Financial Performances of Islamic versus Conventional Banks

Abstract

This chapter aims to gain a better understanding of the competitive advantages and disadvantages of Islamic banks compared to conventional banks operating in Muslim countries. From the perspective of the murabaha syndrome, Islamic banks are labouring under a major disadvantage: long-term financing with mudaraba or musharaka which is riskier that the medium- and long-term lending of conventional banks. They also need to presuppose a high degree of trust between business partners, whereas conventional banks can maintain a hands-off relationship with their clients that is subject to minimal monitoring of their businesses. Without the trust, Islamic financiers would undergo far higher monitoring costs than conventional banks because their long-term lending takes the form of an equity-like investment in the business that would otherwise be borrowing funds from a conventional bank. In addition, an Islamic bank cannot afford to be a sleeping partner sharing in the profits of the enterprise because the latter may manipulate its profits and losses at the expense of the bank. Overall, conventional banks enjoy tremendous advantages over Islamic banks in their ability to place funds they raise from the public. However, Islamic banks enjoy one competitive advantage over conventional banks: the majority of Muslims believe that the fixed interest offered to depositors is a form of riba and hence illicit. Substantial numbers of them apparently prefer to put their savings into Islamic rather than conventional banks. The chapter discusses the financial performances of Islamic banks and conventional banks from a comparative perspective, and aims to determine how viable Islamic banking is in the various local Middle Eastern commercial banking markets. It also determines whether the special advantages in raising funds offset Islamic banking's disadvantages in placing them, and whether Islamic banks can keep up with conventional banking in competitive national markets.