Performance of Islamic Financial Services 233
■ (^) Islamic banks’ solvency was better, mainly due to low leverage which
helped them contain the adverse impact on profi tability in 2008, but
their weaknesses in risk management practices caused larger declines in
profi tability than experienced by conventional banks in 2009.
■ (^) The weak performance in some countries was associated with sector
concentration and, in some cases, was facilitated by exemptions from
concentration limits.
■ (^) Islamic banks experienced higher profi tability during the pre - global cri-
sis period (2005–07), but their average profi tability for 2008–09 was
not much different from conventional banks, indicating better cumula-
tive (pre - and post - crisis) profi tability.
■ (^) Larger Islamic banks performed better than small ones because of better
diversifi cation, economies of scale, and stronger reputation.
In a World Bank study, Beck, Demirgüç - Kunt and Merrouche (2010)
found Islamic banks to be more cost - effective than conventional banks in
a broad cross - country sample but this fi nding was reversed in a sample
of countries. Islamic banks had higher capitalization and higher liquid-
ity reserves, which were considered the source of their better performance
when compared to conventional banks. Interestingly, the study found that
conventional banks that operate in countries with a higher market share of
Islamic banks were more cost - effective but less stable.
Whereas analyzing the performance of fi nancial institutions requires
extensive data and information, which is not always readily available, it is
relatively easy to see the performance of Islamic products in capital markets.
We undertook a simple comparison of Dow Jones Islamic Indices with their
conventional benchmarks and found that the Islamic indices outperformed
the benchmark (whether it be US or World) when performance was mea-
sured in risk - adjusted value.
Table 11.1 shows a comparison of the Dow Jones Islamic US Index and
the S&P 500 for the fi ve - year period from December 1, 2005 to November
30, 2010. The analysis was performed on weekly index returns, and
cumulative returns are reported for the last one - , two-, three-, four - and
fi ve - year periods. We computed excess return (ER), tracking error (TE)
and information ratio and found that the Islamic index outperformed the
S&P 500 in each year in risk - adjusted terms as measured by information
ratios.
Figure 11.1 shows the weekly cumulative returns of the two indices. An
interesting observation can be made here. Although, on a risk - adjusted basis,
the Islamic index had better nominal returns, the S&P 500 outperformed the
Islamic index from December 2005 to late 2007 when the Islamic index
began to show better nominal returns. One possible explanation for this
could be that the S&P 500 included fi nancial stocks, which are not part of
the Islamic index. During the boom time, the inclusion of fi nancial stocks
created a leverage effect and gave better returns; but before and during the
crisis, fi nancial stocks were hit hard.