Impact Of Global Economic Crisis On Banks In United Arab Emirates

Selected Banks – Dubai Islamic Bank, Sharjah Islamic Bank, National Bank of Abu Dhabi, Abu Dhabi Commercial Bank

Question:

Discuss about the Systematic and Unsystematic Risk Determinants.

This is a study which will analyse the impact of the global economic crisis on the banks in United Arab Emirates. The study will aim to highlight the profitability of the banks after the global economic crisis. The four banks that are taken in to account belong to two categories, Islamic and conventional banks. The banks that will be analysed to identify the profitability are Dubai Islamic Bank, Sharjah Islamic Bank, Abu Dhabi Commercial Bank and National Bank of Abu Dhabi. Dubai Islamic Bank was the bank who implemented the principles of Islam in the all the practices of the organization. It is one of the largest Islamic bank in the United Arab Emirates (Dubai Islamic Bank ,2017). The organization being a public joint stock company is listed in the Dubai Financial Market. The organization is involved in both international and local partnerships and has a network of 200 branches in Pakistan. The banking license of the organization was received from the Central Bank of Jordon to work as a financial institution of Islamic nature. Sharjah Islamic Bank is also bank which has implemented the Islamic principles in the banking system of their organization (Sharjah Islamic Bank, 2017). The headquarter of the bank is in Emirates and has been converted in to an Islamic bank in the year of 2004. On the contrary, the Abu Dhabi Commercial Bank has been established as a public shareholding listing organization and had limited liability. However, the government of Abu Dhabi holds 65% of the shares of the company (ADCB, 2017). The rest of the funds of the organization is held by individuals and financial institutions. The bank is a joint company which provides services in the field of commercial, retail, merchant, investment, fund management and brokerage. National Bank of Abu Dhabi is one of the largest lender bank in the United Arab Emirates and the market capitalization of the bank is one of the largest. The headquarters of the bank is in Abu Dhabi and is situated in the main financial district in Abu Dhabi. There is diversity in the portfolio of the bank and provides services such as corporate, retail, investment and wholesale banking facilities. The other services provided by the bank includes wealth management, brokerage, Islamic Banking, leasing and property management (NBAD UAE, 2017).   

The study will evaluate the ROE of the banks, ROA of the bank, Equity multiplier and asset utilization ratio. The comparative study will facilitate in understanding the profitability of each of the banks and the causes behind it.

Objectives – Comparison and Contrast of Response to Global Economic Crisis, Analysis of ROE, ROA, Asset Utilization Ratio, Equity Multiplier of Banks

The global economic crisis had profound impact on all the banks all around the world. However, the impact of the global economic crisis was different in Islamic banks and conventional banks. The principles these banks follow is different so the impact of the global economy will be different on both type of the banks. The study will analyse the profitability of each of the banks by analysing their return on investment, return on asset and equity multiplier ratio. These values will highlight the impact of the global economic crisis on each of the banks and how they have coped up with it.

• What is the impact of global economic crisis on the Islamic banks?
• What is the impact of global economic crisis on the conventional banks?
• What is the significance of the global economic crisis on the profitability of the Islamic banks?
• What is the significance of the global economic crisis on the profitability of the conventional banks?

The study aims to identify the impact of the global economic crisis on the banks in United Arab Emirates. The study has chosen two conventional banks and two Islamic banks which will be analysed based on their return on investment, return on asset and the equity multiplier. The findings form the study will be able to validate the existing theories of literature and will provide a better understanding of the topic.

H₀ –  The global economic crisis has impacted the profitability of the banks in United Arab Emirates

H₁ –  The global economic crisis has not impacted the profitability of the banks United Arab Emirates

The literature review is divide in to two parts one is the theoretical literature and the other is the empirical literature. The theoretical literature review will illustrate the various theories from different researchers and the empirical literature review will consist of the calculated data of all the banks that have been taken in to account.

Islamic banks have similar roles when compared to the Conventional banks. The Islamic Banks are the main sponsors to production of information and therefore supports in addressing the problem of asymmetric information. They also facilitate in the reduction of the transaction costs and assists in diversification for investors and small savers. During conducting the organizational business, Islamic Banks mitigate risks which arise from the operational, liquidity and asymmetric information problem. The fundamental difference between Islamic and Conventional Banks is that Islamic banks operate in harmony with the guidelines of Shariah which is the Islamic legal code (Waemustafa & Sukri, 2015).

The intermediation of the conventional banks is mainly based on debt and allows the transfer of risk while the intermediation of Islamic banks have a contrasting character and is based on assets which focuses of sharing of risk.

Risk transfer and Risk sharing
Conventional Banks Risk Transfer	Islamic Banks Risk Sharing
The risk is transferred by the depositors to the banks so that they can ensure that their return is pre-specified.	The Islamic bank share the return and the risk with the investors (profit sharing investment account (PSIA) holders) and there is no pre-specified return in this context and the return will depend on the performance of the bank.
The interest rate is independent of the return and borrowers will have to pay it irrespective of the return. The risks are being transferred through credit default swaps and securitization. The financing of the organizations is based on debt.	The risk is shared in Musharakah and Mudharabah contracts in Islamic banks. Moreover, the sales contracts are conducted in most of the contracts.

Literature Review – Theoretical and Empirical Review, Key Differences Between Islamic and Conventional Banking Systems, Previous Studies and Findings

The level of risk sharing is different in the Islamic banks and according to the standards step by the Islamic principles, the policies are similar to the conventional banking system. However, there is a basic difference in the Islamic banking system that it does not allow making investment in the instruments which are having adverse effect on the conventional competitors which was the cause of the global economic crisis. However, the economic crisis had impacted the both conventional banks and the Islamic banks but the impact will have to be assessed based on certain criteria (Bourkhis & Nabi, 2013).  The indicators which can be used to identify the impact are bank lending, profitability, bank rating and bank asset. Various studies suggest that the analysis of the profitability of the Islamic banks are much better condition than the conventional banks. Beck,  Demirgüç-Kunt & Merrouche, (2013) states the impact of the crisis on the Islamic banks are worse than in other countries. However, in some countries the losses faced by the Islamic banks are more than in United Arab Emirates. The risk-taking factor for the Islamic banks were more so it was expected that the losses incurred will be more but the scenario was opposite. The ratio of the non-performing assets was higher among the Islamic banks than the conventional banks in the country. The credit growth in the economy suggest that the credit growth was more for the Islamic banks than the conventional banks. Thus, the Islamic banks were able to provide stability to the market due to the growth in credit. The asset growth also shows a similar scenario where the asset of the Islamic banks was expected to grow more than the conventional banks. However, there was different situation in different countries and so there is no uniformity in the opinion among the various researchers (Waemustafa & Sukri, 2016).

Comparative analysis of performance between conventional bank and Islamic banks was completed amid the economic crisis for the State of Kuwait, Bahrain, Qatar, Oman, Saudi Arabia, and United Arab Emirates. This examination utilized six proportion investigations what’s more, found that Islamic managing an account endured more amid the money related emergency worldwide as far as capital proportions, use and profit for normal value while regular banks endured more as far as return by and large resources and liquidity. The examination by Hesse & Poghosyan, (2016), studied the impacts of the worldwide budgetary emergency in 2008 and 2009 against Islamic and ordinary saving money in a few nations including Kuwait, Bahrain, Malaysia, Qatar, Jordan, Saudi Arabia, UAE and Turkey. Consequences of the investigation demonstrated that Islamic banks were influenced in an unexpected way than ordinary banks within the worldwide monetary emergency. The gainfulness factor had helped Islamic saving money by lessening the unfavourable impacts of the worldwide monetary emergency.

Impact of Global Economic Crisis – Rationale for Analyzing Impact on Selected Banks, Assessing ROE, ROA, Asset Utilization Ratio, Equity Multiplier to Evaluate Impact

Liquidity is a vital factor in guaranteeing stability in a banking organization. It assumes a critical part in liquidity hazard in existing monetary emergency. The investigation by (), who made examination amongst Islamic and regular keeping money amid the worldwide budgetary emergency in 2007-2008 in Malaysia took into account three markers; productivity, liquidity and credit chance of saving money organizations (Ajmi et al., 2014). The example was taken from 2006 to 2010 and was categorized into some time recently, amid also, after the monetary emergency. The discoveries uncovered that Islamic saving money was less presented to liquidity hazard when contrasted with regular saving money amid the money related emergency. A study was likewise directed in Turkey to survey the security of Islamic and regular saving money area in the worldwide money related emergency from 2006 to 2011. The study utilized yearly examination slant towards productivity, liquidity, hazard and proportion of advantage amount of traditional and Islamic saving money. The outcomes demonstrated that Islamic keeping money was more steady than ordinary banks as far as gainfulness, capital ampleness and liquidity for the period under audit, counting amid the 2008 worldwide money related emergency (Rosman, Wahab & Zainol, 2014).

As stated by (Kapan & Minoiu, 2013), due to the recent global financial crisis the traditional banks got affected in a bad way all across the world. Even though the Islamic banks also got influenced by this global financial crisis, but their performance at the time of this crises was recorded better the traditional banks. On further research it was found that the Islamic banks had to suffer in the areas of capital ratio, leverage and return on equity irrespective of their good performance during 2006-2009 in comparison with the conventional banks. As per the Report of World Bank (Ashfaq, 2016), the comparison carried out between the performances of the traditional banks and the Islamic ones at the time of the financial crisis showed that even though both the forms of banks were influenced by the crisis, the Islamic banks came out superior in terms of credit risk and liquidity reserves. Therefore, it can be easily said the Islamic banks performed better than the convention ones in the financial crisis.

A Dubai based mortgage provider, AMLAK, faced financial lie-down and their Kuwait institute defaulted, in turn failing to issue their SUKUK. However, Islamic finance continued in a relatively positive and sturdy manner, irrespective of the instability and the misery of the overriding financial crisis. Generally, the admission of the financial crisis in the Islamic capital market was not to happen because of a lot of reasons that included: the Shariah not allowing the sale of debt against debt, and it is not possible for someone to be selling the resources till the time the person is possessing the actual resources and it is prohibited by Islam that risky and speculative transactions are carried out.

Research Hypotheses – H0: The global economic crisis has impacted the profitability of the banks. H1: The global economic crisis has not impacted the profitability of the banks.

Additionally, in Islamic finance, lending is founded on capital backing and the generally mortgage loans are presented in exchange of solid assets. In comparison, in traditional baking the main agenda of present crises is simply due to huge amounts of loans being granted by them minus any kind of collaterals. Inside the Islamic regulatory control system, the investors are all conscious of both the risks and returns. As mentioned by Saif-Alyousfi, Saha & Md-Rus, (2017), the result of the execution of profit and loss sharing transactions is complete disclosure and clarity. Due to that there is better comprehension experienced in market discipline, and because of that there is appearance of judicious control over needless lending, which in turn improved the Islamic financial system.

The global financial crisis played a huge role in pushing the developed countries into developing a fresh financial system that would be having eth capability of tackling the crisis issue. The crisis made the developed nations lower their bank rates and that introduced a new financial system that is completely founded on the Islamic principles of interest free financial system. The capitalist system that failed after this financial crisis, was looking for a system that would be solving the speculation issues and financial crisis inside the Islamic financial system as an alternative (Mohamed, 2016). The capitalist system was extremely affected by the harshness shown by the financial crisis, but still managed identifying the failure of risk alleviations at different levels as the cause of the crisis. The capitalist economy was looking for a system that is completely risk free.

Irrespective of different crisis and challenges, steady growth is seen in Islamic financial institutions. Countries such as Bahrain, UAE and Malaysia are the hubs for Islamic finance that are working towards the development of Islamic finances. The leading financial centers of the world like Hong Kong, New York and Singapore make use of Islamic finance simultaneously with traditional banking for the improvement in risk and liquidity management. SUKUK bonds are key instances of Islamic finance growth (Gopalakrishnan & Mohapatra, 2017).

As per Kapan & Minoiu, (2013), analyzing the competitive situation and traditional Islamic financial system found that the Islamic banks are found to be less competitive in comparison with the traditional banking system. Due to high capitalization, the Islamic banks face less financial risk. They kept on showing more durability and flexibility in the face of the global financial crisis of 2007. Even the western banks profited from the Islamic banks in the aftermath of the global crisis in the battle of tackling the crisis for the restoration of their financial stability. Findings have suggested the Islamic banks being more capable of controlling risk in comparison to traditional banks, with the help of better capital ratio, principles free of Gharar and interest. Their finance is based on moral and ethical principles, even proper checking and balance, working in the interest of everyone.

Equity Multiplier (EM)= Total Assets/ Total Equity
2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017
4	5	4	5	4	5	4	5	4	5	4

Findings and Implications – Analysis of Profitability of Banks, Validating Existing Theories, Providing Better Understanding of the Topic

National Bank of Abu Dhabi

Return on Equity (ROE)= Net Income/ Total Equity
2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017
164.26	146.26	-5.74	1.97	14.53	10.77	13.89	15.27	17.39	13.58	13.26

Return on Assets (ROA)= Net Income/ Total Assets
2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017
0.04	0.03	0.03	0.03	0.02	0.03	0.03	0.04	0.04	0.03	0.03

Equity Multiplier (EM)= Total Assets/ Total Equity
2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017
7	7	7	8	8	7	8	8	8	9	9
24,177	26,408	28,728	30,351	31,801	24,270	24,177	26,408	28,728	30,351	31,801

Sharjah Islamic Bank Abu Dhabi Commercial Bank

Return on Equity (ROE)= Net Income/ Total Equity
2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017
18.26	22.33	23.19	22.14	19.4	15.56	9.91	8.44	-8.8	2.79	2.79

Return on Assets (ROA)= Net Income/ Total Assets
2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017
1.19	1.4	1.43	1.33	1.17	1.02	0.68	0.56	-0.55	0.16	0.16

The result of the study suggests that the existing theories have been validated which shows that the return on equity and the return on asset for the Islamic banks are unchanged which means that the global economic crisis was unable to pout significant impact on the performance of the Islamic banks. However, this is not the case for the commercial banks which suggest that there is fluctuation in the return on investment and the return on asset which shows that the commercial banks have been significantly impacted by global economic crisis. Moreover, the equity multiplier for the commercial banks are high which suggest that the banks are relying more on debts for financing purposes which increases the chances of failure risk for them.

Conclusion

Thus, it can be concluded from the analysis of the study that the impact of the global economic crisis of the conventional banks have been huge and their return on investment have been hampered significantly. However, the data suggest that there has been negligible impact of the global economic crisis on the Islamic banks. Moreover, they have been able to provide stability to the macro economic environment of the country. Thus, from the data it is suggested that the conventional banks should rely less on debt for financing purposes. Moreover, the result suggest that the Islamic banks are more profitable than the conventional banks. The return on investment of the Islamic banks are stable and while there is lot of fluctuation in the ratios in both the commercial banks. However, the bank that has been mostly impacted is the National Bank of Abu Dhabi whose performance has decreased significantly over the years. Moreover, the equity multiplier for the organization is too high which suggest that there the organization highly dependent on debt for financing.

References

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