European Journal of Economic and Financial Research ISSN: 2501-9430 ISSN-L: 2501-9430 Available on-line at: http://www.oapub.org/soc Volume 2 │ Issue 5│ 2017 doi: 10.5281/zenodo.1068183 FINANCIAL CONDITION AND PERFORMANCE OF ISLAMIC AND NON-ISLAMIC BANKS IN KENYA: A COMPARATIVE STUDY Polycap Obote Olweny1, Joshua Wanjare2i 1 1 University of Nairobi, Kenya Dr., University of Nairobi, Kenya Abstract: This study compares the financial condition and performance of the Islamic banks against those of the conventional banks in Kenya along the dimensions including profitability, liquidity and solvency. The study applies descriptive financial analysis research design and is longitudinal in nature spanning a period of six years from 2010 to 2015. A sample of seven banks has been studied covering two fully fledged Islamic banks and five non-Islamic banks under the same small peer group according to the C”K bank supervision report of 4. Secondary data collected from the banks’ financial statements has been utilized in this study. The study concludes that the difference in profitability and solvency between the Islamic banks and the conventional banks is not statistically significant. On liquidity, however, Islamic banks have proven to be significantly better than the Non-Islamic banks. JEL: G21, G24, E50 Keywords: Islamic banks; non Islamic banks; financial condition; financial performance 1. Introduction Financial intermediation is of paramount importance to any country as without its proper functioning economic growth becomes an illusion. Attracting deposits from savers for onward lending to deficit units (borrowers) is a major function of banks as it enables investment to take place and thus spur economic development of any nation Copyright © The Author(s). All Rights Reserved. © 2015 – 2017 Open Access Publishing Group 102 Polycap Obote Olweny, Joshua Wanjare FINANCIAL CONDITION AND PERFORMANCE OF ISLAMIC AND NON-ISLAMIC BANKS IN KENYA: A COMPARATIVE STUDY “li, . Islamic banking has been defined as banking in consonance with the ethos and value system of Islam and governed, in addition to the conventional good governance and risk management rules, by the principles laid down by Islamic law Moin, 2008). Masruki, Ibrahim, Osman & Wahab consider Islamic banking as a banking model that is consistent with Islamic law and guided by Islamic economics . Islamic banks I”s proscribe interest as it is considered exploitative and undesirable. Islam emphasizes on fully following the Quran and not maximizing return on transactions [(Kader, et al, 2007 as cited by Widago & Ika (2008)]. Non Islamic banks (NIBs), on the other hand, are those banks whose activities are based on a fixed rate of interest . “part from ensuring that a borrower is capable of paying by background check, they also demand that the period of repayment determines the final amount to be paid (Al-Shami, 2009). Non Islamic banks (NIBs) act on the basis of pure financial intermediation from which they make their profits from margins generated from deposits and also interests earned from moneys advanced to investors or individuals (Ryu et al., 2012, as cited by Onakoya & Onakoya, 2013).These financial institutions provide a variety of services and these are; saving mobilization from surplus units to deficit units and secondly, they also provide other related services such as; transfer of funds, facilitation of international trade, consultancy services, custody of treasures, and other ancillary services for which they receive payments. NIBs provide deposit services in which reward is fixed in advance and predetermined unlike IBs (Hanif, 2011). Under the Non-Islamic Banking model, the bank bears the total risk and net return is kept after defraying other expenses and the depositors’ interest at a fixed rate. This is different from Islamic banking model where both reward (not interest- riba) and risk are shared and they are pegged on the outcome of the investment. In the Non-Islamic banking context, it means collection of funds followed by their disbursement based on interest charge. However, interest is prohibited in Islam therefore Non-Islamic banking does not cater for the religious disposition of an Islamic economy. The capital structure of an Islamic bank does not include debts and thus no interest is charged and consequently their returns come from profit and loss sharing arrangements (Hanif, 2011; Ali, 2011). It is majorly on this premise that Islamic banks only concentrate on trading, leasing, fee based services as well as investment activities”, as noted by Ali (2011). According to Islamic finance, anyone who does not bear any risk should not claim any benefit and this forms the foundation of profit and loss sharing paradigm (Jedidia & Hamza, 2014). While the Islamic banking model has a distinct calling to fulfill the instructions as per the Holly Quran by being fare and a free system where fairness is the primary objective, Non-Islamic banking model is all about maximization of returns on investments (Usman & Khan, 2012). European Journal of Economic and Financial Research - Volume 2 │ Issue 5 │ 2017 103 Polycap Obote Olweny, Joshua Wanjare FINANCIAL CONDITION AND PERFORMANCE OF ISLAMIC AND NON-ISLAMIC BANKS IN KENYA: A COMPARATIVE STUDY In Kenya, both Islamic and Non-Islamic banks (NIBs) are still lumped together under the same Banking Act, Cap 488 of the laws of Kenya, notwithstanding the apparent advantages usually enjoyed by the NIBs over the Islamic banking model such as being paid interest on their reserves held by the Central Bank, a deal that Islamic Banks (IBs) prohibit. Thus, Islamic banks have different characteristics; be it in the area of their objectives, operations or procedures. This study investigates the relative profitability, liquidity, risk and solvency related to the two banking models in the Kenya’s context. The foundation and development of Islamic finance and by extension, Islamic banking, is Islam itself and the degree and readiness of its adherents to live according to their calling while Non-Islamic banking is based on pure financial intermediations (Ali, 2011).The rapid growth of IBs have been put to question with others suggesting that comparing these models (IBs and NIBs) is not appropriate because NIBs have been there for years and years (Masruki, Ibrahim, Osman and Wahab, 2011). Skeptics like Samad (2004) as cited by Masruki, Ibrahim, Osman and Wahab (2011) wonder how non-conventional institutions like IBs that do not accept interest and are required to follow two rules-manmade laws and Islamic laws, seem to be performing unbelievably well as compared to NIBs that are even free to enter into any business transaction as they like. Islamic financial institutions are under obligation to share their profits or losses as the case may be with depositors and other users of their funds something which does not apply to NIBs (see for example, Ali, 2011, Hanif, 2011, Jedidia & Hamza, 2014). According to the conventional capital structure theorists, it was advanced that there were only two sources of capital namely; debt and equity ( Modigliani & Miller, 1958, 1963, Myer ,1984 ,Miller, 1995).However, the proponents of Islamic finance maintain that the idea of financial risk applicable to conventional capital structure (debt and equity) is irrelevant to IBs because the capital structure of IBs do not include debts (Al Deehani et al.,1999 as cited by Aldeehani, El-sadi & Al-Deehani,2015). Usman and Khan (2012) carried out a comparative analysis of financial performance of IBs and NIBs in Pakistan between 2007 and 2009 and their study concluded that the IBs were booming as compared to their counterparts. Johnes, Izzeldin & Pappas using Data Envelopment Analysis (DEA) reports no substantial variance in gross (on average) efficacy between the two banking models after the scale is reduced to a common frontier . Conversely, the outcome differs when they use Meta-frontier analysis (MFA) as it reveals that Islamic banking model is less efficient compared to the Non-Islamic model. Garo (2013) studied the factors influencing financial performance of IBs as compared to the NI”s in Kenya. Ng’ang’a (2013) carried out a study on the effects of financial structure on the financial performance of NIBs and IBs. Thomi (2014) did a study to find out the effects of Islamic banking products on financial performance of commercial banks in Kenya between European Journal of Economic and Financial Research - Volume 2 │ Issue 5 │ 2017 104 Polycap Obote Olweny, Joshua Wanjare FINANCIAL CONDITION AND PERFORMANCE OF ISLAMIC AND NON-ISLAMIC BANKS IN KENYA: A COMPARATIVE STUDY 2009 and 2013. Jamal (2013) did a comparative study of financial performance of IBs and NIBs (2010 -2012, three year period) using a CAMEL model. This study intends to include the period 2010 to 2015 (six years) because between those times the pure IBs in Kenya had matured enough to compete in equal footing with the conventional counter parts. Harris (2012) as cited by Jamal (2013) noted that the two IBs in Kenya managed to break even within three years of their operations hence it is only fair to evaluate their performances from the year 2010 onwards with the entrenched NIBs. Jamal (2013) after carrying out a comparative study of financial performance of IBs and NIBs in Kenya (2010 to 2012-three years) also suggested that an expanded period of study should be carried out and hence this study intends to fill that gap. Apart from the above observations, the study adopted a different methodology by using Discriminant Analysis model and One Way-Repeated Measures Analysis of Variance (rANOVA) model which others have not tried out here locally to the researcher’s knowledge. The study will answer the question; do these two banking models differ in terms of their financial conditions and performances in Kenya? For viewing / downloading the full article, please access the following link: https://oapub.org/soc/index.php/EJEFR/article/view/268 European Journal of Economic and Financial Research - Volume 2 │ Issue 5 │ 2017 105