The Quarterly Review of Economics and Finance 65 (2017) 71–87

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The Quarterly Review of Economics and Finance

journal homepage: www.elsevier.com/locate/qref

Convergence in bank performance for commercial and Islamic banks

during and after the Global Financial Crisis
Dennis Olson a,∗ , Taisier Zoubi b,1
a
Department of Economics and Finance, Gulf University for Science & Technology, Block 5, Building 1, Mubarak Al-Abdullah Area/West Mishref, Kuwait
b
Department of Accounting, School of Business Administration, American University of Sharjah, P.O. Box 26666, Sharjah, United Arab Emirates

a r t i c l e i n f o a b s t r a c t

Article history: This study examines whether the Global Financial Crisis (GFC) has led to a convergence in performance
Received 3 January 2016 between Islamic and commercial banks in the Middle East, Africa, and Southeast Asia (MENASA) region
Received in revised form 26 June 2016 in recent years. Using the largest sample to date for 1996–2014, we find that Islamic banks (IBs) initially
Accepted 29 June 2016
weathered the onslaught of the GFC better than commercial banks (CBs) in 2007–2008. Then, as the crisis
Available online 6 July 2016
spread to the real economy in 2009, profitability declined substantially for IBs relative to CBs. Beta and
sigma convergence tests suggest convergence toward the mean for all banks and all financial ratios. The
JEL classification:
speed of convergence is generally slower for Islamic banks but the difference has declined in the aftermath
G21
G15
of the GFC. The recently developed more robust Phillips and Sul (2007a) log-t test for convergence shows
little convergence over the whole sample period, but for the years 2010–2014, all banks appear to be
Keywords: converging toward similar levels of profitability as measured by ROA and ROE. The log-t test shows
Islamic and commercial banks convergence in profitability across all banks (IBs and CBs) in the post-crisis period. However, it does not
Bank performance show convergence across all asset composition and risk measure—meaning that IBs and CBs still operate
Financial crisis
differently even if they are moving toward similar profitability results. Club convergence results indicate
Convergence tests
a lack of convergence over the whole sample, but quite strong convergence across all banks post-crisis.
Speed of adjustment
However, some clusters, such as the Southeast Asia region does not display convergence in profitability
ratios—suggesting that the GFC has differentially impacted various countries and regions.
© 2016 Board of Trustees of the University of Illinois. Published by Elsevier Inc. All rights reserved.

1. Introduction
During the last decade, the Islamic banking sector has become
one of the fastest growing industries world-wide. There are cur-
rently more than 300 Islamic banks (IBs) operating around the
world with total assets worth more than $1.50 trillion US dol-
lars. These banks will likely continue to grow at a fast pace in
countries where they are presently operating due to increases in
the Muslim population, which is projected to reach 2.3 billion by
2030, up from 1.7 billion in 2014. Also, even though Islamic finance
has not significantly penetrated the banking markets in Western
countries, serving the banking needs of the sizeable Muslim popu-
lations in these nations represents an important opportunity for
future growth.
∗ Corresponding author.
E-mail addresses: dolson prof@yahoo.com (D. Olson), tzoubi@aus.edu
(T. Zoubi).
1
Tel.: +971 6 515 2367.
In general, IBs are governed by Sharia rules and principles that
lead to five important differences between the operations of Islamic
and commercial banks (CBs).2 (1) The most important characteristic
of IBs is the prohibition of both the receipt and payment of interest
(riba) in all transactions. (2) Secondly, although IBs obtain funds pri-
marily by issuing equity and receiving customer deposits, CBs can
also issue debt instruments to finance their investment activities.
(3) A third tenet of Islamic finance is the principle of risk sharing on
both sides of the balance sheet. To raise funds, IBs use profit sharing
(mainly Mudarabah-based) arrangements rather than conventional
2
Commercial banks represent about 80% of the bank-year observations avail-
able in Bankscope for “conventional” banks in the Middle East, North African and
Southeast Asia (MENASA) region. Data for bank holding companies, coop banks,
investment banks, microfinance institutions, multi-lateral government banks,
central banks, real estate banks, credit institutions, and investment and trust corpo-
rations are not included in our analysis because these specialty financial institutions
often operate differently than full-service commercial and Islamic banks. To avoid
notational complexity, our discussion does not distinguish between commercial and
conventional banks. However, in the literature review section, the abbreviation CB
more accurately denotes all conventional banks, rather than only commercial banks.

http://dx.doi.org/10.1016/j.qref.2016.06.013
1062-9769/© 2016 Board of Trustees of the University of Illinois. Published by Elsevier Inc. All rights reserved.
72 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87
deposits. On the asset side, in place of conventional loans, IBs
issue exchange-based contracts (Murabaha), lease-based contracts
(Ijarah and Istisna), and profit-sharing contracts (Mudarabah and
Musharka). Although the profit/loss sharing contracts may embody
the central tenets of Islamic finance better than the exchange-based
or lease-based products, IBs have been cautious in relying upon
Mudarabah and Musharka contracts due to their higher perceived
risk.3 (4) The fourth major difference between IBs and CBs involves
restrictions on the uses of funds. CBs face few investment con-
straints except for the need to meet desired levels of return and
risk. In contrast, IBs are limited in the types of investments they
can offer to customers due to Sharia-imposed Islamic restrictions.
For example, IBs may not invest in haram activities, such as gam-
bling, alcohol production or distribution, gambling, etc. IBs are also
precluded from undertaking many types of potentially rewarding,
but excessively risky investments. This restriction follows from the
Islamic prohibition on gharar, which precludes gambling and most
types of speculation. As a result, IBs facing a restricted set of invest-
ment opportunities may be more prone to risk concentration and
may be less flexible in responding to changing economic condi-
tions than CBs.4 (5) Finally, internal corporate governance structure
adds to the differences between CBs and IBs since the latter need to
establish a “Sharia Committee” consisting of experts in Islamic law
whose role is to ensure that IBs’ activities are in compliance with
Sharia. As a result, IBs exhibit a “multi-layered” corporate gover-
nance structure that includes the Sharia Committee in addition to
the regular board of directors. The Sharia Committee restrains the
board of directors and the management of the bank from taking
excessive risk, such as creating credit against credit (which would
be in violation of riba), or undertaking doubtful investments such
as sale of goods which are not present at hand (which would be
in violation of gharar). Mollah and Zaman (2015) show that Sharia
supervisory boards have a positive impact on Islamic bank profit-
ability, while Sharia boards that merely serve in an advisory capacity
have a negligible impact on performance.
Against this background, an exacerbated debate on the compar-
ative performance of IBs and CBs has emerged during the recent
financial crisis. Academic and anecdotal evidence suggest that IBs
weathered the onslaught of the Global Financial Crisis (GFC) in
2007–2008 better than CBs (Alqahtani, Mayes, & Brown, 2016;
Bourkhis & Nabi, 2013). Khan and Crowne-Mohammed (2009-
2010) and Hasan and Dridi (2010) argue that Islamic banking
principles (particularly investment restrictions that prohibited IBs
from holding derivatives and other potentially “toxic” assets) pro-
tected IBs during the GFC, while Čihák and Hesse (2010), Rajhi
and Hassairi (2013), Bourkhis and Nabi (2013), and Mobarek and
Kalonov (2014) show that IBs (particularly small IBs) in the Middle
East, Africa, and Asia are more financially stable than CBs. Never-
theless, Rashwan (2010) notes that the superior performance of IBs
during the initial financial phase of the GFC shifts to under perfor-
mance in 2009 as the financial crisis spread to the real economy.
For the years 2007–2009, Bourkhis and Nabi (2013, p. 68) find “no
significant difference in terms of the effect of the financial crisis
on the soundness of Islamic and conventional banks.” A compar-
ative study conducted by Olson and Zoubi (2008) establishes that
while IBs and CBs in the Middle East operated similarly, financial
3
A more detailed description about the specifics of these Islamic financial prod-
ucts is available in Appendix. The interested reader is also referred to Abedifar et al.
(2013) for a thorough discussion of the principles of Islamic banking and finance.
4
For instance, the cost plus contract (Murabaha), widely utilized by IBs, is based
on the sale of a physical asset to a customer on a cost plus profit basis (e.g., a car
purchase financed through a sale to the customer after the bank purchases the car).
Profit on the sale is fixed at inception. Unlike CBs, IBs cannot profit from changes in
the underlying inter-bank offer rates. However, IBs can hold Sukuk and make similar
profits to CBs.
ratios used in nonlinear classification models could effectively help
to distinguish between the two types of banks.
In the aftermath of the GFC, competitive banking conditions
could cause a further convergence between IBs and CBs. For exam-
ple, Escribano and Stucchi (2014) found that recessions lead to
productivity convergence across Spanish manufacturing firms by
creating symmetric incentives for less productive firms to become
more competitive. The issues of comparative performance and
whether there are significant differences between the business ori-
entation of IBs and CBs can be formally addressed by adopting
techniques used in the recent literature on economic convergence.
Three commonly used tests for convergence and economic integra-
tion include tests for beta, sigma, and log t-tests of convergence.
Results from tests of banking sector integration in Europe provide
mixed results for what to expect for IBs and CBs in the MENASA
region. Weill (2009) and Casu and Girardone (2010) find beta and
sigma convergence in European bank cost efficiency ratios using
data up to 2005, but Rughoo and Sarantis (2012) and Matousek,
Rughoo, Sarantis, and Assaf (2015) mostly reject convergence based
on log t-tests once the years of the financial crisis are included in
the analysis.5
The primary purpose of this paper is to determine whether
there has been a convergence in performance across a range of
financial variables between Islamic and commercial banks in the
MENASA region during and after the Global Financial Crisis.6 We
also address the comparative performance and profitability of
IBs and CBs over time and examine the speed of adjustment for
both types of banks to changing economic conditions. Adopting a
dynamic panel approach to analyze the determinants of individ-
ual bank profitability and financial stability, in general we find that
the same variables are significant for both IBs and CBs and have a
similar impact on both types of banks. Consistent with Berger and
Bouwman (2013), we highlight the crucial role of higher bank cap-
italization in explaining bank performance and profitability (ROA)
over the years 1996–2014. Also, we observe that loan specialization
and securitization ratios are positively related to bank profitabil-
ity for both IBs and CBs while cost inefficiency and being unlisted
(not being listed or even delisted from a national stock market) are
negatively related to bank profitability. The variables determining
financial performance are similar for both CBs and IBs—suggesting
that profitability is determined more by individual bank character-
istics than by the type of bank. More formally, beta, sigma, and log
t convergence tests indicate that although there are still some dif-
ferences between IBs and CBs, both types of MENASA banks have
been generally converging toward similar values in the aftermath
of the Global Financial Crisis. Our results are consistent with argu-
ments made by Chong and Lui (2009) and Khan (2010) that IBs have
become more similar to their commercial counterparts in recent
years.
Our results have particular implications for regulators and bank
managers: First, although IBs are governed by Islamic principles,
profitability of both types of banks is determined more by individ-
ual bank characteristics than by type of bank. Therefore, managerial
5
Alternatively, panel unit root tests could be used to test for stationarity and
convergence. However, Kim and Rous (2012), Aspergis et al. (2014), and Caporale
et al. (2015) all point out that panel unit root tests are less precise than Phillips and
Sul (2007a) log t-test of convergence. Based on studies such as Guetat and Serranito
(2007), we could expect results similar to those obtained when examining beta
and sigma convergence for any data period. Although not reported in the paper,
various panel unit root tests did produce similar results to those from beta and
sigma convergence tests.
6
The Global financial crisis started in U.S. and Europe in late 2007 (Jutasompakor,
Brooks, Brown, & Treepongkaruna, 2014) and took several months to fully transmit
its negative effect to the MENASA banking sector. Hence, the GFC did not significantly
affect MENASA banks until 2008–2009.
 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87
performance can be assessed on the basis of profitability for both IBs
and CBs. Nevertheless, there are several noticeable differences in
financial ratios between bank types. Although convergence across
all MENASA banks has occurred across most profitability ratios and
some asset composition and efficiency ratios, convergence is gen-
erally rejected across risk measures and some asset composition
ratios. Thus, regulators should not treat the two types of banks
identically when setting up and implementing bank regulations.
Our results show that IBs weathered the initial onslaught of the
Global Financial Crisis in 2007–2008 better than CBs. However, as
the financial crisis spread to the real economy, the profitability of
IBs fell relative to CBs in 2009–2010. From 2011 to 2014, IBs and
CBs have moved toward similar levels of profitability, but IBs have
still not recovered to the extent that CBs have recovered. Based
on beta, sigma and t-log tests, it seems that all MENASA banks are
converging toward common values for profitability ratios, such as
return on assets and return on equity. However, results are mixed
for convergence on net interest and net non-interest margins. The
overall evidence may suggest that even though profitability is con-
verging, both IBs and CBs continue to operate differently and that
there are still some country differences. Also, the speed of conver-
gence varies by geographical area—meaning that the GFC has had
a differential impact across countries and regions.
The remainder of the paper is structured as follows. Section 2
provides a review of the literature on the determinants of profit-
ability and bank efficiency while Section 3 describes the data and
sample. Section 4 next examines profitability ratios for IBs and
CBs, followed by Section 5 that considers other financial ratios and
differences between IBs and CBs over time. Section 6 analyzes con-
vergence and the speed of adjustment for CBs and IBs over various
time periods. Section 7 concludes.
2. Literature review
Historically, IBs have been shown to be more profitable than
CBs. Over the period 1990–2006, Ariff, Badar, Shamser, and Hassan
(2011) report a return on average assets (return on average equity)
of 1.40% (11.61%) for IBs compared to 1.27% (9.61%) for CBs in the
same countries. However, the net interest margin (NIM) of the lat-
ter was 3.91% compared to 3.66% for IBs. For the years 2000–2005,
Olson and Zoubi (2008) show that IBs in the Gulf Cooperation Coun-
cil (GCC) region had a 2.40% annual average return on assets (ROA)
and 18.20% return on equity (ROE) compared to 2.00% and 14.40%
respectively for CBs. For the years 2000–2008, Olson and Zoubi
(2011) show that IBs in the Middle East and North Africa (MENA)
region had 2.69% ROA (20.18% ROE) compared to 1.56% ROA (12.80%
ROE) for CBs. Alqahtani et al. (2016) adopt a CAMEL framework and
find that IBs led (lagged) CBs in terms of profitability in the early
(later) stage of the financial crisis period for a sample of Islamic and
conventional banks from the GCC region. To summarize, the litera-
ture indicates that IBs have generally outperformed CBs up to 2009
(i.e., before and in the initial year of the Global Financial Crisis).
Delving into the determinants of banks profitability, Demirgüç-
Kunt and Huizinga (1999) find that profitability differences among
banks in 80 countries over the period 1988–1995 could be rea-
sonably explained by a set of bank-specific financial ratios (e.g.,
staff expenses to total assets, cash and securities to total assets,
bank capital to total assets, size, etc.), macroeconomic variables
(e.g., money supply growth, inflation, and interest rates), and indus-
try variables (e.g., concentration and ownership structure). Several
studies have followed this seminal work to examine the profitabil-
ity of Islamic banks (e.g., Mollah, Hassan, Farooque, & Mobarek,
2016).
More recent studies using accounting ratios to investigate the
determinants of performance generally adopt panel techniques,
73
rather than simple ordinary least squares. To illustrate, Olson and
Zoubi (2011) explore the determinants of profitability of IBs and
CBs in ten MENA countries for the years 2000–2008 and show that
larger bank size, greater dependence upon loans for revenue, higher
market concentration, greater GDP growth, and higher proportions
of equity capital to assets are generally associated with greater pro-
fitability. Higher liquidity, greater provisions for loan losses, cost
inefficiencies, and more reliance on debt have been indicative of
lower bank profits. The authors also find that profitability is posi-
tively related to capitalization strength, as measured by the equity
to assets ratio and in each bank’s loan specialization ratio, which is
the degree to which a bank relies on loans relative to other earn-
ing assets. Performance is found to be negatively affected by cost
inefficiencies and credit risk (as measured by loan loss provisions
to total loans).
Another strand of the literature examines the financial stability
of Islamic vs. conventional banks using Z-scores.7 Čihák and Hesse
(2010) focus on banks in 18 countries during the years 1993–2004,
and find that large CBs are more stable over time than large IBs,
but that small IBs are more financially stable than large IBs or small
CBs. Bourkhis and Nabi (2013) adopt a paired approach to 34 IBs
and 34 CBs across 16 countries for the years 2006–2009 and exam-
ine the comparative soundness of the two types of banks during the
GFC. Using the Z-score indicator of bank stability, they conclude that
there is no significant difference between the stability of IBs and CBs
over the entire period. Beck, Demirgüç-Kunt, and Merrouche (2013)
further investigate the reasons for these differences and argue that
CBs are less stable than IBs primarily in those countries where IBs
have a larger market share. Mobarek and Kalonov (2014) exam-
ine the relationship between efficiency and financial stability of
both IBs and CBs using the Z-score methodology. Their results indi-
cate that IBs are more financial stable than CBs. Rajhi and Hassairi
(2013) extend the analysis of Čihák and Hesse (2010) and confirms
their results using robust estimation techniques on a data set for
the years 2000–2008 that contains substantial outliers,8 Abedifar,
Molyneux, and Tarazi (2013) assess the risk in Islamic banking,
and report that IBs (particularly small IBs) have lower credit risk
than CBs across 23 countries for the years 1999–2009. However,
in contrast to previous work, they find that IBs have become less
financially stable over time and faced greater insolvency risk than
CBs during the years 2008–2009. Grira, Hassan, and Soumare (2016)
estimate the implicit risk-based premiums for deposit insurance of
Islamic banks and conventional banks for the period 1999–2013.
The results of this study suggest that publicly listed conventional
banks are riskier than their Islamic counterparts.
Which type of bank has been less damaged by the Global Finan-
cial Crisis? Tentative answers to this question may be found in Čihák
and Hesse (2010) and Hasan and Dridi (2010). Hasan and Dridi
(2010) examine the impact of the GFC on CBs and IBs in emerg-
ing markets for 2007–2009 and find that IBs performed better than
CBs in 2007–2008. They argue that weak risk management prac-
tices in some IBs may then have contributed to a large decline in
IBs profitability in 2009.
Beck et al. (2013, p.445) using data over the entire period
2005–2009 show that “the higher capitalization and better asset
quality have helped IBs outperform CBs during the latest cri-
sis.” Nevertheless, an extensive comparative analysis of the
7
Although there are some differences across studies in constructing this variable,
the Z-score consists of the sum of the expected ROA plus the equity to assets ratios,
divided by the variability of returns (i.e., the standard deviation of each bank’s return
on assets).
8
He finds that the median Southeast Asian Islamic bank has a significantly higher
Z-score of financial stability than the median CBs. He also confirms that smaller IBs
are more stable than larger IBs.
74 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87
performance for the two types of banks for years after 2009 (post-
crisis years) is, to the best of our knowledge, yet to be documented.9
To summarize, the extant literature indicates that IBs are less
affected initially by financial shocks, but that CBs may adjust more
quickly to longer-term changes in economic conditions. If there are
benefits from both types of banking models, IBs and CBs poten-
tially could learn from one another so that performance could
converge across all banks in the MENASA region in the aftermath
of the GFC. To more formally test this hypothesis, we refer to the
growing literature on economic convergence that is used to test
whether a variable or ratio is moving toward some common cur-
rent or historical mean value for that variable. To date, four main
approaches have been adopted to test for convergence: beta con-
vergence, sigma convergence, stochastic convergence based upon
unit root and cointegration tests, and finally relative convergence
based on log t-tests.
The solution adopted in the economic growth literature pio-
neered by Barro (1991) and Barro and Sala-i-Martin (1992) has been
to look at changes from one period to the next in income or output
growth, or in the dispersion in the cross sectional values of a vari-
able between each period. Beta convergence can be measured by
regressing the growth rate of a variable on the beginning of period
level of that variable. For example, when applied to income or GDP
growth, there is beta convergence if countries or regions with low
values grow at a faster rate than those with high initial levels of
income or output. Hence, the beta coefficient in the so called “Barro
regression” must be negative. For banking sector data, beta conver-
gence would imply mean reversion in panel units, or for individual
banks. Sigma convergence, also attributable to Barro (1991) and
Barro and Sala-i-Martin (1992), tests how quickly the level of some
variable converges to the cross sectional average of some group
of countries, regions, or firms. Sigma convergence requires that
the beta-like coefficient of dispersion away from the cross sec-
tional annual mean is negative. Beta convergence is a necessary,
but not sufficient condition for sigma convergence and sigma con-
vergence in the banking sector would occur if there was an overall
reduction in cross sectional dispersion of some financial variable
over time. In a study relevant for what might be expected in the
MENASA region, Weill (2009) uses data for the banking sector in ten
European countries for the years 1994–2005 and finds evidence of
beta and sigma convergence in the levels of cost efficiency across
countries. Such results support the notion of increased financial
integration in the banking sector over time. Similarly, Casu and
Girardone (2010) support beta and sigma convergence in bank effi-
ciency across 15 European countries using data for 1997–2003. Beta
and sigma convergence tests, since their development in the 1990s,
have certainly become the most frequently used tests for conver-
gence and have been applied to test convergence for a wide range
of economic and financial variables across many countries.
Stochastic convergence is often applied to panel data and it
focuses on unit root tests of stationarity to determine whether a
variable is stationary and reverts to some mean value over time,
or whether it just wanders and fails to mean-revert or converge
to some value. To illustrate the application of such tests, Guetat
and Serranito (2007) applied panel unit root tests to examine the
convergence of GDP per capita across 11 MENA countries over
the period 1960–2000. They reported mixed results with levels
of convergence varying by time period considered, but gener-
ally found convergence across countries for the years 1960–1990
and then convergence clubs of various countries over the entire
period or for various subperiods. Lin and Huang (2012) applied
9
Some clues about the relative performance of IBs and CBs post-crisis appear in
few studies. For instance, Dahduli (2010) reports that ROA and ROE of IBs improved
relative to CBs in 2008.
a battery of univariate and panel stationarity test to measures of
income inequality across 48 states in US for the years 1916–2005.
Although traditional univariate unit root tests and simple panel
tests failed to reject non-stationarity, the more sophisticated panel
techniques that include structural breaks and cross correlation
rejected the unit root hypothesis and supported stochastic conver-
gence in inter-state incomes. Nevertheless, Kim and Rous (2012),
Aspergis, Christou, and Miller (2014), and Caporale, Erdogan, and
Kuzin (2015) point out that panel unit root tests require many
restrictive assumptions and are not as precise as measures of rela-
tive transition, such as the log t-test for convergence as developed
by Phillips and Sul (2007a).
Currently, the Phillips and Sul (2007a) log t-test represents the
state of the art in testing for convergence in any variable. It is gen-
erally applied to panel data and convergence cannot be rejected
if the gamma coefficient on the relative transition parameter in a
log t regression is positive, or if it is negative and insignificant. This
relative transition variable measures the dispersion of a financial
variable away from the annual mean in an initial period divided by
dispersion in later periods. Convergence requires cross sectional
dispersion to decrease over time and with the way this variable
is constructed, it happens when the relative transition variable is
positively related to time. For banking sector data, the log t-test
can be used to test for overall convergence across all banks, for
convergence clubs that include only some countries, or for clubs
that contain only certain types of banks. Hence, following Phillips
and Sul (2007b), the log t-test can be used to see whether IBs are
converging toward their own mean or toward the mean of all banks
(IBs plus CBs). The same tests can be done to see if CBs converge
toward the mean of all banks. When applied to the question of
financial integration in the European banking sector, Rughoo and
Sarantis (2012) adopt the log t-test and support convergence in
deposit and lending rates across 15 European countries for the years
2003–2007. However, when the years 2008–2011 are included, the
null of convergence in the deposit and credit markets is strongly
rejected. Similarly, Matousek et al. (2015) reject convergence in
bank cost efficiency across the 15 countries in the Eurozone for
the years 2005–2012. Based on the European experience, the GFC
may have reduced convergence in performance of all banks across
countries, but our focus in the next section is only on whether IBs
and CBs as a group are becoming more alike over time.
3. Data and sample
To identify the determinants of bank profitability in emerg-
ing markets and to examine operational differences between IBs
and CBs, we collect financial statement data from Bankscope
for the years 1996–2014.10 This database provides standard-
ized figures so that most of the items are comparable across
time and banks. Furthermore, many prior studies (i.e. Abedifar
et al., 2013; Daher, Masih, & Ibrahim, 2015) used the Bankscope
data as a reliable source for Islamic bank data. The period of
analysis represents the years for which electronic data are cur-
rently available for 22 countries in Asia and Africa that have
both IBs and CBs in their national banking sector. Although
IBs and Islamic windows exist outside these 22 countries,
they do not represent a significant portion of the banking
sector in those countries. For example, IBs in the United King-
dom consist of only 1/2 of 1% of total bank-year observations
available in Bankscope or that country and Iran is excluded
10
External variables affecting bank performance (e.g., inflation, GDP) were col-
lected from the International Monetary Fund (IMF). In general, however, country
dummies provided greater explanatory power for firm performance than country-
specific macroeconomic variables.
 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87 75

Table 1
Description of data sample.

Panel A: Number of banks in sample by country for the years 1996–2014

Country Year

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Totals

Bahrain 6 5 6 7 7 8 7 10 10 15 15 19 20 16 18 16 18 18 17 238
Bangladesh 18 19 20 27 29 33 33 33 32 32 13 33 33 33 37 38 38 45 43 607
Brunei 1 3 3 3 3 3 3 3 3 3 2 2 2 2 2 2 2 2 2 46
Egypt 24 24 24 23 22 22 23 23 23 23 22 24 25 24 25 25 25 25 24 450
Indonesia 30 35 27 33 44 38 36 38 38 50 50 53 53 58 60 64 72 85 86 950
Iraq 1 2 2 2 2 2 1 1 1 4 4 5 7 5 7 9 11 10 9 85
Jordan 11 11 11 11 1 13 13 13 14 13 14 1413 13 13 13 14 14 14 14 246
Kuwait 8 8 8 8 8 8 8 8 8 10 11 10 9 9 9 10 11 11 11 173
Lebanon 39 39 39 38 39 30 30 29 29 31 29 31 30 37 35 34 34 32 29 633
Malaysia 23 23 23 23 21 24 26 26 26 30 34 37 42 42 43 46 45 47 47 628
Mauritania 4 4 3 2 4 4 6 7 7 7 5 5 4 6 8 7 5 5 3 96
Oman 5 5 5 5 5 5 5 5 5 5 5 6 6 6 6 6 6 8 8 106
Pakistan 15 14 15 15 13 15 13 18 19 21 25 26 28 27 26 27 28 28 28 401
Palestine 0 1 1 1 1 1 1 2 2 2 2 2 3 4 4 4 4 4 4 43
Qatar 6 6 6 6 6 7 7 7 7 7 7 7 8 8 9 10 10 10 10 144
Saudi Arabia 9 9 9 8 9 9 9 9 10 10 10 11 11 12 12 12 12 12 12 195
Sudan 3 5 5 6 6 8 9 6 6 8 10 13 14 14 14 15 14 12 9 177
Syria 1 1 1 1 1 1 0 0 0 5 6 7 11 10 11 10 10 11 8 95
Tunisia 13 13 14 15 17 17 16 14 14 14 14 15 16 16 15 15 14 11 11 274
Turkey 3 3 4 19 17 21 24 25 26 25 26 28 29 31 31 30 31 32 34 439
United Arab Emirates 16 16 18 17 17 18 19 19 19 20 20 20 21 21 20 22 25 25 25 378
Yemen 4 5 5 5 5 6 6 7 7 7 7 7 8 8 7 6 8 7 1 116
Totals 240 251 249 275 288 293 295 302 306 342 349 375 393 402 412 422 437 454 435 6520

Panel B: Number of banks in sample by type (commercial or Islamic) for the years 1996–2014

Country Total observations

Commercial Islamic % Islamic

Bahrain 131 107 45.0

Bangladesh 499 108 17.8
Brunei 19 27 59.0
Egypt 400 50 11.1
Indonesia 894 56 5.9
Iraq 66 19 22.4
Jordan 198 48 19.5
Kuwait 94 79 45.7
Lebanon 623 10 1.6
Malaysia 456 172 27.4
Mauritania 82 14 14.6
Oman 102 4 3.8
Pakistan 328 73 18.2
Palestine 25 18 41.9
Qatar 97 47 32.6
Saudi Arabia 151 44 22.6
Sudan 45 132 74.6
Syria 86 9 9.5
Tunisia 256 18 6.6
Turkey 376 63 14.4
United Arab Emirates 290 88 23.3
Yemen 78 38 32.8
Totals 5296 1224 18.8

because it had no CBs during the period of analysis. Data for
Algeria, Morocco, Gambia, Kazakhstan, and Senegal have been
omitted because of too few usable observations. Although bank-
ing in Sudan and Pakistan follows general Islamic principles, data
are included because Bankscope categorizes each bank as either an
IB or a CB.
Panel A of Table 1 shows the number of bank-year obser-
vations for 22 countries: Bahrain, Bangladesh, Brunei, Egypt,
Indonesia, Iraq, Jordan, Kuwait, Lebanon, Malaysia, Mauritania,
Oman, Pakistan, Palestine, Qatar, Saudi Arabia, Sudan, Syria,
Tunisia, Turkey, United Arab Emirates, and Yemen for the years
1996–2014. The data contain 6520 bank-years of observations
for the various financial variables used in this study. All data
are expressed in US dollars and the definitions of the variables
are given in Table 2. These variables include a set of profit-
ability ratios, asset composition measures, efficiency ratios, risk
measures, and dummy variables that capture individual bank
characteristics.
The largest number of usable data points come from
Indonesia—950 bank-year observations, while Malaysia has the
most Islamic bank-year observations—172. Palestine and Brunei
have only 43 and 46 usable observations. The annual sample size
begins with 240 observations in 1996 and peaks at 454 in 2013.
Due to problems with outliers, we only included banks with posi-
tive reported numbers for equity, deposits, fixed assets, operating
expenses, operating income, net loans, interest expense, and inter-
est income. To obtain the largest possible data set, we included
banks with missing observations for cash, labor expenses, and loan
loss provisions, but then deleted those observations when calculat-
ing financial ratios involving those variables. Finally, we followed
Beck et al. (2013) and winsorized all variables at the 1% and 99th
percentiles.
76 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87
Table 2
Definitions of variables and ratios.
Profitability and performance ratios
1. ROA = return on assets = net income/total assets
2. ROE = return on equity = net income/stockholders’ equity
3. ROD = return on deposits = net income/total deposits
4. NIM = net interest margin = (total interest income − total interest
cost)/total assets
5. NNIM = net non-interest margin = (total non-interest income − total
non-interest expense)/total assets
Asset composition variables
6. SIZE = natural log of total assets
7. LSPEC = loan specialization ratio = total net loans/total assets
8. SECUR = security specialization ratio = other interest bearing assets
(non-loans)/total assets
9. DEPA = deposit specialization ratio = total deposits/total assets
10. LOANDEP = total net loans to total deposits
11. CTA = cash to assets ratio = cash and cash equivalents/total assets
12. FATA = fixed asset ratio = fixed assets/total assets
13. NIBA = ratio of non-interest bearing assets to total assets
Efficiency ratios
14. INEFF = inefficiency ratio = operating expenses/gross income
15. LCI = labor cost to income = personnel expenses/gross income
16. OOEI = other operating expenses/gross income
17. IEI = interest expense to income = income expenses/gross income
Risk measures
18. CRISK = credit risk = loan loss provisions/net loans
19. IMPAIR = impairment ratio = impaired loans/net loans
20. CAPSTR = capital strength = total equity/total assets
21. Z-score = stability measure = sum of ROA and CAPSTR/standard
deviation of each bank’s ROA
Dummy variables
22. ISLAMIC = dummy variable equal to one if the bank is Islamic, zero
for commercial banks
23. UNLISTED = dummy variable equal to one if bank shares are not
traded on a stock exchange, nor delisted
24. Country dummies for 21 of 22 countries. Malaysia is the intercept
term because it has the most Islamic banks.
Bankscope definitions and conventions used to obtain various Islamic equivalent
variables are as follows:
Net income = commercial net income before taxes, plus Zakat.
Loans = asset value of Mutajata + Murabaha + Istisna + Ijarah + Salam + Musharka +
Mudarabah + Wakalat.
Customer deposits = unrestricted Mudarabah deposits + Murabaha deposits +
Medium Term Wakala Financing + savings accounts + current accounts.
Interest income = income from Murabaha + Musharka + Istisna + Ijarah + Salam +
Mudarabah + Wakalat.
Interest expense = distributions (expense) on customer deposits.
Non-net interest income = income from commission and fees + portfolio manage-
ment and Sukuk management fees received.
Non-interest expense = portfolio management fees paid + professional and licenses
fees paid.
Loan loss provisions = net provisions for Islamic financing and investing activities
(Murabaha, Musharka, Istisna, Ijarah, Salam, Mudarabah, and Wakalat).
Impairment = impaired Murabaha, Musharka, Mudarabah, Istisna, Ijarah, Salam.
Panel B of Table 1 shows the composition of banks by country
and by type (IB or CB) over the entire period of the data sample.
There are s 5296 bank-year observations for CBs and 1224 obser-
vations for IBs. IBs comprise about 19% of our sample, while country
percentages of usable observations for IBs range from about 2% in
Lebanon up 75% in Sudan.
4. Profitability and bank financial ratios
Table 2 shows the financial ratios examined in our study, begin-
ning with five measures of profitability. Panel A of Fig. 1 graphically
indicates the average annual values for profitability as measured
by return on assets (ROA), return on equity (ROE), net interest
margin (NIM), net non-interest margin (NNIM), and return on
deposits (ROD) for IBs and CBs for the years 1996–2014. Kosmidou,
Pasiouras, and Tsaklanganos (2007) and Van Horen (2007) have
argued that ROA is the most useful measure of profitability over
time because assets have a direct impact on both income and
expenses. However, our discussion below examines both ROA and
ROE.11
Average ROA for IBs and CBs were similar for the years
1996–1999. Then, as IBs proliferated across Asia and Africa in
the period 2000–2007, ROA for IBs initially dropped in 2000, but
remained notable high relative to CBs for the years 2001–2008.
Note that average ROAs for both IBs and CBs in 2007 (2.12% and
1.52%, respectively) were above historical averages for 1996–2006
(1.41% and 1.27%). Similarly, Panel A of Fig. 1 indicates peak pro-
fitability for ROE and ROD for the years 2004–2007 and a big drop
from 2007 to 2008 and from 2008 to 2009. Hence, we define the
financial crisis period for MENASA banks as the years 2008–2009.
During the financial phase of the crisis in 2008, average ROA
fell to 1.49% for IBs and to 1.30% for CBs in 2008. Then, as the cri-
sis spread to the real economy, the economic phase of the GFC
reduced average ROA to 0.85% for IBs and to 1.22% for CBs in 2009.
For 2010–2014 average ROA has been 1.24% for commercial banks
and 1.09% for Islamic banks. Looking at the time pattern of response
of banks to the financial crisis, IBs may initially weather the shock
better, but they decline more in terms of profitability in a prolonged
crisis. As pointed out by Grassa (2012), Islamic profit-loss sharing
products present greater insolvency risk than products offered by
CBs and this type of risk has a more detrimental impact on perfor-
mance during a prolonged crisis. IBs have taken longer to move back
toward pre-crisis levels of profitability, but differences in recovery
speed may be due to the large expansion of Islamic banking in the
pre-crisis era and reflect a type of mean reversion that was hastened
by the Global Financial Crisis. Also, profitability ratios for Islamic
banks show greater year to year variability than those for commer-
cial banks so that the current underperformance of IBs relative to
CBs may be due to normal fluctuations.
Panels B–E of Fig. 1 present average annual values for the vari-
ables presented in Table 2. These are bank-specific variables that
have been used in a variety of studies to explain bank performance
and profitability. These panels illustrate the trend over time for var-
ious asset composition variables, efficiency ratios, and measures of
risk for IBs and CBs in the MENASA region. Although there appear
to be some convergence in profitability ratios between IBs and CBs,
there is less convergence in other ratios.
To further assess the convergence proposition, Table 3 shows
the average values for CBs before, during and after the crisis of
2008–2009. Values are obtained from ordinary least squares regres-
sions of each variable on three dummy variables, adjusted for
heteroskedasticity and autocorrelation. The dummy variable PRE
represents pre-crisis years (1996–2007), CRISIS is for the years
2008–2009, and AFTER is a dummy variable for period 2010–2014.
The profitability ratios, ROA and ROD were significantly larger
at the 1% level for IBs relative to CBs for 1996–2007. ROD remained
higher for IBs during 2008–2009, but both ROA and ROD are essen-
tially the same for both bank types in the aftermath of the crisis.
ROE was similar for IBs and CBs in the pre-crisis era, but ROE has
been significantly smaller for IBs after 2007.
NIM was similar for IBs and CBs from 1996 to 2009, but then
smaller for IBs in the years 2010–2014. The net interest margin has
been slightly higher for CBs relative to IBs over the entire period
1996–2014. In contrast, NNIM has been slightly higher on average
for IBs over the entire period.
Regarding the asset composition ratios, Islamic banks are
smaller than commercial banks. They tend to have higher loan
11
Bankscope also provides data for the return on average assets (ROAA). Its denom-
inator is calculated as the average of the end of period and beginning of period total
assets, rather than from end of period total assets for ROA. The two ratios are over 98%
correlated, so results for ROAA are not presented. Similarly, the Bankscope return
on average equity (ROAE) is 93% correlated with ROE.
 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87 77

specialization ratios, loan to deposit ratios, cash to asset ratios, fixed
assets to total assets, and greater proportion of non-interest bearing
assets than commercial banks. IBs have lower security specializa-
tion and deposit to asset ratios. IBs had lower inefficiency ratios
pre-crisis, but they have significantly higher inefficiency ratios than
CBs from 2008 to 2014. IBs have higher labor costs and other operat-
ing expense to income ratios, but lower interest expense to income
ratios than CBs. For the risk measures, IBs had significantly lower
credit risk pre-crisis, but have since taken on more such risk than
CBs. IBs have lower loan impairment ratios and greater capital
strength than CBs. Nevertheless the Z-scores for IBs have fallen
relative to CBs since 2008. In summary, IBs and CBs have similar
levels of profitability, but they do it with different operating char-
acteristics due to different asset composition ratios and different
risk exposures.
5. Determinants of ROA and ROE
A substantial body of literature has examined the variables
that determine individual bank profitability. Our purpose in this
section is to discover whether the determinants differ between
IBs and CBs. Following Olson and Zoubi (2011), we estimate ROA
using an unbalanced dynamic panel model with the financial vari-
ables listed in Table 2 as the independent variables that may
identify operational and profitability differences between IBs and
CBs.
The basic framework for our random effects panel model is:
ROAit = ˛i + ˇ Xit + Dummy Variables + εit , (for i = 1, 6520)
(1)

Panel A: Profitability Raos

2.8 16
ROA ROE

2.4
14

2.0
12

1.6

10
1.2

8
0.8

0.4 6
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

ROAI ROAC ROEI ROEC

7 4.0
ROD NIM

6
3.6

5
3.2

2.8
3

2.4
2

1 2.0
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

RODI RODC NIMI NIMC

-0.6
NNIM
-0.8

-1.0

-1.2

-1.4

-1.6

-1.8

-2.0

-2.2
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

NNIMI NNIMC

Fig. 1. Panel A: Profitability ratios. Panel B: Asset composition ratios. Panel C: Efficiency ratios. Panel D: Risk measures.
78 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87

Panel B: Asset Composion Raos

70
15.2 LSPEC
SIZE
65
14.8

60
14.4

55
14.0

50
13.6

13.2 45

12.8 40
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

SIZEI SIZEC LSPEC I LSPEC C

48 72
Securitization Ratio DEP A
70
44
68
40
66

36 64

62
32
60
28
58

24 56
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

SECRATI SE CRATC DEPA I DEPA C

130 16
LOANDEP CTA
120
14

110
12

100
10
90

8
80

6
70

60 4
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

LOANDEPI LOANDEP C CTAI CTAC

3.6 2.8
NIBA FATA
3.4 2.6

3.2 2.4

3.0 2.2

2.8 2.0

2.6 1.8

2.4 1.6

2.2 1.4

2.0 1.2
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

NIBA I NIBA C FATAI FATAC

Fig. 1. (Continued ).
 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87 79

Panel C: Efficiency Raos

92 24
Inefficiency Ratio LCI

88 22

84 20

80 18

76 16

72 14

68 12
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

INEFFI INEFFC LCII LCIC

28 65
OOEI IEI
26
60
24
55
22

20 50

18
45
16
40
14

12 35
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

OOEII OOEIC IEII IEIC

Panel D: Risk Measures

4.0 11
CRISK Impairment Ratio
10
3.5
9
3.0
8

2.5 7

6
2.0
5
1.5
4

1.0 3
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

CRISKI CRISKC IMPAIRI IMPAIRC

24
22 Z-Score
CAP STR
20 22

18
20
16

14 18

12
16
10

8 14
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

CAPS TRI CAP STRC ZEDI ZEDC

Fig. 1. (Continued ).
80 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87

Table 3 The final coefficients selected in the Table 4 are based on an

Means of variables for commercial banks and the differential value for Islamic
exhaustive search to maximize the log likelihood function using a
banks before, during and after the financial crisis of 2008–2009.
5% cutoff value for coefficients, as estimated by version 9.1 of the
Variable Commercial banks Islamic bank differentials
Before During After Before During After
RATS statistical package. For each non-dummy variable in Table 2,
1996– 2008– 2010– 1996–2007 2008– 2010– the financial variable was multiplied by an Islamic dummy variable
2007 2009 2014 2009 2014 to determine if there were any differences in the determinants of
ROA 1.30 1.25 1.24 0.35*** -0.08 -0.14
ROE 12.47 11.62 10.53 -0.83 -3.29*** -1.57** ROA between IBs and CBs. Only one variable, SIZE-Islamic is sig-
ROD 2.30 2.22 2.28 1.55*** 1.14** 0.49 nificantly different from the coefficient for CBs. Although SIZE is
NIM 3.15 3.21 3.15 -0.04 0.03 -0.26** positively related to profitability for CBs, it is negatively related to
NNIM -1.41 -1.59 -1.56 0.21** -0.22 0.03
ROA for IBs. This result confirms the findings of Beck et al. (2013)
SIZE 13.88 14.63 14.84 -0.52*** -0.38*** -0.31*** that smaller IBs are more profitable than larger IBs. Other explana-
LSPEC 46.67 50.25 51.18 4.45*** 0.60 1.17
SECUR 39.47 33.68 33.26 -7.07*** -6.92*** -6.33***
tory variables are roughly of the same magnitude and sign for both
CTA 8.86 10.68 10.67 0.11 4.05*** 3.43*** IBs and CBs. Overall, Table 4 indicates that the determinants of indi-
FATA 1.77 1.75 1.60 0.47*** 0.56** 0.54*** vidual bank profitability, as measured by ROA, are essentially the
NIBA 2.39 2.43 2.41 0.37*** 0.33** 0.23***
DEPA 69.40 69.67 69.34 -5.86*** -9.14*** -6.61***
same for both IBs and CBs. The coefficients on the pre-crisis, cri-
LOANDEP 77.27 80.21 86.56 28.63*** 42.48*** 29.38*** sis, and after-crisis dummy variables for differences between IBs
and CBs are insignificant. That is, individual bank characteristics
INEFF 81.13 80.49 77.77 -2.28* 5.60* 4.63***
LCI 14.64 16.58 18.37 2.85*** 2.17** 1.77*** determine profitability.
OOEI 15.31 16.22 16.92 5.38*** 8.53*** 6.86*** To summarize the ROA results from Table 4, more profitable
IEI 53.03 48.26 42.64 -10.91*** -4.64** -4.73***
banks have greater capital strength and loan specialization ratios,
CRISK 2.01 1.79 1.47 -0.48*** 0.46 0.18 but lower inefficiency ratios. Hence, issuing loans, controlling costs,
IMPAIR 9.22 7.21 6.50 -3.37*** -3.12*** -1.22** and maintaining adequate equity capitalization are important for
CAPSTR 11.25 12.58 13.36 5.37*** 3.81*** 2.49***
Z-score 18.47 19.46 21.93 0.88 -1.04 -1.60* all banks, regardless of whether they are Islamic or commercial
banks. Similar variables have been identified in previous studies
All ratios are expressed in percent and mean values are obtained from a regression
of each accounting ratio on six dummy variables—one for each of the three time as the primary determinants of individual bank profitability. For
periods across both commercial and Islamic banks. The t-statistics used to judge example, Kosmidou et al. (2007) finds that larger bank size is a
significance levels are adjusted for heteroskedasticity. Due to missing data only major determinant of profitability. Berger and Bouwman (2013)
5977 observations are available for LCI and 5405 for CRISK. Means for all other show that having adequate bank capital (CAPSTR) is an important
variables are based on 6520 observations.
***, **, * indicates a ratio for Islamic banks that is significantly different from the
factor for bank survival during financial crises. Finally, the bank-
same ratio for commercial banks at the 1%, 5%, and 10% levels. Black boldfacing ing literature has focused substantially on cost efficiency and the
indicates a mean value for an Islamic bank that is statistically larger than the inefficiency ratio appears to be perhaps the major determinant of
same coefficient for a commercial bank, while red boldfacing shows a coefficient profitability for our sample of IBs and CBs. For our data set, risk is
that is statistically smaller. (The results are qualitatively similar using the t-test
not a significant determinant of profitability.
of means based on unequal variances between bank samples.)
The dummy variable UNLISTED is negatively related to pro-
fitability, meaning that stock market listing contributes to
where ROAit is the dependent variable, ˛ is the common inter- profitability. Stock market listing is another measure of size, age,
cept across banks in the random effects model, Xit is a vector of and the reputation of the bank. The significantly positive country
explanatory variables described in Table 2 (including bank-specific dummies for Bangladesh, Indonesia, Sudan, Syria, and the United
accounting ratios and financial variables such as size), ˇ is a vec- Arab Emirates show above average profitability for banks in those
tor of regression coefficients, and εit is the disturbance term that is countries, even after adjusting for the impact of individual bank
assumed to be normally distributed with a mean of zero. Dummy characteristics. None of the countries show distinctly lower ROA
Variables include country dummies for the 21 of the 22 countries than the reference country of Malaysia, but the lower ROA for Saudi
with Malaysia as the intercept term and an UNLISTED dummy vari- Arabia would be significant if a country such as the United Arab
able that equals one if a bank is neither listed on a national stock Emirates Turkey, or Indonesia were used as the reference country
exchange, nor delisted from a national exchange. The constant (˛) instead of Malaysia.
term can be further expanded to illustrate differences between time Similar to Beck et al. (2013) once individual bank results have
periods (PRE, CRISIS, and AFTER) and between IBs and CBs in any of been adjusted for variables like capital strength and the inefficiency
the three time periods. The PRE-Malaysia constant term in Table 4 ratios, there is no significant difference between the performance
is a projected base ROA for commercial banks in Malaysia in the of IBs and CBs. The determinants of ROA are essentially the same for
pre-crisis period given the values of other variables. Any country both IBs and CBs—it is primarily individual differences in bank char-
could have served as the constant and the choice of Malaysia rather acteristics that explain performance differences and not whether a
arbitrary, but Malaysia was selected as the constant because it has bank is commercial or Islamic.
the most bank-year observations for Islamic banks and because it Eq. (1) can be used to examine the determinants of ROE and
is reasonably close to the sample average for the various profit- the results are shown in Table 4. Explanatory variables are similar
ability ratios. Hence, PRE-Islamic denotes the differential returns to those for ROA with one exception. Capital strength is nega-
to IBs relative to Malaysian CBs in 1996–2007, Crisis (2008–2009) tively related to ROE. The reason is that higher values of equity
is the base point ROA for Malaysian CBs during the crisis, Crisis- in the denominator of the ROE ratio reduce its value—apparently
Islamic is the differential return for IBs during the crisis, and After by more than higher equity increases net income. As was the case
and After-Islamic apply to the years 2010–2014. for ROA the inefficiency ratio is negatively related to profitability
Although a fixed effects model dominates the random effects and appears to be the most significant determinant of ROE. The
specification on the basis of the log of the likelihood function, securitization ratio is positively related to ROE, while the loan spe-
results from the random effects model are presented to illustrate cialization ratio is not a significant determinant of ROE. The deposit
the impact of country-specific dummies and the impact of stock to assets ratio is also positively related to ROE. It is also posi-
market listing. The adjusted R-squared value is taken from the tively related to ROA, but loses significance once other variables
equivalent fixed effects model that does not include the time- are included in the ROA equation. UNLISTED is significantly nega-
invariant dummy variables. tively related to ROE, as it is to ROA. Once again the PRE-Islamic,
 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87 81

Table 4
Determinants of ROA and ROE.

Independent variable ROA ROE

Coefficient t-Statistic Coefficient t-Statistic

Constant (PRE-Malaysia) 3.644 (12.63)*** 34.12 (12.49)***

PRE-Islamic (1996–2007) 0.449 (1.28) −0.74 (−0.99)
Crisis (2008–2009) 3.478 (10.62)*** 33.22 (12.09)***
Crisis-Islamic 0.448 (1.20) −0.51 (−0.57)
After (2010–2014) 3.292 (10.92)*** 31.41 (11.48)
After-Islamic 0.488 (1.29) 0.91 (1.26)
SIZE 0.029 (2.12)**
SIZE-Islamic −0.052 (−2.00)**
INEFF −0.043 (−87.95)*** −0.290 (−70.95)***
CAPSTR 0.036 (21.88)*** −0.222 (−11.02)***
LSPEC 0.003 (3.29)***
SECUR 0.021 (3.13)***
DEPA 0.030 (3.68)***
UNLISTED −0.159 (−3.76)*** −1.093 (−3.02)***
Bahrain 0.146 (0.47) −3.034 (−0.75)
Bangladesh 0.491 (1.97)* 6.305 (1.84)*
Brunei −0.300 (−0.70) −12.439 (−2.40)**
Egypt 0.233 (0.88) −2.879 (−0.82)
Indonesia 0.523 (2.23)** 5.174 (1.58)
Iraq 0.402 (1.11) −6.754 (−1.63)
Jordan 0.218 (0.74) −4.946 (−1.29)
Kuwait 0.330 (1.08) −3.050 (−0.79)
Lebanon 0.334 (1.32) 2.847 (0.80)
Mauritania −0.105 (−0.23) −1.741 (−0.40)
Oman 0.024 (0.06) 7.531 (1.43)
Pakistan 0.368 (1.30) 1.904 (0.51)
Palestine 0.012 (0.03) −2.267 (−0.51)
Qatar 0.290 (0.77) −1.392 (−031)
Saudi Arabia −0.529 (−1.57) −6.825 (−1.61)
Sudan 1.026 (3.21)*** 5.713 (1.41)
Syria 0.964 (2.83)*** 4.939 (1.18)
Tunisia 0.214 (0.69) 1.509 (0.37)
Turkey 0.436 (1.56) 3.551 (0.95)
United Arab Emirates 0.566 (1.94)* 0.074 (0.02)
Yemen 0.575 (1.37) 0.156 (0.03)

Adjusted R2 70.65% 54.96%

Hausman test 169.52*** 104.46***

Random effects panel estimation of the determinants of ROA and ROE. The final model is selected from an exhaustive search of the independent (non-profitability) variables
in Table 2. A 5% cutoff criterion was used to maximize the log of the likelihood function. The t-statistics are shown in parentheses. Coefficients on continuous independent
variables are qualitatively similar for models without dummies included.
*
Significance at 10% level.
**
Significance at 5% level.
***
Significance at 1% level.

Crisis-Islamic, and After-Islamic dummy variables are insignifi-
cant in explaining profitability differences between banks. ROE in
Bangladesh is significantly higher than in the reference country and
ROE is significantly lower in Brunei. Once again profitability would
be significantly lower in Saudi Arabia than other countries if a coun-
try such as Turkey had been used as a reference point, instead of
Malaysia. The determinants of ROE are similar to those for ROA
and serve as a robustness check for measures of profitability. Basi-
cally, bank profitability is determined by individual bank-specific
variables such as the inefficiency ratio, capital strength, asset spe-
cialization ratios, and whether a bank is listed or unlisted. The
banking models may be different, but profitability does not seem
to be determined by whether a bank is an Islamic or a commercial
bank.
6. Convergence and speed of adjustment
The graphical results presented in Fig. 1 as well as the general
lack of significance in differentials between IBs and CBs after the
GFC in Table 3 might suggest that the two types of banks are becom-
ing more similar over time. To more formally test this hypothesis,
we refer to the growing literature on economic convergence that
is used to test whether a variable or ratio is converging toward
some common current or historical mean value. This issue has
been addressed by four different approaches: beta convergence,
sigma convergence, panel unit root tests, and log t convergence
tests. However, for the sake of brevity, we do not present results for
panel unit root tests because studies such as Kim and Rous (2012),
Aspergis et al. (2014), and Caporale et al. (2015) indicate that such
tests are generally not as precise as the Phillips and Sul (2007a) log
t-test of convergence.
6.1. Beta convergence
We denote yit (for bank i in year t) as the value of any of the
ratios or bank variables listed in Table 2. Then, following procedures
developed by Barro and Sala-i-Martin (1992), beta convergence is
then estimated from a fixed effects panel estimator of the following
equation:
 y 
it
ln = ˇ ln (yit−1 ) + ˇIslamic ln (yit−1 )Islamici + εit , (2)
yit−1
where ˇ and ˇIslamic are the coefficients to be estimated for each
financial variable, ln is the natural log function, and εit is an error
term. Beta convergence occurs if the coefficient for ˇ based on the
82 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87

Table 5 changes slower than CBs across several variables; however, given
Beta convergence of financial ratios.
the small magnitude of the Islamic differentials, IBs still display
Variable Entire period (1996–2014) Post-crisis (2010–2014) convergence toward some overall mean for each ratio. Moving
βCommercial βIslamic βCommercial βIslamic to the After-Crisis period of 2010–2014, all 21 variables display
convergence toward a common value. For many of the ratios, con-
ROA -0.639 0.110 -0.720 0.088 vergence is faster than over the entire period, but the positive
(-44.31) (4.43) (-25.66) (2.04)
ROE -0.640 0.028 -0.652 0.086 Islamic differential for slower convergence is still observed for 7 of
(-47.34) (0.96) (-27.87) (1.80) 21 financial variables. Focusing on ROA, IBs react slower than CBs to
ROD -0.540 0.088 -0.542 0.018 profitability changes, both over the entire period and in the post-
(-38.02) (3.87) (-19.77) (0.45)
NIM -0.518 0.071 -0.492 0.009 crisis years. However, both IBs and CBs appear to be converging
(-40.07) (3.24) (-20.98) (0.26) toward the mean for all banks in the MENASA region.
NNIM -0.613 0.044 -0.735 -0.006
(-44.37) (1.68) (-27.75) (-0.13)
SIZE -0.273 -0.007 -0.189 -0.011
(-30.66) (-1.35) (-12.84) (-1.76) 6.2. Sigma convergence
LSPEC -0.416 -0.009 -0.454 0.024
(-38.14) (-0.96) (-25.44) (1.72) We denote the difference between the value of yit for an indi-
SECUR -0.433 -0.034 -0.400 -0.119
(-36.91) (-1.64) (-21.26) (-3.59) vidual bank and the cross sectional
n mean of that variable for each
DEPA -0.432 0.009 -0.374 0.005 year as: Wit = ln (yit ) − (1/n) i=1 yit . Then sigma convergence is
(-39.03) (1.21) (-19.91) (0.42) estimated from a fixed effects panel estimator of the following
LOANDEP -0.425 -0.030 -0.400 -0.005
(-38.43) (-3.27) (-21.96) (-0.38)
equation:
CTA -0.590
(-53.79)
0.033
(-1.70)
-0.620
(-28.45)
0.173
(4.60)
 W 
it
NIBA -0.439 0.063 -0.385 -0.009 ln = ˇ ln (yit−1 ) + ˇIslamic ln (Wit−1 )Islamici + εit , (3)
Wit−1
(-36.36) (3.20) (-19.51) (-0.32)
FATA -0.349 -.033 -0.347 0.174
(-29.17) (-1.57) (-17.35) (5.94) where Wit replaces the yit values in Eq. (2), and sigma conver-
INEFF -0.554 0.013 -0.679 0.001
gence requires that ˇ < 0. Sigma convergence measures whether
(-44.69) (2.67) (-30.93) (0.06)
LCI -0.742 0.045 -0.879 0.216 there is a lessening in the cross sectional dispersion in each variable
(-65.42) (2.45) (-40.07) (6.49) over time. It is a more stringent condition than beta convergence
OOEI -0.476 0.022 -0.549 0.019 because beta convergence is a necessary, but not sufficient con-
(-41.01) (1.87) (-27.37) (1.08)
IEI -0.440 -0.013 -0.493 -0.035 dition for sigma convergence. Nevertheless, the results for sigma
(-39.31) (-1.24) (-25.53) (-1.83) conversion in Table 6 are nearly identical to those for beta con-
CRISK -0.722 0.054 -0.811 0.159 vergence in Table 5. Sigma convergence across all 21 variables is
(-43.46) (1.42) (-24.48) (2.42)
IMPAIR -0.521 0.059 -0.546 0.181 indicated by the negative coefficients on ˇCommercial over the whole
(-38.98) (2.27) (-21.67) (4.12) period. Similarly, sigma convergence is observed for all 21 ratios
CAPSTR -0.402 0.023 -0.473 0.039 over the period 2010–2014. Once again IBs display slower conver-
(-37.31) (1.94) (-23.84) (2.25)
Z-score -0.343 0.032 -0.285 -0.078 gence than CBs for 7 of 21 variables over the whole period and
(-31.36) (1.77) (-13.71) (-2.40) for the post-crisis period. Overall, sigma convergence is observed
Beta coefficients are from fixed effects panel regressions for the whole period across all banks; with CBs generally shower faster convergence than
and the post-crisis period. t-Statistics are in parentheses. Black boldfacing for the IBs—particularly for variables such as ROA.
ˇCommercial coefficients indicates convergence in levels for commercial banks that
is significant at the 5% level. The ˇIslamic coefficients show the differential speed
of adjustment for Islamic banks relative to commercial banks. Black (red) bold-
6.3. Gamma (log t) convergence
facing means significantly faster (slower) at the 5% significance level for Islamic
banks relative to commercial banks. Random effect models with listing and coun-
try dummies are similar, but the Hausman test rejects the random effects model Since its introduction in 2007, the Phillips and Sul (2007a) log
at the 1% level for all independent variables. t-test has become the preferred test for measuring convergence
of economic or financial variables. It offers better discrimina-
initial beginning of period level of the variable or ratio is negative.12 tory power than tests for beta convergence, sigma convergence,
In Eq. (2), the beta coefficient represents speed of adjustment and or various unit root and cointegration tests for stationarity
it is further divided so that ˇ represents commercial banks and or co-movement between variables. Since the now standard
ˇIslamic shows the differential speed of adjustment for IBs relative methodology for relative transition parameters and log t-tests of
to CBs. As shown in Table 5, all of the beta coefficients (labeled convergence has been extensively presented by Phillips and Sul
ˇCommercial ) are negative and statistically for all 21 financial vari- (2007a, 2007b, 2009) and summarized in Matousek et al. (2015),
ables. This indicates that all banks are converging toward some we only briefly discuss how the test is developed for our data set.
common value for each ratio over time. The ˇIslamic coefficients are We define the relative transition parameter hit as:
positive and statistically significant for 7 of 21 ratios: ROA, ROD,
y
NIM, NIBA, INEFF, LCI and IMPAIR. IBs adjust faster than CBs only hit = 
it
n (4)
for the case of the loan to deposits ratio. In general, IBs adjust to (1/n) y
i=1 it

It describes the transition path for each bank relative to the panel
12
or cross section average in each year. The average value for hit must
For ratios that can take on negative values (e.g., ROA, ROE, NNIM, etc.), Eq. (2)
is estimated using the log of (1 + yit ) with the ratio expressed in decimal format. be one, so the cross sectional dispersion of the relative transition
These variables could instead be estimated using raw, untransformed data. For all parameters relative to their average in any year may be defined as:
variables, there was little difference between using log or non-log data in testing
for convergence. Some studies, such as Casu and Girardone (2010) include lagged H  1
n
values of the dependent variable in Eqs. (1) and (2). This formulation for beta and 1 2
ln = (hit − 1) . (5)
sigma convergence tests had little impact on other coefficients and we adopt the Ht n
formulation in the paper for greater simplicity. i=1
 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87 83

Table 6 for the  coefficient is t < −1.65, the null hypothesis of conver-
Sigma convergence of financial ratios.
gence can be rejected with a one-sided t-test at the 5% confidence
Variable Entire period (1996–2014) Post-Crisis (2010–2014) level. If t > −1.65 the null hypothesis of convergence is accepted.
σCommercial σIslamic σCommercial σIslamic The −2 ln [ln(t + 1)] term in our Eq. (6) behaves like a penalty func-
ROA -0.653 0.139 -0.726 0.109
(-44.71) (5.32) (-25.39) (2.32) tion for the regression and has been defined as −2 ln [ln(t)] in some
ROE -0.650 0.052 -0.647 0.108 empirical applications of the log t-test. Finally, many studies de-
(-47.43) (1.70) (-23.72) (2.11) trend the data using a Hodrick-Prescott filter. We experimented
ROD -0.544 0.100 -0.545 0.026
(-38.06) (4.20) (-19.29) (1.00)
with this filter and various smoothing techniques for the ROA vari-
NIM -0.518 0.108 -0.491 0.009 able and found that the results were about the same as winsorizing
(-38.95) (4.38) (-19.09) (0.21) at the 2nd and 98th percentile levels. Hence, we adopted this rather
NNIM -0.640 0.045 -0.742 0.042
simple winsorizing technique for all 21 financial ratios when imple-
(-44.22) (1.65) (-27.60) (0.87)
SIZE -0.271 0.029 -0.191 0.108 menting the log t-test.
(-28.69) (1.35) (-11.37) (3.37) To implement the log t regressions, Phillips and Sul (2007a)
LSPEC -0.370 -0.029 -0.367 -0.035
recommend discarding from 20% to 30% of the observations after
(-30.78) (-1.29) (-22.03) (-1.06)
SECUR -0.014
calculating ln (H1 /Ht ). For the full sample, H1 is 1996, but we discard
-0.419 -0.380 -0.081
(-34.35) (-0.56) (-18.95) (-2.04) the first five of nineteen years (about 26% of the data) to estimate
DEPA -0.387 -0.063 -0.321 -0.104 the log t regressions. To examine convergence in the more recent
(-30.79) (-2.88) (14.49) (-3.12)
2008–2014 period, H1 becomes 2008. We then discard the first two
LOANDEP -0.406 -0.123 -0.207 -0.198
(-28.12) (-5.77) (-8.64) (-6.06) of seven years (about 29% of the data) and convergence is examined
CTA -0.595 0.011 -0.639 0.315 for 2010–2014.
(-52.75) (0.53) (-28.25) (6.06) Table 7 shows the results of the log t convergence test over
NIBA -0.486 0.062 -0.427 0.047
(-36.47) (2.69) (-18.98) (1.29) the entire period from 1996 to 2014, as well as for 2010–2014.
FATA -0.414 0.085 -0.443 0.174 The second column (for  All ) shows significantly large negative
(-32.82) (4.17) (-20.96) (5.72) gamma coefficients for 7 of 21 variables—meaning that the log-t
INEFF -0.708 0.100 -0.821 0.136
(-47.48) (3.75) (-31.53) (3.03) tests rejects convergence across all banks for these seven ratios. The
LCI -0.752 0.019 -0.25 0.022 gamma coefficients are insignificant for 10 of 21 variables (includ-
(-63.99) (0.93) (-3.82) (2.089) ing ROA) —meaning that the log t results are inconclusive regarding
OOEI -0.610 0.019 -0.665 0.133
(-40.71) (2.42) (-24.97) (3.37) convergence. Finally, the  All coefficients are positive and statisti-
IEI -0.554 0.062 -0.641 0.040 cally significant for 4 of 21 ratios (NIM, SIZE, CTA, and CAPSTR) and
(-41.97) (2.37) (-27.67) (0.93) suggest convergence in rates for these ratios.
CRISK -0.731 0.063 -0.811 0.144
(-43.95) (1.70) (-24.42) (2.22)
The coefficients for  Islamic and  Commercial are obtained from
IMPAIR -0.416 -0.140 -0.301 -0.294 separate log-t regressions following the procedures in Eqs. (4)–(6),
(-35.94) (-4.90) (-14.79) (-6.04) except that yit represents only Islamic or only commercial banks in
CAPSTR -0.513 0.109 -0.549 0.171
Eq. (4) and the cross sectional mean is the mean ratio for all banks
(-37.01) (4.80) (-23.80) (4.46)
Z-score -0.345 -.007 -0.287 -0.109 (IBs and CBs) in a given year. Note that the signs and magnitudes
(-29.82) (-0.32) (-14.50) (-2.99) of the  Islamic and  Commercial coefficients are similar for most vari-
Sigma coefficients are from fixed effects panel regressions. t-Statistics are in ables. These coefficients indicate whether IB financial variables are
parentheses. Black boldfacing for the ˇCommercial coefficients indicates conver- converging toward the values for those of all banks and whether
gence in levels for commercial banks that is significant at the 5% level. The ˇIslamic CB financial variables are converging toward the values for those
coefficients show the differential speed of adjustment for Islamic banks relative
to commercial banks. Black (red) boldfacing means significantly faster (slower) at
of all banks. The results provide only weak support for conver-
the 5% significance level for Islamic banks relative to commercial banks. Random gence, but they show that there is little difference in convergence
effect models with listing and country dummies are similar, but the Hausman test characteristics between IBs and CBs in the MENASA region.
rejects the random effects model at the 1% level for all independent variables. The right-most three columns in Table 7 examine convergence
in the post-crisis period of 2010–2014. Positive statistically sig-
Then, Phillips and Sul (2007a) perform an ordinary least squares nificant gamma coefficients indicate convergence across 7 of 21
regression on the dispersion of the relative transition parameters variables. Ratios have been converging to a greater extent in the
(Ht ) as follows: aftermath of the Global Financial Crisis than was seen in earlier
H  years. In particular, we note that convergence in rates across all
1
ln − 2 ln[ln(t + 1)] = a +  ln(t) + et (6) banks has occurred for our two main measures of profitability—ROA
Ht and ROE. Results are inconclusive for 9 ratios and convergence is
This notation follows Phillips and Sul (2009), where et is the rejected for only 5 of 21 ratios (NIM, FATA, IMPAIR, CRISK, and Z-
error term and the regression equation is adjusted so that the score). Signs and magnitudes of gamma coefficients are similar for
parameters are corrected for heteroskedasticity and autocorrela- both IBs and CBs—once again indicating little difference between
tion. Since the  parameter on log t indicates speed of adjustment, IBs and CBs. Note that convergence is rejected across all banks for
Eq. (6) can be referred to as a test for gamma convergence. However, the net interest margin—a variable where one might expect differ-
it is similar to sigma convergence since it involves the dispersion ences between IBs and CBs given the prohibition of riba in Islamic
of cross sectional variance over time. Values of  ≥ 2 imply con- banking. Also, three of the non-converging variables–credit risk, the
vergence in levels for a variable or ratio, while values of 2 >  ≥ 0 impairment ratio, and Z-score—are all measures of risk in banking.
imply conditional convergence or that growth rates converge over Since IBs and CBs operate under different principles, the risks fac-
time. Convergence requires that the cross sectional dispersion in ing them may be different so that convergence across risk ratios
a variable decreases over time. Since H1 represents dispersion in does not occur. This is consistent with findings of Baele, Farooq,
the first year and Ht is the dispersion in any year, the ratio (H1 /Ht ) and Ongena (2014) that default rates on Islamic loans in Pakistan
will increase over time if convergence is occurring (because Ht were only about one-half that for loans issued by commercial banks.
will decline relative to H1 ). Hence, convergence requires a positive To summarize, competitive pressures in the aftermath of the GFC
gamma coefficient. Phillips and Sul (2007a) have set up the log t test may have led to converge in profitability measures across MENASA
so that the null hypothesis is convergence over time. If the t-statistic banks. However, since IBs and CBs operate differently, they have
84 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87

Table 7
Gamma (log t) convergence of financial ratios.

Variable 1996–2014 2010–2014

γAll γIslamic γCommercial γAll γIslamic γCommercial
ROA 0.175 -0.301 0.426 1.174 1.081 1.359
(0.29) (-0.73) (0.93) (2.98) (2.06) (3.86)
ROE 0.190 -0.445 0.348 1.657 4.849 0.734
(0.44) (-1.13) (0.74) (5.98) (3.25) (1.62)
ROD -0.181 -0.086 -0.192 -0.038 0.600 -0.371
(-0.62) (-0.81) (-0.41) (-0.25) (2.70) (-1.16)
NIM 0.523 0.327 0.650 -0.706 -1.019 -0.535
(4.07) (2.51) (4.18) -2.09) (-1.53) (-1.80)
NNIM 0.235 0.266 0.225 0.153 0.141 0.143
(1.22) (0.92) (1.31) (0.41) (0.73) (0.33)
SIZE 0.172 0.051 0.182 -0.134 -0.723 0.011
(2.99) (0.48) (3.75) (-0.95) (-2.29) (0.09)
LSPEC 0.061 0.234 0.037 1.176 1.320 1.146
(0.60) (1.34) (0.39) (2.20) (3.09) (2.00)
SECUR -0.404 -0.207 -0.415 -0.226 -0.267 .0.119
(-7.31) (-1.58) (-5.14) (-1.05) (-0.61) (-0.87)
DEPA -0.788 -1.126 -0.585 -0.032 0.537 -0.269
(-8.56) (-4.06) (-7.28) (-0.38) (0.99) (-0.81)
LOANDEP 0.070 0.011 0.132 0.796 1.479 0.551
(1.45) (0.07) (2.42) (3.24) (9.22) (1.38)
CTA 0.773 1.078 0.730 0.826 3.088 0.084
(4.41) (4.09) (4.12) (0.95) (49.49) (0.07)
NIBA 0.094 0.044 0.142 0.468 -0.534 0.879
(0.63) (0.54) (0.81) (2.76) (-2.28) (6.13)
FATA -0.321 -0.540 -0.242 -2.120 -2.469 -1.888
(-2.57) (-2.30) (-2.36) (-14.13) (-5.40) (-10.80)
INEFF -0.426 -0.955 -0.197 0.400 -0.274 0.854
(-2.82) (-3.96) (-1.26) (0.95) (-0.51) (2.22)
LCI 0.118 -1.167 0.688 0.561 0.116 1.196
(1.04) (-4.46) (4.58) (2.89) (1.80) (4.66)
OOEI 0.151 -0.104 0.305 0.278 -0.087 0.544
(1.34) (-0.78) (2.77) (1.28) (-0.76) (2.07)
IEI -0.875 -0.733 -0.888 0.432 0.128 0.743
(-4.52) (-4.13) (-3.81) (2.55) (0.76) (3.81)
CRISK -0.296 -0.614 -0.235 -1.100 -0.484 -1.156
(-2.58) (-1.31) (-2.38) (-3.35) (-0.58) (-2.43)
IMPAIR -1.109 -0.708) -1.194 -1.964 -1.354 -2.137
(-14.16) (-4.80) (-12.93) (-15.28) (-6.75) (-14.49)
CAPSTR 0.625 0.675 0.612 -0.057 -0.448 0.158
(12.71) (10.33) (11.56) (-0.17) (-3.69) (0.36)
Z-score 0.061 0.589 -0.060 -1.034 -0.509 -1.215
(0.49) (4.50) (-0.46) (-10.58) (-1.73) (-6.64)
Obtained from six separate OLS log-t regressions for convergence of gamma toward the cross sectional mean for
all banks, Islamic banks and commercial banks over two timeframes. t-Statistics are in parentheses, but regres-
sion constants are not presented. Coefficients of  ≥ 2 imply convergence in levels, 2 >  ≥ 0 implies convergence
in rates and  < 0 suggests possible divergence. The null hypothesis of convergence is rejected at the 5% signif-
icance level when the t-statistic is t < −1.65 and shown by red boldfacing. Black boldfacing implies significant
values for acceptance of convergence.

reached the profitability results in different ways so that there has
not been a convergence in all asset composition and risk ratios.
6.4. Gamma (Log t) club convergence
Studies that find little evidence of overall convergence often test
for club convergence across a subset of countries or firms where
convergence still may occur. Since we generally support conver-
gence in profitability ratios across all banks, further testing for club
convergence should only strengthen our results. Nevertheless, we
follow the example of Phillips and Sul (2007a,b, 2009) and test for
club convergence with various subsets of our data. We limit our
tests to the profitability ratios ROA, ROE, NIM, and NNIM based
on clustering using only the ROA variable. Based on our previous
results, we expect to discover stronger convergence in clubs for
ROA and ROE, but lack of convergence in NIM. The results for NNIM
are unclear a priori.
Club convergence results for three geographical regions are
shown in Table 8. First is the Gulf Cooperation Council (the six GCC
countries) consisting of Bahrain, Kuwait, Oman, Qatar, United Arab
Emirates and Saudi Arabia. The second region is Southeast Asia,
consisting of Bangladesh, Brunei, Indonesia, Malaysia and Pakistan.
Third is the Africa region consisting of banks in Egypt, Maurita-
nia, Sudan and Tunisia. Other regions could be considered, but our
results are illustrative of what could be expected based on geo-
graphical regions (Table 9).
For the GCC, convergence results for the entire period
1996–2014 are about the same as for all countries in Table 7. For
2010–2014, we observe much stronger club convergence across
all banks for both ROA and ROE. In fact, the results suggest conver-
gence in levels, which is a stronger result than convergence in rates
observed in Table 7. There is no evidence of convergence across all
banks for NIM or NNIM, but we observe convergence in rates for
Islamic banks relative to all banks in the GCC region for the variable
NIM.
Results for Southeast Asia are mixed with convergence in
rates across all banks for the variables NIM and NNIM over the
whole period 1996–2014. However, for 2010–2014 convergence is
 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87 85

Table 8
Gamma (log t) Club convergence results for profitability ratios by region.

GCC region 1996–2014 2010–2014

Variable γAll γIslamic γCommercial γAll γIslamic γCommercial
ROA -1.756 -1.51 -1.801 3.001 2.680 4.108
(-3.97) (-3.38) (-3.51) (2.15) (1.65) (2.90)
ROE -1.994 -4.581 -0.859 6.329 29.66 2.189
(-3.38) (-1.90) (-1.75) (3.57) (3.84) (0.83)
NIM 0.347 1.410 -0.680 0.352 1.091 -0.175
(1.51) (3.75) (-6.35) (1.27) (2.06) (-0.39)
NNIM 1.186 1.844 0.881 0.263 0.273 0.200
(1.14) (1.56) (0.96) (0.33) (0.34) (0.23)

Southeast Asia 1996–2014 2010–2014

region
Variable γAll γIslamic γCommercial γAll γIslamic γCommercial
ROA -0.078 -0.766 0.041 -0.786 -1.391 -0.576
(-0.21) (-1.99) (0.10) (-1.77) (-5.49) (-1.12)
ROE -0.190 -0.160 -0.230 -0.887 -1.456 -0.770
(-0.48) (-0.32) (-0.47) (-1.67) (-0.92) (-1.16)
NIM 0.253 -.001 0.446 -0.644 -1.740 -0.190
(2.22) (-.00) (5.69) (-1.71) (-1.88) (-0.64)
NNIM 0.469 0.505 0.478 1.243 0.696 1.375
(2.84) (2.14) (3.05) (2.78) (2.02) (2.53)

Africa region 1996–2014 2010–2014

Variable γAll γIslamic γCommercial γAll γIslamic γCommercial
ROA -0.435 -0.544 -0.225 3.439 4.034 3.096
(-1.18) (-1.50) (-0.65 (83.92) (18.45) (25.29)
ROE -0.234 -0.797 -0.158 2.785 6.940 1.882
(-1.06) (-0.82) (-0.61) (2.90) (8.65) (1.38)
NIM -0.621 -0.280 -0.453 -1.578 -1.173 -1.951
(-3.32) (-0.48) (-4.45) (-16.18) (-11.56) (-57.62)
NNIM -0.018 0.003 -0.069 -1.189 -1.149 -1.184
(-0.17) (0.01) (-.72) (-2.09) (-1.71) (-2.16)
Obtained from six separate OLS log-t regressions for convergence of gamma toward the cross sectional mean for
all banks, Islamic banks and commercial banks over two timeframes. t-Statistics are in parentheses, but regres-
sion constants are not presented. Coefficients of  ≥ 2 imply convergence in levels, 2 >  ≥ 0 implies convergence
in rates and  < 0 suggests possible divergence. The null hypothesis of convergence is rejected at the 5% signif-
icance level when the t-statistic is t < −1.65 and shown by red boldfacing. Black boldfacing implies significant
values for acceptance of convergence.

Table 9
Gamma (log t) Club convergence results for profitability ratios—clustering by high, middle and low historical
return on asset groups of countries.

Obtained from six separate OLS log-t regressions for convergence of gamma toward the cross sectional mean for
all banks, Islamic banks and commercial banks over two timeframes. t-Statistics are in parentheses, but regres-
sion constants are not presented. Coefficients of  ≥ 2 imply convergence in levels, 2 >  ≥ 0 implies convergence
in rates and  < 0 suggests possible divergence. The null hypothesis of convergence is rejected at the 5% signif-
icance level when the t-statistic is t < −1.65 and shown by red boldfacing. Black boldfacing implies significant
values for acceptance of convergence.
86 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87
rejected for ROA, ROE, and NIM. Such results probably have arisen
because of the heterogeneous nature of the countries placed in this
group.
For Africa, results are inconclusive for 1996–2014 except for
the rejection of convergence in NIM. For 2010–2014, results are as
hypothesized. There is convergence in levels across African banks
for ROA and ROE. Convergence is rejected across all banks for NIM
and NNIM. Once again the signs and magnitudes of the gamma
coefficients are similar for IBs and CBs. The club convergence results
are more decisive than seen for all MENASA countries in Table 7.
Another way to select clubs is to adopt a clustering algorithm, as
in Phillips and Sul (2007a, 2007b, 2009). We place countries identi-
fied as having high historical ROA in one group and countries with
low historical ROA in another group. The high ROA cluster consists
of Iraq, Qatar, Saudi Arabia, Sudan, and the United Arab Emirates.
This group is similar to the GCC in composition and not surprisingly
the results for 2010–2014 support convergence in levels across all
banks in the cluster for the profitability variables ROA and ROE.
Convergence is rejected across all banks for the variables NIM and
NNIM.
The low ROA cluster consists of the countries Brunei, Egypt,
Lebanon, Malaysia, Pakistan, Syria, and Tunisia, and is a combina-
tion of banks from the Africa and Southeast Asia regions. For the
period 2010–2014, convergence in levels across all banks is found
for ROA and ROE. Convergence is rejected for NIM and NNIM. A third
club of middle ROA countries could be formed, but not surprisingly,
most of the results for this cluster were inconclusive.
7. Summary and conclusion
This paper has examined the profitability of commercial and
Islamic banks before, during and after the financial crisis of
2008–2009. Using the largest sample to date of Islamic and com-
mercial banks operating in Africa, Asia, and the Middle East, we
confirm that Islamic banks were more profitable and more finan-
cially stable than their commercial counterparts prior to the Global
Financial Crisis. Islamic banks weathered the initial onslaught
(financial phase) of the crisis better than their commercial coun-
terparts in 2008. However, as the crisis spread to the real economy
(economic phase) in 2009, Islamic banks noticeably underper-
formed commercial banks. Islamic banks have been catching up,
but at a slower rate than commercial banks, and they have still not
returned to pre-crisis levels of profitability.
Convergence tests indicate that all banks are converging toward
similar levels of profitability as measured by return on assets and
return on equity, but convergence is not occurring across all finan-
cial ratios. In particular, banks are not converging across net income
margins or risk characteristics. This non-convergence results hold
for the whole period from 1996 to 2014 and in the post-crash period
of 2010–2014. A possible explanation is that competitive pressures
force banks toward convergence in profitability metrics. However,
because Islamic and commercial banks have different operating
philosophies, the profitability results are obtained in different ways
so that convergence does not occur across risk measures and some
asset composition ratios.
Our findings have several policy implications: Although there
have been periods where one type of bank outperformed the other,
we expect them to perform rather similarly in the future. Since
Islamic banks and commercial banks maintain different asset com-
position characteristics and risk profiles, regulators need not apply
all of the same regulations to both types of banks.
Even though IBs are governed by Islamic principles, profitability
of both types of banks is determined more by the characteristics of
the individual bank than the type of bank (IBs vs. CBs). Hence, the
performance of bank’s management can be assessed on the basis of
profitability measures for both IBs and CBs. Yet, there are several
noticeable differences in financial ratios between bank types. Thus,
regulators should not treat the two types of banks identically when
setting up and implementing bank regulations. Islamic banks still
need to find ways to enhance non-interest based revenues, while
commercial banks should note that a more conservative philosophy
toward banking as evidenced by Islamic principles may serve them
to avoid losses caused by the so called “toxic assets” that may have
contributed to the Global Financial Crisis.
Appendix.
In general, there are two types of Mudarabah: restricted and
unrestricted. Under the restricted Mudarabah, the IB receives the
money and the customer specifies a particular business for which
the IB shall invest the money in. IB acts as a fund manager and
normally the funds are accounted for off-balance sheet. In Unres-
tricted Mudarabah, an IB receives funds from depositors that it
is subsequently allowed to use the funds in any activity that the
management feels appropriate, so long as the activities are not
forbidden by Islamic Sharia. In doing so, the IB makes the funds
available to entrepreneurs who have ideas and expertise to use the
funds in productive activities. The bank and its client share profits
but the client does not share in losses. IB usually pools all profits
and losses from different Mudarabah investments (entrepreneurs)
and shares the profit with depositors of funds based on a pre-agreed
ratio. IBs are thus looked upon as partners with both depositors and
entrepreneurs, and they share risk with both.
In Musharka, IB provides part of the needed funds to an
entrepreneur who has a specific project. The partners’ contrib-
utions do not have to be equal and contributions may be in the
form of physical or intangible capital, such as machinery, labor or
management. IB may or may not participate in the management
of the business. Both parties share profits on a pre-agreed ratio,
but the losses are shared based on the ratio of capital provided by
each party. This is a joint venture between the bank and the client
designed for a certain project and ending within an agreed period
of time.
Another type of contract is Ijarah (leasing). It is designed for
financing mainly tangible assets such as aircrafts vehicles, equip-
ment and machinery. The IB buys the asset and then leases the asset
to an entrepreneur for a mutually agreed charge. IB receives peri-
odic payments from the lessee so long as the leased-property can
be used by the lessee and it is carried as an asset in the balance
sheet of the IB (lessor). At the end of the lease term, the ownership
(title) of the leased-property can be transferred to the entrepreneur
(Ijarah Muntahia Bittamlek). Thus, the IB is an ‘investor’ when pro-
viding financing for asset services using Ijarah, and perhaps when
providing financing for asset acquisitions using Ijarah Muntahia
Bittamlek.
Murabaha, not profit-sharing contract, is one of the most widely
utilized forms of financing contract by IBs where the bank pur-
chases for a client certain commodities based on her request. The
client promises to buy the goods from the bank on a pre-agreed
profit basis. The IB may briefly bear some asset price risk in respect
of the item being sold, but may mitigate this by requiring a deposit
from the customer (e.g., car financed through a sale to the customer
after the bank purchases the car). The bank justifies the profit on
the grounds that it takes some risks because the client has no legal
obligation to fulfill his initial promise. Murabaha in general is used
to provide sale on credit resulting in account receivable. In this case,
the bank is a creditor not an investor.
IBs replace loans with investments that are generally riskier
than secured interest bearing loans. The account receivable result-
ing from the sale is no more risky than an unsecured loan to a
 D. Olson, T. Zoubi / The Quarterly Review of Economics and Finance 65 (2017) 71–87
customer with a similar credit standing, and may be collateralized
in which case it is no more risky than a loan with similar security.
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