MBA (Accounts & Finance) Project

Impact of Internal Indicators on Financial Performance Of Islamic

Banking Sector

In partial for the fulfillment of the requirement for the degree of

Master of Business Administration

Preston University Islamabad

2016
 Abstract

Conventional and Islamic banks are operating side by side in the Pakistani economy. However, rapid
growth of Islamic banking system in Pakistan creates intensive competitions in the industry. Each bank
tries to be more financially feasible by increasing activities and innovating products to gain higher
market share. Therefore, there is an urgent need to make comprehensive analysis of Pakistani banking
sectors performance.

The objective of this study is to provide performance analysis of Islamic banking sector in Pakistan as
well as to examine the impact of banks internal characteristics indicators on financial performance. All
the fully Islamic banks operating in Pakistan are financially analyzed between 2011 and 2015. The
methodology used is ratio and regression analysis to test the research hypothesis.

The time series show that total assets, which measure the size of bank, affect negatively in Pakistani
banks, which means that bigger banks are less profitable. Secondly the regression analysis shows that
operating expenses have a negative influence on banks ROA. Thirdly, operating income has positive
impact on banks financial performance, which means increasing the activities of banks causes increase
in banks performance.
 TABLE OF CONTENTS

CHAPTERS
I.0 INTRODUCTION 1

1.1 Background 1

1.2 Problem identification . 2

1.3 Research Question .. 2

1.4 Objective of the study .. 3

1.5 Significance of the study 3

1.6 Theoretical Framework .. 3

1.7 Graphical Representation . 5

1.8 Hypothesis Testing 5

1.9 Recommendations 6

2.0 LITERATURE REVIEW 7

3.0 METHOD 10

3.1 Sample 10

3.2 Instruments and measures .. 10

3.3 Procedure 10

4.0 RESULTS AND DISCUSSION 12

5.0 CONCLUSION AND RECOMMENDATION 29

6.0 REFERENCES 31

APPENDIX 33
 LIST OF TABLES

TABLE HEADING PAGE NO.

NUMBER

4.1 RATIO ANALYSIS OF ALBARKA BANK 12

4.2 RATIO ANALYSIS OF BANK ISLAMI 14
4.3 RATIO ANALYSIS OF BURJ BANK 16
4.4 RATIO ANALYSIS OF DUABI ISLAMIC BANK 18
4.5 RATIO ANALYSIS OF MEEZAN BANK 20
4.6 EQUITY TO TOTAL ASSET RATIO 22
4.7 OPERATING EXPENSES TO TOTAL ASSET RATIO 23
4.8 RETURN ON ASSET RATIO 24
4.9 MODEL SUMMARY 26
4.10 ANOVA . 27
4.11 REGRESSION COEFFICIENT 28
 LIST OF FIGURES

FIGURE HEADING PAGE NO.

NUMBER

4.1 RATIO ANALYSIS OF ALBARKA BANK 12

4.2 RATIO ANALYSIS OF BANK ISLAMI 14
4.3 RATIO ANALYSIS OF BURJ BANK 16
4.4 RATIO ANALYSIS OF DUABI ISLAMIC BANK 18
4.5 RATIO ANALYSIS OF MEEZAN BANK 20
4.6 EQUITY TO TOTAL ASSET RATIO 22
4.7 OPERATING EXPENSES TO TOTAL ASSET RATIO 23
4.8 RETURN ON ASSET RATIO 24
 Chapter No. 1

INTRODUCTION

1.1 Background

Islamic banking system has developed significantly over the last few decades. The Islamic
banking system has expanded rapidly especially in the Asian and Middle Eastern countries and
keeping in view the European and North American states. The main purpose of the Islamic banks
is to provide interest free facilities to the customers. Islamic banks work in accordance to the
Islamic rules and principles. As interest is not allowed in Islam, that is why banks working
according to shariyah never use any kind of interest. Thus Islamic banks work on mutual sharing
of profit as well as loss and some other sales agreements.

On the other hand, other banks are functioning on interest basis. These banks function on the
interest earned from the borrowers and pay interest to the lenders. The conventional banks use
this system to finance most of the businesses.

The banking sector is playing a major role in the enhancement and development of the economic
structure and condition through different means such as providing funds to companies. Islamic
and conventional banks both are active and are working in the industrial sector for the
maximization of the profit. Many studies show that the ratio of the performance of the Islamic
banks is satisfactory. Islamic banks are capitalized, stable and profitable (Iqbal and Molyneux,
2005). In Pakistan, Muslims are the majority and are affiliated with the Islamic teachings, rules
and principles and avoid dealing with interest seeking banks. Many conventional banks in the
Pakistan have adopted the Islamic banking system by providing a window to target higher
market share.

The basic idea which emphasizes all of financial performance, research, discussions is that
increasing financial performance will lead to improved functions and activities of the
organization (Tarawenh, 2006).

The focal point of Pakistans Islamic banking sector is to provide effective resources, innovative
ideas for the productions of new technology of better quality for generating, investing and saving
money. Comprehensive analysis is required for the performance of the Pakistans Islamic
banking sector.

This research will critically analyze and study the financial performance of Pakistans selective
Islamic banks with respect to banks size, operational efficiency and asset management.

1.2 Problem Identification

A tremendous competition has been evolved in Pakistani banking sector due to expansion in
Islamic banking, in providing Islamic products with innovation, management of resources as in
to save money efficiently. The fact is efficient and effective banking structure helps in long-
term growth and development, so banks are trying to be unique for achieving high market
shares. Thus, this study is conducted to answer several questions:

The questions are about the strengths and weaknesses of banks, lists of banks according to their
financial stability, integrity of these banks with respect to characteristics, influence of different
factors on Pakistani bank`s profitability and dependence of financial performance of banks on
internal indicators.

1.3 Research Question

What is the impact of internal indicators on financial

performance of Islamic banking sector in Pakistan?

1.4 Objectives of the Study

The aim of this research is to examine the impact of

internal indicators on financial performance of Islamic
 banking sector in Pakistan. The key objectives of this
research are as follows:
To examine influence of asset management on
financial performance of Islamic banking sector.

To observe impact of operational efficiency on

financial performance of Islamic banking sector.

To analyze influence of size of the bank on

financial performance of Islamic banking sector.

1.5 Significance of the study

The study is about the impact of internal indicators on financial performance of Islamic banking
sector. This topic has been preferred because there is no worthwhile research done in Pakistan on
concerns of internal indicators on the profitability of Islamic banking sector. By detailed
erudition, the fundamental ground rules were examined, which indicators affect the profitability
of Islamic banking sector positively and which indicators have negative impact on the
profitability of Islamic banking sector.

1.6 Theoretical Framework

Variables

This research embarks on the matter of recognizing the

impact of internal indicators on financial performance
of Islamic banking sector in Pakistan. The selection of
the variables was prejudiced by previous published
papers related to performance analysis of banking
sector. Following variables were used to test the
hypothesis of our study.
Return on Assets (ROA)

ROA quantify the profitability of the firm and it is used

as dependent variable. It is defined as earnings before
interest and taxes (EBIT) divided by total assets of the
firm.

Equity to total assets (EQTA)

EQTA is an independent variable that indicates the

proportion of equity relative to the total assets and is
defined as the total equity divided by total assets of the
firm.
Operating Expenses to Total Assets (OPEXTA)

OPEXTA is an independent variable that indicates the

fraction of operating expenses relative to the total
assets and is defined as operating expenses divided by
the total assets of the firm.
Total Assets (TA)
 TA is an independent variable that indicates the
proportion of short term debt relative to total assets
and is to normalize the high values of total assets we
used the formula of standardization i.e. value minus
mean and then divide it by standard deviation.

1.7 Graphical Representation

 1.8 Hypothesis Testing
As the intention of the study is to observe the relation between internal indicators and financial
performance of Islamic banking sector in Pakistan, this study formulates following set of testable
hypothesis.

Hypothesis 1

H1(a): Asset Management has a significantly positive effect on profitability.

H1(b): Asset Management has a significantly negative effect on profitability.

Hypothesis 2

H2(a): Operational Efficiency has a significantly positive effect on profitability.

H2(b): Operational Efficiency has a significantly negative effect on profitability.

Hypothesis 3

H3(a): Bank size has a significantly positive effect on profitability.

H3(b): Bank size has a significantly negative effect on profitability.

1.9 RECOMMENDATIONS
After the completion of the study there are some recommendations for Islamic Banking sector
operating in Pakistan.

The size of the banks should not be too big as the size of firm has negative relation with
profitability.

The banks should focus on asset management to enhance their profitability as the study
reveals that higher asset management leads to high profits.

The firms should also keep an eye on the operational efficiency of the firm by managing their
operating expenses in order to attain maximum revenues as operational efficiency has
positive effect on profitability.
 Chapter No. 2

LITERATURE REVIEW

Islamic banking system is an important part of the banking sector and this system is three
decades old. Islamic banking system is known as profit-loss sharing or interest-banking system
(Alkassim 2005). So, it is necessary to give explanation of the Islamic banking system that what
is Islamic banking? History of the Islamic banking, its core concept and principles keeping in
view some examples of the Islamic lending models.

What is Islamic banking system?

Islamic banking system can be defined as the banks that work under the umbrella of the Islamic
rules and principles Shari (Islamic Laws). In Islamic banks the transaction are mended to be
lawful (HALAL), free from all interests (RIBBA) (Maali, Casson and Naiper 2006). In appendix
A, difference between conventional and Islamic bank has been highlighted. The fundamental
rules that Islamic should apply can be explained after given a brief introduction of the
development of Islamic finance.

History and growth of Islamic finance

During the 1950s, Muslim states were able to utilize their resources and the consumer need
without any interest (Molyneux and Iqbal, 2005). After the emergence of the commercial banks,
many Shia scholars objected banking system because of the interest rates.

The first non-profit bank description was presented by the Islamic economist which was in
Mudarabah (profit-loss sharing contract) or Wakalah (unrestricted investment account in which
the Islamic bank earns a flat fee). From 1950s to 1960s, economist started work on Islamic
economics. Malaysia and Egypt were the first to establish non-interest financial institutes that
were bound to work under the Islamic economic principles (Greuning and Iqbal, 2008).

During 1970s, many small commercial banks emerged competing for funds during the oil
revenue phase. In 1974, first private commercial bank was established in UAE. In 1975 first
Islamic Development Bank (IDB) was established in Jeddah, KSA as an international financial
institute (Greuning and Iqbal, 2008).

In 1980s, the Islamic finance industry expanded during this phase. The major development
during the 80s was the establishment of the training institutes by IDB, the main aim of these
institutes was it continues research on both theoretical and conceptual level. Islamic banking was
being promoted by many countries such as Malaysia and Bahrain. On the other hand, many
countries such as Pakistan, Sudan and Iran started to convert banking systems to non-profit
institutions. Islamic banks started to take place of the western commercial banks by providing
values and to resell them at markup amount. Islamic products were offered by these banks
through Islamic window (Greuning and Iqbal, 2008).

In 1990s, innovative products were introduced by institutions and public lawmakers which got
the attention of the market. Bahrain established the Accounting and Auditing Organization for
Islamic Financial Institution (AAOIFI). Islamic Insurance (Takaful) was also introduced; Islamic
Equity Funds are also introduced (Greuning and Iqbal, 2008).
Islamic financial services institution is introduced to oversee the corporate governance issues and
to make rules for the Islamic financial market. In the millennium, the banking sector has
observed tough competition in the market by introducing new products and unique ideas. For the
past five years, Islamic assets have grown form 15 to 20 percent annually and have made Islamic
banking as one of the fastest growing sector in the financial services industry (Booz & Company,
2008).

Core concept of Islamic banking and its principles

Interest (riba) is prohibited in Islamic banking that makes it different from conventional banking
system, in other words the major difference between both the Islamic and conventional banking
system is the usage of money. In conventional banks money is used as a commodity for the sales
and purchase through the interest money (Alkassim 2005). The Islamic concept of banking is to
provide services to customers without interest and the usage of interest (riba) is prohibited in all
transactions (Lewis And Algaoud, 2001).

Alternative mechanisms are adopted in Islamic system because of prohibition of interest (riba).
As interest is prohibited then how Islamic banks work? For this Profit- Loss Sharing System
(PLS) is the alternative mechanism; it will be described briefly in the following section. In the
following lines principles have been summarized that should be applicable to Islamic financial
institution for achieving the Islamic norms and these principles are:

Interest (ribba) is prohibited in all transactions: in the Holy Quran as it is mentioned that
interest is completely prohibited. Only loan that is allowed in Islam is Qard Al-hasan
(literally good loan), the lender does not charge money above the actual amount lent
(Kettel, 2007).
According to Islamic finance, the money should be treated as a source of exchange, for
sale and purchase of things rather than making money from money. In Islam, money is
valued as potential capital not capital itself, it means that money will be considered
capital when it is invested in the business (Ariff, 1988).
Risk sharing: as interest is prohibited in Islam, the funding body becomes the investor
rather than becoming the lender, so the risk factor will increase in business for gaining
profits.
Transparency in all transactions: in Islam sale is not allowed or is invalid if the buyer
 does not know the quality and the quantity of the product. Islam proposes that all
business transactions should be in written form to avoid any misconception leading to
any disagreement (Ismail, 2001).
Gambling (Maiser) is strictly prohibited in Islam and transaction should be free from
uncertainty (Ghrar) (Lewis and Hassan, 2007).
All the investment made should be legal in nature, the product should be useful not
harmful as mentioned in the Holy Quran (Lewis, 2001).
Levy (Zakat) are to be paid by the banks for the benefit of the society (Lewis and
Hassan, 2007).
Finally, if these rules and principles are applicable, then the banks functioning is considered
Islamic.
 Chapter No. 3

METHODOLOGY

3.1 Sample

The aim of this study is the contribution towards a vital aspect of financial management that is
impact of internal indicators on profitability of Islamic banking sector with reference to Pakistan.
In this research, the sample selected was based on the financial statements of five Islamic banks
currently working in Pakistan namely Albaraka Bank, Bank Islami, Burj Bank, Dubai Islamic
Bank and Meezan Bank for the period of five years starting from 2011 to 2015.

3.2 Instruments and Measures

The research is based on the secondary data therefore no questionnaires were circulated and
instead of questionnaires financial data was examined. The key source of data were the financial
statements i.e., income statement and balance sheet of Albaraka Bank, Bank Islami, Burj Bank,
Dubai Islamic Bank and Meezan Bank for the phase from 2011 to 2015. Reason of time-period
restriction to five years is that the study has to be completed within a given timeframe. The
annual reports of the banks were used to understand their background. The data used in this study
was collected from the Internet i.e. website of business recorder and the websites of individual
banks.

3.3 Procedure

Various financial ratios were calculated and examined for the selected banks. The data was
extracted from the financial statements such as income statement and balance sheet of the banks.
Then data was entered in excel for ratio calculation which includes Equity to total assets,
Operating Expenses to Total Assets, Total Assets and Return on Assets. Various statistical tools
like mean and time series were applied on the data to extract conclusive results from the data.
Afterwards regression analysis was used to find out the affect of the internal indicators on
financial performance of the bank.
 Chapter No. 4

Results and Discussions

TABLE: 4.1 Ratio Analysis of Al Baraka Bank

2011 2012 2013 2014 2015 Mean

TA -0.8419 -0.5578 -0.2255 -0.0844 1.7094 0.0000
EQTA 0.9638 0.4272 0.2460 0.1767 0.1007 0.3829
OPEXTA 0.0650 0.0442 0.0575 0.0727 0.0263 0.0531
-
ROA
-0.0681 -0.0094 -0.0237 -0.0404 -0.0259 0.0335

FIGURE: 4.1 Ratio Analysis of AlBarka Bank

0.04

0.02

0
2011 2012 2013 2014 2015 Al Barka
Bank Islami
-0.02
Burj Bank
Dubai Islamic
-0.04

-0.06

-0.08

The ratio analysis of Al Baraka Bank shows that with the passage of time the size of the
company (TA) increased and the asset management ratio (EQTA) decreased whereas both the
other ratios i.e. operational efficiency (OPEXTA) and profitability ratio (ROA) have very less
change over the passage of time.

Asset management ratio is used to ascertain the overall financial stability of a company. The ratio
is a measure of creditors risk. At first the company shows that it is a strong body of assets and
relatively little debt and can be considered a very good investment. As its a fact that the less
leveraged the company, the safer the creditors` interests. The high ratio of shareholders` equity to
assets represents a relatively large degree of security for the firm, but it also indicates that the
firm is not highly leveraged. But with the passage of time the value of EQTA decreased which
tends to show that now the company has relatively few assets that are completely owned and
controlled by the company and it would not be considered as a good investment any more.

Profitability ratio (ROA) is the ratio of earning before tax (EBT) to total assets. It is the indicator
of how profitable a company is relative to its total assets. ROA gives an idea as to how
efficient management is at using its assets to generate earnings. Return on assets measures a
companys earnings in relation to all of the resources it had at its disposal. Thus, it is the most
stringent and excessive test of return to shareholders. The higher profitability ratio shows that
they tend to use internally generated funds first and then resort to external financing.
TABLE: 4.2 Ratio Analysis of Bank Islami

2011 2012 2013 2014 2015 Mean

TA -1.1883 -0.5482 -0.2634 0.6694 1.3304 0.0000
EQTA 0.4977 0.2661 0.2720 0.1379 0.1058 0.2559
OPEXTA 0.0396 0.0353 0.0542 0.0515 0.0426 0.0446
-
ROA
-0.0085 -0.0070 -0.0120 -0.0143 0.0010 0.0082

FIGURE: 4.2 Ratio Analysis of Bank Islami

0.04

0.02

0
2011 2012 2013 2014 2015 Al Barka
Bank Islami
-0.02
Burj Bank
Dubai Islamic
-0.04

-0.06

-0.08

The ratio analysis of Bank Islami shows that with the passage of time the size of the company
(TA) increased and the asset management ratio (EQTA) decreased whereas both the other ratios
i.e. operational efficiency (OPEXTA) and profitability ratio (ROA) have very less change over
the passage of time.

Asset management ratio is used to ascertain the overall financial stability of a company. The ratio
is a measure of creditors risk. At first the company shows that it is a strong body of assets and
relatively little debt and can be considered a very good investment. As its a fact that the less
leveraged the company, the safer the creditors` interests. The high ratio of shareholders` equity to
assets represents a relatively large degree of security for the firm, but it also indicates that the
firm is not highly leveraged. But with the passage of time the value of EQTA decreased which
tends to show that now the company has relatively few assets that are completely owned and
controlled by the company and it would not be considered as a good investment any more.

Profitability ratio (ROA) is the ratio of earning before tax (EBT) to total assets. It is the indicator
of how profitable a company is relative to its total assets. ROA gives an idea as to how
efficient management is at using its assets to generate earnings. Return on assets measures a
companys earnings in relation to all of the resources it had at its disposal. Thus, it is the most
stringent and excessive test of return to shareholders. The higher profitability ratio shows that
they tend to use internally generated funds first and then resort to external financing.
TABLE: 4.3 Ratio Analysis of Dawood Islamic (Burj) Bank

2011 2012 2013 2014 2015 Mean

TA -1.2672 -0.5424 -0.0685 0.53201.3462 0.0000
EQTA 0.9965 0.5351 0.4259 0.37220.2447 0.5149
OPEXTA 0.0220 0.0243 0.0454 0.05270.0577 0.0404
-
ROA
0.0038 0.0047 0.0063 -0.0311 -0.0466 0.0126

FIGURE: 4.3 Ratio Analysis of Dawood Islamic (Burj) Bank

0.04

0.02

0
2011 2012 2013 2014 2015 Al Barka
Bank Islami
-0.02
Burj Bank
Dubai Islamic
-0.04

-0.06

-0.08

The ratio analysis of Dawood Islamic Bank which is now known as Burj Bank shows that with
the passage of time the size of the company (TA) increased and the asset management ratio
(EQTA) decreased whereas both the other ratios i.e. operational efficiency (OPEXTA) and
profitability ratio (ROA) have very less change over the passage of time.

Asset management ratio is used to ascertain the overall financial stability of a company. The ratio
is a measure of creditors risk. At first the company shows that it is a strong body of assets and
relatively little debt and can be considered a very good investment. As its a fact that the less
leveraged the company, the safer the creditors` interests. The high ratio of shareholders` equity to
assets represents a relatively large degree of security for the firm, but it also indicates that the
firm is not highly leveraged. But with the passage of time the value of EQTA decreased which
tends to show that now the company has relatively few assets that are completely owned and
controlled by the company and it would not be considered as a good investment any more.

Profitability ratio (ROA) is the ratio of earning before tax (EBT) to total assets. It is the indicator
of how profitable a company is relative to its total assets. ROA gives an idea as to how
efficient management is at using its assets to generate earnings. Return on assets measures a
companys earnings in relation to all of the resources it had at its disposal. Thus, it is the most
stringent and excessive test of return to shareholders. The higher profitability ratio shows that
they tend to use internally generated funds first and then resort to external financing.
TABLE: 4.4 Ratio Analysis of Dubai Islamic Bank

2011 2012 2013 2014 2015 Mean

TA 0.8546 0.2670 0.3402 0.2726 -1.7344 0.0000
EQTA 0.1168 0.1065 0.1050 0.1235 0.8630 0.2630
OPEXTA 0.0249 0.0258 0.0228 0.0214 0.0192 0.0228
ROA 0.0091 0.0145 0.0203 0.0223 0.0246 0.0181

FIGURE: 4.4 Ratio Analysis of Dubai Islamic Bank

0.04

0.02

0
2011 2012 2013 2014 2015 Al Barka
Bank Islami
-0.02
Burj Bank
Dubai Islamic
-0.04

-0.06

-0.08

The ratio analysis of Dubai Islamic Bank shows that with the passage of time the size of the
company (TA) increased and the asset management ratio (EQTA) decreased gradually in 1st year
and then became stable afterwards whereas both the other ratios i.e. operational efficiency
(OPEXTA) and profitability ratio (ROA) have very less change over the passage of time.

Asset management ratio is used to ascertain the overall financial stability of a company. The ratio
is a measure of creditors risk. In first year the company shows that it is a strong body of assets
and relatively little debt and can be considered a very good investment. As its a fact that the less
leveraged the company, the safer the creditors` interests. The high ratio of shareholders` equity to
assets represents a relatively large degree of security for the firm, but it also indicates that the
firm is not highly leveraged. But afterwards the value of EQTA decreased which tends to show
that now the company has relatively few assets that are completely owned and controlled by the
company and it would not be considered as a good investment any more.

Profitability ratio (ROA) is the ratio of earning before tax (EBT) to total assets. It is the indicator
of how profitable a company is relative to its total assets. ROA gives an idea as to how
efficient management is at using its assets to generate earnings. Return on assets measures a
companys earnings in relation to all of the resources it had at its disposal. Thus, it is the most
stringent and excessive test of return to shareholders. The higher profitability ratio shows that
they tend to use internally generated funds first and then resort to external financing.
TABLE: 4.5 Ratio Analysis of Meezan Bank

2011 2012 2013 2014 2015 Mean

TA -1.1236 -0.6492 -0.2353 0.6543 1.3538 0.0000
EQTA 0.1026 0.0849 0.0701 0.0740 0.0716 0.0806
OPEXTA 0.0221 0.0263 0.0318 0.0279 0.0300 0.0276
ROA 0.0168 0.0189 0.0116 0.0140 0.0137 0.0150

FIGURE: 4.5 Ratio Analysis of Meezan Bank

0.04

0.02

0
2011 2012 2013 2014 2015 Al Barka
Bank Islami
-0.02
Burj Bank
Dubai Islamic
-0.04

-0.06

-0.08

The ratio analysis of Meezan Bank shows that with the passage of time the size of the company
(TA) increased and the asset management ratio (EQTA) decreased slowly whereas both the other
ratios i.e. operational efficiency (OPEXTA) and profitability ratio (ROA) have very less change
over the passage of time.

Asset management ratio is used to ascertain the overall financial stability of a company. The ratio
is a measure of creditors risk. At first the company shows that it is a strong body of assets and
relatively little debt and can be considered a very good investment. As its a fact that the less
leveraged the company, the safer the creditors` interests. The high ratio of shareholders` equity to
assets represents a relatively large degree of security for the firm, but it also indicates that the
firm is not highly leveraged. But with the passage of time the value of EQTA decreased which
tends to show that now the company has relatively few assets that are completely owned and
controlled by the company and it would not be considered as a good investment any more.

Profitability ratio (ROA) is the ratio of earning before tax (EBT) to total assets. It is the indicator
of how profitable a company is relative to its total assets. ROA gives an idea as to how
efficient management is at using its assets to generate earnings. Return on assets measures a
companys earnings in relation to all of the resources it had at its disposal. Thus, it is the most
stringent and excessive test of return to shareholders. The higher profitability ratio shows that
they tend to use internally generated funds first and then resort to external financing.
TABLE: 4.6 Equity to Total Assets Ratio

2011 2012 2013 2014 2015 Mean

0.963
Al Baraka 8 0.4272 0.2460 0.1767 0.1007 0.3829
0.497
Bank Islami 7 0.2661 0.2720 0.1379 0.1058 0.2559
0.996
Burj Bank 5 0.5351 0.4259 0.3722 0.2447 0.5149
0.863
Dubai Islamic 0 0.1235 0.1050 0.1065 0.1168 0.2630
0.102
Meezan Bank 6 0.0849 0.0701 0.0740 0.0716 0.0806
Industry Mean 0.2995

FIGURE: 4.6 Equity to Total Assets Ratio

The asset management ratio analysis of Islamic Banking sector shows that Al Baraka Bank and
Burj Bank have higher asset management ratio than the industry mean i.e. 0.2995 which shows
that they are strong bodies of assets and relatively little debt and can be considered as very good
investments. As its a fact that the less leveraged the company, the safer the creditors` interests.
The high ratio of shareholders` equity to assets represents a relatively large degree of security for
the firm, but it also indicates that the firm is not highly leveraged. Whereas the other three banks
in the sector i.e. Bank Islami, Dubai Islamic and Meezan Bank have lower asset management
ratio than the industry mean which means that these banks have relatively few assets that are
completely owned and controlled by the company and they would not be considered as good
investments.

TABLE: 4.7 Operating Expenses to Total Asset Ratio

2011 2012 2013 2014 2015 Mean

0.065
Al Barka 0 0.0442 0.0575 0.0727 0.0263 0.0531
0.039
Bank Islami 6 0.0353 0.0542 0.0515 0.0426 0.0446
0.022
Burj Bank 0 0.0243 0.0454 0.0527 0.0577 0.0404
0.019
Dubai Islamic 2 0.0214 0.0228 0.0258 0.0249 0.0228
0.022
Meezan Bank 1 0.0263 0.0318 0.0279 0.0300 0.0276
Industry Mean 0.0377

FIGURE: 4.7 Operating Expenses to Total Asset Ratio

The operational efficiency ratio is defined by OPEXTA, which is calculated by dividing total
operating expenses by total assets. The operational efficiency analysis of Islamic Banking sector
shows that AlBarka Bank, Bank Islami and Burj Bank have higher operating efficiency ratio than
the industry mean i.e. 0.377 which shows that either they are not utilizing their funds very
effectively on their expenses or they are not backed up by a huge reserve of assets which force
this ratio to scramble even higher than industry mean. Whereas the other two banks in the sector
i.e. Dubai Islamic and Meezan Bank have lower operational efficiency ratio than the industry
mean which means that either they are utilizing their funds very effectively on their expenses or
they are backed up by a huge reserve of assets which force this ratio to descend even lower than
industry mean.

TABLE: 4.8 Return on Asset Ratio

2011 2012 2013 2014 2015 Mean

-
Al Barka 0.0681 -0.0094 -0.0237 -0.0404 -0.0259 -0.0335
-
Bank Islami 0.0085 -0.0070 -0.0120 -0.0143 0.0010 -0.0082
Burj Bank 0.0038 0.0047 0.0063 -0.0311 -0.0466 -0.0126
Dubai Islamic 0.0246 0.0223 0.0203 0.0145 0.0091 0.0181
Meezan Bank 0.0168 0.0189 0.0116 0.0140 0.0137 0.0150
Industry Mean -0.0042

FIGURE: 4. 8 Return on Asset Ratio

The profitability ratio is defined by ROA, which is calculated by dividing earnings before
interest and taxes (EBIT) by total assets. The profitability analysis of Islamic Banking sector
shows that only Dubai Islamic and Meezan Bank have higher profitability ratio than the industry
mean i.e. -0.0042 which shows that they tend to use internally generated funds first and then
resort to external financing. These banks have bigger cushion to protect themselves during hard
times & reflects a competitive advantage to improve market share when things will improve
again. Whereas the other three banks in the sector i.e. Al Baraka, Bank Islami and Burj Bank
have lower profitability ratio than the industry mean this shows that they tend to use externally
generated funds rather than to depend on internal funds. These industries have lower cushion to
protect themselves during hard times.
Table 4.9: Model Summary Table:

Summary measures

0.986
Multiple R 3
0.972
R-Square 8
0.945
Adj R-Square 7
0.005
StErr of Est 0

The value of multiple R i.e. 0.9863 shows multiple correlation coefficient between the
independent variables which are long term debt, short term debt and total debt and the dependent
variable which is profitability. The value of R2 is 0.9728 which shows that all three independent
variables together account for 97.28% of the variance in the dependent variable. The value of
adjusted R2 is 0.9457, which shows that if the data is taken from population instead of sample
then variation will probably decrease to 94.57%. The standard error is 0.0050, which shows that
the value can vary to 00.50% across different cases or can say that regression coefficient is
measured with 00.50% of accuracy.
Table 4.10: ANOVA Table:

ANOVA Table

D
Source f SS MS F p-value
Explained 2 0.0018 0.0009 35.8011 0.0272
Unexplained 2 0.0000 0.0000

The table shows that the model is significant because the value of significance is 0.0272, which
is less than 0.05. This shows that there is almost certainly a true difference in effect of
independent variables on the dependent variable in the population from which the sample was
drawn. The sum of square of explained source is 0.0018 which shows the variance which is
explained by the independent variables. In sum of square column the unexplained 0.0000 shows
the variance, which is not explained by the independent variables.
Table 4.11: Regression Coefficient Table:

Regression coefficients

Coefficient Std Err t-value p-value

Constant 0.3604 0.0733 4.9135 0.0000
EQTA 0.6584 0.2087 3.1550 0.0041
OPEXTA 1.4862 0.5127 2.3127 0.0257

The above table of regression coefficients shows the following results:

Equity to total assets ratio shows the coefficient of 0.6584 and p value of 0.0041, which means it,
is positively and significantly related to profitability. Thus it shows that hypothesis 1(a) is
accepted which is asset management has a significantly positive effect on the profitability of the
firm.

Operating expenses to total assets ratio has t statistics of 2.3127 and p value of 0.0257. The
coefficient of operating expenses to total assets ratio is 1.4862. The p value and statistical
significance validates the acceptance of our hypothesis 2(a) that there is significantly positive
relation between operational efficiency and profitability of the firm.
 Chapter No. 5

CONCLUSION

This Project is aimed to provide a comparative analysis of Islamic banks and the complete

banking sector to examine the impact of assets management, operational efficiency, and banks

size on financial performance of Pakistani Islamic banking sector. The study covered five

Islamic banks situated in Pakistan between the time period of 2011 and 2010. The methodology

used for this purpose includes panel data regression analysis as well as ratio analysis. The data

was extracted from the financial statements and then entered in excel for ratio calculation then

mean and time series were applied on the data. Afterwards regression analysis was used to find

out the affect of the internal indicators on financial performance of the bank.

The performance analysis of Islamic banking sector indicates that Dubai Islamic bank

is the best bank in Pakistan by applying a key number of financial ratios: profitability, liquidity,

capital structure, and efficiency. Moreover, Meezan banks performance has reached the mature

growth unlike other banks in the industry. Meanwhile, small-size banks are encountering some

challenges to achieve better growth. In general, all Islamic banks are doing well to maintain the

stability of banking sector in Pakistan.

The performance indicator ROA was taken as dependent variable to test the hypothesis.

The variables in the regression analysis reacted differently to profitability indicators for entire

Islamic banks. First, total assets, which measure the size of bank, impact negatively on

Pakistani banks, which mean that bigger banks are less profitable. Second, operating expenses,

have a negative influence on banks ROA. Third, operating income has positive impact on

banks financial performance, which means increasing the activities of banks causes increase in
banks performance.
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