Wed, May 23, 2018
A A A
Welcome Guest
Free Trial RSS
Get FREE trial access to our award winning publications
Opalesque Islamic Finance Intelligence

Kulliyyah Korner: Measuring the Performance of Islamic Banks by Adapting Conventional Ratios By Ahmed Mohamed Badr-Eldin

Thursday, April 29, 2010

Ahmed is an Assistant Lecturer at the German University in Cairo (GUC), he graduated from the GUC with Double Majors of Finance and International Business and took his Masters in Economics with a thesis in Islamic Finance. He has been working as a teacher for several years and recently published his paper on "Measuring the Performance of Islamic Banks by Adapting Conventional Ratios" (see reference link).

Before discussing the paper I would like to highlight that I have witnessed the huge potential of students in the Finance majors with special focus on Islamic Studies but at the same time almost all my students have highlighted these two significant barriers: The first is that they have a very hard time finding resources and information about Islamic Finance and cannot find any centers or companies that are able to help them. Secondly, they feel that their research and work in the Islamic Finance area is useless because there are no well known journals that can communicate their findings to the practical world, since most of the research around Islamic Finance is very practical and can be applied, but "there is no one to listen".

A key driver for developing this paper was to gain a better understanding of the Islamic Banking sector, as I had already realized that the industry is still growing and is missing many aspects which have been covered in the conventional banking sector. Beginning with Performance Measurement, I decided that Islamic Banks need their very own custom-made performance measurement tools in order to have better insights and greater understanding of how these banks (and their balance sheets) are performing and how to compare them, which I believed would be very useful academically for more progress in studying the sector, identifying how they are performing and finally in comparing it to conventional banks. Similarly, it would be very useful for the actual mainstream users (whether bankers, government entities or even financial analysts) in order to have a more solid basis for making their decisions and investment calls.

The abstract of the paper provides a brief but concise summary of the complete paper: "One consequence of the current financial crisis is that many countries began to reevaluate their financial systems and recognize its flaws and drawbacks. They also began the search for alternative systems for their economies; one of the proposed systems is the current Islamic financial model. This model is still in its infancy and many modifications and additions are required. It also lacks the necessary financial performance measurement tools similar to those used by conventional banks for managers and investors alike. This paper evaluates this lack of performance measures. It then adapts a currently applied ROE Analysis Tool used in conventional banks, to the currently established model of Islamic Banks and tests its applicability and evaluates its usefulness. The findings suggest that such an adapted model would be quite successful for use in Islamic banks and would offer much better analysis and basis of comparison within the Islamic financial system. It also suggests that much of the previously measured performance of Islamic Banks is unsound and should be revised for accuracy and reliability because of the flawed methods used for measurement in the first place".

Furthermore, the attached graph provides an illustration of the process that is developed in the paper itself, outlining the tracing procedure used to adapt the Return on Equity of Islamic banks in order to make them comparable to conventional banks. When these changes are taken into consideration then "it becomes possible to use the Adapted ROE Scheme to measure performance of Islamic banks fairly and accurately without any loss of information, discrepancies in intended meaning or incorrect categorization of funds, deposits or income".

Explaining the Tracing Procedure of the Adapted ROE Scheme



Ratios and Abbreviations used in the Adapted ROE Scheme

Ratio Abbreviation Used Gross Profit Margin
Risk Provision Margin
Return On Assets
Equity Ratio

Return on Equity (Pre-Tax)
Cost Income Ratio
Risk Provision Ratio
GPM
RPM
ROA
ER
ROE
CIR
RPR
Financing Margin FM
Fee-Based Margin FBM
Investment Margin IM
Extraordinary and Other Income Margin EXOT
Gross Income Margin GIM
Operating Expenditure Margin OEM

It must be said that there were several obstacles faced (and can be found in the limitations section of the paper) which mainly revolved around the diversity in accounting standards used by Islamic banks across the world, as well as the actual sub-items presented in the financial statements. These need to be more uniformly prepared in order to ensure a complete and transparent understanding of the financial positions of these banks. Another great obstacle was the availability of data on Islamic banks, most of the data collected has been downloaded directly from each and every bank€™s annual report and website. Such a method is very time consuming (even if ensuring complete accuracy and liability of information falls on the banks themselves and not on some other database supplying the data), as well as limited in scope as not all banks have published their statements online, or might not have enough historical reports available for download.

I believe a good step now for Islamic banks would be to first adopt the Islamic Accounting Standards in their preparation of financial statements, this can be followed by more accurate performance measurement which can in turn allow people to make more secure investment decisions which might show Islamic Banks to be much more superior to other investments and will definitely improve and prosper the sector and allow it to take its real and significant position among the global banking sectors.

Your feedback and comments are very important to us, please feel free to contact the author via email.



Article Link

<< Go Back to Archive

Today's Exclusives Today's Other Voices More Exclusives
Previous Opalesque Exclusives                                  
More Other Voices
Previous Other Voices                                               
Access Alternative Market Briefing

 



  • Top Forwarded
  • Top Tracked
  • Top Searched
  1. News Briefs - Warren Buffett: Target date funds aren't the way to go, Cambridge Analytica could be reborn under a different name[more]

    Warren Buffett: Target date funds aren't the way to go Planning for retirement can be complicated and stressful. This is why target date funds - funds that are managed based on when you expect to retire - are so attractive. Over time, the balance of stocks, bonds and cash evolve automati

  2. Investing - Hedge funds hike Smurfit Kappa positions amid takeover deal hopes, Hedge fund IBV Capital digs deep to unlock long-term value in a competitive market, Eisman of 'The Big Short' fame recommends shorting Deutsche Bank[more]

    Hedge funds hike Smurfit Kappa positions amid takeover deal hopes From Irishtimes.com: Two US hedge funds, Davidson Kempner and York Capital, have accumulated a combined 4.74 per cent interest in cardboard box maker Smurfit Kappa using financial derivatives. It comes as many investors cl

  3. Foundations of hedge fund managers gave big to controversial donor-advised funds[more]

    In the world of philanthropy and tax-deductible charitable giving, the explosion of donor-advised funds has touched off intense debate. Now, there is evidence that the DAF boom is being further fuelled by hedge fund foundation money. Four of the top five foundations that gave the most to large do

  4. Study: For hedge funds, smaller is better[more]

    From Institutionalinvestor.com: The smaller the hedge fund is, the better its performance is likely to be, according to a new study. The study - "Size, Age, and the Performance Life Cycle of Hedge Funds," released April 26 - sought to determine whether a hedge fund's size and age had any effect on i

  5. Hedge fund returns rose in April for first gain since January[more]

    From Bloomberg.com: Bloomberg Hedge Fund Database shows returns flat this year - Currency strategies had the biggest monthly gain at 13% Hedge fund returns increased 0.78 percent in April, reversing two consecutive monthly declines. The swing of 134 basis points was driven by gains in all seven