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Islamic vs. conventional banks in the GCC

Islamic banking has gained a lot of significance in the past decade owing to its immense growth potential. This banking model is expected to fuel dampened growth in conventional banks. Islamic banks (IB) offer products similar to conventional banks (CB), but with a slightly different concept. These are prohibited from charging interest (riba) since in Islam money cannot be treated as a commodity and hence, profits aren’t made through lending money. On the other hand, conventional banks make profits through higher interests on loans than they pay on deposits. Islamic banking system employs three major principles:

1. Risk and reward sharing.

2. No interest is charged. They charge fees and rentals for the services offered.

3. Strict adherence to investments in Sharia-compliant products. These cannot invest in businesses involving tobacco, gambling, etc. All investments and loans are backed by assets.

Thus, Islamic banks invest in real assets and can be directly correlated with the real GDP growth of an economy. The below table points out few differences among conventional and Islamic banks through certain products.

The global Islamic banking assets breached the $1.5 trillion mark at the end of 2016, while conventional banking assets amounted over $35 trillion. The below graph explain this in a better way. The growth in Islamic banking assets was higher than conventional banks, supported largely by the unbanked Muslim population, growth of “halal based” products industry, governmental support in both the Muslim and non-Muslim nations and due to numerous Shariah compliant investment opportunities. 

The GCC (Gulf Cooperation Council, this include United Arab Emirates, Bahrain, Saudi Arabia, Oman, Qatar and Kuwait) accounts for 41% of the total Islamic banking assets in the world. These nations are also most invested and nearly 50% of their banking assets are in Islamic banking institutions. Iran, Malaysia, Bangladesh, Sudan and Brunei are few such countries outside the GCC that have significant assets in Islamic banking institutions. 

The below are asset and revenue growth rates of few of the top conventional and Islamic financial institutions, this help to delve deeper in the GCC.

The main reason behind the sharp growth of many Islamic banking institutions was their ability to maintain consistent profitability while taking calculated risks. These, when compared with conventional banking, were found a tad more profitable, they were also riskier.

Moreover, Televisory assigned scores to a select GCC bankers as listed above on different parameters including profitability (financial management score), capital ratios, liquidity, credit quality (risk management score) and plotted these in the below graph. 

Note: Analysis is based on annual reports of year 2016. Please refer to the appendix for methodology and other details. Orange indicate Islamic Banks (IB) and Blue indicate Conventional banks (CB). Short names for all banks are given in the table above the graph. 

Therefore, from the above graph, Televisory inferred that for any given level of profitability, Islamic banks are less risky than conventional banks in the GCC. For instance, QAIB (Qatar Islamic Bank) is less risky than QNBCB (Qatar National Bank), while being slightly more profitable than the latter. Conventional banks scored better in terms of profitability management because of higher net income margin and better efficiency ratio than their Islamic banking peers. In fact, Kuwait Finance House (KFHIB) scored lower in both these accounts and has the lowest profitability management score. Islamic banks maintain more liquidity in terms of cash, lower loan defaults, sufficient provisioning and lower leverage as compared to conventional banks. Hence, their risk management scores are better than conventional banks. In addition, both Islamic and conventional banks in the GCC maintained higher capital ratios (both tier 1 and total risk-based capital) than required under Basel 3 regulations. The credit quality is better in Islamic banks due to their risk sharing model of business, this ensures prudent underwriting practices. Although the risk exposure of Islamic banks is higher as they partake borrower’s risk, the rate of default and subsequent costs associated are much lower in comparison to conventional counterparts.

The Islamic banking is bound to grow not just in the GCC, but in other parts of the world as new nations including India are comprehending the benefits of the banking model and making it assets backed and connected to the real GDP growth. Islamic banking is considered as “ethical financing” or “socially responsible financing” and several governments are contemplating measures to introduce the banking model to bring in the much-needed stability in the financial system. Additionally, Islamic banks are presently at least 12 times smaller than the large conventional banks thereby, diluting the concept of ‘too-big-to-fail’ in the conventional banking industry. This is also being viewed as an important tool for financial inclusion, especially for the unbanked Muslim population across the world. It should be noted that with the rise of Islamic banking institutions, stricter regulations pertaining to liquidity, capital adequacy and KYC norms should be implemented in the context of these institutions as in the case of conventional banks.  Thus, with a proper regulatory board and extensive governmental support, the market for Islamic banking is set to grow manifold and provide stability in the upcoming decade.

Analysis methodology

Ratios for all the banks were calculated based on latest annual data. Further, each category of ratio was assigned a total weightage of 100%, profitability ratios were categorised under financial management and credit quality, liquidity and capital ratios were categorised under risk management. The criteria and weightage assigned are explained below:

The ratios (or variance) were multiplied with their respective weightages and scores were attained under each of the categories. This was further collated under financial management and risk management as stated above.

Appendix:

Ratios for each of the banks used for analysis is for year 2016.

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