## 1. Market Share and Growth in Assets of Islamic Banks (IBs) and Conventional Banks (CBs) in Selected Countries

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### Key statistics and market size
- Global size of the Islamic banking industry at end-2008: US$820 billion (estimated).
- Market share of Islamic finance in GCC banking systems:
  - End-2008 range: 11−35 percent.
  - 2004 range: 5−24 percent.
- Selected country figures (market share; growth rate assets IBs; growth rate assets banking system; period):
  - Saudi Arabia: Market share 35.0; Growth rate of assets (Islamic banks) 33.4; Growth rate of assets (banking system) 19.0; Period 2003-2008
  - Bahrain: Market share 29.9; Growth rate of assets (Islamic banks) 37.6; Growth rate of assets (banking system) 9.6; Period 2000-2008
  - Kuwait: Market share 29.0; Growth rate of assets (Islamic banks) 28.3; Growth rate of assets (banking system) 19.0; Period 2002-2008
  - UAE: Market share 13.5; Growth rate of assets (Islamic banks) 59.8; Growth rate of assets (banking system) 38.1; Period 2001-2008
  - Qatar: Market share 11.5; Growth rate of assets (Islamic banks) 65.8; Growth rate of assets (banking system) 38.1; Period 2002-2008
  - GCC average: Market share 23.8; Growth rate of assets (Islamic banks) 45.0; Growth rate of assets (banking system) 24.8
  - Jordan: Market share 10.3; Growth rate of assets (Islamic banks) 20.6; Growth rate of assets (banking system) 11.2; Period 2001-2008
  - Turkey: Market share 3.5; Growth rate of assets (Islamic banks) 41.0; Growth rate of assets (banking system) 19.0; Period 2001-2008
  - Malaysia: Market share 17.4; Growth rate of assets (Islamic banks) 20.0; Growth rate of assets (banking system) 14.0; Period 2000-2008

### Sample and data coverage
- Bank-level data covering 2007−10 for about 120 IBs and CBs in eight countries: Bahrain (including offshore), Jordan, Kuwait, Malaysia, Qatar, Saudi Arabia, Turkey, and the UAE.
- Proportion Islamic in sample: about one-fourth of the approximately 120 banks.
- Sample coverage: covers over 80 percent of IBs globally if Iran is excluded.
- Key assessment variables: changes in profitability, bank lending, bank assets, and external bank ratings.

### Major findings on performance during the global financial crisis
- Profitability:
  - IBs fared better than CBs in 2008.
  - This advantage was reversed in 2009 as the crisis hit the real economy.
- Credit and asset growth:
  - IBs’ growth in credit and assets continued to be higher than that of CBs in all countries except the UAE.
  - On average, IBs‘ credit growth was twice that of CBs during 2007–09.
  - On average, IBs‘ asset growth was more than twice that of CBs during 2007–09.
- External ratings:
  - With the exception of the UAE, the change in IBs’ risk assessment (ratings) has been better than or similar to that of CBs.
- Overall assessment:
  - IBs showed stronger resilience, on average, during the global financial crisis, with heterogeneous country outcomes and a reversal in 2009 for some IBs.

### Explaining differences in performance
- Factors containing adverse impact on profitability in 2008:
  - Limited exposure to toxic assets, derivatives, and conventional financial institution securities (Islamic model does not allow investing in these instruments).
  - Asset-based and risk-sharing nature limited exposure to the assets linked to large losses in many CBs.
- Factors weakening IBs’ performance in 2009:
  - Weaknesses in risk-management practices in some IBs led to larger declines in profitability.
  - Real-economy impact of the crisis affected IB profitability.
- Balance-sheet characteristics:
  - IBs exhibited lower leverage and higher solvency, helping meet stronger demand for credit and maintain stable external ratings.
- Evolution away from risk sharing:
  - PSIAs being replaced in practice by time deposits based on reverse Murabahah (guaranteed return), reducing risk-sharing features.
  - Financing largely in form of Murabahah or installment sales (70−80 percent), making credit risk the main risk faced by IBs.

### Limitations and methodology notes
- Cross-country comparisons are challenging due to heterogeneity in regulatory frameworks, macro shocks, and policy responses.
- Analysis focuses on performance at the country level to control for heterogeneity.
- Countries with dominant IB sectors such as Iran and Sudan were not included.

### Policy-relevant observations and institutional constraints
- Risk profile:
  - IB contracts involve credit and market risks and create liquidity, operational, strategic, and other risks.
  - Interest-rate-type risk is very limited for IBs, but hedging instruments are largely unavailable.
- Liquidity management challenges:
  - PSIAs have uncertain returns; liquidity risk management infrastructure and tools are underdeveloped.
  - Dependence on bank deposits is limited; absence of an interbank rate (except limited reverse Murabahah).
  - IBs usually maintain higher liquidity buffers but have limited tools (e.g., sovereign sukuks) to deploy liquidity.
- Regulatory context:
  - IFSB Capital Adequacy and Risk Management standards suggest financial risks in Shariah-compliant contracts are not significantly different from conventional ones.
  - IBs can be a source of systemic risk as they accept deposits and grow in size; regulation is as important as for CBs.
  - In practice, IBs are subject to similar regulatory and supervisory regimes and levels as CBs.

### Case illustration: Kuwait Finance House (KFH) and investment account holders (IAHs)
- Historical return pattern for KFH IAHs:
  - Zero return in 1984 with the crash in the real estate market.
  - Low return in the early 1990s after the Iraqi invasion of Kuwait.
  - Significantly higher return in the 2000s with the economic boom.
- KFH investment deposit practice:
  - Approximately 90 percent of investment deposits for an unlimited period are generally invested.
  - 80 percent of investment deposits for a limited period are generally invested.
  - 60 percent of the investment savings accounts are generally invested.
  - The remaining non-invested portion of these investment deposits is guaranteed to be paid back to depositors.

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### Appendix II — Database and Detailed Findings on Islamic Banking Sample

### Database and sample composition and initial conditions
- Main data sources: banks’ annual and interim reports, Zawya database, rating agencies.
- Country/model differences:
  - Jordan, Kuwait, Turkey: CBs do not have Islamic windows.
  - Bahraini offshore banks: largely investment activities; sample includes Bahrain offshore to cover investment banking.
  - Malaysian IBs in sample: all subsidiaries of CBs.
- Coverage and market shares:
  - Five countries (Turkey, Saudi, the UAE, Malaysia, and Kuwait) represent about 85 percent of the sample total assets and about 77 percent of the IB market share.
- Pre-crisis characteristics:
  - IBs have higher capital adequacy ratios and are less leveraged.
  - IBs have smaller investment portfolios and rely less on wholesale deposits.
  - Profitability (2005–07): IBs’ average return on assets/equity was clearly higher than CBs.
  - Nonperforming loans pre-crisis: IBs had slightly higher NPL ratios on average.

### Sectoral distribution of credit and cautions
- Sectoral patterns (2008):
  - IBs’ exposure to real estate and construction lower in Saudi Arabia, Bahrain, Jordan, and Malaysia.
  - IBs’ exposure to real estate and construction significantly higher than system average in Qatar, Turkey, and the UAE; in the UAE and Qatar it exceeded legal limits for banks.
- Data caveats:
  - Sector definitions vary across countries; mortgage loans classification differs.

### Empirical assessment of crisis impact — Profitability details
- 2008:
  - IBs fared better in all countries except Qatar, the UAE, and Malaysia.
  - In Saudi Arabia, Bahrain offshore, Jordan, and Turkey the change in profitability was significantly more favorable for IBs.
  - Aggregate test: on average, IBs fared better than CBs in 2008.
- 2009:
  - IBs fared worse on average; profitability declined significantly more for IBs in Bahrain (including offshore) and the UAE; in Qatar IB profitability increased less than CBs.
  - Aggregate test: on average, IBs fared worse than CBs in 2009.
- Cumulative (average 2008 and 2009 vs 2007):
  - IBs fared better in all countries except Bahrain, Qatar, and the UAE.
  - Aggregate test: difference between cumulative impacts on profitability of IBs and CBs is insignificant on average.
- Interpretation:
  - Initial impact in 2008 on IB profitability was limited; as crisis moved to the real economy, IBs in some countries faced larger losses.
  - Average return on assets and equity for 2008–09 were very close between IBs and CBs, suggesting higher profitability for IBs over the 2005−09 business cycle.
  - Nonperforming loan ratios for IBs remained slightly higher than for CBs; in Bahrain both IBs‘ and CBs‘ NPLs doubled.

### Credit and asset growth empirical findings
- Credit growth:
  - IBs maintained stronger credit growth than CBs in almost all countries and years.
  - IBs‘ credit growth was twice that of CBs during 2007–09.
  - Change in credit growth rate: IBs’ credit growth less affected by crisis except in Bahrain and Qatar.
  - Caveat: very high credit growth may reflect weakening underwriting standards; supervisors should monitor high credit growth.
- Asset growth:
  - IBs maintained stronger asset growth than CBs in almost all countries.
  - IBs‘ asset growth was more than twice that of CBs during 2007–09.
  - Change in asset growth rate: IBs‘ asset growth decelerated faster than CBs in general; factors include weaker performance in 2009 and differential liquidity support (easier to direct government deposits to CBs).
  - Example numeric detail: Public sector deposits in Jordan Islamic banks were about 1.5 percent of total deposits while public sector deposits averaged 8 percent in the banking system deposits in 2008.

### External ratings
- Ratings compared: pre-crisis (before September 2008) vs April 2010 by Fitch, Moody‘s, S&P.
- Mapping: ratings to 1-year probability of default via Moody‘s Average Cumulative Issuer Default Rates.
- Coverage: external ratings available for about 70 banks in the sample.
- Findings:
  - Except for the UAE, change in IBs‘ ratings has been more favorable or similar to CBs.
  - In Qatar and Saudi Arabia, the crisis did not change agencies’ views on banks’ capacity to meet long-term obligations, reflecting public sector support.
  - Malaysian IBs largely subsidiaries of CBs; absence of independent ratings explained.

### Limitations, timing, and caveats
- Results provisional; impact of crisis still unfolding.
- Specific concerns:
  - Increase in NPLs likely to continue into 2010.
  - Losses from Dubai debt restructuring and European crisis likely reflected in 2010.
  - Delay in recognizing deterioration in asset quality (due to rescheduling/restructuring or relaxed classification/provisioning) complicates full impact assessment.
- CBs have more flexibility in debt restructuring since they can provide customers with cash, facilitating regulatory compliance for rescheduling.

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### Part V — Regression Analysis: Factors Explaining Profitability, Credit and Asset Growth

### Regression framework and dependent variables
- Dependent variables for profitability regressions:
  - 100*(2008_profits/2007_profits -1)
  - 100*(2009_profits/2007_profits -1)
  - 100*((2009_profits*0.5+2008_profits*0.5)/2007_profits -1)
- Country dummies (omitted: Bahrain offshore) materially improve model fit versus macro variables.

### Profitability regressions (2008 vs 2007) — selected findings from Table 5
- Key interpretations:
  - A one percent higher investment-to-asset ratio or a one-time higher assets-to-capital ratio lead to a decline in profitability by 1.8 and 12.2 percent, respectively (Models 5 and 6).
  - Models 3, 5, and 6 indicate profitability likely to increase by about 44 percent if the bank is an IB.
  - Model 7: profitability likely to improve by about 66 percent if the bank is a large IB.
- Selected coefficients and P-values (Models 1–7):
  - Investment portfolio-to-total assets: -4.59 P-value 0.00; -4.50 P-value 0.00; -2.81 P-value 0.02; -2.65 P-value 0.01; -1.79 P-value 0.06; -1.80 P-value 0.06; -1.50 P-value 0.13.
  - Leverage (assets-to-capital): -5.93 P-value 0.08; -3.60 P-value 0.27; -9.54 P-value 0.01; -7.92 P-value 0.03; -12.16 P-value 0.00; -12.31 P-value 0.00.
  - Islamic bank dummy (IB=1): 30.79 P-value 0.23; 44.85 P-value 0.06; 43.55 P-value 0.07.
  - Size of the IB dummy (Large=1): 65.93 P-value 0.04 (Model 7).
  - Change in interbank rate: 20.29 P-value 0.04 (Model 4).
  - Country dummies (Model 6) examples: UAE 148.51 P-value 0.00; Bahrain 114.45 P-value 0.01; Jordan 193.56 P-value 0.00; Malaysia 180.34 P-value 0.00; Saudi 183.66 P-value 0.00; Turkey 157.53 P-value 0.00; Qatar 185.41 P-value 0.00.
- Model fit indicators (Models 1–7):
  - Number of obs: 113; 113; 113; 113; 120; 120; 120.
  - F-statistics: 7.72; 8.19; 6.05; 7.21; 6.21; 5.71; 5.55.
  - Prob > F: 0.000 for all models.
  - R-squared: 0.30; 0.2768; 0.48; 0.46; 0.41; 0.41; 0.36.
  - Adj R-squared: 0.26; 0.2430; 0.40; 0.40; 0.34; 0.34; 0.30.

### Profitability regressions (2009 vs 2007) — selected findings from Table 6
- Summary:
  - Balance sheet variables generally not statistically significant for 2009–2007.
  - Models 3, 5 and 6 indicate other IB-associated factors not captured could explain IBs’ weaker 2009 performance.
  - Model 7: profitability likely to improve by 68 percent and 53 percent if the bank is a large IB or CB, respectively.
- Selected coefficients and P-values (Models 1–7):
  - Investment portfolio-to-total assets: -2.99 P-value 0.00; -3.09 P-value 0.00; -1.32 P-value 0.17; -1.06 P-value 0.21; -1.06 P-value 0.17; -1.06 P-value 0.17; -0.69 P-value 0.35.
  - Banks' deposits-to-total deposits: -1.58 P-value 0.01; -1.56 P-value 0.01.
  - Size of the bank dummy (Large=1): 30.58 P-value 0.06; 38.56 P-value 0.02; 38.39 P-value 0.02.
  - Size of the IB dummy (Large=1): 66.67 P-value 0.00 (Model 7).
  - Country dummies (Model 6) examples: UAE 167.62 P-value 0.00; Bahrain 74.57 P-value 0.02; Jordan 201.30 P-value 0.00; Malaysia 208.83 P-value 0.00; Saudi 157.90 P-value 0.00; Turkey 177.82 P-value 0.00; Qatar 210.08 P-value 0.00.
- Model fit indicators (Models 1–7):
  - Number of obs: 111; 111; 111; 111; 118; 118; 118.
  - F-statistics: 6.99; 7.80; 6.77; 8.06; 9.30; 8.35; 10.69.
  - Prob > F: 0.000 for all models.
  - R-squared: 0.29; 0.27; 0.52; 0.50; 0.52; 0.49; 0.53.
  - Adj R-squared: 0.25; 0.24; 0.44; 0.44; 0.46; 0.43; 0.48.

### Cumulative profitability regressions (average 2008 and 2009 vs 2007) — selected findings from Table 7
- Summary:
  - Most bank-specific variables insignificant for cumulative measure; investment portfolio variable nearly significant at 10 percent.
  - Large banks fared better on average than small ones; large IBs in particular fared better.
- Selected coefficients and P-values (Models 1–7):
  - Investment portfolio-to-total assets: 0.46 P-value 0.67; 0.41 P-value 0.70; 1.76 P-value 0.16; 1.80 P-value 0.10; 0.37 P-value 0.73; 0.29 P-value 0.78; 0.85 P-value 0.42.
  - Leverage (assets-to-capital): 6.27 P-value 0.05; 6.27 P-value 0.04; 3.33 P-value 0.35; 5.39 P-value 0.11; 4.19 P-value 0.27.
  - Size of the bank dummy (Large=1): 35.34 P-value 0.09; 46.13 P-value 0.04; 54.67 P-value 0.01.
  - Size of the IB dummy (Large=1): 67.83 P-value 0.04 (Model 7).
  - Country dummies (Model 6) examples: UAE 195.11 P-value 0.00; Jordan 212.89 P-value 0.00; Malaysia 240.19 P-value 0.00; Saudi 130.17 P-value 0.00; Qatar 242.06 P-value 0.00.
- Model fit indicators (Models 1–7):
  - Number of obs: 111; 111; 111; 111; 118; 118; 118.
  - F-statistics: 3.51; 4.23; 4.29; 4.67; 6.52; 6.40; 6.61.
  - Prob > F: 0.000 for all models.
  - R-squared: 0.17; 0.17; 0.40; 0.36; 0.40; 0.42; 0.41.
  - Adj R-squared: 0.12; 0.13; 0.31; 0.29; 0.34; 0.36; 0.35.

### Credit and asset growth regressions (selected coefficients)
- Credit growth (dependent variable 100*(2009_Credit)/2008_Credit -1), Table 8 (Models 1–3):
  - Consumer loans: 0.51 P-value 0.04; 0.62 P-value 0.02; 0.50 P-value 0.05.
  - Real estate & construction-to-total loans: 0.60 P-value 0.05; 0.72 P-value 0.03; 0.60 P-value 0.05.
  - Banks' deposits-to-total deposits: 0.71 P-value 0.01; 0.63 P-value 0.03; 0.70 P-value 0.01.
  - Islamic bank dummy (IB=1): 24.06 P-value 0.00; 27.07 P-value 0.01.
  - Number of obs: 9; 9; 9.
  - R-squared: 0.35; 0.29; 0.35.
  - Adj R-squared: 0.23; 0.16; 0.22.
- Asset growth (dependent variable 100*(2009_Assets)/2007_Assets -1), Table 9 (Models 1–3):
  - Consumer loans: 0.8037790 P-value 0.009; 0.86997120 P-value 0.003; 0.8379350 P-value 0.003.
  - Capital adequacy ratio (CAR): 1.6266930 P-value 0.082; 2.088050 P-value 0.026; 2.0902210 P-value 0.006.
  - Islamic bank dummy (IB=1): 20.764150 P-value 0.041; 19.257230 P-value 0.05.
  - Country dummies: UAE 67.056380 P-value 0.032; Qatar 111.12830 P-value 0.001 (Model1).
  - Number of obs: 103; 102; 103.
  - R-squared: 0.3855; 0.3702; 0.3795.
  - Adj R-squared: 0.2796; 0.2517; 0.2888.

### Interpretation and implications from regressions
- Investment portfolio size and leverage associated with worse profitability outcomes during the crisis.
- IBs’ better performance in 2008 partly explained by smaller investment portfolios and lower leverage; zero exposure to toxic assets, derivatives, and conventional financial institution securities also relevant.
- In 2009, unexplained IB-associated factors (e.g., name concentration) may have contributed to weaker IB performance; large IBs continued to fare better than small IBs across periods.
- Country-specific effects important; country dummies substantially improve explanatory power.
- Size advantage appears driven by large IBs, suggesting diversification, economies of scale, and reputation bolster resilience.

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### BOX 3 — Examples of Banks’ Losses and Crisis Lessons

### Illustrative bank losses during the crisis
- Gulf International Bank (GIB, Bahraini wholesale CB): about US$1.3 billion losses in securities investments in debt-based toxic assets and in U.S. banks (e.g., Lehman Brothers); shareholders injected US$1 billion of new capital and bought toxic asset-backed securities worth $4.8 billion.
- The Arab Banking Corporation (Bahraini wholesale CB): $1.2 billion losses; shareholders injected $1 billion of new capital.
- Gulf Bank (Kuwaiti CB): $1.4 billion losses due mainly to derivatives activities; shareholders and the Kuwait Investment Authority injected an equivalent amount of capital.
- National Commercial Bank (NCB, Saudi conventional bank): lost more than one billion riyal on changes in fair value for financial instruments in 2008.
- Global Finance House (wholesale IB): lost $730 million, including $311 million in provisions for a Dubai real estate project.
- Bahrain Islamic Bank exposure to Saudi groups Saad and Algosaibi contributed to $51 million losses in 2009.

### Profit/loss-sharing and IB profitability
- Profit/loss-sharing investment deposits provide IBs with an additional buffer but were not stress-tested as most banks remained profitable.
- KFH PSIA return in 2009 exemplifies sharing of IBs’ profitability with IAHs.
- Some IBs use income-smoothing strategies to limit short-term profitability disadvantages.

### Challenges for IBs highlighted by the crisis
- Underdeveloped liquidity risk management infrastructure and tools.
- Incomplete or untested legal frameworks; lack of harmonized contracts.
- Shortage of expertise at supervisory and industry levels relative to industry growth.
- Shallow money markets and paucity of Shariah-compliant collateral/instruments for central bank facilities.
- Need to develop the sukuk market, especially sovereign sukuks, and Shariah-compliant money markets.
- Legal episodes (East Cameron Gas Company sukuk US$167 million; Kuwait Investment Dar sukuk US$100 million; Saad Group US$650 million Golden Built Sukuk; Nakheel sukuk episode) highlighted legal and regulatory risks.
- Standards and expertise:
  - Local standards mix IFRS, IAS, AAOIFI and other specific standards; IFSB standards not fully implemented in many countries.
  - Mutual recognition of financial standards/products and development of human capital recommended.
- Empirical liquidity note:
  - IBs carry 40 percent more liquidity than conventional counterparts and commit about 95 percent of funds to short-term Ijarah, Murabahah and Musharakah instruments (Khan et al, 2008).
  - A Liquidity Management Task Force was formed in early 2009 by the IFSB and the Islamic Development Bank.

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### Conclusions and policy implications (as presented)
- Structural differences:
  - Conventional intermediation: debt-based, allows risk transfer.
  - Islamic intermediation: asset-based, centers on risk sharing; features provide additional buffers and tend to reduce contribution to excesses and bubbles.
- Performance summary:
  - Business-model factors helped contain adverse impact on IB profitability in 2008; risk-management weaknesses led to larger declines in 2009 in some IBs.
  - Adherence to Shariah precluded many IBs from investing in instruments that affected CBs.
  - Weak performance in some countries associated with sectoral/name concentration and exemptions from concentration limits (e.g., UAE real estate lending exceeding 25 percent limit).
- Industry trends and supervision:
  - Despite higher pre-crisis profitability (2005–07), IBs‘ average profitability for 2008–09 was similar to CBs.
  - Large IBs fared better than small ones; developing large, well-managed IBs recommended.
  - IBs’ credit and asset growth at least twice that of CBs during the crisis implies growing market share and supervisory responsibility.
  - External rating agencies’ reassessment of IBs generally more favorable or similar to CBs.
- Policy priorities:
  - Build a well-functioning liquidity management infrastructure and ensure neutrality to bank type.
  - Ensure supervisory and legal infrastructure, including bank resolution frameworks, remain relevant to Islamic finance and global reforms.
  - Promote greater convergence and harmonization of regulations and products, and develop human capital in IBs and supervision to support sustainable industry growth.

*Source: IMF Working Paper — 1. Market Share and Growth in Assets of Islamic Banks (IBs) and Conventional Banks (CBs) in Selected Countries (excerpts).*

### 1. Market Share and Growth in Assets of Islamic Banks (IBs) and

### 1. Market Share and Growth in Assets of Islamic Banks (IBs) and Conventional Banks (CBs) in Selected Countries

### Key statistics and market size
- It is estimated that the size of the Islamic banking industry at the global level was close to US$820 billion at end-2008 (IFSB et al, 2010).
- Market share of Islamic finance in the banking systems of the GCC countries at end-2008 was in the range of 11−35 percent, compared with 5−24 percent in 2004.
- Table 1 (selected country figures reported in source text):
  - Saudi Arabia: Market share 35.0; Growth rate of assets (Islamic banks) 33.4; Growth rate of assets (banking system) 19.0; Period 2003-2008
  - Bahrain: Market share 29.9; Growth rate of assets (Islamic banks) 37.6; Growth rate of assets (banking system) 9.6; Period 2000-2008
  - Kuwait: Market share 29.0; Growth rate of assets (Islamic banks) 28.3; Growth rate of assets (banking system) 19.0; Period 2002-2008
  - UAE: Market share 13.5; Growth rate of assets (Islamic banks) 59.8; Growth rate of assets (banking system) 38.1; Period 2001-2008
  - Qatar: Market share 11.5; Growth rate of assets (Islamic banks) 65.8; Growth rate of assets (banking system) 38.1; Period 2002-2008
  - GCC average: Market share 23.8; Growth rate of assets (Islamic banks) 45.0; Growth rate of assets (banking system) 24.8
  - Jordan: Market share 10.3; Growth rate of assets (Islamic banks) 20.6; Growth rate of assets (banking system) 11.2; Period 2001-2008
  - Turkey: Market share 3.5; Growth rate of assets (Islamic banks) 41.0; Growth rate of assets (banking system) 19.0; Period 2001-2008
  - Malaysia: Market share 17.4; Growth rate of assets (Islamic banks) 20.0; Growth rate of assets (banking system) 14.0; Period 2000-2008

### Sample and data coverage
- Bank-level data covering 2007−10 for about 120 IBs and CBs in eight countries: Bahrain (including offshore), Jordan, Kuwait, Malaysia, Qatar, Saudi Arabia, Turkey, and the UAE.
- Of the approximately 120 banks in the database, about one-fourth are Islamic.
- The sample covers over 80 percent of IBs globally if Iran is excluded.
- Key assessment variables: changes in profitability, bank lending, bank assets, and external bank ratings.

### Major findings on performance during the global financial crisis
- Profitability:
  - IBs fared better than CBs in 2008.
  - This advantage was reversed in 2009 as the crisis hit the real economy.
- Credit and asset growth:
  - IBs’ growth in credit and assets continued to be higher than that of CBs in all countries except the UAE.
- External ratings:
  - With the exception of the UAE, the change in IBs’ risk assessment, as reflected in ratings by various rating agencies, has been better than or similar to that of CBs.
- Overall assessment:
  - IBs showed stronger resilience, on average, during the global financial crisis.

### Explaining differences in performance
- Factors that helped IBs contain adverse impact on profitability in 2008:
  - Business-model features such as limited exposure to toxic assets, derivatives, and conventional financial institution securities (IBs’ model does not allow investing in these instruments).
  - Asset-based and risk-sharing nature of Islamic finance limited exposure to the types of assets associated with large losses in many CBs.
- Factors that weakened IBs’ performance in 2009:
  - Weaknesses in risk-management practices in some IBs led to larger declines in profitability compared to CBs in 2009.
  - The real-economy impact of the crisis affected IB profitability.
- Balance-sheet characteristics:
  - IBs exhibited lower leverage and higher solvency, which helped meet relatively stronger demand for credit and maintain stable external ratings.

### Limitations and methodology notes relevant to findings
- Cross-country comparisons of IBs vs CBs are challenging because of heterogeneity across countries in regulatory frameworks, macro shocks, and policy responses.
- The paper focuses on performance at the country level to control for heterogeneity across countries where IBs operate.
- Countries with dominant IB sectors such as Iran and Sudan were not included because the analysis focuses on comparing IBs and CBs in the same country.

### Policy-relevant observations and institutional constraints
- Risk profile and contracts:
  - IB contracts involve credit and market risks, and IB activities create liquidity, operational, strategic, and other types of risks.
  - Interest-rate-type risk is very limited for IBs, but hedging instruments are largely unavailable.
- Liquidity management challenges:
  - Managing liquidity is more challenging in IBs because PSIAs (profit sharing investment accounts) have uncertain returns and the infrastructure and tools for liquidity risk management by IBs are still in their infancy in many jurisdictions.
  - Dependence on bank deposits is limited due to a less active market and the absence of an interbank rate, except under limited reverse Murabahah.
  - IBs usually maintain higher liquidity buffers, but limited tools (e.g., sovereign sukuks) for making use of this liquidity prevent IBs from operating at a level playing field with CBs.
- Evolution away from risk sharing:
  - In practice, PSIAs are being replaced in a number of IBs by time deposits based on reverse Murabahah transactions; these deposits do not have the risk-sharing features of PSIAs since the return is guaranteed.
  - On the asset side, risk sharing (Mudharabah, Musharakah) is the exception rather than the rule: most financing is in the form of Murabahah contracts or installment sales (70−80 percent), making credit risk the main risk faced by IBs, similar to CBs.
- Regulatory and supervisory context:
  - The IFSB Capital Adequacy and Risk Management standards suggest that the type and size of financial risks in Shariah-compliant contracts are not significantly different from those in conventional contracts.
  - Since IBs accept deposits and are growing in size, they can be a source of systemic risk; their regulation is as important as that of CBs.
  - From a practical point of view, IBs are subject to similar regulatory and supervisory regimes and levels as CBs.

### Case illustration: Kuwait Finance House (KFH) and risk sharing
- Historical return pattern for KFH investment account holders (IAHs):
  - Zero return in 1984 with the crash in the real estate market.
  - Low return in the early 1990s after the Iraqi invasion of Kuwait.
  - Significantly higher return in the 2000s with the economic boom.
- The KFH example shows how risk sharing translates into variable returns for IAHs and can provide an additional buffer against adverse market conditions and smooth return on equity.
- KFH investment deposit practice (as described):
  - Approximately 90 percent of investment deposits for an unlimited period are generally invested.
  - 80 percent of investment deposits for a limited period are generally invested.
  - 60 percent of the investment savings accounts are generally invested.
  - The remaining non-invested portion of these investment deposits is guaranteed to be paid back to depositors.

*Source: IMF Working Paper — 1. Market Share and Growth in Assets of Islamic Banks (IBs) and Conventional Banks (CBs) in Selected Countries (excerpts).*

### Appendix II discusses in more detail the database used in the analysis.

### Appendix II — Database and Detailed Findings on Islamic Banking Sample

### Database and sample composition
- Main sources used in building the database include banks‘ annual and interim reports, Zawya database, and information from rating agencies.
- Countries differ in terms of Islamic banking model and market structure:
  - In Jordan, Kuwait, and Turkey, CBs do not have Islamic windows.
  - The Bahraini wholesale (offshore) banks are largely involved in investment activities and are not regulated as rigorously as domestic (retail) banks; by covering Bahrain offshore activities, the sample includes an important part of investment banking.
  - The Malaysian IBs included in the sample are all subsidiaries of CBs.
- Coverage and market shares:
  - Five countries (Turkey, Saudi, the UAE, Malaysia, and Kuwait) represent about 85 percent of the sample total assets and about 77 percent of the IB market share (Figure 2).
- Islamic banking activities conducted by CBs are not captured in the sample due to lack of reliable data.

### Initial conditions and structural features (Section B)
- Average pre-crisis characteristics (summary from Figures and text):
  - IBs have higher capital adequacy ratios and are less leveraged (i.e., have higher capital-to-assets ratio).
  - IBs have smaller investment portfolios and rely less on wholesale (banks) deposits.
  - Restrictions and model features noted:
    - Asset-based financing, weaker interbank markets, and restricted lender-of-last-resort limit leverage and reliance on wholesale deposits.
    - Restrictions on investments (e.g., no investments in toxic assets, bonds or conventional financial institution securities), and the lack of hedging instruments limit the size of IB investment portfolios.
- Profitability pre-crisis:
  - Figure 4 indicates average profitability of IBs, measured by average return on average assets or average return on average equity, for 2005–07 (pre-crisis) was clearly higher than that of CBs during the same period.
- Nonperforming loans pre-crisis:
  - Figure 5 shows, on average, IBs had slightly higher nonperforming loan ratios pre-crisis.
  - Explanations proposed:
    - IBs have limited capacity to evergreen loans, given their inability to lend in cash.
    - Limited exposure to the risk-free government sector and relatively higher exposure to consumer sector, which usually has a higher default rate.

### Sectoral distribution of credit (Table 3 and cautions)
- Table 3 compares IBs' and CBs' sectoral distribution of credit (In percent, 2008) across countries (Saudi Arabia, Kuwait, UAE, Bahrain, Qatar, Jordan, Bahrain offshore, Malaysia, Turkey).
- Noted sectoral patterns:
  - IBs‘ exposure to the real estate and construction sectors are lower in Saudi Arabia, Bahrain, Jordan, and Malaysia.
  - IBs‘ exposure to real estate and construction is significantly higher than the system‘s average in Qatar, Turkey, and the UAE; in the UAE and Qatar it exceeded limits imposed by law for banks, preventing CBs level playing field with IBs and increasing risk concentration.
- Data interpretation caveats:
  - The definition of sectors varies across countries (e.g., classification may be by type of borrower rather than use of loans).
  - Mortgage loans may be classified differently: in some countries as part of real estate loans, in others grouped with consumer loans while real estate loans include mainly commercial real estate.

### Empirical assessment of crisis impact (Section IV)
- Analytical framework:
  - Four key indicators used to assess the impact on IBs and CBs: changes in (i) profitability; (ii) bank lending; (iii) bank assets; and (iv) bank ratings. Changes in profitability (profit level in dollars) are the key variable.
  - Country-level focus to control for pre-crisis excesses, vulnerabilities, and policy responses.

- Profitability (Section A; Figures 6–7 and Table 4 Part 1):
  - 2008:
    - IBs fared better in all countries except Qatar, the UAE, and Malaysia.
    - In Saudi Arabia, Bahrain offshore, Jordan, and Turkey, the change in profitability was significantly more favorable for IBs (the difference in the weighted average change in profitability was statistically significant).
    - The banking sector in these economies represents about 52 percent of the sample, while IBs hold about 37 percent of IBs assets in the sample (Figures 2a-2b).
    - An aggregate test for the whole sample indicates that, on average, IBs fared better than CBs in 2008.
  - 2009:
    - The picture is reversed in 2009, with IBs faring clearly worse in three countries (highlighted in yellow in the source).
    - In Bahrain (including offshore) and the UAE, the profitability of IBs declined significantly more than that of CBs; in Qatar the increase in IB‘s profitability was significantly lower than that of CBs.
    - The banking sector in these countries represents about 30 percent of the sample, and IBs hold about 44 percent of IBs‘ assets in the sample.
    - An aggregate test for the whole sample indicates that, on average, IBs fared worse than CBs in 2009.
  - Cumulative (average 2008 and 2009 vs 2007):
    - IBs fared better in all countries except Bahrain, Qatar, and the UAE.
    - In four countries (Bahrain offshore, Jordan, Saudi Arabia, and Turkey), the change in profitability was significant in favor of IBs.
    - The banking sector in these countries represents 52 percent of the sample, and IBs in these countries represent about 37 percent of IBs‘ assets in the sample.
    - In Qatar and the UAE, IBs fared relatively worse than CBs; the banking sector in these countries represents 22 percent of the sample, and IBs hold about 27 percent of IBs‘ assets.
    - An aggregate test for the whole sample indicates that, on average, the difference between the cumulative impacts of the crisis on the profitability of the two groups of banks is insignificant.
  - Interpretation:
    - Initial impact in 2008 on IBs‘ profitability was limited; with the crisis moving to the real economy, IBs in some countries faced larger losses compared to CBs.
    - Despite higher average returns in 2005–07, Figures 9a and 9b show average return on assets and equity for 2008–09 were very close between IBs and CBs, suggesting higher profitability for IBs over the business cycle (2005−09).
    - Figure 8 shows nonperforming loan ratio for IBs remained slightly higher than for CBs; in Bahrain both IBs‘ and CBs‘ NPLs doubled.

- Credit growth (Section B; Table 4 Part 2 and Figures 1 and 3a in Appendix II):
  - IBs maintained stronger credit growth compared to CBs in almost all countries in all years.
  - On average, IBs‘ credit growth was twice that of CBs during 2007–09.
  - Implications:
    - IBs‘ market share is likely to continue to increase going forward.
    - IBs contributed more to macro stability by making more credit available.
  - Change in rate of credit growth:
    - In general, IBs‘ credit growth was less affected by the crisis, with the exception of those in Bahrain and Qatar.
    - International experience suggests strong credit growth is usually followed by a large decline, but this was not the case for IBs in the sample.
    - Caveat: very high credit growth rate could be at the expense of strong underwriting standards; supervisors should monitor very high credit growth in IBs as well as in CBs.

- Asset growth (Section C; Table 4 Part 3 and Figures 2 and 3b in Appendix II):
  - IBs maintained stronger asset growth compared to CBs in almost all countries.
  - On average, IBs‘ asset growth was more than twice that of CBs during 2007–09.
  - Implications:
    - IBs‘ market share is likely to continue to increase.
    - IBs were less affected by deleveraging.
  - Change in rate of asset growth:
    - The fourth line of Part 3 in Table 4 shows that, in general, IBs‘ asset growth decelerated faster than that of CBs.
    - Possible factors mentioned:
      - Weaker performance for IBs in 2009 could explain decline in asset growth rate in some countries (e.g., Bahrain).
      - Liquidity support in the form of government deposits is easier to be directed to CBs given the easiness of auctioning government deposits to CBs.
    - Example numeric detail from footnote:
      - Public sector deposits in Jordan Islamic banks (largest IBs in Jordan) were about 1.5 percent of total deposits while public sector deposits averaged 8 percent in the banking system deposits in 2008.

- External ratings (Section D; Table 4 Part 4):
  - Ratings based on foreign long-term debt by Fitch, Moody‘s and S&P; pre-crisis (before September 2008) ratings compared with April 2010 ratings.
  - Ratings mapped to 1-year probability of default via Moody‘s Average Cumulative Issuer Default Rates scale; change corresponds to change in average probability of default as identified by the three agencies.
  - External ratings were available for about 70 banks in the sample.
  - Findings:
    - With the exception of the UAE, the change in IBs‘ ratings has been more favorable or similar to that of CBs.
    - In Qatar and Saudi Arabia, the financial crisis did not change rating agencies‘ views about the capacity of banks to meet their long-term obligations, reflecting in part the support banks could receive from the public sector.
    - Almost all IBs in Malaysia are subsidiaries of CBs, explaining the absence of an independent rating for IBs in Malaysia.

### Limitations, timing, and caveats on capturing full impact (Section E)
- Results are provisional because the impact of the crisis is still unfolding.
- Specific concerns:
  - The increase in nonperforming loans is likely to continue well into 2010.
  - Losses due to restructuring of Dubai debt and the crisis in Europe are likely to be reflected in 2010.
  - Delay in recognizing deterioration in asset quality (due to debt rescheduling/restructuring or relaxation of classification and provisioning requirements) complicates obtaining a complete picture.
- Noted flexibility differences:
  - CBs have more flexibility in debt restructuring since they can provide customers with cash (liquidity), facilitating compliance with regulatory requirements for debt rescheduling/restructuring.
  - Example: Turkey relaxed the classification and provisioning requirements during the crisis.

### Policy-relevant observations and recommendations (drawn from analysis)
- Supervisory monitoring:
  - Supervisors should monitor very high credit growth in IBs as well as in CBs, given the potential for underwriting standards to weaken amid rapid expansion.
- Market structure and regulatory considerations:
  - Differences in market structure (e.g., offshore wholesale banks, IBs as subsidiaries of CBs, absence of CB Islamic windows in some countries) affect comparability and regulatory oversight; these differences should inform country-specific supervisory approaches.
- Data and transparency needs:
  - Lack of reliable data on Islamic banking activities conducted by CBs and variations in sectoral classifications across countries limit comparability and completeness of impact assessment; improved and harmonized data collection is implied as necessary to better capture risks and exposures.

*Source: Appendix II and related sections of the supplied IMF working paper content.*

### Part 4: Change in Rating between pre Lehman Brothers and April 9, 2010 (change in the probability of default; positive c

### _wp10201 - Part 4: Change in Rating between pre Lehman Brothers and April 9, 2010 (change in the probability of default; positive change = downgrading)

### Overview
- Section V examines factors that could explain differences in performance between Islamic banks (IBs) and conventional banks (CBs), focusing on bank-specific factors (investment portfolio, sectoral credit distribution, leverage, dependence on wholesale deposits, size and type).
- Dependent variables used in regressions: change in profitability measured as 100*(2008_profits/2007_profits -1), 100*(2009_profits/2007_profits -1), and 100*((2009_profits*0.5+2008_profits*0.5)/2007_profits -1).
- Country dummies (omitted category: Bahrain offshore) materially improve model fit compared with macro variables like change in interbank rate and change in GDP growth.

### Profitability — Factors explaining change between 2008 and 2007 (Table 5; Models 1–7)
- Key regression findings cited in text:
  - "A one percent higher investment-to-asset ratio or a one-time higher assets-to-capital ratio lead to a decline in profitability by 1.8 and 12.2 percent, respectively (Models 5 and 6)."
  - Models 3, 5, and 6 indicate profitability is likely to increase by about 44 percent if the bank is an IB.
  - Model 7 shows profitability is likely to improve by about 66 percent if the bank is a large IB; the size of CBs has a negative but insignificant impact on profitability.
- Selected coefficients and significance levels from Table 5 (as reported):
  - Investment portfolio-to-total assets: -4.59 P-value 0.00 (Model 1); -4.50 P-value 0.00 (Model 2); -2.81 P-value 0.02 (Model 3); -2.65 P-value 0.01 (Model 4); -1.79 P-value 0.06 (Model 5); -1.80 P-value 0.06 (Model 6); -1.50 P-value 0.13 (Model 7).
  - Leverage (assets-to-capital): -5.93 P-value 0.08 (Model 1); -3.60 P-value 0.27 (Model 2); -9.54 P-value 0.01 (Model 3); -7.92 P-value 0.03 (Model 4); -12.16 P-value 0.00 (Model 5); -12.31 P-value 0.00 (Model 6).
  - Islamic bank dummy (IB=1): 30.79 P-value 0.23 (Model 1); 44.85 P-value 0.06 (Model 2); 43.55 P-value 0.07 (Model 3).
  - Size of the IB dummy (Large=1): 65.93 P-value 0.04 (Model 7).
  - Change in interbank rate: 20.29 P-value 0.04 (Model 4).
  - Country dummies examples (Model 6): UAE 148.51 P-value 0.00; Bahrain 114.45 P-value 0.01; Jordan 193.56 P-value 0.00; Malaysia 180.34 P-value 0.00; Saudi 183.66 P-value 0.00; Turkey 157.53 P-value 0.00; Qatar 185.41 P-value 0.00.
- Model fit indicators (Table 5):
  - Number of obs: 113 (Models 1–4); 120 (Models 5–7).
  - F-statistics: 7.72, 8.19, 6.05, 7.21, 6.21, 5.71, 5.55 (Models 1–7).
  - Prob > F: 0.000 for all models.
  - R-squared: 0.30, 0.2768, 0.48, 0.46, 0.41, 0.41, 0.36 (Models 1–7).
  - Adj R-squared: 0.26, 0.2430, 0.40, 0.40, 0.34, 0.34, 0.30 (Models 1–7).

### Profitability — Factors explaining change between 2009 and 2007 (Table 6; Models 1–7)
- Summary statements:
  - Banks’ balance sheet variables are generally not statistically significant for 2009–2007.
  - Models 3, 5 and 6 indicate other IB-associated factors not captured by the model could explain IBs’ weaker performance in 2009.
  - Model 7: profitability is likely to improve by 68 percent and 53 percent, respectively, if the bank is a large IB or CB.
- Selected coefficients and significance levels from Table 6 (as reported):
  - Investment portfolio-to-total assets: -2.99 P-value 0.00 (Model 1); -3.09 P-value 0.00 (Model 2); -1.32 P-value 0.17 (Model 3); -1.06 P-value 0.21 (Model 4); -1.06 P-value 0.17 (Model 5); -1.06 P-value 0.17 (Model 6); -0.69 P-value 0.35 (Model 7).
  - Banks' deposits-to-total deposits: -1.58 P-value 0.01 (Model 1); -1.56 P-value 0.01 (Model 2).
  - Size of the bank dummy (Large=1): 30.58 P-value 0.06 (Model 1); 38.56 P-value 0.02 (Model 2); 38.39 P-value 0.02 (Model 3).
  - Size of the IB dummy (Large=1): 66.67 P-value 0.00 (Model 7).
  - Size of the CB dummy (Large=1): 14.95 P-value 0.35 (Model 7).
  - Country dummies examples (Model 6): UAE 167.62 P-value 0.00; Bahrain 74.57 P-value 0.02; Jordan 201.30 P-value 0.00; Malaysia 208.83 P-value 0.00; Saudi 157.90 P-value 0.00; Turkey 177.82 P-value 0.00; Qatar 210.08 P-value 0.00.
- Model fit indicators (Table 6):
  - Number of obs: 111 (Models 1–4); 118 (Models 5–7).
  - F-statistics: 6.99, 7.80, 6.77, 8.06, 9.30, 8.35, 10.69 (Models 1–7).
  - Prob > F: 0.000 for all models.
  - R-squared: 0.29, 0.27, 0.52, 0.50, 0.52, 0.49, 0.53 (Models 1–7).
  - Adj R-squared: 0.25, 0.24, 0.44, 0.44, 0.46, 0.43, 0.48 (Models 1–7).

### Cumulative profitability — Factors explaining average (2008 and 2009) vs 2007 (Table 7; Models 1–7)
- Summary statements:
  - Most bank-specific variables are insignificant for the cumulative measure, except the investment portfolio variable which is nearly significant at the 10 percent level.
  - Large banks fared better on average than small ones (Models 3, 5, and 6); Model 7 confirms that large IBs fared better than small ones.
- Selected coefficients and significance levels from Table 7 (as reported):
  - Investment portfolio-to-total assets: 0.46 P-value 0.67 (Model 1); 0.41 P-value 0.70 (Model 2); 1.76 P-value 0.16 (Model 3); 1.80 P-value 0.10 (Model 4); 0.37 P-value 0.73 (Model 5); 0.29 P-value 0.78 (Model 6); 0.85 P-value 0.42 (Model 7).
  - Leverage (assets-to-capital): 6.27 P-value 0.05 (Model 1); 6.27 P-value 0.04 (Model 2); 3.33 P-value 0.35 (Model 3); 5.39 P-value 0.11 (Model 4); 4.19 P-value 0.27 (Model 5).
  - Size of the bank dummy (Large=1): 35.34 P-value 0.09 (Model 1); 46.13 P-value 0.04 (Model 2); 54.67 P-value 0.01 (Model 3).
  - Size of the IB dummy (Large=1): 67.83 P-value 0.04 (Model 7).
  - Size of the CB dummy (Large=1): 53.42 P-value 0.02 (Model 7).
  - Country dummies examples (Model 6): UAE 195.11 P-value 0.00; Jordan 212.89 P-value 0.00; Malaysia 240.19 P-value 0.00; Saudi 130.17 P-value 0.00; Qatar 242.06 P-value 0.00.
- Model fit indicators (Table 7):
  - Number of obs: 111 (Models 1–4); 118 (Models 5–7).
  - F-statistics: 3.51, 4.23, 4.29, 4.67, 6.52, 6.40, 6.61 (Models 1–7).
  - Prob > F: 0.000 for all models.
  - R-squared: 0.17, 0.17, 0.40, 0.36, 0.40, 0.42, 0.41 (Models 1–7).
  - Adj R-squared: 0.12, 0.13, 0.31, 0.29, 0.34, 0.36, 0.35 (Models 1–7).

### Interpretation and implications (as presented in the text)
- Investment portfolio size and leverage are associated with worse profitability outcomes during the crisis; higher leverage and larger investment portfolios likely implied higher risk-taking and greater exposure to securities losses.
- IBs' better performance in 2008 is partly explained by smaller investment portfolios and lower leverage, and possibly by IB-specific characteristics such as zero exposure to toxic assets, derivatives, and conventional financial institution securities.
- In 2009, unexplained IB-associated factors (e.g., name concentration) may have contributed to weaker IB performance; however, large IBs continued to fare better than small IBs across periods.
- Country-specific effects are important; replacing macro variables with country dummies substantially improves explanatory power.
- The size advantage in the sample appears to be driven by large IBs, suggesting diversification, economies of scale, and reputation may have bolstered resilience for large IBs.

*Source: Authors' estimates and calculations (from the provided tables and text).*

### BOX 3. EXAMPLES OF BANKS’ LOSSES DURING THE CRISIS

### BOX 3. EXAMPLES OF BANKS’ LOSSES DURING THE CRISIS

### Illustrative bank losses
- Gulf International Bank (GIB, a Bahraini wholesale CB) incurred about US$1.3 billion losses in securities investments in debt-based toxic assets (mortgage backed collateralized debt obligations) and in U.S. banks, such as Lehman Brothers. Shareholders injected US$1 billion of new capital and bought toxic asset-backed securities worth $4.8 billion.
- The Arab Banking Corporation (a Bahraini wholesale CB) incurred $1.2 billion losses; shareholders injected $1 billion of new capital.
- Gulf Bank (a Kuwaiti CB) incurred $1.4 billion losses due mainly to derivatives activities; shareholders and the Kuwait Investment Authority injected an equivalent amount of capital.
- National Commercial Bank (NCB, the largest Saudi conventional bank) lost more than one billion riyal on changes in fair value for financial instruments in 2008.
- Global Finance House (a wholesale IB) lost $730 million, including $311 million in provisions for a real estate project in Dubai.
- Bahrain Islamic Bank exposure to Saudi groups Saad and Algosaibi contributed to $51 million losses in 2009.

### Profit/loss-sharing nature of investment deposits and IB profitability
- Profit/loss-sharing nature of investment deposits provides IBs with an additional buffer but was not tested during the crisis as most banks remained profitable.
- In a loose monetary stance, CB profitability benefits from higher interest rate margins while IAHs’ return is based on IBs’ performance (Figures 10a and 10b referenced).
- Example: The KFH PSIA‘s return in 2009 illustrates sharing of IBs’ profitability with IAHs.
- Some IBs could use income-smoothing strategies to limit short-term disadvantages to profitability.

### Credit growth — key regression findings (Table 8, dependent variable: Change in Credit = 100*(2009_Credit)/2008_Credit -1)
- Consumer loans: 0.51, P-value 0.04 (Model1); 0.62, P-value 0.02 (Model2); 0.50, P-value 0.05 (Model3).
- R. estate & construction-to-total loans: 0.60, P-value 0.05 (Model1); 0.72, P-value 0.03 (Model2); 0.60, P-value 0.05 (Model3).
- Trade: 0.25, P-value 0.36 (Model1); 0.26, P-value 0.36 (Model3).
- Capital adequacy ratio (CAR): 0.88, P-value 0.22 (Model1); 1.32, P-value 0.08 (Model2); 0.81, P-value 0.28 (Model3).
- Banks' deposits-to-total deposits: 0.71, P-value 0.01 (Model1); 0.63, P-value 0.03 (Model2); 0.70, P-value 0.01 (Model3).
- Leverage (assets-to-capital): -0.60, P-value 0.66 (Model1); -0.10, P-value 0.95 (Model2); -0.66, P-value 0.64 (Model3).
- Islamic bank dummy (IB=1): 24.06, P-value 0.00 (Model1); 27.07, P-value 0.01 (Model2).
- Number of obs: 9, 9, 9 (Models 1–3).
- F: 2.98, 2.14, 2.59 (Models 1–3).
- Prob > F: 0.00, 0.01, 0.00 (Models 1–3).
- R-squared: 0.35, 0.29, 0.35 (Models 1–3).
- Adj R-squared: 0.23, 0.16, 0.22 (Models 1–3).

### Asset growth — key regression findings (Table 9, dependent variable: Change in Assets = 100*(2009_Assets)/2007_Assets -1)
- Investment portfolio-to-total assets: -0.468950, P-value 0.36 (Model1); -0.60829760, P-value 0.245 (Model2); -0.53020, P-value 0.291 (Model3).
- Consumer loans: 0.8037790, P-value 0.009 (Model1); 0.86997120, P-value 0.003 (Model2); 0.8379350, P-value 0.003 (Model3).
- R. estate & construction-to-total loans: -0.062470, P-value 0.872 (Model1).
- Trade: -0.03226270, P-value 0.928 (Model1).
- Capital adequacy ratio (CAR): 1.6266930, P-value 0.082 (Model1); 2.088050, P-value 0.026 (Model2); 2.0902210, P-value 0.006 (Model3).
- Banks' deposits-to-total deposits: 0.3589620, P-value 0.307 (Model1); 0.30349250, P-value 0.398 (Model2); 0.4060090, P-value 0.239 (Model3).
- Leverage (assets-to-capital): -1.511560, P-value 0.389 (Model1); -1.1035230, P-value 0.529 (Model2).
- Islamic bank dummy (IB=1): 20.764150, P-value 0.041 (Model1); 19.257230, P-value 0.05 (Model2).
- Country dummies with notable coefficients and P-values: UAE 67.056380, P-value 0.032 (Model1); Qatar 111.12830, P-value 0.001 (Model1).
- Number of obs: 103, 102, 103 (Models 1–3).
- F: 3.64, 3.12, 4.19 (Models 1–3).
- Prob > F: 0.0001, 0.0003, 0.0000 (Models 1–3).
- R-squared: 0.3855, 0.3702, 0.3795 (Models 1–3).
- Adj R-squared: 0.2796, 0.2517, 0.2888 (Models 1–3).

### Challenges facing Islamic Banks (IBs) highlighted by the crisis
- Key challenges:
  - Infrastructure and tools for liquidity risk management underdeveloped in many jurisdictions.
  - Legal framework incomplete or untested.
  - Lack of harmonized contracts.
  - Insufficient expertise at supervisory and industry levels relative to industry growth.
- Liquidity-specific challenges:
  - Shallow money market: small number of participants and absence of instruments usable as collateral or for discounting at the central bank discount window.
  - Inability to attract or maintain deposits by promising higher return.
  - Some IBs ran overly liquid balance sheets, sacrificing profitability.
  - Need to further develop the sukuk market, especially sovereign, and Shariah-compliant money markets.
- Institutional and legal risks:
  - Importance of appropriate institutional arrangements for resolution of troubled financial institutions; absence of precedents for IBs.
  - Recent defaults or near defaults of sukuk highlighted legal and regulatory risks (examples cited: East Cameron Gas Company sukuk (US$167 million), Kuwait Investment Dar sukuk (US$100 million), Saad Group US$650 million Golden Built Sukuk).
  - Nakheel sukuk episode created legal uncertainty despite holders not facing losses.
- Standards and expertise:
  - Lack of harmonized accounting and regulatory standards; local standards mix IFRS, IAS, AAOIFI and other specific standards.
  - IFSB standards not fully implemented in many countries.
  - Mutual recognition of financial standards and products across jurisdictions recommended to reduce transaction costs and facilitate oversight.
  - Shortage of professionals versed in both conventional finance and Shariah; product complexity and scarcity of specialists constrain innovation and risk management.
- Empirical notes:
  - IBs carry 40 percent more liquidity than their conventional counterparts and commit about 95 percent of their funds to short-term Ijarah, Murabahah and Musharakah instruments (Khan et al, 2008).
  - A Liquidity Management Task Force was formed in early 2009 by the IFSB and the Islamic Development Bank.

### Conclusions and policy implications
- Structural differences:
  - Conventional intermediation largely debt-based and allows risk transfer; Islamic intermediation asset-based and centers on risk sharing.
  - Islamic features provide additional buffers and tend to reduce contribution to excesses and bubbles.
- Performance during the crisis:
  - IBs fared differently than CBs: business-model factors helped contain adverse impact on profitability in 2008; weaknesses in risk management in some IBs led to larger decline in profitability in 2009.
  - Adherence to Shariah precluded many IBs from investing in instruments that affected conventional competitors.
  - Weak performance in some countries associated with sectoral/name concentration and exemptions from concentration limits (example: UAE some IBs exceeded the 25 percent limit on lending to real estate sector).
- Industry trends:
  - Despite higher pre-crisis profitability (2005–07), IBs‘ average profitability for 2008–09 was similar to CBs.
  - Large IBs fared better than small ones; developing large, well-managed IBs recommended.
  - IBs’ credit and asset growth were at least twice higher than that of CBs during the crisis, implying growing market share and supervisory responsibility.
  - External rating agencies’ reassessment of IBs’ risk generally more favorable or similar to CBs.
- Policy priorities:
  - Build a well-functioning liquidity management infrastructure; ensure liquidity infrastructure is neutral to bank type.
  - Ensure supervisory and legal infrastructure, including bank resolution frameworks, remain relevant to Islamic finance and global reforms.
  - Promote greater convergence and harmonization of regulations and products, and develop human capital in IBs and supervision to support sustainable industry growth.

*Source: BOX 3. EXAMPLES OF BANKS’ LOSSES DURING THE CRISIS (extracted from the supplied PDF content).*

### REFERENCES

### _wp10201 - REFERENCES

### References (bibliography)
- Lists cited works on Islamic finance, including authors and titles such as Archer and Abdel Karim (2002), Aziz (2009, 2010), Balston and Halkett (2009), Chapra (2008, 2009), Čihák and Hesse (2008, IMF Working Paper 08/16), Choong and Ming-Hua (2006), El-Gamal (2001, 2006), El Said and Ziemba (2009), Financial Times (2008), Imam and Kangni (2010, IMF Working Paper forthcoming), International Financial Services London (2010), Islamic Financial Services Board, Islamic Development Bank, and Islamic Research and Training Institute (2010), Iqbal and Llewellyn (2002), Konow (2003), Khan and Bhatti (2008), Power (2009), Qutub (2008), Saddy (2009), Subbarao (2009), The Economist (2008, 2009), and Yilmaz (2009).

### Sources and uses of funds for Islamic banks (IBs)
- Sources of funds
  - Profit sharing investment accounts (PSIA) and safekeeping have become the main source of funds for many IBs.31
  - The expected level of return for PSIA holders would be close to line B in Figure 1 for both Islamic and conventional banking, given that competition in the market would prevent a permanent higher return (Area A) or lower return (Area C).
  - Positive (negative) market conditions and good (bad) management on the part of the IB could lead to a higher (lower) return, Area A (C), for investors and possibly a higher (lower) future market share for the bank.
  - Safekeeping deposits (current accounts) do not participate in profit sharing because they are not made on the basis of a profit sharing contract (e.g., mudarabah) and are not exposed to loss.
  - Footnote: 31 See Box 2 for the definition for these accounts.
- Uses of funds
  - Shariah principles imply agreements to share risk and return on an investment and/or a sale/lease contract and an underlying asset behind financial transactions conducted by IBs.
  - Key Shariah-compliant financial contracts: Mudharabah (profit sharing), Musharakah (joint venture), Murabahah (cost plus sale), and Ijarah (leasing).
  - Shariah prohibits bayu al-gharar (trading in risk) where gharar means excessive uncertainty; also prohibits selling assets not owned, selling someone‘s debt, and the use of traditional derivatives.
  - Islamic finance excludes investment or financing activities involving alcohol and gambling.
  - Figure 3 and accompanying text summarize implications of Shariah compliance on allowable financial contracts; borders of compliance can vary across Shariah schools of thought.
  - Footnote: 32 For a description of various Islamic financial contracts, see http://en.wikipedia.org/wiki/Islamic_banking#Mudarabah_.28profit_sharing.29 .

### Key definitions: Box 1 — Shariah-compliant contracts (sources and uses of funds)
- Sources of Funds (Deposits)
  - Profit Sharing Investment Account (PSIA)
    - Contract by which an investor/depositor places an investment fund with an IB on the basis of Mudharabah.
    - IB may have restricted or full discretionary power in investment decisions; IB acts as entrepreneur, PSIA holder as capital provider.
    - Profit-sharing ratio must be disclosed and agreed at account opening.
    - Profits shared per the Mudharabah agreement; losses borne solely by PSIA holder unless due to IB misconduct, negligence or breach.
    - IB‘s money (bank capital) usually invested in the same income-producing assets or activities; low income (losses) affect IB via low (negative) return on shareholders‘ invested capital and low (zero) income from managing PSIA accounts.
    - This source of revenue is the main one for the IB and is used to cover operational expenses.
  - Wadiah (safekeeping deposit)
    - Contract between depositor and IB (custodian) for safekeeping.
    - Depositor grants IB permission to utilize funds for Shariah-permitted purposes.
    - Bank guarantees the value of the deposit and allows easy access for withdrawals.
- Uses of Funds (Financing and Investment)
  - Murabahah (Cost-plus financing)
    - IB sells to a customer, at acquisition cost plus an agreed profit margin, a specified asset already in its possession.
    - After delivery, a credit risk in respect of the receivable arises; from modern finance perspective, similar to an asset-backed risky loan.
  - Salam (Purchase with deferred delivery)
    - Agreement to purchase, at predetermined price, a specified commodity to be delivered on a specified future date in specified quantity and quality.
    - IB makes full payment upon execution of the Salam contract; may use Parallel Salam to mitigate price risk by entering a back-to-back sale.
  - Ijarah (Lease)
    - IB leases an asset to a customer for an agreed period against specified lease rental installments.
    - Contract requires IB to purchase or lease an asset prior to entering the lease agreement.
    - May offer lessee option to purchase the asset at lease-end by gift or token consideration, or by installments during the lease period.
  - Musharakah (Equity financing)
    - IB and customer contribute capital to an enterprise or ownership of real estate/moveable asset, on permanent or diminishing basis (diminishing Musharakah).
    - Profits shared per Musharakah terms; losses shared in proportion to respective capital contribution.
    - Footnote: 3 Diminishing Musharakah is a means of providing financing on a profit and loss sharing basis.
  - Mudharabah (Participation or trust financing)
    - IB contributes capital to an enterprise managed by the customer/investor.
    - Profits shared per Mudharabah terms; losses borne solely by the IB unless due to customer/investor misconduct, negligence, or breach.
- Footnotes and notes
  - 1 This box follows closely the Islamic Financial Services Board (IFSB) definition of contracts.
  - 2 In the case of lease-to-buy contracts, the asset backing the lease is strictly not collateral as it remains the property of the lessor. It may be described as quasi-collateral (see the IFSB Capital Adequacy standard).

### Appendix III — Description of the database
- Scope and coverage
  - Bank-level data collected for CBs and IBs in five GCC countries (Bahrain, Kuwait, Qatar, Bahrain, Saudi Arabia, and the UAE), three non-GCC countries (Jordan, Turkey, and Malaysia) and the Bahrain offshore banks.
  - The dataset includes 120 CBs and IBs, of which about one-fourth are Islamic (Annex I).
- Data sources by country
  - GCC countries and Jordan
    - Zawya Dow Jones was the main data source, covering financial statements and interim accounts of most banks in these countries, both in local currency and U.S. dollars.
    - Data on risk-weighted assets, regulatory capital and nonperforming loans were obtained from individual bank annual reports for end-of-year reporting and from Basel Capital Disclosures statements for interim data.
  - Turkey
    - Data mostly obtained from the Turkish Banking Association; individual bank annual reports used for some series such as nonperforming loans.
  - Malaysia
    - Individual bank annual reports/interim reports were used for all data included in the study.

### Annex I — List of banks (by bank name, type, country)
- Annex I provides a country-by-country listing of banks included in the dataset, showing bank name, type (Islamic Bank or Conventional Bank), and country.
- Countries and examples shown in Annex I include:
  - United Arab Emirates (examples: Abu Dhabi Islamic Bank — Islamic Bank; Abu Dhabi Commercial Bank — Conventional Bank; Emirates NBD — Conventional Bank)
  - Bahrain (examples: Bahrain Islamic Bank — Islamic Bank; Ahli United Bank — Conventional Bank)
  - Kuwait (examples: Boubyan Bank — Islamic Bank; National Bank of Kuwait — Conventional Bank)
  - Qatar (examples: QIIB — Islamic Bank; Qatar National Bank — Conventional Bank)
  - Saudi Arabia (examples: Al Rajhi Bank — Islamic Bank; National Commercial Bank — Conventional Bank)
  - Jordan (examples: Jordan Islamic Bank — Islamic Bank; Arab Bank — Conventional Bank)
  - Turkey (examples: Bank Asya — Islamic Bank; Türkiye Garanti Bankası A.Ş. — Conventional Bank)
  - Bahrain offshore (multiple Islamic and Conventional banks listed, e.g., Albaraka — Islamic Bank; Investcorp — Conventional Bank)
  - Malaysia (examples: Bank Islam Malaysia — Islamic Bank; Maybank — Conventional Bank)
- The full annex enumerates the specific banks and their classification used in the analysis.

*Source: _wp10201 - REFERENCES, https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2010/_wp10201.pdf*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2010/_wp10201.pdf_