THE PROFITABILITY OF ISLMIC ND

CONVENTIONAL BANK: PAKISTANI

PERPECTIVE
ABSTRACT

The aim of this paper is to analyze the profitability of the Islamic banks and conventional banks in
Pakistan. This paper uses the time series data with the time period of year 2012 to the year 2016. In
methodology this research paper is using regression, correlation and T-test model. Data (financial
statements of the selected banks) used is this research paper is taken from BLOOMBURG. According to
the regression test on the conventional banks ROA is influenced by the total equity to total
asset while as there is no any significance for ROA in Islamic bank but ROE is significant. As for
the correlation test, there is no any correlation with ROA & ROE in Islamic bank but it is for the
conventional bank.

INTRODUCTION
There are two types of banking system around the world. One is conventional banking system also
known as interest based banking system. And the other is Islamic banking system also known as interest
-free banking system. The basic differences between these two banking system are their goal interest
and risk sharing practices. Due to the different operating method both Islamic banks and conventional
banks create competition to fulfill the expectations and satisfy the needs of the customers and for the
long term economic benefits.

In 1983 the Islamic banking is introduced in Malaysia. In Pakistan the Islamic banking system as per
sharia principle is operated alongside conventional banking system. Islamic banking system provides an
alternative to the customers to conduct the commercial banking transaction. There are 19 Islamic banks
are operating is Pakistan which are offering Islamic products and services. Among them T here are 5 full
fledged Islamic banks operating in Pakistan. Namely Meezan bank, bank Islami, Al-Baraka bank, Dubai
Islamic bank and MCB Islamic bank. These all are the domestic banks operating in Pakistan.

Dual banking system is practiced in Pakistan i.e Islamic and conventional banking system. Pakistan has
34 scheduled banks among them 7 are the foreign banks. Along with conventional banking system, in
Islamic banking sector 5 banks stand out as market leader .Islamic banking industry represent the 10% of
overall banking industry in Pakistan. The purpose of this study is to analyze weather the performance of
the Islamic banks is different from conventional banks operating is Pakistan. This study has two purposes
first is to analyze the profitability in Islamic and conventional banks and second objective is to identify
the factors that influence the profitability of Islamic banks and conventional banks.
LITERATURE REVIEW
For understanding the capital structure of corporate financing Marizah Minhat and Nazam
Dzolkarnaini(2016) has provided in famous proposition of capital structure irrelevance.
Significant progress has been made to understand the determinants of financing choices. That
resulted in empirical evidence that tested various capital structure theories such as agency
theory (Jensen, 1986), trade-off theory and pecking order theory. In his study he provides
research on IFIs over conventional debt amongst less profitable firms consistent with the notion
that IFIs attracts cheaper source of financing because of ready demand created by restricted
Islamic financial market to lend or invest only according to Islamic sharia.

Here in another study provided by Snaullah Ansari, Khalil ur Rehman on Islamic banks, financial
performances, conventional banks, return on assets. Concept of Islamic banking was in
traduced in 1970. By the year the concept reached to climax practically in Middle East and
generally in all over world. At the moment in 70 countries about 300 Islamic institutions are
working effectively. Thestudy indicates the relationship between banks characteristics and
different performance indicators like ROA, and ROE. The variables used in the study reacted
differently on the financial performance of Islamic and conventional banks.

Again in the comparative study of Muhammad shehzad Moin; lecturer department of

international business administration, college of applied sciences. He tells about the rising and
stiff competition between conventional and Islamic banking globalization deregulation,
liberalization and continues innovation provide Islamically accepted financial services.
Examination of the empirical analysis provides profitability measures indicate that conventional
banks are more profitable and are different from Islamic bank.

Another study given by Muhammad Hanif: assistant professor, national university of computer
and emerging sciences, Islamabad. The study indicates that linkage between financial and real
sector as IFIs cannot extend credit facility without having support from real sector.Sharia based
modes of financing which can create a real difference in the society are not getting momentum
in the operations of IFIs. Hanif and Iqbal(2010) identifies the hindrances.

Dr.aznanhasan (corresponding auther) associate professor. IIUM istittute of Islamic banking and
finance, and of Ruslansahirzyanoy. MSc student IIUM institute of Islamic banking and Finance.
Their study indicates that the demand for Islamic shariah compliant products and services is
ever increasing.

Comparative analysis study by Abid Usman assistant professor, Sarhad university of science
and technology. Muhammad kashif Khan, corresponding author lecturer. Indicates in their
study Islamic banking came into existence in 1963 on an excremental basis on a small scale in a
town of EGYPT. In 1970 is operations widened moderately throughout world. Its alike an
intermediary and trustee of money of other people but the difference is that it shares profit
and loss with its depositors.

In September 2003 another study was provided by Abdel-Hameed, M. Bashir in which they
have indicated emerge of Islamic banking and their profitability increasing significant role in
their respective markets. The work was supported by a grant from the economic research
forum of middle east. Presented in annual conference held on October 26-29th 2000 amman,
Jordon.

For the period from 2004 to 2012 another study has been provided by Abubakar Siddique,
M.Khaleequzzaman, Atiq-ur-rehman. The result shows that significant determinants of
profitability include the variables of both types, internal and external. The findings provides an
insight of characteristics and practices of successful Islamic banks in terms of profitability.

Determinants of Islamic banks an study provided by M.Kabir Hassan, PH.D professor of finance,
Abdel-hameed M.Bashir,PH.D senior economist. This study analyzed how bank characteristics
and overall financial enjoinment affects the performance of the Islamic banks by utilizing bank
level data. These paper findings conform eth previous findings and the study revealed that
larger equity to total assets ratio leads to more profit margins.

An study has been given by Anjum siddique(2008). The purpose of this study was to focus on
Islamic modes and examines their risk and other characteristics. Various performance
indicators of two Islamic banks are examined to compare them with traditional banks. Results
showed that Islamic bank in Pakistan is to engage in little long term financing and also showed
good return on assets and equity and also showed better risk management.

This paper was published in 2011 by Faiza, Khalid and Sehrish and their main findings were that the
conventional banking system is influenced by the assets, liquidity and interest of the bank.

Muhammad KASSIM did the study on the 194 different Islamic and conventional banks in the GCC
countries in 2010 and concludes that customer confidence plays great role along with other risk factors
for any bank.

Omar Masood, Hasan Ali Suwaidi, Priya Darshini Pun Thapa(2012) wrote paper in order to identify any
differences between Islamic and non-Islamic banks in the UAE. This study used survey based
methodology and the result showed that now managers of the Islamic banks do not relay on personal
experience and simple credit risk analysis rather Islamic banking practicing newer and robust techniques
in addition to traditional methods to increase their performance compared to non-Islamic banks.
DATA AND METHODOLOGY
Our research paper is Quantitive research and we have taken the secondary data from the
financial statements of the respective banks such as commercial (habib bank, askari bank and
alfalah bank) and Islamic banks (Al-Mezaan, bank al baraka and bank Islami).

We have also sought the data for the definitions of difference between Islamic banking and
conventional banks. We have taken the data such as Total long-term loan, total deposits and
total equity and total assets of the above mentioned banks.

We have taken three independents variables i.e. total loan to total assets, total loan to total
asset and total equity to total assets. While as our dependent variables are return of equity and
return on assets.

Our research model is based on the following equation:

ROA= a+B1X1+B2X2+B3X3+e (module 1)

ROE= a+B1X1+B2X2+B3X3+e (module 2)

Where as

B= beta

X1= total Deposits to asset

X2= total Loan to asset

X3= total Equity to asset

Hypothesis are defined as following

For regression

H0= there are no any factors that change the profit of the conventional and Islamic banks.

H1= there are factors that change the profit of the conventional and Islamic banks.

Hypothesis for correlation

H0= there are no any factors that change the profit of the conventional and Islamic banks.

H1= there are factors that change the profit of the conventional and Islamic banks.

We have also compared the mean of the Islamic and conventional banks of independent
variables.
RESULT AND FINDINGS
Comparison of the mean of Islamic and conventional banks

Standard standard
Average dev error
Conventional 0.794620432 0.0851061 0.038060604
TD to TA Islamic 0.843656734 0.07459378 0.033359354

Conventional 0.384574022 0.0771202 0.034489202

TL to TA Islamic 0.124887602 0.06929539 0.034489202

Conventional 0.065468859 0.00726259 0.003247929

TE to TA Islamic 0.063168529 0.00563284 0.002519084

Aerage str dev str error

Convetional 0.94 0.37335773 0.166970654
ROA Islamic 0.518719722 0.64390755 0.28796421

Standard standard
Average dev error
Conventional 13.65 6.70925832 3.000471535
ROE Islamic 7.69530049 9.18602896 4.108117039

In the above data, in the first part the ratio of total deposit to assets is greater in Islamic
banking than the conventional banking, this shows that the Islamic bank is less risky, and they
have more assets in case of the solvency.

To loans to total assets ratio of the conventional banking is greater than Islamic banking that
might be due to the other factors such as branches of conventional banks, total equity to total
assets ratio of conventional banking is slightly greater than the Islamic banking.
RESULT FOR REGRESSION
Conventional ROA

Above table shows that R square .549 that is representing 54.9% of the data changes in ROA is
due to the independent variables. This result shows that there is no significant factor for total
deposit to total asset and total loan to total asset which is impact the profit of the conventional
banking while keeping ROA as a dependent variable. While as if you look at each variable
independently then total equity to total asset is significant as significance level is 0.009 and t
value is greater than the 2.
 Conventional ROE

In above table R square is 24.4% which shows that 24% change is ROE is because of the

explanatory variables. Above result is showing that there is no significant factor impact the
profitability measuring return of equity of the conventional banks.
Islamic bank ROA

In above table R square is 27.1% showing that 27.1% changes in Return on assets (dependent
variable) is because of the explanatory variables. Above result is showing that there is no
significant factor impact the profitability measuring return of equity of the Islamic banks.
 Islamic bank ROE

Table: 2.4 shows that R square .489 that is representing 48.9% of the data changes in ROA is
due to the independent variables. This result shows that there is no significant factor for total
loan to total asset and total equity to total asset which is impact the profit of the Islamic
banking while keeping ROE as a dependent variable. While as if you look at each variable
independently then total Deposit to total asset is significant as significance level is 0.011 and t
value is greater than the 2.

Results for the Correlation

Conventional ROA
This shows that only total equity to total assets have significance with the ROA which is positive
.603 at the 0.05 significance level while as if we look at the above table then we can conclude
that other variable Total loan to total asset is also correlated with the significance level of 1%.
While as other variables are not correlated for conventional banking.
Correlation of ROE for conventional banking

The above data shows that ROE is not significant at any level. While as other variable total loan
to total deposit is significant at 0.01 and they are positive apart from this no any other variable
is correlated with each other.

Islamic Correlation of ROA

In the above table, ROA of Islamic banking is not significant with variables while as total loan to
total assets have positive significance level of .590. apart from this no any other variable is
significant in Islamic banking with ROA.

Islamic banking ROE

In the above table ROE is not significant at 5% level with any explanatory variable. From the
three variables only, total Deposit to total asset is significant with the Total loan to total assets.

Conclusion

As per the regression test for the conventional banks, result shows that total equity to total
asset is significant factor the influences the profitability of conventional banking whereas for
the ROE there is no any single independent variable which effects it.

While as for the regression in Islamic banking there is no any significant variable which has any
impact on ROA but in the ROE total Deposit to total loan is significant which affects the
profitability of the Islamic banks.

According to the Correlation test findings, in conventional bank only total equity to total asset is
correlated with ROA while no any variable is related with ROE in the conventional banking. For
the Islamic banking, there is no any correlation with ROA and ROE.
REFERENCES
Marizah Minhat and Nazam Dzolkarnaini(2016), Which Firms use Islamic Financing.

Snaullah Ansari, Khalil ur Rehman, comparative financial performance of existing Islamic and
contemporary conventional banks.

Muhammad shehzad Moin, financial performance of Islamic and conventional banks.

Muhammad Hanif(2012), difference and similarities in Islamic and conventional banking.