Implications of Profit Sharing Investment Accounts on the Capital Structure of Islamic Bank: A Comparative Study

Abstract

Islamic banks are different from conventional banks both in terms of their assets and liabilities. One of the major difference in conventional and Islamic banks is the presence of profit sharing investment (PSI) accounts, a quasi-equity, and a buff to bear the financial risk of Islamic banks before it hits the depositors. This paper compares the impact of deposits on the market value, earnings per share (EPS) and financial risk of shareholders of Islamic and conventional banks in Pakistan. The empirical evidence suggests that deposits have a negative impact on market value and EPS of conventional banks. While in the case of Islamic banks, we do not find any significant impact of PSI accounts on market value of Islamic banks; however, we do find the evidence of the significant positive relationship of PSI accounts with EPS. Contrary to the general belief, we find evidence that higher growth in PSI accounts leads to elevated financial risk. The higher financial risk can be attributed to the income smoothing practices of Islamic banks where Islamic banks announce the profit rates of PSI accounts similar to deposit rates offered by their conventional counterparts.