The impact of COVID-19 pandemic on Islamic and conventional banks' profitability

Shah, Sadaqat Hussain et al. Article The impact of COVID-19 pandemic on Islamic and conventional banks' profitability Economies Provided in Cooperation with: MDPI – Multidisciplinary Digital Publishing Institute, Basel Suggested Citation: Shah, Sadaqat Hussain et al. (2023) : The impact of COVID-19 pandemic on Islamic and conventional banks' profitability, Economies, ISSN 2227-7099, MDPI, Basel, Vol. 11, Iss. 4, pp. 1-17, https://doi.org/10.3390/economies11040104 This Version is available at: https://hdl.handle.net/10419/328729 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Citation: Shah, Sayyed Sadaqat Hussain, S ,tefan Cristian Gherghina, Rui Miguel Dantas, Saliha Rafaqat, Anabela Batista Correia, and Mário Nuno Mata. 2023. The Impact of COVID-19 Pandemic on Islamic and Conventional Banks’ Profitability. Economies 11: 104. https://doi.org/ 10.3390/economies11040104 Academic Editor: Angela Roman Received: 9 February 2023 Revised: 11 March 2023 Accepted: 16 March 2023 Published: 24 March 2023 Copyright: © 2023 by the authors. Licensee MDPI, Basel, Switzerland. This article is an open access article distributed under the terms and conditions of the Creative Commons Attribution (CC BY) license (https:// creativecommons.org/licenses/by/ 4.0/). economies Article The Impact of COVID-19 Pandemic on Islamic and Conventional Banks’ Profitability Sayyed Sadaqat Hussain Shah 1, S ,tefan Cristian Gherghina 2,* , Rui Miguel Dantas 3, Saliha Rafaqat 1, Anabela Batista Correia 3and Mário Nuno Mata 3,4 1Department of Commerce and Finance, Government College, University Lahore, Lahore 54000, Pakistan 2Department of Finance, Bucharest University of Economic Studies, 6 Piata Romana, 010374 Bucharest, Romania 3ISCAL-Instituto Superior de Contabilidade e Administração de Lisboa, Instituto Politécnico de Lisboa, Avenida Miguel Bombarda 20, 1069-035 Lisbon, Portugal 4Business Research Unit (BRU-IUL), Instituto Universitário de Lisboa (ISCTEIUL), 1649-026 Lisbon, Portugal *Correspondence: stefan.gher[email protected]o Abstract: The banking sector has a significant impact on a nation’s financial stability and economic development. As one of the fundamental components of the financial sector, banks offer services that are essential for the expansion of the markets. The stability of the financial system is significantly impacted by the efficiency of the banking sector. COVID-19 has had a tremendous effect on the economy. This pandemic cannot be disregarded, considering how widespread it has been and how many people it has affected globally. Both society and the global economy have undergone profound change. Hence, it is critical to ascertain how severely the outbreak has impacted the banking system. To assess the potential impact of pandemic, the current study examined conventional and Islamic banking. This study also investigates how COVID-19’s moderating effect influences the banking system. Financial statements from 10 conventional banks and 5 Islamic banks in Pakistan are the sources of this study’s sample data. COVID-19 is a moderator in this study. The empirical estimations by means of the fixed-effects approach suggests that the moderator has a large impact on bank profitability. In addition, COVID-19 appears to have a stronger influence on the Islamic banking system. Keywords: COVID-19; Islamic vs. conventional; bank profitability; fixed-effects estimation 1. Introduction The banking sector plays an important role in the economic growth and financial stability of countries. Banks are one of the pillars of the financial ecosystem, which provide services that are vital to the foundation of the financial markets. The profitability of the banking sector plays an overly aggressive role in determining the soundness of the banking system. In that respect, the profitability hence becomes a key success factor for booming economies, which is the reason why profitability of the banking sector is so important (Anbar and Alper 2011). There are two types of banking sectors: one is Riba-free, called Islamic, and the other one is interest-based, known as conventional banking. Both of these banking systems create competition to satisfy their customers’ needs and expectations. Islamic and conventional banking each play a major role for the economy, and these are differentiated based on Riba, risk sharing, profit sharing practices and on their goals. The first Islamic bank was introduced in Malaysia in 1983 (Ramlan and Adnan 2016). Islamic finance basically provides financial services and products according to the tenets of Shariah. Islamic financing is increasing day by day, especially in Muslim countries (Hussain et al. 2016). The basic reason for Islamic financing is to satisfy the teachings of the Holy Quran and Sunnah of the cherished Prophet Muhammad (P.B.U.H.), and charging additional money Economies 2023,11, 104. https://doi.org/10.3390/economies11040104 https://www.mdpi.com/journal/economies Economies 2023,11, 104 2 of 17 and accumulating extra profit is strictly prohibited in Islam. According to Shariah and Islamic Common Law, contracts in the context of Riba and Speculation (Gharar) are not allowed. In Islam, carrying balances on credit cards are strictly prohibited, and putting money in fixed-income securities is also not allowed. This includes T-bonds and T-bills or any other product containing a fixed return. Islam does not allow fixed returns. ProfitLoss-Sharing is the concept of Islam. Investors following the Islamic financial system profit when there is a profit, and bear loss when there is a misfortune. Basically, the Islamic financial system is much like the Western Financial system, but it is exactly according to the teaching of Holy Quran and Sunnah, and is still developing and being refined more day by day. Speculators usually are given fair and fixed rates of return, which is strictly prohibited in Islam. The concepts of interest, extra profit and fixed returns differentiate Islamic financing from the conventional financing system. During the last twenty years, there was a very large-scale development of Islamic financing in financial markets and Islamic banking around the world in almost all Muslim countries. Over the past few years Islamic banking has been growing rapidly (Hussain et al. 2016). The COVID-19 pandemic has badly hit the economy of the world. The banking sector also faced challenges due to this pandemic. This virus has not only affected the banking sector, but also the stock markets. The expected default rate is rising due to the uncertainty of health and lockdowns. The banking sector then faces a liquidity problem because of the mismatch of demand and supply (Obeidat et al. 2021). In this pandemic, customers and governments withdraw from banks to support the economy, while borrowers are not returning funds to banks which causes a major reduction in deposits. To deal with this liquidity problem, the central banks announced support to the banking sector by lowering reserve requirements, regulatory capital and buying bonds/sukuks. COVID-19 has had a great impact on conventional and non-conventional banks’ profitability. Since COVID-19 the credit environment of banking has deteriorated, and it is expected that some considerable time will be required to recover credit ratings back to pre-COVID-19 levels (Obeidat et al. 2021). Market stock investors assessed that Islamic banks were not superior to conventional banks during the COVID-19 pandemic. There was a negative impact on stock returns of both banks due to COVID-19 and social distancing policies. Banks with higher operating cost suffered more. Islamic banks are not always immune to shock, as they have higher operating costs than conventional banks. So, there was an adverse impact on Islamic banks compared to conventional ones (Ashraf et al. 2022). It has been found that Islamic Banks (Ibs) enjoy distinctive methods of carrying out bank intermediation functions. Islamic banks have been demonstrated to have resilience in enduring the negative effects of economic crises, and in comparison to conventional banks, are claimed to be better equipped to safeguard their profitability during times of crisis. As a result, they can produce shareholder value in the form of higher stock returns. According to the empirical findings, which were based on the data of 426 banks from 48 nations, during the COVID-19 epidemic, Ibs’ stock returns were roughly 10–13 percent greater than those of their conventional equivalents. This is after adjusting for a wide range of pre-crisis bank-level and country-level characteristics, such as the state of each bank’s health and risk-taking culture (Mirzaei et al. 2022). According to the author’s knowledge there is little literature that investigates the comparison of Islamic and non-Islamic profitability with the moderating role of COVID-19 in Pakistan. This study will evaluate the success of Islamic banking as compared to conventional, as Islamic banking is now quite an old concept, and with the passage of time it is growing continuously. Islamic banking is not only growing in Muslim countries but also in non-Muslim countries. Conventional banks have also started using the Islamic window concept, by which they are attracting more banking customers. The novelty of this research will be useful and beneficial for the investors, policymakers, customers, managers, bankers, financial institutions and financial analysts’ decision making. It will help top management and the public in making decisions. The results of this research will be helpful to understand the moderating role of COVID-19 on Islamic and conventional banking. Economies 2023,11, 104 3 of 17 This research is organized around Pakistan’s emerging market, which has a bank-based economy. It is formed of Pakistan’s financial institutions, which constitute an important part of the country’s economy (Sultan and Siddique 2010). The structure of this paper is as follows. Section 2discusses prior literature and formulate the research hypotheses. Section 3describes the sample and data, as well as the empirical framework. Section 4shows the empirical results. Section 5performs the robustness checks. Section 6is focused on quantitative outcomes’ discussion. Last section concludes the paper. 2. Literature Review During the COVID-19 pandemic, Islamic banks are more flexible as compared to conventional banks because of profit sharing system. This system dominates transactions under these challenging conditions. Table 1summarizes the differences between Islamic and conventional banking systems. Table 1. Differences between Islamic and conventional banking systems. Islamic System Conventional System Banking practices and all elements involved are and must be Shariah compliant and free from prohibited activities such as Riba (interest), Gharar (uncertainty) and Maysir (gambling) Conventional bank practices do not have to be Shariah compliance and they include the elements such as Riba (interest), Maysir (gambling) and other prohibited activities in their transactions (Jaffar and Manarvi 2011) Real assets (having their own intrinsic value) are involved and used as products Money is used as a product and is the base of earning There is no concept of the time value of money and profit is earned through trading of goods and services. It is asset-backed financing where there always an asset involved and no concept of money (Awan 2009) This works on the principle of the time value of money and interest is earned on money/capital Loss is shared among banks and the organization/individual when they incur any loss Loss is not shared and the organization/individual has to pay the interest even if it incurs any loss (Arslan et al. 2020) A balanced budget is maintained as no more money is created (issuing bonds or printing new notes for deficit) Transactions are not backed by real assets, thus resulting in deficit financing in money markets Inflation is controlled because no money expansion takes place due to the involvement of goods and services Inflation is created while disbursing funds as the transactions are not backed by real assets, i.e., goods and services, thus resulting in the expansion of money Different Islamic products are Mudaraba, ijara, takaful, Hawala, Musawma, sukuk and Mushakarak. In delaying payment or in default, customers have to contribute in charity funds (Sultan and Siddique 2010) Different conventional banking products are credit cards, interest-based loans, bonds, insurance, car loans and shortand long-term loans. In delaying payment of loans interest will be charged (Jaffar and Manarvi 2011) As the inflation is much controlled and in check in the Islamic financial system, no extra burden or amount is charged by the entrepreneurs Due to inflation, entrepreneurs incorporate the inflationary effect into the cost of their goods and services and in result increase the prices of their goods and services available in the economy However, this pandemic has still hit the profitability of Islamic banking, but the role of Islamic fintech will improve in the post-COVID-19 era (Rabbani et al. 2020). Bashir (2003) examined the profitability of Islamic banks in the Middle East in 1993 and 1998, and stated that the profitability is positively related to equity and macroeconomic variables such as GDP; inflation also impacts profitability. Islamic financing is increasing day by day, especially in Muslim countries (Hussain et al. 2016). According to Shariah and Islamic Common Law, contracts in the context of Riba and Speculation (Gharar) are not allowed. During the last twenty years, there has been a very large-scale development of Islamic financing in financial markets and Islamic banking around the world in almost all Muslim countries (Hussain et al. 2016). According to Fakhri and Darmawan (2021), Islamic banking Economies 2023,11, 104 4 of 17 in Indonesia is more vulnerable compared to conventional banking, but COVID-19 also influences the operating expenses affecting the revenue of conventional banking. In Pakistan, growth of Islamic banking has been slow, but in recent years it started increasing as almost all other conventional banks opened an Islamic banking window because of the increasing trend of Islamic banks internationally. Some of the problems that Islamic banking is facing include the liquidity problem, lack of knowledge and well-trained human resources, fewer products compared to conventional banking, and a slow growth rate; still, the popularity of Islamic banking is increasing day by day. According to Ashraf (2022), who conducted a study to compare Shariahvs. nonShariah-compliant equities during COVID-19, Shariah-complaint stocks performed better than non-Shariah-compliant ones. Furthermore, it was observed that during the COVID-19 pandemic, confirmed cases and government responses were milder for Shariahcompliant companies. Muslim investors were more inclined towards religious beliefs in the COVID-19 crisis. Ali et al. (2022) analyzed the impact of the COVID-19 pandemic on Islamic and non-Islamic stock indexes in Pakistan. The study showed that during the pandemic, stock indexes of both Islamic and conventional natures behaved in almost same way. This global emergency made investors risk-averse and trading activity worsen. Although the concepts of both stocks are different, investors were concerned for profit maximization and preferred to invest funds on their objective rather than on conceptual differences. Sundarasen et al. (2022) examined the market volatility of Shariah and non-Shariah indexes in the ASEAN and GCC regions. The market volatility of ASEAN countries was higher than GCC countries during the COVID-19 pandemic because markets in ASEAN countries were more affected than Middle Eastern countries. The Shariah indexes are more volatile than non-Shariah ones in ASEAN countries because of a lack of portfolio diversification due to Shariah’s strict procedures. Dao and Nguyen (2020) investigated the factors influencing commercial bank profitability in Asian developing countries such as Vietnam, Malaysia, and Thailand, from 2012 to 2016, and found that all entities had a negative association between operational risk and banking profitability. Rwechungura et al. (2020) examined the connection between bank profitability and stability in Tanzania from 2006 to 2015 and concluded that large banks were more profitable than small banks. Katusiime (2021) explored the effects of the COVID-19 pandemic on banking sector profitability in Uganda and showed that the outbreak has a significant adverse impact on banking profitability only in the long run. Similar to the financial crisis of 2007–2009, the COVID-19 crisis initially affected all banks. It negatively affected the rating and funding conditions of banks, especially with low profitability (Aldasoro et al. 2020). The COVID-19 pandemic has had more adverse effects on the banking sector as compared to corporate due to national lockdowns and social distancing measures. Banks with lower liquidity and profitability were much more affected. In this crisis, central banks facilitated banks by providing policies regarding greater liquidity and the flow of credit (Demirgüç-Kunt et al. 2021). This pandemic affected almost all countries because of rapid transmission of the virus, which has great impacts on the economic system. However, this pandemic also created several different opportunities such as online banking, online meeting, food delivery services and all other online stores, which gained more in this period. Banks are a major and important pillar of the economy, and they facilitate in trade, credit facilities and support other businesses by providing loans. However, this pandemic affected the banking industry as well and put this sector under stress around the world (Darjana et al. 2022). Islamic banking faced many challenges during this pandemic. A minimum number of customers were allowed during MCO. The Central bank of Malaysia reduced the BLR, which affects a country’s inflation and leads to lower interest rates, which then causes problems for banks because a low return rate will decrease deposits (Anwar et al. 2020). Fajri et al. (2022) showed that during COVID-19, the profitability of Islamic banking was negatively related with this pandemic in the long run. The result showed that the decrease in interest rates and nonperforming finance was associated with the increase in return Economies 2023,11, 104 5 of 17 on assets. The banking sector in Kuwait has taken steps to protect different sectors from pandemic effects by lowering interest rates because oil prices were decreasing due to the impact of COVID-19 (Almutairi 2022). Kuwaiti banks provided services such as clearing, settlement and payments through the internet and electronic media to facilitate customers during this period. According to Almutairi (2022), the debt and leverage ratio increased after COVID-19 but return on asset, equity and investment decreased after COVID-19. During the first quarter of COVID-19, the U.S bank experienced a huge deposit flow from USD 13 trillion to USD 15 trillion in April 2020 (Levine et al. 2021). There was rapid growth in deposits and saving rates in U.S banks during this pandemic. As the economy was disturbed, households boosted their savings keeping in view the pandemic and economic uncertainty, thus they started saving their income. There was positive relation between COVID-19 and bank deposits in the U.S. There was great uncertainty in financial markets which prompted investors to save their money in bank deposits. This pandemic created panic and anxiety among people, due to which they started worrying about future, which surged their savings (Levine et al. 2021). Deposits are considered as safe and low risk investments. Agnese and Vento (2020) stated that in terms of deposits, the top four European countries, Germany, France, Italy and Spain, were stable and reliable during this pandemic. There was no massive change in deposits from households and nonfinancial corporations. Just like different sectors, investors also faced difficulty in making investment decisions. Cryptocurrencies also faced much instability during COVID-19 as there was an increase in the systematic risk. However, the results show that as Bitcoin is a mature cryptocurrency, it was relatively less vulnerable and more stable than other ones (Akhtaruzzaman et al. 2022). According to the empirical findings, which were based on the data of 426 banks from 48 nations, during the COVID-19 pandemic, Ibs’ stock returns were roughly 10–13 percent greater than those of their conventional equivalents (Mirzaei et al. 2022). According to Fidya (2020), although Indonesia has a large population of Muslims of almost 87% of their total population, they have only 10.5% of their total accounts in Islamic banks. Some of the factors for this are product information dissemination, product knowledge and profit margin factor. These different factors have a great impact on customers in choosing products offered by Islamic or conventional banks which directly affect banking profitability. Saleem and Ashfaque (2020) compared the profitability of Islamic banks between Malaysia and Pakistan, which showed that some factors such as size of bank, asset quality, liquidity and efficiency have an impact on the profitability of both countries in the same manner. However, in Pakistan leverage and asset quality are not good predictors of profitability because it is in the developing phase of Islamic banking. Bank size has a positive impact on the profitability of banks in both countries, but management of Pakistani Islamic banks should focus on the asset quality. Banks should be aware and provide relevant knowledge to their customers whether individual or corporate to use their Islamic products. Zarrouk et al. (2016) states that Islamic banks earns higher profits through non-financial activities. Islamic banking performs better with higher GDP and investment but performance is negatively related to the inflation rate. Jaara et al. (2021) stated that Islamic banks are less efficient than conventional banking in profitability level. Researchers revealed that bank size, capital ratio, GDP growth and inflation influence 85% of conventional bank profitability and 89% on Islamic bank profitability. When inflation rate increases, buying power decreases, which will directly affect bank loans to investors and will reflect on the profitability of Islamic banks. Network theory was used to examine the market power and competitive environment of banks during the global financial crisis. The result indicated that during and after the global financial crisis there was a lower level of competition. Therefore, banks disbursed loans to customers without proper screening, which led to accumulation of NPAs. Regulators should regulate the high credit sold off to their customers, especially during crisis (Rahman and Misra 2021). Economies 2023,11, 104 6 of 17 In the 1970s, Kahneman and Tversky (2013) explained the emotional and psychological aspects of customers in decision making. Prospect theory states that humans weigh loss more than gain as loss causes a more significant impact than gain and customers make decisions to pursue perceived gain more than loss. This theory is based on the process of decision making between different choices. It also explains the concept of loss aversion that investors weigh loss more than the gain; this means any individual will feel the pain of losing USD 200 as twice as the pleasure of gaining USD 200. Loss has a more emotional significant impact than gain. As part of development of behavior finance, the Islamic behavior finance gained light at the end of the 1980s to study the behavior (psychological and religion) of investors and customers towards their decision making in dealing with Islamic finance, Islamic banking and products (Kahneman and Tversky 2013). The theory of bank size was developed by (Krasa and Villamil 1992), which explains the importance of bank size to determine profitability in presence of risk. Stefan and Anne further stated that cost and risk are both important determinants of bank size. The theory also states that even bank portfolios are subjected to non-diversifiable macro risk, which improves default probability and increases monitoring cost. A higher monitoring cost leads to a decline in the profitability of banks. Conventional and Islamic banking have different bank sizes, which differently impact the profitability of banks (Rashid and Ilyas 2018). According to the review of literature, various variables exhibit distinct effects. Conventional banking has more experience than Islamic banking, so it is more stable when compared with Islamic banking. The profitability of conventional banks is higher than Islamic, but Islamic banking is less risky than conventional (Matar 2017). Average profitability of Islamic banking in 2008 and 2009 was better in all countries as compared to 2007 except Qatar, UAE and Bahrain. In Saudi Arabia, Turkey, Bahrain offshore and Jordan, the Islamic banking profitability was significant. The banking sector in these countries represent 52% and Islamic banking in these countries represent 37% of assets in the sample. Islamic banking in UAE and Qatar is worse than conventional, and an aggregate test for the sample showed that the impact of crisis on profitability of both groups (Islamic and conventional) was insignificant (Hasan and Dridi 2010). Islamic products are more complicated than conventional because of restrictions, and how they involve more than one concept. According to Hasan and Dridi (2010), Islamic banks are subject to different effects during crisis. Initially, profitability of Islamic banks was limited, but after some time Islamic banks in some countries faced big losses as compared to conventional. In 2005–2007, Islamic banks had higher returns on assets but after this crisis their profitability largely declined. During crisis, asset growth and credit were higher than in conventional banking because of its growing market share and lending to a less-affected consumer sector helped to support asset and credit growth. In the 2008–2009 crisis, larger Islamic banks performed better compared to small ones because of better diversification and strong reputations. This can be improved by developing the industry and increasing competition through establishing well-managed and large Islamic banks that can perform and compete better than existing ones. This global crisis gave an opportunity to Islamic banking to prove themselves and also highlighted the need to address and overcome different important challenges (Hasan and Dridi 2010). Based on the discussion of prior literature, the below-mentioned hypotheses are devised. In addition, the statistical significance of the estimated coefficients will be examined using a t-test. Only when the test statistic falls in the critical region (i.e., has a value greater than the critical value), the null hypothesis is rejected. As well, the p-value is used to determine if the null hypothesis is disregarded or confirmed (not rejected). If the p-value is less than the specified significance level (i.e., 1%, 5%, 10%), the null hypothesis is rejected; alternatively, it is not. H1. Bank size has a positive impact on profitability with the exogenous shock of COVID-19. Economies 2023,11, 104 7 of 17 H2. Operating efficiency with the moderation of COVID-19 has a negative impact on banks’ return on assets. H3. Interaction of COVID-19 with bank deposits have a positive impact on profitability of banks. 3. Research Methodology In order to analyze and comparing Islamic and conventional banks in Pakistan, we approach a quantitative study in which secondary data are used for analysis. 3.1. Sample Selection The sample consisted of 10 conventional banks and 5 Islamic banks in Pakistan. The sample consisted of Pakistani banks because after this pandemic no proper research was performed on the moderating role of COVID-19. As the pandemic is a part of this world, it is very important to consider this factor, which might help banks to tackle the condition in the future. All these banks are Pakistan-controlled banks and data were obtained from published financial balance sheets and income statements in annual reports of these banks. In this analysis, the sample conventional banks are Habib bank, United bank, Allied bank, National bank of Pakistan, Bank of Punjab, Soneri bank, MCB, Bank Alfalah, Askari bank, Bank Al Habib and the Islamic sample banks are Meezan bank, BankIslami, Bank AlBaraka, Dubai Islamic bank and MIB. A total of 15 banks were taken as the sample because their financial statements provide clear, complete and accurate information. Five Islamic banks were included as they are fully pure Islamic banks. Other banks were not included because they had incomplete financial information, or they were not purely Islamic as they have Islamic windows only. 3.2. Data Description Data were collected on a quarterly basis from the financial statements of banks from 2016 to 2021. They were divided into two parts: before and during COVID-19. COVID19 is used as a moderator. From 2016 to 2018 the value of COVID-19 is considered 0 and during COVID-19 it is assigned 1. Return on assets will be used as proxy to measure the profitability of banks in comparison with independent variables of bank deposits, operating efficiency and liquidity; however, bank size will also be a control variable. A dummy variable is used to examine the effect of the recent COVID-19 outbreak on the Pakistan banking profitability. Descriptive statistics and charts were used to analyze the comparison of Islamic and conventional banking. Stata software was used, and regression analysis was applied on this study’s results. Detailed explanations of the variables are mentioned in below Table 2. Regression analysis is used in this study for testing the relationship between variables. Its purpose is to estimate the effect of different independent variables on a dependent variable. A multiple regression model is used for the comparison of profitability of Islamic and conventional banking in Pakistan with the moderating role of COVID-19. In this model, return on assets is the dependent variable, which is used as a proxy for the measurement of profitability of banks. Bank deposit, size and operating efficiency are independent variables and COVID-19 is a moderating variable. For assessing the relation as indicated in H1, Equation (1) is designed: Return on assets =α+β1Bank sizeit +β2Covid19it +β3(Bank size ∗Covid19)it +β4Depositsit +β5Operating e f f iciencyit +e(1) In order to examine the association as specified in H2, Equation (2) is formed: Return on assets =α+β1Operating e f f iciencyit +β2Covid19it +β3(Operating e f f iciency ∗Covid19)it +β4Depositsit +β5Bank sizeit +e(2) With the purpose of investigating the link as formulated in H3, Equation (3) is devised: Economies 2023,11, 104 8 of 17 Return on assets =α+β1Depositsit +β2Covid19it +β3(Deposits ∗Covid19)it +β4Banksizeit +β5Operating e f f iciencyit +e(3) Table 2. Variable definitions and measurement. Variables Definitions Measurement Abbreviation Prior Studies Dependent variables Profitability (Return on assets) Return on Asset is used to assess the profitability of a firm and to analyze its future outlook in terms of revenues and growth Regression analysis is used to measure the relationship of ROA, a dependent variable with other independent variables ROA =NET INCOME TOTAL ASSETS ROA Jaara et al. (2021) Independent variables Bank deposit Bank deposits are the main funding of the banks, they are deposited by customers. It is a liability of banks but plays a major role in profitability of banks. Banks that have fewer investment avenues will try to improve their deposit base in order to earn revenues BANK DEPOSITS = TOTAL DEPOSITS TOTAL ASSETS Dp Al-Homaidi et al. (2020) Bank size Bank size defines the market share of each bank in the market or certain economy. A bank with large size reduces its cost because of economies of scale BANK SIZE = LOG OF TOTAL ASSETS Log A Ramlan and Adnan (2016) Operating efficiency Operating efficiency is the ratio of bank’s operating expenses to total assets. It indicates the bank management’s efficiency in spending every unit for generating revenues OPERATING EFFICIECNY =TOTAL OPERATING EXPENSE TOTAL ASSETS OPEF Al-Homaidi et al. (2020) COVID-19 (moderating variable) This is the moderating variable that takes 1 value during COVID-19 from 2019 to 2021, otherwise it has a 0 value before COVID-19 from 2016 to 2018 1 = during COVID-19 0 = before COVID-19 Cov Jin et al. (2021) The α represents the constant term. β1 , β2 , β3 , β4 represents the parameter of change and e relates to the error term that satisfies the equation. ROA is used to calculate the bank’s profitability. Operating efficiency is the dependent discrete variable. Bank deposit and size are also dependent variables. Bank size is the log of total assets. COVID-19 is the moderator which will check the impact on Islamic and conventional banks. In Equation (1) , Moderator1 is the multiplication of COVID-19 and bank deposits. In Equation (2), Moderator2 is the multiplication between COVID-19 and operating efficiency. In Equation (3) , Moderator3 is the multiplication of COVID-19 and bank size. 4. Empirical Results Stata software was used to examine the validity of the formulated hypotheses and the panel data regression model tested the relationship between return on assets and the independent variables of Islamic and conventional banks in this study. In this regression model Pooled OLS was used, and this model was estimated by ignoring time series’ and cross-sectional data’s natures and supposing that all entities are equal in the overall time period. This model used their values of intercept which do not change over time. The Hausman test was used to select the appropriate method for estimation. The result of Hausman test indicates that in this study the fixed-effect model will be applied as its p value is 0.007, which is less than 5% (p-value = 0.007 < 0.05). Table 3shows the regression analysis of Islamic and conventional banks without the moderator. It indicates that there is positive and significant relationship of bank size on both Islamic and conventional banks’ return on assets on the level of 1%. It explains that when the size of the bank is larger, then profitability (return on assets) of both types of banks will also increase. Islamic bank size has more impact on profitability as compared to conventional banking. Economies 2023,11, 104 15 of 17 the pandemic, customer trends or beliefs were more centered on Islamic banking compared to conventional banking in Pakistan. Researchers can conduct future studies on the comparison of banking profitability with other developing nations which will help them. With the passage of time, the Islamic banking sector is growing, so this will help future researchers to perform research on different areas of Islamic banking. Future researchers can conduct their studies by taking different pandemics or situations such as natural disasters (flood, dengue) as a moderator. Islamic banking is increasing rapidly, so banks must try to increase their deposits as well as manage their expenses in order to maximize their profitability, as this pandemic affected different sectors of the Pakistan economy. Banking is a meaningful part of the Pakistani financial system, hence it is essential to assess whether such outbreaks impair the banking sector. Author Contributions: Conceptualization, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; methodology, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; software, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; validation, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; formal analysis, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; investigation, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; resources, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; data curation, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; writing—original draft preparation, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; writing—review and editing, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; visualization, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; supervision, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; project administration, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M.; funding acquisition, S.S.H.S., S , .C.G., R.M.D., S.R., A.B.C. and M.N.M. All authors have read and agreed to the published version of the manuscript. Funding: This research received no external funding. Data Availability Statement: Data are available upon reasonable request. Acknowledgments: The authors would like to thank the Editor, as well as the three anonymous reviewers for all useful and helpful comments on the manuscript. Conflicts of Interest: The authors declare no conflict of interest. References Agnese, Paolo, and Gianfranco A. Vento. 2020. The Stability of Retail Banks’ Deposit at the Early Stages of Covid-19 Pandemic: A Preliminary Evidence from Euro Area. Journal of Applied Finance and Banking 10: 241–47. [CrossRef] [PubMed] Akhtaruzzaman, Md, Sabri Boubaker, Duc Khuong Nguyen, and Molla Ramizur Rahman. 2022. Systemic risk-sharing framework of cryptocurrencies in the COVID-19 crisis. Finance Research Letters 47: 102787. [CrossRef] [PubMed] Aldasoro, Iñaki, Ingo Fender, Bryan Hardy, and Nikola Tarashev. 2020. Effects of COVID-19 on the Banking Sector: The Market’s Assessment. Basel: Bank for International Settlements. Al-Homaidi, Eissa A., Faozi A. Almaqtari, Ali T. Yahya, and Amgad S. Khaled. 2020. Internal and external determinants of listed commercial banks’ profitability in India: Dynamic GMM approach. International Journal of Monetary Economics and Finance 13: 34–67. [CrossRef] Ali, Kashif, Muhammad Ashfaque, Adil Saleem, Judit Bárczi, and Judit Sági. 2022. Did the Islamic stock index provide shelter for investors during the COVID-19 crisis? Evidence from an emerging stock market. Risks 10: 109. [CrossRef] Almutairi, Humoud Awad. 2022. COVID-19 and Its Impact on the Financial Performance of Kuwaiti Banks: A Comparative Study Between Conventional and Islamic Banks. The Journal of Asian Finance, Economics and Business 9: 249–57. Anbar, Adem, and Deger Alper. 2011. Bank specific and macroeconomic determinants of commercial bank profitability: Empirical evidence from Turkey. Business and Economics Research Journal 2: 139–52. Anwar, Irda Syahira Khair, Norul Akma Mansor, SITI Marlia Shamsudin, and Farah Husna Mohd Fatzel. 2020. The Impact of COVID-19 Outbreak towards Islamic Banking: The Case of Malaysia. Paper presented at the 7th International Conference on Management and Muamallah, Bangi, Malaysia, November 4. Arslan, Erdal, A. Ali, and Abdul Hasib Amanat. 2020. Comparative Analysis of Conventional and Islamic Banking: The Case of Bakhtar Bank Transforming into Islamic Bank of Afghanistan. Yönetim ve Ekonomi Dergisi 27: 479–93. [CrossRef] Ashraf, Badar Nadeem. 2022. The performance of Islamic versus conventional stocks during the COVID-19 shock: Evidence from firm-level data. Research in International Business and Finance 60: 101622. Ashraf, Badar Nadeem, Mosab I. Tabash, and M. Kabir Hassan. 2022. Are Islamic banks more resilient to the crises vis-à-vis conventional banks? Evidence from the COVID-19 shock using stock market data. Pacific-Basin Finance Journal 73: 101774. [CrossRef] Economies 2023,11, 104 16 of 17 Awan, Abdul Ghafoor. 2009. Comparison of Islamic and conventional banking in Pakistan. Paper presented at the 2nd CBRC, Lahore, Pakistan, November 14; pp. 1–36. Baicu, Claudia Gabriela, Iuliana Petronela Gârdan, Daniel Adrian Gârdan, and Gheorghe Epuran. 2020. The impact of COVID-19 on consumer behavior in retail banking. Evidence from Romania. Management & Marketing 15: 534–56. Bashir, Abdel-Hameed M. 2003. Determinants of profitability in Islamic banks: Some evidence from the Middle East. Islamic Economic Studies 11. Dao, Binh, and D. P. Nguyen. 2020. Determinants of profitability in commercial banks in Vietnam, Malaysia and Thailand. The Journal of Asian Finance, Economics and Business 7: 133–43. [CrossRef] Darjana, Darjana, S. K. Wiryono, and D. P. Koesrindartoto. 2022. The COVID-19 Pandemic Impact on Banking Sector. Asian Economics Letters 3. [CrossRef] Demirgüç-Kunt, Asli, Alvaro Pedraza, and Claudia Ruiz-Ortega. 2021. Banking sector performance during the COVID-19 crisis. Journal of Banking & Finance 133: 106305. Fajri, Mohammad Zen Nasrudin, Adamu Abubakar Muhammad, Khoirul Umam, Lila Prisilia Putri, and Mohammad Ali Ramadhan. 2022. The Effect Covid-19 and Sectoral Financing on Islamic Bank Profitability in Indonesia. Journal of Islamic Economic Laws 5: 38–60. [CrossRef] Fakhri, Ulumuddin Nurul, and Angga Darmawan. 2021. Comparison of Islamic and conventional banking financial performance during the covid-19 period. International Journal of Islamic Economics and Finance (IJIEF) 4: 19–40. [CrossRef] Fidya, Kasih Maulidya. 2020. Factors That Influence Muslim Customers in Choosing Products of Islamic Bank. Padang City: Universitas Andalas. Hasan, Maher, and Jemma Dridi. 2010. The Effects of the Global Crisis on Islamic and Conventional Banks: A Comparative Study. Journal of International Commerce, Economics and Policy 2: 163–200. [CrossRef] Hussain, Mumtaz, Asghar Shahmoradi, and Rima Turk. 2016. An overview of Islamic finance. Journal of International Commerce, Economics and Policy 7: 1650003. [CrossRef] Hussien, Mohammed Ebrahim, Md Mahmudul Alam, Md Wahid Murad, and Abu NM Wahid. 2019. The performance of Islamic banks during the 2008 global financial crisis: Evidence from the Gulf cooperation council countries. Journal of Islamic Accounting and Business Research 10: 407–20. [CrossRef] Ichsan, R., Sudirman Suparmin, Mohammad Yusuf, Rifki Ismal, and Saleh Sitompul. 2021. Determinant of Sharia Bank’s Financial Performance during the Covid-19 Pandemic. Budapest International Research and Critics Institute-Journal (BIRCI-Journal) 4: 298–309. [CrossRef] Jaara, Bassam Omar Ali, Mohammad A. AL-Dahiyat, and Ismail AL-Takryty. 2021. The Determinants of Islamic and Conventional Banks Profitability in the GCC Region. International Journal of Financial Research 12: 78–91. [CrossRef] Jaffar, Muhammad, and Irfan Manarvi. 2011. Performance comparison of Islamic and Conventional banks in Pakistan. Global Journal of Management and Business Research 11. Jin, Guangchun, Jian Xu, Feng Liu, Muhammad Haris, and Faizi Weqar. 2021. Does R&D investment moderate the relationship between the COVID-19 pandemic and firm performance in China’s high-tech industries? Based on DuPont components. Technology Analysis & Strategic Management 34: 1464–78. Kahneman, Daniel, and Amos Tversky. 2013. Prospect theory: An analysis of decision under risk. In Handbook of the Fundamentals of Financial Decision Making: Part I. Singapore: World Scientific, pp. 99–127. Katusiime, Lorna. 2021. COVID 19 and Bank Profitability in Low Income Countries: The Case of Uganda. Journal of Risk and Financial Management 14: 588. [CrossRef] Krasa, Stefan, and Anne Villamil. 1992. A theory of optimal bank size. Oxford Economic Papers 44: 725–49. [CrossRef] Levine, Ross, Chen Lin, Mingzhu Tai, and Wensi Xie. 2021. How did depositors respond to COVID-19? The Review of Financial Studies 34: 5438–73. [CrossRef] Ludeen, Abdullah, and Mansur Masih. 2017. What Factors Affect Islamic Bank Deposits? Malaysian Case Based on ARDL. Available online: https://mpra.ub.uni-muenchen.de/109880/1/MPRA_paper_109880.pdf (accessed on 3 February 2022). Masood, Omar, and Muhammad Ashraf. 2012. Bank-specific and macroeconomic profitability determinants of Islamic banks: The case of different countries. Qualitative Research in Financial Markets 4: 255–68. [CrossRef] Masood, Omar, Muhammad Ashraf, and Seref Turen. 2015. Bank-specific and macroeconomic determinants of bank profitability: Evidence from Member States of the OIC. Journal of Islamic Financial Studies 1. Matar, Ali. 2017. Evaluating the performance of Islamic and commercial banks in Jordan: A comparative study. Jordan Journal of Economic Sciences 4: 57–75. [CrossRef] Mirzaei, Ali, Mohsen Saad, and Ali Emrouznejad. 2022. Bank stock performance during the COVID-19 crisis: Does efficiency explain why Islamic banks fared relatively better? Annals of Operations Research 1–39. [CrossRef] Obeidat, Muhanned, Ahmad Tarawneh, Mohammad Khataibeh, and O. Ghassan. 2021. The performance of banks in a developing country: Has COVID-19 made any difference? Journal of Economics Finance and Accounting 8: 102–8. Paltrinieri, Andrea, Alberto Dreassi, Simone Rossi, and Ashraf Khan. 2021. Risk-adjusted profitability and stability of Islamic and conventional banks: Does revenue diversification matter? Global Finance Journal 50: 100517. [CrossRef] Economies 2023,11, 104 17 of 17 Rabbani, Mustafa Raza, Yomna Abdulla, Abu Basahr, Shahnawaz Khan, and Mahmood Asad Moh’d Ali. 2020. Embracing of Fintech in Islamic Finance in the post COVID era. Paper presented at the 2020 International Conference on Decision Aid Sciences and Application (DASA), Sakheer, Bahrain, November 8–9. Rahman, Molla Ramizur, and Arun Kumar Misra. 2021. Bank competition using networks: A study on an emerging economy. Journal of Risk and Financial Management 14: 402. [CrossRef] Ramlan, Hamidah, and Mohd Sharrizat Adnan. 2016. The profitability of Islamic and conventional bank: Case study in Malaysia. Procedia Economics and Finance 35: 359–67. [CrossRef] Rashid, D., and Muhammad Ilyas. 2018. Returns volatility in stock market and performance of banks: Evidence from Pakistan. Pakistan Journal of Applied Economics 28. Rwechungura, Kamugisha, Jones Kaleshu, and Benson Otieno Ndiege. 2020. Stability and Profitability of Commercial Banks in Tanzania. East African Journal of Social and Applied Sciences 2: 76. Saleem, Adil, and Muhammad Ashfaque. 2020. An analysis of profitability determinants of Islamic banks: Empirical study of Malaysia vs. Pakistan. International Journal of Business Reflections 1. Sultan, Mirza Ali Huzaifa, and Muhammad Zahid Siddique. 2010. Comparative analysis of Islamic and conventional banking performance. Research Journal of the Institute of Business Administration Karachi-Pakistan 5: 91. [CrossRef] Sundarasen, Sheela, Kamilah Kamaludin, and Izani Ibrahim. 2022. The impact of COVID-19 pandemic on the volatility of conventional and Islamic stock indexes: A comparative study on ASEAN and GCC countries. Journal of Islamic Accounting and Business Research ahead-of-print. [CrossRef] Zarrouk, Hajer, Khoutem Ben Jedidia, and Mouna Moualhi. 2016. Is Islamic bank profitability driven by same forces as conventional banks? International Journal of Islamic and Middle Eastern Finance and Management 9: 46–66. [CrossRef] Disclaimer/Publisher’s Note: The statements, opinions and data contained in all publications are solely those of the individual author(s) and contributor(s) and not of MDPI and/or the editor(s). MDPI and/or the editor(s) disclaim responsibility for any injury to people or property resulting from any ideas, methods, instructions or products referred to in the content.