THE PERFORMANCE OF ISLAMIC BANKS AND ...repository.um.edu.my/34887/1/AA3 - Suria and Roza - z83...The Performance of Islamic Banks and Macroeconomic Conditions 84 ISRA International

83ISRA International Journal of Islamic Finance • Vol. 5 • Issue 2 • 2013

THE PERFORMANCE OF ISLAMIC BANKS AND MACROECONOMIC

CONDITIONS

Suria Rismawati Sanwari* and Roza Hazli Zakaria**

Abstract

The recent financial meltdown has made manifest the need to search for an alternative financial system that is more resilient. Theoretically, the principles underlying Islamic banking and finance promise a more stable system. According to these principles—which originate in the SharÊÑah—Islamic banks should focus on feasible economic investments, undertake transactions backed by real assets and finance potentially productive activities. Hence, in principle, they are insulated from speculative and unproductive activities, and their performance is not subject to the same macroeconomic forces as that of their conventional counterparts. However, empirical evidence that supports the claim that the performance of Islamic banks is not related to the external economic environment is very limited. Accordingly, the motivation of this study is to fill in the gap by providing empirical evidence as to whether the performance of Islamic banks depends more on their internal conditions rather than external factors. Using global Islamic banks’ data and applying the standard panel data approach, our findings point that the performance of Islamic banks depends more on bank specific characteristics such as capital, asset quality and liquidity while macroeconomic factors do not significantly influence Islamic banks’ profits. This lends support to the theoretical assertion that Islamic bank performance does not rely heavily on the macroeconomic environment.

Keywords: Panel data regression, Panel Generalized Least Square (GLS), Islamic bank performance, macroeconomic conditions.

* Suria Rismawati Sanwari is Lecturer at the Department of Business Management and Economics, Kolej Poly-Tech MARA (KPTM), Kuala Lumpur. She can be contacted at [email protected].

** Roza Hazli Zakaria is Senior Lecturer at the Department of Economics, Faculty of Economics and Administration, University of Malaya, Kuala Lumpur. She can be contacted at [email protected].

The Performance of Islamic Banks and Macroeconomic Conditions

84 ISRA International Journal of Islamic Finance • Vol. 5 • Issue 2 • 2013

I. INTRODUCTION

The recent global financial meltdown has raised the need to search for an alternative banking and financial system. It has provided evidence on how the current interest-based financial system—which relies purely on market signals—has led to procyclical behavior among banks and financial institutions. These institutions were too optimistic during periods of economic boom, leading them to lend excessively. In the process, lending guidelines—which were originally designed to ensure that lending is channeled only to low risk borrowers or to finance viable investment projects—were sacrificed. Instead, banks even preferred to lend to high risk customers as they were able to charge higher interest rates and hence earned higher expected returns. In addition, new securitized products were derived from those loans to generate more returns and, more importantly, transfer risk to the unsuspecting. Inevitably, the high risk lending proved to be unsustainable when borrowers eventually defaulted. Consequently, the high default rate led to the depletion of banks’ assets and capital base. Banking crises followed that eventually contributed to the meltdown of the financial system.

Meanwhile, the Islamic banking and financial system has attracted the attention of scholars as most Islamic banks were relatively unaffected during the crisis, as opposed to their conventional counterparts (Hassan and Dridi, 2008). This is supposed to be related to the SharÊÑah principles that guard the operations of Islamic financial institutions. For instance, Islamic banking activities have to be tied to real assets and be guided by the restriction on sale of debt, short sales, excessive uncertainty (gharar) and gambling (maysir) (Chapra, 2008). Hence, Islamic banks were not that exposed to those newly engineered securitized products that have no tangible asset base. Similarly, where financing activities are concerned, Islamic principles underline that they must be based on SharÊÑah permissibility and the creditworthiness of the borrowers. Accordingly, the decisions of Islamic banks to provide financing should not be related to the aggregate economic activity such as economic booms and busts. Due to this reason, it is envisaged that Islamic banks are not subjected to the hypothesised business cycle theory, which claims that banks tend to increase lending (over-lend) during periods of economic boom as a result of optimistic economic forecasts. Instead, Islamic banks’ decisions on provision of financing would be kept within strict Islamic financial guidelines. Hence, this would minimize the possibility of over-financing that could lead to problems in the case of default.

Suria Rismawati Sanwari and Roza Hazli Zakaria


Although that is what is expected from theoretical explanations, it remains to be seen whether Islamic banks’ performance in practice adhered to the Islamic principles. Thus far, the existing empirical evidence is not conclusive. For instance, the studies by Haron (1996, 2004), Bashir (2000, 2003), Hassan and Bashir (2004), Alkassim (2005), Ghazali (2008) and Zantioti (2009) find that the interest-free lending practice that is implemented by Islamic banks tend to lay emphasis on financial performance. In fact, the International Monetary Fund (IMF) study conducted by Hasan and Dridi (2010) finds that Islamic banks performed better compared to their conventional counterparts in terms of profitability, credit and asset growth. In addition, research by Chapra (2008) and Ahmed (2010) suggests that the principle of profit-and-risk sharing adopted in Islamic banking helps to inject greater discipline into the financial system and reduce financial instability. This is because adoption of these principles, and in particular non-interest-based transactions, reduces the potential risks resulting from excess leverage and speculative lending activities which are part of the root cause of the global financial crisis 2008 (Ahmed, 2010).

In the light of the above, this study aims to find further empirical evidence on the ability of Islamic banking to offer an alternative to the current banking system. The focus of the study is to examine specifically the issue of whether current Islamic banking practices are sound and different from the conventional banking system in terms of their sensitivity to macroeconomic conditions. One of the implications if Islamic principles are the guiding business rules of Islamic banks is that the banks’ performance would be independent of their external economic environment. This is because their portfolio decisions would rest on the future real potential of the projects they are financing and not on speculation or weak projection of these projects. Of course, being a financial institution operating in an open economy means that Islamic banks would still be subjected to risks posed by economic swings. Yet, they should not be significantly affected by their external economic environment.

This study is different from other studies in one important aspect. While most studies gauging the performance of Islamic banks focused specifically on certain countries or regions—hence leading to more specific findings—this study employs global Islamic bank data which will provide a broader and more general view on whether Islamic banks’ performance is determined by external factors or not.

The paper is accordingly organized as follows: Section II provides an overview of the literature review on determinants of the



performance of Islamic banks. Section III discusses the methodology adopted in this study. Section IV provides a discussion on the empirical findings. Finally, Section V concludes the paper.

II. LITERATURE REVIEW

Literature on the determinants of the performance of Islamic banks is available in abundance. Probably this is due to the importance of Islamic banks’ performance in ensuring their survival and sustainability, as well as the growing interest of scholars regarding the development of Islamic banking. Since the objective of this paper is to examine whether the performance of Islamic banks is determined by their own characteristics and management decisions or by the external environment, the determinants of the performance of Islamic banks are segregated into internal and external factors.

Internal factors refer to factors influenced by management decisions such as quality of assets, capital ratios, liquidity ratios, efficiency ratios and portfolio diversification; and bank specific characteristics such as bank size, market share and ownership structure. Previous findings—such as Dermirguc-Kunt and Huizinga (1997), Vong and Chan (2006), Sufian and Chong (2008), Rasiah (2010), Haron (1996; 2004), Bashir (2003), Alkassim (2005), Shahimi et al. (2005), Sanusi and Ismail (2005), Ghazali (2008), Zantioti (2009), Prastiyaningtyas (2010) and Idris et al. (2010)—conclusively report that internal factors determine bank performance, but how each factor affects performance is different—a matter which is not surprising given the complexity of bank resource management. For instance, findings are divided on how capital affects performance. Theoretically, a high level of capital is associated with good bank capital adequacy and would indicate a low possibility of the bank being a troubled bank. In addition, it increases the trust of the community and the profitability of Islamic banks (Prastiyaningtyas, 2010). This hypothesis is supported by the findings of Dermirguc-Kunt and Huizinga (1997), Rindhatmono (2005), Sufian and Chong (2008), Vong and Chan (2006), Bashir (2000, 2003), Hassan and Bashir (2004), and Ghazali (2008). However, Pratomo and Ismail (2007), Rasiah (2010) and Zantioti (2009) find a negative and significant relationship between equity capital and bank profit. These findings could be explained by the agency cost hypothesis: that high leverage cost or low equity capital ratio reduces the cost of equity and external agencies, and this increases the value of the firm and leads to better performance of the bank.



Similarly, the bank’s diversification strategy relates differently with bank performance. Portfolio theory suggests that greater portfolio diversification will generate a more stable income to the bank as this will reduce the dependence on a single income source, especially the ones easily influenced by a volatile economic environment. Findings by Sufian and Chong (2008) support this hypothesis. However, this contradicts the findings of Dermirguc-Kunt and Huizinga (1997), Hassan and Kabir (2004), Sanusi and Ismail (2005), and Zantioti (2009) who find a negative relationship between diversification and Islamic banks’ profits.

Other internal factors that were found to determine performance for Islamic and conventional banks are liquidity (Rindhatmono, 2005; Prastiyaningtyas, 2010; and Rasiah, 2010); asset quality (Vong and Chan, 2006; and Sufian and Chong, 2008); bank size (Vong and Chan, 2006; Pratomo and Ismail, 2007; Haron, 1996 and 2004; Davydenko, 2010; and Idris et al., 2011); and market share (Haron, 1996; Rindhatmono, 2005; Vong and Chan, 2006). The relationship between asset quality and bank performance is conclusively positive while that between liquidity and bank performance is found to be negative. These findings are consistent with theoretical predictions; however, the findings related to bank size and market share are not.

Market share is considered an internal factor that determines banks’ profits based on the assumption that the bank experiences increasing returns to scale with increasing market share. Hence, the greater the market share, the greater will be the amount of funds made available to the bank for investment and, consequently, the higher will be the bank’s profits. Rindhatmono (2005), in his study which involves both Islamic and conventional banks, finds a positive relationship between market share and profit. However, Haron (1996, 2004) consistently finds an inverse relationship between market share and profitability of Islamic banks. This could be due to the excess liquidity held by Islamic banks whereby the funds deposited by customers are lying idle, thus producing little to no income for the banks (Haron, 2004). In turn, this might be due to the lack of SharÊÑah-compliant investment instruments that hinder banks from investing their deposits. Another explanation, in the case of Islamic banks, is that most of the deposits are in the form of demand deposits. Following Islamic banking principles, demand deposits cannot be invested, as banks are only appointed as custodians to manage the funds (Haron and Wan Azmi, 2009).

As for bank size, the findings are seemingly mixed. For instance, Haron (1996 and 2004) and Idris et al. (2011) report that the economies of scale argument holds true for the Islamic banking sector. However,



findings from Pratomo and Ismail (2007) indicate that Islamic banks experience diseconomies of scale where larger banks negatively affect performance. This difference in findings—especially between Idris et. al. (2011) and Pratomo and Ismail (2007)—could be due to the difference in the time period studied. Both studies in fact examined banks in Malaysia; the latter considered a period where Islamic banking in Malaysia was relatively new, hence inefficient, as opposed to the former, which examined a more recent time period.

Apart from the internal factors, to a certain extent, bank performance will be affected by the external economic and financial environment. This could not be completely avoided as Islamic banks form part of the overall financial system; hence, they are also subject to changes in macroeconomic conditions. Among external factors that are empirically proven to influence bank performance are economic growth and the interest rate.

Economic growth, as measured by Gross Domestic Product (GDP), is often used as a macroeconomic indicator of the total economic activity of a country. GDP growth also reflects the economic cycle. It is well documented, both theoretically and empirically, that banks are procyclical (see, Rochet, 2008; Adrian and Shin, 2008; Bouvatier and Lepetit, 2008; Gruss and Sgherri, 2009; Albertazzi and Gambacorta, 2009). They tend to over-lend during periods of economic boom in the light of positive future economic expectations; while lending tends to contract during periods of bust. Moreover, the prospects of increasing profits could lead to the relaxation of project evaluation criteria during the lending process.

Islamic banks, on the other hand, are expected to be different from their conventional counterparts in terms of their response to economic booms or downswings. Since they are supposed to evaluate their operations such as investment and financing based on the feasibility and potential of the projects, the probability of over-investing or over-financing should not be a cause for concern as evaluation guidelines should be strictly followed regardless of the general economic environment. However, this is not necessarily supported by empirical findings. For instance, studies by Hassan and Bashir (2004), Ghazali (2008), and Zantioti (2009) find that GDP growth significantly affects Islamic banks’ profit. Nonetheless, Bakar (2012) documents evidence that Islamic banks’ financing operations do not depend on economic cycles.

The interest rate enters into the bank profitability equation as the main price of funds. Higher interest rates would increase savings but decrease demand for low risk financing. Should the bank decide



to ration credit to reduce the risk of adverse selection, the bank’s income might be reduced, since the bank’s main income is from financing. This is of greater concern for Islamic banks since they have very limited alternatives to financing given the limited investment potentials in SharÊÑah-compliant financial instruments. At the same time, Islamic banks face displaced commercial risk where banks have no alternative but to increase return to depositors when there is an increase in the general interest rate in the economy, in order to minimize the risk of deposit run. Empirical evidence on the impact of interest rates on profit is limited since most studies on Islamic banking exclude the interest rate from the performance equation. Haron (1996; 2004), who uses the central bank discount rate as a proxy to scarcity of capital, finds that interest rates only have a positive relationship with profits when the measure used is the ratio of interest income to total assets; but the relationship is negative with respect to other measures of profits. Haron (1996; 2004) also confirms that Islamic banks will increase their charge to customers and thus increase their total income; while at the same time, they will increase the rewards given to depositors, which will have the opposite effect of reducing their proportion of income.

Generally, existing studies on the performance of Islamic banks reveal that they relied on external factors, especially business cycle, as proxied by GDP. Yet, one shortcoming from previous studies is that the samples are limited to banks situated in a certain country or geographical region. As such, the findings on the performance of Islamic banks cannot be generalized to the whole Islamic banking sector. There is also the need to incorporate interest rate in the Islamic bank profitability estimate. Many studies exclude interest rate since, theoretically, the practice of Islamic banking is free from interest-based transactions. However, Islamic banks operate in the environment where interest is the universal cost of funds. Hence, the pre-determined rate of saving and financing is still subject to the conventional rate of interest and Islamic banks’ return rate is tied to conventional interest rates (Choong and Liu, 2006; Yap and Kader, 2009). Hence, we argue that there is a need to re-examine how the performance of Islamic banks is related to the external factors using global Islamic bank data and incorporating interest rate as one of the explanatory factors.



III. METHODOLOGY

This section delineates the model specification and data sources used in this study.

A. Model Specification

In order to examine whether the performance of Islamic banks relies on external factors, a bank performance estimation model is specified with internal and external factors being included as determinants. Internal factors—notably, bank specific characteristic variables—follow the CAMEL variables: capital, asset quality, management, equity and liability. External variables included in the model are level of economic activity, interest rate and inflation rate.

Theoretically, it is expected that Islamic banks’ decisions and, hence, performance should be based on the feasibility of each investment or financing activity. Thus, unlike their conventional counterparts, a booming economy should not induce Islamic banks to relax their financing or investment decision criteria or to be more aggressive in pursuing their banking activities. If this holds true, then the level of economic activity should not be significantly related to bank performance.

Interest rate is also included to examine its impact on Islamic bank performance. Despite the ideal theoretical framework that claims Islamic banking operations should be interest free, the fact is Islamic banks operate in a much larger system that relies on interest as the cost of funds. Under the Islamic banking framework, interest rate is used as a benchmark in fixing their charges to users of funds as well as rewards to depositors (Haron, 1994).

Subsequently, the model for evaluating the performance of Islamic banks is specified as follows:

where π = bank performance, EQTA = a proxy of capital adequacy, LLPTL = asset quality, LDR = liquidity, OVRHD = management, NIETA = bank’s diversification, GDP = level of economic activity, CPI = inflation, RINT = interest rate, LogTA = bank size, MKSH = market share, TAX

= tax policy and ε

it = error term.



B. Data Sources and Description

This study employs panel data of 74 Islamic banks from around the world for the period 2000 to 2009, obtained from the annual report of Islamic banking from Bank Scope database. The study involves 16 countries, namely Malaysia, Indonesia, the United Arab Emirates (UAE), Saudi Arabia, Bahrain, Egypt, Qatar, Jordan, Yemen, Sudan, Kuwait, Turkey, South Africa, Pakistan, Bangladesh and Iran. The measurement of each variable is as summarized in Table 1.

Two different measures of bank performance will be used: (i) Return on Assets (ROA), which shows the bank management’s ability to convert assets to net profit, and (ii) Return on Equity (ROE), which measures the return flow to the shareholders of the bank. Following Rasiah (2010), this study will use both before- and after-tax-profit as a measure of bank performance. The use of before- and after-tax-profit as the dependent variable would give a better indication of bank performance since this study involves banks from various countries which are subjected to different tax structures. However, from another perspective, tax is part of a bank’s operating cost and, hence, after-tax-profit would be a more appropriate indicator to measure the banks’ performance (Rasiah, 2010).

Table 1: Variable Measurement and Hypothesis

Variables MeasurementExpected

sign

Dependent variablePerformance BTTAATTABTCR

ATCR

Before-tax-profit as a percentage of total assetsAfter-tax-profit as a percentage of total assetsBefore-tax-profit as a percentage of capital and reserves After-tax-profit as a percentage of capital and reserves

Independent variables

Capital (EQTA) Asset quality (LLPTL) Liquidity (LDR)Efficiency (OVRHD)Diversification (NIETA)Economic growth (GDPGR)

Ratio of total equity to total assetRatio of loan loss provision to total loan Ratio of loan to deposit Ratio of overhead expense to total asset Ratio of non-interest income to total asset Growth rate of gross domestic product

+/--+-++

Inflation (CPI)Real interest rate (RINT)Taxes (TAX)Size (LnTA)Market share (MKSH)

Consumer price index Annual real interest rate Tax paid to before tax profit Natural logarithm of total asset (in US Dollar)Total deposit bank to total deposit in each country

+/-+/--++



IV. FINDINGS

Before we ran the regression, a normality test was conducted to examine whether the sample data was normally distributed. The normality test represented the descriptive statistics of the data for the common sample in Appendix 1. From the table in Appendix 1, we see that the data is not normally distributed, based on the fact that the mean is not the same as the median, the value of the kurtosis is not equal to three, and the value of Jarque-Bera is significant with a high probability value. This leads to the conclusion that the data is not normally distributed, and hence, the Generalized Least Square (GLS) method is more appropriate compared to the Ordinary Least Square (OLS) method.

Prior to estimating the model, a correlation test was also conducted among the variables to test for any multicollinearity problem among the explanatory variables. Based on the result in Appendix 2, the highest correlation is only 0.43, which is less than 0.9 (except for BTTA, ATTA, BTCR and ATCR),1 suggesting that multicollinearity is not a problem in this estimation.

The model estimation follows the standard panel data procedure. The models were estimated using Generalized Least Square (GLS) with pooled effect, fixed effect model and random effect model. The estimation results are presented in Table 2. For interpretation purposes, several diagnostic tests were performed to identify the preferred specification. Then the results were interpreted following the preferred specification. Initially, an F-test was performed to test whether the differences in constant terms capture the differences across countries. The probability of the calculated F-ratio is found to be significant; therefore, the null hypothesis of a common intercept and common slope coefficients between the cross sections was rejected. The F-test, in all cases, showed that the panel is not sufficiently homogenous across countries to use the pooled estimator. Accordingly, the fixed effect model is preferred to the pooled estimator, when comparing only two estimators.

Another approach to the specification of the country-specific effects is to assume that they are random and contribute to the overall variance of the error term. If the country-specific effects are correlated

1 Since BTTA, ATTA, BTCR and ATCR are used as dependent variables and will be regressed separately, the high correlation among these variables could not be considered a multicollinearity problem.



with the regressors, the random effect estimator will be inefficient and inconsistent, in which case the fixed effect is the preferred estimator. To test the efficiency of the random effect estimates, the Hausman test is performed. Chi-Square statistics, in all cases, are found to be significant, so the hypothesis that country specific effects are uncorrelated with the regressors is rejected at any conventional level of significance. This implies that the random effect estimates are unreliable, and the country-specific effects have to be treated as fixed.

Table 2: Bank Performance Estimation Result

ModelVariable

PANEL EGLS MODEL WITH FIXED EFFECT MODEL

ROA ROE

MODEL 1 MODEL 2 MODEL 3 MODEL 4

C 0.0114*** 0.0074*** 0.3356*** 0.2229***

EQTA 0.0095*** 0.0052* -0.1785*** -0.1332***

LLPTL -0.2978*** -0.1885*** -4.3643*** -2.9576***

LDR 0.0091*** 0.0070*** -0.0646*** -0.0252

NIETA 0.1209*** 0.1412*** 1.2372*** 1.1271***

D(OVRTA) -0.1508*** -0.1464*** -1.1013** -1.0049**

D(RGDP,2) 0.0001 0.0000 -0.0002 -0.0002

CPI 0.0001 0.0001 -0.0010 -0.0010

RINT 0.0002*** 0.0002*** 0.0004 0.0004

D(TAX) -0.0011 -0.0014 0.0263* 0.0015

D(LNTA) -0.0043*** -0.0022* -0.0337* -0.0105

MKSH -0.0274 -0.0293* -0.4557* -0.4396*

R-squared 0.8797 0.8678 0.8138 0.7703

Adjusted R-squared 0.8458 0.8304 0.7611 0.7054

S.E. of Regression 0.0064 0.0050 0.0857 0.0660

F-statistic 25.8767*** 23.2135*** 15.4577*** 11.8624***

Sum squared residual 0.0078 0.0048 1.4025 0.8323

Durbin-Watson statistic 1.8965 1.9830 1.7370 1.8639

No. of Observations 246 246 246 246

Redundant Fixed Effect Test 16.7009 21.4490 11.7787 9.4025

Hausman Specification Test 28.0256 30.3988 46.5589 46.4336



The R2 statistics in the regressions indicate that more than 75% of the variation in bank performance can be explained by the explanatory variables. The lower standard error and the relatively large F-statistic indicate the significance of the regression as a whole. The result also shows that there is no autocorrelation in the model based on the Durbin Watson statistic as it is above the rejection region of autocorrelation (DU=1.874) for 5% level of significance.

Model 1 and Model 3 refer to before-tax-profit while Model 2 and Model 4 refer to after-tax-profit. Of particular interest in this result is that—regardless of the bank performance measure used—the significant determinants of bank performance are the internal factors such as capital structure, liquidity ratio, diversification policies and overhead cost. On the other hand, there is no evidence that the level of economic activity influences bank performance. The results consistently show that there is no significant relationship between GDP and bank performance. Only real interest rate turned out to be a significant determinant of ROA, where an increase in interest rate would lead to an increase in ROA. To a certain extent, it is consistent with the findings of Haron (2004), which stated that Islamic banks benchmark their rate to the conventional rates.

Besides the findings regarding whether Islamic banks’ performance depends on external factors, especially the level of economic activity, a few other interesting results could also be observed.

• First, the banks’ diversification policy was consistently found to have a positive and significant effect on bank performance. This suggests that Islamic banks could diversify their financing policy by adopting fee-based activities to improve their performance.

• Second, the relationship between asset quality and bank performance was as expected—notably, there was no trade-off between asset quality and bank performance. A lower level of non-performing loans is usually associated with better bank performance.

• Third, market share was found to negatively affect bank performance. Consistent with the study by Haron (1996, 2004), this contradictory finding is due to the limited investment opportunity available to Islamic banks, which concentrate more on short-term financing. Based on the data collected in this sample, we found that funds deposited in Islamic banks were mostly in the form of current and saving accounts. However, this type of deposit does not give significant income to the bank since



they cannot be invested. The role of the banks is limited to that of a guardian of the fund. So, although Islamic banks are able to expand their market share by attracting more deposit funds, they are still unable to convert these funds into earning assets.

• Fourth, an increase in bank size was found to be associated with lower bank performance, suggesting that, generally, Islamic banks are still facing efficiency problems. Increasing the size would adversely affect bank returns since the increase in assets could not be managed effectively. This is consistent with the findings of Pratomo and Ismail (2007).

Relating the findings to the research objective, the results can be said to offer supportive evidence that the performance of Islamic banks does not rely on external factors such as level of economic activity and inflation, at least within the studied period, from 2000–2009. This is the period where the global economic and financial environment was relatively volatile. However, we do find evidence that Islamic banks’ profit is somehow associated with the interest rate.

The findings provide an insight on the issue of why Islamic banks have been performing better, relative to their conventional counterparts, during the global financial crisis. Part of the answer lies in the fact that their performance depends heavily on their internal decisions relating to deposit-financing allocation and banking activity diversification. Given that their performance is not related to external factors such as macroeconomic conditions, arguably this implies that their decisions on financing and investment activities were most probably made independent of the aggregate level of general activity—usually one of the factors that underlies conventional banks’ decision to over-lend during periods of economic boom.

V. CONCLUSION

This study aimed at finding supporting evidence as to whether the performance of Islamic banks depends on the external environment in which they operate. Accordingly, panel data of 74 Islamic banks from around the world was examined for the period 2000 to 2009. The data were obtained from the annual report on Islamic banking from Bank Scope database. The study differed from previous studies, which focused instead on data from specific countries or regions. The use of the global panel data helped to provide a general overview on the performance of Islamic banks across the world.



Our results provide empirical support to the argument that Islamic banks were relatively unaffected by the recent financial crisis since their performance was not found to be significantly related to the external factors such as level of economic activity. Rather, their performance was found to depend more on the quality of their internal management decisions pertaining to liquidity holdings, capital ratio and diversification strategy. Thus, the findings differed from previous studies which have thus far documented that Islamic banks’ performance, similar to their conventional counterparts, depends on external factors such as macroeconomic conditions.

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AP

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