CREDIT RISK AND PROFITABILITY OF ISLAMIC BANKS IN PAKISTAN

Abstract

Purpose: The aim of this study is to investigate and perform analysis to determine the effects of equity and debt financing on the credit risk and profitability of the Islamic banks in Pakistan. To understand the relationship of both types of financing on the earning of the banks, credit risk has been studied as a mediator between the independent and predicting variable. Methodology & Design This study is an explanatory research to determine the relationship among the variables. There are total four full-fledged IBs operating in Pakistan, all of which were part of this study. The research was performed on the data collected from year 2009 to 2018 annual reports ofthe IBs. Findings According to the results ofregression analysis, the equity (PLS) does not have a major impact on the earnings and debt (NPLS) financing contracts have significant negative effects on the earning ofthe banks. While these two financings may have indirect effects on the profitability, as they have a positive impact on the credit risk of the banks. Thus, increase in credit risk decreases the earning ofthe banks. Limitations The limitation of data unavailability, time constraint and Islamic banks not offering similar contracts as their counterparts were faced conducting this research. Recommendations Islamic banks need strong and efficient risk management framework, which would identify, eliminate and control the credit risk associated with the financing contracts of the IBs. Actions must be taken for client’s non-disclosure of information. Mudarabah and Musharakah contracts must be practiced more, as they are the ideal types of investment contracts without interest.