Comparison of Islamic Banks with Conventional Banks: Evidence from an Emerging Market

Abstract

This paper evaluates and compares the performance of Sharia-compliant banks with their conventional counterparts operating in Pakistan. Data of five full-fledged Islamic banks and fifteen conventional banks, all from Pakistan, have been used for the study. Study period comprises of six years from year 2008 to year 2013. Bank’s orientation, efficiency, asset quality and stability are the measures used to compare the performance of Islamic and conventional banks. The Islamic banks in Pakistan are younger in age and smaller in size compared to the conventional banks. Based on the financial ratios of two types of banks, we find that the business model of Islamic banks is inferior to the model of conventional banks. Islamic banks are less cost efficient than conventional banks. However, Islamic banks have superior asset quality with better bank stability position. Further, we have compared the market efficiency measures of Islamic and Conventional banks. Liquidity and volatility measures are examined to compare the two banking systems based on daily observations from January 1, 2007 to June 30, 2013. Only two Islamic banks and fourteen conventional banks are listed on the Karachi Stock Exchange of Pakistan. Bid-Ask Spread and Amihud illiquidity ratio are used to check liquidity in the market, whereas, relative high-low price volatility is the measure to check daily price volatility. We find that Islamic bank stocks are less volatile compared to conventional banks after controlling for factors that influence price volatility measure. But we find mixed evidence on liquidity measures for two types of banks.