Int. Journal of Economics and Management 11 (S1) : 169 – 181 (2017)
IJEM
International Journal of Economics and Management
Journal homepage: http://www.econ.upm.edu.my/ijem
169
*Corresponding author: Email : nisful.laila@gmail.com
LAILA, N.* AND WIDIHADNANTO, F.
Universitas Airlangga, Jalan. Airlangga 4, Surabaya, Indonesia
ABSTRACT
This research aims to assess financial distress prediction of Islamic and
conventional banks by analyzing Bankometer score between Islamic
and conventional banks. This research compared the bankometer scores
of four Islamic banks and 10 conventional banks observed for the year
period of 2011-2014. The data were obtained from annual reports of the
sampled banks from 2011to 2014. The results of this research show that
both Islamic and conventional banks had a fine level of resilience against
financial distress. This finding suggests that there was no difference of
financial distress prediction between Islamic banks and conventional
banks. This result also confirms finding Gamaginta & Rokhim (undated),
Hanif et al., (2012) and Abdul Rahman & Masngut (2014). On the other
hand, contradicts to that of Pappas et al., (2012) who concluded that
Islamic banks are 55% less hazardous to failure than conventional banks.
Keywords: Financial Distress, Bankometer, Islamic Bank, Conventional
Bank
JEL Classification: G21, G33
Financial Distress Prediction Using Bankometer Model on
Islamic and Conventional Banks: Evidence from Indonesia
International Journal of Economics and Management
170
INTRODUCTION
Research Background
Imam and Kpodar (2010) identifies several factors that may positively or negatively influence
the growth of an Islamic banking industry, such as Muslim population, GDP, petroleum export,
distance to Islamic Financial Centers (I.e. Bahrain and Malaysia), banking system advancement,
interest rate, inflation and trade with Middle Eastern countries. Like in many other Muslim
majority populated countries, Islamic banking industry in Indonesia has also been growth,
stimulated by several factors, such as large Muslim population, government support and Muslim
scholar existence etc. (Ismal, 2013:15). The growth of Islamic banking was stated to be larger
than that of its conventional counterpart for the year 2001-2004; however, it experienced a
slow-down in growth for the year 2005-2010 (Ismal, 2013:20).
Despite its outstanding growth, Ismal (2013:148) stated several facts that indicate the
growth of Islamic banking has not yet been optimal, such as the depositors of Islamic banks
only consisted of 3,8% of the total Muslim population in Indonesia, lack of fund allocated by
the government for the Islamic banking industry and the low number of full-fledged Islamic
banks operational within the country. The slow-down of the growth of the Islamic banking
industry in Indonesia is something to be aware. Ismal (2013:154) predicted that the Islamic
banking industry in Indonesia would have attained a negative growth since 2018, whenthe
market share of the industry at that moment should be around 11% in proportion to the whole
banking industry in Indonesia. This condition has raised worries as the market share of the
Islamic banking industry has currently only been 5%.
A well-established Islamic banking industry would significantly contribute to economy.
Economy is an integral part of a healthy and morally upright society, which in fact is the purpose
of Islam (Iqbal & Mirakhor, 2011:46). The most contributive feature that Islamic banking could
give to a creation of a just economy is the abolishment of Riba (usury). The abolishment of riba
is intended to promote a just and upright economic behavior (Iqbal & Mirakhor, 2011:64). Riba
may also indirectly create hostility, jealousy and grudges among men (Muhammad, 2004:24).
Islamic banking is also perceived as having better resilience in face of crisis than its
conventional counterpart. Hasan & Dridi (2010) stated that in the year 2008 Islamic banking
had better profitability than conventional banking. However, in the year 2009, the profitability
of Islamic banking significantly declined when compared to conventional banking. The cause
is believed to be a lack of good management.
On the other hand, Ouerghi (2014) states that the profitability of Islamic banking is below
than conventional banking, and only have begun to rise after the crisis. It means that Ouerghi’s
research (2014) contradicted to Hasan & Dridi’s (2010). Nevertheless, these two researches
agreed upon Islamic bank’s solvency that is better than conventional banks for periods during
and after the crisis. Although normatively Islamic banking is supposed to have a better
degree of resilience than conventional banking, this may not all be true positively. Even in
Indonesia, the Islamic banking industry has already started to show its decline. For that reason,
a comprehensive study on the industry is advisable. Additionally, strategic policy taken by the
government is also crucial in supporting the growth of the Islamic banking industry in Indonesia.
Financial Distress Prediction on Islamic and Conventional Banks
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While there hasn’t been a conclusive study indicating the inefficiency of Islamic banks,
this does not suggest that Islamic banks shouldn’t pay attention to their performance. None
of Islamic banks has failed due to their unique form of intermediation (Iqbal & Mirkahor,
2011:243).Nevertheless, lacks of good management and supervision have become factors
causing bank failures. A research on Islamic banks in UAE by Al Tamimi (2012) suggests that
good corporate governance plays a significant role in the advent of financial distress.
Iqbal & Mirakhor (2011:238) states that there are failures of Islamic financial institutions
which claimed to have offered Islamic financial products. Ismal (2013:333) added that both
withdrawal risk and bankruptcy risk are the most important risks that Islamic banks in Indonesia
have to face.
LITERATURE REVIEW
Financial Distress and Its Prediction Model
There has not been an agreed upon definition of financial distress from previous studies (Platt
& Platt, 2006). The absence of a formal definition of financial distress puts into questions on
the validity of researches conducted within the domain. Different measures of standards would
categorize non distressed firms as distressed and vice versa; thus, without a formal definition
of financial distress, it would be very difficult to address this problem (Platt & Platt, 2006).
Financial distress relates to a condition where a debtor (personal or institutional) is not able
to fulfill its obligation towards its creditors (Ehab et al., 2011). Financial distress often involves
two parties, debtor and creditor; therefore, if financial distress is defined as a condition where
a company could not fulfill its financial obligation, this will suggest that financial distress can
only occur within companies using external funding (Outecheva, 2007). Outecheva (2007)
categorizes financial distressed into three, namely: (1) event-oriented, (2) process-oriented,
and (3) Technical.
In the first category, financial distress is mostly associated with terms such as default,
failure and bankruptcy (Outecheva, 2007). Altman and Hotchkiss (2006:4) explain that various
terms have been used to describe the formal and economic condition of a failing company.
Four terms mostly used interchangeably are default, failure, insolvency and bankruptcy; even
though these terms are often used interchangeably, formally each of them presents a different
definition (Altman & Hotchkiss, 2006:4).
Failure, moreover, means that the realized rate of return on invested capital is significantly
lower than prevailing rates on similar investments (Altman & Hotchkiss, 2006:4). It should be
noted that a company may have had an economic failure for many years, yet never failed to
meet its obligations (Altman & Hotchkiss, 2006:4). Insolvency, furthermore, is another term
depicting negative firm performance, and is generally used in a more technical fashion; whereas
technical insolvency may be a temporary condition although it is often the immediate cause
of bankruptcy (Altman & Hotchkiss, 2006:5). Altman and Hotchkiss (2006:4-5) also defines
that insolvency in bankruptcy sense is a condition where total liabilities exceed a fair value of
total assets rendering the net worth of the firm negative.
International Journal of Economics and Management
Another corporate condition often associated with default distress can be technical and/
or legal and always involve the debtor-creditor relationship (Altman & Hotchkiss, 2006:5).
Technical default takes place when the debtor violates a condition of an agreement with a
creditor, and can be grounds for legal action (Altman & Hotchiss, 2006:5).
Bankruptcy may be understood as a formal process where a firm announces in court that
it has gone bankrupt followed by the petition to liquidate its assets or to undergo a recovery
program (Altman & Hotchiss, 2006:6). Zmijewski defines financial distress as an act of
declaring bankruptcy within formal court, as a result, any company that has not been declared
bankrupt within court cannot be categorized as financial distress (Wertheim & Robinson, 2011).
As for the second category, financial distress is defined as a process; this definition helps
in understanding financial distress as a phenomenon in constructing a comprehensive theory
of financial distress (Outecheva, 2007). Purnanandam (2007) states that financial distress is
a process situated between solvent and insolvent, and considered as a condition where the
company experiences low cash flow and losses without being insolvent.
The third category defines financial distress through indicators used by various financial
distress prediction models (Outecheva, 2007). Though still criticized by many, the use of ratios
in many financial distress prediction models is to produce results relating to the likelihood
of financial distress and default within a company (Outecheva, 2007). In general, ratios that
measure profitability, liquidity and insolvency are commonly used in predicting financial
distress, despite not knowing which one is the most significant (Altman, 1968).
