Abstract
ABSTRACTThis paper empirically investigates the difference between Islamic and conventional banks in terms of business dynamics, cost structure, credit quality, and stability. It also examines the difference in the response of two types of banks during peak and trough phases of the business cycle. The analysis is carried out for a sample of 280 banks in 20 countries over the 1995–2014 period. The results reveal that Islamic banks are more involved in fee-based business, are less cost-efficient, have higher credit quality, and have higher capitalization than conventional banks. We also find that Islamic banks outperformed conventional banks with regard to their credit quality and stability indicators during the trough phase of the business cycle. The improved performance seems to be due to the differences in the provisioning strategies of the two types of banks, the non-aggressive lending profile of Islamic banks, and investment in real assets. Finally, based on the empirical findings, the paper also highlights potential lessons that conventional banks in Baltic States, which were severely hit by the 2007–2008 global financial crisis, can draw from Islamic banking principles.
Highlights
Increased volatility in the global financial system as a result of the recent financial crisis paves the way for a strong and resilient financial system less influenced by volatility and external exposure
When we compare business orientation, we observe that Fee-Income Ratio (FIR) has an average of 17.75%; the mean value is higher for the conventional banks as compared to Islamic banks
Comparing credit quality, we find that the mean value of Loan Loss Reserves (LLR) is lower for Islamic banks and Loan Loss Provisions (LLP) is higher for Islamic banks
Summary
Increased volatility in the global financial system as a result of the recent financial crisis paves the way for a strong and resilient financial system less influenced by volatility and external exposure. Islamic banking due to linkages with the real economy helps reduce the uncertainty in the financial system. Apart from its popularity among people desirous of products consistent with their religious beliefs, Islamic banking is adopted by nonMuslims. It is currently the fastest growing banking industry. According to Islamic Financial Services Industry Stability Report (IFSB), the total Islamic banking assets increased to USD 1.5 trillion in 2017. Shariah-based banking is present in 31 countries having a dual financial system, and the number of jurisdictions where Islamic banking is systemically important (market share of more than 15% of total banking assets) increased to 12. About 88% of the Islamic banking assets are held in these 12 countries (IFSB, 2017)
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