Islamic Economic Studies Vol. 11, No. 1, September 2003 DETERMINANTS OF PROFITABILITY IN ISLAMIC BANKS: SOME EVIDENCE FROM THE MIDDLE EAST # ABDEL-HAMEED M. BASHIR * The paper analyzes how bank characteristics and the overall financial environment affect the performance of Islamic banks. Utilizing bank level data, the study examines the performance indicators of Islamic banks across eight Middle Eastern countries between 1993 and 1998. A variety of internal and external banking characteristics were used to predict profitability and efficiency. In general, our analysis of determinants of Islamic banks’ profitability confirms previous findings. Controlling for macroeconomic environment, financial market structure, and taxation, the results indicate that high capital-to-asset and loan-to-asset ratios lead to higher profitability. The results also indicate that foreign-owned banks are likely to be profitable. Everything remaining equal, the regression results show that implicit and explicit taxes affect the bank performance and profitability negatively while favorable macroeconomic conditions impact performance measures positively. Our results also indicate that stock markets and banks are complementary to each other. 1. INTRODUCTION The steady expansion of Islamic banks has been the hallmark of the Middle East financial landscape in the 1980s and 1990s. With a network that spans more than 60 countries and an asset base of more than $200 billion, Islamic banks are now playing an increasingly significant role in their respective markets. To this end, # This work was supported by a grant from the Economic Research Forum of Middle East. The first draft was presented at the ERF Annual Conference held on October 26-29th, 2000, Amman, Jordan. The paper was also presented at the Annual meeting of MEEA/AEA, New Orleans, Louisiana, January 4-7, 2001. The author gratefully acknowledges comments made by the participants in the above two conferences, the editor of this journal, and two anonymous referees. The findings, interpretations, and conclusions expressed here are those of the author and do not necessarily reflect the view of ERF, its staff, or its member countries. *Economist in the Department of EP & SP, Islamic Development Bank, E mail- AMBashir@isdb.org