Differences between islamic and conventional banking

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The objective of this paper is to investigate whether it is possible to distinguish between an Islamic bank (Albaraka) and a conventional bank (Amen bank) on the basis of financial ratios that measure profitability, bank efficiency, risk, asset quality, and liquidity. Our findings reveal a great difference across these two banks. Albaraka is more profitable and less risky than Amen bank. However, the efficiency of the Islamic bank is lower than that of the conventional bank.

JEL classification:G 21; P 51

1. Introduction

The earliest Islamic bank is the Mit Ghamr established in Egypt in 1963. Islamic banking is developing rapidly around the world and is increasingly recognized as a viable alternative mode of financing. This prosperity of Islamic finance helps to fulfill the needs of Muslims to obtain a financing that respects their religion (Halal financing). Moreover, recent studies argue that Islamic finance can even survive in non-Muslim countries. Indeed, there are approximately 50 Islamic banks located in western countries and offshore centres. London tends to be the European hub for Islamic finance with 22 fully-fledged Islamic banks and Islamic windows. In 1999, Dow Jones created ‘Islamic Market Indexes' to offer Sharia-compliant investment portfolios. Several major Western banks such as Citibank, HSBC, ABN Amro, Bank of America, Standard Chartered, and the Union Bank of Switzerland, either have Islamic Banking subsidiaries or have Islamic windows that offer Islamic financial products to their customers (Khan, 2010).

Islamic finance is based on the prohibition of Riba (usury). Riba is forbidden (non-halal) by the Holly Qur'an as well as by the Sunnahbecause money itself has no intrinsic value. The Islamic financial system prohibits the payment or receipt of any predetermined, fixed rate of return. The Sharia (Islamic Law) forbids making money from money. The wealth can be raised by investing in assets.

The second principle of Islamic banking is the profit-and-loss sharing (PLS). This principle is complementary with the first one. Banks do not charge fixed interest on the loans offered to their customers but they are rewarded by participating in the profit resulting of bank funds. However, Chong and Liu (2009) find that only a negligible portion of Islamic bank financing in Malaysia is compliant with PLS principle. Similarly, Zaman and Movassaghi (2001) conclude that some of the practices and the financial instruments used by the Islamic banks do not respect Islamic principles.

In this study, we attempt to investigate the difference between Islamic and conventional banking in Tunisia by the comparison of financial ratios of Albaraka and Amen bank. Our findings indicate that this difference is strongly significant.

The remainder of this paper is organized as follows. Section 2 provides an overview about promising growth of the Islamic finance industry worldwide. Section 3 presents the financing techniques provided by Islamic banks. Section 4 investigates empirically the difference between Islamic and conventional banking on the basis of some accounting ratios. Section 5 concludes.

2. Overview on Islamic banking

Islamic banking is currently practiced in more than 50 countries worldwide (Chong and Liu, 2009). Islamic banks operate in over sixty countries, though mostly concentrated in the Middle East and Asia (Zaman and Movassaghi, 2001). There are more than 300 Islamic financial institutions around the world, including banks, mortgages companies, Takaful companies and investment funds. There are many indicators that reveal the increasingly importance of Islamic finance. The value of assets of Islamic financial institutions (IFIs) was roughly five billion U.S. dollars in 1985 (Iqbal, 1997). At the dawn of the third millennium, it was estimated at 100 billion dollars, which, represents nearly the quarter of short-term external debts of developing countries (World Bank 2000, p. 79). In 2008, the value of the world's “Islamic assets” became about US $700 billion (Economist, 2008) and it is estimated that by 2012, Islamic assets will reach about US $1,600 billion, with revenues of US $120 billion (Islamic Financial Services Board, 2010).

The reason of the tremendous progress of Islamic banking is due to their rationality and effectiveness experienced by Muslim as well as Non-Muslim countries (Ebrahim and Safadi, 1995). Gambling and Karim (1986) suggest that if the individuals are Muslims so their personalities are Islamic and their culture is Islamic. However, Ariss (2010) notes that Islamic finance is not limited to stakeholders with common religious backgrounds.

Figure 2 shows that 36 percent of Islamic finance assets are located in Iran. This evidence can be explained by the fact that in this country entire banking system has been converted to Islamic banking. Indeed, the Iran's Islamic revolution of 1979 had been followed by a government initiative for the establishment of interest-free banking. Gambling and Karim (1991) show that this Islamic revolution was a result of the dissatisfaction of the less wealthy social classes with the West backed politico-economic system that governs Iran under the Shah.

Table 1 shows the number of Islamic banks and financial institutions by country, their total assets, and the repartition of assets between each Islamic sector for the year-end 2008. Of the 302 financial institutions operating over the world, 118 are located in five countries of the Gulf Cooperation Council region. Following the events of September 11, 2001, a considerable amount of Arab money flowed out of western countries back to the Middle East. This has further increased the dominance of the GCC region in Islamic banking world-wide (Olson and Zoubi, 2008).

Table 1. Islamic banks and financial institutions at year-end 2008 (in US $ billion)



of firms

Total of


of which













































































































Other countries












Source: International Financial Services, London, (Islamic finance 2010).

3. Islamic mode of financing

Islamic banks provide several forms of funding (Tamouil) that are in line with Sharia(Islamic Law)

3.1. Musharaka

The Musharaka is a partnership agreement between two or more parties in the capital of a company, project or operation. The profits are distributed according to an allocation formula for allocating predetermined. In the event of a loss, it is supported by the parties in proportion to the capital invested.

By offering this type of contract, Islamic Banks account on the morality of the client on a relationship of trust and profitability of the project or transaction.

3.2. Moudharaba

The Moudharaba (profit-sharing) is a contract between two parties. A named party “donors” or “Rab Al Mal” provides the second part, called “Manager” or “Moudhareb” funds. The latter is responsible to manage, while defining a prior allocation of profits to be made.

3.3. Murabaha

Murabaha(cost plus) is a contract of sale at cost plus a margin known and agreed between the bank and the customer. Thebank buys the asset chosen by the client and resells it at the buying price plus a profit at a rate agreed between the two parties at the time of entering into the contract.

3.4. Ijara

By contrast, if the client does not want to buy the asset and prefers to rent it, this transaction can be undergone in the Islamic framework as Ijara (leasing). Under the Ijara transaction, the bank (referred as Mu'jir) purchase the property as requested by the client (referred as Must'jir) and gives the customer the right to use and benefit for a period of predetermined time and the customer pays part against an agreed rent in advance (referred to as Ujrah). The property is owned by the Bank since only the usufruct, that is to say the right to use, is transferred to the leaseholder. The Ijara can be defined as the enjoyment of the usufruct determined with a known margin for a period of time.

3.5. Istisna'a

The Istisna'a is defined as a contract of sale between the "Final Buyer" or "Al Mustasni '" and "seller" or "Al Sani'." The latter undertakes to manufacture or acquire an asset subject of the contract, requires a process of manufacture. The seller is committed to buy raw materials, and provide the necessary work to deliver the goods manufactured in accordance with predefined description of the characteristics of the property. The sale price and payment terms are agreed and set at the contract signing. Payment can be done at the conclusion of the contract, in installments or on a specified date in the future.

3.6. Salam

Salam can be defined as a contract of sale with deferred delivery. The price is paid in advance at the time of contracting while the delivery of the purchased goods or services is postponed to an agreed future date.

4. Islamic banking in Tunisia

Islamic banking in Tunisia was implemented in 1983 by the incorporation of Albaraka Bank which holds currently nine branches. It provides a large range of products and services that are Sharia-compliant. The experience of Noor Islamic Bank belonging to Dubai Holding Group in Tunisia was very short since it retired after only one year.

However, Islamic banking is still underdeveloped in Tunisia. Indeed, it's surprising to note that Zitouna bank established in May 2010 is the first Islamic Tunisian bank unless 99% of Tunisians are Muslim, the Islam is the religion of the State according to the Constitution of 1959, Kairouan is the Islam's fourth holiest city, and that Tunisia is the native country of several great Islamic scholars such as Ibn-Khaldoun (1332-1406 AD) and Imam Sahnoun (776-854 AD). This branch of finance is still largely unknown, not only from public but also from professionals. The plausible explanation of this insignificance of Islamic banking is that Tunisia has been governed since her independence by a secular left-wing party. Indeed, the entire conversion in Iran to Islamic banking system is explained by the existence of an Islamic government that evolved from the revolution of 1979.

Naser and Jamal (1999) conduct a questionnaire in order to evaluate the degree of customer awareness and satisfaction of products and services offered by Islamic banks in Jordan. They find that respondents are dissatisfied with some of Islamic bank services. Their survey reveals also that customers know Islamic financial products but they do not deal with them. Khan (2010) documents evidence that much of Islamic banking and finance still remains functionally indistinguishable from conventional banking.

4. Empirical analysis

4.1 Data

Our sample includes only two banks: one Islamic “Albaraka” and another conventional “Amen bank”. In Tunisia, there are only two Islamic banks Albaraka incorporated since 1983 and Zitouna launched in 2010. Our choice of Amen bank to compare between Islamic and conventional banking was based on the criteria of the amount of capital. Al Baraka Tunis named Bank Ettamouil Tounsi Saoudi (B.E.S.T BANK) currently has 8 branches. It operates mainly with non residents. Amen Bank was founded in 1966.

Annual reports of these two banks were downloaded from their websites. Our sample period is from 2000 to 2008.

4.2 Definitions of financial ratios

In this study, we used 13 financial ratios to distinguish between Islamic and conventional banking. Following Olson and Zoubi (2008), these ratios can be clustered into five general categories: profitability, efficiency, asset quality, liquidity, and risk. Table 2 defines the 13 ratios.

Table 2. Definitions of financial ratios

Bank profitability ratios

1. ROA = return on assets = NI / TA = net income / total assets

2. ROE = return on equity = return on equity = NI / SE = net income / shareholders equity

3. PM = profit margin = NI / OI = net income / operating income

Bank efficiency ratios

4. OIA = operating income to assets = OI/ TA = operating income / total assets

5. OEA = operating expenses to assets = OE / TA = operating expenses / total assets

6. OER = operating expenses to revenue = OE / OI = operating expenses / operating income

Risk ratios

7. DTA = deposits to assets = TD / TA = total deposits and clients dues / total assets

8. ETD = equity to deposits = SE / TD = shareholders equity / total deposits and clients dues

9. TLE = total liabilities to equity = TL / SE = total liabilities / shareholders equity

Liquidity ratios

10. CTA = cash to assets = C / TA = cash / total assets

11. CTD = cash to deposits = C / TD = cash / total deposits and clients dues

Asset-quality indicators

12. LTD = loans to deposits = TL / TD = total loans / total deposits and clients dues

13. LR = loan ratio = TL / TA = total loans / total assets

4.3Empirical findings

Table 2 reports descriptive statistics for both subsidiaries. A t-test for equality of means between the Albaraka bank and Amen bank for each of the 13 financial ratios is presented in the last column of the table. Only the difference of return on asset is non-significant. The other ratios are significantly different between the two subsidiaries at the 1% level.

This table shows that two of the three profitability ratios indicate that the Islamic bank is more profitable than the conventional bank. This findings is consistent with previous results reported in previous papers such as Rosely and Abu Baker (2003), and Olson and Zoubi (2008). The ROA averages 1.8% annually for Albaraka versus 1.1% for Amen bank. The difference is significant at 1% level.

Efficiency ratios reveal that the Islamic bank is less efficient than the conventional bank. Mokhtar, Abdullah, and Al-Habshi (2006) investigate the efficient of the overall Islamic banking industry in Malaysia over the period 1997-2003. Their findings suggest that Islamic banks are less efficient than conventional banks. In addition, the efficiency of fully-fledged Islamic banks is higher than that of Islamic windows. Their study reveals also that Islamic windows of foreign banks tend to be more efficient than those of domestic banks. . This lower efficiency of Islamic banking relative to conventional banking may be due to lack of economies of scale due to the smaller size of Islamic banks, or it may arise because customers of Islamic banks are pre-disposed to Islamic products regardless of cost (Olson and Zoubi, 2008).

The risk ratios reveal that the conventional bank is riskier than the Islamic bank. This lower risk of Albaraka compared to Amen bank may be due to the fact that Albaraka Tunisia activity is exclusively oriented to non-residents.

The liquidity ratios suggest that Albaraka held less cash relative to assets and deposits than Amen bank. This evidence may be due to the lack of short-term liabilities to cover for the Islamic bank. Holding a lot of cash tends to reduce the profitability of the bank because cash pays no interest.

The asset-quality indicators show that the conventional bank takes more risk than the Islamic bank since it gives more loans relative to deposits and assets.

Table 3. Descriptive statistics of the financial ratios



Standard deviation

t-test for equality of means


Amen Bank


Amen Bank



Bank profitability ratios






















Bank efficiency






















Risk ratios






















Liquidity ratios















Asset-quality indicators















The t-test for equality of means is based on the mean for Albaraka minus that of Amen Bank for each financial ratio.

*** Denotes significance at 1% level.

5. Conclusion

The empirical results of this study suggest that we can distinguish between Islamic and conventional banks on the basis of financial ratios. They indicate that although Islamic banking is more profitable than conventional banking, it‘s still less efficient. This study represents an overview on the underdevelopment of Islamic banking in Tunisia compared to its strengthening growth world-wide. Future researches should focus on the reasons of the irrelevance of Islamic finance industry in Tunisia although the capacity of this branch of finance to contribute towards sustainable development and a global prosperity.