A study on banking financials: Upgrading regulatory regime

There is a direct relationship between the level of development in a financial system and economic development in general. Banking industry of our country has 2.67 per cent contribution in GDP (gross domestic product). Apart from this direct contribution in GDP, this industry has significant indirect role through financing in literally each and every sector of the economy. Of course, the main source of this finance is not the banks' equity rather the deposits from individuals. Banks have just mediated the whole process. There are two main groups in every society, those who have surplus money but are not able to or do not want to invest on their own and those who are able to operate as producers, but do not have enough money to invest. Here lies the importance of banks shouldering responsibility of collecting surplus money from savers/depositors and allocating it to producers/borrowers.
In this write-up, five year (2009-2013) data from audited annual financial statements of 30 private commercial banks (23 mainstream and seven Islamic) have been analysed. To maintain the time consistency of data nine fourth generation banks have been excluded. Due to lack of available data from Islamic banking branches or windows only seven full-fledged Islamic banks (excluding Union Bank Ltd.) have been considered in this analysis.

FINANCIAL POSITION: The data shows that Islamic banks are growing faster than mainstream banks. This has resulted the increasing market share of Islamic banks and decreasing market share of mainstream banks. In 2009, Islamic banks had 28 per cent market share and mainstream banks had 72 per cent market share in credit comprising general loans and bills purchased & discounted. In 2013, this rate is 30 per cent for Islamic and 70 per cent for mainstream. Due to shariah restrictions Islamic banks can't participate in government securities such as treasury bills and bonds. To maintain a level playing field in this regard, the central bank has allowed Islamic banks to keep SLR at 5.50 per cent against mainstream banks' 13 per cent. During this time (2009-2013), general loans of Islamic banks have grown at an average rate of 22 and that of mainstream banks at 19 per cent. Bills purchased & discounted of Islamic banks have also grown at a faster rate of 31 per cent which is 19 per cent in case of mainstream banks.
Islamic banks had 26 per cent market share of total assets in 2009 and in 2013 this has increased to 27 per cent reducing mainstream share by 1.0 per cent. During this period, the total assets of Islamic banks have grown at an annual average rate of 24 and mainstream banks have had 21 per cent of growth in assets.
In 2013, Islamic banks' market share of deposit has increased to 28 per cent from 26 per cent in 2009 resulting 2.0 per cent market share loss by the mainstream banks. Islamic banks' deposit has grown at average rate of 23 and deposit of mainstream banks has grown at 20 per cent. Cost free deposit of Islamic banks has grown at an average rate of 26 and that of mainstream banks has grown at 23 per cent. The cost bearing deposit of Islamic banks has also grown faster (at 23 per cent) than 19 per cent of mainstream banks.
Since 2009 Islamic banks have gained 3.0 per cent market share in equity (paid-up capital and reserves) putting this rate 24 per cent in 2013. Mainstream banks had 79 per cent equity market share in 2009 and it reduced to 76 per cent in 2013. Equity of Islamic banks has grown at a faster rate of 29 per cent which is 23 per cent in case of mainstream banks. During this time mainstream banks have had higher average growth rate of 30 per cent in paid up capital but Islamic banks have had lower growth rate of 24 per cent. In reserves Islamic banks have had 37 per cent rate of growth and mainstream banks have had 19 per cent.

FINANCIAL PERFORMANCE: Islamic banks' higher growth in assets and liabilities has also been reflected in the increasing market share in financial performance. Islamic banks have increased their market share in total income comprising interest/investment income and non-interest/income from 22 per cent in 2013 to 26 per cent in 2009. From 2009 to 2013, total income of Islamic banks has grown at average rate of 28 per cent and mainstream banks' at 21 per cent. During this time, interest/investment income share of Islamic banks has increased from 25 per cent to 29 per cent with average growth rate of 31 per cent against mainstream banks' 24 per cent. In non-investment income the market shares between Islamic and mainstream remain unchanged that is 14 per cent and 86 per cent. The non-investment income of both these groups of banks has grown at almost same rate i.e., Islamic banks 19 per cent and mainstream banks 18 per cent.
In 2013, Islamic banks had only 5.0 per cent market share in income from shares and securities and in 2009 it was 3.0 per cent. The reason is Islamic banks have less exposure to government securities due to shariah considerations. Moreover, they have less investment in share market. Islamic banks' share of Income from commission remained almost unchanged at 24 per cent. Islamic banks have experienced higher rate of average growth 17 per cent in income from commission and this rate is 13 per cent in case of mainstream banks. In other operating income there is almost no change in market share of both Islamic banks (19 per cent) and mainstream banks (81 per cent).
Islamic banks' market share in operating profit has increased from 21 per cent in 2009 to 25 per cent in 2013. In contrast, mainstream banks' share has decreased from 79 per cent in 2009 to 75 per cent in 2013. During this time, the average growth rate was 12 per cent for mainstream banks and 27 per cent for Islamic banks.
Islamic banks' market share in net profit after tax has increased from 16 per cent in 2009 to 25 per cent in 2013. In contrast, mainstream banks' share has decreased from 84 per cent in 2009 to 75 per cent in 2013. During this time, the average growth rate was 11 per cent for mainstream banks and 28 per cent for Islamic banks.
The total income of mainstream banks comprises 71 per cent from interest income and 29 per cent from non-interest income. In case of Islamic banks investment income has 84 per cent contribution and non-interest income has 16 per cent contribution. The data clearly shows that Islamic banks are more dependent on investment income than mainstream ones. If we dig deep into the

elements of non-investment or non-interest income, it is evident that mainstream banks mostly depend on income from shares and securities (50 per cent) but Islamic banks' income from shares & securities has only 13 per cent contribution to it. Furthermore, for non-investment income Islamic banks mostly depend on commission income (69 per cent) and mainstream banks have only 36 per cent contribution to it. In other operating income the rate of contribution has less difference of 4 per cent (18 per cent-14 per cent) between Islamic and mainstream banks.
STRENGTH AND SOUNDNESS: Against regulatory requirement of 10 per cent Capital Adequacy Ratio (CAR), mainstream banks maintained at 11.34 per cent and Islamic banks did 10.52 per cent. Due to capital short fall in ICB Islamic Bank this rate is a bit worse in Islamic banks. Average NPL to Equity ratio of mainstream banks is 19 per cent and that of Islamic banks is 32 per cent. Mainstream banks' 'Liquid Asset to Short Term Liabilities' is 71 per cent against Islamic banks' 36 per cent meaning mainstream banks have had more liquid assets than Islamic banks. The reasons behind this situation are Islamic banks don't participate in call money market and they have less exposure in share market investment. Islamic banks 'Borrowing Liabilities to Total Liabilities' is 3.0 per cent as against Mainstream banks' 4 per cent meaning Islamic banks have less borrowed liabilities than mainstream banks. Average 'Advance Deposit Ratio' is 84 per cent in Mainstream banks against the Central Bank's ceiling 85 per cent. The 'Investment Deposit Ratio' of Islamic banks is 90 per cent which is as same as the ceiling of 90 per cent.
PROFITABILITY AND EFFICIENCY: The average 'Return on Asset'

is 1.62 per cent in Mainstream banks and in Islamic banks this rate is 1.28 meaning Mainstream banks are maintaining their asset slightly more efficiently. On the other hand, data shows that Islamic banks are able to maintain their equity a bit more efficiently than mainstream banks as Islami banks' 'Return on Equity' is 17.56 per cent and mainstream banks' 17.29. It is also seen that mainstream banks are a bit more efficient in terms of 'Total Expenditure to Total Income'. In Islamic banks this rate is 72 per cent and in mainstream banks, 71 per cent.
ASSET QUALITY: Though the NPL (non-performing loans) growth rate is almost same in both groups of banks, the credit growth is higher in Islamic banks than in mainstream banks. The NPL of mainstream banks has grown at an average rate of 33 per cent against their credit growth rate of 19 per cent and in Islamic banks the NPL has grown at 23 per cent against investment growth of 22 per cent.  The rate of 'NPL to Loan' is 2.24 in mainstream banks and in Islamic banks this rate is 2.82.  
CONCLUSION: From growth and market share perspectives it is evident that Islamic banks are growing faster than mainstream banks. As a result, Islamic banks are gaining more share but mainstream banks are losing. In terms of efficiency and asset quality, the difference between these groups is quite mixed. Islamic banks are doing better in terms of asset-backed transactions free from interest and any kind of speculation. Moreover, Islamic banks have an edge over other banks in terms of faith-based banking in our country. For that very reason, more and more commercial banks are now showing their enthusiasm to be converted to Islamic ones. So, to meet this growing demand of the people the respective authorities need to pay more attention to upgrade the regulatory regime and other issues. Of course, to have much more sustainable contribution to the economy Islamic banks need to think about adopting the profit and loss sharing approach. To do that a concerted effort from all stakeholders is a must. Are we ready to go ahead?
The writer is a banker.
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