Academic journal article International Journal of Business and Management Science

Bank-Specific, Industry-Specific and Macroeconomic Determinants of African Islamic Banks' Profitability

Academic journal article International Journal of Business and Management Science

Bank-Specific, Industry-Specific and Macroeconomic Determinants of African Islamic Banks' Profitability

Article excerpt

Abstract:

This paper studies the effect of factors that contribute towards the profitability of Islamic banks in Africa over the period 1999-2009. Using panel data techniques, this study estimate several specifications to examine the impact of bank-specific and country-specific variables on profitability. Results show that Bank characteristics, financial structure and macroeconomics variables are important in explaining African Islamic banks' profitability. Bank's capital and size increase bank's profitability whereas credit risk and operating efficiency reduce it. With regards to the macroeconomic indicators, higher economic growth and inflation spur banks' profitability. The study also provides evidence for the positive impact of market concentration on Islamic banks profitability. Finally, the empirical results show robust supports to suggest that higher bank development leads to lower bank profitability.

Keywords: Bank Profitability, Islamic Banking, Profit Loss Sharing, Africa

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

Islamic finance is gaining universal acceptance all over the world and is nowadays regarded as a serious competitor to "conventional finance". During the last three decades, Islamic banking matured into a viable alternative model of financial intermediation and gained credibility as witnessed by the establishment of a large number of Islamic financial institutions all over the world.

The Islamic financing activity is based on the Islamic faith and must stay within the limits of Islamic Law or the Shariah's compliant in all of its actions and deeds. The system is different from the traditional one mainly by the fact that rather than fulfilling the only function of financial intermediation as does the conventional banking system, it fulfills the role of direct partnership. The main difference between the Islamic banking system and the conventional one is that while the latter is guided by a pre-determined interest-based principle, the former follows the interest-free principle and profit and loss sharing (PLS) principle in financing activities. Under the PLS principle, the relationship between lender, borrower, and intermediary are rooted rather on partnership than on credit. Compared to conventional banks, Islamic banks have no fixed liabilities in thenbalance sheets and deposits are considered as shares (Khan, 1996). Shubber and Alzafiri (2008) argue that deposit accounts of Islamic banks cannot be considered as a liabilities because they fall within the definition of "profit-and-loss sharing" principles.

Banks' depositors, who either choose not to be remunerated at all, or place their savings in "investment accounts", obtain variable returns, dependent on the bank's performance. At the end of the period, an Islamic bank has to share its "profits" with the depositors who accepted the investment risk. In fact, such an Islamic bank does not share its entire "profits", defined as the wealth transferred to shareholders, but shares an amount of income one can identify as the "income before cost of funding" (IBCF).

The cost of non-equity funds is precisely what distinguishes Islamic banks from conventional banks. While conventional banks rely on debt and deposits with mainly fixed interest rates, Islamic banks rely on a funding base whose cost depends on the return of its assets (Hassoune, 2002). It is necessary to distinguish between the expressions 'rate of interest' and 'rate of return'. Whereas Islam clearly forbids the former, it encourages the latter (trading). As the use of interest rates in financial transactions is prevented, Islamic banks are expected to undertake operations only on the basis of PLS arrangements or other acceptable modes of financing. We distinguish four sets of laws that govern Islamic investment environment: the absence of interest-based (riba) transactions, the avoidance of economic activities involving speculation (ghirar), the introduction of an Islamic tax (zakat), and the discouragement of the production of goods and services which contradict the value pattern of Islamic law (haram). …

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