BACHELOR OF BUSINESS ADMINISTRATION (HONS)

FINANCE – BM242

A research project for Quantitative Research Method subject

(MGT646)

DETERMINANTS OF PROFITABILITY ON LOCAL

ISLAMIC BANKS IN MALAYSIA

BY GROUP (NBF8A)

NUR LIYANA ABD KADIR 2014259236

SHERIN ASNIZA BT MOHD AFANDI 2015611756
FARIDATUL ZAHARAH BINTI ABDUL MANAF 2015443322
NUR SAFINA BINTI HANAPIAH 2015696182

DECEMBER 2019

PREPARED FOR:
DR. EHSAN FANSUREE BIN MOHD SURIN
Contents
1. CHAPTER 1: RESEARCH OVERVIEW...................................................................... 3
1.1. Introduction ........................................................................................................... 3
1.2. Background of the Study........................................................................................ 3
1.3. Problem Statement................................................................................................. 6
1.4. Research Objectives .............................................................................................. 7
1.5. Research Questions ............................................................................................... 7
1.6. Research Hypotheses ............................................................................................. 7
1.7. Significance of the Research .................................................................................. 7
1.8. Scope of study ....................................................................................................... 8
1.9. Limitation of the Research ..................................................................................... 9
1.10. Definition of Term and Variables ....................................................................... 9
1.11. List of Abbreviation ......................................................................................... 12
2. CHAPTER 2: LITERATURE REVIEW AND RESEARCH FRAMEWORK .............. 12
2.1. Literature Review ................................................................................................ 12
2.2. Conceptual Framework ........................................................................................ 17
2.3. Research Questions and Hypotheses Development ............................................... 18
3. CHAPTER 3: RESEARCH METHODOLOGY .......................................................... 18
3.0 Methods of the Research ...................................................................................... 19
3.1. Population ........................................................................................................... 19
3.2. Sample ................................................................................................................ 19
3.3. Sample Design .................................................................................................... 19
3.4. Unit of Analysis .................................................................................................. 20
3.5. Setting................................................................................................................. 20
3.6. Data Collection Method ....................................................................................... 20
3.7. Operationalization of Variables ............................................................................ 20
3.8. Data Analysis ...................................................................................................... 21

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4. CHAPTER 4: DATA ANALYSIS .............................................................................. 26
4.1. Methods of the Research ...................................................................................... 26
4.2. Descriptive Statistics ........................................................................................... 26
4.3. Normality test (Jarque-Bera Test)......................................................................... 27
4.4. Multicollinearity .................................................................................................. 28
4.5. Autocorrelation ................................................................................................... 29
4.6. Autoregression test .............................................................................................. 30
4.7. Heteroscedasticity ............................................................................................... 31
4.8. Redundant Effect –Likehood Ratio Test ............................................................... 32
4.9. Hausman Test...................................................................................................... 33
4.10. Panel Regression Fixed Effect Model ............................................................... 34
4.11. Panel Regression Random Effect Model ........................................................... 35
4.12. Pooled OLS Model........................................................................................... 36
5. CHAPTER 5: CONCLUSION AND IMPLICATIONS ............................................... 37
5.1. Introduction ......................................................................................................... 37
5.2. Discussion of Major Findings .............................................................................. 37
5.3. Implications of the Study ..................................................................................... 38
5.4. Recommendations for Future Research ................................................................ 38
5.5. Conclusion ....................................................................................................... 391
6. REFFERENCE........................................................................................................... ...42

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1. CHAPTER 1: RESEARCH OVERVIEW

1.1. Introduction

Banks and financial institutions are the backbone of the economy of the country
everywhere and all over the world. Profitability is one of the major criteria for evaluating the
performance of bank. Other than Commercials Bank that gives income in economy Malaysia,
Islamic banks also part of important to the financial segment particularly in developing
economies where capital markets are not well developed and strong. Islamic Bank’s
profitability also important because the soundness of an industry is closely connected to the
soundness of the whole economy.

There are many factors affect to the profitability of the banking sector. Generally, these
factors are categorized as bank specific factors and macroeconomic factors. Bank specific
factors such as bank size, capital ratio, liquidity ratio, leverage ratio and interest rate. These are
internal determinants of bank profitability. Meanwhile, macroeconomic factors such as
inflation and GDP. Many researchers have investigated the determinants of the bank
profitability however they don’t give a clear picture. Therefore in this proposal paper we
analyse the financial data of Islamic bank in Malaysia to examine the bank-specific
determinants of profitability over the time period from 2014 to 2018.

1.2. Background of the Study

The banking system, comprising Islamic banks, Islamic bank also one of the main
source of financing that supports economic activities in Malaysia other than Commercial bank
and Investment bank. Nowadays, Islamic banks also major players in the banking system. The
main function of Islamic banks is to provide retail banking services, such as accepting deposits,
granting loans and advances, and financial guarantees. Apart from that, Islamic banks provide
trade financing facilities such as trust receipts, Banker’s Acceptance, shipping guarantees and
letter of credit. Risks are usually defined as the negative impact on the profitability of many
various sources of uncertainty.

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 Although the types and degree of risks an organization may being depends on several
factors, such as size, complexity of business activity level, it is believed that in general most
banks are faced with Credit, Market, Liquidity, Operational, Compliance, Legal and
Reputational Risks. Because there are many risks of involvement in banking, risk management
is now becoming a discipline at the midpoint of each financial institution. Profit is the foremost
motive for everyone to put an immense effort and make the business successful, since profit is
a central source of investment funds. The determinants basically reflect on the differences in
bank management policies and decisions in regards to sources and uses of funds management,
capital, liquidity and expenses management. There can be analysed by examining the balance
sheet and profit and loss statement. These two financial statement will be shows the ability and
profitability of the bank.

According to Zingales and Hart (2009), banks must hold more capital to have a good
financial performance. However, there some researcher argues that if bank holds too much
capital, this may negatively affect the financial performance especially in terms of profitability
since the capital can better used to make other investment. The efficiency and profitability of
Islamic banks in the Arab countries research by Iqbal and Molyneux (2005), concluded that
when the cost of inefficiency is the same, then the inefficiency advantage will vary. This is
because situation of Islamic banks will usually reflect different services.

This proposal research attempts to investigate the impact of four major determinants
such as Bank Size, Deposit, Capital and Liquidity determinants on local Islamic banks’
profitability in Malaysia. The most relevant and significant variables have been chosen to
investigate their impacts on bank’s profitability which is measured by return on assets (ROA).
Meanwhile there are having arguments that macroeconomic is contributed on the performance
in Islamic Bank. So that, our task is to prove that these determinants support the theory made
by other researchers or not. By using secondary data in this research study, we will reveals to
support our argument. The data will be pick from many sources i.e. researcher’s journal, bank’s
annual report, and websites and so on. We are focus on five (5) main Bank in Malaysia that
shown in table 1 - highlighted.

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 Table 1
List of Islamic Banks in Malaysia (Major Bank)

Islamic Banks
No Name Ownership
1. Bank Islam Malaysia Berhad Local
2. Maybank Islamic Bank Local
3. CIMB Islamic Bank Berhad Local
4. Public Islamic Bank Berhad Local
5. RHB Islamic Bank Berhad Local
6. Affin Islamic Bank Berhad Local
7. Alliance Islamic Bank Berhad Local
8. AmBank Islamic Berhad Local
9. Bank Muamalat Malaysia Berhad Local
10. Hong Leong Islamic Bank Berhad Local
11. OCBC Al-Amin Bank Berhad Foreign
12. Standard Chartered Saadiq Berhad Foreign

13. Al Rajhi Banking & Investment Corporation (Malaysia) Foreign

Berhad
14. HSBC Amanah Malaysia Berhad Foreign
15. Kuwait Finance House (Malaysia) Berhad Foreign
16. OCBC Al-Amin Bank Berhad Foreign

Source: www.bnm.gov.my

Table 2
Asset of the Malaysian Financial System
Islamic Banks
Year
(RM Bil)
2014 469,024.10
2015 526,328.80
2016 572,865.10
2017 643,003.80
2018 732,920.00
Source: www.bnm.gov.my

In addition, as shown in table 1, is a list of local and foreign Islamic banks in Malaysia.
Meanwhile, in table 2 it shown of asset of the Malaysian Financial system from year 2014 until
2018.

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 1.3. Problem Statement

Most of the available literatures on the factors effect local Islamic banks profitability
combine both micro, industry and micro determinants with few of the focus on internal factors,
which influenced profitability. Empirical work on identifying macroeconomic determinants of
Islamic bank profitability is sparse thus requires further attention. For instance, Wasiuzzaman
and Tarmizi (2009) and Guru et. al. (2002) focused on analysis on factors determining Islamic
banks’ profitability. Notwithstanding however, the scope of analysis done by Haron (1996) as
well as Wasiuzzaman and Tarmizi (2009) was limited to Islamic banks and did not cover much
on macroeconomics perspectives, while the scope of Guru et. al. (2002) was only confined to
local Islamic banks in Malaysia.

This paper attempts to provide more recent evidence on the determinants of bank
profitability performance, which intends to investigate in four major determinants of
profitability in local Islamic banks industry. Exploring other methods or new ways of
improving profitability should be encouraged. While the extant factors are considered to be
common variables fuelling firms’ profitability, this study would like to find out if these factors
are still applicable to banking sector in Malaysia. In a global environment, banks have to take
advantage of any opportunity that will give them the cutting edge in order to remain
competitive and viable.

Certainly, by being able to understand how the determining factors could impact bank
profitability, bank managers may be able to take relevant measures and necessitate appropriate
decision making, in order to drive the company towards achieving a higher level of profit.
Furthermore, the bank’s owner and the policy maker can reassess, regulate and reform
operational and management strategy in order to maximize revenue and profit.

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 1.4. Research Objectives

The objective of this proposal paper is to clearly identify the effect of Islamic banks bank-
specific determinants on profitability performance of Malaysian based on the period 2008-
2017. This research will explore further to assess some specific objectives, which are as
follows:
 to determine whether a firm size, capital structure, firm liquidity and deposit structure
have any relationships on bank profitability in Malaysia
 to examine if there is a strong or weak relationship between firm size, firm capital
structure, firm liquidity and deposit structure on firm profitability in Malaysia

1.5. Research Questions

 Does the bank size significantly affect the bank profitability?

 Does the deposit structure significantly affect the bank profitability?
 Does the liquidity significantly affect the bank profitability?
 Does the capital structure significantly affect the bank profitability?

1.6. Research Hypotheses

1.6.1. H0 There is no relationship between bank size and bank profitability

H1 There is a positive relationship between bank size and bank profitability
1.6.2. H0 There is no relationship between deposit structure and bank profitability
H2 There is a positive relationship between deposit structure and bank
Profitability
1.6.3. H0 There is no relationship between liquidity and bank profitability
H3 There is a positive relationship between liquidity and bank profitability
1.6.4. H0 There is no relationship between capital structure and bank
profitability
H4 There is a positive relationship between capital structure and bank
Profitability

1.7. Significance of the Research

Since the banking sector is considered to be an important source of financing economic

activities in every country, it became necessary to all stakeholders such as managers of bank,

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regulators of bank, depositors – investors, researchers and the government of the country. The
significance of this proposal paper can be seen in the following ways:

1.7.1 Significant to managers of bank since the level of profitability of banks indicate
the ability of banks to accommodate shock such as financial risk. This profitability of bank
can compare to the overall banking situation because this serve as a good indicator to managers
of bank to understand the strength of the banks against the overall banking industry.

1.7.2 This research it also significant to the monetary authorities since it is a major
role of the Central Bank of Malaysia to improve liquidity and financial stability in the Malaysia
banking system. With the findings of this study the monetary authorities will be able to
strengthen their policies and advisory services in order to stabilize the banking sector.

1.7.3 Significant to depositors/investors since bank profitability performance serve as

an indicator whether to invest or withdraw their fund from the bank. They need past
performance in term of profitability of the banks to know if it will be beneficial to deposits or
invests to earn more returns that will enable them maximize their wealth.

1.7.4 This proposal research is significant as a reference material to further

researchers who may wish to carry out further research in this topic. This research can be
conduct as a basis for additional research to interested researcher or future scholars.

1.8. Scope of study

This proposal research covers a sample of 5 banks out of the 16 combination of local and
foreign Islamic banks in Malaysia for the periods of 2014 to 2018. There will be use an
independent variable and a variable dependant. Independent variable consists of firm size,
capital structure, firm liquidity and deposit structure. Also a dependant variable is profitability

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of bank. It is depends on independent variable. The data of bank-specific variables are collected
from Balance Sheet and Income Statements obtained from Malaysian Islamic banks.

1.9. Limitation of the Research

It is obvious that one has to confront some limitations on time constraint. The major limitations
confronting this research are inaccessibility of relevant materials and non-availability of
adequate data. However, we try to curb the problems by subscribing to get journals on the
internet has been used. Furthermore, the most materials found is consists of macroeconomics
factors (external) has influenced to the profitability of local Islamic bank. Therefore, this
research study used only one measure of profitability – Return on assets (ROA).

1.10. Definition of Term and Variables

1.10.1 Bank Profitability

Bank according from Wikipedia, is a financial institution that accepts deposits from the
public and creates credit. Lending activities can be performed either directly or indirectly
through capital markets. Due to the importance in the financial stability of a country, banks are
highly regulated in most countries.

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 According Elisa Menicucci & Guido Paolucci et al.,2016, the term “profitability” refers
to the ability of the business organization to maintain its profit year after year. The profitability
performance of the banks indicates the success of the management and it is one of the most
important performance indicators for the investors. In other words, this is a company capability
of generating profits of its operation. A profit is what is left of the revenue a business generates
after it pays all expenses directly to the generation of the revenue, such as producing the
product, and other expenses related to the conduct of the business activities.

1.10.2 Deposit

Generally, deposit consists of money placed into banking institutions for safekeeping.
According Wikipedia, deposit is the act of placing cash or equivalents with some entity, most
commonly with a financial institution such as a bank. It is one of a funding come from
customers. It is called as a ‘depositors’ from customers and deposits to banks and other
financial institutions. Deposits of the banks are considered the main source of bank funding
and hence, it has an impact on the profitability of the banks. The account holder has the right
to withdraw deposited funds, as set forth in the terms and conditions governing the account
agreement. There are several different types of deposit may take a number of forms including:
(a) Transactional account: saving account or current account
(b) Term deposit or time deposit
(c) Overnight lending occurs usually from noon to noon, using a special rate to give
as security or in part payment.

1.10.3 Liquidity risk of Bank

Liquidity in banking is ability of banks to meet its financial obligations. It is one of the
biggest challenges of banks to maintain the SLR and CRR in all circumstances. In simple term
liquidity in banks means how quickly a bank can dispose the assets and get the cash to face a
variety of risks, such as market risk, credit risk, operational risk, reputational risk and a host
risk of others in their day to day operation. In fact, liquidity risk remains as a debatable key
indicator of a bank’s profitability. It indicates the profitability of a bank run out of cash and
borrowing capacity to meet the short term obligations such as deposit withdrawals, loan
demand and other cash needs.
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 1.10.4 Capital

The capital (CAP) of banks includes mainly funds from issuing shares and retained
earnings. Banks capital acts as a safety net in the case of adverse development (Anthanasoglou
et al.,2008). The two concept of capital are actual capital and regulatory capital. Actual capital
is also known as physical capital which is composed of equity and long term debt and it is
represented in the balance sheet of banks. It is usually measured as the ratio of equity to total
assets and also knows as capital ratio. Meanwhile, Regulatory capital is the capital based on
risk which is maintained in accordance with the rules determined by supervisor in a country.
This capital is measured as the ratio to risk-weighted assets and also known as risk-based
capital adequacy ratio (CAR). The relationship between capital and bank profitability is said
to be unpredictable (Sharma & Gounder, 2012). The studies show that there is a positive
relationship between capital and bank profitability (Berger1995; Demirgµc-Kunt & Huizinga,
1999; Hassan & Bashir, 2005; Dietrich & Wanzenrid, 2009; Davydenko, 2010; Olweny &
Shipho 2011; Ani, Ugwunta, Ezeudu, & Uqwuanyi, 2012; Rao & Lakew, 2012).

1.10.5 Bank Size

Definition of Size is entities that are small in terms of number of people involve and
level of capitalization certainly can blow thing up. Bank size is representing the ownership of
asset by bank. Generally, larger bank have the advantage of more access to additional financing
resources, but dealing with liquidity problem and diversifying risk is another issue. Industrial
economic theory postulates that if an industry is subject to economies of scale, large institutions
will be more efficient, and thus are able to produce services at a lower cost. Larger size is
expected to have a positive effect on bank profitability. The natural logarithm of the bank's
total assets is used as a measure of bank size.

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 Table 3
Ranking of Islamic Banks in Malaysia by total assets
Islamic Banks
No Name Total Assets(RM Billion)
1 Bank Islam Malaysia Berhad 63.9
2 Maybank Islamic Bank 181.8
3 CIMB Islamic Bank Berhad 66.6
4 Public Islamic Bank Berhad 57.12
5 RHB Islamic Bank Berhad 65.62
Source: Wikipedia by update as of 7/9/2018

1.11. List of Abbreviation

BNM Bank Negara Malaysia

CAR Capital Adequacy Ratio
DEP Deposit
IV Independent Variable
JB Test Jarque-Bera Test
LIQ Liquidity
SIZE Bank Size
ROA Return on Asset

2. CHAPTER 2: LITERATURE REVIEW AND RESEARCH FRAMEWORK

2.1. Literature Review

The economic growth of the countries is built on the performance of financial sector.
According to (Siraj and Pillai, 2012) the growth and economic stability depend on the stability
of its banking sector. It helps in facilitating funds for productive purposes, contributing to
economic development and acting as an intermediary in linking deficit and surplus unit. The
previous study also found that management efficiency, risk weighted assets, and asset size have
influences on Islamic banking credit risk, while conventional banking credit risk is influenced
by loans exposed to risky sectors, capital regulation, risk weighted assets on credit risk and

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allocation of losses financing, S. Sodhi (2005). The management of assets and liabilities for a
bank is very important by making a correct structuring and strategy (Manuji and Mentzer,
2008). According to Rosly and Abu Bakar (2003), the used of financial ratio of Islamic banks
in Malaysia to show that profitability based on return on asset, profit margin and net profit
margins was statically higher for Islamic banks in Malaysia. Islamic banking now expanded
their banks size and operation globally and receives the attention from other Islamic and non-
Islamic countries.

Nowadays, Islamic banking was being operated in almost every country and becoming
an alternative system for conventional banking system. According to Jamali et al., (2012), the
stakeholders such as general public, investors and customers are very important to the overall
bank performance. The nature of bank profitability comes from two categories which are
external and internal determinant. However, for this study, researchers will only focus on the
internal determinants only which are return on asset, capital adequacy, liquidity and asset
quality

Dependent variable: Bank’s Profitability

2.1.1 Return on Assets (ROA)

The economic growth of the countries is built on the performance of financial sector.
According to (Siraj and Pillai, 2012) the growth and economic stability depend on the stability
of its banking sector. It helps in facilitating funds for productive purposes, contributing to
economic development and acting as an intermediary in linking deficit and surplus unit. The
previous study also found that management efficiency, risk weighted assets, and asset size have
influences on Islamic banking credit risk, while conventional banking credit risk is influenced
by loans exposed to risky sectors, capital regulation, risk weighted assets on credit risk and
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allocation of losses financing, S. Sodhi (2005). The management of assets and liabilities for a
bank is very important by making a correct structuring and strategy (Manuji and Mentzer,
2008). According to Rosly and Abu Bakar (2003), the used of financial ratio of Islamic banks
in Malaysia to show that profitability based on return on asset, profit margin and net profit
margins was statically higher for Islamic banks in Malaysia. Islamic banking now expanded
their banks size and operation globally and receives the attention from other Islamic and non-
Islamic countries. Nowadays, Islamic banking was being operated in almost every country and
becoming an alternative system for conventional banking system. According to Jamali et al.,
(2012), the stakeholders such as general public, investors and customers are very important to
the overall bank performance. The nature of bank profitability comes from two categories
which are external and internal determinant. However, for this study, researchers will only
focus on the internal determinants only which are return on asset, capital adequacy, liquidity
and asset quality

Independent variables: Bank-Specific Determinants

2.1.2 Bank size

The size of the bank was seen to contribute positively to profitability and efficiency of
operations. A larger sized bank was assumed to benefit from economies of scale (and reduced
costs), and economies of scope (resulting in higher product diversification and better access to
clients). With regard to effect on efficiency, the results were conflicting: lower costs were
identified in both large (Altunbas et al., 2001; Berger, Humphrey, 1997; Bikker and Hu, 2002;
Spathis et al., 2002; Srairi, 2009, Terraza, 2015) and small banks (Pallage, 1991; Vander
Vennet, 1998; Kosmidou et al., 2006; Aladwan, 2015). As to profitability, the effect of the

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banks' sizes were contradictory too: whilst Ali et al. (2011) showed that bank size is positively
related to bank profitability, Obamuyi (2013) demonstrated negative effects. Other researchers
found limited influence of bank size on profitability (Berger et al., 1987; Boyd, Runkle, 1993).
In addition, Husain AL‐ Omar, Abdullah AL‐ Mutairi, (2008) "Bank‐ Specific Determinants
of Profitability: The case of Kuwait, mentioned that size and capital adequacy, usually proxied
by total assets and the ratio of equity to assets respectively, are used to account for existing
economies of scale in the industry. A positive relationship between size and bank profitability
is expected (Smirlock, 1985).

H1. There is a positive relationship between size and bank profitability.

2.1.3 Capital

Based on a theory of bank capital (Diamond, Rajan, 2000), a positive

relationship was hypothesized between bank capital and profitability, and between
return on equity and capital to asset ratio, with banks being able to reduce bankruptcy
risks and the need to rely on external funding sources. The hypothesis generally found
support (Bourke, 1989; Liu, Wilson, 2010; Goddard et al., 2004); however, Hughes and
Mester (1998) established that a higher capital to assets ratio led to increased variable
costs, and hence lower profitability. Other numerous theoretical explanations are
proposed in the literature. Accordingly with these findings, Bourke (1989) stated a
significant positive relation between capital adequacy and profitability in his study on
the determinants of banks’ performance for 12 countries selected from Europe, North
America and Australia. Similarly, the studies of Berger (1995b) and Angbazo (1997)
concluded that the US banks, those which are well capitalized, are more profitable than
the others.

H2. There is a positive relationship between capital ratio and bank profitability.

2.1.4 Deposits

Banks rely significantly on customer deposits to allocate credits to other

customers. Thus, more deposits a bank will get, more loan opportunities it will be able
to provide to customers and then it will be able to generate further profits. This
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argument is
underlined by Lee and Hsieh (2013) by concluding that additional deposits can
advantage banks in producing more profits, while low deposits may impact negatively
on their profitability. Therefore, customer deposits are positively related with bank
profitability; but, on the other hand, banks’ incapacity in not releasing money through
loans may reduce its profitability level because of the interests paid to depositors.
However, if there is insufficient loan demand, more deposits may dampen earnings, as
this kind of funding is costly. Being the main source of funding for banks, it is generally
supposed that customer deposits affect banking performance positively if there is a
satisfactory demand for loans in the market. It could be expected that a higher growing
deposits would be able to expand the business of the bank and consequently generate
more profits.

Nevertheless, the impact on profitability that originates from a growth in

deposits depends on several factors. First, the impact is influenced by the bank’s ability
to transform deposit liabilities into income-earning assets, which also reveals banks’
operating efficiency. The effect also depends on the credit quality of these assets
because a positive effect on bank profitability is regularly achieved by investing in
assets of higher credit quality.

Empirical evidence from Ben Naceur and Goaied (2001) showed that the best-
performing banks are those that have preserved high levels of deposit accounts related
to their assets. Increasing deposits (i.e. the ratio of total deposits to total assets) implies
growing the funds available to different profitable uses (e.g. lending activities and
investments), which should upsurge the bank’s return on assets when other factors are
constant (Allen and Rai, 1996). The effect of fund source on profitability is captured by
deposits over total assets ratio and is based on some of the previous studies. It can be
hypothesized that:

H3. There is a positive relationship between deposits and bank profitability.

2.1.5 Liquidity Risk

Liquidity risk refers to the failure of a firm to fulfill its short-term liabilities.
Kosmidou(2008) and Adusei (2015) use bank liquidity risk as a measure of loan-to-
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 deposit ratio. To avoid insolvency risk, Curak et al., (2012) suggest that Islamic banks
keep a substantial amount of liquid assets, which can easily transform into cash.
However, higher liquidity decreases bank profitability because of lower rate of return
on liquid assets. Similarly, Adusie (2015) and Rose and Hudgins (2008) also suggest a
ratio between cash and due from balances to total assets as a measure of liquidity risk.
Thus, our study follows Rose and Hudgins (2008) and Adusie (2015) guidelines to
measure bank liquidity risk. Liquidity risk (LRISK) is the ratio between total assets and
cash and due balances held at other depository institutions (Rose and Hudgins, 2008;
Adusei, 2015; Fiordelisi and Mare, 2014).

The current ratio is chosen to represent the liquidity risk of the banks in this
paper. Current ratio is the most popular measure of liquidity risk. It is the ratio which
indicates the efficiency of a bank operating cycle to turn its assets into cash. The higher
the ratio, the more capable the bank is of paying its obligations.

H4. There is a positive relationship between liquidity and bank profitability.

2.2. Conceptual Framework

Conceptual Framework
Independent Variable

Dependent Variable

Liquidity Risk
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 2.3. Research Questions and Hypotheses Development

2.3.1 Research Questions

RO1 : To determine the relationship between bank size and bank profitability
RO2 : To determine the relationship between capital ratio and bank profitability
RO3 : To determine the relationship deposit and bank profitability
RO4 : To determine the relationship between liquidity and bank profitability

2.3.2 Hypotheses Development

H0 There is no relationship between bank size and bank profitability

H1 There is a positive Relationship between bank size and bank profitability

H0 There is no relationship between deposit structure and bank profitability

H2 There is a positive relationship between deposit structure and bank profitability

H0 There is no relationship between liquidity risk and bank profitability

H3 There is a positive relationship between liquidity and bank profitability

H0 There is no relationship between capital structure and bank profitability

H4 There is a positive relationship between capital structure and bank profitability

3. CHAPTER 3: RESEARCH METHODOLOGY

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3.0 Methods of the Research

The main objective of this study was to examine the variables or indicators that
impacted the profitability of local Islamic banks. To achieve this objective, the methodology
described in this section. This section discusses the study variables and the statistical tools and
techniques applied while conducting the research.

3.0.1. Variables
In order to analyse the determinants of local Islamic bank profitability, there have 2
variable which dependent variable and independent variable.

i. Dependent variables
In the literature, bank profitability measured by return on asset (ROA). ROA is defined
as net profit divided by total asset and is expressed in percent. ROE is defined as net profit by
shareholders’ equity and is expressed in percent.

ii. Independent variables

Bank specific determinants as internal factors such as bank size, capital, deposit and
liquidity. The following four bank specific characteristics as internal determinants of bank
profitability including bank size, capital, deposit and liquidity.

3.1. Population

Population of this study comprised of all the 8 local Islamic bank in Malaysia. This
population had the potential to provide the relevant information on determinants of bank’s
profitability.

3.2. Sample

The sample of bank profitability local Islamic banks comprise from the financial
statements published in each of the respective institution’s annual report. This research is solely
focused on local Islamic banks due to its role as the country’s largest and most significant fund
provider in the Malaysian banking system

3.3. Sample Design

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 This study used the quantitative approach to analyse the data. The study covered all
local Islamic banks of Malaysia. The data were collected from secondary sources, particularly
the banks’ annual report from 2014 to 2018. The secondary data is used in this study. This
research is to test how and why the bank size, capital, deposit and liquidity will affect the bank
profitability. Hypothesis testing is generated to examine the relationship among the variables.

3.4. Unit of Analysis

Panel data is used in this paper because data comprised of the five (5) local Islamic
bank and time series data (year 2014 to 2018). Furthermore, panel data can provide more
informative data, more variability among the variables and more efficiency.

3.5. Setting

The secondary data is gathered for the purpose of completing this research. The
secondary data composed of the journal of previous studies and annual reports of the five local
Islamic banks which are Maybank Islamic Bank, CIMB Islamic Bank Berhad, Public Islamic
Bank Berhad and RHB Islamic Bank Berhad. Because, of data constraints, our balanced panel
data cover a sample period of 2014 until 2018.

3.6. Data Collection Method

The data relating to the internal determinants including bank size, capital, deposit, and
liquidity were obtained from banks annual reports over the period 2014 to 2018. The bank
specific variables are derived from income statements and balance sheet of the Islamic banks.
To examine the determinants of bank profitability, we will use the ratio. The secondary data
composed of the five local Islamic banks which Maybank Islamic Bank, CIMB Islamic Bank
Berhad, Public Islamic Bank Berhad and RHB Islamic Bank Berhad. In order to obtain some
mathematical data for this research, the “E-view” software is also used.

3.7. Operationalization of Variables

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 Since all the independent variables are measured by ratios, therefore researchers use
each of the variables ratio formula to calculate out all the financial ratios for each bank. The
ratios are calculated by referring to the balance sheets, income statements, cash flow statements
and notes to accounts in the annual reports. The data sources and unit measurements for each
variables are shown as below:

Variable Measurement
Return of Assets (ROA) Total Income / Total Asset
Bank Size Total Asset
Capital Adequacy (CA) Total equity / Total Asset
Deposit Total Deposit / Total Asset
Liquidity Management (LM) Total Loan / Total Deposit

3.8. Data Analysis

In this study, it shows interpretation of the study on the factors affecting bank
profitability of the 5 local Islamic banks. A brief general description of summary statistics on
the dependent and independent variables will be included. In the E-view result it will show the
coefficient, probability and other relevant information. To analyse the data panel data
modelling normally used to capture heterogeneity across samples. To examine the determinants
of bank profitability, we use panel data.
Panel data models are usually estimated using either fixed effects or random effects
models. In the fixed effects model, the individual-specific effect is a random variable that is
allowed to be correlated with the explanatory variables. The rationale behind random effects
model is that, unlike the fixed effects model, the individual specific effect is a random variable
that is uncorrelated with the independent variables included in the model. The fixed effects
model is an appropriate specification if we are focusing on a specific set of N firms and our
inference is restricted to the behaviour of these sets of firms (Baltagi, 2005). Also, in order to
find which of these models is the most appropriate, the Hausman test can be conducted. In this
study, the fixed effects model is used.

A data set that comprises both time series and cross-sectional elements is known as a panel of
data or longitudinal data. In panel data models, the data set consists of n cross-sectional units,

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denoted i = 1,…,N, observed at each of T time periods, t = 1, ….,T. In data set, the total
observation is nxT. The basic framework for the panel data is defined according to the
following regression model (Brooks, 2008):

yit = α + 'β xit + uit

where yit is the dependent variable, α is the intercept term, β is a kx1 vector of parameters to
be estimated on the explanatory variables, and xit is a 1 x k vector of observations on the
explanatory variables, t = 1, …,T; i = 1, …,N.

3.8.1 Normality test (Jarque-Bera Test)

Normality of error terms defined as error terms are normally distributed. Normality
assumption for error terms is one of the assumptions in classical linear regression model. Error
terms are represent the omitted variables, specification bias or error of measurements, therefore
error terms need to be normally distributed in order to ensure the mistakes captured by error
terms are small and at best random. Normality test, known as Jarque-Bera Test is a diagnosis
test to detect whether a regression model meets the normality assumption for error terms. The
hypothesis testing can be p-value approach or test statistics approach. The formula of the test

statistics is where s= skewness, and k= kurtosis. The Jarque-

Bera Test (p-value approach) is shown as below:

H0: Error terms are normally distributed.

H1: Error terms are not normally distributed.

Decision rule: Reject H0 if the p-value is less than significance level of 0.05. Otherwise, do not
reject H0. Decision: Do not reject H0 since p-value is greater than the significance level of
0.05.

Conclusion: There is insufficient evidence to conclude that the error terms are not normally
distributed at significance level of 5%.

3.8.2 Model Specification (Ramsey’s RESET Test)

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Model specification error is defined as the model is incorrectly regressed. A correct
model specification is important as it ensure the regression model is a correct model
and hence the model is appropriate to be used to conduct the research objectives.
Ramsey‟s RESET Test is a diagnosis test to detect the existence of wrong functional
form of a regression model. The hypothesis testing can be p-value approach or test
statistic approach. The formula of test statistic is The Ramsey‟s RESET Test (p-value
approach) is shown as below:

H0: Model specification is correct.

H1: Model specification is incorrect.

Decision rule: Reject H0 if the p-value of the test is less than significance level
Otherwise, do not reject H0. Decision: Do not reject H0 since p-value of is greater than
the significant level of 0.05.

Conclusion: There is insufficient evidence to conclude that the model specification is

incorrect at significance level of 5%

3.8.3 Multicollinearity

Multicollinearity occurs when two or more explanatory variables in the model are
correlated with one another. In classical linear regression model (CLRM), the
regressors are assumed to have no exact linear relationship between them. There are
two types of multicollinearity, perfect multicollinearity and imperfect multicollinearity.
If two or more independent variables are perfectly correlated, the degree of
multicollinearity problem in the model will be more serious as compare to imperfect
multicollinearity. According to Gujarati & Porter (2009), when VIF and TOL are equal
to 1, there is no multicollinearity problem in the model. As VIF more than 10 or TOL
close or near to zero, the model contains serious multicollinearity problem.

3.8.4 Autocorrelation

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 Autocorrelation is defined as error term for any observation is related to the
error term of other observation. The assumption of no autocorrelation between the error
terms is one of the classical linear regression model assumptions. The problem of
autocorrelation normally occurs in a pure time series data but less likely to be occurred
in a pure cross-sectional data. There are two types of autocorrelation, they are pure
autocorrelation which caused by internal data problem, and impure autocorrelation
which caused by external factors such as specification bias.

H0: The model does not have autocorrelation problem.

H1: The model has autocorrelation problem.

Decision rule: Reject H0 if the p-value of the test is less than significance level of 0.05.
Otherwise, do not reject H0. Decision: Do not reject H0 since p-value of is greater than
significance level of 0.05.

Conclusion: There is insufficient evidence to conclude that the model has

autocorrelation problem at significance level of 5%.

3.8.4 Heteroscedasticity

Heteroscedasticity is defined as the variances of error terms are not constant.

The assumption of homoscedasticity is one of the classical linear regression model
assumptions. Therefore, it is important for the model to achieve homoscedasticity so
that OLS estimators will achieve best, linear, unbiased and efficient (BLUE) properties,
as a result all hypothesis testing will become valid and reliable.

H0: The model does not have heteroscedasticity problem.

H1: The model has heteroscedasticity problem.

Decision rule: Reject H0 if the p-value of the test is less than significance level of 0.05.
Otherwise, do not reject H0. Decision: Do not reject H0 since p-value of is greater than
significance level of 0.05.

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Conclusion: There is insufficient evidence to conclude that the model has
heteroscedasticity problem at significance level of 5%.

3.8.5 Pooled OLS Model

Pooled OLS regression model, also known as constant coefficients model is a

type of panel regression model that used to analyze the panel data for this study.
According to Gujarati & Porter (2009), there are three assumptions needed to be
fulfilled in order to use pooled OLS model, they are constant intercepts across
companies, constant slopes across companies, and there is no time effect (time
invariant). In this study, Pooled OLS Model is used to examine the relationship of bank-
specific (independent variable) determinants on the bank’s profitability, therefore
assume all the local Islamic banks has constant intercepts, constant slopes and time
invariant in this observations.

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4. CHAPTER 4: DATA ANALYSIS

4.1. Methods of the Research

This chapter shows the empirical results and interpretation of the study on the factors
affecting bank profitability of four largest local Islamic banks which stated in previous chapter.
In the first section, a brief general description of summary statistics on the dependent and
independent variables will be included. Panel date is used in this paper and hence Pooled
Ordinary Least Square (Pooled OLS) method will be employed. Followed, the E-views result
will attached in this chapter. The E-views result included the coefficient, t-statistic, probability,
standard error of each variable, the R-squared, adjusted R-squared and other relevant
information. The last section is formed from the inferential analysis of the variables as well as
the conclusion.

4.2. Descriptive Statistics

Descriptive statistics was utilized to summarize collected data in terms of mean, standard
deviation, maximum values and minimum values. Table 4.1

Table 4.1 – Descriptive Statistic result for the variable of local Islamic banks in Malaysia from
2014 – 2018

ROA SIZE CR DEP LIQ

Mean 10.12000 4.656505 11.23050 12.25053 12.34618

Median 10.02154 4.245032 11.35064 13.3506 13.54549
Maximum 11.52045 6.122410 13.67103 13.3606 13.54554
Minimum 9.40545 3.232514 10.46145 13.3042 13.54324
Std. Dev. 0.79011 0.67040 0.40154 0.05453 0.14129
Skewness 1.71092 -0.20535 3.54104 0.02428 -1.5545
Kurtosis 4.05405 2.064584 21.38242 1.67752 5.04866
Jarque-Bera 55.34054 3.58042 1126.2445 5.45405 46.8856
Probability 0.000000 0.15065 0.000000 0.054149 0.00000

Notes*** Significant at the 1% level, ** Signiificant at the 5% level, ** Significant at the 10% level

Results of table 4.1 show average profitability by ROA of the local Islamic banks in
Malaysia with maximum and minimum ROA is 12.52 and 9.40 respectively. The mean for
ROA 11.52. There are four independent variables used in this paper. The mean and standard
deviation of Bank Size are 4.62% and 0.67%. In term of Capital Ratio has a mean 11.23% with

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a standard deviation of 0.40%. Deposit has a mean 12.25% and standard deviation of the
deposit 0.05%. For liquidity ratio aspect, has a mean 12.34% and the standard deviation
0.142%.

4.3. Normality test (Jarque-Bera Test)

H0: The data series are normally distributed

H1: The data series are not normally distributed

Table 4.2 Normality Test Result

Table 4.2 the result of the Jarque-Bera test shows evidence fail to reject null hypothesis.
The null hypothesis for JB test is the error term is normally distributed. The p-value of 0.335070
shown in table 4.2 is more than 10% (p-value > 0.1). Insignificant Jarque-Bera test, fail to reject
null hypothesis, means the distribution of residual is normal. Therefore, to solve the problem,
log the data and check if there is any outliers.

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 4.4. Multicollinearity

Table 4.3 Measuring Multicollinearity

LOGSIZE LOGDEP LOGCR LOGLIQ

LOGSIZE 1.000000 -0.467031 0.184462 0.378481
LOGDEP -0.456031 1.000000 -0.306546 -0.354105
LOGCR 0.198462 -0.304546 1.000000 0.145124
LOGLIQ 0.375481 -0.340505 0.156424 1.000000
**Multicollinearity problem exist if there is correlation coefficient higher than 0.80

The result show that there is no multicollinearity problem since the IV are below than 0.80.
Therefore all the IV are correlation.

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 4.5. Autocorrelation

Table 4.4 Autocorrelation

The Durbin-Watson Stat shows 1.439 that the linear regression estimated is not free from
autocorrelation problem (Durbin-Watson statistics is not between 1.8 – 2.5). to remove
autocorrelation, will run AR (Autoregression test).

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 4.6. Autoregression test

Table 4.5 Result Autoregression Test

The Durbin-Watson Stat shows that the linear regression estimated is free from autocorrelation
problem (Dutbin-Watson statistics is between 1.8 – 2.5). The result Durbin-Watson is
2.298345.

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 4.7. Heteroscedasticity

Table 4.6 HADRI TEST

HADRI TEST
Level 1st Difference
Variable No Trend Trend No Trend Trend
ROA 4.1049 7.4526 1.6548 14.184
(0.0000)** (0.0000)** 0.0423 (0.0000)**

Notes*** Significant at the 1% level, ** Significant at the 5% level, ** Significant at the 10% level

The result of Hadri test show that data for ROA is not stationary. Statistically significant result
from Hadri test lead to reject null hypothesis that the data has no unit root (stationary).

Table 4.7 Breusch-Pagan

H0: There is no heteroscedascity problem.

H1: There is heteroscedascity problem.

The result use the Breusch-Pagan Test, the p-value 0.00000 reject the H0. Since the p-value less
than significance level.

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 4.8. Redundant Effect –Likehood Ratio Test

Table 4.8 – Result from Redundant Effects-Likehood Ratio Test

Based on table 4.8, the significant results from redundant Effects-Likehood Ratio Test the p-
value < 0.1 is significant. Reject null means the Panel regression fixed effect should be used as
an empirical model. Therefore the suitable empirical model to be estimated in this study is
Panel Regression Fixed Effect Model.

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 4.9. Hausman Test

Table 4.9 – Result HausmanTest

Notes*** Significant at the 1% level, ** Significant at the 5% level, ** Significant at the 10% level

The significant results from Hausman Test the p-value < 0.1 for Cross section provide evidence
to reject null hypothesis that Panel Regression Fixed Effect Model cannot be employed to the
data. Therefore, the suitable empirical model to be estimated in this study is Panel Regression
Fixed Effect Model.

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 4.10. Panel Regression Fixed Effect Model

Table 4.10 – Result Panel Regression Fixed Effect Model

Notes*** Significant at the 1% level, ** Significant at the 5% level, ** Significant at the 10% level

The coefficients of panel regression fixed effect model the result p-value variable capital
adequacy is significant. Meanwhile for variable bank size p-value 0.0029, deposit p-value
0.0218 and liquidity p-value 0.0030 is not significant.

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 4.11. Panel Regression Random Effect Model

Table 4.11 – Result Panel Regression Random Effect Model

Notes*** Significant at the 1% level, ** Significant at the 5% level, ** Significant at the 10% level

The coefficients of panel regression random effect model the result p-value variable capital
adequacy and bank size was significant. Meanwhile for variable deposit p-value 0.4880 and
liquidity p-value 0.0244 is not significant.

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 4.12. Pooled OLS Model

Table 4.7 Eview result

Notes*** Significant at the 1% level, ** Significant at the 5% level, ** Significant at the 10% level

Based on the result, the = 0.376172, therefore the is considered as high. 37.6172 of the
variation in expected ROA can be explained by the variation in the independent variables
which bank size, capital adequacy, and deposit and liquidity risk.

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5. CHAPTER 5: CONCLUSION AND IMPLICATIONS

5.1. Introduction

This chapter summarizes the results in the previous chapter and provides discussions
on the major findings. Major findings are used to compare with the hypotheses testing that had
set on the first chapter. Besides, summary of statistical analyses comprise on the descriptive
and inferential analyses presented and discussed in the previous chapter. Moreover, implication
of the study is also included in this chapter. This will include the practical implications for
policy makers and professionals. Limitations of the study will be included and the
methodologies to improve the study will be recommended. The conclusion section will provide
the overall summary of the whole research project.

5.2. Discussion of Major Findings

Table 5.1 Summary of E-views Results

INDEPENDENT VARIABLES RESULT

BANK Significant* 
Supported
CAPITAL Significant* 
Supported
DEPOSIT Significant* 
Not supported
LIQUIDITY RISK Significant* 
Not supported
Notes*** Significant at the 1% level, ** Significant at the 5% level, ** Significant at the 10% level

Significant at * 10 percent, **5 percent and *** 1 percent

“” indicates results consistent with hypothesis

The data is regressed in form of Pooled OLS Model by u sing Eviews and the result shown in
table 5.1. Overall the results from the study indicate that profitability of local Islamic banks
in Malaysia is mostly driven by the independent variable. There are four independent
variables are significant at level of 10 percent, they are bank size and capital adequacy which
supported.

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In contrast, bank size and liquidity risk are insignificant (not supported) towards the
profitability of the local Islamic banks. On the other hand, in year 2008 the financial crisis
known as the global financial crisis.

5.3. Implications of the Study

In Malaysia, all banking industry is supervised under the act of Financial Services Act
2013 (FSA 2013) and Islamic Financial Services Act 2013 (IFSA 2013). Therefore, they have
same principles, concepts, and operations. Banks act as financial intermediaries that bring
together the demanders of fund and the suppliers of fund. Furthermore, based on IFSA 2013,
the central bank of Malaysia which is Bank Negara Malaysia (BNM) has the right to control
over all the flow of money and operations under each individual bank and also other financial
institutions.
The result of this paper show important information to public and it is useful to economy
especially for stock market investors. Policy maker, central bank (Bank Negara Malaysia),
economist, and stock market participants should have more understand the situation in the bank
of Malaysia. This research is useful for the investor in order to let them know which bank they
should invest in. Besides, they can clearly identify which bank is facing higher risk as compare
to other banks.

In addition, BNM also has the power to enhance banking operation systems within the
banking industry in Malaysia to make sure all the banks do not violate the act of IFSA 2013.
In this study, the major difference between five of the banks which is Maybank Islamic Bank,
CIMB Islamic Bank Berhad, Public Islamic Bank Berhad and RHB Islamic Bank Berhad is
the benefits that they offer to their respective customers. Thus, the comparison of credit risk
and liquidity risk has made based on the group of customers the bank has made based on the
group of customers the bank has.

Furthermore, based on the research on bank’s profitability, banks can clearly know
about their efficiency level in the bank’s operation. The top level of management in the bank
can determine the best solution to allocate all their available resources to achieve the maximum
level of efficiency. Each of the banks can also determine the crucial factors that will affect their
profitability and provide a scheme to prevent the particular risk. Although the risk cannot be
fully prevented, it still can be reduced to the minimum or optimum level. Thus, the banks can
easily achieve their goal in the future.

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 The followings are the managerial implication for this research paper. Firstly, the future
researcher will know the type of policy should be carried out in order to justify the current and
certain condition in Malaysia. Once there are changes in the value of independent variables
such as bank, liquidity risk, capital and deposit. The future researchers should be more careful
when implementing the relationship between the variables with the profitability of bank.

5.3 Limitations of the Study

Throughout the studies, there are some limitations which affecting the flow of the research
for further improvement.

5.3.1 Limited Time Range

In this research, the period of studied is not sufficient and adequate. The most
time range that can be extracted is limited to only ten years, which is from 2014 to 2018.
It is due to some of the sample banks only disclose their most recent years’ annual
report. Moreover, data available in “DataStream” more than this timeframe is
incomplete. The data constraint might lead to distorting and less accurate result as
compared to longer study period.

5.3.3 Number of Sample Bank

There are total of eight licensed local Islamic banks located in Malaysia in term
of asset size and market capitalization for the year 2018. The incapability to comprise
all the five local Islamic banks are due to the resources constrain. Thus, the result might
not fully reflect the whole situation of the Malaysian Islamic banking sector.

5.4. Recommendations for Future Research

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 As mentioned in the previous section, this study is constrained by various drawbacks. In
order to make a more precise and exact research, a few recommendations or guidelines are
given for future scholars who are interested in conduct the similar topic of this study.
Firstly, the time period of study should be lengthened in order to capture a more accurate and
precise result. It is because bank profit might change over time due to new regulation and
liberalization. The year of coverage in this study is from year 2014 to 2018 which is not
considered as a long period (as local Islamic banks are operated for a long period of time in
Malaysia.)

Further research using tax rate as a determinant of bank profit is highly recommended
since there are less researches being done in this sector. Based on the empirical analysis from
this research, the result has shown that tax rate is positively related to the bank profit. Thereby,
more research based on tax rate as a determinant of bank profit should be carry out in order to
gain more evidence that tax rate is relatively a significant determinant towards bank profit.

Last but not least, future researchers are highly encouraged to include all of the five
local Islamic banks to conduct the similar study. Furthermore, this research can be extended to
those foreign banks that have subsidiaries in Malaysia, rather than just focus on domestic-based
banks. It can widen the scope of investigation in term of the impact of determinants and capture
bank-based differences precisely. Moreover, it enhances the comprehension on bank
performances and stability.

5.5 Conclusion

In a nutshell, every Islamic bank in Malaysia is facing the same risk especially inflation
rate, interest rate risk and tax rate. This is because liquidity and credit risk can be controlled by
Page 40 of 43
the bank management while the other three risks are based on government regulation and also
the economic condition. Malaysia is still a developing country nowadays, it tries to build a
strong banking and financial sector, thus the relationship between bank’s profitability and five
types of risks should be carried out in a deeper way in order to have more improvement.

There are eight Islamic banks in Malaysia, and all Islamic banks are taken in this study.
Test has been carried out on bank’s profitability-return on assets (ROA) with bank size,
liquidity risk, deposit and capital. The result shows that all of the five independent variables
have significant result on the profitability of banks. The results might have some differences
with the research carried out by the previous researchers. This may be due to the different of
country and also the time period used in the study. The different country might have different
level of risk as the economic condition is unpredictable and unstable.

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