This justification rests, as IFSB (2011) notes, a major concern for IAHs. For one reason, Islamic banks have full discretion to make use of deposits when managing

76 This justification rests, as IFSB (2011) notes, a major concern for IAHs. For one reason, Islamic banks have full discretion to make use of deposits when managing

unrestricted IAHs’ funds without denoting where, how and for which purpose those funds are to be invested. For another, restricted IAHs make agreement with Islamic banks on how their deposits will be utilized and for what purpose. Exposition of restricted IAHs to rate of return risk in view of the fact that any loss incurred from assets funded by their deposits will be born solely by them may push unrestricted IAHs to withdraw their money from Islamic banking, leading to a liquidity crisis. IFSB’s study establishes a clear idea about the existing relationship between liquidity levels and profit rates, where Islamic banks tend to attract and maintain deposits by providing higher returns.

5.3 Impact of Islamic banks’ performance on profit distribution: CAMELS approach CAMELS approach results revealed that Islamic banks’ performance is definitely affecting banks’ intention regarding profit distribution. The overall model of equation

( 3 ) is significant at 1 per cent level. The findings indicate that a good performance in all the five aspects of the operations of Islamic banks will promote IAHs’ share of profit. The sensitivity to market risk variable added to this model is also significant, providing evidence that in addition to banks’ operations, IAHs are also affected by the external market risk ( Table VII ).

If we further analyze the general results, we find that capital adequacy ratio measures respond positively to the profit-sharing ratio at 5 per cent significance level. This result supports the previous findings in equation ( 2 ). This implies that a high capital adequacy ratio indicates a good financial health of Islamic banks, which reduces their incentives to manage the profit distribution ratio.

The outcome of equation ( 3 ) indicates that the cost to income ratio has a strong role in explaining the distribution of profit to IAHs. The results show that poor performance indicated by a mismanagement of costs incurred relative to income generated will push

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managers to distribute less profit to depositors. The proxy of management soundness is found to be significant at 1 per cent level. The same conclusion was noticed concerning administrative expenses ratio, meaning that the more a bank is incurring administrative expenses, the less willingness to distribute profit to depositors. The rationale behind it is that the profit margin tends to shrink when cost levels rise, inducing banks to manage profit distribution regarding IAHs in a way to smooth earnings allocated to banks’ shareholders. The latter sheds light on corporate governance issues in Islamic banking. To make it clearer, equity investors, namely, PSIAHs, need to have a corporate governance structure that offers them the required and efficient monitoring of their funds. Unlike shareholders who have the board of directors designed to protect their rights, PSIAHs do not have such mechanism of governance established in Islamic banks. However, some Islamic banks have established governance committees to deal with this issue, but the effectiveness of this mechanism is questionable.

Islamic banking

Wald chi 2 (12) 91.90 0.0000 No. of Observations

No. of Groups

Notes: The table shows regression results using generalized least-squares model. The dependent variable is the profit distribution ratio and the IVs are CAMELS ratios. Also country dummy is added

Table VII.

to the model as a control variable. This idea behind adding this model is to assess the effect of sensitivity Banks’ performance to market on the profit-sharing issues; * represents coefficient significant at the level of 10 per

impact on profit cent, ** for those significant at 5 per cent, *** for those significant at 1 per cent; (–) omitted because of

distribution: CAMELS collinearity

approach

Profitability level as a proxy of good performance is found to affect positively profit-sharing ratio. ROE, ROA as well as NIM are significant at 1 per cent level. The

results of ROE and ROA impact on profit distribution are in line with equation ( 2 ) findings, which give more strength to the outcome. However, NIM turned to be significant in this model at 1 per cent level. Yet, the study predicted that all profitability measures including NIM will impact positively profit distribution ratio, but precisely the opposite has proven true regarding NIM. The counterintuitive finding that higher NIM will make Islamic banks distribute less profit to depositors may be appropriate in

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terms of assets composition. Basically, Islamic banks rely on contractual structure for fund management activities, namely, Mudarabah. These structures differ from one type of investment account to another. For instance, UIAs appear in Islamic banks’ balance sheet, whereas RIAs are treated as off balance sheet items. The latter creates complication in the supervision of Islamic banks as well as corporate governance problems as described earlier. These complications facilitate the task for Islamic banks to manipulate profit distribution to depositors.

The sixth dimension added to the CAMEL, sensitivity to the market risk, is found to

be significant at the level of 1 per cent. Higher price to earnings ratio may raise the concern that the stock market may be headed for a downturn, because Islamic banks’ share prices have become very high relative to their earnings. Some financial analysts who hold this outlook point out that in the past, high price-earnings ratios have usually been followed by slow growth in stock prices ( Shen, 2000 ). Thereby, to be in a position

IMEFM

to face a potential risk from the external market, Islamic banks may be tempted to

7,1 allocate part of their profit as a reserve on the expense of distributing less to their

depositors. This evidence reveals that higher sensitivity to the market risk will affect negatively Islamic banks’ performance, which in turn drives profit-sharing ratio downturn.