Potential for the application of emerging market Z‐score in UAE Islamic banks

Abstract

Purpose

The purpose of this study is primarily to implement the emerging market (EM) Z‐score model to predict bankruptcy and to measure the financial performance of major Islamic banks in the UAE. In addition, this study aims to introduce the Z‐score model to this industry as a beneficial diagnostic tool for possible causes standing behind the deterioration of financial performance.

Design/methodology/approach

The methodology that has been used in this study is based on Z‐score model for EMs developed by Altman. The related studies have proved that Z‐score has more than 80 percent accuracy and verified it is a robust tool and is useful in assessing the business performance and prediction of potential distress of firms. The approach determined in this study is to examine the financial statements of the UAE Islamic banks by calculating the EM Z‐score for the past three years and comparing it with the current year's score as an effort to measure the overall financial performance as well as the likelihood of bankruptcy of the UAE Islamic banks.

Findings

The paper finds that UAE Islamic banks should work on improving the ratios that are dragging their scores down to better understand their past performance and realize their current position in the industry; Z‐score can be adopted by the UAE Islamic banks as effective evaluation approach toward financing the potential long‐term partnership projects including small and medium business enterprises (SMEs); Z‐score model can be adapted by Islamic banks as an independent credit risk analysis approach to measure the competencies and financial strengths of potential projects; Islamic banks in the UAE are by and large financially sound and healthy and that Z‐score is a beneficial analytical tool that can be adapted by Islamic banks in the UAE to complement other financial analysis techniques to establish Islamic banking industry averages. The study also finds that the ratios used in calculating Z‐score can be considered to provide valuable instrumental indicators.

Research limitations/implications

Z‐score model is a valid model to measure the performance of Islamic banks and the ratios used in calculating Z‐score can be considered to provide valuable instrumental indicators. Z‐score can be adopted by the UAE Islamic banks to finance long‐term partnership projects and SMEs. Limitations including the Islamic banking industry are still considered small size, which might has negative effect on the maximum outcomes of the study. Future studies are needed toward updating the coefficient values connected to each ratios in Z‐score model as per the inputs from the Islamic banking industry.

Practical implications

Z‐score model is a valid model to measure Islamic banks performance and the ratios used in calculating Z‐score can be considered to provide valuable instrumental indicators. Z‐score can be adopted by the UAE Islamic banks to finance long‐term partnership projects and SMEs.

Social implications

The model is believed to widen the industry exposure in order to finance more projects and companies which is believed will reflect positively on the society welfare. By adopted Z‐score SMEs will be provided with all financings needed specially providing the microfinance for small projects.

Originality/value

Introducing Z‐score to the Islamic banking industry as crucial credit risk measuring tool.

Citation

Saif H. Al Zaabi, O. (2011), "Potential for the application of emerging market Z‐score in UAE Islamic banks", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 4 No. 2, pp. 158-173. https://doi.org/10.1108/17538391111144498