- Islamic banks fared differently from conventional banks during global crisis
- Weaknesses in risk management hurt Islamic bank profitability in 2009
- Crisis revealed important regulatory and supervisory challenges
A new IMF study compares the performance of Islamic banks and conventional banks during the recent financial crisis, and finds that Islamic banks, on average, showed stronger resilience during the global financial crisis.
But the study also finds that Islamic banks faced larger losses than their conventional peers when the crisis hit the real economy.
In “The Effects of the Global Crisis on Islamic and Conventional Banks: A Comparative Study,” economists Jemma Dridi of the IMF’s Middle East and Central Asia Department and Maher Hasan of the IMF’s Monetary and Capital Market Department look at the effects of the crisis on bank profitability, credit, and asset growth in countries where both types of banks have a significant market share. The new working paper adds an empirical dimension to the debate on the relationship between Islamic banking and financial stability, a topic that has generated renewed interest since the global crisis.
Too big to ignore
Islamic finance is one of the fastest growing segments of the global financial industry. In some countries, it has become systemically important and, in many others, it is too big to be ignored. It is estimated that the size of the Islamic banking industry at the global level was close to $820 billion at end-2008. The largest Islamic banks are located in the countries of the Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates).
While Islamic banks play roles similar to conventional banks, fundamental differences exist between the two models. The main difference between Islamic and conventional banks is that the former operate in accordance with the rules of Shariah, the legal code of Islam. The central concept in Islamic banking and finance is justice, which is achieved mainly through the sharing of risk. Stakeholders are supposed to share profits and losses, and charging interest is prohibited.
There are also differences in terms of financial intermediation, the paper notes. While conventional intermediation is largely debt based, and allows for risk transfer, Islamic intermediation, by contrast, is asset based, and centers on risk sharing. One key difference between conventional banks and Islamic banks is that the latter’s model does not allow investing in or financing the kind of instruments that have adversely affected their conventional competitors and triggered the global financial crisis. These include toxic assets, derivatives, and conventional financial institution securities.
To control for varying conditions across financial systems, the paper looks at the actual performance of Islamic banks and conventional banks in countries where both have significant market shares (see Chart 1). It uses bank-level data covering 2007−10 for about 120 Islamic banks and conventional banks in eight countries—Bahrain, Jordan, Kuwait, Malaysia, Qatar, Saudi Arabia, Turkey, and the United Arab Emirates. These countries host most of the world’s Islamic banks (more than 80 percent of the industry, excluding Iran) but also have large conventional banking sectors. The key variables used to assess the impact are the changes in profitability, bank lending, bank assets, and external bank ratings.