Did Islamic Banks in the Gulf Do Better Than Conventional Ones in the Crisis?

By Masood Ahmed

The IMF’s latest regional economic outlook for the Middle East compares the performance of Islamic banks in the countries of the Gulf Cooperation Council (GCC) with conventional ones during the global financial crisis.

Islamic banks were less affected during the initial phase of the crisis, reflecting a stronger first-round impact on conventional banks through mark-to-market valuations on securities in 2008. But, in 2009, data for the first half of the year indicate somewhat larger declines in profitability for Islamic banks, revealing the second-round effect of the crisis on the real economy, especially real estate.  

Going forward, Islamic banks overall are better poised to withstand additional stress, according to the IMF analysis.

Portfolio risk

Islamic banks have grown substantially in recent years, with their assets currently estimated at close to $850 billion. Overall, the risk profile of Islamic banks is similar to conventional banks in that the risk profile of Shariah-compliant contracts is largely similar to that in conventional contracts, and credit risk is the main risk for both types of banks.

Islamic banks are not permitted to have any direct exposure to financial derivatives or conventional financial institutions’ securities—which were hit most during the global crisis (photo: Karim Sahib/AFP/Getty Images)

Islamic banks are not permitted to have any direct exposure to financial derivatives or conventional financial institutions’ securities—which were hit most during the global crisis (photo: Karim Sahib/AFP/Getty Images)

Unlike conventional banks, however, Islamic banks are not permitted to have any direct exposure to financial derivatives or conventional financial institutions’ securities—which were hit most during the global crisis.

An analysis of the top 50 banks in the GCC indicates that conventional banks also had this advantage going into the crisis—direct exposure to equity investments (and derivatives in the case of conventional banks) were very low in both types of banks (a mere 1 percent of total assets in conventional banks and 2 percent for Islamic banks in 2008). 

Risk concentration

The main difference in risk exposures appears to be related to concentration risk of Islamic banks in certain countries. While Islamic banks’ exposure to the risky real estate and construction sectors is lower in Saudi Arabia, Kuwait, and Bahrain, it is significantly higher than the system’s average in the United Arab Emirates (U.A.E.) and Qatar.

While Islamic banks were less affected by the initial impact of the global crisis, profitability fell substantially across both types of banks in 2008 and the first half of 2009, with declines somewhat larger for Islamic banks during the second phase. The weaker performance of Islamic banks in 2009 was largely driven by the U.A.E. and Qatar, where they had a considerably higher exposure to the real estate and construction sectors. A more complete view of the impact of the crisis on the two groups of banks will become available next year. 

Which group of banks is better positioned?

With larger capital and liquidity buffers, Islamic banks are better positioned to withstand adverse market or credit shocks.

On average, Islamic banks’ capital adequacy ratio in the GCC is higher than that for conventional banks (except in the U.A.E.). The risk-sharing aspect of Shariah-compliant contracts adds to this buffer as banks are able to pass on losses to investors.

2017-04-15T14:51:01-05:00October 14, 2009|


  1. Bill October 16, 2009 at 4:30 pm

    In theory Shariah compliant banks can pass on losses to investors (I assume one means depositors). Has it ever happened? Not to my knowledge — as far as I know Islamic banks return “profits” to depositors roughly equal to Libid (Libor less a margin) in good times and bad. This is based on my experience some years ago, maybe things have changed. Have they?

  2. iMFdirect October 19, 2009 at 4:58 pm

    Masood Ahmed replies:
    The term “investors” refers to holders of profit sharing investment accounts (PSIAs). On average, given competition pressures, Islamic banks’ returns are close to those of conventional banks. However, some Islamic banks have used the flexibility to mitigate the impact of asset losses through a temporary reduction in the rates of return to investors. Similarly, some Islamic banks’ rates of return have been temporarily higher than the market’s average, particularly in periods of low interest rates and strong economic growth.

  3. iMFdirect October 21, 2009 at 3:26 pm

    The post by Masood Ahmed is interesting. It throws light on an aspect I was unclear about. My observations from the past couple of decades do not entirely correspond to his views, however:

    1. The issue concerns, of course “Riba” and the interpretation thereof. Some interpret it as any kind of interest, others only as usury. In Pakistan, beginning in the 1980s, under the strict interpretation, banks simply introduced a loan and security agreement which was a sale-repurchase agreement (repo) with a “mark-up”. The mark-up always corresponded to the margin over the cost of funds that a non-islamic bank would incur via a deposits and interbank lending funding base and varied on a 1 to 1 basis with the tenor of the transaction.

    The “investors” at every tenor would never get more than non-Islamic international banks with a depository and interbank borrowing base and the borrowers would always pay a mark-up equivalent to Libor (or local currency rate) plus the same spread a non-Islamic bank would take.

    The “investors” never bore any loss (if there were losses they were borne by the bank, and its direct investors — owners– and not by the “investors” on the liability section of the balance sheet.) Were any bank really to pass through losses, there would have been a run on the bank.

    Ahmed says
    this is not always the case, but it was in all the cases I was aware of. In other words, the Sharia compliance was cosmetic. The banks bore the same risks as non-Islamic banks, made the same profits and losses and the “investors” got the market rate of return they would have received for interest bearing deposits. In reality many banks were funding themselves from the international money market, at least for loans in convertible currencies. Foreign banks had to follow the same rules in their Pakistani branches but in their own consolidated income statements as well as asset-liability management “profit sharing” was simply treated as interest; you would never know from either internal management accounting or external financial reporting that “profit sharing” even existed.
    2. Islamic banking in other countries, as far as I know, pretty much followed this procedure.

    Egypt has both Islamic and non-Islamic banking — both avoided sub-prime loans, but not because of Sharia compliance, but because they were never permitted by the Central Bank to take foreign currency exposures of the magnitudes that would hurt them in the first place.

    3. Ahmed says, not always the case, and he may be right, I’ve been retired for 6 years — but my suspicion is that some version of the same repo arrangement is used by all Islamic banks on their own balance sheets (we’re not talking about third party asset management wherein most equity funds if not already Sharia compliant as far as interest goes can easily be made so. Thus Sharia compliance comes down to avoiding investments in forbidden activities — these funds may have avoided some of the global meltdown, but I doubt that since global equities melted down nearly everywhere and in nearly all

    4. There is an interesting historical parallel in the West: At the end of the Middle Ages in Europe there was the same argument over interest in the Catholic church as there is over Riba today. But there were so many currencies in circulation in fragmented provinces of the former Roman Empire that nearly every commercial banking transaction involved foreign exchange at some point. The exchange rates between currency x and y varied with the length of the transaction. Historians have determined, with respect to Venetian banks, that many of them didn’t charge interest but the variations in FX rates corresponded precisely with what we would call “forward points” today — i.e., the differential interest rates between x and y (I don’t know what reference rate the historians used).

    Hence my skepticism. I’m not dogmatic; things could be completely different today, but that’s what I observed between about 1980 and 2003. That is to say, this is a semantic distinction, not an economic one.

  4. Lucia October 8, 2010 at 7:12 pm

    ANALYSING CONVENTIONAL COMPETITION will be discussed at World Islamic Retail Banking Conference (http://www.wirb2010.com).

    Badlisyah Abdul Ghani, CIMB Islamic Bank Berhad, Executive Director and Chief Executive Officer; Dr. Humayon Dar, BMB Islamic UK Ltd, CEO; Irfan Siddiqui, Meezan Bank Ltd., President & CEO; Khalid Al Jasser, Bank Al Bilad, Saudi Arabia, CEO; Ali Shaqoosh Al Mueen, Ajman Bank, Deputy CEO and Amman Muhammad, Absa Islamic Banking (South Africa), Managing Director
    will held panel discusion exactly on this topic.

    The major questions are:
    • Promoting ‘Islamic Brand’ Vs ‘Innovative Product’
    • Market Segmentation- how important?
    • Enhancing Distribution Avenues
    • What should be the ideal strategy?

  5. Mikel Rosher October 14, 2011 at 3:07 pm

    I do consider all of the ideas you’ve offered on your post. They are very convincing and will definitely work. Still, the posts are too quick for starters. May just you please extend them a bit from subsequent time? Thanks for the post.

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