Competition, efficiency and stability in Islamic and conventional banking systems: an emerging market perspective

Abstract

This chapter examines the banking competition-efficiency-stability relationship using 324 banks over a 12-year period from 13 countries in the Middle East and Asia comprising both conventional and Islamic banking systems. Using dynamic panel data estimation techniques, we find that market power significantly increases efficiency in both banking sectors. However, it is of a higher magnitude for Islamic banks, leading to reject the competition-efficiency hypothesis. Efficiency positively affects the stability of conventional banks but has no significant impact on stability in Islamic banks. Subsequently, market power increases the stability of both banking sectors, suggesting that uniform competition policy can govern both banking systems since the impact of competition on stability is the same. However, given that Islamic banks are not as efficient as conventional banks, there is a need for policymakers and practitioners to make them more efficient as a means of improving their stability.