A Comparative Analysis of Islamic Finance and Conventional Banking

This report provides a comparative analysis of Islamic finance and conventional banking, highlighting the fundamental differences between the two systems. It explores the prohibition of interest in Islamic banking and its adherence to Shari'ah principles, contrasting it with the conventional banking model. The report examines the application of traditional financial ratios in assessing the performance of both Islamic and conventional banks, including profitability, efficiency, and liquidity. It emphasizes the exclusion of interest-related components in Islamic banking analysis. The study uses ratio analysis to compare banks in Pakistan, deriving financial data from various sources, including financial statements and journal articles. The findings reveal differences in performance metrics such as EPS, Debt to assets, ROE and ROA, indicating superior returns for Islamic banks. The report aims to enhance understanding of Islamic banking and its financial ratios, enabling students to differentiate between the two banking systems.

Running Head: ISLAMIC FINANCE 1
Islamic Finance
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Islamic Finance
Islamic banking differs significantly from conventional banking as it prohibits interest.
It, therefore, deals with financial products which are interest-free and are by the Shari’ah
principles. Most of the commercial banks have considered introducing Islamic financial
products that are unique from the conventional ones. Although Islamic banks are prevalent in
Muslim countries, they also have non-Muslim customers (Khan & Mirakhor, 2015).
There is a lot of recently published research that studies the usefulness of traditional
financial ratios in conventional banking analysis in Islamic banking and finance. For instance,
various researchers such as Anwar have identified the differences between the financial
performance of Islamic banks and conventional banks in different parts of the world. Various
researchers adopted different techniques in measuring the performance variables, and they
established different outcomes. The limitations of the previous study on Islamic banking and
finance is the lack of sufficient exploration on how the traditional ratio analysis affects the
financial performance of Islamic banks in comparison with conventional ones. As such, this
research aims to explore the question of whether or not traditional financial ratios are as useful
in Islamic banking analysis as in the conventional banks (Salman & Nawaz, 2012).
The traditional ratios are useful in the analysis of Islamic banking just like in the
conventional banks. Traditional ratios such as Loan to deposit ratio, total equity to total assets,
the cost to income ratio, and operating expenses to total assets ratio will be much helpful in the
financial analysis of Islamic banks. However, ratios that have interest components would be
excluded since Islamic banking does not incorporate interest factors. The financial ratios are
similar, and their formulas are the same as well, with small variations where they involve
interest components. The balance sheet of the selected conventional banks differs from that of

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Islamic banks since the later does not include interest components such as interest expense
(Khan & Mirakhor, 2015).
In this research, we used the technique of traditional ratio analysis to compare Islamic
banking to conventional banks in Pakistan. We calculated the ratios of profitability and
performance for the selected Pakistan banks. The researchers acquired most of the financial
information from the financial statements on securities and stock exchange websites as well as
journal articles. The outcomes of the ratio analysis such as EPS, Debt to assets, ROE and ROA
were negative for the conventional banks and positive for the Islamic banks, meaning that the
later showed high returns to its shareholders (Salman & Nawaz, 2012, pp. 168).
This research will enable learners to gain sufficient understanding of the Islamic banking
system and its key financial ratios. By analyzing the ratios, students would differentiate between
a conventional bank and an Islamic bank.

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References
Salman, A. & Nawaz, H. (2012). Islamic Financial System and Conventional Banking. State
Bank of Pakistan, Islamic Banking Department Retrieved from
file:///C:/Users/owner/Downloads/1-s2.0-S2214462518300410-main.pdf
Khan, M. S., & Mirakhor, A. (2015). Theoretical Studies in Islamic Banking and Finance.
Pennsauken, NJ: BookBaby.