Bank capital, lending and financing behaviour of dual banking systems

Abstract

As a “novel” business model based on risk-sharing, Islamic banking largely differs from the risk-based conventional banking model. We investigate whether the quality of bank capital affects bank lending and financing in Islamic versus conventional banks, using 123 banks operating in 10 Middle Eastern and Asian countries. The sample period 2005–2014 helps highlight the effects of the 2008 Global Financial Crisis and differentiate between bad time intervals and good ones. A distinction is established between Tier 1 bank capital and Tier 2 bank capital, respectively standing for high loss-absorbing capacity versus low loss-absorbing capacity. We find that high-quality capital helps provide banks with enough strength to effectively withstand financial crises. Additionally, Islamic versus conventional banks display different behaviours, with Tier 1 capital serving as a buffer in Islamic banks and as an incentive device in conventional banks.