Two banks, one Islamic and one conventional, which are directly comparable

When people compare Islamic banks and conventional banks, they are often at risk of "comparing apples and oranges."

The reason is that banks can differ in very many ways, quite apart from whether they are Islamic or conventional. For example:

While planning my August 2019 column for the magazine "Islamic Finance News" I realised that the above comparability problems should be much less if the Islamic and the conventional bank are under common ownership and operate in the same country.

You can read the ensuing article below. I recommend downloading the 2018 accounts mentioned for reference:

Two directly comparable banks, one conventional, one Islamic

I often stress that an Islamic bank is a bank. Complying with the requirements of its Shariah Supervisory Board makes that bank Islamic.

I compared two Malaysian banks, both owned by CIMB Group Holdings Berhad, (“CIMB Group”). Given common ownership, both should have the same management culture, and achieve similar financial results apart from differences due size. The following numbers all come from the accounts for the year ended 31 December 2018.

CIMB Bank Berhad (“CIMB Bank”) is a conventional bank. CIMB Bank’s consolidated assets of RMB 451.9 billion comprise 85% of CIMB Group’s consolidated assets of RMB 534.1 billion.

This conventional bank, CIMB Bank, also owns an Islamic bank, CIMB Islamic Bank Berhad (“CIMB Islamic”). CIMB Islamic is much smaller, being about ¼ of the size of its conventional parent with consolidated assets of only RMB 103.7 billion.

As well as owning CIMB Islamic, CIMB Bank also undertakes some Islamic banking itself. These Islamic operations are small, with income during the year of only RMB 149 million out of total CIMB Bank net income before overheads of RMB 8.1 billion.

I expected CIMB Bank to be more profitable than CIMB Islamic, due to economies of scale. The raw figures I computed surprised me.

For 2018, CIMB Bank had net profit after tax and zakat of RMB 2.8 billion. The 31 December 2018 ordinary shareholders equity was RMB 33.4 billion, apparently giving a return on closing equity of only 8.38%.

However, this ignores the fact that RMB 6.5 billion of CIMB Bank’s equity is financing the investment in shares of CIMB Islamic. Reducing the equity to RMB 33.4 – 6.5 = 26.9 billion (the equity financing the banking operations) gives a noticeably higher return on closing equity of 10.4%.

CIMB Islamic had a 2018 net profit after tax and zakat of RMB 0.8 billion. Its 31 December 2018 ordinary shareholders equity was RMB 5.3 billion, resulting in a return on equity of 15.1%.

This surprised me. I had expected it to be less profitable than CIMB Bank. The explanation lies in its balance sheet.

CIMB Bank’s own balance sheet (not the consolidated balance sheet) shows total assets of RMB 321.9 billion. Logically, we should eliminate the RMB 6.5 billion investment in CIMB Islamic shares, leaving banking assets of RMB 315.4 billion. Comparing them with the reduced banking equity of RMB 26.9 billion computed above gives a basic (not risk weighted) leverage ratio of 315.4 / 26.9 = 11.7.

Conversely the CIMB Islamic balance sheet has total assets of RMB 103.7 billion. With ordinary shareholders’ equity of RMB 5.3 billion its basic leverage ratio is 19.57. That is surprisingly high in today’s regulatory environment.

At present I have not investigated how it has been allowed to operate with so much leverage, but there may be an implied promise of support from its parent for which there is no inter-company charge.

To have the same 11.7 basic leverage ratio as computed above CIMB Bank, CIMB Islamic would need extra equity of RMB 3.6 billion since 103.7 / (5.3+3.6) = 11.7.

With this extra equity, CIMB Islamic’s return on equity would fall to 0.8 / (5.3+3.6) = 9.0%. That looks more sensible in comparison to the adjusted figure for CIMB Bank of 10.4%, given the size difference between the two banks.

Both sets of results look creditable given that even 11 years after the global financial crisis the business environment for banks remains challenging with interest rates being comparatively low by historical standards.