Sustainable performance during the COVID-19 pandemic: a comparative analysis of Islamic and conventional banks

ABSTRACT

This study examines the role of market competition and efficiency in explaining banks’ stability during the COVID-19 pandemic. Using a sample of 575 banks in 20 countries in the Middle East and North Africa (MENA) region for the period 2006-2021, we investigate the individual and joint effects of competition and efficiency on bank profitability and risk during the COVID-19 pandemic. The results indicate that both market power and efficiency are strong determinants of bank performance and stability in the MENA region, and these effects are similar across different types of banking systems (conventional and Islamic) in the pre-COVID-19 period. The analysis of bank performance during the pandemic period (2020-2021) shows that efficient banks exhibit better profitability and cost-effectiveness if they operate in a more competitive environment and are Islamic. Regarding the interaction effect, our results indicate that market competition seems to reinforce the positive effect of efficiency on Islamic banks ‘stability during the recent financial crisis.

KEYWORDS:

• Competition
• efficiency
• profitability
• COVID-19 pandemic
• stability

Disclosure statement

No potential conflict of interest was reported by the author(s).

Ethical compliance

All procedures performed in studies involving human participants were in accordance with the ethical standards of the institutional and/or national research committee and with the 1964 Helsinki Declaration and its later amendments or comparable ethical standards.

Notes

1 The empirical literature alsoexamined ‘the influence of the dual board structure on the financial performance of Islamic banks’ (Farag, Mallin, and Ow-Yong 2018, 59). Someauthorsfind ‘that the larger the Shari’ah Supervisory Board (SSB) the better the financial performance and this result reinforces the fundamental role of the SSB to certify permissible financial instruments and products’ (Farag, Mallin, and Ow-Yong 2018, 59).

2 Using a sample of 532 banks (129 Islamic and 403 conventional) located in 23 Muslim countries, Boubaker et al. (2023) investigated ‘whether the Islamic banking business model makes corporate earnings more uncertain’. They reported that ‘IBs’ return on assets is significantly more uncertain than CBs due to higher operational costs’ (Boubaker et al. 2023, 1).

3 According to Cosset, Somé, and Valéry (2016) market competition and corporate governance seem to be complementary in explaining firm value in developing countries. The complementarity hypothesis becomes even more important for banks in the sense that market competition may support internal governance mechanisms for improving bank performance.

4 In our robustness tests, we and employ the efficiency-adjusted Lerner index instead of the traditional Lerner index ‘to deal with both cost and profit inefficiencies in the empirical measurement of the Lerner index’ (da Silva Neto 2021, 24).

5 We also use non-interest income to total assets ratio as a proxy of revenue diversification (see Appendix A). The expect sign of the relationship with bank profitability is positive.

6 In the risk-taking models in which the dependent variable is Z-score, for methodological reasons, the NPL ratio was not included as an explanatory variable.

7 To address the issue of time-variant factors that might influence bank performance, we add year dummies to our baseline model and run a Robust Hausman test. The results indicate that the random effects specification is the valid model in this case. Another approach used in the empirical literature to address this issue is the two-way panel fixed effects model (Wooldridge 2021).

8 In the first stage, we estimate the main determinants of market power (the Learner index) and efficiency (DEA score) – as suspect endogenous variables – using their lagged variables (up to 3 lags) as instruments. In the second stage, we estimate the relationship between market power and efficiency and financial performance, ‘controlling for the fitted variables of the suspect endogenous variable’ (Farag, Mallin, and Ow-Yong 2018, 21).

9 To better understand the reasons for these results, we calculated FSI for each country in the sample and found that the FSI values were not homogeneous across the sample. For some countries, the values are higher in the 2020–2021 period than in the preceding years (e.g., the Syrian Arab Republic and Yemen), indicating a strong and stable financial position of banks in these countries. For others (e.g., Iran and Tunisia), we found evidence of substantial credit risk related to the NPLs portfolio that translates in negative values of FSI index. Furthermore, we removed few extreme values (outliers). The adjusted index values in Table 2 show slightly negative values for IBs and positive for CBs.

10 The economic relevance of the coefficient estimates in Table 3 indicates that, for instance, in column 2 and 5, a one standard deviation increase in market power (20%) leads to an increase of 0.32% (0.016*20%) of bank profitability of CBs and 2.28% (0.114*20%) for IBs (measured by ROE).

11 The impact of market power on bank stability is not only statistically significant but also economically relevant. For instance, in Table 6, a one standard deviation increase in market power (20%), leads to a decrease of 1.64% (-0.082*20%) of bank stability of CBs and 15.22% (-0.761*20%) for IBs (measured by Z-Score). Likewise, the efficiency effects are economically relevant for both types of banks (CBs and IBs).