Islamic versus Conventional Banking: An Empirical Assessment

Abstract

Islamic banking has evolved as the focused area of research by policy makers, academicians and banking personnel following global financial crisis. Despite extensive research on Islamic banking, many aspects remained unfolded. Islamic banking is an emerging market which is flourishing day by day and ensuring its presence around the world. With the innovation and development of non-interest based products, the need for the research in this area is increasing. Apart from the studies comparing Islamic and conventional banks based on traditional performance analysis, we studied Islamic banking from three different perspective. Precisely, this dissertation comprises of three separate but interrelated essays. Each essay is based on a specific objective with respect to comparison of Islamic and conventional banks with regards to their response to different phases of business cycles, their ability to provide stability to the overall financial system, and their contribution in economic development of a country over the period 1995-2014. In first essay, we empirically investigate the difference between Islamic and conventional banks in terms of business dynamics, cost structure, credit quality, and stability. We also examine the difference in response of two types of banks during peak, expansion, contraction, and trough phases of the business cycle. The empirical findings of first essay reveal that Islamic banks are more involved in fee based business, are less cost efficient, have higher credit quality, and have higher capitalization than conventional banks. We also find that Islamic banks outperformed conventional banks with regards to their credit quality and stability indicators during trough phase of business cycle. This better performance seems to be due to the differences in the provisioning strategies of the two types of banks, the non-aggressive lending profile of Islamic banks, and due to their investment in real assets. The second essay examines the financial stability of the countries having both Islamic and conventional banks versus the countries having conventional banks only. The investigation reveals that dual banking system is more stable than single banking system, and higher stability of dual banking system is attributed to the presence of Islamic banks in the system. Furthermore, when only dual banking system is investigated, the results confirm greater stability of Islamic banks as compared to their conventional counterparts. Islamic banks are mimicking conventional banking practices, but due to their increased interaction to the real economy and limited exposures to the speculative activities are proved to be more resilient and protected. The third essays investigates the impact of Islamic banking development on economic growth and domestic investment and finds strong evidence that Islamic banking development has a significant impact on economic growth and domestic investment. Islamic banking stimulates growth and investment in the economy due to unique nature of their activities which are linked to the real economy and are based on physical transactions. Moreover, Shariah promotes social justice and equity, and prohibits Islamic banks from undertaking harmful products and activities. The findings of this study provides useful insights for regulators and policymakers regarding adoption and working of Islamic banking.