Do Islamic Banks Withstand Crises Better? Evidence from the COVID-19 Pandemic in Pakistan and Bangladesh

Abstract

The COVID-19 pandemic created an exceptional economic and financial shock that affected banking systems through reduced economic activity, weaker consumer spending, supply-chain disruption, unemployment, market uncertainty, and deterioration in borrowers’ repayment capacity. This study examines the effect of COVID-19 on the financial performance and risk profiles of Islamic and conventional banks and compares the two banking models in Pakistan and Bangladesh. The study uses annual financial statements of selected banks covering 2015–2021, thereby allowing comparison between the pre-pandemic and pandemic periods. Five Islamic and five conventional banks are considered from each country. The study employs descriptive statistics, independent/paired-sample t-tests, a chi-square test, Z-score analysis, and regression analysis. The COVID-19 period is represented through a dummy variable, while bank type is represented through an Islamic-bank indicator. The reported results indicate that the pandemic had a statistically significant negative association with financial performance (β = −0.245, p = 0.036) and a statistically significant positive association with the risk profile (β = 0.316, p = 0.015). The evidence does not establish a statistically significant difference in risk profile attributable simply to Islamic bank status (β = −0.128, p = 0.192), although the Islamic-bank indicator is positively associated with financial performance in one reported specification (β = 0.212, p = 0.042). The descriptive evidence and Z-score comparisons also show deterioration in financial health between 2015 and 2021 for the banks examined. The findings suggest that the COVID-19 shock increased banking-sector risk across both models and that the resilience advantages associated with Islamic banking principles should not be interpreted as evidence of uniformly lower observed risk. The study contributes comparative evidence from two South Asian banking markets and provides implications for risk management, regulatory flexibility, business continuity, digital infrastructure, and future crisis preparedness.