Capital regulation, market power and bank risk-taking in the MENA region: New evidence for Islamic and conventional banks

Abstract

This paper investigates the impact of capital requirements and market power on the risk of financial institutions in the Middle East and North Africa (MENA) region. We test the hypothesis that capital requirements have a significant effect on risk behavior of both Islamic and conventional banks in the MENA region. We also investigate the moderating effect of market power on the relationship between capital requirements and bank risk. Our analysis indicates that capital ratio has a strong positive impact on the credit risk of conventional banks, whereas this effect is insignificant in the sample of Islamic banks. For the conventional banking sector, the increase in the capitalization level imposed by the regulators is negatively linked to the credit risk level only for banks with high market power. Regarding the IBs behavior, that the relationship between capital ratio and credit risk is not moderated by market competitive conditions. This means that Islamic banks are less sensitive to the conditions of market competition in the MENA countries but strongly depend on the regulatory authorities’ initiatives. Our findings inform the policymakers and regulators concerned with improving the banking sector’s stability in the MENA region to set their policy differently depending on the level of banking market competition.