THE IMPACT OF ISLAMIC MODES OF FINANCE ON ISLAMIC BANK’S PROFITABILITY

Abstract

Purpose: This study focuses on the establishment of the relationship between Islamic mode of finance and its ability to make profits in the Islamic banking system. In order to do so, the purpose of this study is to identify the impact of Ijarah (Lease Financing), Musharakah (House Financing), Murabaha (SME Financing), and Bai Salam (Agri Financing) on ROA of Islamic Banks. Methodology & Design: This study uses quantitative research methods and deductive approach to address the research questions and achieve the research objectives. This is achieved through testing the hypotheses and analyzing them based on the information acquired from secondary sources, which are financial and annual reports ofthe Islamic banks from the past five years. Findings: The research finds that the Ijarah (Lease Financing) has a significant as well as positive impact on ROA in Islamic Banks. Moreover the research also finds that the relationship between Diminishing Musharakah (House Financing) and ROA in Islamic Banks is significant but has a negative relation. On the other hand, the research finds that impact of Murabaha (SME Financing) on ROA in Islamic Banks and Bai Salam (Agri Financing) on ROA in Islamic Banks is insignificant. Limitations: This study only covers the data obtained from the Islamic banks functioning in Pakistan, and the data is obtained through the financial reports of these banks from the last five years. This study does not include any information regarding the profitability ofthe bank or the factors that might affect it before 2014. Recommendations: It is recommended for the Islamic banks to strategize and include all modes ofIslamic financing to reap their benefits, it is also recommended for the banks to understand the implications of each Islamic mode of finance in order to offer better services and guidance to the consumers and develop long-term relationships, which eventually will lead to better performance and i profitability. The future research may cover wider grounds on the performance of Islamic banks,such as stability, prudence, efficiency and impact on the economy. The future research may include the other Islamic modes of finance as an attempt to understand the factors that impact profitability of Islamic banks.