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Profitability and risk in interest-free banking industries: a dynamic panel data analysis

Author

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  • Mohamed Ali Trabelsi
  • Naama Trad
Abstract
Purpose - The purpose of this paper is to examine whether Islamic finance could replace or complement the traditional financial system and could guarantee stability in times of crisis. Design/methodology/approach - To achieve the aim, the authors examined both risk-taking and profitability of 94 Islamic banks (IBs) operating in 18 countries observed during the 2006-2013 financial crisis period. A series of bank-specific and other country-specific indicators are combined to explain profitability of IBs as measured by return on assets and return on equity, and risk divided into credit risk measured by impaired loans/gross loans and total equity/net loans, and insolvency risk measured by Z-score. Indeed, a bank is stronger than another if it is stable with a higher capacity to absorb risks, on the one hand, and increased performance on the other. Findings - Using dynamic panel data econometrics (generalized moment method system), the authors estimated five regressions and found the following results: bank capital is found to be the main indicator that contributes to maximizing profitability and stability of IBs and reducing their credit risk. However, the study of liquidity and asset quality determinants often leads to inconclusive results. Nevertheless, they found that Gulf region-operating IBs are more profitable, more solvent and less risky than those operating in the South East Asian region. At the macroeconomic level, the authors could not find a significant relationship between inflation rate and IBs profitability. However, unlike for IBs in Southeast Asia, the authors found that inflation rate improves IBs stability and reduces their credit risk level. Practical implications - The results of this study have numerous implications for bank management and the different stakeholders (investors, customers). This study identified several factors that may help bank managers to improve their financial outlook by controlling risk level and profitability. These factors could as well help to understand how macroeconomic indicators affect both banking risk and profitability, in particular Islamic banking. Likewise, portfolio managers can use these results to support their decisions to include IBs in their assets portfolios to mitigate potential risk. Originality/value - This study contributes to the existing literature in two ways. First, this paper provides fresh data and recent information on Islamic banking in Gulf Cooperation Council and South East Asian countries. Second, the obtained results helped us to conclude that the Islamic financial system cannot replace but rather supplements the traditional system. This result may be explained by the fact that Muslims look for Islamic banking products, which conventional banks are not offering.

Suggested Citation

  • Mohamed Ali Trabelsi & Naama Trad, 2017. "Profitability and risk in interest-free banking industries: a dynamic panel data analysis," International Journal of Islamic and Middle Eastern Finance and Management, Emerald Group Publishing Limited, vol. 10(4), pages 454-469, October.
    • Handle: RePEc:eme:imefmp:imefm-05-2016-0070
    DOI: 10.1108/IMEFM-05-2016-0070
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    4. Asma Hkimi & Neila Boulila Taktak, 2022. "Managing the Risks of Investment Deposit Account in Islamic Banks: An Examination of Mudharaba Contract Between MENA and International Markets," Springer Books, in: Abdelghani Echchabi & Rihab Grassa & Welcome Sibanda (ed.), Contemporary Research in Accounting and Finance, pages 195-216, Springer.
    5. Pejman Ebrahimi & Maria Fekete-Farkas & Parisa Bouzari & Róbert Magda, 2021. "Financial Performance of Iranian Banks from 2013 to 2019: A Panel Data Approach," JRFM, MDPI, vol. 14(6), pages 1-15, June.
    6. Iqbal, Muhammad & Kusuma, Hadri & Sunaryati, Sunaryati, 2022. "Vulnerability of Islamic banking in ASEAN," Islamic Economic Studies, The Islamic Research and Training Institute (IRTI), vol. 29, pages 159-168.
    7. Agus Widarjono & Diana Wijayanti & Suharto Suharto, 2022. "Funding liquidity risk and asset risk of Indonesian Islamic rural banks," Cogent Economics & Finance, Taylor & Francis Journals, vol. 10(1), pages 2059911-205, December.
    8. Maria Elisabete Neves & Catarina Proença & António Dias, 2020. "Bank Profitability and Efficiency in Portugal and Spain: A Non-Linearity Approach," JRFM, MDPI, vol. 13(11), pages 1-19, November.
    9. Hassan Akram & Adnan Hushmat, 2024. "Bank liquidity creation and solvency risk with moderating role of loan concentration: a comparative study of Islamic and conventional banks in Pakistan and Malaysia," Risk Management, Palgrave Macmillan, vol. 26(4), pages 1-32, December.
    10. Muhammad Iqbal & Hadri Kusuma & Sunaryati Sunaryati, 2022. "Vulnerability of Islamic banking in ASEAN," Islamic Economic Studies, Emerald Group Publishing Limited, vol. 29(2), pages 159-168, May.
    11. Marta Anita Karaś & Michał Boda, 2024. "Stabilność i wyniki finansowe banków w krajach Europy graniczących z konfliktem militarnym w Ukrainie," Gospodarka Narodowa. The Polish Journal of Economics, Warsaw School of Economics, issue 2, pages 64-111.
    12. Sitara Bibi & Fatima Mazhar, 2019. "Determinants of Banks Profitability & Liquidity and the Role of BASEL III in Islamic & Conventional Banking Sector of Pakistan: A Case Study of NBP," The Economics and Finance Letters, Conscientia Beam, vol. 6(1), pages 40-56.

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