Abdus Samad & M. Kabir Hassan

The study evaluates intertemporal and interbank performance of Islamic bank (Bank Islam Malaysia Berhad (BIMB) inprofitability, liquidity, risk and solvency; and community involvement for the period 1984-1997. Financial ratios areapplied in measuring these performances. T-test and F-test are used in determining their significance. The study found thatBIMB is relatively more liquid and less risky compared to a group of 8 conventional banks. Our analysis of the primary dataidentified reasons why the supply of loans under profit sharing and joint venture profit sharing is not popular in Malaysia.40% to 70% bankers surveyed indicated that lack of knowledgeable bankers in selecting, evaluating and managingprofitable project is a significant cause.I. Introduction

Evaluation of bank performance is important for all parties: depositors, bank managers and regulators. In a com-

petitive financial market bank performance provides signal to depositor-investors whether to invest or withdraw

funds from the bank. Similarly, it flashes direction to bank managers whether to improve its deposit service or loan

service or both to improve its finance. Regulator is also interested to know for its regulation purposes.

Bank Islam Malaysia Bhd (BIMB) is a single full-fledged Islamic bank in Malaysia. The important underlying force

that led to the establishment of this Islamic bank in Malaysia was the elimination of riba that is used for interest.

Tabung Haji took the initiative to do business without using interest considered as being predetermined rate of

return to a deposit. Tabung Haji is an organization for the Muslim for taking care of pilgrims to Mecca. It is

basically act as a privately to facilitate the Muslims to perform their Hajj with the feeling of minimum financial

burden. Its objective is to implement Muslim code of life (shariah) in Hajj and all business transactions. All trans-

actions in the conventional banks are based on interest or “riba” which is prohibited by Islam. Tabung Hajj wanted

to get rid of “riba” (interest). Islamic bank is sought as a solution to it. With the increase in Muslim populations and

awareness of Islamic values, there was a greater demand for Islamic bank and interest-free finance by Muslim

consumers, traders, investors, and businessmen.

Bank Islam Malaysia was established in July 1983 to meet these demands and challenges. Since then BIMB

introduced and marketed various interest free products such as Wadiah ad Dhamana account, Mudarabah,

Musharakah and others. Bank’s business has expanded over the years. Its assets and deposits have increased

from RM 325 mil to RM 4,440 mil in 1997. The financing of loans and services increased to RM 991 mil in 1997.

The number of branches increased to 75 in 1998.

However, 15 years have passed since BIMB was established. There has been no study as to how the bank

performed in liquidity, profitability, risk and solvency, as well as its commitment to economy and Muslim community

during 1984-1997. The previous studies on profitability and other measures, Samad (1998), Ariff (1989), Dirrar

(1996), Mohiuddin (1991) Sum (1995) and Hassan (1999) are far from satisfactory. These studies used neither

statistical technique nor made inter-temporal and inter-bank comparisons with three sets of conventional banks.

However, such issues of profitability, liquidity, risk and solvency; and community involvement of the bank during

1984-1997 are very important to depositors and investors. So, the present study intends to evaluate the perfor-

mance of Islamic banks using the above mentioned criteria. This study is different from the earlier studies with

respect to contents, coverage of years and methodology. In evaluating BIMB’s performances, this study also

wants to test two hypotheses. The first hypothesis states that the liquidity ratios of Islamic banks are expected to

be higher in earlier years of operation than later years due to a learning curve. The second hypothesis states that as

Islamic banking makes its inroad in the society, the volume of two truly islamic financial modes of lending

(Mudharabah and Musharakah) are expected to grow larger in later years of its operation.

Hassan (1999) examines the Islamic banking principles in theory and its application with a case study of Bangladesh.

The abundance of short-term funds compared to long-term funds available for lending is a rational response on

behalf of banks to solve informational asymmetries prevalent in credit market. In traditional finance literature, it is

shown that debt contract (murabaha) is superior to equity contract. However, equity contract can be superior to

debt contract in an economy where informational asymmetries resulting from adverse selection and moral hazard

are smaller. In Islam, business is an Ibadah (worship) and is recommended whereas riba (interest) is prohibited.

From business point of view Islamic bank is not only a firm but also a moral trustee of the depositors where deposits

are trust given to banking firm. It is naturally expected that as a custodian of trust for the depositors’ deposits,

Islamic bank is likely to be more liquid and become more solvent compared to its counterpart conventional banks.

Islamic bank management, according to Islamic ethics, is accountable to the depositors in this world and the world

hereafter for their failure to keep the trust entrusted upon them. It is, therefore, expected that the liquidity and

solvency ratio of the Islamic bank will be higher than conventional banks.

However, it is also expected that the liquidity ratio of the Islamic bank may decline during the later periods com-

pared to its early eras. As the bank grows, it acquires more skill and the art of banking business, it will keep less

liquidity and thus the liquidity ratio may decline. This paper wants to test the hypothesis that the liquidity ratio and

solvency for Islamic banks in the early periods are higher than those of later periods are.

Instead of interest based contract, Islamic bank is founded on different philosophy; and it delivers a set of distin-

guished products in the financial market. Unlike conventional banks where interest is an integral part of bank

business, Islamic bank was established to avoid interest in all bank transactions. It does not deal with interest.

Interest is avoided because “riba” is prohibited in Islam. As a business firm BIMB delivers special financial prod-

ucts that are different from the conventional banks. It delivers interest-free products. For example, trust profit

sharing (called Mudarabah) and joint venture profit sharing (called Musharakah) are two distinguished and unique

products of an Islamic bank. The important feature of this loan (Mudarabah and Musharakh) is that they are

interest-free. There are no elements of interest involved in this transaction. For the Muslims there is a great

demand for them. BIMB was established to meet these demands. With the increase in Muslim population, business

firms and entrepreneurs in Malaysia, the supply of Mudarabah and Musharakah loan was a long waited product. In

these transaction Muslims can serve religious obligation and at the same time can earn profits. With the economic

development of Malaysia and the increase in Muslim population, Islamic values, Muslim business and firms, it is

expected that demand for these products (Mudarabah and Musharakah) are likely to increase gradually over the

years. It is also expected that the information gap between bank and the bank borrowers to be minimum because

both party jointly working to maximize profit and minimize losses. Projects undertaken under the Mudarabah and

Musharaka are constantly supervised and monitored by the Islamic bank. So the chances of failures are minimized.

Based on the expectation of minimum failure it is expected that the supply of these loans will increase over the

years. This paper will test the hypothesis that the supply for this loan (Mudarabah and Musherakah) of the Islamic

bank increases over years.

The paper is organized as follows. Following introduction and rational of this study in section I, Section II describes

methodology, data and the tools for measuring bank performance. Section III provides empirical evidence and

analysis. Summary and Conclusion are provided in Section IV.


Please refer for reference and appendix International Journal of Islamic Financial Services Vol. 1 No.3


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