ijcrb.webs.com S 2012 I J O C R I BUSINESS VOL O 5 · banking sector in Pakistan from year 2007-2011. The Islamic banking in Pakistan is new as compared to the conventional banking

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Financial Performance Analysis of Islamic Banks and Conventional Banks in Pakistan:

A Comparative Study

Saba Sehrish (Corresponding author)

Lecturer - Department of Management Sciences, University of Wah

The Mall, Quaid Avenue, Wah Cantt (47040) – Pakistan

Faiza Saleem


The Mall, Quaid Avenue, Wah Cantt (47040) - Pakistan

Muhammad Yasir

Lecturer - Department of Management Sciences

COMSATS Institute of Information Technology

Near Officers Colony, Kamra Road, Attock (43600) – Pakistan

Farhan Shehzad

Independent Researcher – Pakistan

Kamran Ahmed


The Mall, Quaid Avenue, Wah Cantt (47040) – Pakistan

Abstract

The aim of this research work is to compare the financial performance of Islamic banking sector and conventional

banking sector in Pakistan from year 2007-2011. The Islamic banking in Pakistan is new as compared to the

conventional banking. Therefore, to give a clear picture of Islamic banks to the stakeholders, the financial position

of Islamic banks has been analyzed and compared with that of well established conventional banks in Pakistan. To

measure Performance, six ratios are developed. Financial ratio analysis has been conducted to test the ratios of eight

sample banks. The results show that Islamic banks are less risky in terms of dealing in loans and less efficient in

expense management as compared to the conventional banks. Whereas, no significant difference has been found in

the profitability of both the banking sectors. Overall, Islamic banks’ performance has found satisfactory.

Keywords: Islamic Banks, Conventional Banks, Profitability, Efficiency, Credit Risk, Pakistan.

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1. Introduction

Banks are financial institutions which play an important role in the development of an economy. Banks are very old

entities; though they existed differently in ancient times, but the industrial revolution in last two centuries has

brought major reforms and formalization in the operations of banking sector. In this technological era, the modern

banking incorporates many new products and services to facilitate a smooth flow of funds in the economy. The

evaluation of bank performance is very useful for decision making, whether they are investors, savers, borrowers or

policy makers.

Banking sector in Pakistan has witnessed drastic changes since 1947. Initially, due to political influence and poor

quality of products and services, this sector faced shortage of financial resources. But with liberalization,

privatization and structural reforms in banking sector, this industry has expanded tremendously. Banking industry in

Pakistan has shown an unprecedented growth as the best performing sector having banking assets of more than $60

billions. In Pakistan, banks are exposed to a high competition regarding service quality to have satisfied customers

and long term benefits.

In the existence of highly competitive conventional banks, Islamic banking got popularity in 1970s with the

operations entirely based on the principles of Shariah. The main objective of Islamic Banking is to develop an

environment of interest (Riba) free financing. The reason of interest free financing is to eliminate the fixed return on

capital. Islamic Shariah prohibits the effort less and risk free transactions. In this regard, Islamic banking offers

different products on the basis of profit and loss sharing principle of Shariah. Islamic modes of finance are used for

leasing and other financial contracts. Islamic banks are mainly concerned to eradicate Interest based financing by

promoting risk sharing practices for the welfare of economy. It is clear that when bank is able to receive stream of

Halal Income, the depositors of the banks ultimately receive the stable and Halal Income (Ashraf and Rehman,

2011). The Shariah principles of Islamic banking and finance do not only focus on Islamic banking system but they

also provide guidance for the operations of financial instruments, intermediaries and markets.

Islamic banking is very nascent sector, while the conventional or Riba based banking is centuries old. But Islamic

banking system has gained popularity so fast that there are more than 300 Islamic financial institutions all over the

world with investment funds in excess of $400 billion (El-Qorchi, 2005). UK, France, China, Singapore and many

other countries have developed special regulatory to facilitate the working of Islamic banking. The market share of

Islamic Banks has grown from around two percent in the 1970s to around fifteen percent in the 1990s (Aggarwal

and Yousef, 2000). The growth of Islamic banking in short period of time has surprised everyone including western

financial experts and analysts. Islamic banking in the modern world focuses on developing and expanding the

application of Islamic principles and laws in financial, banking and related business affairs. By doing this, Islamic

banks can protect the Islamic communities and societies from activities that are forbidden in Islam (Tahir, 2003).

In Pakistan, the serious efforts regarding establishment of Islamic banking system were made in January 2000 when

State Bank of Pakistan (SBP) constituted a Commission for Transformation of Financial System (CTFS) to

introduce Shariah compliant modes of financing, and on September 15, 2003, the State Bank of Pakistan (SBP)

established the Islamic Banking Department. In January 2002, a real boost to Islamic banking system in Pakistan

was given through the establishment of Meezan Bank Limited as a first ever full fledged Islamic Bank. Moreover, a

large number of conventional banks that are operating in Pakistan have established Stand Alone Islamic banking

branches in Pakistan. Total six Islamic banks are operating currently in Pakistan. Islamic banking institutions

represent 7.3% of banking industry and their share of deposit is 7.6% and the share in net financing investment is

7.0% of banking industry of Pakistan as on June, 2011 (Saeed, 2011). Hence, Islamic banking is now playing a vital

role in financing and contributing to different economic and social sectors of Pakistan.

Conventional banking sector is dominating banking sector of Pakistan because of the early mover advantage it

gained over the Islamic banking sector. According to KPMG Banking Survey of 2011, majority of Islamic banks in

Pakistan lie in the category of small size banks on the basis of profitability, assets, size, operating costs and deposits.

One of the reasons of this small size is that these Islamic banks are new as compared to conventional banks in

Pakistan. Secondly, when Islamic banking system was introduced in Pakistan, the conventional banks had already

captured a major portion of the market share and gave a strong competition to newly introduced Islamic Banks.

However, it is an undeniable fact that there is a massive demand for Islamic financial products and services and the

growth in Islamic banking in Pakistan is also admirable. On the other hand, commercial banks in Pakistan are now

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facing problems because of the intense competition and the issue of NPL (Non Performing Loans). The amount

reached Rs. 588 billion till the first quarter of 2011 (Source: Express Tribune).

There are various studies in the existing literature that have been carried for measuring performance of Islamic

banks (see for example: Samad & Hassan, 2000; Hassan & Bashir, 2003; Rosly et al., 2003; Samad, 2004 and Saleh

& Rami, 2006). But to the best of our knowledge there is no detailed recent study that carries comparative analysis

of financial performance of Islamic banks and conventional banks in Pakistan.

The objective of this study is to compare the financial performance of Islamic banks with the conventional banks for

the time period of five years i.e. 2007-2011. The results of this research work will answer the question that whether

Islamic banking sector’s performance outflanks conventional banking sector or not? The rest of the paper is

structured as follows: Review of studies is briefly discussed in section 2, section 3 comprises of methodology,

comparative analysis and discussion of results have been included in section 4, section 5 carries conclusion, while

references are placed in section 6.

2. Literature Review

Akkas (1996) compared the efficiency of Islamic banking with conventional banking in Bangladesh. He found that

the Islamic banks are comparatively more efficient than conventional banks. Samad (1999) analyzed the efficiency

ratio of one Islamic bank from 1992-1996, and compared it with the conventional banks of Malaysia and found that

Bank Islamic Malaysia Berhad operated more efficiently compared to the its rivals in the conventional baking

sector, which implied that in Malaysia Islamic banks were utilizing their funds in a better way as compared to

conventional banking sector.

Samad and Hassan (2000) analyzed the performance in terms of profitability, liquidity, risk and solvency, and

community involvement of a Malaysian bank, Bank Islamic Malaysia Berhad, for the period 1984-1997. The

findings described that the bank was a liquid bank and it was supposed not to have any liquidity issues i.e. the

liquidity shortage. The study established that Bank Islamic Malaysia Berhad was comparatively less risky, less

profitable and more solvent as compared to conventional banks.

Iqbal (2001) analyzed the performance of Islamic banks and conventional banks by comparing both types of 12

banks of same size during 1990-1998. Profitability, liquidity, risk, capital adequacy and deployment efficiency were

also studied. This work concluded that Islamic banks performed very well as compared to conventional banks in

almost all years. Moreover, the study explained that Islamic banks are more cost effective and profitable than their

Conventional counterparts.

Hassoune (2002) found in his research that Islamic banks were undoubtedly more profitable than conventional

banks, but the low levels of efficiency and liquidity were employing more risk to them. Hassan and Bashir (2003)

examined the factors that affect the performance of bank. They utilized cross-country bank level data on Islamic

banks in 21 countries over the period of 1994-2001. According to the findings, the profitability of Islamic banks was

positively influenced by high capital and loan-to-asset ratios, favorable macroeconomic conditions.

Yudistira (2003) empirically analyzed efficiency and performance of 18 Islamic banks over the period 1997-2000.

The overall efficiency results indicated that the inefficiency level across 18 Islamic banks was just above 10% and

this ratio was considerably low as compared to the conventional banking sector. The study explained that Islamic

banks were well performing banks as compared to the conventional banks.

Samad (2004) examined the comparative performance of interest-free Islamic banks and the interest-based

conventional banks in Bahrain during the post Gulf War period 1991-2001. Profitability, liquidity and credit risk

ratios were analyzed to measure the performance. The performance comparison of Bahrain’s conventional banks

with Islamic banks established that there was a significant difference in credit performance between the two sectors.

However, no difference in the profitability and liquidity performances of both banking segments was found.

Saleh and Rami (2006) drew a performance comparison for the Islamic banks in Jordon. They took a sample of two

Islamic banks to evaluate the performance in terms of profitability, capital structure and liquidity. The results of the

financial ratio analysis suggested that there had been an increase in the efficiency of both banks and both the banks

had focused on their short term investments. Both the banks experienced an increase in profitability.

Kader and Asarpota (2007) applied financial ratios to three Islamic banks and five conventional banks in UAE for

the time period 2000 to 2004 to get the glimpse of both the sectors’ performance. These financial ratios covered the

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profitability, liquidity, risk and solvency, and efficiency. The results implicated that the Islamic banks of UAE were

more profitable, more efficient, less liquid and less risky. Sufian (2007) analyzed the efficiency of domestic and

foreign Islamic banking operations in Malaysia for 2001-2004. The study had shown that profitability was

significantly and positively correlated to all efficiency measures. So this could be said that profitability depends on

efficiency.

Johnes et al. (2008) used six financial ratios to measure the efficiency of Islamic and conventional banks. The results

suggested that Islamic banks are less cost effective while more profit and revenue effective as compared to

conventional banks. On the other hand, using Data Envelopment Analysis (DEA), they found that total efficiency in

conventional banks is significantly higher than Islamic banks.

The performance of first Islamic bank in Pakistan was compared with a group of 5 conventional banks for a period

of 2003-2007. The study evaluated the performance in terms of profitability, liquidity, risk, and efficiency. The

study found that the selected Islamic bank is less profitable, less risky and also less efficient comparing to the

average of the 5 Conventional banks (Moin, 2008).

Islamic banks are performing far better than the conventional banks in Pakistan. The Islamic banks have been less

volatile when it comes to profits as compared to conventional banks (Awan, 2009). Ansari and Rehman (2011)

concluded that Islamic banking in Pakistan was performing better than the conventional banking. When the deposits

and expenses of Islamic banks were inflated, they gave boom to the profit generation capacity. Jaffar and Manarvi

(2011) selected a sample of five Islamic and five conventional banks of Pakistan to measure the performance. They

applied CAMEL methodology to test the performance. The study found that Islamic banks performed better than

conventional bank in terms of adequate capital, while conventional banks excelled in terms of management quality

and earning ability.

3. Methodology

3.1 Performance Measures

In this study, a comparative analysis of financial performance of Islamic banks and conventional banks in Pakistan

has been conducted. Generally, financial ratio analysis has been applied to measure the performance of a bank (see

for example: Spindler, 1991; Akkas, 1994; Putnam, 1983; Sabi, 1996; and Samad & Hassan, 2000). Performance, in

this research work, has been measured by six financial ratios. These ratios have been classified into three groups, (i)

profitability ratios, (ii) efficiency ratios and (iii) credit risk ratios for the Islamic and conventional banks in Pakistan

during 2007-2011.

3.1. 1 Profitability Ratios

As profit of a firm is the amount by which its revenues are more than the cost, therefore, profitability is taken as an

important yet the most difficult element of a firm to evaluate and conceptualize (Ross et al., 2005). Profitability

ratios depict the ability of a firm to generate earnings that are higher as compared to all the costs and expenses of the

firm. Therefore, if a profitability ratio is relatively higher as compared to the previous year’s ratio, industry averages

or competitors’ same ratio, then it is taken as indicator of better performance of the bank. In our study, the

profitability of the two sectors is measured through: Return on assets (ROA) and Return on Deposits (ROD).

3.1.1.1 Return on asset (ROA)

Golin (2001) concludes that ROA is the key measure of profitability for banks. It measures how much the bank is

earning after tax for each dollar invested in the assets of the bank. ROA shows how a bank can convert its asset into

net earnings (Samad & Hassan, 2000). Generally, a higher ratio means that efficient management of the bank is

utilizing assets affectively. ROA is calculated as under:

ROA = Net Income after tax / Total Assets

3.1.1.2 Return on Deposit (ROD)

ROD measures the percentage return on each dollar of customer’s deposits. It indicates how effectively the

management of a bank is able to turn deposits into net earnings (Rosly and Bakar, 2003). It measures how much the

bank is earning after tax for each dollar deposited in the bank. In other words, ROD is net earnings per dollar

invested. ROD is calculated as under:

ROD = Net Income after tax / Total Deposits

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3.1.2 Efficiency Ratios

These ratios indicate the overall effectiveness of the firm in utilizing its assets to generate sales, quality of

receivables, the promptness of payment to suppliers, effectiveness of the inventory management practices, and

efficiency of firm in controlling its expenses. Higher value of these ratios is taken as good indicator (Moin, 2008).

Ratios used in our study to measure efficiency of the banks are: Asset Utilization (AU) and Operating Efficiency

(OE).

3.1.2.1 Asset Utilization (AU)

This ratio measures capability of a bank to generate revenue with its asset. The high value of this ratio indicates the

high productivity of bank’s asset (Widagdo and Ika, 2008). Like, Moin (2008) total revenue of the bank in this study

is defined as net spread before provision plus all other income. AU is calculated as under:

Asset Utilization = Total Revenues / Total Assets

3.1.2.2 Operating Efficiency (OE)

This ratio indicates how efficiently bank uses its assets, revenues and minimizing the expenses. In other words, it

shows how well bank could reduce the expenses and improves productivity (Widagdo and Ika, 2008). OE is

calculated as under:

O.E = Total Operating Expense / Total Operating Income

3.1.3 Credit Risk Ratios

These ratios are usually taken to evaluate the banks’ performance in terms of its lending activities because it is

mostly seen in case of banks that the customers get default due to failure of the businesses for which they have taken

loan from the respective banks (Sufian, 2007). Two of the financial ratios, EQL and IMGL, are used for measuring

credit risk performance of the banks in our study.

3.1.3.1 Equity to Net Loan Ratio (EQL)

It measures equity capital as a percentage of total net loans. EQL provides equity as a cushion (protection) available

to absorb loan losses of a bank. The higher the ratio of EQL, the higher is the capacity for a bank in absorbing loan

losses (Samad, 2004).

Equity to Net Loan ratio = Total Equity / Net Loans

3.1.3.2 Total Impaired Loan to Gross Loan Ratio (IMLGL)

Impaired loans or non-performing loans of a bank are the loan that is past due in six months is considered as non-

performing loans. This is one of the most important criteria to assess the quality of loans or asset of a bank. It

measures the percentage of gross loans which are doubtful in banks’ portfolio. The lower the ratio of IMLGL, the

better is the credit performance of the banks (Samad, 2004).

Total Impaired Loan to Gross Loan ratio = Impaired Loan / Gross Loan

3.2 Sample and Data

This research work makes comparison of financial performance of Islamic banks and conventional banks in

Pakistan. Currently, six Islamic banks and more than twenty five conventional banks are working in Pakistan. For

this study, a sample of four Islamic banks (Meezan Bank Limited, Bank Islami Pakistan Limited, Dubai Islamic

Bank (Pakistan) Limited and Burj Bank Limited) and four conventional banks (Standard Chartered Bank (Pakistan)

Limited, Askari Bank Limited, Silkbank Limited and The Bank of Khyber) has been selected for the time period of

5 years: 2007-2011. For measuring performance, the sample Islamic banks have been compared with the sample

conventional bank on the basis of profitability, efficiency and credit risk in each of the selected five years. The

annual financial data has been gathered from balance sheets and income statements of the sample banks.

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3.2.1 Selection Criteria

KPMG is an accounting firm and it carries financial analysis on logical basis. In KPMG Banking Survey of 2011,

commercial banks of Pakistan are classified in three categories, (i) Large size banks (ii) Medium size banks and (iii)

Small size banks on the basis of their profitability, assets, size, deposits and loans. In Pakistan, only Meezan bank is

included in Medium size banks category, while all other Islamic banks are lying in Small size banks category,

because they are new and will take time to become big banks. Therefore, to make a transparent and accurate

comparative analysis of financial performance, the sample conventional banks have also been chosen from the

categories of medium and small size banks.

4. Results and Discussion

4.1 Profitability

4.1.1 Return on Asset (ROA)

Table 4.1 shows the results of Return on Asset (%) of Islamic banks and conventional banks in Pakistan from 2007-

2011. The ROA of Islamic banks has found to be 0.05%, 0.06%, -0.42%, -0.43% and 0.39% in respective years.

Whereas, the ROA results of conventional banks are -0.60%, -0.68%, -1.30%, 0.25% and 1.02% from 2007-2011

respectively.

From the analysis of Figure 4.1, it is quite clear that from 2007 to 2009, the ROA of Islamic banks has remained

higher as compared to conventional banks, which shows that Islamic banks have managed their assets affectively to

generate profits. Although, the ROA of Islamic banks has faced a decreasing trend in year 2009 and 2010 but it has

been recovered sharply in year 2011. From year 2010, there has been an improvement in the conventional banks’

profit generation through efficient asset utilization. Overall, ROA figures of Islamic banking sector are showing a

healthy sign and further improvements in the coming years.

[Insert Table 4.1]

[Insert Figure 4.1]

4.1.2 Return on Deposit (ROD)

Table 4.2 shows the results of Return on Deposit (%) of Islamic banks and conventional banks in Pakistan from

2007-2011. The ROD of Islamic banks has found to be 0.22%, 0.10%, -0.89%, -0.66% and 0.42% in respective

years. Whereas, the ROD results of conventional banks from 2007-2011 are -0.68%, -0.94%, -1.83%, 0.39% and

1.48%.

After analyzing Figure 4.2, we come to know that ROD of both the sectors has followed the same pattern like ROA

in our selected time window. As it is shown that from 2007 to 2009, the graph of ROD of Islamic banks has

remained above the graph of conventional banks, which means that Islamic banks have invested their deposits

efficiently to generate higher profits. Moreover, both the sectors have faced a decreasing trend in ROD during year

2007-2009 but an increase has been observed from year 2010 which is continued till the last year of our study time

period. The increasing trend of ROD has proved healthy for the conventional banks as compared to Islamic banks.

Overall, the study finds some major fluctuations in ROD of conventional banks, e.g. 2009: -1.83% and 2010: 0.39%.

The ROD figures of Islamic banks have remained smooth and shown no major jumps during 2007-2011, which is a

positive indication. Moreover, ROD of Islamic banks has shown negative results in two years only, which is less as

compared to conventional banks in Pakistan.

[Insert Table 4.2]

[Insert Figure 4.2]

4.1.3 Discussion

The study concludes that Islamic banks have remained more profitable as compared to conventional banks in year

2007, 2008 and 2009, but the profitability is decreasing continuously. In year 2009, as a result of financial crisis, the

profitability performance of both the banking sectors has decreased sharply, but Islamic banks have managed to

control this decrease in profitability and their losses have remained less than the losses of conventional banks. On

the other side, conventional banks have shown a tremendous improvement in profitability in year 2010 and 2011 in

comparison with conventional banks. In year 2011, the level of profitability being achieved by conventional banks is

the highest in all 5 years. Subsequently, the study combines all the results and concludes that there is no significant

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difference in profitability performance of Islamic and conventional banks, as both of these sectors have shown

mixed results during the study time window. This result is consistent with those of Ansari and Rehman (2011),

Samad and Hassan (2000) and Samad (2004).

4.2 Efficiency

4.2.1 Asset Utilization (AU)

Table 4.3 shows the results of Asset Utilization (%) of Islamic banks and conventional banks in Pakistan from 2007-

2011. The AU of Islamic banks from year 2007-2011 is as follows: 6.14%, 10.33%, 9.32%, 9.25% and 9.91%

respectively. Whereas, the AU results of conventional banks are 10.73%, 10.25%, 9.99%, 10.41% and 10.63% in

respective years.

Figure 4.3 highlights the asset utilization comparison of Islamic and conventional banks. It is known that high value

of this ratio indicates high productivity of bank’s asset, therefore, the findings describe that in each year of the

selected time window, except year 2008, conventional banks have successfully managed their assets to generate

higher total revenues as compared to Islamic banks. Although, the Islamic banks have shown an attractive increase

in asset utilization in year 2008 (from 6.14% to 10.33%), but this increase is less than the maximum asset utilization

value of conventional banks in year 2007 i.e. 10.73%. The difference of Asset Utilization in both the banking sectors

is minimum, except year 2007, still the study finds conventional banks to be more efficient in using their assets in

full capacity to generate high total revenues as compared to Islamic banks in Pakistan. From year 2011, an

improvement in the figures of asset utilization has been observed in both the sectors.

[Insert Table 4.3]

[Insert Figure 4.3]

4.2.2 Operating Efficiency (OE)

Table 4.4 shows the results of Operating Efficiency (%) of Islamic banks and conventional banks in Pakistan from

2007-2011. The OE of Islamic banks from year 2007-2011 is as follows: 65.66%, 79.38%, 80.15%, 74.4% and

69.88% respectively. Whereas, the OE results of conventional banks are 59.89%, 61.95%, 65.43%, 63.31% and

62.54% in respective years.

Figure 4.4 shows the operating efficiency comparison of Islamic and conventional banks. As this ratio describes the

managerial efficiency in controlling the operating expenses and generating operating revenues, that is why lower

OE is preferred over higher OE as lower OE indicates that operating expenses are lower than operating revenues.

The results indicate that the conventional banks have efficiently managed their operating expenses and have

generated higher operating incomes as compared to Islamic banks from year 2007-2011. In year 2007 the difference

of OE of both the banking sectors is not very large but it expands in year 2008 and 2009. But the study depicts that

Islamic banks have successfully controlled their operating expenses in year 2010 and the trend continues in year

2011 as well.

[Insert Table 4.4]

[Insert Figure 4.4]

4.2.3 Discussion

After analyzing both the Efficiency measures, the study concludes that Islamic banks are less efficient as compared

to conventional banks in Pakistan in terms of asset utilization and operating expense management to generate high

revenues. However, the study also describes the fact that a positive improvement has been observed in the efficiency

performance of Islamic banks since year 2010. Therefore, a high efficiency performance could be expected from

Islamic banks in Pakistan in the near future. The result is consistent with the one of Moin (2008).

4.3 Credit Risk

4.3.1 Equity to Net Loan (EQL)

Table 4.5 shows the results of Equity to Net Loan ratio (%) of Islamic banks and conventional banks in Pakistan

from 2007-2011. The EQL of Islamic banks has found to be 58.22%, 48.96%, 49.63%, 38.17% and 32.74% in

respective years. Whereas, the EQL results of conventional banks from 2007-2011 are 26.93%, 24.81%, 21.89%,

26.03% and 32.43% respectively.

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EQL provides equity as a protection available to a bank to absorb loan losses. Figure 4.5 shows that Islamic banking

is enjoying high EQL throughout the time period of this study. This shows that Islamic banks have quite a large

capacity of absorbing loan losses as compared to conventional banks. However, there has been a decreasing trend of

EQL in Islamic banks from year 2007-2011. In Islamic banks, the EQL in year 2011 (32.74%) is far small than the

EQL of year 2007 (58.22%). On the other side, there has been a reduction in EQL of conventional banks from year

2007-2009. But then the improvement of year 2010 has been so tremendous in conventional banks that their EQL

has almost become equal to the EQL of Islamic banks.

[Insert Table 4.5]

[Insert Figure 4.5]

4.3.2 Total Impaired Loan to Gross Loan (IMLGL)

Table 4.6 shows the results of Total Impaired Loan to Gross Loan ratio (%) of Islamic banks and conventional banks

in Pakistan from 2007-2011. The IMLGL of Islamic banks has found to be 0.94%, 3.55%, 8.42%, 9.57% and 7.21%

in respective years. Whereas, the IMLGL results of conventional banks from 2007-2011 are 13.20%, 19.08%,

21.50%, 17.33% and 16.50% respectively.

IMLGL measures the percentage of gross loans which are doubtful in banks’ portfolio. The analysis of Figure 4.6

shows that the credit performance of Islamic banks is very impressive during 2007-2011. This shows that Islamic

banks do not face the problem of non-performing loans to the extent which the conventional banks are facing in

Pakistan. Moreover, there has been a continuous increasing trend in this ratio in Islamic banks, except year 2011.

The conventional banks in Pakistan also have achieved an increasing trend in IMLGL from yeqr 2007-2009, but

there comes a sharp reduction in year 2010.

[Insert Table 4.6]

[Insert Figure 4.6]

4.3.3 Discussion

After analyzing Credit Risk performance of both the banking sectors, the study concludes that there exists a lower

percentage of risk for Islamic banks as compared to conventional banks in Pakistan. Islamic banks’ ability to absorb

financial losses and to deal with the non-performing/impaired loans is higher than conventional banks. The findings

depict that Islamic banks are less risky than conventional banks in Pakistan. These results are consistent with those

of Moin (2008), Sammad (2004) and Ansari and Rehman (2011).

5. Conclusion

In the light of empirical results and their comparative analysis, the study concludes that although Islamic banks have

performed well in the first three years of study time window, but then conventional banks have excelled in term of

profitability performance. As the results show an increase in both the profitability measures of Islamic banks in year

2011, therefore, it is expected that in the future Islamic banks would again surpass the profitability level of

conventional banks. Ultimately, the study has concluded no significant difference in profitability of both the banking

sectors.

In the beginning, when Islamic banking was at its initial stages in Pakistan, it was very difficult to match the

profitability level of existing well established conventional banks. One of the reasons of this problem was that

Islamic banks were newly established banks having less expertise and the common people were not fully aware of

the interest free banking system. Keeping this fact in mind, the position of Islamic banks in banking industry is very

satisfactory.

According to the findings of second measure of performance, Islamic sector is not working efficiently in asset and

operating expense management for the generation of high revenues. The problem lies with the operating expenses of

Islamic banks because asset utilization of Islamic banks have improved in year 2008 which means they have

improved their revenue by utilizing their assets efficiently. But during the same period operating efficiency of

Islamic banks have also increased which means the banks faced higher costs as compared to their operating income.

In short, it can be concluded that Islamic banks have increased their revenues in last few years but the expenses to

generate these revenues are much greater which has put a barrier to Islamic banks’ efficiency.

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Through the results, Islamic banks have come out to be an impressive sector in credit risk measures. Islamic banks

have a better capacity of absorbing the financial crises and shrinking their impaired loans. The situation of being less

risky gives a sense of protection to Islamic banks. However, Islamic banks of Pakistan will have to be conscious

about their EQL ratio because a continuous decrease has been found in this ratio, this can be turned into an alarming

situation in future for the Islamic banks of Pakistan.

Islamic banks started their operations very recently but still their position in the banking industry is admirable.

However, this study results can differ within two or three years of time as the Islamic banking sector has accelerated

its profits and growths in a positive manner during the last two year of this study time window, so we can expect a

much better results from this sector in the coming years.

Finally, for future studies, as the time passes, when there will be more Islamic banks to study and longer time

periods, a similar study would generate better insight on the issue of performance comparison.

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http://www.sbp.org.pk/departments/ibd/Lecture_8_Related_Reading_1.pdf

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Annexure

Table 4.1

Sector/year 2007 2008 2009 2010 2011

Islamic Banks 0.05% 0.06% -0.42% -0.43% 0.39%

Conventional Banks -0.60% -0.68% -1.30% 0.25% 1.02%

Table 4.2

Sector/year 2007 2008 2009 2010 2011

Islamic Banks 0.22% 0.10% -0.89% -0.66% 0.42%

Conventional Banks -0.68% -0.94% -1.83% 0.39% 1.48%

Figure 4.1

-1.50

-1.20

-0.90

-0.60

-0.30

0.00

0.30

0.60

0.90

1.20

1.50

2007 2008 2009 2010 2011

Islamic

Banks

Conventional

Banks

R

O

A

(%)Year

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Table 4.3

Sector/year 2007 2008 2009 2010 2011

Islamic Banks 6.14% 10.33% 9.32% 9.25% 9.91%

Conventional Banks 10.73% 10.25% 9.99% 10.41% 10.63%

Figure 4.2

-2

-1.6

-1.2

-0.8

-0.4

0

0.4

0.8

1.2

1.6

2

2007 2008 2009 2010 2011

Islamic Banks

Conventional

Banks

R

O

D

(%)Year

Figure 4.3

5

6

7

8

9

10

11

2007 2008 2009 2010 2011

Islamic Banks

Conventional

Banks

AU

(%)

Year

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Table 4.4

Sector/year 2007 2008 2009 2010 2011

Islamic Banks 65.66% 79.38% 80.15% 74.4% 69.88%


Table 4.5

Sector/year 2007 2008 2009 2010 2011

Islamic Banks 58.22% 48.96% 49.63% 38.17% 32.74%


Figure 4.4

60

62

64

66

68

70

72

74

76

78

80

82

2007 2008 2009 2010 2011

Islamic

Banks

Conventional

Banks

O

E

(%)

Year

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Table 4.6

Sector/year 2007 2008 2009 2010 2011

Islamic Banks 0.94% 3.55% 8.42% 9.57% 7.21%


Figure 4.5

20

25

30

35

40

45

50

55

60

2007 2008 2009 2010 2011

Islamic Banks

Conventional

Banks

E

Q

L

(%)

Year

Figure 4.6

0.9

3.9

6.9

9.9

12.9

15.9

18.9

21.9

2007 2008 2009 2010 2011

Islamic Banks

Conventional

Banks

I

M

L

G

L

(%)

Year

Documents

ijcrb.webs.com S 2012 I J O C R I BUSINESS VOL O 5 · banking sector in Pakistan from year 2007-2011. The Islamic banking in Pakistan is new as compared to the conventional banking