Risk, efficiency and financial performance in the GCC banking industry: Islamic versus conventional banks

Abstract

Purpose

The purpose of this study is to critically evaluate how conventional and Islamic banks trade off risk, efficiency and financial performance in their business models, to investigate how patterns of risk and efficiency vary between conventional and Islamic banks and to critically evaluate how the profitability of conventional and Islamic banks varies following the financial crisis.

Design/methodology/approach

This study uses univariate and multivariate statistical techniques by investigating 12 Islamic banks and 34 conventional banks operating in the Gulf Cooperation Council (GCC) region has been studied over the period 2011–2018.

Findings

The results suggest that Islamic and conventional banks differ not in the levels of efficiency, risk and profitability, but rather in how risk and efficiency influence banks’ financial performance. Islamic banks are found to be less influenced by the adverse effects of credit risk, which is consistent with the risk-sharing nature of Islamic financing. However, the results only hold for return on assets (ROA) and return on equity (ROE) while the net interest margin is observed to be negatively influenced by credit risk. Lower cost-income efficiency is also found to boost ROA and ROE of Islamic banks which could be attributed to a larger share of non-interest revenues due to Sharīʿah-compliance.

Research limitations/implications

From a theoretical point of view, this study helps to understand the risk, efficiency and financial performance of Islamic banks in comparison with conventional banks.

Practical implications

The results of this study can serve bank managers, regulators and shareholders. Policymakers should encourage a more risk-sharing structure of Islamic financing as it brings less adverse effects of credit risk and increases income sustainability for Islamic banks. The present study may help bank managers to improve the financial performance of their firms by controlling risk and efficiency. The study results also have implications for shareholders and depositors of Islamic and conventional banks as they should have a predetermined position about the level of credit risk and efficiency in each banking system.

Originality/value

The foremost contribution is that this is one of the few studies to compare risk, efficiency and financial performance of Islamic and conventional banks in the GCC region. By using the latest data, this paper hopes that the findings will be more relevant than previous studies to the current situation of the banking industry in the region.

Citation

Hidayat, S.E., Sakti, M.R.P. and Al-Balushi, R.A.A. (2021), "Risk, efficiency and financial performance in the GCC banking industry: Islamic versus conventional banks", Journal of Islamic Accounting and Business Research, Vol. 12 No. 4, pp. 564-592. https://doi.org/10.1108/JIABR-05-2020-0138