Al Baraka Banking Group (ABG) and Bank Muamalat Indonesia (BMI) An Annual Report Analysis ( ) Conducted by

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1 Al Baraka Banking Group () and Bank Muamalat Indonesia () An Annual Report Analysis (21-214) Conducted by Name Student Id Student Student Student Financial Performance 1. CAMEL Analysis CAMEL framework is widely used as a tool to evaluate bank performance as it consists of important parameters which represent results of banking performance from different factors (Dincer et.al. 211 and Sarker 26). Summary of CAMEL ratio in both banks can be seen in Appendix 2. Capital Capital adequacy ratio (CAR) is essential to measure the potential of bank s capital to protect the depositors from the potential losses or (Sarker 26). During 21 to 214, both and s CAR have exceeded the requirement from the Central Bank. Central Bank of Bahrain set a minimum CAR of not less than 12%, while Central Bank of Indonesia, based on Bank Indonesia regulation No. 1/15/PBI/28 requires banks to maintain its CAR at a minimum 8%. In the term of Equity to Asset ratio, has higher average (1.1%) than (6.5%), which implies that has better solvency than. However, figure 1 and 2 shows that has downward trend both in CAR and Equity to Asset ratio, while shows the upward trend during the analysis period Figure 1 : Total Capital Ratio

2 Figure 2: Equity / Total Assets Asset Quality Asset quality rating represents the potency of credit risk associated with a certain asset which also implies the management s ability to control its credit risk (FDIC 1997). This rating is measured by using loan loss reserve to gross loans ratio which depicts banks loss estimation due to default per total loan. The higher the ratio, the more vulnerable the bank (Sarker 26). Loan loss provision to net interest revenue which measures the loss expense in each year and impaired loss per gross loan are also used to assess this rating. According to figure 3, 4 and 5, there is a significant increase in, in the three ratio in 213 due to a significant decrease in the collectability of the loan. This is mainly derived by NPF (non-performing financing) from its major debtor which were subject to bankruptcy (Voa-islam 215). In 214, both banks have the only slight difference in their ratio (figure 3 and 4), except for the impaired loans / gross loans which are higher in for it has written off most of its NPF. Figure 4: Loan Loss Prov / Net Int Rev

3 Figure 3: Loan Loss Res / Gross Loans Figure 5: Impaired Loans / Gross Loans Management Quality Despite its qualitative nature, management quality can be quantified by using certain ratio, such as total cost to total income (Sarker 26). This ratio represents how efficient management in running the operation of the bank; therefore, the lower the ratio, the more efficient the bank is. Figure 6 highlights that has quite a stable cost to income ratio with average 54.1%, which is lower compared to whose average ratio is 69.9%. Accordingly, s management is considered to be more efficient than. Figure 6: Cost To Income Ratio

4 Based on EY report (216), Islamic banks (IB) in Bahrain in average has cost to income ratio by 65% in 214. This means that s efficiency is better than its average competitor. Whereas in Indonesia, in average, IB has scored 73%, which means that is less efficient than its competitor. Earnings Earnings quality are evaluated through bank s ability to absorb losses by providing an adequate capital base (Sundarajan and Errico, 22). The most widely used ratio to measure earnings and profitability are return on assets (ROA), return on equity (ROE) and net interest margin (NIM) (Sarker 26). Figure 7, 8 and 9 shows that has higher average ROA and ROE, while the NIM is lower than. has quite stable ROA, ROE, and NIM with the upward trend during In 214, average ROA and ROE for IB in Bahrain is only 1.2% and 9%, respectively (EY 216). This means that s performance is better than its competitor. Meanwhile, experiencing downward trend for its profitability, especially since 213. EY (216) reported that the average IB in Indonesia has ROA and ROE by 1% and 13%, respectively. Therefore, s profitability is lower than its competitor. The rationale behind this trend is the deceleration of Indonesia s economic growth and the prolonged decrease in commodity prices lead to the less conducive condition to the development of the real sector (BI Report 213). Figure 7: Return On Assets (ROA)

5 Figure 8: Return On Equity (ROE) Figure 9: Net Interest Margin Liquidity Liquidity represents the bank s ability to fulfill its financial obligations (Altan, et. al. 214). According to Sarker (26), an adequate liquidity position can be achieved when the bank has enough deposits or assets to meet its liquidity needs or how quick its assets to be converted to cash. Accordingly, bank s liquidity is measured by using net loans to deposit ratio and a liquid asset to deposit and short-term funding ratio. During analysis period, shows lower average net loans to deposit ratio compared to ; however, the average percentage of liquid asset per total deposit of is higher than. This implies that has better liquidity position than. 5

6 Figure 1: Net Loans / Dep & ST Funding Figure 11: Liquid Assets / Dep & ST Funding Financial Impact on Significant Changes in the Organization On July 212, acquired 58.32% of the voting shares of Itqan Capital, an unlisted company in Saudi Arabia, through its subsidiary, AlBaraka Islamic Bank. This acquisition increases the bank s goodwill by US$ 17,82 thousand, where the total purchase consideration transferred is US$ 27,676 thousand ( Annual Report 213). On June 214, there is a major replacement of the Board member following the downward trend of profitability of the bank since 213. The new executive director has committed to solving the NPF problem by written off all the financing with high default possibility. This conduct is reflected in figure 5 which depicts the increase of non-performing loan per total gross loan. 6

7 Non-Financial Performance 1. Quality of Corporate Governance A good corporate governance plays an important role in business activities. Chapra (22) argues that Islamic banks cannot be developed and expanded without an effective corporate governance (CG), as the problem in the organization is getting more complex, the need of an effective CG is also increased. CG performance of the banks is evaluated by using the AAOIFI governance standard No.6 whose result is presented in appendix 3. The result shows that scored 89% in average during , higher than which only scored 86%. The explanation of CG component is elaborated in the following section. A. Ownership Structure The Ownership structure of the banks could reflect its agency problem. According to Jensen and Meckling (1976), agency problem arises from the separation between ownership and control (vertically) and from the majority versus minority ownership (horizontally). The agency theory suggests that the publicly owned company has higher agency cost than a privately owned company; hence, a public company is required to present more transparent disclosure to its shareholders (Gogineni 213). Accordingly, given the ownership structure of the banks (Table 1), is expected to have higher agency cost than. With regards to horizontal agency problem, some studies show that high concentrated ownership could lead to the extraction of the firm s resources by the majority owners at the expense of other shareholders (Gogineni 213). Table 1 shows that s highest shareholder is an individual, Sheikh Saleh Abdullah, who is the chairman and founder of Dallah Albaraka Group and the chairman of as well. Since he owns the shares in the Dallah Albaraka Group as well, indirectly he owns more than 5% shares of the bank. This lead to a higher agency cost for the bank. In the case of, major shareholder is Islamic Development Bank which is classified as government. According to Taktak (212), research related to the government ownership shows a mixed result, but mostly show the negative impact to the company s performance. In the case of, its performance during the analysis period is below s performance. 7

8 B. Board of Director Related to the Board structure, both and have complied with the OECD standard which requires the separation of management and control function. However, has not complied with the independence requirement as its chairman hold significant share ownership in the bank. For the diversity of board member, both banks have a quite good diversity in the term of age, nationality, education and experience. However, there is still a lack of gender diversity as most of the member of the board are male. Related to the diversity and performance, Sicilano (1996) stated that the wider the diversity in board member characteristics, the better performance of the organization as it will give wider insight and perspectives. Further detail of the board structure is presented in appendix 4. C. Sharia Supervisory Board (SSB) Unlike the BoD structure, the SSB composition of both banks are lack of age and gender diversity, and for, it is also in education and experience. In addition, the members of SSB have been sitting in their position for more than 1 years and most of them aged more than 6 years old. In the case of, 8

9 the SSB s chairman currently sitting on 95 boards, which prone to jeopardize the active involvement and their independence (Hamza 213). Further detail of the SSB structure is presented in appendix 5. D. Auditors One way to ensure that the bank protects the depositor s right is by using the external auditor function to ensure that the bank provides a reliable and transparent report to all stakeholders (Chapra and Ahmed 22). Therefore, it is important for the bank to choose a reliable audit firm as research by Eshleman and Guo (214) shows that big 4 audit firm perform higher quality audits compare to mid-tier auditors. In this case, both and have been appointed EY, one of the big 4 audit firm, as their auditor. During the analysis period, both banks got an unqualified opinion, which means that their financial reports are presented fairly and free from material misstatement. The detail of audit and non-audit services are summarized in appendix Corporate Social Responsibility Assessment of CSR disclosure is conducted by using Belal, et.al. (214) checklist which comprises of 11 categories. Those categories represent universal (governance issues) and sharia-related issues disclosure which are derived from several established standards such as IFSB and AAOIFI standard. Based on the content analysis approach, and in average have fulfilled 67% and 69% of the checklist, respectively. Figure 12 and 13 shows that the highest score is reached by IFSB disclosure, BoD and management, while the lowest score, %, goes to complaints and ethics category (detail is presented in appendix 7) Figure 12: CSR Checklist

10 Figure 13: CSR Checklist Related to universal and sharia category, shows (figure 14) the upward trend for its universal disclosure, while the sharia disclosure is quite stable with average 67%. In contrast, has shown an increase in its sharia disclosure yet the score is below. In overall, both banks have a higher universal disclosure than sharia disclosure. This result, therefore, does not satisfy the public expectation, which expects the sharia bank to be more Islamic and Ethical to legitimate its existence to the Muslims community which relates to legitimacy theory (Newson and Deegan 22). According to the theory, CSR is a response to the environmental expectation including social, political, and economic forces (Dusuki 28). Figure 14 :Universal vs Sharia - 74% 78% 79% 67% 67% 67% 67% 69% 67% 55% 51% Universal Sharia 1

11 Figure 15: Universal vs Sharia - 68% 74% 71% 77% 75% 73% 65% 65% 65% 53% 57% 61% Universal Sharia 3. Reporting in Islamic Sections Report of zakah, qardh hassan, and charity fund have been assessed through the Belal et.al. checklist (appendix 7). Each year, discloses the calculation of zakah per share as it considers that the obligation to pay zakah is borne by the shareholders and IAH, not the bank. The calculation is subject to the assessment by SSB. Unlike, pays zakah from the bank and from other parties. Zakah fund will be distributed by its representative institution, Baitul Maal Muamalat, which also distribute infaq and sadaqah. In the case of qardh hasan financing, only who disclose the source of funds. Furthermore, for the charity fund, both banks have been disclosed the description, source and balance of which in their annual reports quite consistently. 4. Quality of Narrative Reporting A. Diction Impression management practice is recognized when the company tries to use certain language to cover the negative performance (Cho et. al. 21). s quite stable economic performance is reflected in its chairman statement which shows the same trend related to optimism and certainty expression (figure 16). In contrast, figure 17 indicate impression management practice by, whereby the optimism increase as the profitability decrease (213). However, in 214, as the profit keep declining, the optimism rate is also declining while the certainty rate increase. 11

12 Figure 16: - Diction Result Optimism Certainty ROA ROE Figure 17 : - Diction Result Optimism Certainty ROA ROE B. LIWC Linguistic Inquiry and Word Count (LIWC) is a text analysis application which provides the method to evaluate various emotional, cognitive and structural components in the written or speech samples (Pennebaker et. al. 27). Figure 18 shows that has an upward trend for its positive emotion in its chairman statement along with the decline in the negative emotion, which is in line with the increase in bank profitability. This implies that uses the chairman statement in accordance with the overall content of the annual report. Furthermore, the result of in Figure 19 indicates that the bank did the impression management in 213 when the positive emotion increase though the profitability decrease. In 214, the chairman s statement quite show the real condition of the bank which is indicated by a decrease in the positive emotion along with the increase in negative expression to explain the declining growth in Indonesia which affected the bank s profitability. 12

13 Figure 18: - Positive & Negative Emotion Positive Emotion Negative emotion ROA ROE Figure 19: - Positive & Negative Emotion Positive Emotion Negative emotion ROA ROE Related to the length of the statement, the more complex and longer the narrative indicating the effort of the company to cover its negative performance and can be considered as retrospective sense-making (Merkl-Davies 211). This theory is reflected in both banks chairman statement. Figure 2 shows that the word count of the s statement decreases along with the increase of the profitability. also shows the same pattern, where the word count increase along with the decrease in the profitability (Figure 21). 13

F I G U R E 2 : AB G - W O R D C O U N T 15 1 5 2,5 2,84 1,5711.743 12.488 13.5 13.544 2, 1.874 1,115 1,154 1,5 711 1, 5 1.33 1.285 1.299 1.288 1.

99 21 211 212 213 214 Word Count ROA ROE 5.

14 F I G U R E 2 : AB G - W O R D C O U N T ,5 2,84 1, , ,115 1,154 1, , Word Count ROA ROE F I G U R E 2 1 : B M I - W O R D C O U N T , , ,211 1,5 1, Word Count ROA ROE 5. Financing Composition In the term of financing, Islamic banks (IB) are encouraged to have more equitybased financing instead of debt-based financing, as the main principle of the Islamic finance is based on the profit-loss sharing system (Asutay 212). However, recently the critics to IB s financing practice increased due to IB has been involved in more debt-financing (such as murabahah) rather than promoting the equity-based financing (Mudharabah and Musharakah). Figure 22 illustrates that s financing composition is dominated by debt-equity financing (murabahah). In contrast, shows quite a balance in composition between debt and equity-based financing. 14

15 Figure 22 : Financing Composition -.1% 9.8%.7%.2% 6.7% 82.5% Murabaha Istisnaa Musharaka Ijara Mudaraba Other Islamic Banking Products Figure 23 : Financing Composition - 5.4% 4.9% 46.1% Murabaha Istisnaa Musharaka 6.3% 1.2%.2% Ijara Mudaraba Other Islamic Banking Products Conclusion In overall, in the term of financial performance, has shown the better performance than, except for the asset quality and liquidity. From non-financial aspect, performs better related to its CG and CSR disclosure which is evaluated based on AAOIFI standard and Belal et.al. Checklist. However, in the term of financing composition, has better performance as it shows quite balance composition between equity and debt financing. 15

4 Islamic Banking. Islamic Banking continues to grow both globally and domestically

4 Islamic Banking. Islamic Banking continues to grow both globally and domestically 4 Islamic Banking The increase in assets base of Islamic banking outpaces the growth in the overall banking sector as share of Islamic banking reaches 11.4 percent during CY15 in line with the 5 year strategic