Monday, June 17

Islamic vs. conventional banking: Business model, efficiency and stability

This paper was quite an interesting one. I quote the abstract:

How different are Islamic banks from conventional banks? Does the recent crisis justify a closer look at the Sharia-compliant business model for banking? When comparing conventional and Islamic banks, controlling for time-variant country-fixed effects, we find few significant differences in business orientation. There is evidence however, that Islamic banks are less cost-effective, but have a higher intermediation ratio, higher asset quality and are better capitalized. We also find large cross-country variation in the differences between conventional and Islamic banks as well as across Islamic banks of different sizes. Furthermore, we find that Islamic banks are better capitalized, have higher asset quality and are less likely to disintermediate during crises. The better stock performance of listed Islamic banks during the recent crisis is also due to their higher capitalization and better asset quality.

Given the financial crisis, this new model has quite a lot of lessons for the modern Anglo Saxon world of banking. I've been keeping track of Islamic Finance for some time now and this has changed quite a lot since the early days.


Full-size image (26 K)

The profit sharing element has quite an interesting behaviour as they end up being better capitalised with lower loan losses. In other words, they become a sort of private equity type of firm. Interesting, I wonder if these lessons will be learned by the regulators? Or force bad performing loans to be converted into equity like the CoCo’s? Not for the banks but for the firms to which the banks have lent to?

1 comment:

Anonymous said...

One aspect of Islamic Banking that I find very innovative and potentially momentous is its outlook on deposits and depositors. Depositors are considered the unfair players of the banking game and are pretty much outlawed in theoretical Islamic Banking (in practice not so much). The reason given is that depositors put their money in the bank to protect it from inflation, which is consequently invested by the bank through other loans, or investments. Such activities carry inherent risk, but depositors expect guaranteed returns in form of interest yet bear no risk of the loan/investment. This is considered unfair behavior and thus depositors in an Islamic system must either let inflation run its course on their cash or use sharia compliant contracts to invest.