117
Finance, Accounting and Business Analysis
Volume 8 Issue 1, 2026
http://faba.bg/
ISSN 2603-5324
DOI:
https://doi.org/10.37075/FABA.2026.1.10
The Use of the Z-Score Indicator to Measure Financial Soundness and
Stability in Islamic Banks (The Case of Al Salam Bank Algeria during the
Period 2015–2024)
Zourkata Meriem
1
*
, Damene Ouahiba
2
Department of Finance and Accounting, Ferhat Abbas University Setif 1, Setif, Algeria
1
Department of Finance and Accounting, Ferhat Abbas University Setif 1, Setif, Algeria
2
* Corresponding author
Info Articles
Abstract
History Article:
Submitted 23 February 2026
Revised 30 March 2026
Accepted 24 April 2026
Purpose: This study aimed to measure the level of financial stability and
soundness in Islamic banks through the application of the Z-Score
indicator, using Al Salam Bank Algeria as a case study over the period
(2015–2024).
Design/Methodology/Approach: The research adopted a descriptive-
analytical approach, drawing on financial data extracted from the bank’s
annual financial statements. The Z-Score model was adapted to align
with the operational specificities of Islamic banks, particularly with
regard to investment accounts and profit-sharing mechanisms.
Findings: The findings indicate that the Z-Score calculated on the basis
of funds belonging to Profit Sharing Investment Account holders
(ISLB(Z)
PSIA
) reached 4.4861, while the financial stability index
calculated for shareholders’ equity accounts (ISLB (Z)
share, invest
) recorded
a value of 3.3955. These relatively high values reflect Al Salam Bank’s
strong level of financial stability and the low probability of distress
throughout the study period. The results further confirm the effectiveness
of the Z-Score as a quantitative instrument for assessing financial
stability in Islamic banks, provided that due consideration is given to
their operational specificities.
Practical Implications: The proposed framework offers regulators and
risk managers a more nuanced and precise method to assess financial
stability in Islamic banks. By taking into account the unique structure of
their liabilities and governance practices, it provides a tool that supports
more effective macroprudential oversight and strengthens internal risk
management processes, thereby helping banks better withstand financial
shocks.
Originality/Value: This study makes a significant contribution to the
literature on Islamic banking by developing and empirically testing a
modified Z-Score model that reflects Shariah compliant liability
structures. By applying this model to emerging Islamic banking over a
ten-year period, the research not only improves the methodology for
assessing stability but also offers practical insights that can inform
regulatory policies and supervisory practices.
Paper Type: Research Paper.
Keywords:
Financial stability; Z-Score
indicator; Islamic banks.
JEL: G33; G21; C53.
*
Address Correspondence:
E-mail:
meriem.zourkata@univ-setif.dz
1
ouahiba.damene@univ-setif.dz
2
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118
INTRODUCTION
The worldwide banking network experienced major changes throughout the last few decades because
of financial globalization which expanded quickly and markets became more interconnected and financial
crises started to occur repeatedly. The banking sector accepts Islamic banking as a modern financial system
which follows Sharia law through its operational practices based on the Qur’an and the Sunnah of Prophet
Muhammad and his Companions. The system operates through three core foundations which include the
ban on interest (ribā) and the control of excessive uncertainty (gharar) and gambling (maysir) and the
requirement that financing supports physical economic activities and banks need to share profits and losses
with their business customers (Ansari et al. 2025). The institutional framework of Islamic banking has
enabled Islamic banks to grow their presence through establishing new branches which operate as an
alternative financial system which unites financial efficiency with social responsibility and environmental
protection in Muslim-majority nations and non-Muslim countries that have shown an increasing interest in
ethical financial practices (Pesendorfer and Lehner 2016).
The worldwide financial crisis of 2008 led to a sharp increase in academic studies about Islamic
banking because researchers wanted to understand why traditional banking systems showed weak structures
during that period. The Islamic banking system-maintained stability during the financial crisis while multiple
traditional banks faced complete collapses because researchers believe these banks operated through asset-
based activities and stayed away from dangerous financial products (Hasan and Drid 2011). The banking
financial stability concept returned to economic discussions because economists started to view banking
stability as their primary economic concern instead of focusing on bank earnings.
The International Monetary Fund defines banking financial stability as a state which enables banks
to handle various challenges without losing their essential banking operations for providing credit to the real
economy and managing risks effectively and continuing financial intermediation. The banking system must
prove its stability against economic shocks because it needs to maintain its core operations without
experiencing full system failure or major operational disruptions (IMF 2023). The economic literature under
this conceptual framework has created multiple quantitative measures for bank soundness evaluation with
the Z-score serving as the most popular tool which predicts bank insolvency by combining profitability data
with return volatility and capitalization levels. The Z-score method offers a complete evaluation of banking
stability which makes it the preferred tool for financial stability studies that include both Islamic and
conventional banking systems (Beck et al. 2013).
Study Problem
In light of the foregoing, and against the backdrop of the gradual expansion of Islamic banking in
Algeria in recent years, together with the emergence of specialized Islamic banks such as Al Salam Bank
Algeria, which represents a pioneering experience in the implementation of Islamic banking instruments
within a predominantly conventional banking environment, the present study is structured around the
following central research question: To what extent does the Z-score indicator measure the financial
soundness and stability of Islamic banks, specifically Al Salam Bank Algeria, during the period (2015–
2024)?
Accordingly, the study proceeds from the principal hypothesis that: “Al Salam Bank Algeria
demonstrates a satisfactory level of financial stability within the framework of Islamic banking
principles, as reflected by positive and relatively high Z-score values. This indicates the bank’s strong
capacity to absorb financial shocks and to reduce the probability of default during the period (2015–
2024)”.
Study Objectives
This study seeks to achieve a set of scientific and practical objectives, which may be summarized as
follows:
− To define the conceptual framework of Islamic banks through their operations and essential
guidelines, and to identify potential financial risks that may affect their operational stability;
− To evaluate the financial stability of Al Salam Bank Algeria using the Z-score indicator and its
components which include profitability, earnings volatility, and capitalization over the period (2015
- 2024);
− To develop practical and implementable recommendations to support regulatory authorities and
bank management in enhancing the stability of Islamic banking institutions in Algeria.
............................
Study Significance
The research gains its importance because it solves a specific gap which exists in the applied literature
about Islamic bank financial stability assessment methods for new banking sectors including Algeria because
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researchers lack sufficient data to evaluate bank survival capabilities during economic downturns. The
research advances academic understanding through its application of the Z-score indicator for extended bank
evaluation from 2015 to 2024 which analyses financial stability at the bank level. The research produces a
numerical evaluation tool which benefits both academic investigators and industry professionals. The
research findings enable policymakers and regulatory authorities to build stronger stability and confidence
in the bank which underwent empirical testing. The system enables banks to assess their financial results
which leads to better strategic choices.
LITERATURE REVIEW AND RESEARCH GAP
Recent economic scholarship has shown growing interest in measuring financial stability in Islamic
banks, Hasan and Drid (2011) conducted one of the earliest comparative studies during the 2008 global
financial crisis, demonstrating that Islamic banks exhibited greater resilience, relatively stable profitability,
and lower risk exposure compared to conventional banks during periods of crisis, This resilience was
attributed to the close linkage of their activities to the real economy and their avoidance of complex, high-
risk financial instruments that contributed to the deterioration of conventional banks’ performance during
the crisis, although their analysis relied primarily on descriptive financial indicators, which limits its
predictive capacity.
Within the context of quantitative analysis, Beck et al. (2013) employed the Z-score indicator to
compare levels of financial stability between Islamic and conventional banks across several financial metrics.
They concluded that Islamic banks often achieve higher levels of financial stability, although these findings
may vary depending on the business model and regulatory environment.
Bitar et al. (2021) incorporated regulatory quality, particularly compliance with the Basel Core
Principles (BCPs), and found that while regulatory adherence enhances financial stability, the effect is more
pronounced in conventional banks, suggesting that traditional regulatory frameworks may not fully capture
the unique risk structures of Islamic banks. Subsequent studies, such as Joudar et al. (2023), highlighted the
importance of internal bank factors: capital adequacy and liquidity positively influence Z-score, whereas
bank size negatively affects stability, confirming that operational and governance factors play a critical role
alongside Sharia compliant practices. Fakhrunnas et al. (2024) further linked operational efficiency to
stability using Data Envelopment Analysis combined with Z-score, showing that more efficient banks tend
to achieve higher stability, although establishing causality remains a challenge.
Methodological advances have enhanced our understanding of Islamic banks stability. Mawardi et
al. (2024) employed a Markov Switching model to capture regime changes, finding that Islamic banks are
more likely to remain in stable states but recover more slowly during crises, underscoring the importance of
dynamic analyses. Shair et al. (2025) introduced a modified Z-score to better capture Islamic banking
characteristics, revealing that conventional Z-score metrics may underestimate or misrepresent stability in
these institutions.
The literature has also examined macro financial and technological determinants of stability. Savon
(2025) found that monetary policy changes negatively affect Islamic bank Z-scores, indicating the sensitivity
of stability to macroeconomic conditions. Salem (2025) demonstrated that political and financial risks reduce
Z-score levels in Egyptian banks, highlighting the importance of country risk consideration. At the same
time, technological innovations have emerged as key factors: Mustafa (2024) provided empirical evidence
that digital financial innovations, particularly payment systems, positively affect bank’s Z-score, highlighting
the role of technological advancement in strengthening financial stability, while
Meero (2025) demonstrated
that artificial intelligence and digital tools further strengthen both performance and stability. Susilawati et
al. (2025) confirmed that internal factors, macroeconomic conditions, and Sharia compliance jointly
influence Z-score outcomes, emphasizing the importance of integrating governance and environmental
variables.
Nevertheless, a recent study by Omar et al. (2025) suggests that the existing empirical literature
remains limited in terms of both geographical and methodological diversity. Research has largely
concentrated on specific regions, such as the Gulf and Southeast Asia, with a notable absence of in-depth
analyses in emerging economies, particularly in North Africa, including Algeria.
The number of Islamic banks has increased both qualitatively and quantitatively but researchers still
need to develop enough studies which assess financial stability in these institutions. The research field
contains two major gaps because no one has conducted empirical studies about Islamic banks which operate
within Algerian banking systems that serve the Maghreb region. The first research problem emerges because
no studies exist which use Z-score to assess financial stability in these settings through modifications that
would make the indicator suitable for Islamic banks based on their institutional structure and Sharia
governance system which prevents domestic financial stability analysis of Islamic banks. The second
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research problem emerges because no current studies exist which analyze financial stability through long
time periods while including all new economic and regulatory changes which might influence financial
stability. The research will apply the Z-score indicator to Al Salam Bank Algeria between 2015 and 2024 to
create a realistic evaluation of Islamic bank financial stability in an emerging market
environment.
…………….
Theoretical Framework of the Study
Islamic Banks
Definition of Islamic Banks and Their Fundamental Principles
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) through its
conceptual framework and standards defines Islamic banks as financial entities which operate banking
services and financial operations and investment activities following Shariah principles. The practice of ribā
which means interest and maysir which refers to gambling and gharar which involves high levels of
uncertainty must not occur in any form. All operations and financial instruments must be structured on
Shariah-compliant contracts such as muḍārabah (profit-sharing), mushārakah (partnership), murābaḥah
(cost-plus sale), and ijārah (leasing) (Nuzulia and Roisatun 2024, 117). Islamic banks operate differently
from traditional banks because they use Profit and Loss Sharing (PLS) systems to share financial outcomes
with their customers. The mechanisms work to create financial systems which spread risks between all
parties involved instead of placing the entire burden on the banking institution (Khayat et al. 2025, 271).
Islamic banks follow Shariah governance standards which differ from conventional banking systems because
they have Shariah supervisory boards which verify all products and transactions meet Islamic legal
requirements (Hamed n.d.). Islamic banks function based on religious beliefs which aim to achieve approval
from God. The institutions maintain specific principles which Islamic financial institutions use to operate
their systems according to (Sri Dewi et al. 2023, 366):
− The prohibition of ribā in all transactions and the assurance of transparency regarding the sources
of deposited funds;
− The conduct of commercial and exchange activities on the basis of justice, and the generation of
lawful (ḥalāl) profits without contravening Shariah principles;
− The payment of zakāt on the outcomes of financial activities undertaken by the institution, thereby
contributing to the realization of sustainable development;
− The prohibition of monopoly practices or market control that undermine fair competition;
− The fulfilment of social responsibility through commercial activities and transactions that conform
to the provisions of Islamic law.
Risks in Islamic Banks
The field of Islamic bank risk management has become a subject of rising academic study because
these banks face special obstacles which arise from their need to follow Islamic Sharia financial rules
(Alamgir et al. 2025, 1195). The Islamic Financial Services Board (IFSB 2005, 01) defines risk management
in Islamic financial institutions as a complete system which includes various procedures to identify and
measure and monitor and control different types of risks while the board of directors and senior management
maintain Sharia compliance. The Islamic banking and finance sector recognizes risk through two main
components which consist of gharar prohibition and contractual freedom principles. Gharar is defined as
any probabilistic element involving uncertainty, information asymmetry, risk, or speculation that may result
in illegitimate gain. The Islamic system allows parties to create their own contracts as long as their
agreements follow Sharia rules which prevent both ribā and gharar. Islam recognizes that financial
operations contain risk elements because banking activities naturally include these risks which would
damage Islamic financial institutions' performance and survival if not properly handled. Islamic banks
encounter multiple complex risks which exceed the typical bank risks because they operate under specific
conditions that traditional banks do not face (Nuzulia and Roisatun 2024, 117). The risks which banks
encounter fall into two distinct groups because they face both typical banking risks and Sharia compliance
risks which make Sharia governance essential for bank management (Rahahleh et al. 2019, 11). The main
risks which Islamic banks face include the following according to (Alamgir et al. 2025, 1195):
• Risks Similar to Those Faced by Conventional Banks
− Credit Risk represents the financial danger which clients face when they fail to make their required
payments. Islamic banks face a growing threat because their (PLS) agreements and asset-based funding
systems create direct impacts on their financial performance (Rehman et al. 2025). The credit risk
management system of Islamic finance uses multiple tools which include strong credit evaluation methods
and collateral backing and shared risk agreements. The bank needs to perform comprehensive feasibility
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studies and risk evaluations before it can provide financial support to clients who enter into mudarabah
contracts which require them to share their business results (Sardar and Farooq Iqbal 2023, 16).
− Organizations face liquidity risk when they cannot produce cash flow which matches their current
financial commitments at their scheduled payment dates (Mikou et al. 2024, 59). The Sharia law which
prohibits interest-based borrowing creates difficulties for Islamic banks to find suitable methods for
managing their liquidity needs because they face barriers when they need to obtain funds at affordable rates.
The various elements have raised Islamic banks' vulnerability to liquidity risk which has made their financial
management operations more difficult to maintain (Rahma and Musa 2020, 59).
− Operational Risk refers to the possibility of financial losses which occur because internal workflows
and staff members and technological systems fail to function properly or because of outside occurrences.
Islamic banks face a growing threat from this risk category because they pursue market expansion through
digital platform development. The financial statement also reveals losses which stem from Sharia non-
compliance and breaches of fiduciary duties (Alamgir et al. 2025, 1195).
− Market Risk stands as a major threat which Islamic banks must face during their operations. The
net asset value experiences changes because equity prices and commodity prices and exchange rates and
interest rates experience market fluctuations. Banks face the risk that their net asset value will drop because
financial markets can generate unforeseen price changes. The risk needs to be understood completely so that
financial institutions can develop risk management policies which will protect Islamic banks against
economic changes in the world (Zolkifli et al. 2015, 01).
• Shariah Non-Compliance Risk
Shariah non-compliance risk refers to the financial dangers which Islamic financial institutions face
when their operations and products fail to follow Shariah rules which Shariah Supervisory Board or
authorized bodies have established. Organizations face multiple risk types because they invest in activities
which violate Shariah rules and they enter into contracts that break Shariah requirements which leads to
financial losses and damage to their public image and they must spend unexpected expenses to conduct
Shariah compliance assessments and fix problems that emerge from these assessments (Hassan 2016, 21-
25). Islamic banks protect themselves from Shariah non-compliance risk through three main approaches
which include Shariah supervisory boards and regular Shariah audits and reviews and the guidance of
Islamic financial jurisprudence scholars and specialists. The financial operations maintain ethical and
normative standards because of these systems which operate under Islamic law rules (Sardar and Farooq
Iqbal 2023, 18).
Financial Stability in Islamic Banks
The Concept of Banking Stability
Financial stability together with banking stability emerged as concepts because of the worldwide
financial and banking institutions experienced multiple crises. The two concepts remain closely linked which
has produced confusion about their meanings so I need to show how they differ from each other.
Financial stability exists as an intricate system which defies accurate definition because its various
financial system elements connect to each other through complex systems that also connect to economic
activities in the real world. The academic community divides financial stability definitions into two main
groups which represent different perspectives. The first definition focuses on financial instability yet the
second definition provides a definition which explains what financial stability means. Financial instability
exists as a general definition which describes conditions that lead to financial crisis risk through three main
factors: financial market imbalances which cause major asset price deviations from their basic worth and
financial system breakdowns and credit availability problems and direct negative impacts on the national
economy (Odeduntan and Adewale 2015, 2-3).
The second approach bases its definition of financial stability on the absence of financial crises and
extreme market fluctuations which matches the definition of financial instability. The analysis fails to show
how a well-functioning financial system generates positive effects which strengthen the entire economic
framework. The economic literature now uses an expanded definition of financial stability which describes
a state where the financial system consisting of financial institutions and markets and infrastructures can
handle shocks without affecting its role of directing funds to their proper uses (Gadanecz and Jayaram 2009,
365-366). The definition shows how financial stability operates on a macroeconomic scale because it proves
that the financial sector functions through its deep connection to the actual economy.
The International Monetary Fund defines financial stability as a state where the financial system
performs its essential functions at peak efficiency through its ability to allocate resources and manage risks
and drive economic activities while maintaining its shock absorption capacity to prevent major disruptions
which would harm the macroeconomic environment. The system's stability index measures the chance of
financial system breakdowns which could result in systemic financial collapse thus serving as a vital measure
for assessing the monetary system's viability and durability (Schinasi 2004, 5-6). The definition maintains its
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status as a widely recognized concept in present-day academic work because it goes beyond crisis
management to focus on how financial institutions maintain operational stability during challenging times
which aligns with current research about financial system stability (Ullah et al. 2024).
Financial stability depends on banks because they serve as fundamental institutions which maintain
market order. The banking system of a nation needs to operate with solid strength because it serves as the
basic requirement which enables economic growth and development and financial stability (Mabkhot et al.
2022). The banking system stability definition remains challenging to establish because it shares many
elements with financial stability so experts define it as the banking system's ability to support economic
liquidity distribution through its core functions without encountering obstacles which stem from financial
system weaknesses. The banking system achieves stability when it distributes financial resources through an
effective system which protects the economy from experiencing any worsening of shocks (Saha et al. 2014,
123).
Ferguson identifies three essential characteristics which banking instability depends on: the first
characteristic involves extreme changes in financial asset values; the second one shows a shrinking credit
market which creates mounting doubts about overdue loan payments; and the third one stems from the
previous points which lead to an economic state that diverges strongly from its equilibrium balance because
total spending fails to match the nation's production capabilities (Saha et al. 2014, 123).
Banking stability at the individual level requires assessment through the bank failure concept because
bank failure occurs when asset values experience a major unusual drop which results in asset liquidation
values dipping below deposit amounts. In such circumstances, the bank is considered to be experiencing
financial distress (Dadi Addoun and Ammi Said 2014, 17).
The definitions show that banking stability depends on multiple factors because it requires banks to
perform their usual duties while staying strong against financial instability. The topic requires a complete
understanding of all elements which affect bank operations and their financial security because these
elements include their organizational design and their operational rules and their economic environment.
Banking stability depends on four essential components which include proper banking operation
oversight and risk management system development and strong crisis management systems and warning
systems and financial instability source control (Ali Nasser and Al Husseini 2025). The foundations present
a complete banking stability view which shows that proper oversight and risk control systems function as
active tools to reduce financial risks while helping banks develop their resistance to shocks. The system
requires banks to adopt a forward-looking approach because they need to establish early warning systems
and crisis management protocols which will safeguard their financial sustainability and protect the entire
financial system from instability. The foundations share common principles with international prudential
frameworks because Basel III focuses on making capital and liquidity requirements stronger and enhancing
risk management systems.
Determinants of Financial Stability in Islamic Banks
Shariah and the Islamic economic system mandate two essential elements for financial stability which
include the complete removal of Western financial interest operations and the establishment of profit-and-
loss sharing systems together with Islamic law-based contractual financing solutions (Ghassan and Krichene
2025). The factors which determine Islamic bank financial stability stem from Islamic financial system
principles that enable these banks to manage financial emergencies while reducing their exposure to potential
market dangers:
− The Islamic financial system is founded upon a set of moral and ethical values, including
trustworthiness, credibility, transparency, facilitation, cooperation, and solidarity. Islam affirms that “there
is no economy without ethics”; accordingly, the presence of such moral values contributes to the realization
of security and stability for all economic agents. At the same time, Islamic law prohibits financial and
economic transactions grounded in deceit, gambling, fraud, excessive uncertainty (gharar), exploitation,
greed, and injustice. Adherence to faith-based and ethical values thus constitutes the normative framework
governing the conduct of Muslims whether producers or consumers, sellers or buyers in times of prosperity
or recession, and under conditions of stability or crisis (Saidani and Biraz 2023, 484);
− Under Islamic law, the sale of debt for debt does not constitute a valid contract (such as discounting
post-dated checks, refinancing debt through rescheduling with an increment, short-term debt securities, or
compound interest arrangements). Jurists attribute the rationale for this prohibition to the presence of
elements of gambling and excessive uncertainty, in addition to the fact that such transactions encumber the
liabilities of both parties in interlinked obligations without generating genuine economic benefit. This
contravenes the fundamental Shariah objective of sale contracts, which is premised upon the effective
transfer and receipt of benefit (Edress 2020);
− Islamic finance operates under a fundamental rule which forbids all forms of interest-based lending
transactions. The law requires that all debt agreements which generate financial benefits through interest
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payments become invalid. The financial products which depend on interest rates become forbidden. The
Islamic system allows parties to lend money when they agree to return only their original amount (Zamir
and Shafiq 2015, 25). The Islamic financial system bases its operations on the principle which allows people
who cannot pay their debts because of uncontrollable events to receive debt relief.
− Islamic law forbids people from using standard financial derivatives because these instruments
function as debt sales which produce ribā through their debt-based structure that creates excessive market
risk. The contracts require buyers to postpone both their payment and asset delivery but they do not receive
ownership rights during the agreement which violates Shariah rules that demand both asset transparency
and actual possession of assets in financial agreements (Khan and Rashid 2020). The research shows that
financial derivatives which markets misuse through complex instruments like credit default swaps and asset-
backed securities caused a rapid build-up of systemic risk which led to the 2008 global financial crisis while
exposing major weaknesses in worldwide financial supervision and regulatory systems (Zhang 2024).
Mechanisms for Achieving Financial Stability in Islamic Banks
The first phase of the 2008 financial crisis revealed that Islamic banks kept their financial stability
because they focused on funding projects which directly supported the real economy and they operated
under Sharia principles which ban ribā as previously discussed and protect against dangerous financial
activities and dishonest financial dealings. The bank management style-maintained stability during a time
when traditional banks suffered major financial damage (Mehdaoui 2021, 897-898). Financial stability in
Islamic banks depends on three core mechanisms which function as their fundamental operational
framework:
− The financial system based on (PLS) between parties enables Islamic finance to achieve monetary
stability because it links banking operations directly to projects which have actual economic worth. The
financier faces risk which matches their profit-sharing percentage so no additional expenses will show up in
the product's final cost. Islamic finance allows credit expansion or reduction to follow actual economic
growth which maintains monetary stability and stops money supply from growing beyond what the
economy requires (Al Arabi and Qadi 2016, 17).
− The financial system needs particular mechanisms to build trust between its participants, as Islamic
banks distribute risks appropriately according to each participant's ability and financial contribution, as
previously discussed, while complying with Islamic Sharia, which prohibits interest-based transactions and
margin based sales. The government also needs to implement supportive policies to assist Islamic banking
systems during financial crises, as these measures lead to stronger Islamic banking operations and achieve
financial stability (Nizam al Din Hussein al Taie and Moussa Hassan Al Maliki n.d., 189).
− The financial market requires specific tools to maintain stable asset values. The foundation of
Islamic finance rests on (PLS) because it supports the idea that people should only gain when they face
actual risks. The principle establishes boundaries which stop financial assets from separating completely
from real assets while it maintains price stability because Islamic finance maintains strong connections to
actual economic activities. The financial instrument Sukuk functions through partnership-based asset
financing instead of being a conventional debt instrument which allows investors to receive returns that
match asset performance while they take on all associated investment risks (Nawaz 2025). The ribā ban
establishes limits which stop banks from offering too much credit while it stops financial bubbles from
forming during economic upswings. The system which allows debtors to get a break during financial troubles
prevents asset prices from dropping too quickly. The system uses these mechanisms to protect financial
systems from collapse while keeping markets operational (Al Arabi and Qadi 2016, 18).
Islamic banks proved their ability to handle financial crises while facing fewer market shocks which
led to their expanding business operations and their work to create Islamic capital markets. Some
governments have also directed their banking sectors toward adopting these mechanisms during financial
crises, as evidenced in the United States experience. The financial system requires banks to create new
Sharia-compliant financial products which must follow Islamic banking principles to prevent future financial
crises from emerging. The development needs jurists and economists and banking experts to work together
for creating Sharia-compliant financial products which should reflect Islamic banking principles and work
to stop new financial crises from developing.
The Z-Score as a Measure of Financial Stability and Soundness in Islamic Banks
Economic research uses different analytical tools and performance indicators to evaluate banking
financial stability through capital adequacy ratios and liquidity ratios and non-performing asset ratios and
the Z-score. The banking sector needs these evaluation methods to determine its resistance level because
they help design supervisory approaches which protect the entire financial network from instability. The
research study uses Z-score as its primary financial stability assessment tool for banks because it remains one
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of the most important and current models available.
The World Bank uses the Z-score as an alternative banking stability measurement which predicts
financial institution insolvency by showing how likely their asset values will drop below their total liabilities.
The index shows higher values when financial distress or insolvency becomes less likely but lower values
indicate greater chances of these financial problems occurring (Lu’lu Firdaus et al. 2023, 20).
The Z-score rises when banks show better profitability results and stronger capital positions but it falls
down when their returns onto investments become lower. It is calculated by adding the average return on
assets (μROA) to the equity-to-total-assets ratio (E/A), and dividing the result by the standard deviation of
return on assets (δROA), which should be computed over a period of at least five years. The formula is
expressed as follows (Saidani and Biraz 2023, 490):
(1)
Where:
Z: Financial stability and soundness indicator;
ROAμ: Mean return on the bank’s assets;
E/A: Ratio of equity to total assets;
δROA: Standard deviation of return on assets.
The financial stability assessment through Z-score depends on three basic elements which include
asset returns and capital strength and asset return volatility. A bank's economic shock resistance before
insolvency becomes measurable through the combination of these dimensions which serves as a strong tool
for banking stability assessment.
The Z-score model analysis included 66 public companies from the United States which split into 33
successful companies and 33 failed companies. Research results show that institutions which have Z-scores
below 1.88 become highly vulnerable to financial collapse which probably leads to bankruptcy. Financial
stability in banking operations emerges at institutions which maintain Z-scores above 2.92. The Z-score
range which stretches from 1.81 to 2.99 creates an uncertain zone that institutions occupy during what
experts call their "grey zone" period (Saidani and Biraz 2023, 489).
The following figure illustrates the ranges of variation in Z-score values:
Source: (Saidani and Biraz 2023, 489).
Figure 1. Z-Score Classification Zones
The Z-score formulation expresses the probability of financial failure in conventional banks; however,
it requires reconsideration in the context of Islamic banks. In conventional banking, capital constitutes the
primary line of defence for depositors’ funds against various risks. In contrast, depositors in Islamic banks—
particularly holders of unrestricted and restricted investment accounts—share in the outcomes of investment
activities, whether profits or losses. This risk-sharing mechanism mitigates the impact of investment-related
losses on the erosion of bank capital, unless the Islamic bank is negligent in managing funds (Mahboub and
Sanousi 2020, 415).
Accordingly, the conventional Z-score financial stability indicator is to be modified and adapted to
measure financial soundness in Islamic banks by transforming it into two distinct indicators. The first
assesses the degree of financial stability in an Islamic bank from the perspective of profit-sharing investment
account holders, denoted ISLB(Z)
PSIA
. The second measures financial stability from the perspective of
shareholders or potential investors in Islamic bank equity, denoted ISLB(Z)
SharH,Invest
, as follows:
− The Islamic Banking Stability Indicator ISLB(Z)
PSIA
, from the perspective of profit-sharing
investment account holders, aims to measure the stability of returns generated for these account
holders. It is calculated using the following relationship (Saidani and Biraz 2023, 490).
Zourkata Meriem, Damene Ouahiba / Finance, Accounting and Business Analysis, Volume 8, Issue 1, 2026
125
(2)
Where:
ISL(Z)
PSIA
: Islamic banking stability indicator relating to profit-sharing investment accounts;
R
PSIA
: Net returns realized by holders of profit-sharing investment accounts;
A
PSIA
: Volume of assets financed by holders of profit-sharing investment accounts;
(E/A
PSIA
): Ratio of the bank shareholders’ equity to the total volume of assets financed by profit-sharing
investment accounts;
(R
PSIA
/A
PSIA
) × 100: Standard deviation of the rate of return on assets attributable to profit-sharing
investment account holders, calculated over a period of no less than five years to ensure greater statistical
reliability.
− The Islamic Banking Stability Indicator ISLB(Z)
SharH,Invest
, relating to capital providers or prospective
equity investors, aims to measure the degree of stability in the returns realized by shareholders of
the Islamic bank and its investors. It is calculated using the following relationship (Mehdaoui 2021,
418):
(3)
Where:
ISLB(Z)
SharH,Invest
: the financial stability index of Islamic banks pertaining to capital holders or prospective
equity investors;
R
SharH,Invest
: the net returns realized by equity holders;
A
SharH,Invest
: the volume of assets financed by equity holders;
E/A
SharH,Invest
: the ratio of equity to total assets financed by equity holders;
µ
Annual
/ R
SharH,Invest
: the average annual growth rate of net profits attributable to equity holders;
(R
SharH,Invest/
A
SharH,Invest
) × 100: the standard deviation of the rate of return attributable to equity holders. This
indicator should be calculated over a period of no less than five years to ensure greater statistical significance.
Measuring the Financial Stability and Soundness of Al Salam Bank Algeria during the Period (2015–
2024)
Overview of Al Salam Bank Algeria
Al Salam Bank Algeria is a banking institution operating under Algerian law and in full compliance
with the provisions of Islamic Sharia in all its transactions. The bank was licensed by the Bank of Algeria in
September 2008 and subsequently commenced operations with the objective of providing innovative
banking services.
Al Salam Bank Algeria operates in accordance with a clearly defined strategy aligned with the
requirements of economic development across all vital sectors in Algeria, through the provision of modern
banking services aimed at meeting the needs of the market, clients, and investors. Its transactions are
supervised by a Sharia Supervisory Board composed of prominent scholars in Islamic jurisprudence and
economics (Al Salam Bank 2023, 03).
METHODS AND DATA
This study adopted a descriptive-analytical approach to evaluate the financial stability of Islamic
banks using a modified Z-Score framework. The study focuses on a single case study, specifically Al Salam
Bank Algeria, covering the period from 2015 to 2024. The ten-year timeframe provides sufficient breadth to
observe trends and variations in financial stability under different economic conditions.
The study focuses on the period (2015-2024) due to the availability of consistent financial data and
the relevance of this timeframe for analysing the evolution of financial stability. This period captures
different macroeconomic conditions, including economic fluctuations and external shocks such as Covid-19
pandemic, which allows for a more comprehensive assessment of the bank’s resilience using the Z-Score
indicator.
The study relies on secondary data obtained from the bank’s annual financial statements for the period
(2015-2024), the dataset includes key financial indicators such as: Total assets, Shareholders’ equity, Net
income, Profit Sharing Investment Accounts (PSIA) and Relevant reserves and risk provisions.
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126
All variables were calculated on an annual basis. To ensure accuracy and reliability, the data were
carefully checked for consistency and comparability across the study period, allowing for a robust and
methodologically sound analysis.
RESULT AND DISCUSSION
Key Activity Indicators of Al Salam Bank Algeria
The evolution of the principal activity indicators of Al Salam Bank Algeria during the period (2015–
2024) can be summarized in the following table:
Table 1. Evolution of the Principal Activity Indicators of Al Salam Bank Algeria during the Period (2015–
2024) (million DZD)
Item
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
Total Assets
40,575
53,104
85,775
110,109
131,019
162,626
237,804
261,693
333,886
389,396
Shareholders’
Equity
14,301
15,381
16,563
17,305
19,012
18,900
27,263
27,312
33,088
39,578
Customer
Deposits
30,120
34,512
64,261
85,431
103,792
129,320
195,031
215,076
279,098
362,185
Net Income
301
1,080
1,181
2,418
4,007
3,069
3,389
4,393
5,834
6,672
Return on
Equity (%)
4%
7%
7%
14%
21%
15%
15%
16%
19%
20%
Source: Prepared by the two researchers based on the annual financial reports of Al Salam Bank Algeria for
the period (2015–2024).
From the preceding table, the following conclusions may be drawn:
During the period (2015–2024), Al Salam Bank recorded sustained growth in its operations, as
reflected in the marked increase in total assets, which rose from 40 million DZD in 2015 to 389 million DZD
in 2024. The expansion of customer financing portfolio through client base expansion serves as the main
reason for this growth. The value of shareholders' equity showed steady growth throughout the entire period
except for the year 2020 because the COVID-19 pandemic caused a small decrease of 0.6% in this financial
metric.
Total customer deposits exceeded 300 thousand in 2024, compared with 30 million DZD in 2015.
The banking sector experienced positive growth in all deposit categories which included current accounts
and investment accounts and savings accounts. The bank's deposit category experienced growth because of
two main factors which included their promotional activities that encouraged savings and their practice of
giving incentive-based returns to their deposit holders. The bank shows signs of better client perception
because its customers have developed higher levels of trust toward their banking establishment. The bank
achieved a 100 billion DZD liquidity level during 2023 because its deposit and financing balances expanded
to reach 187% of the planned target (Al Salam Bank 2023).
The results from the previous section along with other factors led Al Salam Bank to achieve steady
net profit growth during most of the research period except for 2020 when the COVID-19 pandemic caused
worldwide economic challenges which affected the Algerian market. Net income declined from 4 million
DZD in 2019 to 3 million DZD in 2020; however, it increased in subsequent years, exhibiting a consistent
upward trajectory. The bank achieved net profits of 6,672,000 DZD during 2024 which represented a 14.5%
increase from its 2023 financial results. The new development led to an overall boost in the return on
shareholders' equity.
The foregoing results may be summarized in the following figure:
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127
Source: Prepared by the two researchers based on the data presented in Table No. 1.
Figure 2. Evolution of Activity Indicators of Al Salam Bank Algeria during the Period (2015–2024)
Analysis of the Financial Stability and Soundness Indicator (Z-Score) of Al Salam Bank Algeria during
the Period (2015–2024)
The Z-Score indicator for Al Salam Islamic Bank will be measured and analysed for both profit-
sharing investment account holders and equity holders, based on the specific formula applicable to each
indicator.
Analysis of the Evolution of the Z-Score for Profit-Sharing Investment Account Holders of Al Salam
Bank during the Period (2015–2024)
The following table illustrates the evolution of the Z-Score for profit-sharing investment account
holders of Al Salam Bank over the period (2015–2024). To measure this indicator, the Equation (2) is
applied.
Based on the annual reports of Al Salam Bank Algeria over the period (2015–2024), the financial data
were collected to compute the ISLB(Z)
PSIA
index, and the results are presented in the following table:
34 512
64 261
85 431
103 792
129 320
195 031
215 076
279 098
362 185
2016 2017 2018 2019 2020 2021 2022 2023 2024
Customer Deposits
301
1 080
1 181
2 418
4 007
3 069
3 389
4 393
5 834
6 672
14 301
15 381
16 563
17 305
19 012
18 900
27 263
27 312
33 088
39 578
2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Net Income Shareholders’ Equity2
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Table 2. Evolution of the Z-Score index for profit-sharing investment accounts at Al Salam Bank Algeria during the period (2015–2024)
Statement
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
Depositors’ profits
from investment
accounts
126000
205547
297918
595517
1064986
1358344
1717260
2315607
2735849
2941928
Net returns realized
for investment
account holders
(R
PSIA
)
126000
205547
297918
595517
1064986
1358344
1717260
2315607
2735849
2941928
Net Islamic financing
and investment assets
6430485
7866447
8171368
10487621
11333094
10335272
13950009
16760405
18123874
14887556
Bank equity (E)
14301000
15381000
16563000
17305000
19012000
18900000
27263000
27312000
33088259
39578947
Customer deposits
(savings accounts and
investment deposits)
2253596
4101081
6026287
7762247
11794091
19201561
32234042
42362802
54143064
64792854
Total
16554596
19482081
22589287
25067247
30806091
38101561
59497042
69674802
87231323
104371801
Financing ratio from
investment account
holders’ funds
0.13613
0.2105
0.26677
0.30965
0.38284
0.50395
0.54177
0.608
0.62068
0.62078
Volume of assets
financed by profit-
sharing investment
account holders
(A
PSIA
)
875381.92
1655887.09
2179875.84
3247491.84
4338761.7
5208460.32
7557696.37
10190326.2
11249126.1
9241897.01
E/A
PSIA
16.3368
9.2886
7.5981
5.3287
4.3818
3.6287
3.6073
2.6801
2.9413
4.2825
(R/A
PSIA
) × 100
14.3937
12.4131
13.6667
18.3377
24.5458
26.0795
22.722
22.7235
24.3205
31.8325
d (R
PSIA
/A
PSIA
) × 100 = 6.7148
Average value of the financial stability and soundness index for profit-sharing investment account holders
ISLB(Z)
PSIA
= 4.4861
Source: Prepared by the two researchers based on the annual financial reports of Al Salam Bank Algeria for the period (2015–2024).
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129
From the results presented in the preceding table, the value of the financial stability and soundness
index for profit-sharing investment account holders ISLB(Z)
PSIA
is derived as follows:
The arithmetic mean of return on assets:
= 23.44833
The arithmetic mean of the ratio of equity to total assets financed by investment accounts:
= 6.6749
The standard deviation of the rate of return attributable to profit-sharing investment account holders:
δ (R
PSIA
/A
PSIA
) × 100 = 6.7148.
Substituting into the ISLB(Z)PSIA index equation, we obtain:
(4)
ISLB(Z)
PSIA
= (23.44833+6.6749) / 6.7148 = 4.4861
The Financial Stability and Soundness Index for Profit-Sharing Investment Account holders
(ISLB(Z)
PSIA
) showed an average value of 4.4861 during the assessment. The bank needs to reduce its profit
by more than 4.4861 times its standard deviation before its equity will vanish which makes the bank unable
to pay its creditors. The bank operates under financial stability according to its Z-score which exceeds 2.99
and its insolvency risk remains at a minimal level. The bank follows Islamic Sharia principles through its
financing methods which have created positive effects on various elements of this index which I will now
examine in detail.
Depositors earned rising profits throughout the research period between 2015 and 2024 when their
earnings increased from DZD 126,000 in 2015 to DZD 2,941,928 in 2024. The profit increase resulted from
higher distribution of earnings to savings account owners and investment certificate holders who follow the
mudarabah contract. The total profit which profit-sharing investment account holders obtained matched the
total profit which investment account depositors received because investment account holders did not face
any expenses during the research period.
The indicator measuring the volume of assets financed by investment account holders (A
PSIA
) recorded
significant growth over the period (2015–2024), rising from DZD 875,381.92 in 2015 to DZD 9,241,897.01
in 2024. The financial results demonstrate investment accounts operate as authentic funding sources which
show how investors trust their bank and how well the bank distributes its investment funds for financial
security and business growth.
The ratio between equity and total assets funded by profit-sharing investment account holders
(E/A
PSIA
) showed a continuous decrease from 16.33% in 2015 to 4.28% in 2024 according to the analysis of
data from 2015 to 2024. The bank needs funds from its investment account holders to support its operations
because Islamic banking follows a profit-and-loss sharing system. The ongoing pattern will create solvency
problems which need investment account holder protection through improved risk control systems.
The ratio of returns to investment account holders relative to the volume of assets financed by them
(R/A
PSIA
) exhibited fluctuations during the period (2015–2024). The indicator reached its lowest value in
2016 (12.41%), subsequently increased, declined again in 2020 due to the COVID-19 crisis, and then rose to
attain its highest level in 2024 (31.83%). The bank has improved its investment fund management which
leads to better financial stability and increased profitability.
Analysis of the Evolution of the Z-Score Index for Equity Holders of Al Salam Bank during the Period
(2015–2024)
The following table presents the evolution of the Z-Score index for the equity holders of Al Salam
Bank over the period (2015–2024). To measure this index, the Equation (3) is applied.
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130
Table 3. Evolution of the Z-Score Index for the Equity Holders of Al Salam Bank of Algeria during the Period (2015–2024)
Statement
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
Net Profits Attributable
to Equity Holders
R
,
2214284
2769196
3989527
7015658
9226913
7701109
9267164
11134236
13685796
16866884
Net Islamic Financing
and Investment Assets
6430485
7866447
8171368
10487621
11333094
10335272
13950009
16760405
18123874
14887556
Bank Equity (E)
14301000
15381000
16563000
17305000
19012000
18900000
27263000
27312000
33088259
39578947
Customer Deposits
(Savings Accounts and
Investment Deposits)
2253596
4101081
6026287
7762247
11794091
19201561
32234042
42362802
54143064
64792854
Total
16554596
19482081
22589287
25067247
30806091
38101561
59497042
69674802
87231323
104371801
Financing Ratio from
Equity Holders
0.86386
0.78949
0.73322
0.69034
0.61715
0.49604
0.45822
0.39199
0.37931
0.37921
Volume of Assets
Financed by Equity
Holders A
sharh, invest
412166
461997
517871
636284
689138
860455
872259
958161
1009084
1131122
The annual growth rate
in shareholders’ equity
0.02
0.075
0.08
0.045
0.1
-0.01
0.44
0.002
0.21
0.2
µAnnual /E = 0.0962
(
,
/
,
) ×
100
537.1
599.4
770.37
1102.6
1338.9
895
1062.43
1162.04
1356.26
1491.16
E/A
sharh,invet
3.4697
3.3292
3.1982
2.7196
2.7588
2.1965
3.1255
1.8067
32.7903
34.9908
(
,
/
,
) ×
=340.53
The Average Z-Score Value for Equity Holders
I()
,
3.3955
Source: Prepared by the two researchers based on the annual financial reports of Al Salam Bank of Algeria for the period (2015–2024).
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131
From the results of the preceding table, the value of the Financial Stability and Soundness Index for
equity holders, ISLB(Z)
SharH,Invest
is derived as follows:
Arithmetic mean of the return on assets:
1146.14
Arithmetic mean of the ratio of equity to total assets financed by equity holders:
= 10.0428
Standard deviation of the rate of return attributable to equity holders:
(R
SharH,Invest
/ A
SharH,Invest
) =340.53
By substituting into the ISLB(Z)
SharH,Invest
index equation, we obtain:
(5)
ISLB(Z)
SharH,Invest
= (1146.14+10.0428+0.0962) / 340.53 = 3.3955
The Financial Stability and Soundness Index for profit-sharing investment account holders
ISLB(Z)
SharH,Invest
shows an average value of (3.3955). The value falls into the low-risk zone because it exceeds
2.99 which shows that Al Salam Bank has achieved its service delivery objectives while keeping its financial
position stable.
The table results indicate a consistent upward trend in net profits attributable to equity holders over
the period (2015–2024), rising from DZD 2,214,284 in 2015 to DZD 16,866,884 in 2024. Al Salam Islamic
Bank shows a continuous positive trend in its financial results. The present situation demonstrates that equity
usage has become more efficient because Sharia-compliant financing and investment operations have grown
which supports financial stability through controlled risk levels maintained by the Islamic banking system
based on profit-and-loss sharing.
The return on assets financed by equity holders (R
SharH,Invest
/ A
SharH,Invest
) exhibited an upward trajectory
during the period (2015–2024), increasing from 537 in 2015 to 1491 in 2024. The bank has improved its own
capital deployment efficiency according to the data. The relative limitation of fluctuations further indicates
a degree of operational stability that has reinforced overall financial soundness.
The E / A
SharH
,
Invest
ratio showed irregular changes throughout the years spanning from 2015 to 2024.
The ratio experienced no major changes between 2015 and 2017 when the capitalization level averaged 3.33
which demonstrates the company used equity to fund its assets equally. The COVID-19 pandemic caused
the value to decrease between 2018 and 2020 with the most significant drop occurring in 2020. The structure
went through a major transformation during 2023 and 2024 because equity showed a strong upward trend.
The bank protects investment account holders from risk through its precautionary capitalization policy
which also reduces financial leverage.
…………..
CONCLUSION
The research study used the Z-Score indicator to evaluate financial stability levels which Islamic
banks maintain while studying Al Salam Bank of Algeria under Islamic banking institutional conditions.
The research aimed to prove this indicator functions well for Islamic banking operations because it matches
their operational structure which follows the profit-and-loss sharing system that sets these banks apart.
The research results showed that ISLB(Z)
PSIA
had a value of -4.4861 which demonstrated Al Salam
Bank of Algeria maintained strong financial stability. The bank receives its core strength from investment
account holders because they determine its ability to handle financial losses and protect against banking
failures. The research shows Islamic banks maintain their stability through profit-and-loss sharing systems
which also defend the whole banking system from collapsing.
The value of ISLB(Z)
SharH, Invest
=3.3955 = 3.3955 shows that Al Salam Bank operates in a low-risk
environment because self-capitalization as a risk indicator does not provide sufficient information about
Islamic banks' risk levels. The two indicators demonstrate that ignoring Islamic funding source
characteristics will result in incorrect evaluations of Islamic banks' stability.
Furthermore, the empirical results indicate that the calculated Z-Score values remained above the
critical threshold throughout the study period. Which reflects the bank’s strong solvency position and its
capacity to withstand potential financial distress. This stability is largely attributed to the relatively high
Zourkata Meriem, Damene Ouahiba / Finance, Accounting and Business Analysis, Volume 8, Issue 1, 2026
132
capitalization level and the prudent risk-management practices adopted by the bank.
In addition, the analysis confirms that the institutional characteristics of Islamic banking particularly
the profit and loss sharing mechanism and the reliance on investment accounts, contribute significantly to
enhancing financial resilience. These factors reduce the likelihood of insolvency and reinforce the bank’s
ability to maintain sustainable financial performance over time.
The research finds that Islamic banking needs specialized financial stability assessment tools which
will provide more accurate banking risk evaluations than standard methods. The system transformation
enables banks to obtain better decision support from their monitoring systems which simultaneously helps
maintain financial system stability. The study suggests that future research should use advanced econometric
methods to analyse larger samples which include various Islamic banks while researchers should use more
indicators to study liquidity and asset quality for better understanding of Islamic banking stability patterns.
Acknowledgments
The authors would like to express their sincere gratitude to the officials at Al Salam Bank Algeria, Setif
Agency, for their cooperation and for providing the necessary information and data that contributed to this
research.
Funding
The authors declare that this research was conducted as a personal contribution and received no specific
grant or financial support from any funding agency in the public, commercial, or not-for-profit sectors for
the conduct, analysis, or publication of the research.
Data Аvailable Statement
The data used in this study were obtained from the official website of Al Salam Bank Algeria:
https://www.alsalamalgeria.com/, and are publicly accessible.
Conflict of interest
The authors declare no conflict of interest.
AI Tools Statement
authors confirm that no AI tools were used in the preparation of this manuscript.
Author contribution (as applicable):
Zourkata Meriem and Damene Ouahiba contributed equally to all aspects of this research, including
conceptualization, methodology, data curation, and formal analysis. Both authors participated in writing
the original draft, as well as the subsequent review and editing process.
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