Determinants of Profitability in Islamic Banks: Some Evidence from the Middle East

Abstract

The paper analyzes how bank characteristics and the overall financial environment affect the performance of Islamic banks. Utilizing bank level data, the study examines the performance indicators of Islamic banks across eight Middle Eastern countries between 1993 and 1998. A variety of internal and external banking characteristics were used to predict profitability and efficiency. In general, our analysis of determinants of Islamic banks’ profitability confirms previous findings. Controlling for macroeconomic environment, financial market structure, and taxation, the results indicate that high capital-to-asset and loan-to-asset ratios lead to higher profitability. The results also indicate that foreign-owned banks are likely to be profitable. Everything remaining equal, the regression results show that implicit and explicit taxes affect the bank performance and profitability negatively while favorable macroeconomic conditions impact performance measures positively. Our results also indicate that stock markets and banks are complementary to each other.