How can an Islamic bank go bankrupt?
Islamic banks are facing financial problems because of high competition among them and the fact that they have limited customers. This research aims to study the bankruptcy risks of these banks. It uses a quantitative approach and a Discriminant analysis method. It also makes use of secondary data from 12 Islamic Banks.
Interest-free loans
Interest-free loans are necessary to meet basic needs. Siddiqi recognized this need and believed it is the duty of the state and community to meet needs. He, therefore, downplayed the role of Islamic banks in providing consumption loans and suggested they could offer limited overdraft facilities at no interest.
However, the popularity of interest-free loans in Islamic countries has been accompanied by the emergence of new market players. The OPEC surplus, which was a boon to both sides, also facilitated the proliferation of these institutions. The multipurpose nature of Islamic banking poses practical problems.
Avoiding risky investments
There are certain factors that can prevent an Islamic bank from going bankrupt. For starters, it should focus on high-return projects. Islamic banks often fail to capitalize on such opportunities because they prefer to borrow from conventional banks, which have lower borrowing costs. Furthermore, an Islamic bank cannot compete with conventional banks, which apply profit-loss-sharing modes.
The main challenge for Islamic banks is the financing of government and consumer debts. Islamic banks have had to rely on fixed-asset return methods to finance these needs. But this practice doesn't completely eliminate risk.
Early warning systems
Having early warning systems for Islamic banks is an important step to combat financial distress. These systems can help managers identify problems before they occur and plan for solutions in advance. Several different methods exist to calculate an early warning score for an Islamic bank. These include the Altman Z-Score, Grover G-Score, and Springate S-Score. All of these methods are designed to predict the likelihood of a bank going under.
The CAMELS score is one of the most popular monitoring tools used to determine financial distress in Islamic banks. This ratio is an indicator of how operating expenses compare to operating income, and is a useful Early Warning System for preventing financial distress. This method is consistent with Kurniasari's (2013) study, although Ismawati's (2015) study disagrees.
Other factors
The credit crisis is wreaking havoc across the Western banking system. Recent reports from the International Monetary Fund (IMF) suggest that global losses could total trillions of dollars. In a move that exacerbates the problem, 150-year-old US financial giant Lehman Brothers filed for bankruptcy. By contrast, Islamic banks are largely unaffected by the subprime mortgage crisis. As a result, many non-Muslims are turning to Islamic banking as a safe haven. In part, this is because of the inherent business ethics of Islamic banking.
While all Islamic banks have been categorized as healthy by the Grover G-Score method, there are some banks that are at risk of bankruptcy. A bank that is in a healthy state has a G-Score of more than 0.01. A bank is in danger of bankruptcy if its G-Score is negative. As a result, it is important to analyze the bankruptcy potential of an Islamic bank.
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