My page "Two banks, one Islamic and one conventional, which are directly comparable" looked at the results of two Malaysian banks, CIMB Bank Berhad (“CIMB Bank”) which is a conventional bank and its subsidiary, the Islamic bank CIMB Islamic Bank Berhad (“CIMB Islamic”).
I was surprised to find that, despite being smaller, CIMB Islamic was the more profitable, measured by return on equity. That page looked at some of the possible reasons.
I returned to the mystery in my September 2019 column in the magazine "Islamic Finance News." You can read it below.
I recommend downloading the 2018 accounting information mentioned for reference:
CIMB Group Holdings Berhad accounts
CIMB Bank Berhad accounts
CIMB Islamic Bank Berhad accounts
CIMB Group Basel II Pillar 3 Disclosures for the period ended 30 June 2018
Last month I was surprised by the fact that CIMB Islamic was noticeably more profitable (measured by return on equity) than its much larger conventional parent, CIMB Bank. A close look at the accounts showed that CIMB Islamic was able to operate with a significantly higher leverage ratio (gross assets / equity) than CIMB Bank.
In that article, I only had space to speculate regarding why CIMB Islamic was permitted to have a higher leverage ratio. I return to that question below.
A reader pointed out to me that CIMB Islamic has a significantly lower expense ratio than CIMB Bank and wondered whether the Islamic subsidiary was being subsidised.
When you look at overheads / (total income before interest expense), CIMB Islamic does indeed have a much lower ratio than CIMB Bank. The respective figures are 14% Islamic and 33% Bank. Accordingly, the lower level of overhead expense is definitely part of the explanation for CIMB Islamic’s higher profitability. I have not investigated further; partly because I suspect that the published accounts won’t give enough details about why CIMB Islamic’s overheads are lower.
Different tax rates are often a reason for a parent company to subsidise a subsidiary. However, the 2018 tax rate for CIMB Bank of 21% is virtually identical with that of CIMB Islamic at 20%.
I also wondered whether CIMB Islamic was charging its customers higher rates than was CIMB Bank. However, the ratio of interest income (or its Islamic equivalent) / gross assets, at 4.2% Islamic and 4.1% Bank, is virtually identical for both banks.
From the CIMB website I downloaded the group’s Basel II Pillar 3 Disclosures for the period ended 30 June 2018. Reading these, one must be careful since the figures for CIMB Bank are consolidated ones including its subsidiary CIMB Islamic which constitutes about 1/5 of the CIMB Bank consolidated numbers. However the CIMB Bank / CIMB Islamic size difference is so great that for most practical purposes you can treat the CIMB Bank numbers as if it was all conventional.
The first important point is that CIMB Islamic has a Tier 1 ratio (tier 1 capital / total risk weighted assets) of 14.7% compared with 13.8% for CIMB Bank. This is the opposite way round from the gross leverage ratios discussed last month.
The straightforward reason is that CIMB Islamic has much less risky assets than does CIMB Bank. The Pillar 3 Disclosures report gives total credit risk gross exposures for CIMB Islamic of RM 97.9 billion which reduces to risk weighted assets after the effects of PSIA (profit-sharing investment accounts) of RM 30.1 billion. i.e. RWA / gross exposures ratio of 30.8%.
For CIMB Bank the equivalent figures are RM 427.8 billion gross credit exposures, RM 220.6 billion RWA, giving an RWA / gross exposures ratio of 51.6%. Furthermore, remember that about 1/5 of the CIMB Bank consolidated assets are those of CIMB Islamic, so the CIMB Bank conventional assets must have an even higher ratio than 51.6%. Some simple arithmetic shows that CIMB Bank’s purely conventional assets have a ratio of 57.7%.
CIMB Bank is not earning a higher rate of interest as compensation for having riskier assets. As stated above, interest income / gross assets is virtually identical for CIMB Bank and CIMB Islamic. Unlike CIMB Islamic, CIMB Bank earned RM 4 billion of non-interest income, some of which might require it to hold these higher risk assets.
Otherwise, the shareholders could reasonably ask CIMB Bank’s management why they are bothering financing assets which are higher risk, while earning no extra reward.
Taken together, these two articles show how much you can learn from published financial information, despite spending a relatively short amount of time analysing it. I am confident that spending extra time would have revealed more about the issue.
At the same time, published financial information has its limitations. In particular, with consolidated accounts, it can be quite difficult to ascertain the detailed results of the parent company as a stand-alone entity. Effectively you need to gather the accounts of all of the subsidiaries, and then attempt to "de-consolidate" the accounts.
I would have tried that if there was a real commercial goal, for example if thinking of investing real money. However it clearly was not worth the effort for a short magazine article!
If any reader has spent additional time considering this issue, I would like to hear from them. My email address is available from my "Contact me" page. Otherwise just post a Disqus comment below.