The Impact of Political Stability and Firm-Specific Variables on the Performance of Islamic Banks in Pakistan

Financial sector of a country plays pivotal role in the economic advancement. Therefore, the aim of this study is to analyze the performance determinants of 5 Islamic banks in Pakistan which remain active from year 2006 to 2018. By applying the Random Effect Model (REM), this study concluded that leverage and size of Islamic banks contributed significantly towards their performance. However, Islamic banks’ performance remained unaffected with respect to change in political stability level and liquidity. Therefore, this study has implication for Islamic banks managers that instead of considering political environment of Pakistan, focus should be made on bank specific matters.


Background and Motivation of Study
As the global economy is growing with rapid pace along with the economic expansion of Islamic countries, the Islamic banking is also emerging as a major player in the global economy (Butt el al. 2011). According to Islamic Finance Development Report (2018) the Islamic finance industry is growing at the pace of 11 % since year 2012 and its size has reached to US$ 2.4 trillion. Out of this, the share of Islamic banks is 71% or US$ 1.7 trillion. Furthermore, such emergence of Islamic banking is not just confined to Muslim countries, but non-Muslim countries are also part of this (Irfan, Majeed & Zaman, 2014). For instance, as of year 2017, total 505 Islamic banks are operating globally. Islamic baking is defined by State Bank of Pakistan (2020) as "A system which is in consonance with the spirit, ethos and value system of Islam and governed by the principles laid down by Islamic Shariah". Islamic banking philosophy emerged from Islamic Shariah laws. Under such laws, Islamic banks cannot involve in the transections related to riba or interest, Gharar  To keep continue the current pace, it is imperative for Islamic banks managers to be familiar with the factors which create impact on the Islamic banks' performance. Therefore, this current study aims at analyzing the impact of political stability and firmwww.psychologyandeducation.net specific variables (leverage, liquidity and size) on the Islamic banks' performance in Pakistan. As it was stated by Mark and Nwaiwu (2015) that political actions in a country can negatively influence the profitability of businesses and may act as a barrier towards foreign investment. In context of Islamic banks in Pakistan, the impact of political stability on their performance is not investigated before.

2.
Literature Review Although, Islamic banking system has a shorter history as compared to the conventional banks, it is attaining an increasing attention of policy makers, investors and researchers (Rashid, Yousaf & Khaleequzzaman, 2017 Omondi and Muturi (2013), as leverage increases, financial risk also increases. As a result, downfall in the profitability of Islamic banks may occur. As a study done by Obeidat, El-Rimawi, Maqableh and Al-Jarrah (2013) in the market of Jordan also found negative impact of leverage on Islamic banks' performance. Therefore, this study also hypothesizes the existence of negative relation between leverage and the profitability of Islamic banks in Pakistan. Liquidity is also an important factor for the existence and development of a company (Sanghani, 2014). It is very difficult to select the best performing company since it might have a high level of profitability but stuck in very bad liquidity issues (Omondi and Muturi, 2013). According to Hasan and Soula (2017), the banks which produce more liquidity may not be liquidity efficient. Furthermore, Al-Qudah and Jaradat (2013) as well as Sanwari and Zakaria (2013) also reported the significant negative linkage among the liquidity and Islamic banks' performance in the market of Jordan and selected Islamic countries respectively. Thus, this study also claims the negative relationship between liquidity and Islamic banks performance in Pakistan. According to Almajali, Alamro and Al-Soub (2012) size of a firm is an important factor in defining of its market power. Therefore, larger market power makes it difficult for small firms to compete with larger one. In addition, large size firms can also achieve economies of scale and scope which make them more efficient. Moreover, they have larger capacity to tackle the adverse market conditions and can easily recruit the employees which have better professional knowledge (Zainudin, Mahdzan & Leong, 2018). In the same way, the supporter of trade-off theory claims that the larger the firm size, the more diversified it would be. Therefore, its chances of bankruptcy reduce (Sheikh & Qureshi, 2017). In addition, Al-Qudah and Jaradat (2013) and Masood and Ashraf (2012) also concluded the significant positive influence of firm size on the Islamic banks' performance in the market of Jordan and Pakistan respectively. Thus, this study asserts a positive association of size with the Pakistani Islamic banks. According to Shahzad and Al-Swidi (2013) political stability contributes significantly towards business environment of a country. Furthermore, study done by Anwar, Abbass and Shaikh (2019) concluded that political stability has significant positive relationship with firm performance. However, their study did not specifically target the Islamic banking sector. Accordingly, Sanlisoy, Aydin and Yalcinkaya (2017) claimed that political stability is one of the potential factors which can impact the banks' profitability. Thus, this study expects the positive influence of political stability on Islamic banks performance.

4.
Data and Methodology In this study, the data of 5 Islamic banks, which remained active from year 2006 to 2018, was collected. The balance panel of the data was made which was based on 65 observations.  Table 1 provides an overview of calculation procedure and data sources of selected variables. In addition, the mathematical equation of the analysis is formed as below: PROit = β1 + β2LEVit + β3LIQit + β4SIZit + β5PSit + µt (1) Whereas: PROit = Profitability of Islamic Banks i at time t; LEVit = Leverage i at time t; LIQit = Liquidity i at time t; SIZit = Size i at time t; PSit = Political Stability i at time t; β1 = Intercept; µt = error term

5.
Results and Interpretations In this study Hausman test was conducted to make selection among Fixed Effect Model (FEM) and Random Effect Model (REM). The result of Hausman test found to be insignificant which highlight that REM is most appropriate model for this study. In addition, different diagnostic tests such as normality, autocorrelation, heteroscedasticity and multicollinearity were also applied to fulfill the REM assumptions. The results of all these tests are reported in appendix.

Conclusion
Islamic banking is an alternative financial system based on Islamic or Shariah laws. So, to analyze the performance of such alternative financial system, the empirical framework of this study enabled the researcher to identify the role of political stability, along with firm specific variables (leverage, liquidity and size) regarding explaining Islamic banks performance. This study found that the level of political stability in Pakistan does not play any role in defining the Islamic banks' performance. Nonetheless, Islamic banks can enjoy higher performance by increasing their size. However, increase in leverage can impair their performance.
At the end, this study is not only useful for the bank managers, but at the same time it also educates the bank customers, investors and policy makers with respect to Islamic banks performance.