Influencing of Specific-Firm Characteristics on Islamic banks’ Profitability; Evidence from Gulf Co-operation Council Countries

Abstract. The Islamic banking industry is considered one of the fastest growing financial sectors in the first decade of the 21st century. The Islamic banking system operates in compliance with the codes of Islamic Shariah, and its profitability plays an important role in the economic growth of Gulf Cooperation Council (GCC) countries. This study aims to determine the impact of bank-specific characteristics, consisting of leverage, capitalization, operating expenses, number of branches, and bank size on profitability of the Islamic banks. After controlling for macroeconomic environment, the robust of OLS regression analysis for the panel data showed that capital adequacy, operating expenses, and number of branches are the most important determinants affecting Islamic banks' profitability in GCC countries. A health capital, a greater number of branches, and lower bank costs lead to increase profitability. Size has a positive association with the level of profits, and is just significant with return on equity (ROE). Consistent with the extant literature, the results showed that GDP per capita has a significantly positive effect on Islamic banks' profitability.Keywords: Islamic banking, bank profitability, firm charateristics, panel data analysisJEL: G21, C23(ProQuest: ... denotes formula omitted.)1 INTRODUCTIONThe banking industry constitutes a primary sector of financial system influencing economic growth. The stability and development of an economy to a great extent are without doubt based on the well-functioning of its banking sector. The financial intermediation efficiency influences national economic development (Levin, 1997; Rajan and Zingales, 1998). In contrast, according to Caprio and Klingebiel (2003), bank insolvencies affect the whole country's economy negatively, and at the same time, in many cases losses increase from 10-20% of gros domestic product (GDP), and sometimes approximately 40-45% of GDP. Further, adequate earnings are necessary for banks to protect solvency, to continue, and expand in an appropriate environment (Golin, 2001).The banking sector in the Gulf Region is regareded an of the essential part of the financial services industry, and it presents the largest sector in the GCC countries' economies. Higher and continued profitability is necessary in protecting the banking industry's stability. Therefore, a healthy profitability and small risk would raise the banks financial performance (Fraser and Fraser, 1991). In addition, the banking sector's strength is vital for governments in order to avoid negative budgetary results. A bank would not be able to absorb adverse shocks due to its weak profitability, which would influence its solvency, even if it is strong. According to Al-Khouri (2011), the banking sector in GCC countries has same features. Firstly, it is mostly dependent on oil sector activities. Secondly, it is not well diversified, wherein the primary operations are construction, real estate, and consumer loans. Finally, it is strongly protected from foreign competition, and controlled by the government.The emergence of the Islamic banking system was established in the 1970s based on the principle of the interest-free loan. Since all transactions and activities of Islamic banks are derived from Shariah rules and principles, the fixed return on the capital and operations are forbidden. The all types of investments' dealings are allowed by the Shariah if they are in the form of profit and loss sharing, which is the main principle covering all kinds of financial transactions.Islamic banks are required to operate under the main Shariah principles: profit sharing and free-interest loans. They give money to provide services to society and generate productive wealth by investment in different sectors to develop the national economy, which is the primary objective of the establishment of those banks.In the last three decades, the Islamic banking sector has emerged as one of the fastest-growing industries in terms of numbers and size with an annual growth rate of 12- 15% or higher (Rogers, 2004; Zaher and Hassan, 2001). …