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IMEFM
10,2
Does Islamic banking really
strengthen financial stability?
Empirical evidence from Pakistan
130 Abdul Rashid
School of Economics, International Institute of Islamic Economics,
Received 15 November 2015
Revised 8 May 2016
International Islamic University, Islamabad, Pakistan
8 November 2016
29 January 2017
Saba Yousaf
Accepted 29 January 2017 International Institute of Islamic Economics (IIIE),
International Islamic University, Islamabad, Pakistan, and
Muhammad Khaleequzzaman
International Institute of Islamic Economics, International Islamic University,
Islamabad, Pakistan

International Journal of Islamic
and Middle Eastern Finance and
Management
Vol. 10 No. 2, 2017
pp. 130-148
© Emerald Publishing Limited
1753-8394
DOI 10.1108/IMEFM-11-2015-0137
Abstract
Purpose – This paper aims to empirically assess the contribution of Islamic banks toward the financial
stability of Pakistan. For this, the authors investigate the relative financial strength of Islamic banks and their
contribution toward the financial stability. They also examine the relationship between the competitive
conduct of banks and banking system stability.
Design/methodology/approach – The authors use quarterly data of ten conventional banks, four
full-fledged Islamic banks and six standalone Islamic branches of conventional banks of Pakistan for the
period 2006-2012. The z-score has been computed and used as the measure of stability of banks and the
random effects estimator applied to quantify the impact of bank-specific variables and macroeconomic
indicators on the financial stability. The empirical framework used in the paper enables the authors us to
examine the differential effect of each underlying variable on the financial stability across Islamic and
conventional banks. To check the robustness of the results, the authors have estimated several models with
different specifications.
Findings – The regression results indicate that income diversity, profitability ratio, loan to asset ratio, asset
size and the market concentration ratio of banks have significant effects on the stability of banks. Comparing
Islamic and conventional banks, notable differential effects of the empirical determinants of financial stability
for Islamic and conventional banks have been observed. The results suggest that Islamic banks have
performed better as compared to conventional banks and contributed more effectively in the stability of
financial sector. Overall, the results depict that the contribution of Islamic banks toward the financial stability
has been reasonable and prospective.
Practical implications – The empirical results of the paper are very useful not only for banks’
managements but also for the investors, bank customers and policymakers. Specifically, the findings help in
enhancing our understanding as to how the bank-specific variables and macroeconomic indicators are related
to the financial stability of the banking system. The results also help understand the role of both Islamic and
conventional banks in the financial stability. Further, the results suggest that the financial soundness can be
enhanced by creating healthy competition in the banking industry. The results about macroeconomic
indicators imply that protective measures are required to intensify (mitigate) the positive (negative) effect of
gross domestic product (inflation) on banks’ financial stability.
Originality/value – This paper provides an overall comparative analysis of financial stability of both
Islamic and conventional banks of Pakistan. First, the paper computes the z-score for each bank included in the
sample, and then, it performs the regression analysis to study how bank-specific variables and
macroeconomic factors are related to the financial stability of banks. Unlike the previous studies, our empirical
framework enables the authors to examine the differential effect of each underlying variable on the financial Islamic
stability across Islamic and conventional banks.
banking
Keywords Financial stability, Z-score, Differential effects, Financial soundness, Islamic versus
conventional banking, Macroeconomic indicators, Random effects estimator
Paper type Research paper

131
1. Introduction
Does the financial stability require the soundness of financial institutions? Can it be achieved
and maintained through the stability of the banking sector of an economy? What
bank-specific and macroeconomic variables are important in determining the financial
stability? Does Islamic banking strengthen the financial stability? Does competition in the
banking industry enhance banking system stability? Such are the questions that have
received immense attention by researchers in the past several years, particularly, the
post-financial crisis period of 2007-2008. Although vast empirical literature on these issues
can be found, yet less is known about the role of Islamic banks in promoting stability of the
financial system.
Assessing the financial stability of the financial sector is difficult and complex
phenomenon. It can only be achieved through the financial soundness indicators. It is
affected by multiple factors such as stock market, political and economic conditions,
monetary and regulatory policies, credit and financial leverage and global financial
conditions. None of the economies has gained high economic growth without attaining the
effective growth of the financial sector. A sound financial system builds confidence among
various stakeholders and thus channelizes the funds efficiently throughout the economy. It
also plays an important role in monitoring and regulating the financial activities of the
economy. In a stable and sound financial system, the key financial institutions build degree
of confidence to meet their contractual obligations and the participants are fully satisfied and
confident about their transactions (Schinasi, 2004; Crockett, 1997).
A well-functioning and efficient banking system positively contributes to the financial
stability. Although the financial stability also depends on the economic development and
price stability (Schwartz, 1995), undoubtedly, a stable financial system is considered a
prerequisite for achieving sustainable economic growth. Further, banking sector growth is
positively related to economic growth. The existing empirical literature, such as McKinnon
(1973), Shaw (1973) and Goaid and Sassi (2010), transpires that the economic growth
increases with banking sector growth. This emphasizes that enhanced banking activities
increase the mobilization of capital funds and savings, improve the efficiency of the
resources and stimulate the technological innovations.
The 2008-2007 financial crisis has brought many worsts to the whole world. It has
raised several questions concerning the stability of financial sectors across the globe
and, in general, broke down the financial system across the world. Financial systems lost
the confidence and the financial intermediation process was affected badly.
Surprisingly, the Islamic banking exhibited tremendous growth and attained high
momentum and the countries practicing Islamic banking services have experienced high
growth in the respective financial sectors.
Globally, the number of institutions providing Islamic products and services has
increased to 300, operating in more than 75 countries, including both Islamic and non-Islamic
regions (Cihak, 2007)[1]. The financial services offered by the Islamic institutions are
expected to further increase the growth and strength of financial stability. The literature also
supports that the Islamic banks have been least impacted by the financial crisis, owing to the
IMEFM unique operations in the real sector and, hence, played productive role in stabilizing the
10,2 economies (Bourkhis and Nabi, 2013; Ahmed, 2010).
Whether Islamic banking really plays a role in promoting a stable and sound financial
system is an important issue. Though the Islamic banks experience a short history as
compared to conventional counterparts, the former invite greater attention of the researcher,
investors and policymaker to different products and operating procedure. Therefore, it is
132 worth exploring whether there is some evidence that Islamic banks contribute positively
toward the financial stability of the banking sector and, in turn, to the economy. However, the
said impact has not been well researched in case of Pakistan.
This paper, therefore, attempts to fill this gap. We understand that this paper provides,
for the first time, an overall comparative analysis of the role in the financial stability of both
Islamic and conventional banks of Pakistan. Accordingly, the objective of the paper is
threefold. First, it measures the relative financial strength of Islamic banks of Pakistan
particularly after the financial crisis of 2007-2008, and their contribution to the overall
financial stability. Second, it examines the relationship between the competitive conduct of
the banks and banking system stability. Finally, it evaluates the relative contribution of
Islamic and conventional banks in the stability of banking sector in Pakistan.
The rest of the paper is constructed as follows. Section 2 presents a brief history and
future prospects of Islamic banking industry in Pakistan. Section 3 presents the literature
review. Section 4 describes methodology and data. Section 5 presents the empirical results.
Finally, Section 6 concludes the paper with some policy implications.

2. History and prospects of Islamic banking in Pakistan

In Pakistan, financial sector consists of scheduled commercial banks (SCBs) and
non-banking financial institutions (NBFIs). The SCBs include the conventional banks
(foreign and private), Islamic banks and specialized banks known as development finance
institutions (DFIs). The investment banks, leasing companies, modaraba companies and
housing finance companies constitute the NBFIs. SCBs conduct their business as guided by
the State Bank of Pakistan (SBP) and are subject to different regulatory requirements such as
capital adequacy and liquidity and cash reserves. The Securities and Exchange Commission
of Pakistan regulates NBFIs. Along with conventional financial institutions, Islamic banking
has also made a swift progress in Pakistan since its re-launch in 2002 as a parallel mode of
financial intermediation in the country. Interestingly, similar to other countries, notably,
Bahrain, Malaysia and Indonesia, the Islamic banking system in Pakistan is progressing on
the strength of its own merit and excellence, instead of any religious or legal obligation and
compulsion. The profit of Islamic banking industry remained Rs. 15 billion in 2014. Islamic
banking industry assets grew by 24.2 per cent to reach Rs. 1,259 billion in December 2014,
while market share of Islamic banking assets in overall banking industry was 10.4 per cent
in December 2014 (Islamic Banking Bulletin, December 2014).
The growth of Islamic banking institutions (IBIs) has been phenomenal over the years. As
of December 31, 2015, there were five full-fledged Islamic banks and one Islamic subsidiary
of Muslim Commercial Bank operating in Pakistan with a branch network of 1,167.
Additionally, SBP has also allowed conventional banks to open standalone Islamic banking
branches (IBBs). Currently, there are 754 IBBs of 17 conventional banks in Pakistan. In
addition to this, it is also worth mentioning that conventional banks are operating 1,047
windows for providing Islamic banking services. Apart from the IBBs and windows, 154
sub-branches of different six banks operate in the country to facilitate Islamic banking in the
country.
 The Islamic banking was introduced in Pakistan in February 1979 to primarily eliminate Islamic
the interest from the economy. Accordingly, House Building Corporation, National banking
Investment Trust and Investment Corporation of Pakistan started their interest-free
operations in January 1981. In addition, the commercial banks also setup their separate
counters to receive deposits on profit and loss (P&L) sharing basis. Nevertheless, in January
1985, SBP circulated the instructions restricting the banks to accept saving deposits on
interest bearing basis. The banks were, therefore, allowed to only accept current accounts as
fully guaranteed and without any benefit of interest or profit. 133
However, owing to several factors involved in the interest-free banking, the effort of
making fully interest-free economy could not be successfully materialized. There was a lack
of any support of Shariah advisory and infrastructural institutions like Accounting and
Auditing Organization for Islamic Financial Institutions and Islamic Finance Service Board
(IFSB). No mechanism was developed by SPB to issue a certificate to banks operating in
agreement with Shariah principles. Therefore, in 1991, the Federal Shariat Court declared
that the operating mechanism introduced in 1985 was against the principles of Shariah.
However, in 2001, SBP articulated criterion to establish full-fledged Islamic banks,
subsidiaries and standalone branches parallel to conventional banking system. Finally, in
2002, the effort of developing the Islamic financial system led to the establishment of first
Islamic bank in Pakistan, namely, the Meezan Bank Limited.
SBP plays a vital role in promoting the Islamic banking in line with the Shariah and
regulatory framework announced by it from time to time. Three types of IBIs, such as
full-fledged Islamic banks, Islamic bank subsidiaries of conventional banks and standalone
IBBs of conventional bank, can be established to offer Islamic banking services in Pakistan.
The SBP has provided level playing field and allowed Islamic banks to operate parallel with
the conventional banks, with a primary objective to provide diversified banking
opportunities to build a sound financial system rendering the economic development
opportunities through Shariah-compliant financial operations. The SBP’s Strategic Plan for
Islamic Banking 2014-2018 focuses on strengthening legal, regulatory and reporting
structure; improving Shariah governance and compliance through standardization and
harmonization of products and Shariah practices; enhancing coordination and collaboration
among internal and external stakeholders to increase awareness about Islamic finance and
capacity building of the stakeholders; and market development by increasing product
diversification and financial inclusion (SBP, 2014).

3. Literature review
A considerable research work has been done on Islamic banks all over the world during the
past two decades. The literature on the Islamic banking is expanding day by day in different
dimensions. In case of Pakistan, the literature is available mainly on the determinants of
performance, measuring the performance, the examination of the efficiency of Islamic banks
and calculation of growth or the profitability of Islamic banks. Shahid and Abbas (2012) are
the first who examined the financial stability of Islamic banks of Pakistan. However, for a
better understanding of the role of Islamic banking in the financial stability, it is important to
examine the financial strength of stand-alone Islamic branches of conventional banks also
along with the full-fledged Islamic banks. Below, we briefly review some of the leading
studies on the stability and the contribution of Islamic banks.
There are different opinions developed in the literature as to whether the contribution of
Islamic banks in the financial stability is significant in the presence of conventional banks or
not. The financial strength of Islamic banks differs widely from country to country. Cihak
and Hesse (2010) examined the impact of Islamic and conventional banks on financial
IMEFM stability for 20 countries. They used data covering the period 1993-2004. The z-score was
10,2 used as a measure of stability of banks. Their findings showed that large Islamic banks are
not as much financially stronger as the small Islamic banks. In particular, their findings
suggest that small Islamic banks tend to be financially stronger than the small conventional
banks, but large Islamic banks tend to be less stronger than the large conventional banks.
They also reported that in large Islamic banks, there are issues related to the credit risk.
134 Moreover, the Islamic banks’ market share does not have any important influence on the
financial stability of conventional banks.
Bourkhis and Nabi (2011) measured the Islamic banks’ stability following the model
adopted by Cihak and Hesse (2010). They computed the stability of Islamic banks between
different time periods and analyzed whether the inclusion of Islamic banks in the financial
sector increases the financial stability. They divided their sample period into three
sub-periods: pre-financial crisis (1993 to 2006), during the financial crisis (2007 to 2009) and
post-financial crisis. Using the data of 409 banks from 19 countries, they concluded that
Islamic banks were financially stronger than the conventional banks before and during the
financial crisis. Although Islamic banks became less stable after the financial crisis, they
remained dominant over conventional banks in terms of their financial soundness.
Rajhi and Hassairi (2013) analyzed the financial strength of 16 Islamic banks in Middle
East and North Africa (MENA) and Southeast Asian countries. Their sample covered 467
conventional banks and 90 Islamic banks for the period 2000-2008. Their findings exhibited
that Islamic banks demonstrated higher financial stability as compared to conventional
banks because the former had, on average, z-score higher than the latter. They also showed
that the credit risk decreased the z-score value in small Islamic banks of MENA countries. In
contrast, for Southeast Asian countries, they found that the credit risk decreased the z-score
value for large Islamic banks.
Gamaginta and Rokhim (2011) analyzed the financial stability of 12 Islamic banks and 71
conventional banks of Indonesia for the period 2004-2009. They applied z-score as a measure
of bank soundness. They found that Islamic banks and conventional banks were
significantly different in terms of their financial stability. Their results showed that the
Islamic banks had generally low tendency of stability as compared to the conventional
banks. Yet, small Islamic banks have almost the same level of stability as of the small
conventional banks. Their results also highlighted that full-fledged Islamic banks had low
financial stability as compared to the Islamic business units.
Ivičic´ et al. (2008) analyzed the bank insolvency risk of seven central and eastern
European countries. They studied the effect of various macroeconomic indicators and
bank-specific variables on the insolvency of banks. They analyzed each individual bank with
the separate pooled regression and computed conditional z-score that is directly related to
banks’ insolvency using data covering the period 1996-2006. They found that the banking
sector stability decreases with increases in credit growth, inflation and the bank
concentration ratio. Demirguc-Kunt et al. (2010) examined the impact of commercial banks
on Islamic banks and found that the presence of conventional banks in the banking sector
lowered systemic stability at the systemic level. They showed that the conventional banks
were less stable in countries that had higher market share of Islamic banks. Yet, they argued
that Islamic banks had high capitalization that depicted better performance of the Islamic
banks.
Ghassan et al. (2012) analyzed the financial stability of Islamic and conventional banks of
Saudi Arabia. Their sample covered four conventional and two Islamic banks for the period
2005-2011. Using z-score as a measure of stability and applying co-integration test, they
found that Islamic banks were financially stronger than their conventional counterparts Islamic
during the financial crisis of 2007-2008. banking
Rahim and Zakaria (2013) compared Islamic and the conventional banks in Malaysia on
the basis of financial stability. Their sample covered 17 Islamic banks and 21 conventional
banks for the period 2005-2010. They used z-score and non-performing loans (NPL) ratio for
measuring the stability of banks. Their findings exhibited that Islamic banks remained
relatively unaffected by the financial crisis of 2007-2008. They showed that Islamic banks 135
were more stable than the conventional banks during the examined period.
Farooq and Zaheer (2015) using data from Pakistan found that branches of Islamic banks
were less likely to face deposit withdrawals during financial panics. They also found that the
Islamic branches engaged with both Islamic and conventional operations tend to attract
deposits during the state of panics. Finally, they documented that Islamic branches granted
more loans during financial panics. They also showed that the lending decisions of Islamic
banks were less sensitive to changes in deposits.
Rashid et al. (2015) analyzed the financial performance of conventional versus Islamic
banks in Pakistan using annual data covering the period 2006-2012. They have first
constructed the financial performance index (FPI) based on CAMELS’ ratios and then ranked
the banks on the basis of the constructed FPI. They documented that conventional banks
were on top of the list and Islamic banks stood mostly after 12th rank. Yet, the progress ratio
depicts that Islamic banks had better financial performance in 2012 as compared to 2006.
Bougatef (2015) investigated the influence of corruption on financial soundness of Islamic
banks for a panel of 69 Islamic banks. He used data covering the period 2008-2010. Using
generalized method of moments (GMM) estimation method, he found strong evidence on the
significant effect of corruption on the financial health of Islamic banks. Overall, the findings
of his study suggest that the level of corruption is one of the major factors behind the problem
of impaired financing.
Rashid and Jabeen (2016) empirically examined the bank-specific, financial and
macroeconomic determinants of financial performance of Islamic and conventional banks in
Pakistan for the period 2006-2012. They first constructed the FPI based on CAMELS’ ratios
and then run the computed index on the said determinants. Estimating generalized least
squares (GLS) regression, they found that operating efficiency, reserves and overheads were
significant determinants of conventional banks’ performance, whereas operating efficiency,
deposits and market concentration were significant in explaining performance of Islamic
banks. Based on their empirical results, they suggested that advancements in overall
management practices and new standards in operating efficiency and financial risk
management are essential to enhance the performance of banks.
Reviewing the reports and empirical work performed by International Monetary Fund
(IMF), we observe that IMF is significantly contributing to promote Islamic finance across
the globe. Further, its members are continuously engaged in research in several key areas of
the Islamic finance, such as Islamic banking regulation and supervision, macro-prudential
policy, Sukuk markets and consumer protection. The IMF has played a key role in the
establishment of IFSB responsible for promoting and enhancing the soundness and stability
of the Islamic financial services industry. As given in the recent co-publication of ADB-IFSB
(2015), the main concern of financial regulation for Islamic banking is twofold:
(1) to provide the protection to investors and customers for financial products; and
(2) to ensure the financial stability and resilience of the financial sector institutions and
of the sector as a whole.
IMEFM Given this, the role of Islamic versus conventional banking in the financial system stability
10,2 is worth exploring: a theme which we investigate in this paper.

4. Methodology and data

Reviewing the existing empirical literature, we find that most of studies have used z-score as
a measure of a bank’s solvency, risk and financial soundness. The z-score is inversely related
136 to the probability of insolvency of a bank. According to Cihak and Hesse (2010), Uhde and
Heimeshoff (2009) and Shahid and Abbas (2012), under the assumption of normality of return
distribution, z-score measures the number of standard deviation a return realization has to
fall to deplete equity. Higher value of z-score falls in the lower upper bound of insolvency
risk. Therefore, higher value of z-score means that having low probability of insolvency and
vice versa. The z-score can be defined as follows:

EQ
⫹ ␮ROA
A
Z-score ⫽ (1)
␴ROA

where EQ/A is equity capital as a percentage of total bank assets, ␮ROA is average return on assets
(ROA) and ␴ROA is standard deviation of return on assets as a proxy for return volatility.
The main theme of our research rests with to test whether the Islamic banking system is
more stable than the conventional banking system. To do this, we run the regression of
z-scores as a function of number of variables by applying random effects (RE) estimator.
Following the existing empirical studies, our regression model includes bank-specific
variables as well as macroeconomic indicators. Bank-specific variables include income
diversity, the profitability ratio, the cost to income ratio, the loan to assets ratio, bank size,
credit risk and the market concentration ratio. A measure of income diversity is computed by
following Cihak and Hesse (2010) and Shahid and Abbas (2012) to describe the bank income
structure.
The profitability ratio includes ROA and returns on equity (ROE). The loans to assets
ratio and the cost to income ratio depict the cost efficiency and asset composition of banks.
Bank size measured by natural log of total assets of a bank is included to control bank-level
differences in size. Credit risk and the market concentration ratio are included to see the
impact of financial risk and market trend on banks’ financial soundness. Gross domestic
product (GDP) and inflation are included to control for macroeconomic conditions.
Specifically, the baseline empirical model takes the following form:

zit ⫽ ␤0 ⫹ ␤1INDIit ⫹ ␤2COINit ⫹ ␤3LOASit ⫹ ␤4PTRTit ⫹ ␤5BASIZit ⫹ ␤6INFt

⫹ ␤7GDPt ⫹ ␤8MRKCt ⫹ Dt ⫹ rei ⫹ ␧it (2)

where subscript i indexes the bank and t indexes the time at which the quarterly data are
collected. Dependent variable is represented by z-score; INDI is the income diversity; COIN is
the income ratio; LOAS is the loan to asset ratio; PTRT is the profitability ratio indicator;
BASIZ is the bank asset size; GDP is the gross domestic product; INF is the inflation defined
as the first difference of log consumer price index (CPI); MRKC is the market concentration
ratio; D is the dummy variable taking value 1 for Islamic banks and 0 for conventional banks;
re denotes the bank-specific RE; and ␧it is the error term.
After estimating the baseline model, we estimate the following model to examine the
differential effects of the empirical determinants of the financial stability across Islamic and
conventional banking industry:
 zit ⫽ ␤0 ⫹ ␤1INDIit ⫻ D isl ⫹ ␤2INDIit ⫻ D con ⫹ ␤3COINit ⫻ D isl ⫹ ␤4COINit ⫻ D con Islamic
⫹ ␤5LOASit ⫻ D ⫹ ␤6LOASit ⫻ D
isl con
⫹ ␤7PTRTit ⫻ D ⫹ ␤8PTRTit ⫻ D
isl isl banking
⫹ ␤9BASIZit ⫻ D ⫹ ␤10BASIZit ⫻ D
isl con
⫹ ␤11GDPt ⫻ D isl ⫹ ␤12GDPt ⫻ D con
⫹ ␤13INFt ⫻ D isl ⫹ ␤14INFt ⫻ D con ⫹ ␤15MRKSt ⫻ D isl ⫹ ␤16MRKSt ⫻ D con
⫹ ␤17CRRKit ⫻ D isl ⫹ ␤18CRRKit ⫻ D con ⫹ ␤19MRKCt ⫻ D isl 137
⫹ ␤20MRKCt ⫻ D con ⫹ rei ⫹ ␧it (3)

where Disl is the dummy variable which takes value 1 for an Islamic bank and 0 otherwise,
and Dcon is the dummy variable that is equal to 1 for conventional bank and 0 otherwise. The
rest of the variables are defined as in equation (2). This empirical framework allows us to
examine the differential impact of each underlying determinant of the financial stability
across both types of banking.
We use an unbalanced panel dataset for empirical analysis. Specifically, we collect
quarterly data of ten conventional banks and ten Islamic banks including four full-fledged
Islamic banks and six IBBs of conventional banks covering the period from 2006 to 2012. The
conventional banks included in this study are the top ten conventional banks of Pakistan
categorized on the basis of size (assets) and credit rating of September 2012 by SBP. Data on
inflation are collected from International Financial Statistics and IMF. Quarterly GDP is
obtained by interpolating annual GDP by following Rashid and Jehan (2013). Variables’
description and definitions are given in Table AI.
Islamic banks include Meezan Bank Ltd, Bank Islami Ltd, Burj Bank Ltd and Dubai
Islamic Bank, while the conventional banks include Bank Alfalah Ltd (AFBL), Bank al Habib
Ltd (BAHL), Faysal Bank Ltd, Habib Metropolitan Bank Ltd (HMBL), National Bank Ltd,
United Bank Ltd (UBL), Habib Bank Ltd (HBL), Muslim Commercial Bank, Allied Bank Ltd
and Askari Bank Ltd. Standalone Islamic branches of AFBL, ASBL, BAHL, HMBL, HBL and
UBL are also included in the sample.
We apply Fisher-type panel-date unit root tests to check whether bank-specific variable are
stationary at their levels. These tests are based on the augmented Dickey–Fuller (ADF)
regressions that include a constant, or a constant and time trend. Fisher-type panel-date unit root
tests first conduct unit-root tests for each panel individually included in the dataset. Then, the
p-values from these individually conducted unit root tests are combined to produce an overall test.
Z and L* statistics combine p-values using inverse normal and inverse logit transformations,
respectively. These tests test the null hypothesis that all panels contain unit roots against an
alternative hypothesis that at least one panel is stationary for the underlying series.
To test the stationary of macroeconomic variables, namely, the rate of inflation and quarterly
GDP, we apply the ADF unit-root test including a constant, or a constant and linear time trend in
the regressions. The null hypothesis for the ADF test is that the series contains a unit root, and the
alternative is that the series does not have unit roots. The optimal number of lags for the ADF
unit-root test is determined by the “general to specific” method proposed by Perron and Campbell
(1991). The results of unit root tests are given in Table AII. The estimated test statistics do not
provide any significant evidence of the presence of a unit root in the underlying bank-specific
variables. This implies that all the variables are integrated of order zero. This finding holds
regardless of whether we consider a linear time trend or not in the ADF regressions. The ADF test
results suggest that both the rate of inflation and quarterly GDP series also appear stationary at
their levels. Summary of descriptive statistics are given in Table AIII.
IMEFM 5. Empirical results and discussion
10,2 5.1 Calculating z-score
We start our empirical analysis by calculating z-score for each individual bank included in
the sample. Specifically, we calculate z-score for each Islamic and conventional bank for each
year over the period 2006-2012. The summary statistics of the z-score is given in Table I. For
comparison purpose, we present the mean, standard deviation and maximum and minimum
138 values of z-score for all banks included in the sample, as well as for conventional and Islamic
banks separately. It can be observed from the table that the mean and standard deviation of
z-score for Islamic banks are greater than the conventional banks. It means that Islamic
banks are, on average, financially stronger than the conventional banks. Yet, the standard
deviation of the z-score indicates that the variability or uncertainty is greater in case of
Islamic banks as compared to their conventional counterparts. This observation is consistent
with the study of Cihak and Hesse (2010) and Shahid and Abbas (2012), who also reported
that Islamic banks were relatively more financially stable than conventional banks. Further,
these statistics also support our hypothesis: as Islamic banks do business based on the
return-risk sharing strategy, they are financially sound and stable as compared to their
conventional counterparts.

5.2 Regression results for full sample

To examine the empirical determinants of the financial stability, using a sample of Islamic
and conventional banks, we estimate equation (2) with several different specifications. The
results are given in Table II. Specification of Model 1 is similar to several previous studies,
such as Mokhtar et al. (2006), Cihak and Hesse (2010) and Shahid and Abbas (2012). We then
add different variables in Model 1 to examine the impact of these variables on the financial
stability. In particular, in Model 2, we include the market concentration ratio as an additional
variable to examine the impact of market competition on banks’ stability. In Model 3, we
examine how macroeconomic variables, namely, GDP and inflation, affect the stability of
financial system. Finally, in Model 4, we exclude the market concentration ratio from the
specification to check the robustness of the results of macroeconomic variables.
As the income diversity coefficient (coefficient ⫽ 8.211; p-value ⫽ 0.012) is positive and
statistically significant, banks with higher income diversity are more likely to be financially
stable and tend to have high z-score. The estimated value of the coefficient suggests that for
each one-unit increase in income diversity, the z-score will increase by 8.211 units. The
positive association of income diversity with the financial stability is consistent with
previous studies by Shahid and Abbas (2012) and Rahim and Zakaria (2013). They have also
concluded that income diversity has a positive and statistically significant impact on the
financial stability.
The coefficient of the cost to income ratio is positive but appears statistically
insignificant. This implies that banks with the high cost to income ratio tend to be more
stable. This result is also in line with the findings of Shahid and Abbas (2012) reporting that
the cost to income ratio is positively related to the financial stability of banks. Although the

Bank sample All banks Conventional banks Islamic banks

Table I.
Descriptive statistics Mean 13.42 7.54 19.68
of z-score for Maximum 420.26 262.77 420.26
conventional and Minimum ⫺1.36 ⫺1.36 1.60
Islamic banks (2006- SD 40.83 18.78 54.74
2012) Observations 485 250 235
Variables Model 1 Model 2 Model 3 Model 4
Islamic
banking
Income diversity 8.211 (0.012)*** 8.594 (0.007)*** 10.203 (0.002)*** 10.121 (0.002)***
Cost to income 0.004 (0.82) 0.003 (0.719) 0.000 (0.972) 0.000 (0.964)
Loan to assets 0.111 (0.045)** 0.088 (0.044)** 0.092 (0.043)** 0.091 (0.097)*
Bank assets 1.922 (0.090)* 1.790 (0.190) 0.000 (0.956) 0.000 (0.994)
Profitability ratio 0.442 (0.000)*** 0.442 (0.001)*** 0.461 (0.004)*** 0.457 (0.000)***
Market concentration (C4) – 1.450 (0.064)* 0.496 (0.075)* – 139
Credit risk 0.395 (0.793) – –
GDP – – ⫺4.930 (0.329) 3.051 (0.002)***
Inflation – – ⫺1.041 (0.086)* ⫺1.031 (0.010)***
Dummy ⫺13.087 (0.050)** ⫺13.701 (0.043)** ⫺13.822 (0.046)** ⫺14.683 (0.048)**
Constant 46.381 (0.042)** ⫺68.744 (0.099)* ⫺115.886 (0.076)* 60.424 (0.000)***
R-squared 0.627 0.712 0.681 0.728
Number of observations 485 485 485 485
2
Wald chi 27.99 30.63 34.42 34.48
Prob ⬎ chi2 0.0001 0.0001 0.0001 0.000 Table II.
REs estimates of
Notes: * indicates significant at the 10% level; ** indicates significant at the 5% level; *** indicates financial stability for
significant at the 1% level; the value of dummy is 1 for Islamic bank and 0 for conventional bank full sample

sign of the coefficient is consistent with previous studies, the coefficient appears statistical
insignificant in our analysis. One possible reason behind this statistical insignificant impact
is that banks included in the sample may have not focused much on the cost efficiency.
The positive impact of the loan to asset ratio (coefficient ⫽ 0.111; p-value ⫽ 0.045)
indicates that banks with high loan to asset ratio tend to have high z-score. This finding is
consistent with the study of Mokhtar et al. (2006) and Shahid and Abbas (2012). They
documented that the financial stability increased with the loan to asset ratio because it
represents the asset composition and the liquidity position of the banks. Banks with high
liquidity and diversified assets are generally considered to be more efficient and stronger and
are likely to have lower probability of insolvency. Therefore, the financial stability of a bank
will increase with its loan to asset ratio. However, this finding is in contrast to the findings of
Cihak and Hesse (2010) that show that banks with high loan to asset ratio tend to be less
stable[2].
When we turn to the impact of the bank’s asset size on its financial stability, we observe
that the estimated coefficient of bank size is positive (coefficient ⫽ 1.922) and appears
significant at the 10 per cent level of significance (p-value ⫽ 0.090). This suggests that bank
size has a positive relationship with the financial stability. In our analysis, we use log of bank
assets as a proxy for bank size. Therefore, we can say that banks with more assets tend to
have high z-score. Banks with high z-score have low probability of insolvency and positively
contribute to the stability of overall financial system. This finding is in support of several
previous studies, such as Bourkhis and Nabi (2011), Mokhtar et al. (2006), Cihak and Hesse
(2010), Shahid and Abbas (2012) and Husein (2014). These studies also found a positive
relationship between bank size and the financial stability.
The profitability of banks plays an important role in the financial stability. This ratio,
being an important financial indicator, depicts the financial performance of a bank. The
estimated coefficient of profitability variable (coefficient ⫽ 0.442; p-value ⫽ 0.000) implies
that banks with higher profits are more stable than the banks that have low profits. This
result is consistent with the previous studies such as Mokhtar et al. (2006) and Hasan and
Dridi (2010). These studies also illustrate that more profitable banks perform well and
IMEFM exhibit low probability of insolvency. Unexpectedly, the estimated coefficient for the dummy
10,2 is negative and appears statistically significant, implying that the intercept value is less for
Islamic banks than that for conventional banks.
As stated above, in Model 2, we also add the market concentration ratio and credit risk
into the specification along with bank-specific variables. We add the market concentration
ratio to examine the impact of market behavior on the financial stability of banks operating
140 in Pakistan. The market concentration ratio coefficient (coefficient ⫽ 1.450; p-value ⫽ 0.064)
implies that market concentration has a significant and positive impact on the financial
stability of banks. The positive impact of the market concentration ratio suggests that banks
with higher market share contribute positively to the financial soundness of the system. The
significant impact of the market concentration ratio is consistent with the findings of several
previous studies. For instance, Ivičic´ et al. (2008), Hassan and Bashir (2003) and
Demirguc-Kunt and Huizinga (2000) reported that market concentration impacts positively
and significantly on the soundness of banks. The estimated coefficient of credit risk
(coefficient ⫽ 0.397; p-value ⫽ 0.793) reveals that credit risk has statistically insignificant
impact on the financial stability of banks. Rajhi and Hassairi (2013) have also documented
insignificant impacts of credit risk on the financially stability.
In Model 3, we include macroeconomic indicators, namely, GDP and inflation along with
market concentration and bank-specific variables into the specification. Inclusion of
macroeconomic variables does not have any significant impact on the estimates of
bank-specific variables. That is, in Model 3, even after controlling for macroeconomic
variables, the estimates of the bank-specific variables are similar to those in Models 1 and 2
in terms of both their signs and statistical significance. The estimates of macroeconomic
indicators suggest that inflation is negatively and statistically significantly related to banks’
financial stability. That is, the higher the inflation in the economy, the lower the z-score of the
banks. This finding suggests that the probability of insolvency increases with increases in
price levels in the economy. The negative impact of inflation is consistent with the findings
of Ivičic´ et al. (2008), Cihak and Hesse (2010) and Shahid and Abbas (2012). Surprisingly, the
GDP coefficient is negative, but statistically insignificant. One possible justification for this
negative impact is that during boom in the economy (in terms of high GDP), banks may offer
risky loans, and thus, they become more risky.
However, to check the robustness of GDP estimate, we estimate another specification
(Model 4) by considering the macroeconomic variables along with the bank-specific
variables. We opt this because of the possibility that the influence of the market
concentration ratio may capture the impact of market conditions to some extent. The results
show that the estimated coefficient of bank-specific variables and inflation are similar to
those in Model 3. However, the GDP coefficient now becomes positive and appears
statistically significant at the 1 per cent level of significance. This finding concludes that
with the increase in GDP, the financial stability of banks is likely to increase. It means that
the economy with increased GDP is more likely to provide an intensive environment to banks
for better performance. This result is in agreement with the previous studies, such as Cihak
and Hesse (2010), Shahid and Abbas (2012) and Ivičic´ et al. (2008).

5.3 Differential effects for conventional and Islamic banks

We estimate equation (3) to examine the differential effects of the empirical determinants of
the financial stability across Islamic and conventional banks and present the results in
Table III. To examine the differential impact of each explanatory variable included in the
model, we define two dummy variables (one for Islamic banks and the other for conventional
banks) and interact them with all the explanatory variables. We prefer this empirical
Variables Model 1 Model 2 Model 3 Model 4
Islamic
banking
Income diversity ⫻ Dcon ⫺10.731 (0.100)* ⫺10.482 (0.257) ⫺11.313 (0.218) ⫺11.812 (0.196)
Income diversity ⫻ Disl 12.360 (0.002)*** 12.910 (0.002)*** 16.756 (0.000)*** 15.877 (0.000)***
Cost to income ⫻ Dcon 0.004 (0.099)* 0.049 (0.100)* 0.046 (0.100)* 0.051 (0.098)*
Cost to income ⫻ Disl ⫺0.005 (0.849) ⫺0.002 (0.927) ⫺0.017 (0.517) ⫺0.021 (0.434)
Loan to asset ⫻ Dcon ⫺0.153 (0.949) ⫺0.163 (0.841) ⫺0.317 (0.437) ⫺0.129 (0.700)
Loan to asset ⫻ Disl 0.171 (0.007)*** 0.164 (0.010)*** 0.088 (0.196) 0.177 (0.009)*** 141
Bank asset ⫻ Dcon ⫺1.20 (0.338) 0.451 (0.921) ⫺5.634 (0.027)** 0.918 (0.853)
Bank asset ⫻ Disl ⫺1.234 (0.317) ⫺0.863 (0.457) ⫺0.642 (0.627) ⫺2.022 (0.123)
Profitability ⫻ Dcon 0.136 (0.493) 0.183 (0.375) 0.105 (0.601) 0.116 (0.578)
Profitability ⫻ Disl 0.757 (0.000)*** 0.729 (0.000)*** 0.546 (0.002)*** 0.740 (0.000)***
Market concentration ⫻ Dcon – 0.721 (0.521) – 1.631 (0.405)
Market concentration ⫻ Disl – 1.121 (0.321) – 3.572 (0.158)
GDP ⫻ Dcon – – 0.272 (0.936) ⫺2.960 (0.612)
GDP ⫻ D isl
– – 4.13 (0.099)* ⫺6.4111 (0.447)
Inflation ⫻ Dcon – – 0.688 (0.528) ⫺0.151 (0.925)
Inflation ⫻ Disl – – ⫺1.661 (0.100)* ⫺4.507 (0.049)**
Constant 36.1680 (0.092)* ⫺35.160 (0.61) 56.172 (0.100)* ⫺82.440 (0.424)
R-squared 0.682 0.735 0.748 0.823
Number of observations 485 485 485 485
Wald chi2 42.79 47.88 63.19 139.01 Table III.
Prob ⬎ chi 0.000 0.000 0.000 0.000 Determinants of
financial stability:
Notes: * indicates significant at the 10% level; ** indicates significant at the 5% level; *** indicates Differential effects for
significant at the 1% level; Dcon is conventional dummy that takes value 1 for conventional bank and 0 for Islamic and
Islamic banks; Disl is Islamic dummy that takes value 1 for Islamic bank and 0 for conventional banks conventional banks

framework to estimate the regression separately for Islamic and conventional banks to
harvest the benefits of large degree of freedom. Further, this approach enables us to directly
compare the impact of each underlying explanatory variable across Islamic and
conventional banks.
We estimate four different specifications, similar to Table II. We present the results in
Table III under Models 1 to 4. The estimation results provide clear indication of the
differential impact of the empirical determinants of financial stability across Islamic and
conventional banks. For instance, the income diversity coefficient (coefficient ⫽ 12.360;
p-value ⫽ 0.002) is positive and statistically significant for Islamic banks. However, this
coefficient is negative and appears statistically significant at the 10 per cent level (in only
Model 1) for conventional banks (coefficient ⫽ ⫺10.731; p-value ⫽ 0.100). This implies that
Islamic banks with higher income diversity tend to increase z-score and ultimately increase
the financial stability. On the other hand, conventional banks with higher income diversity
tend to show lower z-score value that increases the probability of insolvency. The positive
and significant impact of income diversity on financial stability of banks makes sense.
Islamic banks’ income does not solely depend on lending-based operations. Rather, these
banks rely on several different sources of income that positively contribute to improving
the financial stability of these banks.
The sign of estimated coefficient of the cost to income ratio is also different for Islamic and
conventional banks. For conventional banks, it is positive and statistically significant
though at the 10 per cent level of significant, whereas it remains negative and appears
statistically insignificant for Islamic banks. These findings are consistent with Husein
(2014), who also reported that the cost to income ratio does not have any significant impact
IMEFM on Islamic banks. One possible reason for this could be that the conventional banks are
10,2 generally large in size and well established in the business and thus operate at cost-efficient
output levels. In contrast, Islamic banks are relatively young, small and new in the business.
That is why they may incur large costs in their operations. These results are consistent with
several previous studies, including Mokhtar et al. (2006), Cihak and Hesse (2010) and Shahid
and Abbas (2012), reporting that conventional banks are more efficient than Islamic banks,
142 yet this difference is diminishing over time.
The loans-to-assets ratio also affects the financial stability of Islamic and conventional
banks differently. The estimated coefficient for Islamic banks is positive and statistically
significant (coefficient ⫽ 0.171; p-value ⫽ 0.007). This implies that the financial soundness of
Islamic banks increases with loans (investment in case of Islamic banks) relative to banks’
assets[3]. For conventional banks, the loans-to-assets ratio coefficient is negative, yet it
appears statistically insignificant. The negative coefficient implies that the conventional
banks with high loans to assets ratio tend to have low z-score. That is, the probability of
insolvency increases with the increase in the loans-to-assets ratio, suggesting that
conventional banks may take more risky loans, which may increase the likelihood of
insolvency. These findings suggest that conventional banks experience riskier portfolio than
Islamic banks. Such results have also been observed by Cihak and Hesse (2010) and Shahid
and Abbas (2012).
The profitability, still another variable has different effect on both types of banks. In
particular, we find that the estimated coefficient of profitability (coefficient ⫽ 0.757; p-value ⫽
0.000) is positive and statistically significant for Islamic banks, whereas it appears
statistically insignificant for conventional banks. This implies that the profitability of
Islamic banks plays an important role in their financial stability. Islamic banks with higher
profitability ratio tend to observe higher z-sore, and thus contribute positively to the
financial stability of the financial sector. This result is consistent with the findings of Hasan
and Dridi (2010), indicating that profits of the Islamic banks have significant impact on the
financial soundness of the financial sector. The results given in Table III indicate that bank
size does not have any significant impact on the financial stability of banks. Although the
estimated coefficient of bank size appears positive in Models 2 and 4, it is statistically
insignificant. For the market concentration ratio, we find that it is positively related to the
financial soundness of both Islamic and conventional banks even though this relationship is
not statistically significant in either case. This finding is consistent with Schaeck and Cihak
(2007), who also documented that market concentration does not have any significant impact
on the financial stability of the financial sector.
Turning to the effects of macroeconomic indicators, we find that the impact of GDP on
banks’ financial stability is positive for both types of banks except when we estimate the
empirical model without the market concentration ratio. Yet, it is statistically significant at
10 per cent level only for Islamic banks. One reason for not obtaining the significant results
for GDP pertains to the data we use for empirical analysis covering the period 2006-2012
when Pakistan’s economy was facing severe shortages in power supply, political instability
and fight against terrorism. Further, such short span of data may not be enough to capture
the trickle-down effects of macroeconomic conditions. However, one should understand that
we could not acquire data before this period because of its unavailability for Islamic banks in
Pakistan. The insignificant effects of GDP that we reported here are consistent with Cihak
and Hesse (2010), Shahid and Abbas (2012) and Ivičic´ et al. (2008).
Our second macroeconomic indicator, namely, inflation, has also significant differential
effect on the financial soundness of Islamic and conventional banks. Specifically, we find that
inflation is significantly and negatively related to the financial stability of Islamic banks,
whereas the inflation effect for conventional banks is statistically insignificant. These results Islamic
imply that higher inflation in the economy deteriorates the financial stability of Islamic banking
banks, whereas it does not have any significant detrimental effect on the financial health of
conventional banks. There could be several reasons for the differential effect of inflation
across Islamic and conventional banks. For instance, conventional banks generally lend at
fixed rate, while Islamic banks invest against business transactions including P&L sharing
basis. Therefore, increases in price levels may affect Islamic banks’ activities to a greater
extent as compared to their conventional counterparts. 143
In sum, the results that we present in this paper suggest that the effects of the
empirical determinants of the financial stability of banks are considerably different for
Islamic and conventional banks. This implies that both Islamic and conventional banks
contribute differently toward the financial stability of the financial system. These
differential effects are mainly attributed to the differences in the operating principles of
both types of banks. Islamic banks are entitled to conduct their financing and investing
activities as per the Shariah code of conduct, whereas the conventional banks operate on
fixed rate of interest for borrowing and lending business. Therefore, they may not be
able to fully capitalize the benefits of income diversity, increases in loans to assets ratios,
profitability, etc., particularly, in terms of their financial soundness. In general, our
findings suggest that Islamic banks contribute more profoundly to the financial system
stability as compared to the conventional banks.

6. Conclusion and policy implications

The main objective of this paper is to empirically assess the contribution of Islamic
banks in the financial stability of Pakistan. For this, we investigate the relative financial
strength of Islamic banks and their contribution toward the financial stability. We use
quarterly data of ten conventional banks, four full-fledged Islamic banks and six
standalone Islamic branches of conventional banks of Pakistan for the period 2006-2012.
The z-score is calculated and used as the measure of stability of banks. The REs
estimator is applied to quantify the impact of bank-specific variables and
macroeconomic indicators on the financial stability. The empirical framework used in
this paper enables us to examine the differential effect of each underlying variable on
financial stability across Islamic and conventional banks.
By estimating several different specifications, we find that income diversity, the
profitability ratio, the loans-to-assets ratio, bank size and the market concentration ratio
significantly affect the stability of banks operating in Pakistan. Comparing the Islamic and
conventional banks, we demonstrate that Islamic banks are likely to perform better as
compared to conventional banks and contribute relatively more in promoting the stability of
the financial sector. Our results suggest that both bank-specific and macroeconomic
indicators impact differently on the financial soundness of Islamic and conventional banks.
Islamic banks with higher income diversity, higher profitability ratio and higher
investments to assets ratio are likely to achieve higher z-score and, hence, positively
contribute to the stability of the financial system. Overall, the results exhibit that the
contribution of Islamic banks toward the financial stability is found reasonable and
prospective.
The findings of the paper are very useful not only for banks’ managements but also for the
investors, bank customers and policymakers. Specifically, the findings help in enhancing our
understanding as to how the bank-specific variables and macroeconomic indicators are
related to the financial stability of the banking system. The results also help to comprehend
the role of both Islamic and conventional banks in the financial stability. Further, the results
IMEFM suggest that by creating healthy competition in banking industry, the role of banks toward
10,2 financial soundness can be enhanced. The results regarding macroeconomic indicators
imply that protective measures should be undertaken to enhance the positive effect of GDP
on the financial stability and to lessen the negative effect of inflation on the financial system
stability.

144 Notes
1. In 1975, the Islamic Development Bank was set up in Saudi Arabia with the mission to provide
funding to projects in the Islamic countries. The first modern commercial Islamic bank, Dubai
Islamic Bank, opened its doors in 1975.
2. One should also note that as the results presented in Table II are based on the whole sample
including both Islamic and conventional banks, it is very likely that the positive impact of the loan
to asset ratio is driven by the presence of Islamic banks in the sample. This is because, in case of
Islamic banks, higher loan to asset ratio does not mean that Islamic banks are increasing their loans;
rather, it implies that the banks have more investments. This has also been confirmed when we
estimate the impact of the loan to asset ratio separately for a sample of Islamic and conventional
banks. The estimated coefficient of the loan to asset ratio is positive and statistically significant for
Islamic banks, whereas, it is negative but statistically insignificant for conventional banks.
3. In case of Islamic banks, higher loan to asset ratio does not mean that Islamic banks are increasing
their loans; rather, it implies that the banks have more investments.

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Appendix Islamic
banking
Variables Description Definition

Income diversity Income diversity is the bank specific variable Income diversity ⫽ Net interest
that defines the bank income structure. It income ⫺ other operating
describes how much a bank diversified its Income/total operating income 147
income
Cost to income The cost to income ratio is an efficiency Cost to income ⫽ operating
measure. The cost to income ratio describes expenses/operating income
how much cost incurred to earn the income
Loan to asset This ratio measures the liquidity. The loan to Loan to asset ⫽ net loan/total
assets ratio depicts that how much portion of assets
assets are financed through the loans
Profitability ratio The profitability ratio accesses a bank’s ROA ⫽ net income/total assets
ability to earn profit and shows the ability of ROE ⫽ net
the banks to generate how much earning by income/shareholder’s equity
utilizing its resources. It is measured by ROA
and ROE
Bank asset size Bank asset size is an important factor of a We have taken log of the bank
bank’s performance and stability assets a proxy for bank size in
our study
Inflation Inflation is a macro economic indicator. It is a It is defined as the first
rate at which the prices of goods and services difference of log CPI
are increasing in an economy
Gross domestic GDP is also macroeconomic indicator. It is a Following Rashid and Jehan
product monetary measure of all the final goods and (2013), we interpolate annual
services produced in an economy GDP to get quarterly figures
Market concentration The market concentration ratio is a measure C4 concentration ration is used
ratio of the total output produced in an industry to measure the market
by a given number of the firms in an concentration
industry. It depicts the behavior of the
market and the extent of the market control
of the largest firms in the industry
Credit risk Credit risk is a type of financial risk and it Credit risk ⫽ loan loss Table AI.
measures the risk of default. Higher the ratio provision divided by net Variable description
would increase the banks insolvency risk interest income and definition

Constant Constant and trend

Variables Z statistic L* statistic Z statistic L* statistic

Income diversity ⫺4.346 (0.002) ⫺5.864 (0.000) ⫺3.205 (0.003) ⫺4.164 (0.001)
Cost to income ⫺6.974 (0.000) ⫺8.228 (0.000) ⫺4.683 (0.000) ⫺5.765 (0.000)
Loan to asset ⫺9.325 (0.000) ⫺12.975 (0.000) ⫺6.534 (0.000) ⫺8.934 (0.000)
Profitability ratio ⫺5.806 (0.000) ⫺10.792 (0.000) ⫺3.437 (0.000) ⫺4.648 (0.000)
Bank asset size ⫺3.856 (0.000) ⫺6.395 (0.000) ⫺3.116 (0.000) ⫺5.437 (0.000)
Market concentration ratio ⫺11.693 (0.000) ⫺14.837 (0.000) ⫺8.764 (0.000) ⫺9.682 (0.000)
Credit risk ⫺8.438 (0.000) ⫺10.586 (0.000) ⫺4.654 (0.000) ⫺7.539 (0.000)
Inflation ⫺4.865 (0.000) ⫺3.297 (0.000) Table AII.
Quarterly GDP ⫺3.897 (0.002) ⫺2.876 (0.003) Unit root test results
IMEFM Variables Statistics All banks Conventional banks Islamic banks
10,2
Profitability Mean 15.94 11.33 20.85
Max 119.61 38.7 119.61
Min ⫺91.78 ⫺91.78 ⫺52.66
SD 19.72 12.11 24.53
148 Income diversity Mean 0.65 0.53 0.78
Max 4.27 3.2 4.27
Min ⫺2.67 ⫺0.8 ⫺2.67
SD 0.55 0.34 0.68
Cost to income Mean 76.65 64.33 89.76
Max 1272.83 1272.83 824.9
Min ⫺299.31 ⫺299.31 8.18
SD 106.75 89.75 121.09
Loan to assets Mean 0.54 0.55 0.52
Max 3.40 0.75 3.40
Min 0 0.31 0
SD 0.33 0.095 0.45
Credit risk Mean 0.16 0.25 0.06
Max 8.8 8.8 1
Min ⫺3.88 ⫺3.88 ⫺0.05
SD 0.52 0.71 0.11
Market share Mean 5.10 9.12 0.83
Max 61.68 61.68 8.89
Min 0.02 0.24 0.02
SD 6.07 6.05 1.25
Table AIII. Log assets (size) Mean 17.70 19.63 15.65
Descriptive statistics Max 22.49 22.49 19.43
of independent Min 6.31 17.65 6.31
variables (2006-2012) SD 3.08 0.61 3.32

Corresponding author
Abdul Rashid can be contacted at: ch.arahmad@yahoo.com

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