Chapter One The Introduction



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3.5.5 Longitudinal design:

Researchers apply this type of research design to monitor any possible change in the research’s subject over time; it is used to lengthen the survey research period (Sekaran and Bougie, 2010).



3.6 Research's quality:

The quality of the research comprises four basic features:



  1. Validity.

  2. Reliability.

  3. Generalization.

  4. Transparency.

3.6.1 Research’s validity:

According to Hair (2007), a research's validity depends on the following factors:



  1. Instrumentation.

  2. History.

  3. Testing.

  4. Ambiguity relating to the direction of the study.

  5. Maturation.

  6. Morality.

According to this type of research, the first four factors are not related to this study, and maturation has little impact on the research; accordingly, this study uses secondary data that comes from different resources.

3.6.2 Research's reliability:

The research reliability indicates an assurance of the results through testing the results that emerge from the analysis (Quinton and Smallbone, 2006). Therefore, there are four threats that might occur to the reliability, they are:



  1. Bias from the participants.

  2. Participants' error.

  3. Observer error.

  4. Observer bias.

In this research only observer error and observer bias are relevant to the study because there are no interviews in this research.

3.6.3 Generalization:

In quantitative research, the researcher understands that his results may only be usable for that particular research environment and scope. They could be used as a basis and could even be applied in different research. Accordingly, the researcher works to generate a sample that will represent a greater population in order to generalize the results (Quinton and Smallbone, 2006).


3.6.4 Transparency:

The results of the data analysis and the conclusion of this research will illustrate to the reader how the work has been conducted, as well as the relation between data analysis and the conclusion (Hair, 2007).



3.7 Ethical considerations:

Research ethics refers to the methods the researcher will use to formulate, clarify and design the research subject and how the researcher can get access, collect, process and analyse the data and write the research outcomes taking into account more ethical considerations (Saunders, Lewis and Thornhill, 2007).

This research is conducted according to all the ethical rules and guidelines of Coventry University Faculty of Business, Environment and Society.. The research only uses secondary data; this data can be accessed easily, is available any time and I will only use it for the purpose of this research.

3.8 Plagiarism:

The author understands intellectual properties and whenever the author uses work of other authors it will be fully referenced and will be rewritten in the author’s words without any change to the original content idea. The author will provide a chapter at the end of this research with all the references used in accomplishing this research using the Harvard Reference Style.



3.9 Data collection methods:

The researcher is going to use secondary data in order to answer the research questions and cover the objectives of the research. The secondary data may include articles, books, annual reports, newspapers, published journal and raw data (Saunders, Lewis and Thornhill, 2007).

According to the objectives of the study, the research aims to analyse and evaluate the financial performance and the financial stability of the top ten commercial and the top ten Islamic banks. Consequently, the researcher will use the financial information of these banks, and this financial information was issued in the form of financial statements in the annual reports of the banks; accordingly the researcher will use the secondary data from the websites of these banks to obtain the financial statements.

The other reasons for selecting only secondary data are that the researcher does not have access to any bank, the sample banks are in different countries in the world and there is limited time to conduct the research.



3.9.1 Secondary data:

It is possible to collect both qualitative and quantitative secondary data, which can be employed in an explanatory way in descriptive research. There are three subgroups of secondary data: documentary, survey-based and data obtained from many sources (Saunders, Lewis and Thornhill, 2007).





3.9.2 Secondary data resources for this research:

The focus on secondary data collection for the Islamic and commercial banks was the annual reports of the banks, recent articles and journals through websites, university electronic database and books, which include:

The annual reports were issued by the banks, and the financial reports from websites such as the Financial Times, BBS and Congressional.

The literature review includes the most recent published journals that are related to ‘the Islamic and commercial banks’ from Science Direct, EBSCO, Journal of Banking and Finance, Journal of Islamic Economics and Finance, Journal of Finance, Journal of Islamic Economics, Banking and Finance, and Electronic Journal of Social Sciences.

The literature review includes the most recent published journals and articles that are related to ‘the financial crisis’ from Science Direct, EBSCO, Journal of Risk Management in Financial Institutions, Journal of Financial & Quantitative Analysis, International Journal of Monetary Economics and Finance, and International Journal of Political Economy.

3.10 The method applied in the analysis:

The researcher is going to evaluate the financial performance and the financial stability of the top ten commercial banks and the top ten Islamic banks by using the financial ratio analysis, horizontal analysis and Statistical Package for Social Sciences (SPSS).

There are several financial ratios that could be used to determine the financial performance and stability of the banks in order to introduce a clear view about the financial position of these banks. However, since this study is dealing with the analysis of twenty banks in eleven different countries, and as a result of the difference in the countries, also different laws and financial legislation, there appears significant differences in the nature of the financial statements issued; this led the researcher to restrict the selection of the financial ratios to those that are compatible with the financial statements of these twenty banks. Therefore, the researcher will select the financial ratios that they share with each other by using the main items in the balance sheets and income statements; in other words, the commercial and Islamic banks share the following in their financial statements:


  1. Total assets.

  2. Total liabilities.

  3. Total equity.

  4. Total revenue.

  5. Net profits.

  6. Earnings per share.

Accordingly, the researcher adopted these fundamental items in the financial statements in order to determine the best financial ratios to achieve the objectives of this study; therefore the researcher will use the following six financial ratios:

  1. Net profit margin (NPM).

  2. Return on equity (ROE).

  3. Return on assets (ROA).

  4. Assets turnover ratio.

  5. Gearing ratio.

  6. Earnings per share.

3.10.1 Financial ratios analysis

The ratio is a simple expression of a number relative to another number; in order for the ratios to be considered as meaningful indexes, there should be a clear and specific relation between the two numbers used in calculating each ratio. More often there is a need calls to search and test the nature of the information, or the basic numbers used in calculating the ratio, in order to explain and understand the full meaning of this relation; the ratio by itself may not mean much unless it is compared with other ratios in a different year or with the industry standard ratios (Walsh, 2003).

Generally, it is possible to divide the financial ratios into four basic categories as follows.

3.10.1.1 Profitability ratios:

A set of financial ratios that connect profits with sales to express the extent of sales' ability to generate profits and the ability of banks to use their equity and assets to generate profits.




  • Net profit margin (NPM):

This ratio is used to determine the extent to which the firm has the ability to encounter the difficult situations that may emerge either from declines in the product's market price or because of a rise in the product's manufacturing expenditures. In addition, this ratio can be used to measure whether there is a decline in the sales volume and to measure the net profit volume attained after the interests and taxes per dollar from the revenues. Finally, a higher ratio indicates that the firm is more profitable and has a better control over its costs (variable, operating and financial costs) compared with the other competing firms (Melville, 2008).



  • Return on equity: (ROE):

Also called return on net worth, this is used to measure the volume of the achieved profit as a percentage of the common shareholder's equity. Thus it is the average of the net profit that the investors achieve from investing their money, as a return on their risk. This ratio indicates the management’s competence in operating the shareholders’ funds (Melville, 2008).




  • Return on assets (ROA):

This ratio is considered an index to measure the extent of the firm's profitability relative to its total assets. In addition, it measures the management efficiency in using the assets to generate the profits (called return on investment) and it greatly depends on the type of industry and the volume of assets used in production. Accordingly, this ratio is used to compare between firms within the same sector to know the volume of profits resulting from investing in assets (Melville, 2008).



3.10.1.2 Efficiency or activity ratios:

These ratios are used to evaluate the extent to which the firm's management is successful in managing the assets in order to generate revenue, which is considered the basic source of profit.



  • Assets turnover ratio

This ratio is considered one of the most important ratios to measure efficiency. This ratio measures the extent of the ability of the banks to use their assets to generate revenue, and it shows the range of generating revenue from each dollar of assets (Mckenzie, 2010).




3.10.1.3 Capital structure ratios:

These ratios are called solvency ratios and are considered instruments to evaluate the extent of the firm’s ability to pay its long-term obligations; they also measure the extent of the success of the financing policy used in the firm and, in balancing between external and internal financing resources, the reflections of its policy on financial leverage risk. The most important ratios that can be used in this field are the following:



  • Gearing ratio

The assets of the bank can be funded in two ways:

  1. Liabilities (borrowing).

  2. Equity (retained earnings + capital share).

When the banks require the financing of new assets, they make financing decisions based on the costs and risks; borrowing is considered less costly than equity but equity is considered less risky than financing through borrowing. Accordingly, the importance of studying the gearing ratio appears to determine the financial risks that the banks encounter (Mckenzie, 2010).

This ratio was measured based on the ratio of the total liabilities to the total assets.





3.10.1.4 Market ratios:

These ratios help the shares analysts in performing their tasks when evaluating the firms' performance; they also help the present and prospective investors dealing with and working in the financial markets to know the attitudes of the stock market prices.

The most important ratios used in this field are the following:


  • Earnings per share (EPS)

According to the international accounting principle 33, the net profit or net loss for the period for the common stock holders is the net profit or loss after deducting the sum of the profits for the holders of the preferred shares, and all the recognized items of the revenues and expenditures during the period, including the taxes and expenditures, the unusual items and minority equity, mentioned in determining the net profit or loss for the period.

Accordingly, this ratio illustrates the banks' ability to generate net profits to the shareholders per share; furthermore, many of the investors depend on it in their investment decisions because it is an important index regarding the banks’ financial performance (Mckenzie, 2010).




3.10.2 Horizontal analysis:

Horizontal analysis is an essential method used to determine the fluctuations in the total assets, total equity, total liabilities, net profit and total revenue of the banks over a period of time, and to illustrate the strengths and weaknesses of the banks (Elliott, 2009).



3.10.3 SPSS – Statistical Package for the Social Sciences:

SPSS is a computer program for statistical analysis introduced in 1968 by Norman H. Nie; it is used to evaluate variables in relation to government research, bank research, marketing organizations and survey companies, to determine whether the variables are input or output.

SPSS can be used for the purpose of analysing data management and documentation and for other types of analysis, such as descriptive analysis, prediction numerical outcomes, predictions for identifying groups and vicariate statistics.

In this paper, the researcher will calculate the mean and the standard deviation of the financial ratios during the period of study (2005–2009) to outline the results of the financial ratios. In addition, the researcher will calculate the average and the mean of the standard deviations of the study period in order to give a clear understanding regarding the financial position of the Islamic and commercial financial systems (Burns and Richard B, 2008).



3.11 Limitations of the research

1. The differences in the currencies between the banks and the countries.

2. The differences in the financial standards adopted in the issuance of financial statements.

3. The differences in the financial transactions of both systems, which leads to differences in their financial policies.

4. There are huge differences in the total assets, liabilities and equity for both systems, which has an impact on the comparative analysis of both systems.
Chapter Four

The Analysis

4.1 The Introduction

In this chapter, the researcher is going to introduce the results of the determinants of the financial performance, financial stability and the effect of financial crisis on the top ten Islamic and the top ten commercial banks over the period 2005–2009.

This part of the dissertation will present a detailed analysis of the financial performance, financial stability and the effect of the financial crisis on the top ten commercial banks by using different types of the financial ratios, such as net profit margin, return on equity, return on assets, assets turnover, earning per share and gearing, and it will also introduce a detailed analysis about the financial performance and stability of the top ten Islamic banks using the same financial ratios used to examine the commercial banks. Next, there will be a ratio comparison between the top ten Islamic and the top ten commercial banks in order to compare their financial position with each other.

The researcher relies in this analysis on the main items of the Income statement and the balance sheet, whereby the changes in these items during the period of the study led to differentiation in determining the analysis period. Moreover, after the comparison the chapter will present an SPSS analysis on the financial ratios of both types of banks, in order to summarize the financial position in each year for both systems and the entire period of the study.




4.2 Financial Ratios Analysis

4.2.1 Commercial Banks
During the Period 2005–2006:

The relative growth in the net profit and revenue led to stability in the NPM of commercial banks, where it was around 21.5% during this period.

The revenue increased from $458 billion to $611 billion and the net profit increased by $29 billion, which is equivalent to 29% growth. Consequently, according to the difference in the growth, there was slightly decrease in the NPM from 21.75% to 21.7%.

During the period 2006–2007:

During this period, there was a decline in the NPM by 4.15% due to the instability in the growth between the revenue and the net profit. The revenue increased from $611 billion to $740 billion, and the net profit decreased from $129 billion to $117 billion; this fluctuation in the NPM can be seen as a result of inefficiency in controlling the financial and operating costs. Furthermore, the financial crisis strongly affected the market value of the financial assets and led to a reduction in the book value of the assets as well.


During the Period 2007–2008:

During this period, the NPM decreased dramatically from 17.4% to -5% because of the decline in the total revenue of the commercial banks from $740 billion to $687 billion, which is equivalent to 7%, and the net profit decreased sharply from $117 billion profit to $56 billion net loss, which is equivalent to 148%. As a result, the NPM decreased sharply due to the effect of the financial crisis on the banks. For example, Citigroup Bank suffered a loss of $32 billion in 2008 and the Royal Bank of Scotland faced $50 billion losses during the same period.



During the Period 2008–2009:

After the impact of the financial crisis on the commercial banks during the period 2007–2008, these banks attempted to counter the financial crisis more effectively than the previous year; this shows in the ability of the commercial banks to increase NPM from -5% to 12.5%. Although the revenue decreased during this period from $687 billion to $564 billion, with a decrease ratio equal to 18%, the main reason for this increase in the NPM was the great growth in net profits during the same period, where the net profits increased from $-56 billion to $61 billion with a growth ratio of 208%.

For instance, Citigroup Bank reduced its losses from $32 billion to $1 billion, while the Royal Bank of Scotland reduced its losses from $50 billion to $3.7 billion; this indicates the high ability of the commercial banks to reduce their operational expenditures that resulted in an increase in the net profits even as the revenues decreased. Moreover, the governments’ assistance introduced a big opportunity for the banks to improve their financial situation; for instance: “Citigroup received $45 billion in Troubled Asset Relief Program (TARP) funding, including $20 billion through the Targeted Investment Program (TIP) and $25 billion through the Capital Purchase Program (CPP) (Congressional, January 2009). Furthermore, “Royal Bank of Scotland (RBS), Lloyds TSB and HBOS will have a total of £37bn injected into them” (BBC, October 2008).

During the Period 2005–2006:

ROE ratio increased from 15% to 17%; this increase was due to the growth in the net profit from $100 billion to $129 billion, which is around 29%. In contrast the equity increased from $684 billion to $825 billion during the same period, which is around 21%.



During the Period 2006–2007:

During this period, the ROE ratio decreased from 16.6% to 14%; this decrease occurred as a result of the growth in equity and decrease in the net profits during this period. The equity increased from $825 billion to $945 billion, which is equivalent to 14%. In contrast the net profits decreased from $129 billion to $117 billion during the same period, which is equivalent to 9%.



During the Period 2007–2008:

During this period, there was a sharp decrease in the ROE as a result of the impact of the global financial crisis on the financial sector generally, and on the banking sector in particular, which directly affected the revenues and the net profits of the commercial banks. This indicates the commercial banks’ low competence in using the available funds from the equity (shareholders funds and the retained earnings) to generate profits. Generally, the ROE ratio decreased during this period from 14% to -5.1%; this occurred as a result of the great losses that the commercial banks in the sample faced during the financial crisis, whereby the net profits decreased from $117 billion to a net loss of $56 billion, with a decreased ratio equal to 148% and a constant equity growth ratio of 1%.



During the Period 2008–2009:

After the impact of the financial crisis on the commercial banks during the previous period, the commercial banks attempted to counter the financial crisis more effectively than the previous year. This shows in the ability of the commercial banks to increase the ROE ratio from -5.1% to 6.1%; the reason for the increase in the ROE ratio was the result of the great increase in the net profits from -$56 billion to $61 billion, equal to 208%, and the equity increase from $959 billion to $1226 billion, equivalent to 28%.



During the Period 2005–2006:

During this period the ROA increased slightly from 0.77% to 0.82% due to the increase in the total assets and an expected increased in the net profit. The total assets increased from $12,999 billion to $16,100 billion, which is equivalent to 24% and the net profit grew from $100 billion to $129 billion, which is equivalent to a 29% growth in the net profit.



During the Period 2006–2007:

More interestingly, the net profit decreased from $129 billion to $117 billion, and the total assets increased from $16,100 billion to $22,394 billion; this instability led to a decline in the average of the ROA by 9% during this period.



During the Period 2007–2008:

The period of the financial crisis led to a sharp decrease in investment opportunities. Therefore, the ROA decreased strongly, whereas the total assets increased by 8% but this increase was not used properly to increase the net profit, where the average of the net profit fell from $117 billion to a $56 billion loss, equal to a 148% decline.



During the Period 2008–2009:

During this period, the average of the ROA increased dramatically due to the increase in assets of 6% and the commercial banks used these assets properly to generate a high percentage of profit, whereby the net profit increased by 208%. This improvement shows the ability of commercial banks to use their financial assets in order to generate profit.


During the Period 2005–2006:

The assets turnover increased during this period from 3.6% to 3.9%. This occurred as a result of the growth that was accomplished by the top ten commercial banks in terms of revenues, with a ratio higher than the growth in the total assets. The revenues increased from $458 billion to $611 billion, with a growth equal to 33%. At the same time, the total assets increased from $12,999 billion to $16,100 billion during the same period, with growth equal to 24%.



During the Period 2006–2009:

Generally, the assets turnover declined from 3.9% to 2.57% during this period. This indicates that the efficiency of the commercial banks in using their financial assets to generate the revenues decreased; the reason for that were the total assets of the commercial banks increased from $16,100 billion to $22,539 billion during this period, equivalent to 40%, and the revenue increased by 9%.

In other words, the top ten commercial banks increased their financial assets during this period by $6,439 billion but did not take advantage of this increase in their financial assets in an effective way to generate revenues.
During the period 2005–2007:

The EPS increased from $2.34 to $4.86 during this period, due to the increase in the net profit from $100 billion to $117 billion; this increase indicates the ability of the banks to use their share capital in order to increase their shareholders’ wealth.



During the period 2007–2008:

The financial crisis strongly affected the banks’ investments, which led to a decline in the return on the investments and this decline strongly affected the shareholders’ returns, where the EPS decreased from $4.86 to -$0.89 due to the decline in the net profit.



During the period 2008–2009:

During this period, many banks received financial assistance from their governments. For example, the UK government injected £37 billion into three banks in the UK (BBC, October 2008), and the USA government introduced financial assistance to Citigroup by $45 billion through the Troubled Asset Relief Program (Congressional, January 2009). This funding contributed to an improvement in financial performance, where the net profit increased from -$56 billion to $61 billion, which led to increase the EPS during this period.



During the period 2005–2006:

There was great stability in the average of gearing during this period, which was around 94.8%. The reason for this stability is the steady growth between the assets and the liabilities, whereby the average of the assets increased by 24% and the average of the liabilities increased by 24%.



During the period 2006–2008:

There was increasing in the average of gearing of 0.9%, due to the increase in the average of funding for the assets by loans. However, the total assets increased by $7,986 billion, of which $7,852 billion was funded by borrowing, and the rest was funded through equity ($134 billion).



During the period 2008–2009:

After the effect of the global financial crisis on the commercial banks during 2008, these banks attempted to reduce their financial and liquidity risks through reducing their gearing ratio; this is clearly seen through the decrease in the total assets and liabilities with the increase in equity during this period. Commercial banks reduced their total assets by $1,547 billion, equal to 6%; the total liabilities were reduced by $1,814 billion, a decline equal to 8%; and there was an increase in equity of $267 billion, a growth equal to 28%.



4.2.2 Islamic Banks
During the period 2005–2007:

During this period, there was a massive increase in the NPM, where it rose from 34.18% to 49.78%. This occurred as a result of an increase in the net profit from $1,758 to $5,259 million, equivalent to 195%, and the revenue increased from $4,887 to $10,413 million, equivalent to 113%.



During the period 2007–2008:

The financial crisis affected the NPM of the top ten Islamic banks, where the NPM decreased from 49.78% to 37%. This decline was due to the unbalanced growth in the net profit and the total revenue, whereby the total revenue increased from $10,413 million to $12,558 million, equal to 21% growth, and the net profit declined from $5,259 million to $4,666 million, equivalent to 11%. Therefore, the decline in the average of the net profit shows the effect of the financial crisis on the ability of Islamic banks to control their administrative and financing expenditures.



During the period 2008–2009:

The decline of the NPM continued during this period, where the total revenue increased by 11% and the net profit decreased from $4,666 million to $3,870 million, which is equal to 17%; this illustrates that the Islamic banking system did not have the efficiency to reduce the effect of the financial crisis.


During the period 2005–2007:

The ROE increased from 16.72% to 24.74% due to the massive growth in the net profit and the total equity, where the net profit increased from $1,758 million to $5,259 million and the total equity increased from $12,462 million to $23,621 million. This increase indicates the high ability of the Islamic banks to use their financial recourses from equity to generate profit, which led to an increase in their shareholders’ wealth.



During the period 2007–2009:

More interestingly, the financial crisis affected the shareholders’ returns, where the total equity increased by 19%. In contrast, the average of the net profit decreased by 26%, due to the financial leverage for the Islamic banks, in particular in 2008–2009 and, according to the financial leverage theory, any decrease in the revenue will lead to further decline in the net profit (Korteweg, 2010). This decrease in the net profits indicates a decline in the average of the investments of the Islamic banks during this period.



During the period 2005–2007:

During this period, there was an increase in the average of the ROA, where the ROA increased from 2.37% to 3.33%, and this increase was due to the improvement in the average of the net profit, whereby the net profit increased from $1,785 million to $5,259 million with a growth rate of 195%, and the equity increased from $12,468 million to $23,621 million with a growth rate of 90%.



During the period 2007–2009:

It is obvious from the ROA ratio the impact of the global financial crisis on the Islamic banks during this period. It is also obvious through the great decrease of the ROA ratio from 3.33% to 1.7% during this period; this occurred as a result of the increase in the total assets, which was supposed to result in an increase in the net profits, but actually there was a decrease in the net profits.

The Islamic banks’ total assets increased during this period from $151,888 million to $205,655 million, with a growth ratio equal to 35%, while the net profits decreased from $5,259 million to $3,870 million during the same period, with a decreased ratio equal to 26%.

This indicates that the Islamic banks increased their total assets by 35% but these banks did not take advantage of these new assets to generate additional profits.


During the period 2005–2006:

The assets turnover of Islamic banks increased from 6.26% to 6.58% during this period, due to the growth that occurred in the revenues by a higher ratio than the growth in the total assets during this period, whereby the total revenues of the Islamic banks sample increased from $4,887 million to $7,508 million, which is equal to 54%, and the Islamic banks’ total assets increased during this period from $83,421 million to $112,728 million with a growth ratio equal to 35%.



During the period 2006–2008:

The Islamic banks continued to improve their competence and used their assets to generate revenues; this is clear through the rise in the ratio of the assets turnover during this period, whereby this ratio increased from 6.58% to 7.33%.



During the period 2008–2009:

The assets turnover decreased slightly, due to the increase in the total assets being bigger than the increase in revenue. In other words, the Islamic banks increased their assets, but this increase was not used effectively in order to generate revenue, which led to a decrease in the assets turnover ratio from 7.33% to 7.21%.



During the period 2005–2007:

During 2005–2007 there was growth in the earnings per share due to the massive increase in the net profit, whereby the net profit increased from $1,785 million to $5,259 million, growth of around 195%, which led to an increase in the EPS from $0.67 to $1.02; this indicates the high ability of the Islamic banks to generate profit for their shareholders in order to increase their wealth (ignoring the market share price).



During the period 2007–2009:

The EPS of Islamic banks decreased during this period due to the effect of the financial crisis; the net profit declined from $5,259 million to $3,870 million, with a decreased ratio equal to 26%. This decline in the net profit occurred as a result of inefficiency in controlling their financial and operating expenses.


During the period 2005–2008:

The rate of gearing for the Islamic banks was increased due to the fact that their new assets were funded strongly by liabilities. Where the total assets increased by $102,007 million, the total liabilities increased by $88,699 million and the equity increased by only $13,308 million; in general, 87% of the new assets were financed by liabilities and 13% were financed by equity, which led to an increase in the financial risk and the financial leverage.



During the period 2008–2009:

There was stability in the gearing during the financial crisis, because the Islamic banks tried to reduce their financial risk in order to face the financial crisis, whereby their assets increased by 11%, their liabilities by 11% and their equity by 9%.


4.2.3 Comparison between Commercial and Islamic Banks
The results of the net profit margin of the two systems illustrate that there was stability for the two systems in generating net profits from the revenue during 2005–2006. The Islamic banks were more efficient and more stable than commercial banks due to the ability of Islamic banks to control their financial, administrative and operational expenditures, and also the effect of the financial crisis on commercial banks was stronger than Islamic banks; these results are supported by those found by Ali (2010).

In 2009, government assistance introduced big opportunities to the commercial banks to improve their financial situation and counter the financial crisis (BBC, October 2008). The average net profit margin of the Islamic banks during the period of study was 26–49%, and the average net profit margin of the commercial banks was -5–21.7%.

According to the above chart, the financial performance of the Islamic banks in using the share capital and returned earnings seems to be more beneficial to the shareholders than that of the commercial banks. Furthermore, the return on equity of the Islamic banks over the period of study was between 13.79% and 24.74%. On the other hand, the return on equity of commercial banks was between 16.61% and -5.13%.

During the period of the financial crisis there was a sharp decrease in the return on equity of commercial banks, which strongly affected the shareholders’ return; the effect on Islamic banks was less than on commercial banks.


The outcomes of the above chart show that the financial performance of the Islamic banks in using their assets to generate net profits seems to be stronger than that of commercial banks; the average ROA for the Islamic banks over the period of study is between 1.72% and 3.33%, and for commercial banks it is -0.19% to 0.82%. These results are supported by those found by Johnes, Izzeldin and Pappas (2009).

The financial crisis led to a decline in the book value and the market value of the assets for both banking systems, with a greater rate of decline for the commercial banks than Islamic banks.


The average of the assets turnover of Islamic banks to generate revenue seems to be more effective than commercial banks, whereby the assets turnover of Islamic banks ranged from 6.3% to 7.33%. In contrast, the average of the assets turnover of commercial banks was between 2.57% and 3.9% during the period of study. Moreover, in the commercial banks, the financial investments in the financial derivatives led to a reduction of the average of the revenue due to the high rate of risk in this type of investments. On the other hand, the Islamic banking system focuses on investments with a low rate of risk.

The above chart indicates that the ability of the commercial banks to increase the shareholders’ returns was higher than that of Islamic banks during 2005–2007 (ignoring the market share price). However, the effect of the financial crisis in 2008 was stronger on the commercial banks compared to the Islamic banks, due to the increase in the average of gearing and the financial leverage during this period, which led to instability in their profits. On the other hand, the top ten Islamic banks had more stability in their profits due to the low financial leverage and low financial risk for these banks. These results are supported by those found in The World Economic and Financial Survey (2009).

The average of the gearing ratio for both systems indicates more stability for commercial banks than Islamic banks but the gearing level for commercial banks was higher than Islamic banks, and the average of debt for commercial banks was assessed from 94.4% to 95.7%. In contrast, it was 80% to 87.3% for Islamic banks.

The fluctuation in the financial situation in the world has affected the banks in different ways. The variation in revenue will directly affect the net profit; in general, if the revenue increases by 10%, this increase may reflect negatively or positively on the net profit due to the variation in the operating and financial expenses (operating and financial leverage) (Korteweg, 2010).

Accordingly, the commercial banks had more financial leverage, which resulted in the strong effect of the high fluctuations in the financial situation for these banks.



4.3 Horizontal Analysis

4.3.1 Commercial Banks
According to the above chart, there was an increase in the total revenue of 62% during 2005–2007; but this increase in the revenue did not greatly improve the net profit, which increased by 17% only. Moreover, during the period of the financial crisis there was a decline in the average of the revenue of 7% and this led to a decrease in the net profit of 148%. Furthermore, during 2008–2009 the average of the revenue fell by 18% and the net profit increased dramatically, where the net losses increased from -$56 billion to become $61 billion, equivalent to 208% growth in the net profit. This increase illustrates the ability of the commercial banks to improve their investments by controlling their operating and financial costs and recovering their financial situation after the effects of the financial crisis. On the other hand, the government financial assistances helped the commercial banks to improve their financial performance during this period.

The above chart illustrates the fluctuations in the average of assets, liabilities and equity during the period of study, where the total assets increased by 72% during 2005–2008, there was an increase in the total liabilities by 74% during the same period and the total equity rose by 38%.

Moreover, during 2008–2009 there was a decrease in the total assets of 6% and a decline in the total liabilities of 8%. In contrast the total equity rose by 28%; this fluctuation shows the ability of commercial banks to reduce the effect of the financial crisis by reducing their total liabilities and total assets and increasing their total equity in order to reduce the financial and liquidity risk.

4.3.2 Islamic Banks
According to the above chart, there was an increase in the average of the revenue by 113%, where the revenue increased from $4,887 million to $10,413 million during 2005–2007 and the net profit increased by 195% during the same period. This increase in the revenue introduced a good opportunity for the Islamic banks to increase their net profit. Moreover, during 2007–2009 there was an increase in the revenue of 34%, but the effect of the financial crisis led to reduce the net profit by 26%, this resulting from the increasing in their operating and financial expenses.

There was an increase in the total assets of the Islamic banks of 82% during 2005–2007, the total liabilities increased by 81% during the same period, and the total equity grew by 81%. However, this increase in the total assets, liabilities and equity occurred as a result of financing 84% of the assets from the liabilities and 16% from the equity. Moreover, during 2007–2009 the total assets increased by 35%, the total liability rose by 38% and the total equity increased by 19%. These increases indicate that Islamic banks financed their assets more from their liabilities than their equity, where 91% of the total assets were financed by the liabilities and 9% from the equity.


4.4 SPSS Analysis

In this part of the analysis, the researcher will introduce an examination of the results of the financial ratios for each year of the study by using SPSS. Moreover, there will be an explanation about the situation of the financial performance and the stability of each system in order to determine the more efficient system.



During 2005:

The profitability ratios (NPM, ROE and ROA) illustrate that the Islamic banks are more efficient in using their assets and equity to generate profit compared to the commercial banks; on the other hand, the commercial banks achieved a higher earnings per share for their shareholders than Islamic banks (ignoring the market share price). Furthermore, the gearing ratio shows that the commercial banks had more financial risk than Islamic banks.



During 2006:

According to the results of the SPSS analysis, Islamic banks were still more efficient in using their assets and equity to generate profit (ROA, ROE), while the commercial banks were more efficient to achieve higher EPS for their shareholders (ignoring the market share price). However, the commercial banks still had more financial risk than Islamic banks.



During 2007:

The profitability ratios (ROE, ROA and NPM) indicate that the Islamic banks were more efficient in using their assets and equity to generate profit than the commercial banks, with a low rate of financial risk. On the other hand, the commercial banks achieved higher EPS for their shareholders than Islamic banks (ignoring the market share price).



During 2008:

The financial crisis strongly affected the commercial banks, where the results of the profitability ratios appear in negative and show the massive financial losses during this year. Furthermore, the financial crisis strongly affected the commercial banks’ shareholders’ returns compared to the Islamic banks. Finally, the results of the SPSS show that the commercial banks are more exposed to financial risk than Islamic banks.



During 2009:

According to the profitability ratios, the commercial banks improved their financial performance after the massive losses in 2008, but the Islamic banks still had a better financial performance than the commercial banks. Moreover, the commercial banks achieved higher earnings per share for their shareholders than Islamic banks (ignoring the market share price), and it also had more financial risk.


4.4.1 The Summary of SPSS during the Period of Study 2005–2009

The results of the SPSS indicate that the financial performance of Islamic banks seems to be more efficient than the commercial banks. This can be seen by the results of the profitability ratios (ROA, ROE and NPM), whereby the Islamic banks were more efficient in using their financial assets and equity to generate net profits compared to the commercial banks (ROA, ROE), and the Islamic banks were more efficient in using their assets to generate revenue (assets turnover ratio).

However, the results of the shareholders’ returns show that the commercial banks were more efficient in increasing their shareholders’ wealth than the Islamic banks (ignoring the market share price). Furthermore, the commercial banks depend on funding their assets by liabilities at a higher rate than equity compared to the Islamic banks. Therefore, the commercial banks are more exposed to financial risks than Islamic banks, and this is considered the main reason for the strong effect of the financial crisis on the commercial banks compared to the Islamic banks. On the other hand, during economic prosperity the commercial banks have more opportunities to achieve higher profits and returns compared to the Islamic banks due to their financial leverage (Nielsen, 2010).

Chapter Five

5.1 The Conclusion

This study aims to evaluate the financial performance and stability of the top ten Islamic and the top ten commercial banks during the period 2005–2009. In addition, it attempts to determine the impact of the global financial crisis on the both systems in order to explore which is the most efficient system.

The study began with an explanation of the importance of the banking system, the services offered by Islamic and commercial banks and the difference between Islamic and commercial banks in order to meet the first objective.

In the literature review, the researcher discussed Islamic banking transactions, the principles of the Islamic banking system and some previous studies which have examined the financial performance, efficiency and stability of both systems in different regions.

In the analysis chapter, the researcher employed six financial ratios and the horizontal analysis to determine the financial performance and stability of both systems in order to meet the second and third objectives, and to determine the impact of the current financial crisis on the two systems and determine which system was more efficient in facing the financial crisis in order to meet the fourth objective. Then the researcher used the statistical program known as SPSS to summarize the financial results of the financial ratios.

The results of the financial ratios and statistical program (SPSS) indicate that the financial performance of the top ten Islamic banks was better than the financial performance of the top ten commercial banks during the period of study.

The financial crisis affected both systems. However, the financial performance of the commercial banks declined strongly compared to the financial performance of the Islamic banks. However, in 2009, the effect of the financial crisis continued on the Islamic banks, while the commercial banking system improved its financial performance. However, the performance of Islamic banks remained better than the commercial banks. Accordingly, we reject both null hypotheses and accept both alternative hypotheses.

5.2 Recommendations

1. Create a market for short-term borrowing between Islamic banks, which would assist in managing their liquidity, just like a market where commercial banks borrow from each other (such as the London Interbank market, which deals with LIBOR interest from one day to five years).

2. Apply hedging policies in investment portfolios of Islamic banks based on the geographical distribution of the financial risk, and interest from the distribution of risks appears when a collapse of financial markets has not been affected by other financial markets in different countries.

3. Develop asset, liability and liquidity management in both Islamic and commercial banks, which is contributing in reducing the impact of the financial crisis on both systems.

4. Increase Islamic bank branches in non-Muslim countries, such as America and European countries, due to the existence of a large number of Muslim communities, in addition to the interest that appears from the hedging of risks in the fluctuations in the revenues of foreign currency deposits.

5. Improve the financial services for their customers in both systems in order to increase customer loyalty to these banks, which is contribute in reducing the phenomenon of a sudden rush of withdrawals by the depositors.

6. Improve the quality of the financial investments in both systems, particularly in the commercial banks, for instance, investments in the financial derivatives, such as CDS (credit default swap), which was one of the most important reasons for the current financial crisis.

7. Apply a mergers and acquisitions policy (M&A) between the banks in order to increase the strength of banks in the face of potential risks.

8. Commercial banks should carefully study the Islamic banking system in order to take positive points from it, and Islamic banks should carefully study the commercial banking system to take positive points.

9. Establish an international Islamic bank and international financial market and support existing regional Islamic markets.


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