Financial Performance of Islamic and Conventional Banks in Pakistan: A Comparative Study

8th International Conference on Islamic Economics and Finance
Financial Performance of Islamic and Conventional Banks in Pakistan: A

Comparative Study
Sanaullah Ansari 1
Atiqa Rehman
This study was conducted to compare the financial performance of Islamic and
Conventional banks to facilitate depositors, bank managers, shareholders,
investors and regulators by providing true picture of financial position of
Islamic and Conventional banks in Pakistan. Financial ratios were estimated
from annual reports and financial statements i.e. Income statement and Balance
sheet for the period of 2006 to 2009. Eighteen financial ratios were estimated to
measure these performances in term of profitability, liquidity, risk and solvency,
capital adequacy, deployment and operational efficiency. Independent sample t-
test and ANOVA was used to determine the significance of mean differences of
these ratios between and among banks. The study concluded that Islamic banks
proved to be more liquid, less risky and operationally efficient than
conventional banks.
Key Words: Islamic banks, conventional banks, financial performance, Pakistan
1 Introduction
1.1 Background of the paper
Islamic banking having distinct modes of operations as compared to conventional banks has
been started in the 1970s to address the problem of Riba. The committed and resourceful
individuals, professional bankers, Islamic economists and religious scholars are attributed to
be pioneer of Islamic banking. Its philosophies and principles are, however, not new having
been outlined in the Holy Qur’an and the Sunnah of Prophet Muhammad (p.b.u.h.) more than
1,400 years ago. The emergence of Islamic banking is often related to the revival of Islamic
financial system which is totally usury (Riba) free. There was no initial working model to act
upon, except the thought that interest-based banking might be replaced by banking on the
basis of profit-and-loss sharing. The basic purpose of Riba-free financial system was the
elimination of all interest based transactions. Effort for the establishment of this system took
place when the financial system at large, as also the regulatory environment, was Riba-based.
At the start Riba free financial institute were established through private parties but soon
things began to change in the late seventies and in the early eighties when Iran, Sudan,
Pakistan and Malaysia realized the need to develop Riba-free financial system in all these
countries (Ahmad, 1991).
Islamic banking started with the establishment of two financial institutions in Mit-Ghamr in
the Nile Delta and in Karachi from 1963-1967. The progress was made in this movement by
the establishment of full- fledged Islamic bank with the name of Dubai Islamic Bank in 1965.
By the end of 1996, the number of Islamic financial institutions reached to 166 in at least 34
Muslim and non-Muslim countries. Islamic banking got popularity in 1970s (Chapra, 2001).
1
Shaheed Zulfikar Ali Bhutto Institute of Science & Technology (SZABIST), Islamabad, Pakistan.
E: Sanaullah@szabist-isb.edu.pk
1
Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation
Islamic banks are now operating and providing Islamic banking services in more than 60
countries of the world (Aggarwal, Rajesh and Tarik, 2000).
There are more than 300 Islamic financial institutions all over the world with investment
funds in excess of $400 billion (El-Qorchi, 2005).The Islamic banking industry’s world-wide
annual growth rate is more than 16%. Islamic banking has also gained approval by
international financial institutions (IFI), professional bankers and the academic world. Islamic
banking has successfully established its identity and performing its operations distinct from
its conventional counterparts. Islamic banking in the modern world, generally aims to
promote and develop the application of Islamic principles, law and traditions to transactions
of financial, banking and related business affairs. Islamic banks, by doing so, will safeguard
the Islamic communities and societies from activities that are forbidden in Islam (Tahir,
2003).
Pakistan is an ideological state and was created in the name of Islam in 1947. By the time,
Islamic banking is becoming more popular in Pakistan due to its Riba free products. Many
efforts are being made by State Bank of Pakistan to make this system workable and
successful as compare to conventional banking. SBP developed a Three-step strategy to
fulfill this purpose. The first step is to setup exclusive Islamic banks. In the second step
existing conventional banks is permitted to have Islamic Banking subsidiaries. Third step of
this strategy is the establishment of stand alone branches by existing commercial banks. The
State Bank also appointed Shariah board to regulate and approve guidelines for the emerging
Islamic banking industry. Being a Muslim country there is huge scope for Islamic and
Modaraba banking system in the country. The country's first full -fledged Islamic Bank,
which is Meezan Bank licensed by SBP in 2002, is a successful business enterprise and a
premier one. It has been very careful in its expansion drive. National Bank of Pakistan has
started Mudaraba banking and trying its level best to enhance its profitability and
accommodate the general masses. Muslim Commercial Bank (MCB), Faysal Bank and Al-
Meezan banks are also in the Islamic banking field. Pak-Kuwait Investment Company
Limited, which is one of the country's premiere joint venture financial institutions, is
launching the first ever Islamic Insurance Company in Pakistan. There is huge market of
Islamic banking in the country (Khan, 2004).
Presently, there are six full-fledged Islamic banks operating in Pakistan. These banks with
their year of incorporation are:
1. AlBaraka Islamic Bank Pakistan (1991)
2. Meezan Bank Limited (2002)
3. BankIslami Pakistan Limited (2003)
4. Dubai Islamic Bank Pakistan Limited (2005)
5. Emirates Global Islamic Bank Limited (2007)
6. Burj Bank Limited (2007)
1.2 Significance of the paper
Financial Institutions are very important for every economy because they are the most
contributing factor to keep economies on the path of economic growth and development.
Financial ratios are the indicator of financial health of organization. Ratio analysis is not only
important for depositors but also for management to improve organization future
performance. The purpose of the study is to provide full picture of banks financial position to
investors, management and shareholders .The another purpose of research is to make people
2
aware of Islamic banks financial position and to make comparison of performance of Islamic
and Conventional banks in order to identify, which one has, better financial position.
2 Literature Review
Previous studies on the empirical investigation of the financial institutions operating on the
interest-free principles are very limited. The existing ones are mostly descriptive, and focus
on the simple financial ratios. Although few empirical studies are available which have
undertaken a comparative analysis and explored the performance of the Islamic and
conventional banks among these, Moin (2008), Samad (2004), Samad and Hassan (1999) and
Iqbal (2001) got great importance.
The performance of first Islamic bank in Pakistan i.e. Meezan bank was compared with 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 compare to conventional banks (Farrukh, 2006).
Metwally (1997) evaluated the performance of 15 interest-free banks and 15 conventional

banks in terms of liquidity, leverage, credit risk, profitability and efficiency. He concluded
that the two groups of banks may be differentiated in terms of liquidity, leverage and credit
risk, but not in terms of profitability and efficiency. Interest-free banks rely more heavily on
their equity in loan financing and face more difficulties in attracting deposits than interest-
based banks. Interest-free bank hold a higher Cash/deposit ratio because they tend to be
relatively more conservative in using their loanable funds and lack lending opportunities. The
profit/loss sharing principle has made it difficult for interest-free banks to finance personal
loans and pushed interest-free banks to channel a greater proportion of their funds to direct
investment (using Musharaka and Mudaraba tools of finance). Both banks offer their
depositors similar returns and direct the largest proportion of their funds towards the
financing of durables. Interest-free banks rely heavily on the Murabaha mode of finance
which is like interest charge and based on the use of a mark-up. These performance measures
were analyzed by Samad (2004) to compare the performance of Bahrain Islamic and
conventional banks. He used studet-t test and found similar results in respect of profitability
and risk while no difference was found in liquidity of two banks.
Samad and Hassan (1999) evaluated the intertemporal and interbank performance of Islamic
bank Islam Malaysia Berhad (BIMB) for the period 1984-1997 by using same performance
measures and found that in inter-temporal comparison Islamic bank BIMB's made
(statistically) significant progress in profitability while the BIMB risk increased. In interbank
comparison the study found that BIMB is relatively more liquid and less risky compared to a
group of 8 Conventional banks. A study conducted on five Islamic banks from MENA region
analyzed their financial statements over the period 1993 – 2002 found that liquidity risk
arises because of pre mature withdrawal by account holders due to a mismatch between
investor’s expectations of return and the actual return. Therefore Islamic banks are required
3
to keep adequate cash or cash equivalents to meet the demand. They identified the other
reasons of liquidity risk can be the lack of confidence on the banking system, reliance on few
large depositors, reliance on current accounts and restrictions of Islamic banks on sales of
debt. The profitability of Islamic banks is low due to short term investments and low equity
base (Badr-El-Din, Ibrahim and Vijaykumar, 2003). In case of Islamic banks, short term Debt
financing includes Murabaha, Salam, and Qard fund and long term debt financing includes
Sukuk, leasing and Istisna. In case of Conventional banks short term debt financing include
treasury bills, trading bonds, short term loan and advances and deposits at other financial
institution that mature within one year. Long term debt financing include non trading bonds
and medium and long term loans (Hussein, 2004).
The Islamic bank Bangladesh, as a case in the region has successfully developed and
employed Islamic modes of banking. The performance of IBBL over the last 16 years has
been continuously increasing. Performance is measured by using some additional variables as
Bank’s deposits, investment, remittances, and foreign exchange business. IBBL overall
performance has been very significant in respect of mobilization of deposits, deployment of
funds, operating results, capital adequacy ratio, provision for bad & doubtful investments,
liquidity, equity, profit paid to depositors, income from ancillary business, payment of
dividend, return on equity and foreign exchange business (Ahmad, Hussain and Hannan,
1999).There are differences between Islamic and conventional banks with respect to
mobilization of deposits and application of funds. In Islamic bank depositor profit is not pre-
determined and principal amount is not guaranteed while Conventional banks have
guaranteed principal and accrued interest (Siddiqui, 2005). One of the major advantages of
opening a PLS savings account with the Islamic bank is that the initial deposit figure to open
a savings account is only Taka 100.00 (2.5 US $) where in any other Commercial banks in
Bangladesh it is not less than Taka 4000 (US $ 100). The Islamic bank invests its funds
mainly under Murabaha, Musharaka, Bai-Muajjal, Hire Purchase and Quard E Hasana mode
of investments. The remarkable advantages of Islamic bank are easy procedure of obtaining
loan and quick action in processing loan activities (Alam, 2000).
Iqbal (2001) made comparison of performance of Islamic banks with conventional banks. He
compared performance of both types of 12 banks of equivalent size during 1990-1998. In
additional to profitability, liquidity, and risk some more variables such as capital adequacy
and deployment efficiency were also studied. The performance of Islamic banks has been
evaluated using both trend and ratio analysis. He concluded that Islamic banks as a group out-
performed the former in almost all areas and in almost all years. He analyzed through ratio
analysis Islamic banks are not suffering from excess liquidity and are more cost effective and
profitable than their Conventional counterparts. Kader, Janbota, Asarpota and Anju (2007)
and Safiullah (2010) found the same results in UAE and Bangladesh respectively. The
conventional banks profitability theories exist in Islamic banking. It is found that
determinants such as capital ratio, liquidity, interest rate and money supply have similar
effect on Islamic banks. Capital ratio, interest rate and inflation are positively related with the
profitability of Islamic banks. However there is negative relationship between market share
and profitability (Haron & Ahmad, 2001).The conventional financing system is concerned
only with the interest rate, while the Islamic financial system provide loan without interest
and collateral or only against an administrative cost ( Arif, 1988; Ayub, 2002). Islamic banks
are certainly more profitable than their conventional peers enjoying the same balance sheet
structure. The main reason for such a difference is that Islamic banks benefit from a market
imperfection. Islamic banks lose on the grounds of liquidity, assets and liabilities
concentrations and operational efficiency (Hassoune, 2002). The net non-interest margin
4
(NIM) another indicator of performance measure indicate that Conventional banks are
operationally efficient than Islamic banks. The profitability of interest-free banks is positively
influenced by high capital and loan-to-asset ratios, favorable macroeconomic conditions, and
negatively to taxes (Hassan & Bashir, 2003).
Hassan (2005) using a panel of interest-free banks from 22 countries, and using multiple
efficiency techniques, found that interest-free banks were relatively less efficient in
containing cost than conventional counterparts in the world but they are efficient in
generating profit. The variable used to measure efficiency were bank size, profitability and
loan to asset ratios. The reason of less efficiency of interest-free banks is that they often face
regulation not favorable to Islamic transactions in most countries.
All above studies conducted in different countries deal with common problem. Most of them
were conducted to analyze the performance of Islamic and conventional banks. All studies
have not same result because of differences in selected time periods, analytical tools and
cultural perspective. It is analyzed through these studies that Islamic banks are more
profitable, more liquid, cost effective, and less risky and have better quality of loan portfolio
and capital adequacy than their conventional counterparts but they loose at the ground of
operational efficiency.
3 Conceptual Framework
Financial
Performance
Profitability Liquidity Risk and Capital Operational Deploym

solvency adequacy efficiency ent
efficiency
ROAA CR NIM
DER ELR
IEDR
CAR OOPI
ROAE DTAR CRAR
ILR
PEM LDR LDR NIE
NL/ CIR
TAR
5
4 Methodology
4.1 Theoretical Framework
The ratio analysis involves method of calculating and interpreting financial ratios to asses’
bank performance. Financial ratios are the indicator of financial performance of bank. In
order to compare performance of Islamic banks and Conventional banks for the period of
2006-2009 the study uses inter-bank analysis. The study evaluates inter-bank performance of
Islamic and Conventional banks in term of profitability, liquidity, risk and solvency, capital
adequacy, operation and resource allocation efficiency. Financial ratios are applied to
measure these performances. The study uses eighteen financial ratios to evaluate bank
performances. These ratios are grouped under six broad categories.
Profitability Ratios
Profitability ratios measure the managerial efficiency. These ratios use margin analysis and
show the return on assets, deposits, investments, and equity. The higher profitability ratios
are indicator of better performance. Sammad and Hassan (1999) used three profitability ratios
to evaluate the performance of Islamic bank Malaysia. These ratios were Return on average
assets (ROAA), Return on average equity (ROAE), and Profit expense ratio (PEM).This
study uses the same Profitability measure to analyze the performance of banks in Pakistan.
1. Return on average assets (ROAA) = Earnings after tax/Average assets
2. Return on average equity (ROAE) = Earnings after tax/Average equity
3. Profit Expense Margin (PEM) = Profit before tax/operating expense
Liquidity Ratios
Liquidity ratios measure the bank ability to meet its short-term obligations. Banks face
liquidity problem due to excess withdrawal from current and saving account. There are
several measures of liquidity. Iqbal (2001) used current ratio as liquidity measure. Samad &
Hassan (1999) used two more measures which include Loan/deposit ratio (LDR) and Current
asset ratio (CAR) to evaluate the performance of Malaysian Islamic bank during 1984-1987.
Hassan & Bashir (2003) also used Net loans/ total assets ratio as liquidity measurement
indicator. Liquidity position of banks in Pakistan is measured by using four above ratios.
1. Current Ratio (CR) = Cash and account with banks/Total deposits
2. Current Asset Ratio (CAR) = Current asset /Total asset
3. Loan Deposit Ratio (LDR) = Loans/ Deposits
4. Net Loan/ Total Asset Ratio (NLTA) = Net loans/Total assets
Risk and Solvency Ratios
Solvency ratios give a picture of a bank's ability to generate cash flow and pay its long-term
financial obligations. If the total value of bank assets is greater than its equity then the bank is
solvent. Samad & Hassan (1999) used three risks and solvency ratios in their study .These
ratios included Debt equity ratio (DER), Debt to total asset ratio (DTAR) and Loan deposit
ratio (LDR).This study uses the same hold to measure risk and solvency of banks in Pakistan.
The above mention ratios are calculated with the help of following formulas.
1. Debt Equity Ratio (DER) = Total Debt / Shareholder Equity
2. Debt to total asset ratio (DTAR) = Total Debt/ Total asset
3. Loan Deposit Ratio(LDR) = Loans/ deposits
6
Capital Adequacy Ratios
Capital ratios indicate the healthiness of financial institution to shock withstanding losses.
These ratios identify the already existing banking problems. Adverse trends in these ratios
may increase risk exposure and capital adequacy problems. Iqbal (2001) used Capital Asset
Ratio (CAR) as capital adequacy measure. Hassan & Bashir (2003) in addition to CAR used
Equity/Liabilities ratio to measure capital adequacy in their study. This study focused on two
following Capital ratios.
1. Equity/Liabilities ratio = Average equity/ Average liabilities
2. Capital Risk Asset ratio = Total Capital/Risk weighted Assets
Operational Ratios
Operational ratios show how efficient a company is in its operations and use of assets. There
are several ways of measuring operations. Iqbal (2001) used cost to income ratio to evaluate
the operational efficiency of banks. Hassan & Bashir (2003) used thirteen operating ratios to
evaluate operating efficiency of banks in their study. Some ratios used by Hassan & Bashir as
operating ratios other researches used them as profitability ratios. This study also focused
them as profitability measures.
This study uses Net Interest Margin (NIM), Other Opt Income / Average Assets, Non Interest
Exp / Average Assets and Cost income ratio to measure bank efficiency in its operations and
use of assets. The following formulas are given to calculate these ratios
1. Net Interest Margin = Net markup & interest income/Average assets
2. Other Opt Income/Average Assets = Other operating Income / Average Assets
3. Non Interest Expense /Average Assets = Non-interest expenses/ Average Assets
4. Cost/Income ratio =
Markup & interest expense + Non - markup & interest expense + provision for losses + Bad debts write off
Markup & interestincome + Non − markup & non − interestincome
Deployment Ratios
Deployment ratios are used to evaluate how well bank is using its resources. Iqbal (2001)
used two deployment ratios to evaluate the Performance of Islamic and conventional banks in
1990s. This study uses the same deployment ratios to evaluate bank efficiency in resources
allocation.
1. Investment/ Equity & Deposit = Total Investment /Total equity + Total Deposits
2. Investment/ Liabilities = Total Investment /Total Liabilities
Population
The population of this research is Islamic and conventional banks of Pakistan.
Sample
Meezan Bank Limited, Bank Islami Limited and Dubai Islamic Bank Limited are selected as
Islamic banks and Askari Commercial Bank Limited, Atlas Bank Limited and Samba Bank
Limited are selected as Conventional banks.
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Hypothesis
H 1 : Islamic banks are less profitable than Conventional banks.

H 2: Islamic banks liquidity is higher than conventional banks.
H 3: Islamic banks are less risky than Conventional banks.
H 4: Islamic banks are well capitalized than Conventional banks.
H 5: Islamic banks operational efficiency is less than conventional banks.
H 6: Islamic banks resource allocation efficiency is less than Conventional banks.
Data Sources
The Audited financial statements i.e. Income Statement and Balance Sheet of both Islamic
and Conventional banks for the period of 2006 -2009 are used for ratio analysis. The ratios
have been calculated with the help of ratio formulae. The other sources used for data
collection are SBP, KSE and business recorder databases.
Data Analysis
Inter-bank comparison or cross-sectional analysis is used to compare the performances of

both banks. Independent Sample t-test and ANOVA is used to determine the significance of
mean differences of these ratios between and among banks. The decision criterion is P value.
If P value is greater than 0.05 we will accept null hypothesis and reject research hypothesis.
5 Data Finding, Analysis and Discussion
This chapter analyzes and discusses the results obtained through financial ratios, Independent
sample t-test and ANOVA. In order to make comparison more reliable, Independent sample
t-test and ANOVA is used. The equality of means of banks is tested through Independent
sample t-test and ANOVA. T-test is used to check the significance of mean differences
between banks and ANOVA is used to check the significance of mean differences among
banks.
Profitability of banks is analyzed by using three profitability measures ROAA, ROAE and
PEM. ROAA is the net earnings per unit of a given asset. ROAE is the net earnings of per
dollar equity capital. PEM is measure of cost efficiency which analyzes the bank efficiency
of making higher profits with given expense. Results show a fluctuating situation in all the
profitability measures of Islamic banks from 2006-2009. There is a declining trend in
Conventional bank’s ROAE from 2006-2009 while ROAA and PEM volatile. It is analyzed
from these figures that the profitability of both banks has increase, decrease trends. Average
profitability ratios ROAA, ROAE and PEM for Islamic bank are -1.49, 1.9 and 2.12
compared to -2.53, -9.58 and -46.13 for Conventional banks. T-test shows that this difference
in profitability performance of two banks is not significant at 5% level of significance.
However, ANOVA shows significance difference among the ROAE and PEM of banks from
2006-2009.
8
T-test of Return on Average Assets (ROAA)

Banks Ratios 2006 2007 2008 2009 Mean SD t-value P-value
IB ROAA -0.08 -0.4 -0.06 -5.43 -1.49 5.33 0.566 0.577
CB ROAA -1.78 -3.07 -2.56 -2.72 -2.53 3.49
ANOVA of Return on Average Assets (ROAA)
Banks N Mean SD F-value P-value
Meezan Bank Limited 4 -2.77 2.54
Bank Islami Limited 4 1.27 0.44
Dawood Islamic Bank 4 0.92 0.68
Askari Commercial Bank Limited 4 -1.02 1.35
Atlas Bank Limited 4 -4.72 8.82
Samba Bank Limited 4 -5.76 2.83
Total 24 -2.01 4.44 2.139 0.107
T-test of Return on Average Equity (ROAE)

IB ROAE 0.68 2.58 1.76 2.58 1.9 10.49 1.574 0.130
CB ROAE -4.68 -6.14 -10.3 -17.19 -9.58 22.97
ANOVA of Return on Average Equity (ROAE)

Meezan Bank Limited 4 14.40 3.44
Bank Islami Limited 4 -3.13 4.36
Dawood Islamic Bank 4 -5.58 7.49
Askari Commercial Bank Limited 4 14.15 10.18
Total 24 -3.84 18.42 6.966 0.001**
(** Significant at 1%)
T-test of Profit Expense Margin (PEM)

IB PEM -8.49 4.4 -0.24 12.83 2.12 48.26 1.860 0.076
CB PEM -21 -61.08 -45.76 -58.68 -46.63 76.9
ANOVA of Profit Expense Margin (PEM)

Bank Islami Limited 4 -23.83 5.47
Dawood Islamic Bank 4 -28.43 42.01
Total 24 -22.25 67.54 15.007 0.000**
9
Overall result shows that profitability performance of Islamic and Conventional banks is not
significantly different so research hypothesis is rejected that Islamic banks are more
profitable than conventional banks. This result is consistent with those of Metwally (1997),
Samad and Hassan (1999) and Samad (2004).
The liquidity position of Islamic and Conventional bank is analyzed through Current ratio,
Current Asset ratio, Loan Deposit ratio and Net Loans to Total Asset ratio. CR indicates the
bank ability to meet its current liabilities. A higher value of CR shows that the bank has more
liquid assets to pay back to its depositors. CAR indicates the percentage of bank liquid assets.
A high CAR is sign of liquidity. LDR measure the degree of bank relines on borrowed funds.
The high figure of LDR shows that bank is more relying on borrowed funds and leads to
illiquidity. Net loans to total assets ratio measures the total loans outstanding as a percentage
of total assets. The higher this ratio indicates that a bank is loaned up and its liquidity is low.
T-test of Current Ratio (CR)

IB CR 37.96 26.22 22.89 18.4 26.37 14.46 3.463 0.002**
CB CR 14.07 10.47 10.7 11.07 11.58 3.14
ANOVA of Current Ratio (CR)

Atlas Bank Limited 4 8.88 1.96
Samba Bank Limited 4 12.35 3.36
Total 24 18.97 12.72 7.948 0.000**
T-test of Current Asset Ratio (CAR)

IB CAR 20.18 19.23 16.64 14.82 17.71 6.43 4.768 0.000**
CB CAR 9.78 7.3 7.39 7.79 8.06 2.8
10
ANOVA of Current Asset Ratio (CAR)

Total 24 12.89 6.92 13.764 0.000**
T-test of Loan Deposit Ratio (LDR)
IB LDR 69.38 57.89 59.98 55.03 60.57 13.26 -1.407 0.173
CB LDR 68.92 55.96 83.18 72.22 70.07 19.28
ANOVA of Loan Deposit Ratio (LDR)

Total 24 65.32 16.90 3.685 0.018*
(* Significant at 5%)
T-test of Net Loan/Total Assets Ratio (NL/TA)

IB NL/TA 40.29 44.05 45.74 44.18 43.56 12.08 -0.880 0.388
CB NL/TA 45.11 39.42 56.93 52.11 48.39 14.65
ANOVA of Net Loan/Total Assets Ratio (NL/TA)

Total 24 45.98 13.36 6.263 0.002**
Result shows that there is declining trend in CR and CAR of Islamic banks while LDR and
NL/TAR ratio volatiles. There is rise and fall condition in all the liquidity measure of
Conventional banks. However the values of CR and CAR are higher for Islamic bank during
11
whole selected period. This shows that Islamic bank has more liquid asset to meet its current
liabilities. Islamic bank average CR and CAR are 26.37 and 17.71 as compared to 11.58 and
8.06 for Conventional banks and this mean difference is statistically significant at 1% level of
significance.
Islamic bank average LDR and NL/TA ratio are 60.57 and 43.56 as compared to 70.07 and
48.39 for Conventional banks. This mean difference between two banks is not significant at
5% level of significance. ANOVA shows significant mean difference in LDR and NLTA
ratio of banks at 5% and 1% respectively. LDR and NL/TA ratio are in the favor of Islamic
banks. These ratios are lower for Islamic banks, the lower these ratios it is considered better.
These ratios show that Islamic banks do not rely more on borrowed funds and their
percentage of assets tied up in loan is lower than conventional banks. These results are
consistent with those of Metwally (1997), Hassan (1999), Iqbal (2001), Badr-El-Din, Ibrahim
and Vijaykumar (2003) and Kader. Janbota, Asarpota and Anju (2007). Overall results of
liquidity ratios support the hypothesis that Islamic banks are more liquid than conventional
banks.
The reasons of Islamic bank high liquidity are firstly they do not have enough investment
opportunities. Secondly, they are bound by religion and are allowed to invest only in Sharia
approved projects. Thirdly, they rely more on their equity in making loans so they lack
lending opportunities.
T-test of Debt Equity Ratio (DER)

IB DER 30.82 14.69 22.65 32.84 25.24 36.86 -2.659 0.014*
CB DER 97.67 56.95 83.46 70.15 77.06 56.53
ANOVA of Debt Equity Ratio (DER)

Total 24 51.15 53.65 15.360 0.000**
12
T-test of Debt to Total Assets Ratio (DTAR)

IB DTAR 3.49 1.36 2.00 2.54 2.35 3.08 -3.080 0.005*
CB DTAR 12.71 5.4 9.47 7.96 8.89 6.68
ANOVA of Debt to Total Assets Ratio (DTAR)

Total 24 5.62 6.08 3.938 0.014*
Three Risk and solvency measure DER, DTAR and LDR have been used to evaluate the
riskiness of banks. DER measures the bank ability to absorb financial shocks. DTAR is the
indicator of bank financial strength to pay its debtors. There is rise and fall condition in all
risk measures of both Islamic and Conventional banks during whole selected period. Average
DER, DTAR and LDR for Islamic bank are 25.24, 2.35 and 60.57 as compared to 70.07, 8.89
and 51.90 for their Conventional counterpart. Independent Sample t-test and ANOVA
supports that the mean difference of DER and DTAR is statistically significant at 5% level of
significance. The lower risk and solvency ratios are good and show low riskiness of bank. All
risk and solvency indicator shows lower percentage of risk for Islamic banks as compared to
Conventional banks. It is analyzed from these results that Islamic bank are less risky than
Conventional banks. It is concluded that Islamic banks ability to absorb financial shocks and
their financial strength to pay their debtor is higher than Conventional banks. These results
are consistent with Moin (2008), Sammad (2004) and Hassan (1999).
T-test of Equity/Liabilities Ratio (ELR)

IB ELR 57.6 30.9 22.3 16.8 31.89 27.27 1.160 0.259
CB ELR 16.1 23.5 25 21.5 21.53 14.67
ANOVA of Equity/Liabilities Ratio (ELR)

Total 24 26.71 22.06 4.217 0.010*
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T-test of Capital Risk Assets Ratio (CRAR)

IB CRAR 15.13 24.68 22.73 31.55 23.52 15.63 -0.285 0.779
CB CRAR 18.79 33.8 25.21 25.02 25.7 21.49
ANOVA of Capital Risk Assets Ratio (CRAR)

Total 24 24.61 18.41 11.271 0.000**
Capital adequacy of banks is measured with the help of Equity/Liability and Capital risk asset
ratios. Islamic and Conventional bank capital adequacy ratios show increase and decrease
trends. When average Capital ratios are compared for Islamic and Conventional banks it is
analyzed that Islamic bank have higher Equity liability and lower Capital risk asset ratio than
Conventional banks. Islamic bank average capital risk asset ratio and Equity liability ratios
are 23.52 and 31.89 respectively while these ratios for Conventional banks are 25.7 and 21.53
respectively. T-test shows that there is no significant mean difference between these ratios at
5% level; however ANOVA supports significant mean difference among banks at both 5%
and 1% level of significance. Results do not provide any evidence in either way that Islamic
banks are well capitalized. These results do not support the hypothesis that Islamic bank are
better capitalized than their Conventional peers.
T-test of Net Interest Margin (NIM)

IB NIM 1.9 3.8 4.8 15.6 6.51 9.52 1.514 0.144
CB NIM 1.2 2.6 2.9 2.5 2.28 1.67
ANOVA of Net Interest Margin (NIM)

Total 24 4.40 7.02 1.144 0.373
14
T-test of Other Operating Income/Average Assets (OOI)

IB OOI/AA 0.3 0.6 0.4 0.4 0.39 0.33 -0.273 0.788
CB OOI/AA 0.4 0.9 0.3 0.2 0.44 0.54
ANOVA of Other Operating Income/Average Assets (OOI)

Total 24 0.42 0.44 1.318 0.301
T-test of Non Interest Expenses/Average Assets (NIE)

IB NIE/AA 3.2 6.1 5.5 24.9 9.95 17.8 0.917 0.369
CB NIE/AA 4.3 4.2 6.3 6 5.18 2.56
ANOVA of Non Interest Expenses/Average Assets (NIE)

Total 24 7.57 12.69 1.100 0.394
T-test of Cost/Income Ratio (CIR)

IB CIR 151.9 92.5 76.5 76.7 99.4 62.52 -1.280 0.214
CB CIR 172.8 129.6 115.6 124.3 135.59 75.37
15
ANOVA of Cost/Income Ratio (CIR)

Total 24 117.50 70.20 2.394 0.079
The fifth component of the study is operational ratios. NIM is one indicator of bank
operational efficiency. The higher this ratio it is considered better. Islamic bank NIM
increases from 2006-2009 while there is a fluctuation in Conventional bank NIM. The
average NIM ratio for Islamic bank is 6.51 higher than Conventional bank ratio 2.28. This
mean difference between two banks is not statistically significant at 5% level of significance.
This ratio indicates that Islamic banks has high margin. The average Non Interest
Exp/Average Assets ratios and Other Opt Income/ Average Assets ratio are 9.95 and 0.39 for
Islamic banks as compared to 5.18 and 0.44 for Conventional banks. However, a Cost /
Income ratio is lower for Islamic banks. The lower the cost income ratio it is better. Islamic
Bank Cost/Income ratio 99.40 is lower than Conventional bank 135.59. The mean differences
of these ratios are not significant at 5% level. It is analyzed from overall results that major
operational ratios NIM and Cost income ratios are in favor of Islamic banks and supports the
hypothesis that Islamic banks operational efficiency is better than Conventional banks. These
results are consistent with Ahmad, Hussain and Hannan (1999), Iqbal (2001) and Kader,
Janbota and Asarpota (2007).
The last component of financial performance is deployment ratios. Deployment ratios
measure the resource allocation efficiency. The higher these ratios are considered better.
T-test of Investment/Equity & Deposit Ratio (IEDR)

IB IEDR 10.3 20 19 16.8 16.53 7.18 -2.797 0.011*
CB IEDR 26.9 24.5 19.3 25.5 24.03 5.89
ANOVA of Investment/Equity & Deposit Ratio (IEDR)

Total 24 20.28 7.48 3.746 0.017*
16
T-test of Investment/Liabilities Ratio (ILR)

IB ILR 16.1 23.7 21.8 17.6 19.8 9.26 -1.592 0.126
CB ILR 25.7 27.3 21.7 26.6 25.3 7.59
ANOVA of Investment/Liabilities Ratio (ILR)

Total 24 22.55 8.74 6.228 0.002**
Islamic bank has lower average deployment ratios than Conventional bank. The average
Investment/ Equity and Deposits and Investment/ Liabilities are 16.53 and 19.80 for Islamic
banks as compared to 24.03 and 25.30 for Conventional banks. This mean difference is
significant at 1% level for Investment / Equity and Deposit ratio; however this mean
difference between banks is not significant for Investment Liabilities ratios. ANOVA
supports significance mean difference for deployment ratios. Results support the hypothesis
that Islamic bank resource allocation efficiency is less than conventional banks. This is
concluded from these results that deployment ratios are in favor of Convention banks and
they make much better use of their resources.
6 Conclusion
A comparative study conducted to examine the performance of Islamic and Conventional

banks in Pakistan found that Islamic banks in Pakistan have better financial performance than
their Conventional counterparts. Profitability measures of performance of ROAA, ROAE and
PEM do not show (statistically) significant difference between the performances of Islamic
and Conventional banks and reject the hypothesis that Islamic banks are more profitable than
Conventional banks. Liquidity measures CR, CAR show that interbank liquidity
performances of Islamic and Conventional banks are statistically different. Islamic banks are
more liquid than Conventional banks in CR and CAR measures. LDR and NL/TA ratios are
lower for Islamic banks which mean that Islamic banks do not rely more on borrowed funds
and their percentage of assets tied up in loan is lower than Conventional banks. The study
found that risk and solvency measures i.e. DER and DTAR show (statistically) significant
difference between the performances of the two banks. Islamic bank financial strength to pay
their debtors is high. These finding support the hypothesis that Islamic banks are less risky
than Conventional banks. Capital adequacy measures do not support the hypothesis that
Islamic banks are well capitalized than conventional bank. Capital adequacy measures of
performance Capital risk asset ratio and Equity/Liabilities ratio shows that mean difference of
the two banks is not statistically different. Operational efficiency measures of both Islamic
and conventional banks do not show (statistically) significant difference between the
performances of both banks. NIM and Cost Income ratios are in the favor of Islamic bank
which shows Islamic bank are more cost effective than their Conventional counterpart and
17
reject the hypothesis that Islamic bank’s operationally efficiency is less than their
Conventional counterparts. Deployment ratios are higher for Conventional banks and accept
the hypothesis that Islamic bank resource allocation efficiency is less than Conventional
banks. It is concluded from the overall research that Islamic banks are more liquid, less risky
and operationally efficient than Conventional banks.
7 Suggestions for Further Research
1. Sample size should be increased for the same study. More banks should be taken as a
sample to generalize the result of study on the whole industry.
2. Since Islamic banking are in the introductory phase in Pakistan. There is a strong need
to conduct Performance evaluation studies from time to time so that corrective actions
may be taken accordingly
3. This research provides new avenues for future research. Finding of this study
generate a lot of questions in researchers mind; e.g.
i. Why there is no difference between the profitability of two banks
ii. Why Islamic bank are more liquid than Conventional banks
iii. Why Islamic banks are less risky than Conventional banks
iv. Why operational efficiency of Islamic bank is better than Conventional banks.
References
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of Money, Banking, and Credit, 32(1), 93-120.
Ahmad, M. F., Hussain, M. S. & Hannan, S.A. (1999). Experiences in Islamic Banking: A
Case Study of Islamic Bank Bangladesh. Dhaka: Institute of Policy Studies.
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N.M.B.H.N. Hassan, Development and Finance in Islam, Malysia: International Islamic
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Banks (ISBS) A Case Study of Selected Banks In The Mena Region. Research report 422
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Farrukh, Z. (2006). Corporative Performance of Islamic and Commercial Banks. Karachi:

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December 2003, Marrakech: Morocco.
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Journal of Islamic Financial Services, 4(2).
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Jeddah: Islamic Research and Training Institute, Islamic Development Bank.
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Islamic vis-à-vis Conventional Banks in the UAE”. Paper presented at 2006-2007 Annual
Student Research Symposium & First Chancellor’s Undergraduate Research Award at UAE
University.
Khan, M. H. (2004). Banking Industry of Pakistan: Performances and Constrains. Retrieved

October 10, 2010, from http://www.mediamonitors.net/biopakbymuhkhan.html
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Iqbal, Islamic Banking and Finance: Current Development in Theory and Practice, United
Kingdom: The Islamic Foundation.
Metwally, M.M. (1997). Differences between the Financial Characteristics of Interest-Free

Banks and Conventional Banks. European Business Review, 97(2), 92-98.
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Safiullah, M. (2010). Superiority of Conventional Banks & Islamic Banks of Bangladesh: A

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19

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8th International Conference on Islamic Economics and Finance

Financial Performance of Islamic and Conventional Banks in Pakistan: A

Key Words: Islamic banks, conventional banks, financial performance, Pakistan

1.1 Background of the paper

1.2 Significance of the paper

Metwally (1997) evaluated the performance of 15 interest-free banks and 15 conventional

Profitability Liquidity Risk and Capital Operational Deploym

4.1 Theoretical Framework

Risk and Solvency Ratios

Capital Adequacy Ratios

The population of this research is Islamic and conventional banks of Pakistan.

H 1 : Islamic banks are less profitable than Conventional banks.

Inter-bank comparison or cross-sectional analysis is used to compare the performances of

5 Data Finding, Analysis and Discussion

T-test of Return on Average Assets (ROAA)

T-test of Return on Average Equity (ROAE)

ANOVA of Return on Average Equity (ROAE)

T-test of Profit Expense Margin (PEM)

ANOVA of Profit Expense Margin (PEM)

T-test of Current Ratio (CR)

ANOVA of Current Ratio (CR)

T-test of Current Asset Ratio (CAR)

ANOVA of Current Asset Ratio (CAR)

ANOVA of Loan Deposit Ratio (LDR)

T-test of Net Loan/Total Assets Ratio (NL/TA)

ANOVA of Net Loan/Total Assets Ratio (NL/TA)

T-test of Debt Equity Ratio (DER)

ANOVA of Debt Equity Ratio (DER)

T-test of Debt to Total Assets Ratio (DTAR)

ANOVA of Debt to Total Assets Ratio (DTAR)

T-test of Equity/Liabilities Ratio (ELR)

ANOVA of Equity/Liabilities Ratio (ELR)

T-test of Capital Risk Assets Ratio (CRAR)

ANOVA of Capital Risk Assets Ratio (CRAR)

T-test of Net Interest Margin (NIM)

ANOVA of Net Interest Margin (NIM)

T-test of Other Operating Income/Average Assets (OOI)

ANOVA of Other Operating Income/Average Assets (OOI)

T-test of Non Interest Expenses/Average Assets (NIE)

ANOVA of Non Interest Expenses/Average Assets (NIE)

T-test of Cost/Income Ratio (CIR)

ANOVA of Cost/Income Ratio (CIR)

T-test of Investment/Equity & Deposit Ratio (IEDR)

ANOVA of Investment/Equity & Deposit Ratio (IEDR)

T-test of Investment/Liabilities Ratio (ILR)

ANOVA of Investment/Liabilities Ratio (ILR)

A comparative study conducted to examine the performance of Islamic and Conventional

7 Suggestions for Further Research

Ariff, M. (1988). “Islamic Banking.” Asian-Pacific Economic Literature, 2(2), 46-62.

Farrukh, Z. (2006). Corporative Performance of Islamic and Commercial Banks. Karachi:

Hassoune, A. (2002). Islamic Banks’ Profitability in an Interest Rate Cycle. International

Hussein, K.A. (2004). Banking Efficiency in Bahrain: Islamic VS Conventional Banks.

Khan, M. H. (2004). Banking Industry of Pakistan: Performances and Constrains. Retrieved

Metwally, M.M. (1997). Differences between the Financial Characteristics of Interest-Free

Safiullah, M. (2010). Superiority of Conventional Banks & Islamic Banks of Bangladesh: A

Samad, A. (2004). “Performance of Interest-free Islamic banks vis-à-vis Interest-based

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