The Profitability of Islamic and Conventional Bank - Science Direct

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ScienceDirect Procedia Economics and Finance 35 (2016) 359 – 367

7th International Economics & Business Management Conference, 5th & 6th October 2015

The Profitability of Islamic and Conventional Bank: Case study in Malaysia Hamidah Ramlana,* , Mohd Sharrizat Adnana a

Universiti Tenaga Nasional, Muadzam Shah, 26700 Pahang, Malaysia

Abstract This study aims to analyze the profitability in Islamic Banks and Conventional Banks in Malaysia. The study uses the period of the year 2006 to until the year 2011. In methodology, this research using T-Test Model, Regression and Correlation.Meanwhile, data are collected from the Bursa Malaysia and bank website in Malaysia. This study finds that Islamic Banks are more profitable than Conventional Banks whereas Total Loan to Total Asset for Islamic bank is higher than Conventional bank. Based on Regression test, for Conventional Banks, ROE is an influence profitability of Conventional Bank.and for Islamic Banks, ROA and ROE are significant factor that influence profitability. Based on Correlation test, ROE is an influence profitability of Conventional Bank and for Islamic Banks, ROA and ROE are significant relationship with independent variable which is Total Equity to Total Asset. © 2016 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license © 2015 The Authors. Published by Elsevier B.V. (http://creativecommons.org/licenses/by-nc-nd/4.0/). Peer-reviewed under responsibility of Universiti Tenaga Nasional. Peer-reviewed under responsibility of Universiti Tenaga Nasional Keywords: Profitability, Conventional Banks, Islamic Banks, T-Test, regression, Malaysia

1. Introduction The world’s banking system around the two types of banks. The one is interest-based banking system called as the conventional banking system and the other is an interest-free banking system called as the Islamic banking system. Islamic banks and conventional banks both create competition among themselves to satisfy customers and fulfill their expectations and long term benefits for the economy. The conventional banks and the Islamic banks are differentiated commonly on the basis of their goals, riba and risk sharing practices. The Islamic banking was first introduced in

*

Corresponding author. Tel.: +60-17-616-7927; fax: +60-9-455-2006. E-mail address: [email protected]

2212-5671 © 2016 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

Peer-reviewed under responsibility of Universiti Tenaga Nasional doi:10.1016/S2212-5671(16)00044-7

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Hamidah Ramlan and Mohd Sharrizat Adnan / Procedia Economics and Finance 35 (2016) 359 – 367

Malaysia in 1983. Since more than 50% of the population in Malaysia is made up of Muslims, the Islamic banking system which subscribes to Syariah principles is provided to operate alongside the conventional banking system. This is to provide an alternative to the customers for conducting commercial banking transactions. To regulate Islamic banking, the Islamic Banking Act 1983 was legislated and came into effect on April 7, 1983. There are 17 Islamic banks operating in Malaysia. (Bank Negara Malaysia, 2007). Among them are fully fledged Islamic banking institutions, namely Bank Islam (M) Bhd, Bank Muamalat (M) Bhd and Bank Kerjasama Rakyat Malaysia Bhd. A few of them are from international Islamic banks e.g. Al Rajhi Bank, Kuwait Finance House and some are divisions of the nine domestic groups operating in Malaysia also offer Islamic banking products and services under the Islamic Banking Scheme (IBS banks). The banking sector in Malaysia, practiced dual banking system, i.e. conventional and Islamic banking systems. Malaysia has nine major domestic banks and 13 foreign banks in its conventional banking sector. Parallel to the conventional banking sector is the Islamic banking sector. It is reported that, four stands out as market leaders (Malayan Banking, CIMB, Public Bank and RHB Bank) and they have together captured a 70% market share in the conventional market. (Bank Negara Malaysia, 2007). The main focus of this study is to look into whether the performance of Islamic Banks is different from the Conventional Banks with respect to profitability. The first objective is to analyze the profitability in Islamic Banks and Conventional Banks. The second objectiveis to identify the factors that influence the profitability of Islamic Banks and Conventional Banks. 2. Literature review International Association of Islamic Banks (IAIB) defined the Islamic banking as “the Islamic Bank basically implements a new banking concept in that it adheres strictly to the rules of Islamic Shariah in the fields of finance and other dealings. Therefore, the point is obviously clear that Islamic banking differentiate from conventional banking in terms and conditions of its mission and objectives and duties toward society. The Islamic bank takes all these duties and responsibilities greater than conventional banks, (Hassan & Adnan, 1998). Conventional banking is fundamentally based on the debtor-creditor relationship between the depositors and the bank on the one hand and between the borrowers and the bank on the other, with interest as the price of credit, that reflect the opportunity cost of money. Bashir (2000) examined the performance of Islamic Banks in the Middle-Eastern region between 1993 and 1998. To measure profitability, he used Non-Interest Margin (NIM), Before Tax Profit (BTP), Return on Assets (ROA), and Return on Equity (ROE). The results confirm previous findings and show that Islamic Banks’ profitability is positively related to equity and loans. The results also indicate that favorable macroeconomic conditions positively impact profitability. According to, Hassoune (2002) examined the Islamic bank profitability in an interest rate cycle. This paper states that Islamic banks operate on a profit and loss sharing basis compared to conventional bank's operations which are based on interest. Hassoune also compares ROE and ROA Volatility for both Islamic and conventional banks in three GCC region, Kuwait, Saudi Arabia, and Qatar. He states that since Islamic banking is based on profit and loss sharing, managements have to generate sufficient returns for investors given that they are not willing accept no returns (Hassoune, 2002). According to Sanullah Ansari and Atiqa Rehman (2010) the performance of first Islamic bank in Pakistan i.e. Meezan bank was compared with a group of 5 conventional banks. The study evaluated the performance in terms of profitability, liquidity, risk, and efficiency for the period of 2003-2007. Twelve financial ratios such as Return on Asset (ROA), Return on Equity (ROE), Loan to Deposit ratio (LDR), Loan to Assets ratio (LAR), Debt to Equity ratio (DER), Asset Utilization (AU), and Income to Expense ratio (IER) were used as variables to assess banking performances. T-test and F-test were used to measure the significance difference of these Performances. The study found that MBL is less profitable, more solvent (less risky), and also less efficient comparing to the average of the 5 Conventional banks. However, there was no significant difference in liquidity between the two sets of bank (Moin, 2008). Islamic bank business development framework is not working efficiently as compared to conventional banks (Farrooq, 2007). In addition to the studies that had been done, Mahmood (2005), by using banks in Pakistan as a case study, compared the financial performance of Islamic banking against conventional banking. He found that, almost in all ratios, Islamic banks were superior to conventional banks during the four year period, from 2000 to 2004. Similar studies in other Middle East countries were also conducted, as evident in the research of Kader, et al. (2007), where comparative financial performance of Islamic banks and conventional banks in the UAE was also examined. The


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findings indicated that there were no major difference between Islamic banks and conventional banks with respect to profitability and liquidity. In Bahrain situation, Samad (2004) examined the comparative financial performance of Islamic banks and the conventional banks during 1991-2001. The result also indicated that there was no significant difference between Islamic banks and conventional banks with respect to profitability and liquidity. Samad and Hassan (2000) evaluate intertemporal and interbank performance in profitability, liquidity, risk and solvency, and community involvement of an Islamic bank (Bank Islamic Maalysia Berhad (BIMB) over 14years for the period 1984-1997. The study is intertemporal in that it compares the performance of BIMB between the two time period 1984-1989 and 1990-1997). To evaluate interbank performance, the study compares BIMB with two conventional banks (one smaller and one larger than BIMB) as well as with 8 conventional banks. Using financial ratios to measure these performance and F-test and T-test to determine their significance, the results show that BIMB make statistically significant improvement in profitability during 1984-1997, however, this improvement when compared with conventional banks is lagging behind due to several reasons. 3. Data and methodology This study analyzes by using secondary data such as internet, journals and other available information. The financial data include ROA, ROE, Total Equity to Total Assets, Total Loans to Total Assets and Deposits to Total Assets. This set of data will be used to evaluate and to highlight the profitability Islamic Banks (Bank Islam Malaysia Berhad, Bank Muamalat Malaysia Berhad , CIMB Islamic Bank Berhad(Commerce Tajiri Bank Berhad) and Conventional Banks Hong Leong Bank Public Bank Berhad, Malayan Banking Berhad) Conceptual model of relationship between Islamic Banks and Conventional Banks to bank’s profitability. Independent Variables x x x

Total Equity to Total Assets Total Loans to Total Assets Deposits to Total Assets

Dependent Variables x x

Return on Asset (ROA) Return on Equity (ROE)

This study analyzes by using secondary data which are T-test, regression and correlation about the project of study on profitability Islamic Banks and Conventional Banks. Analysis Research Model ROA = α + B1X1 + B2X2 + B3X3 + e…. (Module 1) ROE = α + B1X1 + B2X2 + B3X3 + e…. (Module 2) Where: B1 = Beta X1 = Total Equity to Total Assets X2 = Total Loans to Total Assets X3 = Deposits to Total Assets e = Error term Hypothesis for T-test model. H1 = there is a significant difference between the profitability of Islamic Bank and Conventional Bank. Hypothesis for Regression test. H1 = there is significant factor that influence profitability of Islamic Bank and Conventional Bank. Hypothesis for Correlation test.

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H1 = there is significant relationship between the profitability of Islamic Bank and Conventional Bank. 4. Results and findings 4.1 Results for Independent T-test Table 1: Comparison of mean between Islamic and Conventional Banks Group Statistics Bank Mean Std. Deviation TLtoTA Conventional 57.786056 8.3181529 Islamic 76.094272 26.3044703 DtoTA Conventional 83.993578 8.1805193 Islamic 83.268672 5.6241002 TEtoTA Conventional 6.636167 1.0866795 Islamic 6.375967 3.5868261

Std. Error Mean 1.9606074 6.2000231 1.9281669 1.3256131 .2561328 .8454230

From the table above, it show the comparison mean between Conventional and Islamic banks in Malaysia. The Total Loan to Total Asset for Islamic bank is higher than Conventional bank. The mean of Total Loan to Total Asset for Islamic is 76.094272 while for Conventional bank the mean is 57.786056. Besides, Deposit to Total Asset and Total Equity to Total Asset for Islamic bank is lower than Conventional bank regarding to the comparison of their mean. The mean of Deposit to Total Asset for Islamic bank is 83.268672 while for Conventional bank the mean is 83.993578. The Total Equity to Total Asset of Islamic bank is 6.375967 while for Conventional bank the mean is 6.636167. So, we can conclude that Islamic bank have better growth for Total Loan to Total Asset rather than Conventional bank. Table 2: independent sample T-test Independent Samples Test Levene's Test for Equality of Variances

TLtoTA

DtoTA

TEtoTA

Equal variances assumed Equal variances not assumed Equal variances assumed Equal variances not assumed Equal variances assumed Equal variances not assumed

F 41.426

3.243

13.201

Sig. .000

.081

.001

t-test for Equality of Means

34

Sig. (2Mean tailed) Difference .008 -18.3082167

Std. Error Difference 6.5026355

-2.816

20.366

.011 -18.3082167

6.5026355

.310

34

.759

.7249056

2.3398884

.310

30.136

.759

.7249056

2.3398884

.295

34

.770

.2602000

.8833709

.295

20.095

.771

.2602000

.8833709

t -2.816

df

The independent T - test is used to compare the mean score of two groups between Islamic and Conventional bank. The results from the table above show that the Total Loan to Total Asset for Islamic bank is higher than Conventional bank and significant at 10 % with means difference -18.3082167. Deposit to Total Asset and Total Equity to Total Asset is no significant difference between the means for Islamic and Conventional bank. Overall, we can conclude that only Total Loan to Total Asset has significant difference between the means of the two groups which is Islamic and Conventional bank for profitability. Based on the hypothesis, H1 is accepted but inconclusive because from the three variables there is only one significant.


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4.2 Results for Regression Table 3: Conventional ROA ANOVAb Model Sum of Squares df Mean Square 1 Regression .293 3 .098 Residual 1.028 14 .073 Total 1.321 17 a. Predictors: (Constant), TEtoTA, TLtoTA, DtoTA b. Dependent Variable: ROA c. The estimated R square is . .222 Coefficientsa Standardized Unstandardized Coefficients Coefficients Model B Std. Error Beta 1 (Constant) 1.055 .740 TLtoTA .001 .010 .037 DtoTA .013 .013 .379 TEtoTA -.160 .099 -.623 a. Dependent Variable: ROA

F

Sig. 1.331

t

.304a

Sig. 1.426 .127 .961 -1.609

.176 .900 .353 .130

Table 3 show the estimated R square is .222, indicating that 22.2 % changes in ROA (dependent) is due to changing in independent variable are reliable. However, the result shows there is no significant factor that influences profitability measuring ROA with independent variables for Conventional bank. Table 4: Conventional ROE ANOVAb

1

Model Regression Residual Total

Sum of Squares 343.030

df 3

Mean Square 114.343

229.674

14

16.405

572.704

17

F 6.970

Sig. .004a

a. Predictors: (Constant), TEtoTA, TLtoTA, DtoTA b. Dependent Variable: ROE c. The estimated R square is . .599 Coefficientsa

Model 1

(Constant) TLtoTA DtoTA TEtoTA a. Dependent Variable: ROE

Unstandardized Coefficients B Std. Error 31.540 11.061 .119 .145 .088 .201 -4.238 1.486

Standardized Coefficients Beta .170 .124 -.793

t

Sig. 2.851 .818 .439 -2.853

.013 .427 .667 .013

Table 4 show the estimated R square is .599, indicating that 59.9 % changes in ROE (dependent) is due to changing in independent variable are reliable. For ROE there is a significant factor that influences profitability with independent variable which is Total Equity to Total Asset. Only Total Equity to Total Asset shows negative effect and significant effect to bank’s profitability with beta coefficient -4.238 and significant at level 0.013. Therefore, H1 is accepted only for ROE because there is a significant factor that influences profitability with independent variable which is Total Equity to Total Asset.

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Table 5: Islamic ROA Model 1

Sum of Squares Regression 1.949 Residual 3.074 Total 5.023 a. Predictors: (Constant), TEtoTA, DtoTA, TLtoTA b. Dependent Variable: ROA c. The estimated R square is .388

ANOVAb df 3 14 17

Mean Square .650 .220

F

Sig. 2.958

.069a

Coefficientsa

Model 1

(Constant) TLtoTA DtoTA TEtoTA a. Dependent Variable: ROA

Unstandardized Coefficients B Std. Error 2.272 2.513 .006 .008 -.016 .037 -.082 .034

Standardized Coefficients Beta .308 -.160 -.539

t

Sig. .904 .811 -.425 -2.428

.381 .431 .678 .029

Table 5 show the estimated R square is .388, indicating that 38.8 % changes in ROA (dependent) is due to changing in independent variable are reliable. For ROA, there is significant factor that influence profitability with independent variable which is Total Equity to Total Asset. Only Total Equity to Total Asset shows negative effect and significant effect to bank’s profitability with beta coefficient -0.082 and significant at level 0.029. Table 6: Islamic ROE Model 1

Sum of Squares Regression 252.885 Residual 274.920 Total 527.805 a. Predictors: (Constant), TEtoTA, DtoTA, TLtoTA b. Dependent Variable: ROE c. The estimated R square is .479

ANOVAb df 3 14 17

Mean Square 84.295 19.637

F 4.293

Sig. .024a

Coefficientsa

Model 1

(Constant) TLtoTA DtoTA TEtoTA a. Dependent Variable: ROE

Unstandardized Coefficients B Std. Error 8.297 23.766 -.048 .074 .129 .345 -1.115 .318

Standardized Coefficients Beta -.225 .130 -.718

t .349 -.643 .372 -3.504

Sig. .732 .531 .715 .004

Table 6 show the estimated R square is .479, indicating that 47.9 % changes in ROE (dependent) is due to changing in independent variable are reliable. For ROE, there is significant factor that influence profitability with independent variable which is Total Equity to Total Asset except Deposit to Total Asset and Total Loan to Total Asset. While only Total Equity to Total Asset shows negative effect and significant effect to bank’s profitability with beta coefficient 1.115 and significant at level 0.04. Therefore, H1 is accepted for both dependent because there is significant factor that influence profitability with independent variable which is Total Equity to Total Asset. The result supported by previous studies by Samad and Hassan (2000)


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4.3 Results for Correlation Table 7: Conventional ROA

ROA

Correlations ROA 1

Pearson Correlation Sig. (2-tailed) N 18 TLtoTA Pearson Correlation .255 Sig. (2-tailed) .308 N 18 DtoTA Pearson Correlation -.043 Sig. (2-tailed) .864 N 18 TEtoTA Pearson Correlation -.367 Sig. (2-tailed) .134 N 18 **. Correlation is significant at the 0.01 level (2-tailed).

TLtoTA .255 .308 18 1 18 .265 .287 18 -.188 .455 18

DtoTA -.043 .864 18 .265 .287 18 1 18 .694** .001 18

TEtoTA -.367 .134 18 -.188 .455 18 .694** .001 18 1 18

For the Conventional correlation between independent variables and ROA, there is no significant relationship. However, the correlation tests between independent variables shows that Total Equity to Total Asset and Deposit to Total Asset have positive correlation at 1% significant level (.694). Table 8: Conventional ROE

ROE

Correlations ROE 1

Pearson Correlation Sig. (2-tailed) N 18 TLtoTA Pearson Correlation .352 Sig. (2-tailed) .152 N 18 DtoTA Pearson Correlation -.381 Sig. (2-tailed) .119 N 18 TEtoTA Pearson Correlation -.739** Sig. (2-tailed) .000 N 18 **. Correlation is significant at the 0.01 level (2-tailed).

TLtoTA .352 .152 18 1 18 .265 .287 18 -.188 .455 18

DtoTA -.381 .119 18 .265 .287 18 1 18 .694** .001 18

TEtoTA -.739** .000 18 -.188 .455 18 .694** .001 18 1 18

For the Conventional correlation between independent variables and ROE, only Total Equity to Total Asset has a significant relationship. There is a negative relationship between ROE (dependent) and Total Equity to Total Asset (independent) at 1% significant level (-.739). It shows that Total Equity to Total Asset have relationship with profitability. The correlation test between independent variables shows that Total Equity to Total Asset and Deposit to Total Asset have positive correlation at 1% significant level (.694).

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Table 9: Islamic ROA

ROA

Correlations ROA 1

Pearson Correlation Sig. (2-tailed) N 18 TLtoTA Pearson Correlation .249 Sig. (2-tailed) .318 N 18 DtoTA Pearson Correlation .050 Sig. (2-tailed) .842 N 18 TEtoTA Pearson Correlation -.592** Sig. (2-tailed) .010 N 18 **. Correlation is significant at the 0.01 level (2-tailed).

TLtoTA .249 .318 18 1 18 .813** .000 18 -.132 .601 18

DtoTA .050 .842 18 .813** .000 18 1 18 .074 .772 18

TEtoTA -.592** .010 18 -.132 .601 18 .074 .772 18 1 18

For the Islamic correlation between independent variables and ROA, Total Equity to Total Asset has a significant relationship. There is a negative relationship between ROE (dependent) and Total Equity to Total Asset (independent) at 1% significant level (-.592). It shows that Total Equity to Total Asset have relationship with profitability. The correlation test between independent variables shows that Deposit to Total Asset and Total Loan to Total Asset have positive correlation at 1% significant level (.813). Table 10: Islamic ROE

ROE

Correlations ROE 1

Pearson Correlation Sig. (2-tailed) N 18 TLtoTA Pearson Correlation -.025 Sig. (2-tailed) .921 N 18 DtoTA Pearson Correlation -.106 Sig. (2-tailed) .674 N 18 TEtoTA Pearson Correlation -.679** Sig. (2-tailed) .002 N 18 **. Correlation is significant at the 0.01 level (2-tailed).

TLtoTA -.025 .921 18 1 18 .813** .000 18 -.132 .601 18

DtoTA -.106 .674 18 .813** .000 18 1 18 .074 .772 18

TEtoTA -.679** .002 18 -.132 .601 18 .074 .772 18 1 18

For the Islamic correlation between independent variables and ROE, only Total Equity to Total Asset has a significant relationship. There is a negative relationship between ROE (dependent) and Total Equity to Total Asset (independent) at 1% significant level (-.679). It shows that Total Equity to Total Asset have relationship with profitability. The correlation test between independent variables shows that Deposit to Total Asset and Total Loan to Total Asset have positive correlation at 1% significant level (.813). 5.0 Conclusions and Recommendation Based on T-test model, Islamic Banks is more profitable than Conventional Banks whereas Total Loan to Total Asset for Islamic bank is higher than Conventional bank and significant at level 10 %. H1 is accepted but inconclusive because from the three variables there is only one significant. Based on Regression test, for Conventional Banks, H1 is accepted only for ROE because the result shows there is no significant factor that influence profitability measuring ROA with independent variables and for ROE there is a significant factor that influence profitability with independent variable which is Total Equity to Total Asset with


significant at level 1 %. For Islamic Banks, H1 is accepted because both dependent variables are significant factor that influence profitability with independent variable which is Total Equity to Total Asset with significant at level 5 %. Based on Correlation test, for Conventional Banks, H1 is accepted only for ROE because the result shows there is no significant relationship between the profitability of ROA with all independent variables and for ROE there is a significant relationship between the profitability of ROE with Total Equity to Total Asset at 1 % significant level. For Islamic Banks, H1 is accepted because both dependent variables are significant relationship with independent variable which is Total Equity to Total Asset with significant at a level 1 %. References Abid Usman., Muhammad Kashif Khan., 2012. Evaluating the Financial Performance of Islamic and Conventional Banks of Pakistan: A Comparative Analysis. Alkassim, F.A., 2005. The Profitability of Islamic and Conventional Banking in the GCC Countries: A Comparative Study. Basir., 2000. Determinants of profitability in Islamic banks: Some evidence from the Middle East Islamic Economic Studies 11, 31–57 Bank Negara Malaysia, 2007, Shariah Resolutions in Islamic Finance, Kuala Lumpur: Bank Negara Malaysia. Fauziah Hanim Tafri., Zarinah Hamid., Ahamed Kameel Mydin Meera., Mohd Azmi Omar., 2010. The Impact of Financial Risks on Profitability of Malaysian Commercial Banks: 1996-2005. Farooq, Muhammad., 2007. Forecasts of Future Profitability based on Disaggregated Earnings: A Comparative Analysis of I slamic and Conventional Banks. Journal of Managerial Sciences Volume VII Number 2 256. Hasan., Adnan., 1998. Optimal Shari’ah Governance Model In Islamic Finance Regulation. Hassan., Bashir., 2004. Determinants of Islamic Banking Profitability. A. Hassoune., 2002. Islamic banks' profitability in an interest rate cycle, International Journal of Islamic Financial Services 4, 1–13. Kader, et al., 2007. Comparative Study on Performance of Islamic Banks and Conventional Banks in GCC region. Mahmood., 2005. The Effects of the Global Crisis on Islamic and Conventional Banks: A Comparative Study. Mian Muhammad Ashraf., Zia-ur-Rehman., 2011. The Performance Analysis of Islamic and Conventional Banks: The Pakistan’s Perspective. Rosnia Masruki., Norhazlina Ibrahim., Elmirina Osman., Hishamuddin Abdul Wahab., 2007. Financial Performance of Malaysian Islamic Banks Versus Conventional Banks. Samad, A., 200. Islamic banking and finance in theory and practice: The experience of Malaysia and Bahrain. The American Journal of Islamic Social Sciences 22(2), 69-86. Sanaullah Ansari., Khalil-ur-Rehman., 2011. Comparative Financial Performance of existing Islamic Banks and Contemporary Conventional Banks in Pakistan. Sanaullah Ansari., Atiqa Rehman., 2010. Financial Performance of Islamic and Conventional Banks in Pakistan: A Comparative Study.

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