An empirical analysis of Islamic banking division profitability performance

Abstract

In this paper an attempt is made to evaluate the profitability performance of Islamic banking business between 1996 to 1999, with specific reference to Islamic Banking Division (IBD). In doing so, the financial ratio approach has been adopted to reflect the managerial efficiency of the Islamic banking firms. In this study seven financial ratios were computed to measure Islamic banking performance, namely the return on equity, return on asset, return on deposits, profit margin, asset utilization, net operating margin and operating expenses ratio. This study shall consist of two parts First, it looks at the profitability performance of IBD of selected financial institutions providing Islamic products in the conventional banks. Secondly, the study evaluates the impact of the Asian financial crisis on the Islamic banking performance, IBD in specific. Among others, the study discovered that IBD has performed relanvely better than conventional banks (CB) on giving return to its shareholders and depositors. This may be caused by IBDs utilizmg conventional banking operation overhead and their smaller default payment leading to lower costs thus contributing to a higher earning percentage for IBD. In portfolio management however, IBD is less efficient compared with the CB as shown by a lower asset utilization and investment margin ratios. During the 1997-1998 economic downturn, both the financial institutions were severely affected by the crisis but the impact is more intense on the CB industry due to its high level of bad loans. On the performance of IBD during an upswing event of interest rate, the performance of IBD showed a decline in its investment margin, indicating its weakness in generating commendable profits during this period. This may be caused by the high dependence on the fixed-rate financing mechanism such as al-bai-bithaman a)ll by the IBDs, whilst its deposits are in essence, are mostly variable rate liabilities.