Balance sheet analysis: Islamic vs.

Conventional Difference in account Category: The structure of a typical balance sheet has demand deposits and investment accounts from customers on the liability side and Islamic financing and investing accounts (the equivalent of conventional banks loans to customers) on the asset side. This pattern reflects the nature of banks as intermediaries, with ratios of capital to liabilities at such a low level that their leverage would be unacceptable to any business outside the financial services industry. The analyst should be able to assess the risk profile of the bank simply by analysing the relative share of various asset items and changes in their proportionate share over time. Risk Profile: hen compared with conventional banks, balance sheet risk profile of Islamic banks is different. !irst, the foremost feature of anIslamic bank is the "pass#through nature of the balance sheet. This feature removes the typical assetliability mismatch e$posure of a conventional bank, as the Islamic banks depositors return is linked to the return on the assets of the bank. %owever, this feature also introduces some operational issues, such as estimation and accrual of e$#post returns and the treatment of intra#period withdrawal of deposits. Nature of Asset: &econd, the nature of assets of two institutions is different. hereas a conventional bank tends to stay with fi$ed income very low credit risk debt securities, an Islamic banks assets are concentrated on the asset#based investments which has credit risk but are also backed by a real asset. 's a result, the lending capacity of the Islamic banking sector (at least for commercial banks) is bound by the availability of real assets in the economy. Thus, there is no leveraged credit creation Asset difference: Third, the assets of Islamic banks contain financing assets where tangible goods and commodities are purchased and sold to the customers. This practice creates distinct e$posures. !or e$ample, in case of conventional banking, the asset is financed by a loan from the bank to the customer whereas in case of an Islamic bank, the asset and the financing are coupled together. The bank is not limited to the e$posure as a financier but can develop additional e$posures resulting from dealing with physical assets. 'nother feature which distinguishes the risks of an Islamic bank from a conventional bank is the general lack of liquid securities on the asset side. This feature is not a design issue but is a temporal phenomenon until a well functioning securities market for &hariah#compliant instruments is developed. Prohibition of Interest: !inally, due to prohibition of interest, Islamic banks cannot issue debt to finance the assets which consequently discourages creation of leverage. (ue to the lack of leverage, Islamic banks can be considered less risky during a time of financial crisis. The current financial crisis was precipitated by e$cessive leverage and comple$ity in the financial system, which had developed multiple layers of intermediaries. %ence, the financing ) or the claims on assets ) became remote from the underlying assets