Risk Management in
Islamic Financial Instruments
63
 Equity / Net Loans: this ratio measures the equity cushion available to absorb
losses on the loan book
 Equity / Liabilities : This leverage ratio is simply another way of looking at the
equity funding of the balance sheet and is another way of looking at capital
adequacy.
Operational Efficiency ratios
 Net Interest Margin: This ratio is the net interest income expressed as a
percentage of earning assets. The higher this ratio, the cheaper the funding or the
higher the margin the bank is commanding. Higher margins and profitability are
desirable as long as the asset quality is being maintained
 Net Int Rev / Avg Assets25: Net Interest Income over average assets indicates that
the item is averaged using the net income expressed as a percentage of the total
balance sheet
 Pre-Tax Op Inc / Avg Assets : This is a measure of the operating performance of
the bank before tax and unusual items. This is a good measure of profitability
unaffected by one off non trading activities.
 Return On Avg Assets (ROAA)
 Return On Avg Equity (ROAE)
 Dividend Pay-Out: This is a measure of the amount of post tax profits paid out to
shareholders. In general, the higher the ratio the better, but not if it is at the cost of
restricting reinvestment in the bank and its ability to grow its business.
Liquidity Ratios
 Interbank Ratio: this is money lent to other banks divided by money borrowed
from other banks. If this ratio is greater than 100, then it indicates the bank is net
placer, rather than a borrower, of funds in the market place, and is therefore more
liquid.
 Net Loans / Cust & ST Funding: This loan to deposit ratio is a measure of
liquidity, and high values denote lower liquidity.
 Net Loans / Tot Dep & Bor: This ratio has deposits and borrowings, with the
exception of capital instruments, as its denominator.
 Liquid Assets / Tot Dep & Bor : This ratio is similar to those mentioned above,
but looks at the amount of liquid assets available to borrowers as well as
depositors.
4.2 SAMPLE SELECTION CRITERIA
For each geographic region, a sample of conventional banks is selected as control sample,
where conventional banks are matched with Islamic banks from each country, based on the
closest total asset size. Later, risk matrices are calculated for both the Islamic and conventional
banks, and a comparative analysis is provided. A similar methodology is used in analyzing
25 The acronym "AVG" stands for the arithmetic mean of the value at the end of year t and t-1