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Stability of Islamic and Conventional Banks During the Financial Crisis

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Stability of Islamic and Conventional Banks During the Financial Crisis
1. Ratio Analysis

The performance and the stability of banks can be quantified and measured through the analysis of their financial ratios. We can have several hundreds of ratios at our disposal. However, we will use only those that are common, and of some meaning for the analysis of the banks. Also, it is important to note that we should use only major and comparable ratios in order to fully understand the financial position of these banks as compared to all those ratios that may include some vagueness in the research.

Mainly five categories of these financial ratios are used to eliminate the vagueness created by redundant use of the financial heads and items from the financial statements. Hence, the five categories are: (CFA 2009, p498):

- Profitability Ratios
- Activity Ratios
- Liquidity Ratios
- Solvency Ratios
- Valuation Ratios

However, for the banking industry, which is our main concern, we will use only the first four categories, making an exception of the Valuation category. The financial stability department of the State Bank of Pakistan, which is the central bank of this major economy in the Muslim world, and actively involved in the promotion of Islamic Banking, suggests that the financial ratios fairly reflect the stability, health and the performance of the banks. Hence, these ratios can be used for our purpose.
2. Z-score

Instead of just doing the Financial Ratios Analysis, we should also do the analysis of the banks’ insolvency risk, which is measured by the z-score. This will be done for both the categories of banking systems: Islamic Banks; as well as the Commercial Banks. The statistic based on z-score is calculated with the help of the data on the bank’s expected profits, the riskiness or the variation in such profits and the capital base of the bank. In

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