In this article, financial analysis has been performed of the full-fledged Islamic banks in Pakistan that include Meezan Bank (MBL), Bank Islami (BI), Dubai Islamic Bank (DIB), Burj Islamic Bank and Bank Al-Barakah. The period of analysis is 2007-12. Brief commentary is also given regarding recent trends in Islamic banking by analyzing the various important financial ratios for the last 6 years.
Low Finance to Deposit Ratio
Finance to deposit ratio for most banks has declined during 2007-12. The possible reasons for that include:
a) Rise in markup rates.
b) High cost of doing business, energy crisis, security crisis etc.
c) Lack of product alternatives to provide distress financing other than for purchase of assets. The demand for such financing is more prominent in a recessionary period.
High Deposits to Total Assets Ratio
Islamic banks have effectively mobilized deposits and deposit to total assets ratio has steadily increased during the period 2007-12. Though, we defer the empirical analysis of determinants of growth in deposits for the next section, but, here several possible reasons can be highlighted for strong deposit growth and mobilization.
a) Deposit mobilization has much less contractual frictions than creating a Shari’ah compliant financing asset. In providing finance, it is important that finance is provided for genuine purchase of an asset whose ownership, possession and risk has to be borne by bank so as to be able to earn any sale premium or rents for the use of asset.
b) When people become aware of Islamic banking and accept its status as Islamic, most people would start using Islamic banking services first by opening bank accounts than by obtaining finance.
c) It is easier for a customer to switch from conventional bank deposit to Islamic bank deposit than to convert a conventional debt based liability to Islamic financing product.
d) Islamic banks have remained solvent and liquid and hence during and after consumer-financing bust, people have placed more faith in Islamic banks for parking their surplus funds.
Declining NPL to Financing Ratio Post Crisis (2010 Onwards)
NPL to finance ratio has increased during the consumer-financing bust, but comparatively, Islamic banks have lower NPLs and cleaner balance sheets as compared to conventional banks. After 2010, the ratio is decreasing for all banks in the sample. Possible reasons include:
a) Islamic banks do not provide risky financing, i.e. unsecured loans.
b) Financing is always provided for the purchase of an asset whose ownership belongs to bank.
c) Since Islamic banks can not earn profit on late payments, they only provide financing to sound clients than creating subprime assets.
Expense to Net Markup Margin Ratio
This ratio shows that Islamic banks have not achieved scale efficiency yet, but the ratio is declining for some banks and stabilizing for some other banks showing a possible reversal. Hike in this ratio could be attributed to:
b) Scale inefficiency.
c) Diseconomies of scale and scope. Each financing contract requires thorough documentation and ascertainment of genuine purchase of an asset.
d) Lack of room to provide every type of loan, like credit cards, running finance, personal finance, travel finance, education finance, health finance etc.
Net Markup Margin to Finance Ratio
This ratio does not present a unique picture or trend. This ratio depends on:
a) Movements in benchmark rate. Rise in benchmark rate will increase this ratio.
b) Any changes in average maturity of financing assets. Increase in average maturity of financing given a normal yield curve will also increase this ratio.
Rising Net Income to Financing Ratio
Most banks had been in losses in their initial years of establishment. This is understandable given the heavy capital expenditure required to set up a bank. Secondly, being a small part of the overall market along with increase in number of players in the banking sector of Pakistan during 90s and 2000s, Islamic banks at the moment cannot use price skimming to break even quickly. However, all banks taken in the sample currently are now in profits.
Declining Capital to Finance Ratio
Islamic banks are solvent and have reasonable capital adequacy ratio. With increased penetration and awareness, they are able to park liquidity into financing assets more efficiently than before which is reflected by the decline in this ratio. Market leader during this period has had consistency in this ratio which reflects that there is first mover advantage and dominant firm advantage in the industry.
Improving Net Income to Total Assets Ratio
Most banks had been in losses in their initial years of establishment. However, all banks in the sample currently are now in profits. The top two banks have had much stable path for this ratio during the period as compared to new entrants.
Declining Net Markup Margin to Total Assets Ratio
Fluctuation in benchmark rate, slight rise in NPLs and low ADR has resulted in decline of this ratio in recent years.
Source: Islamic Economics Project, Author, Salman Ahmed Shaikh