The economic cycles and performance banking sector: Commercial versus Islamic banking

Islamic finance is an emerging and important are of research area in finance.  In this paper, we will compare performances of Islamic and commercial banks by using Turkish data for the period 1998-2014. To be particular, we will test if the macroeconomic variables such as output growth, inflation and the stance of monetary policy affect the performance of Islamic and non-Islamic conventional banks differently.

In order to assess the performances of the banking sector, following Demirgüç-Kunt and Huzinga (2010) and Demirgüç-Kunt (2013), we use fee income/total operational income; non deposit funding/total funding; loan to deposit ratio, cost to income ratio; overheads/total assets; loan-loss-reserves/total gross loans; loan-loss-provisions/total gross loans; non-performing-loans/total gross loans, maturity match; z-score, return on assets; and equity to assets ratio. As explanatory variables, we use total assets; non loan earnings assets/total earnings assets, fixed assets/total assets; GDP growth; inflation and Central Banks overnight interbank interest rates. The preliminary evidence that we gather suggests that Islamic banks are associated with lower deposit funding, overhead costs, z-score, return of assets (ROA) and equity to total assets, but associated with higher non-performing loans. However, we could not find statistically significant difference for loan to deposit ratio, cost to income ratio, loss-reserve, loan-loss-provisions and maturity mismatch. When we examined only the statistically significant coefficients, higher growth decreases non-deposit-funding, loss reserves, and non-performing-loans, but increases loan-loss-provision, non-performing-loans and ROA. However, we cannot find statistically significant evidence for these variables, as growth changes, Islamic banks respond differently. Even if as growth increases, we cannot find statistically significant evidence that overhead cost changes for commercial banks, however, it increases for Islamic banks. As inflation increases, we find that only ROA decreases in a statistically significant fashion but we still, cannot find statistically significant evidence that Islamic banks respond differently. As interest rates increase, loan-loss-provisions, non-performing-loans, and ROA increase but, non-deposit-funding, z-score and equity to total asset decrease. Islamic bank decreases non-deposit-funding more and increases ROA more as interest rates increase. Although we cannot find statistically significant evidence that overhead cost and maturity mismatch changes for the commercial banks, overhead cost increases and maturity mismatch decreases with higher interest rates for commercial banks.