Review of LiteratureMerchant (2012) conducted an analysis of the Islamic and Conventional banks. The research was based on two tailed test i.e. t-test. The focal point of the study is to know the efficiency and effectiveness of both Islamic and conventional banks when there are crises in any form whether financial, operational and/or ethical. The study was carried out in GCC area in the year 2008. He inferred that after the crisis Islamic banks increased their LLR in comparison to conventional banks where they increased not only their LLR but also EQTA.Oslon and Zoubi (2008) worked on the Islamic and conventional banks in the GCC area for a period of five years i.e. (2000-2005). The outcome was summarized which indicated that although the profit margin earned by both banks are the same but the efficiency of the Islamic banks were far better than conventional banks. Moreover it was also reported that operational risk level of Islamic Banks are higher as compared to conventional banks. They explained the main elements which raised the level of risk. It was because of upholding of funds which were intended to be utilized in situation where loans went bad i.e. not being realizable or difficult to realize or time barred. In addition to this the conventional banking system allows pre-defined and almost fixed rate of interest on funds invested by Investors while the rate flexibility is higher on such funds as subject to numerous risk which is much real than in conventional banks.Ansari and Rehman (2011) carried out another research work on the same pattern i.e. comparing the conventional banking system with that of nascent Islamic banking system. The study was focused on the efficiency and performance parameters of both these banks. The study span was from 2006 to 2009 activities of the banks. They found out different ratios which were mostly related to Financial and operational aspects of banks. Based on the ratios of Profitability, liquidity, solvency, capital requirements, deployment ratio and operational efficiency and effectiveness it was concluded that liquidity ratio of Islamic Banks are higher than conventional while the operational efficiency was calculated low for Islamic banking

system. They reported that Risk level of Islamic banking system was also low as compared to the conventional banking.

Srairi (2013) conducted research on another side of baning systems i.e. Islamic and conventional. He studied the effect of ownership type on the risk position of banking systems. Study was carried out in 10 MENA countries for both Islamic and conventional banking. The ownership was categorized as Family owned, Company owned and State Owned banks. The scope of study was for a period of five years i.e. 2005-2009. The study was aimed at risk-taking patterns of the two systems of banks. They inferred that there existed a negative correlation between Ownership and allied risk in banks on overall level. It was also reported that the those banks which are owned by State were subject to higher risk and were found more prone to higher degree on non-performing loans as compared to banks owned by family or company. They concluded that those Islamic Banks which are not owned by public or not nationalized would be having good stability as compared to those conventional banks which are owned by state. While reporting the credit risk of the two banking systems the researchers narrated that Islamic banks had low credit risk in comparison to conventional banks.

Gamaginta and Rokhim (2011) worked on the overall stability of Islamic versus conventional banking system. The sample was selected to include 12 Islamic and 71 conventional banks in Indonesia. The analysis was carried out using Z-score for a data taken for 6 years. They inferred that the Islamic banks were less stable than conventional banks. Keeping in view the financial crunch of year 2008, it was reported that stability level of the two systems in this particular time was found equal.

Louati et al based his research on the correlation between behavioural patterns of both banks i.e. Islamic and conventional, and capital adequacy by considering a number of situations. Sample was selected for 12 MENA and south East Asian countries where both Islamic and Conventional banks existed. The data was taken from of 70 conventional and 47 Islamic Banks.

The report concluded that banking behaviour was impacted on a larger extent by the funding ratio. It also indicated that the competitive conditions didn’t have any reasonable effect on the relationship between weighted assets ratio and Islamic bank behaviour. Based on this result the researcher assumed that the Islamic banks might have applied those theoretical models of banking which were aimed at discouraging interest from banking sector.

Rajhi and Hassairi studied those factors relevant to capital structure and its enforceability in Islamic Finance by Islamic banks. The report identified that there was significant difference beween Islamic and conventional banking system. The researchers worked on the capital capability structure in relation to Islamic banks. They inferred from interrelationship of risk management and capital structure for Islamic banking system that the risk management of Islamic banking had specific risk categories. They provided risk weights to free investments for Islamic banking system to establish its own capital requirements in relation to degree of loss tolerance.

Al-Deehani, Rifaat, Murinde (1999) reported that the conventional banking system was based on the concept of Financial Risk which was derived from modern structure theories, has nothing to do with the Islamic banking system. It is stated that there is a binding contract between Islamic Banks shareholders and investments accounts holders in the light of which the profts and/or losses are shared. Both parties agree to certain theoretical models the assumptions of which the increases in the Investment accounts financing help Islamic banks to modify its market value and its shareholder rate of return without any further exposure to financial risk to the bank.

Shubber and Alzafiri (2008) based their research on four basic assumptions:

1. Independence of weighted average cost of capital (WACC) from the level of deposits

2. A larger size of deposits does not entail higher financial risk3. A larger deposit size entails higher earnings per share 4. A large deposit size increases market share of bank.

The scope period was selected for study was from 1993 to 1998. They worked on the relationship which existed among all these four factors. A correlation coefficient for market capitalization and size of deposits with banks obtained as ranging from 0.72 for DIB and 0.88 for QIB with average value of of 0.83. The final result was reported that when the quantum of deposits moves up with banks then the market value of with also goes up without placing any impact on the financial stability of bank.

Zimmerman (1996) conducted researched on the factors which affect the profitability of banks. He took both factors, internally and externally which impact directly the profit ratio of banks. He inferred that these are managemenet policies and practices which cause impact on the loan portfolio concentration and efficiency of bank performance. Moreover the outcome of quality management is satisfactory bank performance. The quality of management was assessed on the basis of how much the senior management was conversant with “Bank policies and controls”.

Staiouras (1999) focused on only two factors i.e. Banks profitability determinants and other factors influencing the profitability. Sample was selected from whole of EU banking sector and period taken from 1994 to 1998. Research tool was taken as OLS models made from data taken. It was found that the profit ratio of all those banks was influenced by the internal factors like management decisions and also subject to external elements like macroeconomic fluctuations. Also it was reported that profit levels were directly proportional to the extent of equity which the bank had i.e. more equity result in high profit ration and vice versa. On the other hand the ratio of loans to total assets is inversely related to Return on asset by the entities. The results were summarized by saying that those banks which had large quantum of non-loan earning assets gave more return and contribution to profit ratio than those banks which had high dependability ratio on assets for their earnings through loans.

Haslem (1968, 1969) had his research based upon the financial statement ratios for data taken from member banks of US Federal Reserve System.

The study was conducted for two years. The conclusion indicated that profitability ratio were mostly worked which were relevant to banking sector and in particular capital ratio, interest paid and received, salaries and wages were concerned. He also argued for better management in banking sector the authority should focus on the management and monitoring of expenses of banks and subsequent emphasis should be given to fund management and fund utilization management. Wall(1985) stated that the assets and liabilities management, funding and non-interest cost controls and management had a substantial direct impact on profitability of banks.

Beck et al. (2013) conducted a research on a sample of 510 banks in 22 different countries for a period from 1995-2009. This was based on the Islamic banking versus the conventional banking systems in the countries. He found that the models of carrying on business by the two systems of banking are different from one another. He concluded that the performance ratio of Islamic banking system is much higher than conventional banks. It had a higher intermediation ratio and quality of assets with Islamic banks is higher and these assets were utilized in the best way as compared to conventional banks. He also proved that whenever the crisis were faced, the Islamic banks performed better by way of capitalization of assets and its relevant quality as compared to conventional banks.

Abedifar et al. (2013) took a sample of 553 banks from 24 countries of the world. The scope period was taken as 199-2009. The main area of research and study was risk and stability of Islamic banking system in relation to the conventional banks. They concluded that the profitability ratio and capitalization rate worked out on average basis was more favorable than conventional banks. The report also stated that the credit risk of Islamic banks is lower as compared to conventional banks in those countries where muslim population was denser than in other countries. The insolvency risk Islamic banks were also found to be more stable than conventional banks.

Belanes and Hassiki (2012) worked on the performance efficiency of 32 Islamic banks which were selected from MENA countries. The scope period of the research was 2006-2009. They performed Data Envelopment Analysis (DEA) method for review and analysis of data in their research. The result documented that there was no significant difference in the performance and efficiency of the two systems of banks i.e. Islamic and conventional banks.

Belanes and Omri conducted a research on the main differences between Islamic and conventional banking systems. The focal point of their study was capital structure. The sample selected was of 44 banks from Islamic system of banking and 66 conventional banks for the study. The sample was taken from markets which were representative of relevant sectors. The scope period was from 2005-2010. They used Discriminate analysis with binary logistic regression for determining the scenarios for variables, equity ratio, profitability ratio which they though would more helpful in forecasting the nature or type of banking system. Their study suggested that equity to asset ratio could better explain the difference between Islamic and conventional banking system rather than using profitability ratios and analysis. They reported that both Islamic and conventional systems of banking did not vary on wider extent from one another if it was compared in terms of profit ratios. However it can be inferred that if the capital ratio for is found high then there is probability that the institution under review is an Islamic Bank. It meant the main determinant of an Islamic ban is Capital ratio. Actually Islamic banks operate in an equity based financing rather than debt based that is why capital ratio may be more relevant in analyzing any Islamic banking system.

Metwally (1997) conducted a research on a sample 30 banks in which 15 are Islamic banks. The scope period was 1992-1994. He argued that the profitability was inversely related to the ratio fo deposits to total assets. It the ratio of deposits to total is lower the profitability ratio of the bank would be high. Also it was suggested as an indicator that if the capital to assets raitio is high then higher were the chances that the institution would be Islamic rather than conventional.

Toumi et al (2011) took a sample of 50 Islamic and 59 conventional banks for the research. The period selected was 2004-2008 for four years. They proved that leverage in case of Islamic banks is smaller or lower as compared to conventional banks. Their research revealed that the Debt to equity ratio in case of Islamic banks moves up on an average basis with a value of 7.8 while the same ratio variates on average basis for conventional banks at 11.8.

Pappas et al (2012) conducted a research on Islamic banking system by taking a sample of 106 Islamic banks and 315 conventional banks out of 20 countries. The study was conducted for period from 1995 to 2010. The conclusions reported were like these:

The Islamic banks has a lower leverage, based on equity to asset ratio with a percentage calculated value of 21.7 % and the same was worked out to be 10.8 % for conventional banks.

They also reported that there was a substantial difference in both system of banking in terms of their sensitivity of failure risk to numerous variables and elements.

Short (1979) and Bourke (1989) worked on the relationship of size of bank and regarded it as external factor for different decisions. The management can establish further branches by extending the operations to new location through acquiring new assets and taking further liabilities against it. Generally there are two main factor affecting a bank operations viz; internal and external factors. The internal factors can further be classified into financial statement and non-financial statement variables. The financial statement variables are those which have direct impact on the Balance sheet and income statement while non-financial statement factors are those involve which are indirectly related to the balance sheet and income statement. In case of banking sector the non-financial variables are number of branches, status of a branch, location and size of branch of particular type of banking system. All the aforementioned factors are called

controllable factors as the decision of these things is in the hands of management.

The external factors are usuall those on which management cannot exercise any control. These are called un-controllable factors or variables. Among such factor some are business comptitiors, market share, ownership, capital scarcity, money supply, inflation and national or international regulations like the one issued by the State Bank of Pakistan which are called Prudential Regulations for financial institutions.

Hester and Zoellner (1996) carried out a research on the relationship balance sheet items and profits of banks. The sample consisted of 300 banks of USA in cities of Kansas and Connecticut. They reported that the variation in the balance sheet items had a substantial impact on the profits of a bank. Assets have direct influence on profits i.e. the profit gets increases when the assets of the banks increase while the liabilities have an inverse impact on the profits of a bank.

Boruke (1989) has been regarded as the first research analyst who considered the internal variables in the explaining the earnings of banks. For the purpose of research the overall country data was taken. He applied capital ratios, liquidity ratios and staff expense variations analysis in his study. Net profit after tax was taken as dependent variable in the study. He inferred that all the internal factors have a direct and positive relationship with profitability of the banks.

Philip (1964) studied the relationship of public regulation, private organizations and institutional market characteristics and the sensitivity of market structure. Such situation has made the competition complex and its not easy to analyse the competition regarding a bank. Emery (1971) was the first person who calculated the impact of competition on bank profitability. He argued that competition has no significant impact on the profits of a bank.

Rhoades (1980) worked on the aspect when a new entry is introduced into the market thereby creating the competition. He stated that there was no relation between the entry and competition in business or grabbing a market share.

Fraser and Roase (1972) worked on the fact that what was the impact on profitability and growth in the light of competition created by any new entrant into market. He argued that the study had proved the slow growth rate and the profitability of institutions like Islamic banks were affected by the opening of new branches of the banks but it effect or impact is not worse.

Mullineaux (1978) conducted research and reported that the promulgations of the regulations had important and significant implications on the profit ratio of financial institutions. Actually the research of Mullineaux, McCall and Peterson (1977) had supported the research results of Vernon and Emery (1971). Through another study conducted by Smirlock (1985) also provided same results and confirmed the work of all researchers i.e. Mullineaux, McCall and Peterson, Emery and Vernon.

According to the concept of Structure conducted performance (SCP) theory when the concentration of market increases the agreement among firms also increases. Hence it has a direct impact or relationship with the competition among firms. The costs which relates to the agreements become lower and it motivates or makes the explicit and/or implicit agreements by firms. Resultantly; the firms in the market enjoys monopoly. This theory was first applied in research by taking data from different sources i.e. manufacturing concerns in 1960s. This study was continued in research till 1980s. Heggested in 1979 analysed the research already conducted from 1961-1976. He noted that the concentration factor of the theory had very meager impact on the dependent factor of profitability ratio, loans, deposit and financing rates by banks.

On the same pattern Gilbert (1984) conducted the study to probe impact the concentration factor of Structure conducted performance (SCP) theory.

He revealed that out of 56 research papers only 27 resulted in the fact that concentration affected the performance indicator in the forecasted direction.

The analysis of Islamic and conventional banks by using CAMEL approach for knowing the profitability of these institutions is used in many studies. Banks plays an important role in the economy development of a country. Several studies are conducted with a view to enhance profits and its determinants and the factors affecting bank performance. Different characteristics, structures, macroeconomic variables of banking institutions are used in researches in different countries.

Bashir (2000) carried out study about the “determeinants of the profitability in the Islamic banks, some from Middle East”. Regression analysis was used to analyse the relationship in characteristics of banks and the financial performance of Islamic banks. He took the data from throughout the country to know the overall impacts. As a sample 14 Islamic banks were taken from 8 different countries. The dependent variables of studies were; Return of Equity, Return on Assets and greater loans to assets ratios which were related to GDP growth. These variables are vital in determing the financial performance of Islamic banks.

He reported that there was direct favourable relationship between increase in capital and loan ratios of banks. Secondly he stated profitability determinants have a positive relationship with overhead costs. This meant that the banks would get more profits if the salaries, wages and investements costs are high. Also it was revealed that ownership was an insignificant factor and argued that those banks were resulted in better results which had a foreign ownership rather than local one. Hence foreign ownership was considered fruitful for Islamic bank profits. Tax impacts were also taken to deliberation in study and it was proved that the government taxes had an unfavourable impact on the profitability of Islamic banks. He also argued that reserve ratio had negative relevancy to the

performance of Islamic banks. Similarly Economic growth plays a direct role in improving the profitability determinant and loan ration to assets ratio.

Capital structure means a particular mix of debt and equity which is used by the institutions in financing its operations. There are four different theories which are generally used in the decision making of capital structure. Their basis are different information including tax benfits linked with the utilization of debt, cost incurred on bankruptcy and agency costs. When the finance is from internal sources then the information which they will get will more than equity holders who usually expect a higher rate of return on the investment. It is also implied that when new equity is called from public then the firm will incur more cost as compared to the internal sources of funds. Conculsively it can be stated that the firms are firstly dependent upon internal sources of funds rather than outside funds and later it will turn towards debts when more finance is required and ulitimately if more funds are required the firms will have to resort to issue new equity to public for getting more funds for operations. Myers & Majluf (1984) stated that accorind to Pecking Order hypothesis have good operational results and are profitable are optimistically rely on the internal sources of funds in comparison to those firms who don’t have high profits to cater for the funds requirements of the firm. Capital structure and taxation are also related to one another in terms of utilization of debt. It is also argued that taxation policy has significant impact on the capital structure decisions by the firms.

As per taxation laws and procedures the interest paid on debt is allowable expense in arriving at taxable income of the firm. Hence it is an advantage which firms can use the source of getting funds through debts wholly or partly. As tax is deducted from dividends when it is paid to equity holders against shares held by public. Now as tax is not allowed as deductible expense in arriving at the taxable income of a firm when funds are acquired through equity issue while in case of finance through debt, cost or interest is allowable or deductible expense for firms. Therefore a firm will necessarily opt for availing debt rather than issue of new shares. Modigliani & Miller (1963) and Miller (1977) stated that the benefit of tax exemption in

taxable income, the investors get that portion of interest as profit through their dividends. But the same income is again subject to tax deduction at source and the personal tax impact becomes negative.

Myers (2001) stated in a report that supply of debt will increase on the pleas by the investor in a chase to look for higher rate of interest so that to get more of income rather taking it in the form of capital gains which are subject to tax implications. Similarly when the debt increase result in higher rate of interest and as a result of this the firms or companies have higher costs related to debt in comparison with the cost of equity.

Merchant (2012) examines to analyze the performance of Islamic banks and conventional banks during the crisis and after the crisis. He studied the Islamic and conventional bank in GCC area during 2008 -11. He applied 2 tailed t-test to the data and found that after crisis Islamic bank increased their LLR, while conventional banks increased their LLR and EQTA.

Olson and Zoubi (2008) studied and compared the Islamic and conventional banks in the GCC over a period of 2000 – 2005. Their study found that profitability between Islamic and conventional banks is almost the same. However, their study says that Islamic banks are less efficient and are operating with higher risk. The reason behind their operating under higher risk is that Islamic banks uphold funds that are to be used in case of bad loans. On the other hand conventional banks offer deposits fund that are completely predetermined by interest rates whereas Islamic banks offer deposit funds that are similar to equity as they share diverse types of risk.

Ansari and Rehman (2011) conducted a study on the performance analysis of Islamic and conventional banks in Pakistan for the period of 2006 – 2009.They studied the following financial ratios i.e. profitability, liquidity, risk and solvency, capital adequacy, deployment ratio and operational efficiency, their study found that Islamic banks were highly liquid and less operational efficient as compared to conventional banks. They also said that Islamic banks were less risky than conventional banks.

Srairi (2013) studied the impact of ownership structure on bank risk. He studied risk-taking behaviour of conventional and Islamic banks in 10 MENA countries under three types of bank ownership i.e. Family-owned, Company-owned and State-owned Banks from 2005-2009. His results showed a negative relationship between ownership concentration and risk. The study further shows that state owned banks showed higher risks and had significantly greater proportions of non-performing loans as comparing to Family-owned banks. By comparing conventional and Islamic banks, the study reveals that private Islamic banks are as stable as private conventional banks. However, Islamic banks have a lower credit risk than conventional banks.

Gamaginta and Rokhim (2011) studied the stability of 12 Islamic banks and 71 conventional banks in Indonesia using the Z-score indicator from 2004 to 2009. Their results showed that the stability of Islamic Banks was generally lower than that of conventional banks. The paper further analyzed that during financial crisis of 2008, the Islamic banks showed the same level of stability as of conventional banks.

Louati et al wanted to find out the behavior of Islamic and conventional banks in relation to the ratio of the capital adequacy in different competitive circumstances. They used data from 12 MENA and South East Asian countries characterized by the coexistence of Islamic and conventional banks. The study concluded that the funding ratio has a significant impact on the behavior of 70 conventional banks and 47 Islamic banks. The study

also reveals that competitive conditions have no significant effect on the relationship between the weighted assets ratio and Islamic bank behavior, which means that this type of banks is applying theoretical models based on the prohibition of the interest.

Rajhi and Hassairi analyzed the issues of capital structure and enforcement in Islamic finance only to the degree that Islamic financial Institutions vary from their conventional peers. They study showed that there is significant differences exist between in Islamic and conventional banks. The study presents the capital capability structure for Islamic banks compared to the setting up of the Basel II capital capability structure. They found that the risk profile of an Islamic banking and on the relationship between risk management and capital structure, it overviews specific risk categories for Islamic banks as an initial step in risk management, and bring to light the differences and similarities in importance of these causes for Islamic banks. They present appropriate risk weights to free investments in order to defining their own capital requirements with regard to loss tolerance.Al-Deehani, Rifaat, Murinde (1999) stated that the concept of financial risk, is not pertinent to Islamic bank, on which modern capital structure theories are based. Given the contractual obligation binding the Islamic bank's shareholders and investment account holders to share profits from investments, they recommend a theoretical model in which, under certain assumptions, an increase in investment accounts financing enables the Islamic bank to increase both its market value and its shareholders' rates of return at no other financial risk to the bank.

Shubber and Alzafiri (2008) study found that four assumptions 1. Independence of the WACC from the level of deposits; (2) a larger size of deposits does not entail higher financial risk; (3) a larger deposit size entails higher earnings per share, and (4) a large deposit size increases a bank’s market value. The authors used 1993 to 1996-1998 data, for four institutions, and consider correlations between the costs of equity, deposits,

and the WACC. The data appears to support the four assumptions. The correlation coefficient between markets Capitalization and size of deposits ranged between .72 for DIB and .88 for QIB with an average of .83.Accordingly, the authors concluded that a larger deposit base increases market value without affecting financial stability.

Determinants of bank profitability can be divided into internal and external. Internal determinants of bank profitability are those factors that are affected by the bank’s management decisions and policy objectives. Management effects are the results of differences in bank management objectives, policies, decisions, and actions reflected in differences in bank operating results, including profitability. Zimmerman (1996) found that management decisions, especially regarding loan portfolio concentration, played an important role in bank performance. Researchers frequently say that good bank performance is the result of quality management. Management quality is assessed in terms of senior officers‟ awareness and control of the bank’s policies and performance.

Staiouras (1999) studied the bank profitability determinants and factors influencing this profitability. He collected data of whole EU banking industry from 1994 to 1998 and constructed OLS fixed effects models. He found that the profitability of European banks is affected not only by factors related to their management decisions but also to changes in the external macroeconomic environment. Equity to assets ratio has consistently the same sign and level of significance suggesting that banks with greater levels of equity are relatively more profitable. The loans to assets ratio appears to be inversely related to banks return on assets. This implies that banks which have large non-loan earning assets are more profitable than those which depend more heavily on assets. The results are in contrast to studies that have examined the structure performance relationship for European banking and find a positive effect of the concentration and/or market share variables on bank profitability.Compensate

Haslem (1968, 1969) computed balance sheet and income statement ratios for all the member banks of the US Federal Reserve System in a two-year study. His results showed that most of the ratios were significantly related to profitability, particularly capital ratios, interest paid and received, salaries and wages. He also stated that a guide for improved management should first emphasis expense management, fund source management and lastly funds use management. Wall (1985) concludes that a bank’s asset and liability management, its funding management and the non-interest cost controls all have a significant effect on the profitability record.

Beck et al. (2013) examine the difference between conventional and Islamic banks on a sample of 510 banks across 22 countries over the period 1995–2009. They found few significant differences in business models. However their study revealed that Islamic banks were less efficient, but had higher intermediation ratios, and higher asset quality, and were better capitalized than conventional banks. They also found that Islamic banks performed better during crises in terms of capitalization and asset quality and were less likely to disintermediate than conventional banks.

Abedifar et al. (2013) investigates a sample of 553 banks from 24 countries between 1999 and 2009. They study risk and stability features of Islamic banking and compare them to conventional banking. They found that Islamic banks were, on average, more capitalized and profitable than conventional banks. Their study also suggested that small Islamic banks that were leveraged or based in countries with predominantly Muslim

populations had lower credit risk than conventional banks. In terms of

insolvency risk, small Islamic banks also appeared more stable.

Belanes and Hassiki (2012) examine the efficiency of 32 Islamic and conventional banks from the MENA countries over the period 2006–2009. They used Data Envelopment Analysis (DEA) method and found no significant difference in the efficiency scores between these two types of banks.

Belanes and Omri examined the differences across Islamic and conventional banks, with a special focus on capital structure. As most studies dealing with capital structure focus on non-financial firms and conventional banks and because of less empirical evidence and absence of theoretical research specific to Islamic banking industry, they applied recognized concepts of classical capital structure theories including trade off theory, pecking order theory, agency theory and signaling theory.They applied Discriminate analysis followed by binary logistic regression to identify which variable, equity ratio or profitability ratios, better predicts the kind of bank. They took the sample of 44 Islamic and 66 conventional banks that related to the seven core markets in Islamic finance during 2005-2010. Their study suggests that unlike profitability variables, namely Net income margin, ROE and ROA, equity-to-asset ratio better distinguished Islamic banks against conventional peers. Their study provides empirical support for the fact that Islamic and conventional banks do not widely differ in terms of profitability. However, the higher capital ratio is, the more relevant likelihood that bank is Islamic. Such findings are actually the base of Islamic finance which prevents debt-based funding and urges banks to focus rather on shareholders equity than debt.Metwally (1997) studies a sample of 30 banks of which 15 are Islamic during 1992-1994. His study argues that the lower total deposits-to-assets ratio; the higher probability that bank is Islamic. It also suggests that the upper capital-to-asset ratio, the greater likelihood that bank is Islamic. The study emphasizes that capital-to-asset ratio strongly differentiate between Islamic banks and conventional peers.

Toumi et al. (2011) studies a sample of 50 Islamic and 59 conventional during 2004-2008. They conclusively confirm that leverage at Islamic banks is significantly smaller for Islamic banks. Debt-to-equity ratio increases on average 7.8 times in Islamic banks versus 11.48 times in conventional peers. They also suggest that debt can also decrease by treatment of PLS investment accounts as off-balance sheet items by several Islamic banks.

Pappas et al. (2102) study reveals that Islamic banks are characterized by a lower leverage, as suggested by equity-to assets ratio at 21.7% for Islamic banks against 10.8% for conventional banks. Their study further reveals the significant difference between Islamic and conventional banks in the sensitivity of failure risk to various factors. The analysis is carried on 106 Islamic banks and 315 conventional banks from 20 countries observed between 1995 and 2010.

The literature divides the determinants of conventional bank profitability into two categories that are internal and external. Internal determinants of profitability, which are within the control of bank management, can be divided into two categories, i.e. financial statement variables and non-financial statement variables. Financial statement variables are related to the decisions which directly involve items in the balance sheet and income statement; non-financial statement variables involve factors that have no direct relation to the financial statements. The examples of non-financial variables within this category are number of branches, status of the branch (e.g. limited or full service branch, unit branch or multiple branches), location and size of the bank. Number of branches, status of branches and location are considered controllable variables since decision on those matters are within the decision power of management. In the case of a decision to establish new branches or services available where the locality is bound by regulations, these variables are considered external to the bank. Similarly, the size of the bank is considered an internal determinant on the assumption that management of the bank is responsible for extending their organization by getting additional assets and liabilities. Some researchers (Short, 1979 and Bourke, 1989) considered size as an external variable.External variables are those factors that are considered to be beyond the control of the management of a bank. Among external variables are competition, regulation, concentration, market share, ownership, scarcity of capital, money supply, inflation and size are widely discussed.Hester and Zoellner (1996) examined the relationship between balance

sheet items and the earnings of 300 banks in Kansas City and Connecticut USA. Their study revealed that the changes in balance sheet items had a significant effect on a bank’s earnings. While all asset items get positive results, liability items such as demand, time and saving deposits badly affected profits. Bourke (1989) was the first researcher to include internal variables in a profitability study involving cross-country data. The internal variables used were capital ratios, liquidity ratios and staff expenses; while the dependent variables were consist of the net profit before taxes against total capital ratio and net profit before taxes against total assets ratio. He found that all internal variables were positively related to profitability.

Although competition is considered in the literature as one of the significant determinants of profit for conventional banks, discussion in this area has not been fully resolved. Philips (1964) study reveals that public regulation, private organization and institutional market characteristics made industry performance insensitive to differences in market structure and made competition difficult to examine. In view of the difficulties of measuring the effect of competition, most banking researchers in favor to incorporate this aspect within the scope of market structure or regulations. Emery (1971) was among the first researchers to measure the effect of competition on bank profitability. He used entry into the market as a substitute for competition. Emery’s were found that the competition had no important impact on profits. Rhoades (1980) examined the impact of new entry on competition. His result showed that there was no link between entry and competition.Fraser and Roase (1972) studied whether the opening of new institutions had any important adverse impact on the growth and profitability of competing institutions. Their study reveals that some evidence of slowing growth rate of deposit, the profitability of existing institutions was not badly affected by the opening of new branches by their competitors. Similarly, the Mullineaux (1978) study shows that regulations on the setting-up of banks had an important impact on profitability.

Concentration means that the number and size of firms in the market. The term has appeared from the structure-conduct-performance (SCP) theory which is based on the proposition that market Concentration encourages agreements among firms. The assumption is that the degree of concentration in a market puts a direct influence on the degree of competition among its firms. Highly concentrated market will lower the cost of agreement and encourage implicit and/or explicit agreement on the part of firms. As a result of this agreement, all firms in the market earn monopoly rents. This theory was first used by researchers using data of manufacturing firms and achieved popularity among researchers in banking studies in the 1960s. The effect of concentration on the banking structure were further extended in the 1970s and continued into the 1980s. Heggested (1979), in his survey of the literature from 1961-1976, found that concentration had either a important or a small effect on dependent variables such as profitability, loan rates, deposit rates and the number of bank offices in only Fraser and Roase (1972) studied whether the opening of new institutions had any significant unfavorable effects on the growth and profitability of competing institutions. Their result suggest that instead of some evidence of slowing growth rate of deposit, the profitability of existing institutions was not adversely affected by the opening of new branches by their competitors. The finding of Fraser and Rose, however, was not supported by McCall and Peterson (1977). Similarly, Mullineaux (1978) found that regulations on the setting-up of banks had a significant effect on profitability. The Findings of McCall and Peterson (1977) and Mullineaux (1978) confirmed the studies of Vernon (1971) and Emery (1971). A same approach was used by Smirlock (1985) and his results also confirmed Vernon’s and Emery’s findings. Concentration is defined as the number and size of firms in the market. The term has emerged from the structure-conduct-performance (SCP) theory which is based on the proposition that market concentration fosters collusion among firms. The assumption is that the degree of concentration in a market exerts a direct influence on the degree of competition among its firms. Highly concentrated market will

lower the cost of collusion and foster implicit and/or explicit collusion on the part of firms. As a result of this collusion, all firms in the market earn monopoly rents. This theory was first used by researchers using data of manufacturing firms and gained popularity among researchers in banking studies in the 1960s. The impacts of concentration on the banking structure were further extended in the 1970s and continued into the 1980s. Heggested (1979), in his survey of the literature from 1961-1976, suggest that focus had either an important or a small impact on dependent variables such as profitability, loan rates, deposit rates and the number of bank offices in only 26 of the 44 banks studied. Similarly, Gilbert (1984) summarized the reply of bank performance measures to a change in market concentration and found that in only 27 of the 56 studies reviewed reported that focus significantly affected performance in the predicted direction. Similarly, Gilbert (1984) summarized the response of bank performance measures to a change in market concentration and found that in only 27 of the 56 studies reviewed reported that concentration significantly affected performance in the predicted direction.

The comparative analysis of Islamic and Conventional Banks in terms of profitability determinants which is based on CAMEL approach is very important. All banks are playing a vital role in contribution to the growth of the economy. Many studies are done to improve the profitability indicators and bank characteristics. Recent paper works have employed different characteristic, structures, macroeconomic variables of bank level data across countries.

Bashir(2000), his research was about “determinants of profitability in Islamic Banks, some evidence from Middle East”. He used Regression Analysis, in order to see the association between bank‟s characteristics and measure of financial performance in Islamic Banks. He used cross country panel data to conduct the estimation and showed that profitability measures of Islamic Banks react positively in relationship with increase capital and loan ratios. Financial ratios are employed to measure the performance

measures of Islamic Banks. 14 of Islamic banks are taken 23 across 8 countries. He has taken as dependent variables: Return on Equity, Return on Assets and Profit before Tax over total assets. His research reveals that the larger the total equity to assets and greater loans to assets ratios interrelated with GDP growth which increases profit margins. These results are playing a significant role in explanation of financial performance of Islamic Banks. Secondly Bashir (2000) found that profitability determinants are having positive relationship with OVERHEADS, that is to say the higher the salaries, wages and investment costs that can be explained the banks earn more. Findings and results are consistent with previous studies. Moreover, he regress the ownership as dummy variable on profitability determinants as well, and come up with that foreign ownership contributed significantly to Islamic Banks, that is to say there is statistically significant positive relationship between foreign ownership and profitability indicators. He used tax factors as well, and results showed that the financial repression by using taxes on Islamic banks‟ profitability indicators influenced negatively, in other words the tax structure of government has negative connection with financial performance of Islamic Banks. In addition to, Bashir(2000) had found that reserve ratio has been negatively related to performance measure of Islamic Banks. Good economic growth will improve the profitability determinants and loan to assets ratio positively related to profitability determinants.

Capital structure is defined as the specific mix of debt and equity a firm uses to finance its operations. Four important theories are used to describe the capital structure decisions. These are based on asymmetric information, tax benefits associated with debt use, bankruptcy cost and agency cost. The first is rooted in the pecking order framework, while the other three are explain in terms of the static trade-off choice. These theories are discussed in turn. For example, an internal source of finance where the funds provider is the firm will have more information about the firm than new equity holders, thus these new equity holders will expect a higher rate of return on their investments. This means it will cost the firm more to issue fresh equity

shares than to use internal funds. Similarly, this argument could be provided between internal finance and new debt-holders. The conclusion drawn from the asymmetric information theories is that there is a certain pecking order or hierarchy of firm preferences with respect to This “pecking order” theory reveals that firms will firstly rely on internally generated funds, i.e., undistributed earnings, where there is no existence of information asymmetry; they will then turn to debt if more funds are needed, and finally they will issue equity to cover any remaining the financing of their investments (Myers &Majluf, 1984). Capital requirements. The order of preferences reflects the relative costs of various financing options. Clearly, firms would prefer internal sources to costly external finance (Myers & Majluf, 1984). Thus, according to the pecking order hypothesis, firms that are profitable and therefore generate high earnings are expected to use less debt capital than those that do not generate high earnings. Capital structure of the firm can also be explained in terms of the tax benefits associated with the use of debt. Others observe that tax policy has an important effect on the capital structure decisions of firms.Corporate taxes allow firms to deduct interest on debt in computing taxable profits. This recommended that tax advantages derived from debt would lead firms to be completely financed through debt. This benefit is created, as the interest payments relate with debt are tax deductible, while payments associated with equity, such as dividends, are not tax deductible. Therefore, this tax effect encourages debt use by the firm; as more debt increases the after tax proceed to the owners (Modigliani & Miller, 1963; Miller, 1977). It is important to note that while there is corporate tax advantage resulting from the deductibility of interest payment on debt; investors receive these interest payments as income. The interest income received by the investors is also taxable on their personal account, and the personal income tax effect is negative. (Miller, 1977) and (Myers ,2001) argue that as the supply of debt from all corporations spread out, investors with higher and higher tax brackets have to be attract to hold corporate debt and to receive more of their income in the form of interest rather than

capital gains. Interest rates increase as more and more debt is issued, so corporations face rising costs of debt relative to their costs of equity.

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