Credit Risk Analysis Of Islamic Bank VS Conventional Bank In Malaysia

Abstract

The market-based approach is an alternative to accounting-based approach. The use of accounting information alone does not reflect the appropriate level of credit risk for banks. Therefore, comparisons of credit risk between two groups of banks using both approaches are essential. The aim of this present study is two-fold. First, the level of credit risk between Islamic banks and conventional banks was measured and compared. Second, the level of credit risk was empirically compared using several approaches. The credit risk of two domestic full-fledged Islamic banks and four domestic conventional banks was assessed between 2014 and 2018 using two accounting-based approaches (non-performing financing (NPF) & non-performing loan (NPL) ratios) and Z-score. For higher comparability, the level of credit risk was measured based on distance to default (DD) and probability of default (PD) using KMV Merton model as the market-based indicator. Further statistical test for equality of variances was performed to execute a reliable and meaningful comparison between the two bank groups. The results derived from Z-score and KMV Merton model revealed higher credit risk in Islamic banks, in comparison to conventional banks. The NPF and NPL ratios exhibited contradicting outcomes for Islamic banks (lower credit risk). These findings signify that it is vital for Islamic and conventional banks to implement both accounting- and market-based measures as varying approaches yield different results for credit risk assessment.