A Comparative Study of Conventional and Islamic Banks in Pakistan.

1. Effect of Capital Structure on Bank’s
Profitability
A Comparative Study of Conventional
and Islamic Banks in Pakistan
College Of Business Management,
Institute Of Business Management.

2. Introduction
• The concept of Islamic banking is relatively new and prevailing in many countries
of the world. It is quite logical to assess the financial performance of Islamic banks
from various aspects. The study examines the effect of capital structure on banks’
profitability of both the conventional as well as Islamic Banks in Pakistan. The
dependent variables for the study are Returns on Equity (ROE) and Returns on
Assets (ROA) for Profitability while Total Liabilities to total assets (TLTA), Total
equity to Total Assets (TETA), Total Liabilities to Total Equities (TLTE), and Size (the
natural logarithm of total assets) of the bank as independent variables for capital
Structure. The audited annual statements of the Five Islamic and conventional
banks existing in Pakistan served as the sources of data. Date will be collected and
analyzed by using SPSS Software.
• In 2002, a new clause was added to the Banking Company Ordinance (BCO) 1962
that allowed commercial banks to open subsidiaries for shari’a compliant
operations. This new paradigm allowed three types of Islamic banking institutions
to be operational in Pakistan. Full-fledged Islamic banks, Islamic banking
subsidiaries of conventional banks, and Islamic banking branches of conventional
banks.

3. Significance of the study
• Banks try to attract larger depositors for better profitability but
these efforts are useless without right composition of capital
structure. This study may help academicians and policy makers to
find out which component of capital structure is significantly
contributing for Profitability in Islamic and Conventions Banks of
Pakistan. There is no research available in the literature that could
compare the relationship of capital structure and bank’s profitability
of both the conventional as well as Islamic banks in Pakistani
context. Therefore, this paper tries to fill the existing gap. This study
is also important because Islamic banking is the fastest growing
segment of Pakistan’s financial services sector. According to State
bank of Pakistan’s report 23.3 percent year-on-year growth in
deposits of Islamic banking industry in 2014.

4. Research Objective
• The main focus of this thesis is to understand the
effectiveness of capital structure and its
relationship with performance in Islamic and
conventional banks of Pakistan. Following are the
two specific objectives.
1)To find out the relationship of capital structure on
banks’ profitability
2)To compare the relationship of capital structure
and bank’s profitability of both the conventional
as well as Islamic banks.

5. Research Question
• Is there any significant relationship between
Profitability (ROA and ROE) and Capital
Structure (TLTA, TETA, TLTE and Size) of Islamic
as well as Conventional banks of Pakistan?
• Comparison of Islamic and Conventional
Banks’ capital structure with Profitability in
Pakistan is the second research question for
the thesis.

6. Hypothesis
• Ho: Islamic Banks and Conventional Banks have similar capital
structure in Pakistan
• H1: Islamic Banks and Conventional Banks have different capital
structure in Pakistan
• Ho: There is no significant relationship between capital structure
and Profitability of Islamic Banks of Pakistan
• H1: There is a significant relationship between capital structure and
Profitability of Islamic Banks of Pakistan.
• Ho: There is no significant relationship between Capital structure
and Profitability of Conventional Banks of Pakistan
• H1: There is a significant relationship between capital structure and
Profitability of Conventional Banks of Pakistan

7. Literature Review
• Review of Studies on Islamic Banking
Literature review revealed that, many researchers had identified the relationship of capital
structure and performance in different sectors of the economy, it stills at earlier stage in Islamic
Banking institutions of Pakistan. SudinHaron (1996), while discussing external determinants o f the
profitability of Islamic Banks, argued that conventional banking theory postulates that the bigger
the market, the more profit the banks earn, this theory is not necessarily true for Islamic Banks.
Islamic banks perform well due to efficient use of capital in short term financing. Bashir (2000)
assessed the performance of Islamic banks in eight Middle Eastern countries. The researcher
analyzed important bank characteristics that affect the performance of Islamic Banks by Controlling
economic and financial structure measures. The researcher studied fourteen Islamic banks from
Bahrain, Egypt, Jordon, Kuwait, Qatar, Sudan, Turkey, and United Arab Emirates between 1993 and
1998. To examining profitability, Non interest Margin (NIM), Profit before tax (PBT), Return on
Equity (ROE) and Return on Assets (ROA) as performance indicators. The results reveal that Islamic
banking profitability is positively related to equity and loans. Hassan (2004), studied the
determinates of Islamic banking Profitabilitybetween 1994 to 2001 for 21 countries. The finding
show that Islamic banks have a better capital asset ration as compare to commercial banks which
means that Islamic banks are well capitalized. Alkassim (2005) in his study of Gulf countries find
that higher capital ratios support Islamic banks profitability. However, there is still a shortcoming of
studies for Islamic Banks in Pakistani context.

8. Literature Review
• Review of Studies on Conventional Banking
Spathis, Kosmidou, and Doumpos (2002) research work on the profitability factors in the Greek
banking system in an interesting study which measures the effectiveness of small and large banks in
Greece with the use of ROA, ROE, and Net interest Margin (MARG) ratios as profitability measures.
There were a total of 23 banks (seven large and sixteen small) between 1990 and 1989 using panel
data. The results indicate the large Greek banks have a higher ROA and have more access to
resources then small banks. Surprisingly, small banks had large ROE and MARG as well as high
financial leverage and high capital adequacy (Spathis, Kosmidou, and Doumpos, 2002). Goddard,
Molyneux, and Wilson (2004) confirm the findings of Molyneux and Thorton (1992). Their study
investigates the determinants of profitability in six Europe countries like Denmark, France,
Germany, Italy, Spain and United Kingdom and the study covers 665 banks between 1992 and 1998.
The study used cross-sectional and dynamic panel data. The variables used in the regression
analysis were ROE, the logarithmic of total assets, off balance sheets (OBS) dividends, capital to
asset ratio (CAR). The results from both models were similar: evidence reveals that there is a
positive relationship between size (total assets) and profitability. (Goddard, Molyneux, and Wilson,
2004). Molynenx and Thornton (1992) studied the determinants of European banks profitability.
The paper examined eighteen countries in Europe between 1986 and 1989. The studied sample
included 671 banks in 1986, 1,063 in 1987, 1,371 in 1988, and 1,108 in 1989. This paper replicated
Bourke’s (1989) work by using internal and external determinants of bank profitability. However,
Molynenx and Thornton (1992) results contradict Bourke’s findings showing that government
ownership expresses a positive coefficient with return on capital (profitability). The other results
were similar to Bourke’s, showing that concentration, interest rate, and money supply were
positively related to bank profitability.

9. Limitations
• The research was conducted only at one type of Islamic
banking Institution with small sample size, which may
undermine the external validity. To extend the research
in this topic the researcher should focused on different
types of Islamic banking institutions. At present, we
have three different types of Islamic banking
Institutions in Pakistan.
• Full-fledged Islamic banks
• Islamic banking subsidiaries of conventional banks
• Islamic banking branches of conventional banks

10. Methodology
• Data and sample Size
The data for the research has extracted from
the Audited Annual Statements of Islamic and
Conventional Banks of Pakistan over a period
of 2010-2014. Some of the data was not
completely published in the above resource,
therefore, the state bank reports and websites
of Islamic and Conventional Banks are also
approached as a secondary resource.

11. Methodology
Sample of the study includes5 full-fledged Islamic and 5 Conventional
banks of Pakistan.
Sample of Islamic Banks
• 1. Al-Baraka Islamic Bank.
• 2. Bankislami Pakistan Limited
• 3. Dawood Islamic Bank Limited
• 4. Dubai Islamic Bank Pakistan Limited
• 5.Meezan Bank Limited
Sample of Conventional Banks
• 1. AskariComercial Bank Limited
• 2. JS Bank Limited
• 3. Bank of Khyber Limited
• 4. NIB Bank Limited
• 5. SAMBA Bank Limited.

12. Methodology
Dependent Variables:
• ROE= Return on Equity
• ROA= Return on Assets.
Independent Variables:
• Total equity to Total Assets
• Total Liabilities to total assets
• Total Liabilities to Total Equities
• Size (the natural logarithm of total assets)
Statistical Plan:
• To identify the relationship between capital structure and performance,
the study used correlation analysis with help of SPSS 17.0(Statistical
Package for the Social Sciences). T test analysis used to examine the
similarity of capital structure between Islamic and conventional banks of
Pakistan.

13. Methodology
Equations:
• ROE= β0 + β1TLTA+ β2TETA + β3TLTE+ β4Size+ μ ------------------------------1
• ROA= β0 + β1TLTA+ β2TETA+ β3TLTE+ β4Size+ μ-------------------------------2
Where:
• ROE= Return on Equity
• ROA= Return on Assets.
• β0 = Intercept
• β1TLTA= Total Liabilities to total assets
• β2TETA= Total equity to Total Assets
• β3TLTE= Total Liabilities to Total Equities
• β4Size= Size (the natural logarithm of Book value total assets)

14. Thesis Structure
• Chapter One: Introduction to the topic, rationale and
objective of the research.
• Chapter Two: A brief Literature review on the selected
topic.
• Chapter Three: Sample size, data collection method
and analysis tool and statistical plan will be the part of
methodology.
• Chapter Four: Presentation of tables and identified
results will be the part of this chapter.
• Chapter Five: Results, rejection or acceptance of
hypothesis, conclusion and recommendation will be
the main headings for this part.

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