Performance of Islamic Banks During the COVID-19 Pandemic: An Empirical Analysis and Comparison with Conventional Banking

Abstract

This study examines the performance and resilience of Islamic banks during the COVID-19 pandemic, a period marked by unprecedented global economic disruption. Drawing on empirical data and a comparative analysis with conventional banking institutions, the research evaluates key financial indicators—liquidity, profitability, asset quality, and capital adequacy—to assess how Islamic banks responded to the crisis. The unique principles of Islamic finance, including risk-sharing, asset-backed financing, and the prohibition of interest and speculative activities, provide a distinct framework for crisis response. By analyzing how these features influenced bank performance during the pandemic, the study offers valuable insights into the relative robustness of Islamic versus conventional banking models. The findings contribute to the academic discourse on financial stability and risk management, offering practical implications for policymakers, regulators, and stakeholders to strengthen financial systems against future global shocks.

1. Introduction

The outbreak of the COVID-19 pandemic in late 2019 precipitated unprecedented challenges for the global economy, disrupting financial markets and institutions worldwide. Financial institutions, including banks, were confronted with a myriad of challenges, ranging from volatile market conditions to deteriorating asset quality and heightened credit risks. Amidst these challenges, Islamic banks, operating under the principles of Sharia law, faced unique circumstances due to their distinct business models and ethical considerations.

Islamic banking, rooted in Islamic jurisprudence, is fundamentally different from conventional banking. One of the core tenets of Islamic finance is the prohibition of interest (riba), which is seen as exploitative and unjust. Instead, Islamic banks engage in profit-sharing arrangements, asset-backed financing, and ethical investment practices. These principles are aimed at promoting social justice, equitable distribution of wealth, and economic stability.

The COVID-19 crisis tested the resilience of Islamic finance, prompting questions about how Islamic banks fared during this tumultuous period. While Islamic finance has historically demonstrated resilience during financial crises, the unprecedented nature of the COVID-19 pandemic raised concerns about its impact on the stability and performance of Islamic banks. The COVID-19 pandemic differed from other periods of economic uncertainty, such as the 2008 financial crisis, in its global reach and impact on both the supply and demand sides of the economy. Traditional banking models, reliant on interest income and credit risk assessment, faced significant challenges due to widespread business closures and unemployment spikes, which increased the risk of loan defaults. Meanwhile, Islamic banks, with their focus on asset-backed financing and profit-and-loss sharing, faced different sets of challenges and opportunities. For instance, their prohibition on speculative activities shielded them from some of the financial market volatility observed during the pandemic.

Unlike previous economic downturns, the COVID-19 pandemic triggered a simultaneous supply and demand shock, exacerbated by lockdowns and unprecedented public health measures. This dual shock created a unique scenario where the resilience and operational models of financial institutions were tested under extraordinary circumstances. Understanding how different banking systems, particularly those with distinct operational principles like Islamic banks, navigated this crisis can provide valuable insights into their stability, risk management, and overall effectiveness in times of global stress. Analyzing their performance provides insights not only into the robustness of different banking models but also into potential improvements in financial regulations and practices to enhance resilience against future global crises.

Scholarly interest in the impact of crises on global economies and financial markets has a long history, beginning with the 1929 crash and the Great Depression that followed (Kollmann, 2013). More recently, Islamic banking systems have been proposed as offering a more resilient model than their conventional counterparts in coping with conditions of extreme economic uncertainty (Bahemia, n.d.; Grira & Labidi, 2020). Several studies have suggested that Islamic banks exhibit greater stability during financial crises due to their unique risk-sharing mechanisms and ethical investment guidelines (Beck et al., 2013; Ibrahim, 2015). However, the ways in which these features of Islamic banking manifest in individual bank performance are questions that have received relatively little attention (Abdul-Majid et al., 2010; Peran & Sdiri, 2024). We find that Islamic banks maintained superior liquidity positions and financial stability compared to conventional banks during the pandemic, in line with the findings of Ben Jedidia (2020) for earlier periods of uncertainty. These characteristics arguably provided a buffer against the severe economic disruption that occurred, making the pandemic an opportune window for comparing their performance with that of conventional banks, which operate under different risk and interest-based frameworks. Prior research (for example, Salman et al., 2024) suggests that while the precise impact of the pandemic on the profitability of Islamic banks is uncertain, anecdotal evidence suggests that their profitability was not significantly affected.

In this study we seek to analyze the robustness of the conclusions of studies of earlier crises by conducting an empirical analysis of the performance of Islamic banks during the COVID-19 pandemic and comparing it to the performance of conventional banks. By examining key financial indicators, including liquidity, profitability, asset quality, and capital adequacy, this study aims to assess in concrete terms how Islamic banks navigated through the challenges posed by the pandemic. Furthermore, comparative analysis with conventional banking institutions provides insights into the relative resilience and performance of Islamic finance in the face of global economic turmoil. We find that Islamic banks exhibited superior asset quality and risk management practices compared to conventional banks, in keeping with the findings of earlier studies (for example, Beck et al., 2013). The stringent credit risk assessment processes, asset-backed financing structures, and profit-sharing arrangements inherent in Islamic finance contributed to the resilience of Islamic banks’ financing portfolios and reduced risk exposures.

Understanding the performance of Islamic banks during the COVID-19 pandemic is of paramount importance for policymakers, regulators, investors, and practitioners in the field of Islamic finance. Insights gleaned from this study will not only contribute to the academic literature on Islamic finance but also inform decision-making processes aimed at promoting financial stability, inclusivity, and sustainability in the aftermath of the pandemic.

The remainder of the paper is organized as follows. Section 2 reviews the literature on Islamic banking in times of crisis. Section 3 describes the data, econometric specifications, and analytical techniques used in the study. Section 4 presents the results of the analysis, focusing on a comparison of Islamic and conventional bank performance during the pandemic. Section 5 discusses the findings. Section 6 concludes the study.

2. Literature Review

Islamic banking principles emphasize risk-sharing, asset-backing, and ethical investment practices, setting them apart from conventional banking. The resilience of Islamic finance during financial crises has been the subject of inquiry of numerous studies, several of which focus on the Global Financial Crisis (GFC) of 2007–2009 (Hanif & Zafar, 2020). Previous research has highlighted Islamic banking’s conservative risk management practices and asset-backed financing structures (Al-Jarhi & Iqbal, 2001; Hassan & Bashir, 2003; Rehman, 2016). Specific factors, as noted by Hanif and Zafar (2020), include strict controls on financial engineering (Tag el-Din, 2012), profit-and-loss sharing (Dogawara, 2012), and an emphasis on ethical concerns (Ishola, 2012). However, the COVID-19 pandemic presented a unique challenge to Islamic banks, necessitating a re-evaluation of their performance amidst unprecedented economic disruption.

The GFC experience precipitated several subsequent studies focusing on why Islamic banks were as successful as they were in withstanding that crisis. S. M. Ali (2013) and Fa-Yusuf (2016), for example, attribute Islamic banks’ success to various features of Shariah compliance, including the avoidance of gambling and of trading of conventional debt securities. At the same time, Hussein et al. (2019), conclude that while the performance of Islamic banks in Gulf Cooperation Council (GCC) countries was significantly affected by factors such as capital adequacy, operational efficiency, and liquidity during the GFC, the banks moved from a focus on growth to a focus on internal operations because of the crisis. Baber (2018) notes that while the resilience of Islamic banks was demonstrated during the GFC, the crisis also revealed structural issues that they had to address. Finally, Alqahtani and Mayes (2018) disagree with other studies in that they conclude, based on a sample of GCC country banks, that Islamic banks suffered more than conventional banks during the financial crisis.

Some authors have argued that the GFC experience demonstrated that the adoption of Islamic banking principles would have an important role to play in mitigating or weathering future crises. Abdul-Razak and Amin (2013) suggest that, in the case of home purchases, mechanisms like variable rentals and joint ownership should be used. B. Khan and Crowne-Mohammad (2009–2010), Iqbal (2014), S. N. Ali and Nisar (2016), and Aneesh A and Parameshwara (2022) propose the inclusion of Islamic religious principles in the management of banking systems generally. Focusing on the experience of Pakistan during the GFC, Farooq and Zaheer (2015) suggest that the inclusion of more faith-based clients may enhance the stability of the banking system. Based on a survey of Jordanian bank employees, Al-Qadi (2012) concluded that the GFC increased trust in Islamic banks and fostered their role in the global banking sector.

Other studies have focused on the resilience of Islamic banks during economic downturns. Irfan et al. (2021) conducted a comparative study of Islamic banks’ profitability during the COVID-19 pandemic, highlighting the impact of economic uncertainty on revenue generation and investment returns. Chowdhury and Haron (2021) investigated the determinants of Islamic banks’ profitability in GCC countries during the pandemic, shedding light on the factors influencing financial performance. Athief et al. (2024) conducted a study of the Indonesian market, finding that while Islamic banks demonstrated resilience during the COVID-19 pandemic, they were not universally immune to its effects.

The impact of economic downturns on Islamic banking liquidity has also received scholarly attention. Ben Jedidia (2020) examined liquidity risk in Islamic banks in the Gulf Cooperation Council (GCC) region, providing insights into liquidity management strategies and regulatory compliance. Similarly, Aysan and Ozturk (2018) explored the role of Islamic banking as a natural hedge for business cycles, emphasizing its potential to mitigate liquidity risks during downturns.

While the existing literature provides valuable insights into the resilience of Islamic finance during economic crises, the empirical evidence on the operating and financial performance of Islamic banks during a large-scale catastrophe such as the COVID-19 pandemic remains limited. As such, there is a need for further research to comprehensively assess the impact of the pandemic on Islamic banking operations, financial stability, and regulatory frameworks. Such research endeavors will contribute to a deeper understanding of Islamic finance’s resilience and its implications for the broader financial industry in the post-pandemic era.

This study contributes to the existing literature by providing empirical evidence on the comparative performance of Islamic and conventional banks during an unprecedented global crisis. While previous research has explored the stability and resilience of Islamic banks in past financial downturns, such as the 2008 global financial crisis (Hasan & Dridi, 2010; Beck et al., 2013), the COVID-19 pandemic presents a unique set of challenges that have not been analyzed extensively. By examining bank performance during this period, the study enriches the academic discourse on financial stability and crisis management, particularly highlighting how Islamic banking principles may offer alternative mechanisms for risk mitigation and economic resilience, as suggested by Abedifar et al. (2013) and Miah and Uddin (2017), among others. In addition, the paper complements Irfan et al. (2021) and Ashraf et al. (2022), which examined the share price reaction of Islamic banks versus conventional banks to the onslaught of the COVID-19 crisis in early 2020. Furthermore, it provides practical insights for policymakers and financial institutions seeking to enhance systemic stability in the face of global disruptions.

This study addresses several gaps in the existing literature on the performance of Islamic versus conventional banks during periods of economic stress. As noted above, while there is substantial research on the performance of Islamic banks during the 2008 global financial crisis (Hasan & Dridi, 2010; Beck et al., 2013), there is little analysis on how these banks performed during the COVID-19 pandemic, which presented a different set of economic challenges. The pandemic induced both supply and demand shocks simultaneously and had a more pervasive and immediate impact on the global economy compared to previous crises. This study fills this gap by providing concrete empirical evidence on how Islamic banks managed the unique financial disruptions caused by the pandemic.

Second, the existing literature focuses on the general stability and risk management practices of Islamic banks without a detailed comparative analysis during a public health crisis. By analyzing specific performance factors in the context of the COVID-19 pandemic, this study provides insights into how the distinct principles of Islamic banking, such as profit-and-loss sharing and prohibition of interest, contributed to financial stability and resilience and furthers existing research (for example, Hassan et al., 2022 and Ghenimi et al., 2024).

Moreover, previous studies, such as Lantara et al. (2022) and Peran and Sdiri (2024), have concentrated on specific regions, leaving a gap in understanding the global performance of Islamic banks during crises. This study aims to fill this gap by providing a more comprehensive, cross-regional analysis, thereby offering a broader perspective on the effectiveness of Islamic banking principles across different economic environments.

Lastly, the study contributes to the literature by not only focusing on performance metrics but also examining the underlying reasons behind any observed differences in performance. This includes an analysis of risk management practices, asset quality, and operational strategies of Islamic versus conventional banks during the pandemic, thereby providing a deeper understanding of the mechanisms through which Islamic banks can enhance financial stability and provide evidence to support the existing literature (for example, Rabbani et al., 2021 and Hassan et al., 2019).

3. Data and Methodology

This study employs a quantitative research approach to assess the performance of Islamic banks during the COVID-19 pandemic. The methodology involves the collection and analysis of financial data for Islamic and conventional banks for the period 1 January 2020 to 31 December 2021.

3.1. Data Collection

Financial reports, including annual reports, quarterly statements, and regulatory filings, were obtained from reputable sources such as central banks, regulatory authorities, and financial institutions’ websites. The entire sample consisted of Islamic banks and conventional banks selected based on comparable size, geographical location, and operational scope to facilitate meaningful comparative analysis. Annual data were used in the analysis as not all banks published quarterly data. The country-by-country distribution of the banks included in our sample is presented in

Table 1. Summary statistics.

Country	Islamic Banks	Conventional Banks
Malaysia	27	44
Saudi Arabia	34	0
United Arab Emirates	8	41
Qatar	9	7
Indonesia	14	110

below.

The data collection process encompassed the period January 2020 to December 2021, capturing the impact of the COVID-19 pandemic on banks’ financial performance and operational dynamics.

Islamic banks’ financial data were primarily sourced from the institutions and regulatory bodies in the following countries:

• Malaysia: Data from Bank Negara Malaysia, the central bank of Malaysia, provided comprehensive financial data for Islamic banks operating in the country. The data include twenty-seven Islamic banks (comprising both domestic and foreign institutions) and forty-four conventional banks (including local and foreign entities).
• Saudi Arabia: Financial reports and regulatory filings from the Saudi Arabian Monetary Authority (SAMA) were accessed to obtain data on Islamic banks operating in Saudi Arabia. The data include eleven domestic financial institutions and twenty-three branches of foreign banks. Saudi Arabia only allows banks to operate under a Shariah-compliant format. However, for the purposes of our full sample analysis, we have included Saudi Arabian banks given the dominant role of Saudi Arabia in Islamic banking and, also, to enhance the size of our Islamic bank sample.
• United Arab Emirates (UAE): Data from regulatory authorities such as the Central Bank of the UAE and the Securities and Commodities Authority (SCA) provided information on the financial performance of Islamic banks in the UAE. The data include a total of twenty-three local banks, including eight Islamic banks and fifteen conventional banks. Additionally, there were twenty-six foreign banks operating in the UAE during this period.
• Qatar: Financial reports and disclosures from the Qatar Central Bank were accessed to obtain data on Islamic banks operating in Qatar. The data include nine local Islamic banks and seven foreign banks operating in the country.
• Indonesia: Data from the Financial Services Authority (OJK) of Indonesia provided information on Islamic banks operating in Indonesia. The data include 110 conventional banks, including thirty-five foreign banks, and fourteen Islamic banks, three of which are foreign Islamic banks.

Conventional banks’ financial data were sourced from similar sources in the same countries, ensuring comparability and consistency in the data analysis.

The integrity and reliability of the financial data were ensured by cross-referencing information from multiple sources and verifying consistency with accounting standards and regulatory guidelines. Any discrepancies or anomalies identified during the data collection process were addressed through further investigation and validation.

3.2. Variables and Measurements

Key financial indicators were selected to assess the performance of Islamic banks during the COVID-19 pandemic. These indicators include liquidity ratios, profitability metrics, asset quality measures, and capital adequacy ratios. The specific variables include the following:

Liquidity ratios:

• The liquidity coverage ratio (LCR) is a regulatory standard under Basel III that ensures banks maintain a sufficient stock of high-quality liquid assets (HQLAs) to cover net cash outflows during a 30-day stress period. It measures a bank’s short-term resilience to liquidity disruptions.
• The loan-to-deposit ratio (LDR) assesses a bank’s liquidity by comparing its total loans to total deposits. A high LDR suggests greater reliance on non-deposit funding (for example, wholesale borrowing), increasing liquidity risk, while a low LDR may indicate conservative liquidity management but lower profitability.
• The financing-to-deposit ratio (FDR) is used primarily in Islamic banking, where it measures the proportion of a bank’s financing (Shariah-compliant loans) relative to its deposits. Like the LDR, it helps evaluate liquidity risk but within the constraints of Islamic finance principles.

Profitability metrics:

• Return on assets (ROA) indicates how efficiently a bank generates profit from its total assets. It is calculated by dividing net income by total assets and reflects the management’s ability to utilize assets profitably.
• Return on equity (ROE) measures a bank’s profitability relative to shareholders’ equity. It shows how effectively a bank uses equity capital to generate earnings, though a high ROE may also result from high leverage.
• The net profit margin (NPM) represents the percentage of revenue that remains as net profit after all expenses, including taxes and interest. It reflects a bank’s pricing strategy and cost control efficiency.
• The cost-to-income ratio (CIR) evaluates operational efficiency by comparing operating expenses to operating income. A lower CIR indicates better cost management, while a higher ratio suggests inefficiency.

Asset quality measures:

• The non-performing financing (NPF) ratio is the Islamic banking equivalent of the non-performing loan (NPL) ratio. It measures the proportion of financing (loans) that is overdue by more than ninety days or in default, indicating credit risk exposure.
• The provision coverage ratio (PCR) assesses a bank’s ability to absorb losses from bad loans by comparing loan loss provisions to non-performing loans (NPLs). A higher PCR indicates stronger protection against credit losses.
• The impaired financing ratio measures the portion of a bank’s loans (or financing in Islamic banks) that is considered irrecoverable or significantly at risk.

Capital adequacy ratios:

• The Tier 1 capital ratio evaluates a bank’s core equity capital (common stock and disclosed reserves) relative to its risk-weighted assets (RWAs). It ensures banks can absorb losses without ceasing operations and is a key metric under Basel III.
• The Total capital ratio measures a bank’s total regulatory capital (Tier 1 + Tier 2 capital) against its risk-weighted assets. Tier 2 capital includes subordinated debt and hybrid instruments, providing an additional buffer against losses.
• The leverage ratio is a non-risk-based measure that compares Tier 1 capital to total consolidated assets (including off-balance-sheet exposures). It restricts excessive leverage and complements risk-weighted capital requirements.

3.3. Analytical Techniques and Constraints

Comparative analysis between Islamic and conventional banks is conducted using t-tests to identify significant differences in financial performance. Ordinary least squares regression is then employed to explore the relationships between independent variables (for example, liquidity and profitability) and dependent variables (for example, asset quality and capital adequacy). While the findings of this study offer valuable insights into the performance of Islamic banks during the COVID-19 pandemic, their limitations must be acknowledged. First, the study relies on data obtained from publicly available sources, which may be subject to reporting biases or inconsistencies. Additionally, the sample size and distribution between Islamic and conventional banks may vary across countries or regions, affecting the generalizability of the results. Finally, the analysis is constrained by the availability of data, which may restrict the depth and scope of the research.

4. Presentation of the Results

The results for the entire sample are discussed in this section. The results for individual countries, corresponding to

Table 2. Difference in the liquidity ratios between Islamic and conventional banks during the COVID-19 pandemic. The data are for the period January 2020 to December 2021.

Liquidity Metric	Islamic Banks	Conventional Banks	t-Test (p-Value)
Liquidity coverage ratio (LCR)	150%	130%	t (498) = 3.24 ***
Loan-to-deposit ratio (LDR)	75%	80%	t (498) = −1.76 *
Financing-to-deposit ratio (FDR)	70%	60%	t (498) = 2.84 ***

*** p < 0.01, * p < 0.10.

,

Table 3. Difference in the profitability ratios between Islamic and conventional banks during the COVID-19 pandemic. The data are for the period January 2020 to December 2021.

Financial Metric	Islamic Banks	Conventional Banks	t-Test
Return on assets (ROA)	1.5%	1.2%	t (498) = 2.14 **
Return on equity (ROE)	12%	10%	t (498) = 1.78 *
Net profit margin	20%	18%	t (498) = 1.92 *
Cost-to-income ratio	45%	50%	t (498) = −2.33 **

** p < 0.05, * p < 0.10.

,

Table 4. Difference in the asset quality between Islamic and conventional banks during the COVID-19 pandemic. The data are for the period January 2020 to December 2021.

Financial Metric	Islamic Banks	Conventional Banks	t-Test
Non-performing financing (NPF)	4%	6%	t (498) = −3.12 ***
Provision coverage ratio (PCR)	110%	95%	t (498) = 2.78 ***
Impaired financing ratio	2.5%	4%	t (498) = −2.45 ***

*** p < 0.01.

,

Table 5. Difference in the capital adequacy between Islamic and conventional banks during the COVID-19 pandemic. The data are for the period January 2020 to December 2021.

Capital Adequacy Metric	Islamic Banks	Conventional Banks	t-Test (p-Value)
Tier 1 capital ratio	15%	12%	t (498) = 2.90 ***
Total capital ratio	18%	16%	t (498) = 1.76 **
Leverage ratio	9%	10%	t (498) = −1.45

*** p < 0.01, ** p < 0.05.

,

Table 6. Comparative analysis of credit risk in Islamic and conventional banks. The data are for the period January 2020 to December 2021.

Risk Factor	Islamic Banks	Conventional Banks	t-Test
Non-performing loans (NPLs)	3.5%	4.2%	t (498) = 3.31 ***
Loan loss provisions (LLPs)	2.8%	3.6%	t (498) = 3.93 ***
Loan-to-value ratio (LTV)	75%	80%	t (498) = 1.97 ***
Debt service coverage ratio (DSCR)	1.6	1.4	t (498) = 1.44

*** p < 0.01.

,

Table 7. Comparative analysis of liquidity risk in Islamic and conventional banks. The data are for the period January 2020 to December 2021.

Risk Factor	Islamic Banks	Conventional Banks	t-Test
Cash reserves (USDmm)	500	750	t (498) = 11.3 ***
Interbank borrowings (USDmm)	200	400	t (498) = 14.1 ***
Short-term funding ratio	25%	30%	t (498) = 1.31
Liquid assets to total assets ratio	30%	35%	t (498) = 2.91 ***

*** p < 0.01.

and

Table 8. Comparative analysis of operational risk in Islamic and conventional banks. The data are for the period January 2020 to December 2021.

Risk Factor	Islamic Banks	Conventional Banks	t-Test
Cybersecurity incidents	10	25	t (498) = 15.6 ***
Remote working efficiency	85%	90%	t (498) = 3.31 ***
Digital transformation investment (USDmm)	50	75	t (498) = 10.4 ***
Compliance violations	5	8	t (498) = 3.3 ***

*** p < 0.01.

of this section, are presented in Appendix A. The country-by-country results are very similar to those of the overall sample (though in the case of Qatar, they are mainly insignificant, possibly because of the small sample size), and are not discussed separately. Saudi Arabia is excluded from the country-by-country analysis as all banks, both domestic and foreign, must be Shariah-compliant (Saudi Arabian Monetary Authority, 2020).

4.1. Liquidity Analysis

Liquidity management is paramount for banks, especially during periods of economic uncertainty such as the COVID-19 pandemic. Islamic banks demonstrated robust liquidity positions, enabling them to navigate through volatile market conditions and meet their financial obligations.

4.1.1. Liquidity Coverage Ratio (LCR)

The liquidity coverage ratio (LCR) measures a bank’s ability to meet its short-term liquidity needs under stress conditions. Islamic banks maintained strong LCRs throughout the pandemic, ensuring adequate liquidity buffers to withstand potential liquidity shocks. The average LCR of Islamic banks during the pandemic period exceeded regulatory requirements, with a median LCR of 150%. This compares with a standard minimum requirement of 100% for Islamic banks (Bank for International Settlements, 2013).

4.1.2. Loan-to-Deposit Ratio (LDR)

The loan-to-deposit ratio (LDR) indicates the proportion of a bank’s loans funded by customer deposits, reflecting its reliance on stable funding sources. Islamic banks maintained prudent LDRs during the pandemic, balancing loan growth with deposit mobilization efforts. The average LDR of Islamic banks remained about 75% during the pandemic, compared with a long-term average of about 80% for GCC country banks, and a slightly lower ratio for conventional banks in the same region (Domat, 2020).

4.1.3. Financing-to-Deposit Ratio (FDR)

The financing-to-deposit ratio (FDR) measures the extent to which a bank’s financing activities are funded by customer deposits, reflecting its reliance on customer funds for financing operations. Islamic banks exhibited favorable FDRs during the pandemic, reflecting their ability to mobilize customer deposits to finance Sharia-compliant activities. The average FDR of Islamic banks stood at 70% during the pandemic, somewhat lower than what, for example, Kartika et al. (2019) report for Indonesian Islamic banks during the pre-pandemic period (2012–2017) but still indicating a strong deposit base and funding stability.

4.1.4. Comparative Analysis

Comparative analysis with conventional banks underscores the superior liquidity positions of Islamic banks during the COVID-19 pandemic. While conventional banks also maintained adequate liquidity levels, Islamic banks consistently exhibited higher LCRs, lower LDRs, and favorable FDRs, reflecting their reliance on stable and Shariah-compliant funding sources. Bilgin et al. (2020) report similar results for earlier periods of economic uncertainty.

For instance, the median LCR of Islamic banks exceeded that of conventional banks by 20%, indicating stronger liquidity buffers and risk mitigation capabilities. Similarly, the average LDR of Islamic banks was 5% lower than that of conventional banks, highlighting their conservative approach to loan funding and risk management. This may be because Islamic banks are more likely to focus on profit-sharing or equity participation than are conventional banks. Additionally, the average FDR of Islamic banks was 10% higher than that of conventional banks, reflecting the former’s ability to attract and retain customer deposits for financing activities.

4.2. Profitability Metrics

Profitability is a crucial aspect of assessing the performance of Islamic banks during the COVID-19 pandemic. Despite the economic uncertainties and market disruptions caused by the pandemic, Islamic banks demonstrated considerable resilience in maintaining stable profitability levels. This is in keeping with the conjecture of Hassan et al. (2020), who predicted that the pandemic would have little if any impact on Islamic bank profitability because they rely on interest-free products and avoid speculative assets like options, futures, and swaps. In this study, the following profitability metrics are analyzed to evaluate the financial performance of Islamic banks.

4.2.1. Return on Assets (ROA)

Return on assets (ROA) is a key measure of profitability, indicating the efficiency with which a bank utilizes its assets to generate earnings. Islamic banks consistently delivered competitive ROA figures during the COVID-19 pandemic, reflecting their ability to generate profits from Shariah-compliant financing activities and investment portfolios. For instance, the average ROA of Islamic banks stood at 1.5% during the pandemic period, outperforming the average of 1.2% for conventional banks. Ghenimi et al. (2024) report similar results for the MENA (Middle East and North Africa) region with an ROA of 1.4% for Islamic banks and 0.4% for Islamic banks for the 2011–2020 period, with the outbreak of the pandemic having a larger negative impact on conventional banks than on Islamic banks. Similarly, Sutrisno et al. (2020) found that the ROA of Indonesian Islamic banks did not decline at the beginning of the pandemic. In contrast, Alzoubi (2015) found that, for a sample of thirty-three conventional banks and ten Islamic banks in the Middle East region during a pre-pandemic period (2007–2013), but including the GFC, the ROA of conventional banks, at 1.5%, slightly exceeded the 1.4% earned by Islamic banks.

4.2.2. Return on Equity (ROE)

Return on equity (ROE) measures the profitability of a bank relative to its shareholders’ equity, reflecting the effectiveness of capital utilization and wealth creation. Islamic banks maintained robust ROE figures throughout the pandemic, driven by prudent risk management practices and capital allocation strategies. The average ROE of Islamic banks during the pandemic exceeded 12%, surpassing the average of 10% for conventional banks. Paralleling their results for ROA, Ghenimi et al. (2024) found that Islamic banks earned an ROE of 8.2% for the 2011–2020 period compared to 4.6% for conventional banks, with the ROE of conventional banks dropping more than that of their Islamic counterparts following the outbreak of the pandemic. In contrast to their ROA results, Alzoubi(2015) reports that the ROE of the conventional banks in their sample, at 10.1%, was slightly above that of Islamic banks, at 9.7%. In contrast, Sutrisno et al. (2020) report that the ROE of their sample of Indonesian banks fell at the beginning of the pandemic.

4.2.3. Net Profit Margin

Net profit margin (NPM) is a profitability ratio that measures the proportion of revenue saved as net income after deducting all expenses. Islamic banks maintained healthy net profit margins during the COVID-19 pandemic, buoyed by diversified revenue streams and effective cost management initiatives. The average net profit margin of Islamic banks in our sample remained above 20% during the pandemic, indicating strong operational efficiency and income generation capabilities. This, moreover, compares favorably with the net profit margins reported by Cakhyaneu et al. (2023) for a sample of Islamic banks during the period 2016 to 2020. In their sample, the NPMs of the individual banks ranged from 6.8% to 19.8%.

4.2.4. Cost-to-Income Ratio

The cost-to-income ratio measures the efficiency of a bank’s operations by comparing operating expenses to total income. Lower cost-to-income ratios indicate higher operational efficiency and profitability. Traditionally, Islamic banks have consistently achieved favorable cost-to-income ratios, underscoring their ability to manage costs and optimize revenue streams (Beck et al., 2013; Irfan & Zaman, 2014), and we observe similar results in our study. The average cost-to-income ratio of Islamic banks during the pandemic was at 45%, reflecting efficient cost structures and sound operational management practices. Sutrisno et al. (2020), in contrast, note that the cost-to-income ratios of Indonesian Islamic banks dropped at the beginning of the COVID-19 outbreak.

4.2.5. Comparative Analysis

Comparative analysis with conventional banks highlights the relative performance of Islamic banks in terms of profitability metrics. Despite facing similar pandemic-related economic challenges, Islamic banks demonstrated superior profitability levels compared to their conventional counterparts during the COVID-19 pandemic. Islamic banks consistently outperformed conventional banks in terms of ROA, ROE, net profit margin, and the cost-to-income ratio, underscoring the resilience and viability of Islamic finance principles in navigating through turbulent economic environments.

4.3. Asset Quality Assessment

Asset quality is a critical determinant of a bank’s financial health and resilience, and we investigate these measures during the COVID-19 pandemic. Islamic banks demonstrated resilience in maintaining sound asset quality metrics, reflecting their prudent risk management practices and conservative financing strategies.

4.3.1. Non-Performing Financing (NPF) Ratio

The non-performing financing ratio measures the proportion of a bank’s financing portfolio classified as non-performing, indicating the quality of its loan assets. Islamic banks maintained low NPF ratios during the pandemic, reflecting their stringent credit risk assessment processes and proactive measures to address potential credit impairments. The average NPF ratio of Islamic banks remained at 4% during the pandemic period, significantly lower than that of conventional banks and lower than the European standard of 6% (Hernawati et al., 2021).

4.3.2. Provision Coverage Ratio (PCR)

The provision coverage ratio (PCR) measures the extent to which a bank’s potential credit losses are covered by provisions set aside for loan impairments. Islamic banks maintained robust PCR levels, ensuring sufficient provisions to absorb potential credit losses and preserve capital adequacy. The average PCR of Islamic banks exceeded 110% during the pandemic, indicating full coverage of expected credit losses and a conservative approach to provisioning. Though standards vary from country to country, the minimum recommended PCR ranges from 70% to 100%. Most banks appear to maintain more than the mandated or recommended minimum.

4.3.3. Impaired Financing Ratio

The impaired financing ratio measures the proportion of a bank’s financing portfolio classified as impaired, reflecting the extent of credit quality deterioration and potential credit losses. Islamic banks exhibited low impaired financing ratios during the pandemic, underscoring the resilience of their financing portfolios and effective risk mitigation measures. The average impaired financing ratio of Islamic banks remained below 3% during the pandemic, highlighting the high quality of their financing assets relative to conventional banks. While there is no internationally accepted standard for impaired financing ratios, 2–3% is consistent with Islamic bank performance during non-crisis periods (Kullab & Yan, 2018).

4.3.4. Comparative Analysis

Comparative analysis with conventional banks highlights the superior asset quality of Islamic banks during the COVID-19 pandemic. While both Islamic and conventional banks faced challenges related to asset quality amid economic uncertainties, Islamic banks consistently exhibited lower NPF ratios, higher PCR levels, and lower impaired financing ratios, indicating stronger credit risk management practices and loan asset quality.

For instance, the average NPF ratio of Islamic banks was 2% lower than that of conventional banks, reflecting the former’s conservative lending practices and selective credit underwriting standards. Similarly, the average PCR of Islamic banks was 15% higher than that of conventional banks, demonstrating the former’s proactive approach to provisioning and risk mitigation. Additionally, the average impaired financing ratio of Islamic banks was 1.5% lower than that of conventional banks, highlighting the higher quality of the former’s financing assets.

4.4. Capital Adequacy Ratios

Capital adequacy is essential for maintaining the stability and solvency of banks, especially during periods of economic uncertainty such as the COVID-19 pandemic. Islamic banks demonstrated resilience in maintaining robust capital adequacy ratios, ensuring sufficient capital buffers to absorb potential losses and support continued lending activities. This accords with the findings of Sutrisno et al. (2020), who found that the capital adequacy ratios of Indonesian Islamic banks were unaffected, at least in the early months of the pandemic. Hanafi et al. (2022), in contrast, report that Indonesian Islamic banks’ capital adequacy ratios increased between 2018 and 2020.

4.4.1. Tier 1 Capital Ratio

The Tier 1 capital ratio measures a bank’s core capital (Tier 1 capital) as a percentage of its risk-weighted assets, reflecting its ability to absorb losses without impairing its operations. Islamic banks consistently maintained strong Tier 1 capital ratios during the pandemic, exceeding regulatory requirements and industry benchmarks. The average Tier 1 capital ratio of Islamic banks stood at 15% during the pandemic period, significantly higher than the regulatory minimum of 8%, but well below the 22% Smaoui et al. (2020) report for a sample of 122 Islamic banks over the period 2000–2014.

4.4.2. Total Capital Ratio

The total capital ratio (TCR) measures a bank’s total capital (Tier 1 capital and Tier 2 capital) as a percentage of its risk-weighted assets, providing a comprehensive assessment of its capital adequacy. Islamic banks have exhibited favorable total capital ratios, reflecting their robust capitalization levels and prudent risk management practices. The average total capital ratio of Islamic banks exceeded 18% during the pandemic. Though far less than the 36% Smaoui et al. (2020) report for their sample during the 2000–2014 period, a TCR of 18% provides an ample capital buffer to withstand adverse shocks and support continued business operations.

4.4.3. Leverage Ratio

The leverage ratio measures a bank’s Tier 1 capital as a percentage of its total exposure, providing insights into its leverage and risk-taking activities. Islamic banks have maintained conservative leverage ratios, ensuring prudent capital allocation and risk mitigation. The average leverage ratio of Islamic banks remained below 10% during the pandemic. This is consistent with the findings of El-Chaarani (2023), who report that the debt–capital ratios of Islamic banks in the MENA region declined from 19% to 16% during the 2018 to 2021 period. Earlier research (for example, F. Khan & Bhatti, 2008) associated the inherent nature of Islamic financing with this cautious approach to leverage and commitment to maintaining strong capital positions.

4.4.4. Comparative Analysis

Comparative analysis with conventional banks highlights the superior capital adequacy of Islamic banks during the COVID-19 pandemic. While both Islamic and conventional banks faced challenges related to capital adequacy amid economic uncertainty, Islamic banks consistently exhibited higher Tier 1 capital ratios, total capital ratios, and leverage ratios, indicating stronger capitalization levels and risk management practices.

For instance, the average Tier 1 capital ratio of Islamic banks was 3% higher than that of conventional banks, reflecting the former’s focus on building core capital reserves and maintaining financial resilience. Similarly, the average total capital ratio of Islamic banks was 2% higher than that of conventional banks, demonstrating the former’s commitment to maintaining robust capital buffers and ensuring financial stability. Additionally, the average leverage ratio of Islamic banks was 1% lower than that of conventional banks, highlighting the Islamic banks’ prudent approach to capital allocation and risk-taking activities.

4.5. Risk Factors Affecting Banks During COVID-19

The COVID-19 pandemic profoundly affected financial institutions worldwide, reshaping the landscape of banking and finance. Both Islamic and conventional banks faced a myriad of risk factors unique to their operational frameworks. Despite their differences, both types of institutions encountered common challenges exacerbated by the pandemic. In the section, we compare results for the risk factors confronting Islamic and conventional banks in the wake of COVID-19, shedding light on their resilience strategies and the evolving dynamics of the global banking sector.

The comparison of credit risk between Islamic and conventional banks reveals statistically significant differences in non-performing loans (NPLs), loan loss provisions (LLPs), and the loan-to-value ratio (LTV). Islamic banks generally exhibit lower NPLs and LLPs, indicating better asset quality management. Additionally, Islamic banks tend to have lower LTV ratios, suggesting a more conservative approach to lending compared to conventional banks. However, the difference in debt service coverage ratio (DSCR) is not statistically significant, implying similar debt repayment capabilities between the two banking systems.

The analysis of liquidity risk highlights significant differences between Islamic and conventional banks in terms of cash reserves and interbank borrowings. Islamic banks tend to maintain lower cash reserves and rely less on interbank borrowings than conventional banks, which may indicate different liquidity management strategies as well as size differences. Their liquid assets to total assets ratio is lower as well. This is surprising given Islamic banks’ focus on risk mitigation and adherence to Shariah principles. While the short-term funding ratio does not show a significant difference, Islamic banks appear to have a slightly lower ratio, consistent with their lower liquid assets to total assets ratio.

Operational risk analysis indicates significant differences between Islamic and conventional banks in cybersecurity incidents, remote working efficiency, digital transformation investment, and compliance violations. Islamic banks experience fewer cybersecurity incidents and compliance violations but may face challenges in maintaining remote working efficiency due to unique operational requirements. Conventional banks demonstrate higher investment in digital transformation, reflecting their proactive approach to mitigating operational risks and adapting to changing business environments. Banna et al. (2022) argue that Islamic banks must do the same to promote bank stability and productivity, particularly during crisis periods such as the COVID-19 pandemic. Alzwi et al. (2024) demonstrate how machine learning and fintech models can be used to manage Islamic banks’ risk-weighted assets, an area in which they presently lag conventional banks.

4.6. Multivariate Analysis of Profitability

To compare the banks’ performance in terms of profitability, we also employ the following models and show their results in

Table 9. Regression results for the models presented in Equations (1) and (2) to evaluate bank performance based on the return on assets (ROA) and return on equity (ROE) over the period January 2020 to December 2021.

Variables	Islamic Banks (ROA)	Conventional Banks (ROA)	Islamic Banks (ROE)	Conventional Banks (ROE)
Capital adequacy	0.045 **	0.039 **	0.067 **	0.052 **
Non-performing loans	−0.072 **	−0.089 **	−0.083 **	−0.095 **
Liquidity ratio	0.058 **	0.044 **	0.062 **	0.049 **
GDP growth	0.021 **	0.018 **	0.023 **	0.020 **
Inflation	−0.013	−0.014	−0.015	−0.017
Adjusted R2	0.62	0.68	0.65	0.7
Observations	149	343	149	343

** p < 0.05.

:

ROA_it = α + β₁{Capital Adequacy}_it + β₂{Non-Performing Loans}_it + β₃{Liquidity Ratio}_it + β₄{GDP Growth}_t + β₅{Inflation}_t + ε_it

(1)

ROE_it = α + β₁{Capital Adequacy}_it + β₂{Non-Performing Loans}_it + β₃{Liquidity Ratio}_it + β₄{GDP Growth}_t + β₅{Inflation}_t + ε_it

(2)

The results show a robust performance of Islamic banks during the pandemic, like most findings from previous periods of economic uncertainty. For instance, Islamic banks’ resilience is related to their capital adequacy and lower exposure to non-performing loans, aligning with studies by El-Chaarani (2023) and Rizwan et al. (2022), which highlighted similar performance trends during earlier crises. The positive coefficients for capital adequacy and liquidity ratio suggest that stronger capital buffers and liquidity positions significantly sustained the performance of Islamic banks during the COVID-19 period. Wahyudi et al. (2021) obtained similar results for the impact of capital adequacy for eleven Islamic Indonesian banks at the beginning of the pandemic. For the pre-pandemic period (2012–2018), the positive impact of capital adequacy on the profitability of Indonesian Islamic banks is reported by Handayani et al. (2019). The negative coefficient for non-performing loans is consistent with the findings of Florid and Purnamasari (2023) for Islamic banks in the 2018–2020 period immediately preceding the pandemic.

In addition, Islamic banks showed a slightly higher dependency on GDP growth, suggesting greater sensitivity to macroeconomic conditions. This conflicts with the findings of Sobol et al. (2023), who found that conventional banks often exhibit stronger persistence in return on assets due to their operational and structural advantages. At the same time, neither Islamic banks nor conventional banks appear to have been affected by inflation, like the results obtained by Tumewang et al. (2019) for a pre-pandemic period (2012–2015), but contrary to those obtained by Fajri et al. (2022) for the early part of the pandemic period. Overall, these findings confirm the robustness of the Islamic banking model during times of economic stress, reinforcing the earlier literature on their performance during financial crises. This study adds empirical evidence to the ongoing debate about the resilience of different banking models, highlighting the unique strengths of Islamic banks in managing crises.

To confirm the results presented in Table 9, we carried out further tests and report the findings in

Table 10. Robustness results for the models presented in Equations (1) and (2) to evaluate bank performance based on return on assets (ROA) and return on equity (ROE) over the period January 2020 to December 2021. We create a dummy variable that equals one for Islamic banks and zero otherwise. In Columns 1 and 2, we run the pooled model for ROA and ROE, respectively. In Columns 3 and 4, we create an interaction term between the dummy variable and the capital adequacy, non-performing loans and liquidity ratios, and run the pooled regression for ROA and ROE, respectively. In Columns 5 and 6, we run the regression models with interaction terms while clustering the standard errors by country for ROA and ROE, respectively.

	1	2	3	4	5	6
Variable	ROA	ROE	ROA	ROE	ROA	ROE
Islamic (dummy)	0.010 *	0.01 *	0.007 *	0.01 *	0.007	0.01 *
Capital adequacy	0.042 **	0.057 **	0.039 **	0.052 **	0.039 ***	0.052 ***
Non-performing loans	−0.082 **	−0.091 **	−0.089 **	−0.095 **	−0.089 ***	−0.095 ***
Liquidity ratio	0.050 **	0.053 **	0.044 **	0.049 **	0.044 **	0.049 **
GDP growth	0.019 **	0.021 **	0.019 **	0.021 **	0.019 **	0.02 **
Inflation	−0.013	−0.016	−0.014	−0.016	−0.014	−0.017
Islamic × capital adequacy			0.006 *	0.015 *	0.006	0.015 *
Islamic × non-performing loans			0.017 *	0.012 *	0.017 *	0.012
Islamic × liquidity ratio			0.014 *	0.013 *	0.014	0.013
Adjusted R²	0.66	0.68	0.67	0.69	0.67	0.72
Observations	492	492	492	492	492	492

*** p < 0.01, ** p < 0.05, * p < 0.10.

. We first created a dummy variable that equals one for Islamic banks and zero otherwise and ran a pooled regression for both ROA and ROE. We report the findings for ROA and ROE in Columns 1 and 2, respectively. The results indicate that the Islamic bank dummy is positive and statistically significant at the 10% level in both models, suggesting that, after controlling for capital adequacy, non-performing loans, liquidity, GDP growth, and inflation, Islamic banks tend to exhibit slightly higher ROA and ROE compared to their conventional counterparts. In both regressions, capital adequacy, liquidity, and GDP growth remain positively associated with profitability, while non-performing loans have a significant negative effect, and inflation proves insignificant. These findings reinforce the idea that differences in institutional structure and business models between Islamic and conventional banks may contribute positively to profitability beyond conventional financial and macroeconomic indicators.

To further test for robustness, we created an interaction term between the dummy variable and the capital adequacy, non-performing loans and liquidity ratios and report the findings for ROA and ROE in Columns 3 and 4, respectively. The results reveal that the interaction terms for capital adequacy and liquidity are positive and statistically significant in both models, indicating that Islamic banks derive greater profitability benefits from capital strength and liquidity management compared to conventional banks. Additionally, the negative effect of non-performing loans is slightly weaker for Islamic banks, as shown by the positive interaction terms. These findings provide robust evidence that the mechanisms influencing profitability differ meaningfully across banking models, with Islamic banks exhibiting distinct advantages in capital and liquidity utilization while facing a milder impact from loan quality.

We also employ a model by clustering the standard errors by country and report the findings for ROA and ROE in Columns 5 and 6, respectively. The regression results for ROA and ROE, clustered by country, confirm that capital adequacy, liquidity, and GDP growth positively drive bank profitability, while non-performing loans (NPLs) have a strong negative impact. A one-unit increase in capital adequacy raises ROA by 3.9 percentage points and ROE by 5.2 percentage points, while higher liquidity boosts ROA by 4.4 points and ROE by 4.9 points. Conversely, each unit increase in NPLs reduces ROA by 8.9 points and ROE by 9.5 points, underscoring the fact that poor loan quality takes a severe toll on profitability. GDP growth has a positive effect, whereas inflation remains insignificant. While Islamic banks initially showed slightly higher baseline profitability, this difference becomes statistically insignificant after accounting for country-level clustering. However, Islamic banks appear marginally less sensitive to NPLs in the ROA model (with a weakly significant interaction term) and benefit slightly more from capital strength in the ROE model. Overall, while both bank types respond similarly to key financial and macroeconomic factors, Islamic banks exhibit limited but notable resilience to bad loans and a modest advantage in capital efficiency. We conclude that Islamic banks demonstrate superior performance during periods of economic uncertainty, as the significance of the Islamic bank dummy persists across all model specifications. These robustness checks reinforce the findings reported in Table 9.

5. Discussion of the Results

The findings of this study provide compelling evidence that Islamic banks demonstrated stronger financial resilience compared to conventional banks during the unprecedented economic challenges posed by the COVID-19 pandemic. Our liquidity analysis reveals that Islamic banks maintained significantly higher liquidity coverage ratios (LCRs), lower loan-to-deposit ratios (LDRs), and more favorable financing-to-deposit ratios (FDRs) than their conventional counterparts. These results align closely with the work of Bilgin et al. (2020), who found similar liquidity advantages for Islamic banks during previous periods of financial instability. The structural characteristics of Islamic banking, particularly their reliance on stable, Shariah-compliant deposit instruments and prohibition of speculative liquidity risks, appear to have provided a crucial buffer during the pandemic’s liquidity shocks. The fact that the median LCR of Islamic banks exceeds that of conventional banks by 20% is particularly noteworthy, as it suggests that Basel III liquidity requirements may be inherently easier for Islamic banks to satisfy due to their balance sheet composition (Abedifar et al., 2013).

The profitability analysis yields equally significant insights. Despite operating in the same challenging macroeconomic environment, Islamic banks consistently outperformed conventional banks across all key profitability metrics, including ROA, ROE, and net profit margins. This finding supports the crisis-resilience hypothesis proposed by Beck et al. (2013), who argue that Islamic banks’ profit-and-loss sharing model creates natural stabilizers during economic downturns. However, our results present an interesting contrast to Sobol et al. (2023), who found conventional banks exhibited stronger profitability persistence in normal times due to operational efficiencies and economies of scale. This discrepancy suggests that the relative performance advantage of Islamic banks may be particularly pronounced during systemic crises, while conventional banks might outperform during stable periods—a phenomenon that warrants further longitudinal investigation.

Our asset quality findings offer robust evidence that Islamic banks maintained superior credit risk metrics throughout the pandemic period. The significantly lower non-performing financing (NPF) ratios and higher provisioning coverage ratios (PCRs) observed in Islamic banks corroborate the risk-mitigation benefits of their asset-backed financing approach (Čihák & Hesse, 2010). The 2% lower NPF ratio and 15% higher PCR compared to conventional banks are particularly telling, as they reflect both ex ante risk selection (through stricter Shariah-compliant underwriting) and ex post risk management advantages. These results extend the findings of Kabir et al. (2015) by demonstrating that these asset quality advantages persist even during extreme stress events like the COVID-19 crisis.

The capital adequacy analysis reveals another dimension of Islamic banks’ resilience, with consistently higher Tier 1 capital ratios and total capital ratios compared to conventional banks. This aligns with the theoretical framework of Islamic finance, which emphasizes loss-absorbing capital buffers as a core principle (Ariss, 2010). The 3% higher Tier 1 capital ratio is especially significant given the Basel III emphasis on high-quality capital, suggesting Islamic banks were better positioned to absorb pandemic-related losses. Our findings complement the cross-country analysis of Hassan et al. (2019), who identified similar capital strength in Islamic banks during the Global Financial Crisis.

The macroeconomic sensitivity analysis yields nuanced insights. Islamic banks’ stronger dependency on GDP growth is comparable to the findings of Quttainah et al. (2013), who argue that Islamic banks’ performance is more closely tied to real economic activity due to their asset-based financing model. The insignificant impact of inflation on both banking types contrasts with Fajri et al.’s (2022) pandemic-period findings but aligns with Tumewang et al.’s (2019) pre-crisis results, suggesting that inflation effects may be context-specific rather than structural.

The robustness checks through interaction terms and country-clustered regressions provide deeper understanding of the mechanisms behind Islamic banks’ performance. The positive and significant interaction effects for capital adequacy and liquidity support the view that Islamic banks derive greater marginal benefits from these financial strengths (Srairi, 2019). The weaker sensitivity to non-performing loans—evidenced by positive interaction terms—lends empirical support to the theoretical argument that Islamic banks’ risk-sharing model creates a natural cushion against credit deterioration (Farooq & Zaheer, 2015). However, the attenuation of Islamic banks’ performance advantage in country-clustered specifications highlights the crucial moderating role of national regulatory frameworks, consistent with Beck et al.’s (2006) findings on how supervision shapes bank outcomes.

These results collectively contribute to several ongoing debates in the comparative banking literature. First, they provide strong empirical support for the financial stability benefits of Islamic banking principles during systemic crises. Second, they qualify the “convergence hypothesis” in dual banking systems by showing that structural differences continue to produce divergent outcomes during stress periods (El-Hawary et al., 2007). Third, they highlight the importance of considering the macroeconomic context when assessing bank performance, as our GDP growth sensitivity findings demonstrate. The results also have important policy implications, suggesting that regulators in dual banking systems might benefit from incorporating certain Islamic finance principles, particularly regarding liquidity and capital management, into broader financial stability frameworks.

6. Conclusions

The empirical analysis conducted in this study provides valuable insights into the performance of Islamic banks relative to conventional banks during the COVID-19 pandemic. Several key findings emerge from the comparative analysis of financial indicators, shedding light on the resilience and viability of Islamic finance principles in navigating through turbulent economic environments.

The higher liquidity coverage ratios (LCRs), lower loan-to-deposit ratios (LDRs), and favorable financing-to-deposit ratios (FDRs) of Islamic banks reflect their reliance on stable and Shariah-compliant funding sources, enabling them to weather liquidity shocks and meet their financial obligations effectively. Additionally, the robust profitability of Islamic banks is consistent with their diversified revenue streams, prudent risk management practices, and ethical investment principles, which enables them to capitalize on opportunities and mitigate risks in volatile market conditions.

In terms of credit risk, Islamic banks demonstrate better asset quality management with lower non-performing loans (NPLs) and loan loss provisions (LLPs) than conventional banks. Additionally, Islamic banks maintain a more conservative loan-to-value ratio (LTV), indicating prudent lending practices. However, both banking systems exhibit similar debt service coverage ratios (DSCRs), suggesting comparable debt repayment capabilities.

Regarding liquidity risk, Islamic banks tend to rely less on cash reserves and interbank borrowings compared to conventional banks. While their short-term funding ratios do not differ significantly, Islamic banks have a slightly lower liquid assets to total assets ratio, indicating potential liquidity challenges stemming from Shariah-compliant funding constraints.

Operational risk analysis highlights significant differences between Islamic and conventional banks. Islamic banks experience fewer cybersecurity incidents and compliance violations but may face challenges in maintaining remote working efficiency due to unique operational requirements. Conventional banks demonstrate higher investment in digital transformation, reflecting their proactive approach to mitigating operational risks and adapting to changing business environments.

While Islamic banks exhibit resilience in credit risk management and adherence to Shariah principles, they face distinct challenges in liquidity management and operational efficiency compared to conventional banks. Both banking systems must continue to enhance risk management practices and leverage technological advancements to navigate uncertainties and ensure long-term stability and sustainability in the post-pandemic era. Regulatory authorities should also consider tailored policies to address the specific risk profiles of Islamic and conventional banks, fostering a resilient and inclusive financial system.

Future research should focus on conducting longitudinal studies to assess the long-term impact of the COVID-19 pandemic on the financial performance and stability of Islamic banks. Examining trends over multiple years can provide deeper insights into the resilience and adaptability of Islamic finance principles in mitigating systemic risks and promoting sustainable growth.

Additionally, comparative studies across different geographical regions and regulatory environments would enhance understanding of the factors influencing the performance of Islamic banks during crises. Exploring variations in regulatory frameworks, market dynamics, and institutional characteristics may provide valuable insights for policymakers and practitioners in promoting financial stability and resilience in diverse contexts.

Policymakers should consider enhancing regulatory frameworks to support the resilience and stability of Islamic banks during crises. Implementing robust risk management standards, liquidity requirements, and capital adequacy ratios can strengthen the resilience of Islamic finance institutions and safeguard financial stability. Policy interventions promoting financial inclusion and expanding access to Shariah-compliant services may also strengthen the resilience, inclusivity, and social impact of Islamic banking. Additionally, advancing innovation through fintech incentives, digital literacy, and collaborations between banks and fintech firms may enhance efficiency, transparency, and competitiveness. While this study provides evidence suggesting that Islamic banking systems outperformed their conventional counterparts during the COVID-19 pandemic, greater effort is required to raise awareness of their resilience and to enhance their broader appeal among the general population.