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Introduction:The concept of Islamic banking was accelerated in 1940s in Egypt.

Before 1970s the term Islamic financial system or Islamic banking was relatively a new idea for the Muslim world. By 1970s this concept reached in Middle East and generally in all over the Islamic world. With the passage of time all the Muslim countries made Islamic banks a major tool to their economy. In no time this concept flourished in Africa, North America, Asia and Europe as well. At the moment, in almost 70 countries, about 300 Islamic financial institutions are working efficiently with capital investments worth $500-800bn. By 2010, the market value of Islamic financial institutions was of $4 trillion. In Middle East, Islamic banking system has been a wonderful addition in economy sector. Bahrain is at the top of the list regarding Islamic banking in the whole world whereas Malaysia is second in ranking by their remarkable and memorable policies in the sector of Islamic banking. As far as Pakistan is concerned, Islamic banking share in total banking sector is 7% and it rapidly growing with the passage of time. Islamic banking system depends upon profit and loss sharing, owning and transaction of Physical goods, participation in trading process, and also Islamic modes of finance are used for leasing and construction contracts. As for purpose of income generation, Islamic banks deal with assets management. The Islamic banks carefully manage involved risk in assets management with devotion to best exercise of corporate governance. It is clear that when bank is able to receive stream of Halal Income, the depositors of the banks ultimately receive the stable and Halal Income. Gain on the capital is appreciated by the Islamic Shariah but the interest based transactions are prohibited. The interest is fixed amount that is charged over principal amount of loan or debt which is prohibited in Islamic Shariah. Islamic Shariah considers performance of capital when actual capital is rewarded. Islamic Shariah prohibit risk free return and trading, as in the Verse II: 275, of holy Quran that financial activities and transactions in the Islamic Shariah principle are real asset-backed, with an ability of value addition. Mankind has always been seeking security and protection. This need has led him toward the banking system. The bank of Venice is perhaps the first ever regular bank in the banking history and was established in 1157. Conventional banking system is based on the concept of loaning on a fixed rate of interest. Conventional banking is fundamentally based on the debtor-creditor relationship between the depositors and the bank on the one hand and between the borrowers and the bank on the other, with interest as the price of credit, that reflect the opportunity cost of money. When money is lent on the base of Riba (interest), it often leads to the unfairness.

Why Islamic Banking System and Why not Conventional Banking System?
Islamic banking is interest free system while conventional banking is interest based economic system. Earning interest, is in Islamic term, unrightfully taking the wealth of others. The taking of interest prevents, in Islamic Economic terms, a fair profit distribution. Allah declares war on those who continue to take interest after He has prohibited. Islamic banking system enables us to earn Halal. Rasulallah (S.A.W) once remarked. if a person buy a cloth for ten Dirhams, and out of them one is tainted (i.e. it has been acquired by unfair means), none of his salaah will be acceptable to Allah as long as he wears the cloth. Islamic banking system guarantees the provision of security. Islam aims at establishing a peaceful society. Islam guarantee the Rizq (subsistence) for all individuals constituting the society, so peace will also be promoted by this way. Without such guarantee, everyone will suffer from worries and anxieties. It is essential that

we earn, not only to feed ourselves and our families, but also our other Muslim brothers and sisters in need. Islamic economic system enables us to fulfill the needs of poor people. Following are some of main differences between Islamic banks and conventional banks: 1. Conventional banks functions and operating modes are based on self developed principles while Islamic banks functions and operating modes are based on the Islamic Shariah principles. 2. Conventional banks provide fixed return while Islamic banking based on profit and loss sharing. 3. Conventional banks focus only to generate profit without any restriction while Islamic banking focuses to generate profit according to the Islamic Shariah principles. 4. Conventional banks only deals with tax but not deal for the collection and distribution of Zakat while Islamic banks are used to provide services of collection and distribution of Zakat. 5. Conventional banks focus only on lending to get interest in shape of profit while Islamic banking promotes partnership business. 6. The defaulter of the bank pays extra charges as a penalty while Islamic banks are multipurpose institution because of this their scope is wider. 7. The bank has no concern with clients equity growth while Islamic banks highly appreciate equity growth for public interest. 8. Conventional banks can easily borrow money from money market while Islamic Shariah principle of profit and loss sharing provides equal opportunity to the both. 9. Conventional banks did not provide attention to develop expertise in project appraisal and evaluations while Islamic banks provide attention to developing projects appraisal and evaluation process is better due to profit and loss sharing principle. 10. Bank builds relation with clients of creditor and debtors while Islamic bank create a relation with client as a partner, investor and trader.

Performance Measures:Normally, to measure the financial performance of Islamic banks and conventional bank we usually use financial ratios. To assess the financial performance the primary method is used to analyzing accounting data. The Financial ratios generally provide a better and broader understanding of the banks financial situation even from the bank started its operations and constructed from accounting data contained on the banks balance sheet and financial statement. For the purpose of comparison of financial performance of Islamic and conventional banks financial measures are used which contains the following ratios. We will discuss each one by one.

1. Liquidity Ratios: Liquidity ratios are used to measure a firms ability to meet short term
obligations. They compare short term obligations with short term resources available to meet these obligations. For the survival of long run it is very crucial to maintain the correct level of liquidity for any kind of business. But the lower level of liquidity May shows the business financial and operational risks, a higher liquidity is not good for business because this may cause of lower returns. Generally, the higher the value of the ratio, the larger the margin of safety that the company possesses to cover short-term debts. We will use two major liquidity ratios listed below. Current Ratio=Total current Assets/Total Current Liabilities

The Current Ratio is calculated by dividing Current Assets by Current Liabilities. The appropriate value for this ratio depends on the characteristics of the firm's industry and the composition of its Current Assets. However, at a minimum, the Current Ratio should be greater than one. It shows a firms ability to cover its current liabilities with its current assets. Quick Ratio=Total Current Assets-Inventory/Total Current Liabilities This ratio attempts to measure the ability of the firm to meet its obligations relying solely on its more liquid Current Asset accounts such as Cash and Accounts Receivable. This ratio is calculated by dividing Current Assets less Inventories by Current Liabilities.

2. Credit risk Ratios: Solvency can also be described as the capacity of a corporation to meet
up its long-term fixed expense and to complete long-term expansion and growth. The better a company solvency, the better it is financially. We have use two major Credit risk performance ratio below. Debt ratio=Total Debts/Total Asset= Total Assets-Total owners equity/Total

Assets.
A ratio that indicates what proportion of debt a company has relative to its assets. The measure gives an idea to the leverage of the company along with the potential risks the company faces in terms of its debt-load. The Debt Ratio is calculated by dividing Total Debt by Total Assets. Debt to Equity Ratio=Total Debts/Total Owners Equity=Total Assets-Total Owners equity/Total Owners equity A measure of a company's financial leverage calculated by dividing its total liabilities by stockholders' equity. It indicates what proportion of equity and debt the company is using to finance its assets. The Debt to Equity Ratio is calculated by dividing Total Debt by Total Owners' Equity.

3. Profitability ratio: Profitability ratios show a company's overall efficiency and performance
compared to its expenses and other relevant costs incurred during a specific period of time. We use the Gross Profit Margin ratio to find out the profitability of the bank. Gross Profit Margin ratio=Gross profit*100/Income.

4. Earnings Ratio: Earning ratios measure the overall earnings performance of the bank and
its efficiency in utilizing assets, liabilities and equity. For this study purpose, two earnings ratios are used which are listed below. Return on Assets (ROA) = Net Income/Total asset This Ratio indicates the dollars in income earned by the firm on its assets. The ratio is calculated by dividing net income by total assets. Return on Equity (ROE) = Total Income/Total Owners Equity This ratio indicates the dollars of income earned by the firm on its shareholders equity. The ratio is calculated by dividing total income by total owners equity.

For comparison of performance evaluation between Islamic banking and conventional banking, we take the real data from the financial statements of three Islamic banks Mezan bank, Bank Islami and Bank Alfalah and three conventional banks UBL, JS Bank and Bank of Khyber.

Table 1: Sample of banks for comparison of performance analysis Islamic Banks Mezan Bank Karachi Bank Islami Karachi Bank Alfalah Karachi Conventional Banks UBL Karachi JS Bank Karachi Bank of Khyber Karachi

Ratio Analysis:The results of ratio analysis are given in the following table and charts. We took four performance measures liquidity ratio, debt ratio, earning ratio, and profitability ratio. Table 2: financial ratios of Islamic and conventional banks RATIOS MEZAN BANK 0.1841444 BANK ISLAMI 0.2111189 0.9096217 10.064408 0.6912% 7.64868% ALFALAH BANK 0.2273497 0.9446919 17.080546 0.92524% 16.7303% UBL 0.1831949 0.8935577 8.3947749 1.84028% 17.28899% JS BANK 0.3291463 0.8388884 5.2068785 0.66052% 4.09976% BANK OF KHYBER 0.1557545 0.8485119 5.601177 1.27484% 8.41542%

Current Ratio Debt to 0,9264597 asset Ratio Debt to 12.59799 equity Ratio ROA 1.46028% ROE 19.85%

Gross profit 335.87698% 696.03335% 432.46418% 302.82872% 670.80556% 328.53376% margin Source: financial statements of Islamic banks and conventional banks. See annexture

Table 3: performance analysis of Islamic and conventional banks PERFORMANCE MEASURE Liquidity Ratios Current Ratio Debt Ratios Debt to Asset Ratio Debt to Equity Ratio Earnings Ratios Return on 1.0016033% Assets(ROA) Return on 14.742993% Equity(ROE) Profitability Ratios Gross Profit Margin 488.12483% 1.2585467% 9.9347233% 0.9269244 13.247648 0.8603193 6.4009437 ISLAMIC BANKS CONVENTIONAL BANKS 0.2226986 DESCRIPTION Liquidity of Islamic banking is high then conventional banking. Financial risk of Islamic banking is high then conventional banks. Earning through assets of conventional banking is high then Islamic banking. Return on equity of Islamic banking is high then conventional banking. Gross profit margin of Islamic banking is high then conventional banking

0.2075377

434.056%

Source: financial statements of Islamic Banks and Conventional Banks. See annexture

Chart 1: Ratio analysis of Islamic and Conventional banks

Islamic banking vs Conventional banking


16 14 12 10 8 6 4 2 0 Current Debt to Debt to Ratio Asset Ratio Equity Ratio Return on Return on Gross Pofit Assets Equity Margin Islamic banking Conventional banking

Chart 2: performance analysis of Islamic and conventional banks

islamic banking vs conventional banking


9 8 7 6 5 4 3 2 1 0 Liqidity Ratio Debt Ratio Earning Ratio Profitibility Ratio islamic banking conventional banking

Interpretation:From the above tables and charts different measures were used to compare the performance analysis of Islamic and conventional banking system. The current ratio of conventional banks is 0.2226986 which is high than the current ratio of Islamic banks that are 0.2075377.The high the current ratio, the greater the firms ability to pay its debts. The debt to asset ratio of Islamic banks is 0.9269244 which is greater than the conventional bank that is 0.8603193. The higher the debt to asset ratio, the greater the financial risk. The debt to equity ratio of Islamic banks is 13.247648 which are greater than conventional bank that is 6.400437. The lower the ratio, the higher the level of the firms financing that is being provided by shareholders. Creditor would like this ratio to be low. Return on asset ratio of Islamic banks is 1.0016033% which is slightly lower than the ROA of conventional bank that is 1.2585467%. Return on equity of is 14.742993% which are greater than ROE of conventional banks that is 9.9347233%. This ratio shows the earning power on shareholders equity. The gross profit margin of Islamic banks is 488.12483% which is greater than conventional banks that are 434.056%. The higher this ratio shows that firms operations are more efficient.

Conclusion:After comparison the performance analysis for year 2011 of three Islamic banks Mezan bank, Bank Islami and Alfalah bank and three conventional banks UBL, JS bank and Bank of Khyber, we conclude that the liquidity ratio of conventional banks is greater than liquidity ratio of Islamic banks. So conventional banks are more capable of paying their debts than Islamic banks. The Debt ratios of Islamic banks are higher than conventional banks which mean that Islamic banks have greater financial risk as compare to conventional banks. The earnings ratios of Islamic banks are higher than conventional banks which show that Islamic banks have more earning power conventional banks. The profitability ratio of Islamic banking is also greater than conventional banks which show us that Islamic banks are more profitable and have more efficient operations than conventional banks. Islamic banking is newly established banking system in Pakistan. Its market share according to state bank of Pakistan report is 6%. The growth rate of Islamic banking is 26% annually while growth rate of conventional banking is 7%. The transactions in Islamic banks are according to Islamic sharia that is why its growth rate is comparatively more than conventional banking.

References:1. Van Horne James C. (2002) Fundamental of Financial Management, ed.12, London, anheuser-Busch companies Inch. Page 134-148 2. Wordpress.com performance analysis of Islamic and conventional banking retrieved on 10 April 2012 from http://www.wordpress.com

3. Investing.businessweek.com financial statements of UBL, Mezan bank, Bank Islami, Bank Alfalah retrieved on 10 April 2012 from http://www.investing.businessweek.com 4. Bank of Khyber(2012) financial statements, The News International, Islamabad, March 31,2012 5. JS Bank(2012) financial statements, The News International, Islamabad, March 30, 2012

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