Comparing Islamic and Conventional Bankss Financial Characteristics: A Multivariate Approach

Abstract

We perform principal component analysis (PCA) on an array of 20 financial ratios to explore and compare conventional and Islamic banks’ financial characteristics. In contrast to the existing literature, this is the first study to use PCA to derive four components to examine the financial characteristics of both bank types. The PCA shows that capital requirements, stability, liquidity and profitability are the most informative components in explaining the financial differences between Islamic and conventional banks. We further employ logit, probit and OLS regressions to compare Islamic and conventional banks’ financial strength. Our results show that Islamic banks are more capitalized, more liquid and more profitable but less stable than their conventional counterparts. The findings also show important differences between Islamic and conventional banks even when we decompose our sample between small and large banks. Furthermore, Islamic banks were more resilient than conventional banks in terms of capital and profitability during the subprime crisis. Our findings persist when excluding US banks and when comparing banks in countries where the two banking systems co-exist.