Comparative Analysis of Islamic and Conventional Banks in the UAE During the Financial Crisis
To analyze the impact of the 2008 global financial crisis on the banking sector in the UAE and provide recommendations for addressing the challenges faced by the industry.
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This study analyzes the performance of Islamic and conventional banking systems in the UAE during the financial crisis. The study compares the two banking sectors, in terms of; capital adequacy, profitability, liquidity and leverage. The purpose of this analysis is to determine which banking system has adequate performance and was more stable during the financial crisis.
Comparative Analysis of Islamic and Conventional Banks in the UAE During the Financial Crisis
To analyze the impact of the 2008 global financial crisis on the banking sector in the UAE and provide recommendations for addressing the challenges faced by the industry.
Added on 2023-06-15
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Asian Economic and Financial Review, 2016, 6(6): 298-309
298
† Corresponding author
DOI: 10.18488/journal.aefr/2016.6.6/102.6.298.309
ISSN(e): 2222-6737/ISSN(p): 2305-2147
© 2016 AESS Publications. All Rights Reserved
COMPARATIVE ANALYSIS OF ISLAMIC AND CONVENTIONAL BANKS IN THE
UAE DURING THE FINANCIAL CRISIS
Issam Tlemsani1† --- Huda Al Suwaidi2
1Department of Finance and Economics, Qatar University, Qatar
2Senior Internal Auditor, Abu Dhabi Securities Exchange
ABSTRACT
The discourses of Islamic and conventional finance differ according to the principles of Islamic finance there is no
separation of the spiritual and the secular. Islamic finance is explicitly concerned with spiritual values and social
justice, in contrast to conventional finance, which is based on the maximization of individual utility, welfare and
choice, as expressed for example in the shareholder value model. Islamic and conventional banks respond differently
to financial shocks. This study analyses the performance of Islamic and conventional banking systems in the UAE
during the financial crisis. The study was undertaken in two stages, first a comparative analysis one Islamic and one
conventional banks from 2007 until 2008. Secondly, a cross sectional analysis, between the Islamic (8 banks) and
conventional banking sector (43 banks) that operated in the UAE during the period 2007-2008 was undertaken.
© 2016 AESS Publications. All Rights Reserved.
Keywords: Islamic finance, Banks performance, Banking stability and risk management.
Contribution/ Originality
This study contributes in the existing literature and help to the understanding of Islamic finance principles and its
value as a solution to the current and any future financial crises. The findings of this research will be of interest to
conventional and Islamic financial practitioners, policy makers and academicians.
1. INTRODUCTION
The discourse of Islamic banking involves: (a) equity rather than debt, (b) financing in strict relation to assets
rather than leverage, (c) transparency and information sharing between investor and the manager, (d) diversification
of risk by risk sharing. In contrast, the discourse of conventional finance failed as a result of: (a) too much debt, (b)
overleveraging of assets and (c) excessive securitization and creation of new assets that were neither transparent nor
understood.
The focus of this research paper is to evaluate and compare the performance of Islamic and conventional banks
during 2007-2008 in the UAE. The study compares the two banking sectors, in terms of; capital adequacy,
profitability, liquidity and leverage. Analyzing different bank’s performances during the financial crisis allows for an
assessment of the bank’s capability to withstand shocks and depressions (stress test).
The banking industry in the UAE is well developed. The UAE Central Bank was established in 1973, in the early
stages it operated under the name UAE currency broad. In December the 10th 1980, as per union law, The Central
Asian Economic and Financial Review
ISSN(e): 2222-6737/ISSN(p): 2305-2147
URL: www.aessweb.com
298
† Corresponding author
DOI: 10.18488/journal.aefr/2016.6.6/102.6.298.309
ISSN(e): 2222-6737/ISSN(p): 2305-2147
© 2016 AESS Publications. All Rights Reserved
COMPARATIVE ANALYSIS OF ISLAMIC AND CONVENTIONAL BANKS IN THE
UAE DURING THE FINANCIAL CRISIS
Issam Tlemsani1† --- Huda Al Suwaidi2
1Department of Finance and Economics, Qatar University, Qatar
2Senior Internal Auditor, Abu Dhabi Securities Exchange
ABSTRACT
The discourses of Islamic and conventional finance differ according to the principles of Islamic finance there is no
separation of the spiritual and the secular. Islamic finance is explicitly concerned with spiritual values and social
justice, in contrast to conventional finance, which is based on the maximization of individual utility, welfare and
choice, as expressed for example in the shareholder value model. Islamic and conventional banks respond differently
to financial shocks. This study analyses the performance of Islamic and conventional banking systems in the UAE
during the financial crisis. The study was undertaken in two stages, first a comparative analysis one Islamic and one
conventional banks from 2007 until 2008. Secondly, a cross sectional analysis, between the Islamic (8 banks) and
conventional banking sector (43 banks) that operated in the UAE during the period 2007-2008 was undertaken.
© 2016 AESS Publications. All Rights Reserved.
Keywords: Islamic finance, Banks performance, Banking stability and risk management.
Contribution/ Originality
This study contributes in the existing literature and help to the understanding of Islamic finance principles and its
value as a solution to the current and any future financial crises. The findings of this research will be of interest to
conventional and Islamic financial practitioners, policy makers and academicians.
1. INTRODUCTION
The discourse of Islamic banking involves: (a) equity rather than debt, (b) financing in strict relation to assets
rather than leverage, (c) transparency and information sharing between investor and the manager, (d) diversification
of risk by risk sharing. In contrast, the discourse of conventional finance failed as a result of: (a) too much debt, (b)
overleveraging of assets and (c) excessive securitization and creation of new assets that were neither transparent nor
understood.
The focus of this research paper is to evaluate and compare the performance of Islamic and conventional banks
during 2007-2008 in the UAE. The study compares the two banking sectors, in terms of; capital adequacy,
profitability, liquidity and leverage. Analyzing different bank’s performances during the financial crisis allows for an
assessment of the bank’s capability to withstand shocks and depressions (stress test).
The banking industry in the UAE is well developed. The UAE Central Bank was established in 1973, in the early
stages it operated under the name UAE currency broad. In December the 10th 1980, as per union law, The Central
Asian Economic and Financial Review
ISSN(e): 2222-6737/ISSN(p): 2305-2147
URL: www.aessweb.com
Asian Economic and Financial Review, 2016, 6(6): 298-309
299
© 2016 AESS Publications. All Rights Reserved
Bank was formed and was given broader authorities in terms of the monetary system and supervision of banks. The
rapid growth in the UAE’s economy is reflected also in the growth of The Central bank’s activities such as but not
limited to: credit, foreign assets, capital and shares. Figure 1: below illustrates the progress in different activates by
The Central Bank of the UAE from 1980 to 2007.
Figure-1. The Central Bank's activities
Source: Central Bank of the UAE Data 2008
UAE government established the first federal law regarding allowance for Islamic banks activities in 1985. Table
1: below demonstrates the coverage of the banking system in the UAE as of October 31st 2012.
Table-1. Banks in the UAE
Type of financial institutions in the UAE Headquarters in the UAE Number of branches in the UAE
UAE national banks 23 922
Gulf countries banks 6 1
Foreign banks 22 136
Business banks 4 -
Offices of international banks
and financial companies
113 -
Financing companies 25 23
Investment finance companies 23 25
Exchange companies 120 677
ATM machines 4346 -
Source: Central Bank of the UAE Data 2012
1.1. Islamic Financial System
One of the key differences between conventional and Islamic banking is the ban on Riba (usury); riba is any
return/addition/increase for the use/rent of money. Islamic financial institutions must “trade” in real assets or services.
There are several reasons for the prohibition of riba such as Unjust; a contract based on interest involves injustice to
one of the parties, the lender or the borrower. Penalizing someone for default is unjust; a judge should decide the
amount of any compensation for a default, not the party to whom the debt is owed. Qur’an (2:279) “clearly states that
taking an amount in excess of the principal would be unjust”. And Implies Unlawful Appropriation of Other People’s
Property; Interest on money is regarded as representing an unjustified creation of instantaneous property rights. It is
299
© 2016 AESS Publications. All Rights Reserved
Bank was formed and was given broader authorities in terms of the monetary system and supervision of banks. The
rapid growth in the UAE’s economy is reflected also in the growth of The Central bank’s activities such as but not
limited to: credit, foreign assets, capital and shares. Figure 1: below illustrates the progress in different activates by
The Central Bank of the UAE from 1980 to 2007.
Figure-1. The Central Bank's activities
Source: Central Bank of the UAE Data 2008
UAE government established the first federal law regarding allowance for Islamic banks activities in 1985. Table
1: below demonstrates the coverage of the banking system in the UAE as of October 31st 2012.
Table-1. Banks in the UAE
Type of financial institutions in the UAE Headquarters in the UAE Number of branches in the UAE
UAE national banks 23 922
Gulf countries banks 6 1
Foreign banks 22 136
Business banks 4 -
Offices of international banks
and financial companies
113 -
Financing companies 25 23
Investment finance companies 23 25
Exchange companies 120 677
ATM machines 4346 -
Source: Central Bank of the UAE Data 2012
1.1. Islamic Financial System
One of the key differences between conventional and Islamic banking is the ban on Riba (usury); riba is any
return/addition/increase for the use/rent of money. Islamic financial institutions must “trade” in real assets or services.
There are several reasons for the prohibition of riba such as Unjust; a contract based on interest involves injustice to
one of the parties, the lender or the borrower. Penalizing someone for default is unjust; a judge should decide the
amount of any compensation for a default, not the party to whom the debt is owed. Qur’an (2:279) “clearly states that
taking an amount in excess of the principal would be unjust”. And Implies Unlawful Appropriation of Other People’s
Property; Interest on money is regarded as representing an unjustified creation of instantaneous property rights. It is
Asian Economic and Financial Review, 2016, 6(6): 298-309
300
© 2016 AESS Publications. All Rights Reserved
unjustified, because interest is a property right claimed outside the legitimate framework of recognized property
rights.
1.1.1. Non Riba (Usury) Finance
Islam has always emphasized the importance of risk sharing system which has a number of (competitive)
advantages over the system of based upon pre-determined interest rates. We can innumerate some standard properties
of riba finance according to Islamic finance scholars as follows:
Inefficiency
Interest results in an inefficient allocation of resources since the investible funds go to the more creditworthy
borrowers rather than to more productive projects.
Debt finance based on predetermined and guaranteed rates of return on money has unlinked capital movement
from the production processes it is supposed to finance.
Money verses real market
Money creation in a system of debt finance is based on lending, which makes it prone to oversupply, as there is
no direct linkage between additional production and additional money supply.
Public sector
Public sector borrowing, when it is not backed by tangible assets, raises a debt burden for future generations.
Islamic asset-backed financing does not constitute a debt burden as assets are available which can be liquidated
to repay the debts.
Price level
Inflation will be minimal (under an Islamic finance system) as the money supply will be correlated to economic
activities.
Islamic finance encourages individuals to share business risks in return for reward with the understanding that the
level of the expected reward is related to the level of risk. What is condemned in Islamic banking is the notion of a
risk free reward or return which is in contrast to conventional banking principles. Islamic banking principles do
recognize the time value of money but provided that profits are earned through trade and not on lending money. The
distinguishing factors between Islamic from conventional banking are:
Gharar (uncertainty): Any contract based on a future of uncertain event within Islamic banking is not generally
allowable this includes dealing in conventional derivatives and options.
Maysir (gambling): Speculative mentality transactions creating towers of debt based on speculation.
Halal business: Islamic (Sharia) law prohibits dealing in some products or activities e.g. pork, interest based
finance, debt, gambling, alcoholic liquor...etc.
2. LITERATURE REVIEW
Parashar (2010) compared selected conventional and Islamic banks on five performance parameters; capital
adequacy, efficiency, profitability, liquidity and leverage. Their analysis suggests that during the crisis Islamic
banking, were impacted more in terms of capital adequacy and leverage while conventional banking more in terms of
return on average assets and liquidity. For full year analysis the study found that Islamic banks performed better than
conventional banks for the period 2006-2009. The study suggests that Islamic banks did suffer during crisis in terms
of lowering of CAR, E/TA and ROAE.
Loghod (2008) compared the financial performance (profitability, liquidity and structure) of Islamic and
conventional banking from 2000 - 2005. The study found no significant differences in terms of profitability.
300
© 2016 AESS Publications. All Rights Reserved
unjustified, because interest is a property right claimed outside the legitimate framework of recognized property
rights.
1.1.1. Non Riba (Usury) Finance
Islam has always emphasized the importance of risk sharing system which has a number of (competitive)
advantages over the system of based upon pre-determined interest rates. We can innumerate some standard properties
of riba finance according to Islamic finance scholars as follows:
Inefficiency
Interest results in an inefficient allocation of resources since the investible funds go to the more creditworthy
borrowers rather than to more productive projects.
Debt finance based on predetermined and guaranteed rates of return on money has unlinked capital movement
from the production processes it is supposed to finance.
Money verses real market
Money creation in a system of debt finance is based on lending, which makes it prone to oversupply, as there is
no direct linkage between additional production and additional money supply.
Public sector
Public sector borrowing, when it is not backed by tangible assets, raises a debt burden for future generations.
Islamic asset-backed financing does not constitute a debt burden as assets are available which can be liquidated
to repay the debts.
Price level
Inflation will be minimal (under an Islamic finance system) as the money supply will be correlated to economic
activities.
Islamic finance encourages individuals to share business risks in return for reward with the understanding that the
level of the expected reward is related to the level of risk. What is condemned in Islamic banking is the notion of a
risk free reward or return which is in contrast to conventional banking principles. Islamic banking principles do
recognize the time value of money but provided that profits are earned through trade and not on lending money. The
distinguishing factors between Islamic from conventional banking are:
Gharar (uncertainty): Any contract based on a future of uncertain event within Islamic banking is not generally
allowable this includes dealing in conventional derivatives and options.
Maysir (gambling): Speculative mentality transactions creating towers of debt based on speculation.
Halal business: Islamic (Sharia) law prohibits dealing in some products or activities e.g. pork, interest based
finance, debt, gambling, alcoholic liquor...etc.
2. LITERATURE REVIEW
Parashar (2010) compared selected conventional and Islamic banks on five performance parameters; capital
adequacy, efficiency, profitability, liquidity and leverage. Their analysis suggests that during the crisis Islamic
banking, were impacted more in terms of capital adequacy and leverage while conventional banking more in terms of
return on average assets and liquidity. For full year analysis the study found that Islamic banks performed better than
conventional banks for the period 2006-2009. The study suggests that Islamic banks did suffer during crisis in terms
of lowering of CAR, E/TA and ROAE.
Loghod (2008) compared the financial performance (profitability, liquidity and structure) of Islamic and
conventional banking from 2000 - 2005. The study found no significant differences in terms of profitability.
Asian Economic and Financial Review, 2016, 6(6): 298-309
301
© 2016 AESS Publications. All Rights Reserved
However, the key differences found were; Islamic banks are less exposed to liquidity risk, and conventional banks
depended more on external liabilities than Islamic banks.
Zaki (2012) looked at the following two interrelated research issues: Identifying and explaining the determinants
the financial turmoil in the UAE’s financial markets and evaluating the impact of the UAE’s government bailouts on
the UAE’s economy in the short and long run. The findings were that the government saved the troubled banks
through bailouts and drawing down FXRES (Government economic activity). The timing of the increase in the ratio
of leverage risk measures of the banking system and reserve adequacy (liquidity risk) of the UAE’s economy is
consistent with the model’s prediction that the government’s bailouts and foreign reserve policy played a crucial role
in reducing the adverse reaction to the financial crisis in 2007 - 2008. These developments significantly contributed to
the positive expectations in the market. The result was survival of the banking sector with the confidence of market
participants intact.
Beck et al. (2010) observe that Islamic banking have lower overhead costs and cost-income ratio and higher
returns over asset but capital asset ratios is smaller. Islamic banks have higher fixed asset ratio and lower non-interest
earning asset ratio. Maintaining a high fixed asset ratio implies that the Islamic banks are managing their assets more
efficiently and profitably than conventional banks.
Viverita (2010) analyzed the performance of Islamic compared to conventional banks in Indonesia. Different
ratios were used and they found that the cost efficiency ratios were lower in Islamic than the conventional banks in
addition the revenue and profit efficiency ratios were higher in Islamic banking. Also the Islamic banks net interest
margin (NIM) have maximum of 0.182, while conventional banks have 0.097. Furthermore, the operating income to
average asset in conventional bank was 0.006 while in the Islamic bank the mean was 0.013. Islamic banking is
generating higher income from its asset, which is a positive indicator of revenue efficiency performance in Islamic
banks.
Mobeen et al. (2011) studied the top 10 Islamic and conventional banks performance during the financial crisis,
they found that the aggregate net profit for the conventional banks observed a drop while Islamic banks experienced
an increase in their net profit in the same period. Moreover, the leverage ratio (asset/equity) for conventional banks
increased from 16.6% in 2006 up to 18.2 in 2008, however, Islamic banks leverage ratio was 5.8 in 2006 boosted to
6.6 in 2008. The leverage ratio measures the firm’s long term solvency, the ability to meets its obligation, as the
leverage ratio is smaller it means that the firm is using less debt.
Rashwan (2010) assessed the performance of Islamic and conventional banks from 2007 to 2009 in terms of
return on asset and on equity, net loan to total asset and loan loss reserve to gross loan. They used data from 46
Islamic banks and found that Islamic outperformed conventional bank in 2007, but in 2008 there was no significant
difference between the two banking systems. However, conventional outperformed Islamic banks in 2009. they
summarized that although there was no significant difference in terms of performance in 2008, the financial crisis
impacted both banking systems, yet the impact on Islamic banks was limited to a decline in returns.
Toumi et al. (2008) studied the performance of Islamic and conventional banks in the period 2004 - 2009 in
terms of profitability, leverage ratios, return on asset/equity, net margin, dividend payout, total debt to common
equity, long term debt to common equity, total debt to total asset and the size of the bank asset they used a sample of
50 Islamic and 59 conventional banks from 18 countries. Their findings is that Islamic have lower debt to equity ratio
than conventional banks, 7.8 times and 11.48 times for Islamic and conventional banks respectively. Islamic banks
rely more on shareholder capital, unlike conventional banks which relies more on debt to structure the bank.
Moreover, in terms of profitability, they found that Islamic have higher ROA than conventional banks and lower debt
to asset ratio than conventional banks, in terms of long-term debt to common equity. The study found significant
301
© 2016 AESS Publications. All Rights Reserved
However, the key differences found were; Islamic banks are less exposed to liquidity risk, and conventional banks
depended more on external liabilities than Islamic banks.
Zaki (2012) looked at the following two interrelated research issues: Identifying and explaining the determinants
the financial turmoil in the UAE’s financial markets and evaluating the impact of the UAE’s government bailouts on
the UAE’s economy in the short and long run. The findings were that the government saved the troubled banks
through bailouts and drawing down FXRES (Government economic activity). The timing of the increase in the ratio
of leverage risk measures of the banking system and reserve adequacy (liquidity risk) of the UAE’s economy is
consistent with the model’s prediction that the government’s bailouts and foreign reserve policy played a crucial role
in reducing the adverse reaction to the financial crisis in 2007 - 2008. These developments significantly contributed to
the positive expectations in the market. The result was survival of the banking sector with the confidence of market
participants intact.
Beck et al. (2010) observe that Islamic banking have lower overhead costs and cost-income ratio and higher
returns over asset but capital asset ratios is smaller. Islamic banks have higher fixed asset ratio and lower non-interest
earning asset ratio. Maintaining a high fixed asset ratio implies that the Islamic banks are managing their assets more
efficiently and profitably than conventional banks.
Viverita (2010) analyzed the performance of Islamic compared to conventional banks in Indonesia. Different
ratios were used and they found that the cost efficiency ratios were lower in Islamic than the conventional banks in
addition the revenue and profit efficiency ratios were higher in Islamic banking. Also the Islamic banks net interest
margin (NIM) have maximum of 0.182, while conventional banks have 0.097. Furthermore, the operating income to
average asset in conventional bank was 0.006 while in the Islamic bank the mean was 0.013. Islamic banking is
generating higher income from its asset, which is a positive indicator of revenue efficiency performance in Islamic
banks.
Mobeen et al. (2011) studied the top 10 Islamic and conventional banks performance during the financial crisis,
they found that the aggregate net profit for the conventional banks observed a drop while Islamic banks experienced
an increase in their net profit in the same period. Moreover, the leverage ratio (asset/equity) for conventional banks
increased from 16.6% in 2006 up to 18.2 in 2008, however, Islamic banks leverage ratio was 5.8 in 2006 boosted to
6.6 in 2008. The leverage ratio measures the firm’s long term solvency, the ability to meets its obligation, as the
leverage ratio is smaller it means that the firm is using less debt.
Rashwan (2010) assessed the performance of Islamic and conventional banks from 2007 to 2009 in terms of
return on asset and on equity, net loan to total asset and loan loss reserve to gross loan. They used data from 46
Islamic banks and found that Islamic outperformed conventional bank in 2007, but in 2008 there was no significant
difference between the two banking systems. However, conventional outperformed Islamic banks in 2009. they
summarized that although there was no significant difference in terms of performance in 2008, the financial crisis
impacted both banking systems, yet the impact on Islamic banks was limited to a decline in returns.
Toumi et al. (2008) studied the performance of Islamic and conventional banks in the period 2004 - 2009 in
terms of profitability, leverage ratios, return on asset/equity, net margin, dividend payout, total debt to common
equity, long term debt to common equity, total debt to total asset and the size of the bank asset they used a sample of
50 Islamic and 59 conventional banks from 18 countries. Their findings is that Islamic have lower debt to equity ratio
than conventional banks, 7.8 times and 11.48 times for Islamic and conventional banks respectively. Islamic banks
rely more on shareholder capital, unlike conventional banks which relies more on debt to structure the bank.
Moreover, in terms of profitability, they found that Islamic have higher ROA than conventional banks and lower debt
to asset ratio than conventional banks, in terms of long-term debt to common equity. The study found significant
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