results of this research exposes

that the bank performance measures has a unconstructive result of implied and precise

taxes at the same time it has a positive effect of favourable macroeconomic

conditions. Favourable macroeconomic conditions shows to encourage higher profits.

The results also unexpectedly demonstrate a positive relationship between overheads

and profitability with the intention to hold the expense preference behaviour in

Islamic banking market and also there is a negative impact of banking system volume

in profitability.

In the research Yedustira (2003) compose a practical testing on efficiency and

present new evidence on around 18 Islamic bank performances during 1997-2000. The

data for this study is taken from the balance sheet and income statements of those

Islamic banks. The main purpose of this study is to verify the Islamic bank efficiency

affected by the financial crisis. This research is dissimilar to other researches as it uses

non-parametric approaches, DAE (Data Envelopment Analyses) in order to evaluate

the efficiency of Islamic bank. To indicate the input variables and output variables of

Islamic bank it used intermediation approach as per the standard of Islamic financial

system. The research discover certain outcomes, firstly the results of efficiency shows

all 18 Islamic banks has very small inefficiency which is significantly balanced with

conventional banks. The performance of Islamic banks was highly affected by the

global crisis of 1998-99. Though they do better afterwards. Secondly the outcomes

shows Islamic bank with small and medium size faced economic problems.

21 | P a g e




Additionally public listed Islamic banks are less efficient. Finally the main explicit

reasons of the country resolved the efficiency variations of complete data.

Sufian (2007) carry out a parallel research to give latest confirmation on the

comparative efficiency among foreign and domestic Islamic banking process in

Malaysia from the period of 2001 to 2004. The methodology used in this research is

unparametric data envelopment examination to differentiate the practical efficiency

and pure practical scale efficiency. The research also used input and output variables

of Islamic banks. A sequence of tests carried out to observe whether the foreign and

domestic banks were drawn from the same inhabitants as the majority of the

outcomes cannot reject the hypothesis with the significance of 5%. Lastly the

parametric correlation coefficients were used to analyses the relation of scores output

from traditional accounting ratios with DEA. A number of outcomes are drawn from

the study. The outcome shows the efficiency of the Malaysian banks recovered in

2003 and 2004 after the decrease in 2002. The foreign Islamic banks are less efficient

compare to domestic Islamic banks. The major cause of the inefficiency of the

Malaysian banks is wrong scale of operations. The outcomes of the correlation

coefficients confirmed the dominance of scale in measuring the technical efficiency

of Malaysian Islamic banks. The outcomes of this research also specify the

profitability is considerable and absolutely correlated with all efficiency processes.

Chapter:-5

METHODOLOGY

The research methodology applied is comparative study in which comparison

is done between Islamic Bank and a Conventional Bank over the period 2006 to 2010.

Data has been taken from the income statements and the Balance sheets and is

22 | P a g e




common technique used in bank study (Sabi 1966). In today’s environment

comparative study of banking environment is useful as it shows that which bank is

better in the selected parameters of the researcher and helps the fund manager in

making informed decisions.

Various theories have been proposed in measuring banking performance and

they are financial management theories. Accounting ratios is among term. Financial

ratios have been commonly used in study of Banks. The case of financial ratios in

examining the banks were given by (Samad and Hasan, 2000), Akkas (1994), Samad

(1999), Sabi (1997), Patnam (1983). The comparison of the banks of Islamic bank and

the Conventional Bank is done for 5 years interval and the readings are for 12 financial

ratios. The ratios are divided into four classes which are: Profitability Ratio, Liquidity

ratio, Risk and Solvency ratio and Efficiency Ratio.

5.1. Profitability Ratio

Accounting profits means the difference between the revenues and Loss and

it is one of the most difficult factors to measure. (Ross, Westerfield and Jaffe, 2005).

These ratios help in determining the profits of the bank and also its expenses and costs

involved over a period of time. They also indicate a firm’s profitability over the

specified time period and only after taking into consideration expenses and income tax

is the profitability of the firm determined.

Profitability ratios are used to measure the profitability of the bank, if it is

higher in comparison to the opponent and industries average or the previous year’s

ratio than it indicates the good results of the institutions and the tests that apply to

meet the benchmark are Return on Equity (ROE), Return on assets (ROA) and Profit

Expense Ratio (PER).

Return on Asset

ROA is the indicator of profitability of the firm after deductions of expenses

and taxes (Van Home 2005). This is the measure which is keenly looked forward to by

the analysts in measuring the usefulness of the bank to invest their money into. It is a

regular method of administrative performance as it indicates the effectiveness with

which the mangers have been successful in running the operations of the bank and also

shows how competent the bank is in its business areas (Ross, Westerfield, and Jaffe,

2005). It measures the earning of the banks after the taxes have been deducted and

23 | P a g e




represents its net earnings. A higher ratio is an indication of good management

performance and lower ratio indicated the failure of the managers ROA can be

increased by the banks by improving performance and efficiency

ROA= Net Profit after tax/Total Assets

Return on Equity

The ratio indicates the gains to the shareholders of the company and this is

after the deductions of taxes and expenses. It represents the earnings of the firm tax

has been deducted. (Samad and Hassan, 2000). This will indicate and measure

managerial efficiency (Hassan 1999, and Samad, 1998).The larger the ROE indicates

the better the efficiency in functioning of managers. The better return indicates that it

may be due to better performance of debt and also of Equity. The ROA and ROE

differs as the higher leverage acts in favour of ROE

ROE = Net profit after Tax / Shareholders Equity

Profit to Expense Ratio (PER)

This is a measurement of operating profit of the bank in regards to its

operating expenses. Operating profit refers to the earnings before taxes and operating

expenses relate to noninterest expense. The ratio is measurement of operating profit

Earned for each dollar of operating expense. The ratio indicates the efficiency of the

banks in handling its operating expenses. A higher PER refers to profitability of the

banks and cost efficiency.

PER= Profit per tax/operating expenses

5.2. Liquidity Ratio

Above mentioned ratio represents the capability of the company in meeting

the requirements. Liquidity helps the banks in order to avoid a sudden rush of

demanding customers who want to withdraw their funds and it also represents the

cash maintained and therefore the higher the cash maintained and higher the liquidity

position of the bank the safer the bank will be.( Ross ,Jaffe , Weterfield 2005). The

savings accounts and transaction deposits come with a feature of anytime withdrawal

and therefore there is a risk of their removal and thus pose liquidity risk to the bank

and depository institution and withdrawal exceeds certain proportions then it s a

liquidity risk to the banks. Liquidity methods like Loan to Deposit Ratio (LDR),

24 | P a g e




Loan to Asset Ratio (LAR) and Cash and Portfolio Investment to Deposit Ratio

(CPID),

Loan to Deposit Ratio (LDR)

LDR is a measure of liquidity circumstance of the banks and at this point loan

is defined as advances to the commercial organization and institutions and because it

is prohibited for Islamic Banks to attain interest (Riba) and they have to follow

Shariah Principles in conduct of their banking operations they can use their finance s

to provide various types of financial Products. Banks having lower LDR is considered

to have higher levels of cash and therefore lesser profits and lower loan portfolio but a

higher LDR is an inductiveness of the excessive loans and therefore the risks to the

banks are higher.

LDR= Loan/Deposits.

Cash and Portfolio Investments to Deposits Ratio (CPIDR)

This is the other method to find the liquidity of the bank and therefore the

higher the ratio the higher the confidence that the depositor has on the banks financial

soundness. It helps in boosting the trust of the depositors as they know that bank have

enough cash but bank also makes some investment portfolios and earn a little helpful

return from the invested securities. Also if the bank needs some cash then they can

sell these securities.

CPIDR= Cash and Portfolio Investment/ Deposits

Loan to Asset Ratio (LAR)

The ratio indicates that bit measures the solvency of the bank and where LDR

measures the liquidity of the banks in terms of deposits bank hold LAR measures the

liquidity of bank in terms of the assets of the bank. A bank having lower LAR is said

to be having more liquidity and one with higher LAR shows that bank is more

profitable and also highly solvent. It is measured as

LAR= Loan/ Total Assets

5.3. Efficiency Ratio

The efficiency of the managers of the bank can be measured through this

ratio and also the profitability of the bank in increasing the number of products sold.

25 | P a g e




The profitability of the bank also rests in the effectiveness of the bank in collecting

its loans and dues. The banks managers should also make the proper use of its

reserve inventory and save on expenses. The higher the value of this ratio the better

is for the firm. This shows that the bank is effective in inventory management

practices and efficient in control of expenses. The higher the ratio value the greater

its effectiveness. The measure as mentioned above in measuring efficiency of the

bank is 1. Asset Utilisation 2. Income to Expense Ratio 3. Operating Efficiency.

Asset Utilisation (AU)

The effectiveness of the banks is utilization of all kind of assets and can be

calculated with the Asset utilization Ratio. Utilization of assets effectively by the

bank is reflected in the higher value of this ratio and lower value of the ratio indicates

that the bank is not using its assets effectively (Ross, Westerfield and Jaffe 2005).

The calculation of the assets utilisation ratio can be stated as below. The complete

revenue is the net spread before provision in addition to other income.

AU= Total Revenue/ Total assets.

Operating Efficiency (OE)

The operations of bank lead to profits and it is measured as the profit earned

for every dollar that is spent on the operations expenses and in managing the

operations. The bank needs to improve the efficiency of its operations. The bank

would like to have higher value for the operational efficiency as lower efficiency

would show that bank has failed in managing its operations efficiently. The revenue

of the operations of the banks can be calculated as the ratio is

OE= Total operating Expenses / Total operating Revenue

Income Expenses Ratio (IER)

The above mentioned ratio indicates that the income which is got for every

dollar of the operating expense. The ratio is very popular in measurement of financial

ratios. The managers can be assessed for their good work on this parameter and also

the income of the bank can be dwelled upon with use of this ratio. The total income

got by the bank is specified as net income of the bank and this is arrived at before

any kind of provisions being applied and these figures are arrived from the income

statement of the bank and the ratio is found with.

26 | P a g e




IER= Total Income / Total operating Expenses.

5.4. Risk and Solvency Ratio

This measures the risk and solvency of the firms. they are also known as the

gearing, debt or the financial leverage ratios the extent of dependence of the firm on

debt rather than equity to fulfil its contractual obligations will determine that how

solvent the firm is. The higher the debt of the firm the greater difficult it is for the

bank to repay. The debt is crucial way to finance and it may give conflicting interest

to creditors and debtors. The assets have to be greater than the liability of the

company in order for the firm to be solvent.

Deposits are the major source of liability for the conventional or the Islamic

Bank and therefore the borrowed money in any form is a liability to both forms of

the banks as it has to be repaid. To calculate the banks solvency and risk the most

used methods like, 1. Debt to Total Asset Ratio (DTAR), 2. Debt to Equity Ratio

(DER) and 3. Equity Multiplier (EM).

Debt to Total Asset Ratio (DTAR)

The ratio is the measurement of total amount of debt firm uses to finance its

divisions. It is the ability of the banks to protect its subsidiaries and the additional

banking arms which are its own divisions. The bank if it finances its subsidiaries

through debt then it shows that bank has higher DTAR and bank is considered risky.

The calculation of the ratio is done as.

DTAR= Total Debt/Total Assets

Debt to Equity Ratio (DER)

The usage of the debt of the bank can be measured by this ratio and also the

capability of the banks to understand the surprises that arises financially. In

emergence of non-payment of major loans this can act as buffer. A bank with lower

DER is considered to be better than one with higher DER.

DER= Total Debt/ Shareholders Equity.

Equity Multiplier (EM)

The equity multiplier indicates the number of times the assets held by the

bank is more than the shareholders equity. The ratio also shows that what amount of

27 | P a g e




assets per dollar is equity of the consumer. The greater the ratio used bank more of

debt in conversion of assets into share capital. The higher value of the ratio indicates

the danger to the bank and also some kind of loss to the depositors. The calculation

of the ratio is done as.

EM= Total Assets/ Total shareholders’ Equity.

Chapter:-6

Findings

6.1. Profitability Ratio

Return on Asset

The outcome shows some significant points of comparing ROA among the

Islamic bank and conventional bank. Firstly Return on Asset of Islamic bank is lower

than conventional bank apart from the 2007 where the Islamic bank ROA is 1.43%

28 | P a g e




somewhat exceeded to conventional banks (1.23%) ROA. Secondly there is a

considerably decrease in ROA of conventional bank ROA from 2.54% to 1.23%

during the year 2006 to 2007 and at the same time ROA of Islamic bank increased

from 1.30% to 1.43%. Thirdly conventional bank ROA recovered consistently after

the radical decrease in 2006- 2007, whereas Islamic banks ROA has decreased from

1.43% in the year 2007 to 0.73% in 2008. Then the ROA of Islamic bank has

recovered in 2009-2010. Finally the average ROA of Islamic bank is 1.07% whereas

the average ROA of conventional bank is 1.68% which is higher compare to Islamic

banks.

The financial outcomes of 2011 of conventional bank and Islamic bank

determination exposes this increasing movement in ROA of conventional bank will

carry on and Islamic bank ROA will increase or decrease. However Pakistan’s banking

sector is increasing considerably but taking into consideration of last five years ROA

both Islamic bank and conventional bank are facing problems in profitability.

Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 1.30% 1.43% 0.73% 0.83% 1.07% 1.07% 0.0030

Conventional

Bank

2.54% 1.23% 1.39% 1.49% 1.76% 1.68% 0.0052

Return on Equity

The study of Return on Equity of both Islamic bank and conventional bank it

supports some significant points to think comparable to ROA. The outcome shows

29 | P a g e




that Islamic banks ROE is lower 12.68% compare to the ROE of conventional bank

26.88% in 2006. ROE of Islamic bank increased to 16.84% during 2006-2007 at the

same time ROE of conventional banks has decreased to 13.88%. Then in the year

2008 Islamic bank ROE decline to 9.79% whereas conventional bank ROE

recovered. After the huge decline in ROE of Islamic bank it has recovered during

the year 2008 to 2010. ROE of conventional bank is slightly improved. The last 5

years financial statements highlights the overall profits base has improved

comparatively more than equity base in Islamic bank which has lead to increase in

ROE. However Islamic bank ROE is recovering. Still the average ROE of Islamic

bank is 13.19% and ROE of conventional bank is 17.82%.

Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 12.68% 16.84

%

9.79% 11.27% 15.35

%

13.19

%

0.0290

Conventiona

l Bank

26.88% 13.88

%

15.37

%

15.55

%

17.44

%

17.81

%

0.0523

Profit Expense Ratio

One more profitability method of calculating is Profit Expense Ratio.

According to PER conventional bank is more profitable compare to the

Islamic bank during 2006-2010. The study of PER of conventional bank

and Islamic bank shows that conventional bank produced constantly higher

profits for every single amount spent from 2006 to 2010. The PER of Conventional bank reduced to 0.76 in 2007 and remain same in 2008 than it has

30 | P a g e




increased in the year 2009 and 2010 to 1.05. The PER of Islamic bank has reduced

from 0.76 in 2006 to 0.47 in 2010. The financial statements of conventional bank

over a period of five years show expenses have increased but at the same time Islamic

banks expenses decreased during 2006 to 2010. Mean of Islamic bank PER is 0.56

and mean of Conventional bank PER is 0.97.

Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 0.76 0.72 0.37 0.50 0.47 0.56 0.0017

Conventional

Bank

1.39 0.76 0.76 0.87 1.05 0.97 0.0026

On the other hand all the outcomes of profitability ratios are in favour of conventional

bank. The results show that the Islamic bank is less profitable as compared to

conventional bank. Though Islamic bank is constantly performing better in satisfying

the shareholders by offering better returns, managing the operating expenses and alsomaking good return on assets.

6.2. Liquidity Ratio

Loan to Deposit Ratio

The results for LDR shows there is higher loan to deposit ratio (78.47%) for

Islamic bank compare to conventional bank in 2006 and from then it has decreased

consistently to 41.35% during 2009-2010. The LDR of conventional bank has aregular decrease from 77.90 in 2006 to 64.53% in 2010. The liquidity of Islamic bank

31 | P a g e




was comparatively less with the conventional bank in the year 2006 however it has

improved consistently and have more liquidity compare to conventional bank during

2009-2010. On the whole decreasing movement of Islamic bank LDR shows the

tendency of reasonable increase in deposits than loans and improved the liquidity of

Islamic bank. Though mean of Islamic bank LDR is 56.27% which is lower to the

mean of conventional bank 71.62%.

Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 78.47% 63.35% 56.62% 41.57% 41.35% 56.27% 0.1567

Conventiona

l Bank

77.90% 71.49% 77.20% 66.97% 64.53% 71.62% 0.0597

Cash & Portfolio Investments to Deposits & Borrowings Ratio

The Cash and portfolio investments to deposit and borrowing ratio of

conventional bank increased from 37.61% to 44.66% and The CPIDBR of Islamic

bank increased from 25.46% to 29.64% during 2006-2007. But in 2007-2008 the

CPIDBR of Islamic bank and conventional bank considerably decreased to 28.55%

and 21.17% respectively. From there CPIDBR of both conventional and Islamic bank

increased and as of 2010 it has 45.28% and 51.69%. The CPIDBR increasing

movement of Islamic bank and conventional bank shows the increase in liquidity. The

conventional banks have more liquidity compare to Islamic bank as per the cash and

portfolio investment to deposit ratio. The table below explains that mean CPIDBR of

Islamic bank is 33.38% which is lower than the mean CPIDBR of conventional bank

32 | P a g e




40.79%.

Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 25.46% 29.64% 28.55% 31.57% 51.69% 33.38% 0.1047

Conventiona

l Bank

37.61% 44.66% 32.17% 44.22% 45.28% 40.79% 0.0573

Loan to Asset Ratio

The Loan to Deposit Ratio shows Islamic bank liquidity situation is

improving but LAR has different results. The figure given below shows the

swinging trend of both Islamic bank and conventional bank. The LAR movement of

Islamic bank is in between 41.81% and 68% and the LAR movement of

conventional bank is in between 52.46 and 61.61%. Though Islamic banks loan to

asset ratio decrease every year it is still higher compare to conventional bank.

Islamic bank has more financial stress providing too much loans and holds less

assets liquidity. On the other hand it shows better profitability of Islamic bank. The

LAR of Islamic bank and conventional bank decreased from 66.17% to 41.81% and

60.85% to 52.46% respectively during 2006-2010. More LAR analyses shows the

Murabaha as the well-known and mainly used method of finance after Ijara, Export

refinance under Islamic scheme and Dimishing Musharaka.

Generally conventional bank has higher liquididity compare to Islamic bank. The

below table shows the average LAR for Islamic bank is higher (60.40%) with the

conventional bank LAR (56.74%).

33 | P a g e




Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 66.17% 64.64% 67.87% 61.53% 41.81% 60.40% 0.1065

Conventional

Bank

60.85% 55.48% 61.61% 53.30% 52.46% 56.74% 0.0425

As a whole result of liquidity it shows that conventional bank and Islamic bank are

similar to each other apart from LDR. In LDR of Islamic bank is less liquid compare

to Islamic bank. Furthermore the study initiate that Ijarah, Dimishing Musharaka,

Mrabaha and export refinance under Islamic scheme is used mostly in finance.

6.3. Risk and Solvency Ratio

Debt to Equity Ratio

Islamic bank DER increased to 13.63 times in 2010 from 8.76 times in 2006

presenting considerable increasing movement compared to DER of conventional

bank which decreased from 10.17 times in 2006 to 9.25 times in 2010. The increase

in DER of Islamic bank is more than the decrease in DER of conventional bank. Theresult indicates that Islamic bank is more risky compare to conventional bank. A

Deposit composes liability for all kind of banks whether it is a conventional bank or

Islamic bank. Borrowings is the second part of liabilities for all the conventional

banks apart from the Islamic bank as it is prohibited in Shariah by giving or taking

interest loans. The increasing movement of Islamic bank DER specify the

development of deposit base Islamic banks rather than equity base Islamic bank.

From the financial statement of conventional bank over a period of five years has a

decreasing movement of DER as they are based on equity financing and less with

34 | P a g e




deposit base. Islamic banks are more risky compare to conventional bank as the DER

of Islamic bank is higher than the conventional bank for the period of 2006 to 2010.

The average Islamic bank DER is 11.68 times whereas conventional bank has 9.89.

Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 8.76 10.79 12.53 12.68 13.63 11.68 0.0193

Conventional

Bank

10.17 9.67 10.51 9.85 9.25 9.89 0.0048

Debt to Total Asset Ratio

The outcome of DTAR is significantly different from DER. The result shows

the conventional bank is constantly higher compare to the Islamic bank DTAR.

Conventional bank is more risky compare to Islamic bank as per the DTAR. Though

DTAR of Islamic bank has increased significantly from 2006 to 2010. It has increased

from 89.81% to 94.59%. The DER of conventional bank decreased from 95.96% to

93.39% during 2006-2010. Even though the conventional bank DTAR is higher it

had continued constantly among the range of 93% to 96% for last five years. The

average Islamic bank DTAR is 92.46% whereas average DTAR of conventional bank

is 95.09%.

Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 89.81% 91.86% 93.17% 92.85% 94.59% 92.46% 0.0177

Conventional

Bank

95.96% 95.87% 95.29% 94.92% 93.39% 95.09% 0.0104

35 | P a g e




Equity Multiplier

The equity multiplier is other method of calculating Risk and solvency ratios.

Islamic bank has higher risk and less solvent compare to Conventional bank. Result

of EM is same as the DER for both conventional and Islamic bank. Islamic bank

eq uity mu lt ip lie r increased to 14.41 times in 2010 from 9.75 times in 2006.

Conventional bank equity multiplier decreased to 9.91 times in 2010 from 10.60

times in 2006. These results confirm that conventional bank increased more in equity

base and debts. The table below shows the average EM of Islamic bank is 12.61 times

which is higher than the 10.65 times of conventional bank EM.

Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 9.75 11.74 13.49 13.66 14.41 12.61 0.0187

Conventional

Bank

10.60 11.32 11.03 10.38 9.91 10.65 0.0055

36 | P a g e




As a whole results of risk and solvency ratios Debt to Equity Ratio and Equity

Multiplier shows Islamic bank to have higher risk and less solvent compare to the

conventional bank. Since we practice in Loan to Deposit Ratio that Islamic bank wichare based on deposits are rising fast as the deposit compose total liabilities of banks.

For this reason the movement of Islamic bank debt to equity ratio, debt to total asset

ratio and equity multiplier is going up.

6.4. Efficiency Ratio

Asset Utilization

Graph below shows the performance and practical information on AssetUtilization of conventional and Islamic bank. Islamic bank asset utilization increased

from 3.79% in 2006 to 4.51% in 2008 and then it has decreased to 3.02% in 2010.

Asset utilization of conventional bank radical decreased from 5.34% in 2006 to

4.78% in 2009 and then it has increased to 5.41% in 2010. The trend shows that

conventional bank is doing better compared to Islamic bank and also the Asset

utilization ratio of conventional bank is higher than Islamic bank from 2006 to 2010.

The average asset utilization ratio of conventional bank is 5.19% which is higher than

the Islamic bank 3.77%. The asset utilization proves conventional bank have higher

efficiency compare to Islamic bank in generating total revenue.

Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 3.02% 3.33% 4.51% 4.21% 3.79% 3.77% 0.0062

Conventional

Bank

5.41% 4.78% 5.17% 5.23% 5.34% 5.19% 0.0025

37 | P a g e




Income to Expense Ratio

The graph below shows the performance of Income expense ratio of Islamic

bank and conventional bank. The outcome shows that the Income expense ratio is

higher for conventional bank as compared to Islamic bank during 2006-2010. IER

proves conventional bank to be more efficient compare to Islamic bank in managing

expenses. Conventional bank generate more income than the amount they spent on

expenses. But both conventional bank and Islamic bank are on decreasing trend.

Conventional bank decreased from 2.51 to 2.05 times and Islamic bank decreased from

1.75 to 1.47 times during 2006 to 2010. The average IER of conventional bank is 1.56

times lower than the conventional bank which is 1.99 times.

Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 1.75 1.72 1.37 1.50 1.47 1.56 0.0017

Conventional

Bank

2.51 1.76 1.76 1.87 2.05 1.99 0.0031

38 | P a g e




Operating Efficiency

One more method of measuring efficiency of the bank is Operating Efficiency. OE is

calculated through separating operating expense and operating revenue. The

preceding outcomes of efficiency ratios strengthens conventional bank as more

efficient than Islamic bank but OE shows it is more efficient than conventional bank.

There is a huge difference in OE performance of Islamic and conventional bank. OE

of Islamic bank slightly decreased from 77.85% in 2006 to 77.83% in 2010 whereas

OE of conventional bank is decreased from 56.84% in 2006 then the efficiency

increased in 2007-2008 but in 2009 to 2010 OE decreased to 53.09%. Islamic bank is

considerably getting better in their performance in managing the operations as it has

higher operating efficiency compare to conventional bank.

The average OE ratio of Islamic bank is 77.83% which is higher than the

56.29% OE ratio of conventional bank.

Bank 2006 2007 2008 2009 2010 Mean S.D

Islamic Bank 77.85

%

84.97

%

74.09

%

69.67

%

82.55% 77.83

%

0.06201

Conventional Bank

56.84%

57.80%

59.31%

54.40%

53.09%

56.29% 0.02525

As a whole analysis of efficiency ratios shows Islamic bank to have less

efficiency than conventional bank in AU and IER, but at the same time Islamic bank

more efficient than conventional bank in Operating efficiency ratio. On the other

39 | P a g e




hand Islamic bank is getting better significantly in these efficiencies.

Chapter:-7

Conclusion

Considerations of the findings lead to certain conclusions. Firstly, the finding

of profitability measures shows that Islamic bank is less profitable compare to

conventional bank in ROA (Return on Asset), ROE (Return on Equity), PER (Profit

Expense Ratio). Though, Islamic bank has a little difference in profitability measures

with conventional bank. More findings exposes that the trend of Islamic bank is rising

upwards close to conventional bank in ROA and ROE. In the future it is expected that

Islamic bank can overtake the conventional bank as the trend of ROA and ROE is

slightly below. As a whole the trend of Return on Asset of Islamic bank is upwards in

2010 it has dropped in 2007-2008 significantly in arrears of profitability. The trend of

ROE of Islamic bank rose at the same time ROE of conventional bank decreased

40 | P a g e




during the year 2006 to 2010 and this is because of the difference in equity stand of

the bank as the equity of Islamic bank is increasing. Islamic bank creates more profits

than equity so this is effecting in increase of Return on Equity’s growth, while at the

same time it is reverse with the conventional bank ROE which leads to the decrease in

Return on Equity of conventional bank. The profit expense ratio of conventional bank

decreasing from 2006 to 2010 but it is still slightly rising upwards. Whereas as the

findings for Profit Expense Ratio of Islamic bank is not as much of conventional bank

Profit Expense Ratio but it is increasing more than conventional bank. After the huge

increase in trend of ROE of Islamic bank, the ratio is still bellow the conventional

bank.

Liquidity measures findings of both Islamic bank and conventional bank

shows the results in the form of LAR and LDR as the Liquidity of Islamic bank does

not have much difference with the conventional bank. But on the other hand CPIDBR

of the conventional bank initiate to have more liquidity compared with Islamic bank.

The analysis also reveals that Loan to Deposit Ratio of conventional bank is declining

to some extent but it is still stable where as the Loan to Deposit Ratio of Islamic bank

is decreasing more. The higher decrease in trend of Islamic bank is due to the increase

in deposit base system and this decline is measured as a help full and excellent

symbol for Islamic bank, as Islamic bank is creating ways in the world. Furthermore

there is an increase in the expectation and self-belief of the individuals in Islamic

bank with in the course of time and also the expression of people is positive in view

of Islamic financial products as feasible financial option. More findings of Loan to

Asset Ratio show Murabaha as the well known and largely used method of financing

along with Export Refinancing under Islamic Scheme, Ijara and Dimishing

Musharaka correspondingly.

After initiating Islamic bank as not as much profitable with the conventional

bank, we expect about the risk and solvency as per the vital rule of finance “The risk

will be higher when there is higher expected return”. The analysis of Risk and

Solvency completely in format of risk return profile and allocate us in bringing to a

close that Islamic bank is less profitable, less risky and more solvent compare to

conventional bank. The findings measures of risk and solvency DER, EM and

DTAR, shows that Conventional bank is less solvent and have higher risk than

Islamic bank. We practice in the loan to deposit that Islamic banks deposit stand

41 | P a g e




increasing largely as deposits contribute in large elements to the liability of the bank.

Debt Equity Ratio, Debt to Total Asset Ratio and Equity Multiplier of Islamic bank

is also on increasing trend. The distinction in the performance is considerable as it

suggest that Islamic bank and conventional bank do not appear in the same line of

risk. So this assures the willing investors to invest in Islamic banking as it has

feasible products at exceptional risk.

Similar to the financial ratios Conventional bank is dissimilar and more

efficient than Islamic bank in the provisions of utilizing the assets. All the efficiency

ratios, Asset Utilization and Income Expense Ratio imply that Islamic bank is less

efficient compared to conventional bank from 2006 to 2010. But in terms of Operating

Efficiency Islamic banking is performing better with the conventional bank. Islamic

banking is operating well but not generating much income and also not utilizing the

Assets.

The results of the performance evaluation of Islamic banking are different in

Pakistan as compared to the other findings occupied in several researches from

different people of different countries. For instance, Samad and Hassan (2000)

exposed that Bank Islam Malaysia Berhad (BIMB) is less profitable, comparatively

more solvent and less risky evaluate to the conventional banks in Malaysia. Kader and

Asarpota (2007) initiate that Islamic bank in UAE have higher profits, more efficient,

and less risky, less liquidity with that of conventional banks of UAE. Abdus Samad

(2004) performed a comparative study on the performances of Islamic bank and the

commercial conventional bank of Bahrain and come to a conclusion that the difference

exist in credit risk among the two banks. But did not originate any dissimilarity in

liquidity and profitability performance of both conventional banks and Islamic banks.

This dissimilarity in outcomes is highly appropriate to the reality that

these countries have longer history of Islamic banking compare to Pakistan as Islamic

banking started several years before. Furthermore, there is a longer history, huge

practice of learning from the financial markets method, deeper roots and more shares

in financial sector for conventional banks of Pakistan. Taking into consideration of the

facts we are not surprised by the results of our findings. Nevertheless Islamic banking

in Pakistan is on the road to recovery and rising. In the future it is expected that

Islamic banking sector in Pakistan to perform better or balanced with the conventional

bank.

42 | P a g e




Ultimately, as the time goes on and when there are more number of Islamic

banks to revise with having lengthy period then the comparable research will give

good and clear sketch on the comparative performance of evaluation and also gives

better proves on performance either side of the banks.

Chapter:-8

References

Aggarwal, Rajesh K. And Tarik Yousef (2000) “Islamic Banking and InvestmentFinancing” Journal of Money, Credit and Banking. Volume 32, Number 1, February2000, pp. 93-107.

Arif, Mohamed (1988), “Islamic Banking.” AsianPacific Economic Literature, Vol. 2, No. 2, pp.46-62.

Bashir, A. (2000), ‘Assessing the Performance of Islamic Banks: Some Evidence fromthe Middle East’, Paper Presented at the ERF 8th meeting in Jordan.

Chapra, M. Umar (1996), Islam and Economic Development, The International

Institute of Islamic Thought and Islamic Research Institute.

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Dar, H., 2003, Handbook of International Banking Edward Elgar, chap. 8.

Dar, H., and J. Presley, 2000, “Lack of Profit Loss Sharing in Islamic Banking:Management and Control Imbalances,” International Journal of Islamic FinancialServices, 2.

Hardy, D., 2005. Financial sector liberalization, bank privatization, and efficiency:Evidence from Pakistan. Journal of Banking and Finance 29(8- 9), 2381-2406.

Hassan, Kabir and Bashir, M. Abdel-Hameed (2003), “Determinants of IslamicBanking Profitability”, Proceedings of the ERF 10th Annual Conference, Marrakesh,Morocco, 16-18 December, 2003.

Ishrat Hussain (2005), “Banking Sector Reforms in Pakistan”: Blue Chip – TheBusiness People’s Magazine, January 2005.

Kader, J. M., Asarpota, A. J. & Al-Maghaireh, A. (2007). Comparative FinancialPerformance of Islamic Banks vis-à-vis Conventional Banks in the UAE. Proceedingon Annual Student Research Symposium and the Chancellor’s UndergraduateResearch Award.

Karsten, I., 1982. 'Islam and financial intermediation', IMF Staff Papers, March,29(1):10842.

Khan, M. S.,1986. 'Islamic interestfree banking', I M F Staff Papers, March, 33(1):127.

Khan, M. S., 1987 'Principles of monetary policy in an Islamic framework', paper presented to the International Institute of Islamic Economics, Islamabad, Pakistan,July.

KHURSHID AHMAD, (1981)., Studies in Islamic Economics, Published for theInternational Center for Research in Islamic Economics, King Abdulaziz University,Jeddah (Leicester: The Islamic Foundation, 1981). pp. 413.

Kamal Naser, Luiz Moutinho, (1997) "Strategic marketing management: the case of

Islamic banks", International Journal of Bank Marketing, Vol. 15 Iss: 6, pp.187 – 203

Meinster, David and Elyasian, Elyas (1994), “An Empirical test of Test of

Association between Production and Financial Performance: The case of

Commercial banking industry.” Applied Financial Economics, Vol.4, pp. 55-59.

Muhammad Taqi Usmani (1998), “An Introduction to Islamic Finance.”

Idaratul Ma'arif, 1st addition, Karachi, Pakistan

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Mastura, Michael O., 1988. 'Islamic banking: the Philippine experience', in M. Ariff (ed.), above.

M.A. El-Gamal (2006),” Overview of Islamic Finance” Occ. Paper No.4, Aug. 2006.Ross, S. A., Westerfield, R. W, Jaffe, J. (2005), “Corporate Finance.” McGraw-Hill

Inc., 7th Ed.

Ross, S. A., Westerfield, R. W, Jaffe, J. (2005), “Corporate Finance.” McGraw-Hill

Inc., 7th Ed.

Sabi, M. (1996) Comparative Analysis of Foreign and Domestic Bank Operationsin Hungary, Journal of Comparative Economics 22, 179 - 188.

Saiful Azhar Rosly, Mohd Afandi Abu Bakar, (2003) "Performance of Islamic andmainstream banks in Malaysia", International Journal of Social Economics, Vol. 30Iss: 12, pp.1249 – 1265

Saleh, Ali Salman and Zeitun, Rami. 2006. “Islamic Banking Performance in theMiddle East: A Case Study of Jordan”, Economics Working Paper Series: Universityof. Wollongong 06-21.

Samad, Abdus 2004. “Performance of Interest Free Islamic Banks vis-à-vis Interest-Based Conventional Banks of Bahrain” IIUM Journal of Economics and Management,Vol: 12, No:2, pp.1-15.

Samad, A., and M. K. Hassan, 1999, “The Performance of Malaysian Islamic Bank During 1984-1997: An Exploratory Study,” International Journal of Islamic FinancialServices, 1.

Sarkar, M. A. A. (1999). Islamic banking in Bangladesh: Performance, problems & prospects. International Journal of Islamic Financial Services, 1(3).

Shamshad Akhter, (2007), “Pakistan Banking Sector Reforms: Performance andChallenges”, Speech delivered by Dr. Shamshad Akhtar Governor State Bank of

Pakistan, Geneva, 1 February 2007.

Siddiqi, M.N. 1988 “Islamic Banking: Theory and Practice”. In Ariff, M. Ed.Monetary and Fiscal Economics of Islam, Jeddah: International Centre for Research inIslamic Economics.

Samad, Abdus, and Kabir Hassan (2000), “The Performance of Malaysian Islamic

Bank During 1984-1997: An Exploratory Study.” Thoughts on Economics 10, no. 1 &

2: 7-26.

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Spindler, Andrew et. Al (1991). "The Performance of Internationally Active Banksand Securities Firms based on conventional measure of competitiveness, In FederalReserve Bank, NY.

Salman, Syed Ali (2004), “Islamic Modes of Finance and Associated Liquidity

Risks.” Paper prepared for Conference on Monetary Sector in Iran: Strtucture,

Performance and Challenging Issues, Tehran.

Sufian Fadzlan, (2007), “THE EFFICIENCY OF ISLAMIC BANKING INDUSTRY:A NON-PARAMETRIC ANALYSIS WITH NON-DISCRETIONARY INPUTVARIABLE”, Islamic Economic Studies, Vol. 14, No. 1 & 2, Aug. 2006 & Jan. 2007

Suleman, M. Nasser. “Corporate Governance in Islamic Banks,” Society and Economyin Central and Eastern Europe, Quarterly Journal of Budapest University of Economic

Sciences and Public Administration XXII(3), 2001.

Van Horne, James and Wachowicz, John (2005), “Fundamentals of Financial

Management.” Pearson Education Limited, 12th

Ed.

Yudistira, Donsyah (2003), “Efficiency of Islamic Banks: an Empirical Analysis of

18 Banks,” Finance No. 0406007, EconWPA.

8.1 Websites:

www.bankalhabib.com

www.meezanbank.com

www.sbp.org.

www.albaraka.com.

www.bankislami.com.pk

www.dibpak.com

www.egibl.com

www.dawoodislamic.com

www.askaribank.com.pk

www.bankalfalah.com

www.faysalbank.com

www.soneri.com

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www.sbp.org.pk

47 | P a g e




Chapter:-9

Appendix- A

Islamic Method of Financing

The ideology of Islamic banking which hold the behaviour and the transactions

of commercial nature date back to the historic time of origination of Islam in Arabia.

There was a concerted effort by the Islamic Teachers who made all the hard work

which resulted in creation of mode of finance. The foremost thing is to discourage the

Riba among the rules (Aggarwal & Yusuf, 2000).

Islamic banking and their operating subsidiaries have devised a new instrumentthat is interest free. The main basic ways of financing which are in consent with the

Islamic rules and conditions and also apply to financial conditions are Mishawaka,

Salam, Artisan, Ijara, Murabaha, Mudarabah.

These types of Instruments are used on the base of principals are Sharing Profit and

Loss and The Mark UP Principle.

The Islamic Institutions stand Musharaka and Mudarabah are depending on Profit

Loss Sharing rule and Murabaha, Salam, Istisna and Ijara is on the Mark-up principle

(Aggarwal & Yousaf, 2000). Dar (2003) divides the types of financing into:

Investment based, Sale based, Service based, Rent based.

1. Sharing Profit and Loss

The Islamic Banks have to run without earning any interest and therefore one

needs to understand the difference between the rate of interest and return. Rate of

interest is not allowed in Islam however Islam encourages the trade. In the interest free

system the subjects are able to earn the money on their investment only when they are

ready for sharing the risk involved for getting the profit. Banks have to operate on this

principle of sharing profit and loss and other satisfactory forms of business (Suleiman

2001).In the books on Islamic literature of the economics the PLS principle is granted

on the basis of the financial transactions.

48 | P a g e




The bank is involved in both the profit and loss sharing and therefore takes the risk

on its investment (Aggarwal & Yousuf, 2000). The following transactions are used by

the bank on the PLS principles that is Musharka (Joint Venture) and Mudarabah

a. Musharka (Joint Venture):

The most wanted form of investing under the rules of Shariah is Musharka as it is

satisfying the criteria’s of shariah in the absence of interest as it involves risk, loss

bearing and interest free and also links the capital investment to the assets under the

transactions.

Musharaka is a kind of joint partnership where the loss and the share of the profit

are taken by both the partners and also the investment returns are also shared. The

sharing of returns is done on basis of their proportional investment. Musharka is

similar in principles of Western style of investments that talk of equal shareholding

rights and partnership in the company (Aggarwal &Yousuf, 2000). The bank can

supervise the implementation of the project (Naser). The promoter keeps on returning

the loan to the bank as and when the promoter receives the cash flows from the

projects.

b. Mudarabah

This method of financing holds almost the same level of importance as Musharaka.

In this method of financing one partner gives the amount to the other partner for

investing in the commercial organization. The investment is done by the first partner

who is named as “Rabb-ul-mal” and the management of the firm is done by the other

partner who is called Mudarib (Mufti Muhammad Taqi Usmani, 1998).

Mudarabah I also known as the contract of two parties in which there is one

financer and the other looks after the management and profits of the company. The

financer of the company holds the right to attend the board meetings and also

participate in the decisions of the company (Rajesh and Tarik, 2000).

The Profit sharing of the partners is decide at start of the venture, it can be taken as

an example where the financer gets the 60% share in the profits and 40% of the profits

are taken by the mangers. In case of negative returns banks don’t earn anything and

the entrepreneurs have remuneration for his efforts (Aggarwal & Yousuf 2000). The

49 | P a g e




set up treats the capital in equal proportion with the human capital (Suleiman 2001).

Musharka and Mudarabah are in sense equity investments. The latter is akin to

partnership structure and latter with the equity structure (Aggarwal & Yousuf, 2000).

2. Mark-Up Principle:

The principles of this kind of investing can be seen in commercial investments.

The banks here take a share in the profits in lieu of capital financing of the assets

required by the company (Aggarwal & Yousuf, 2000). The instruments following this

principle include, Murabaha, Salam, Istisna, Ijarah.

1. Murabaha

This kind of investment is a unparticipatory way of Islamic Financing and here

the bank is in selling of the investment needed by the customer and this is done on the

behalf of the Entrepreneur and may also seal to the promoter at a price previously

fixed and the profit which was already negotiated (Aggarwal & Yousuf, 2000). The

bank first purchases the asset which is therefore involved in sharing the profits and

also the loss is shared by the banks.

The Payment of the banks is also decide upon the start of the project andtherefore the promoter also gives the bank instalments or does the payment in lump

sum which is also known as Mujjal. The agreement is bound on the two parties

concerned even if the client fails to give the sum (Aggarwal & Yousuf, 2000).

2. Salam

This is the kind of payment where advance is given and the release of the

payment is delayed (Salman 2004). The expenses are done by the vendor in lieu of

goods that are to be given to the buyers at a future date (source, Bank Alfalah). The

commodity becomes the property of the bank at the pre decided date and this is done

only after the payment of Salam and gives the price. The shariah rules forbid the bank

to sell any of its holdings as they have been banned in the rules of Islam and therefore

the bank cannot exit salaam contract. Therefore there is no secondary market for such

contracts. The market is therefore primary with the entrepreneurs and the banks

forming the two parties of the contract.

50 | P a g e




3. Ijara and Ijara Wa- Iqtina (Islamic Leasing)

Ijara is the Islamic way of leasing of assets, in this case it is the banks which

have to lend the assets or there can be case where the banks also get the assets on lease

from a party (Salman, 2004). In the standard hire agreement the client’s rents out the

car, property or any other form of real asset. The client is involved in the periodical

rent for the asset to be used. The rental payment can be fixed or the floating way of

payment. The client gives the rental to the institution and the changes to be made in

agreement about the payment of the rental have to be done with mutual consent (Bank

Alfalah).

The Ijara contract has some aspects in common with the western form of

leasing in which bank is the lessor and the entrepreneur is the lessee. The Islamic Bank

under the contract has to lease an asset which is under the agreement and the payment

schedule is already decided by the parties. The responsibility of supervision and its

maintaining part is done by the lessor.

Ijara Wa Iqtina is almost on the same line as the western part of investments on

the capital or the financing lease. The Islamic Bank which has to operate under the

Islamic Law under Ijara Wa Iqtina contract buys the financial Asset as the building,machinery and may be it can purchase the entire project and then it leases it to the

concerned entrepreneur which can be done for the limited period or as the case may

be. The client can also pay periodical rentals for the asset purchase (Salman, 2004).

This contract can be seen in same vein as Ijara although it has an option of the

ownership of the financial object at the ending of the contract period. Therefore to

avoid any kind of conflicting views things have to agree at the starting itself.

51 | P a g e




APPENDIX – B

Introduction of Meezan Bank Limited

MBL is stock market listed corporation and it was started in the year 1997 on

27th of January and also started functioning as investment bank in August month of the

same year. Meezan bank was also granted the banking license of commercial

undertaking and as an Islamic Bank by the State Bank of Pakistan.

Meezan Bank is currently established as largest Islamic Bank in Pakistan with

the branch network being one of the largest in the sector. The standard development in

the deposits is around 60% per year and through this time the number of the branches

rose to 100. The bank can boast of a reliable and capable team of the Investment

bankers and also has as strong balance sheet with the operational efficiency and profits

being one of the best in the sector.

The Bank has been assigned rating of A+ and for term purposes it is around A-

1. The main shareholders of the bank include Noor Financial Investment Company

which is an AAA rated company in the country, Shamil Bank of Bahrain which is one

of leading bank in Bahrain and the Developmental Bank of Jeddah. The international

reputation and the sound fundamentals of the bank ass to the value of the bank and

also helps the bank in achieving its objectives.

The bank has an able leader in the form of (Retd.) Justice Maulana-Taqi-

Usmani, who is an acclaimed finance specialist in the international finance arena and

one who is known for his high caliber. He is currently the deputy chairman of Islamic

Fiqh Academy, Jeddah and he also served as the Judge in the sharia Appellate bench at

the apex court in Pakistan. The board of Directors has Dr. Imran Usmani who is also a

Shariat advisor of the bank. The functions of Mr. Imran’s department includes that the

transaction of the bank are carried out as per the Islamic Laws and in fair manner.

The objectives of the Meezan bank include that they also have to find the

common functionalities with the conventional Banking system. The Meezan bank has

developed an excellent research and development capability in combination with the

investment bankers and commercial bankers, shariah scholars an legal experts to who

52 | P a g e




can create the new, affordable and competitive features that c meet the complex

financial requirements of the financial world and also provides service that are of

World Standards and also the demand of the customers are given top priority.

The technological advancement of the Meezan Bank can also be seen from the

strong IT department and has strong technology systems. The corporate and the

investment banking divisions are having good infrastructure and the client relationship

are given high importance and also the complaint financing solutions would be done

through the structured financing way.

53 | P a g e




Appendix:-3

Data collection for findings from Meezan bank

MeezanBank

(RUPEESINMILLIONS)

2010 2009 2008 2007 2006

net profit after tax/ (NI) 1649 1025 621 963 604

total assets 1547521241

69 852766717

94643

9

shareholders’ equity 10740 9091 6341 5720 4763

profit before tax 2126 1740 992 1269 780

operating expenses 4536 3458 2713 1765 1028

loan 647067639

5 578764342

63073

1

deposit 1310701003

33 702345458

23444

9

cash & portfolioinvestment 67746

31677 20049

16179 8774

total debt 1463831152

90 794536171

34170

5

total revenue 5867 5223 3844 2235 1404

total income 6662 5198 3705 3033 1807

noninterest expenses 4843 3639 2848 1899 1093

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Appendix:-4

Data collection for findings from Habib bank

HabibBank

(RUPEESINMILLIONS)

2010 2009 2008 2007 2006

net profit after tax/(NI) 156131229

8 10000 80411427

6

total assets

88705

2

8211

27 717302

6558

38

5629

15

shareholders’ equity 895247909

5 650445794

35311

1

profit before tax 250571948

5 158551312

72050

2

operating expenses 239222250

7 208201716

41476

6

loan46533

74376

35 4419013638

883425

35

deposit72106

96534

52 5723995089

864397

24

cash & portfolioinvestment

326532

288948 184145

227293

165372

total debt82844

87794

08 6834986287

545401

68

total revenue 473384293

4 371183132

73048

1

total income 489794199

3 366753029

13699

2

noninterest expenses 251312335

8 220131810

61732

6

55 | P a g e




Appendix:-5

Data Analysis

2010 2009 2008 2007 2006 Mean S.D

Return onAsset

Meezan Bank

1.07%

0.83%

0.73%

1.43%

1.30%

1.07%

0.0029819

HabibBank

1.76%

1.49%

1.39%

1.23%

2.54%

1.68%

0.0051688

Return onEquity

Meezan Bank

15.35%

11.27%

9.79%

16.84%

12.68%

13.19%

0.0289372

HabibBank

17.44%

15.55%

15.37%

13.88%

26.88%

17.82%

0.0521792

Profit toExpenseRatio

Meezan Bank

0.47%

0.50%

0.37%

0.72%

0.76%

0.56%

0.0016959

HabibBank

1.05%

0.87%

0.76%

0.76%

1.39%

0.97%

0.0026339

Loan toDeposit Ratio

Meezan Bank

41.35%

41.57%

56.62%

63.35%

78.47%

56.27%

0.1566673

HabibBank

64.53%

66.97%

77.20%

71.49%

77.90%

71.62%

0.059683

(CPIDR)Meezan Bank

51.69%

31.57%

28.55%

29.64%

25.46%

33.38%

0.1047109

HabibBank

45.28%

44.22%

32.17%

44.66%

37.61%

40.79%

0.0572972

Loan toAsset Ratio

Meezan Bank

41.81%

61.53%

67.87%

64.64%

66.17%

60.40%

0.1065289

HabibBank

52.46%

53.30%

61.61%

55.48%

60.85%

56.74%

0.042529

Debt-Equity

Ratio

Meeza

n Bank

13.63

%

12.68

%

12.5

3%

10.7

9%

8.76

%

11.68

%

0.0192

636Habib 9.25 9.85 10.5 9.67 10.1 9.89 0.0048

56 | P a g e




Bank % % 1% % 7% % 021

Debt to TotalAsset Ratio

Meezan Bank

94.59%

92.85%

93.17%

91.86%

89.81%

92.46%

0.017731

Habib

Bank

93.39

%

94.92

%

95.2

9%

95.8

7%

95.9

6%

95.09

%

0.0103

973

EquityMultiplier

Meezan Bank

14.41%

13.66%

13.49%

11.74%

9.75%

12.61%

0.0187439

HabibBank

9.91%

10.38%

11.03%

11.32%

10.60%

10.65%

0.0055143

AssetUtilization

Meezan Bank

3.79%

4.21%

4.51%

3.33%

3.02%

3.77%

0.006119

HabibBank

5.34%

5.23%

5.17%

4.78%

5.41%

5.19%

0.0024542

OperatingEfficiency

Meezan Bank

82.55%

69.67%

74.09%

84.97%

77.85%

77.83%

0.0620144

HabibBank

53.09%

54.40%

59.31%

57.80%

56.84%

56.29%

0.0252562

IncomeExpenseRatio

Meezan Bank

1.47%

1.50%

1.37%

1.72%

1.75%

1.56%

0.0016544

HabibBank

2.05%

1.87%

1.76%

1.76%

2.51%

1.99%

0.0031393

Documents

Comparison of Islamic and Conventional Banks