A Comparative Analysis of Non-Performing Financing in Islamic and Conventional Banks of Pakistan.

Abstract

This paper seeks to identify the determinants of the non-performing loans of conventional banking and non-performing financing of the Islamic industry. Data of ten (10) year i.e. from 2008 to 2017 of Eight (8) conventional banks and four (4) Islamic banks were taken. The methods of’ T test’ was conducted to ascertain the difference in means of non-performing portfolios, whereas Multiple Regression Analysis using panel data was done to assess the relationship of critical variables with non-performing portfolios of both set of banks. The results suggests that the non-performing loans of conventional banks are greater than non-performing financing of Islamic banks of Pakistan. Moreover, in line with expectation, loan volume have positive effect. However, financing volume-the counterpart of load volume- have negative but more significant effect. Number of branches have inverse but insignificant effect on non-performing portfolios of both set of banks. Another interesting findings is that the staff strength is having negative and significant impact on non-performing portfolios loans whereas in case of Islamic banks, this effect is positive and significant. This might suggest that lack of staff is enforcing the Islamic banks to utilize the services of existing human resource who have conventional banking experience which may result in increasing of non-performing financings of Islamic banks. Furthermore, the relationship of capital adequacy ratio of Islamic banks is inversely and significantly related to non-performing financing of Islamic bank, whereas this relationship is directly and significantly related to non-performing loans of conventional banks. The effect of interest income on Non-performing loan/ Financing was found to be positive as expected however insignificant in case of Islamic banks. This further suggested that conventional lending system is effected by adverse selection problem while Islamic banks having unique asset back position transfer mechanism effectively mitigate that problem. Overall finding suggests that there are significant structural differences between interest base lending and asset backed financing of Islamic banks, the latter being more stable due to lack of adverse selection and moral hazard problems that arise due to interest base lending. Secondly, institutions, learning centers and skill development centers should be established to provide skilled human resources to Islamic banking and finance industry of Pakistan.

Keywords: Non-Performing Loans, Non-Performing Financings, Capital Adequacy Ratio, Interest Based Lending, Asset Backed Financing, Adverse Selection, Moral Hazard