Credit Risk in Islamic and Conventional Banks

Do Islamic Banks Have Higher Credit Risk?

Comparative Credit Risk in Islamic and Conventional Banks

Comparative credit risk in Islamic and conventional bank

The study analyzes macroeconomic and bank specific determinants of credit risk in Islamic and Conventional Banks. Multivariate Regression analysis is applied on the sample of 15 conventional banks and 13 Islamic Banks in Malaysia over the period between 2000 and 2010. The finding shows that the banks specific determinants of credit risk are uniquely influenced the credit risk formation of Islamic and Conventional banks. The study found that risky sector financing; regulatory capital (REGCAP) and Islamic Contract are significant to credit risk of Islamic banks. For Conventional Banks, loan loss provision, debt-to-total asset ratio, REGCAP, size, earning management and Liquidity are significant factors influencing credit risk. As for macroeconomic factors only Inflation and M3 are significant to credit risk for both Islamic and Conventional banks.

PurposeThe study of credit risk has been of the utmost importance when it comes to measuring the soundness and stability of the banking system. Due to the growing importance of Islamic banking system, a fierce competition between Islamic and conventional banks have started to emerge which in turn is impacting credit riskiness of both banking system.Design/methodology/approachUsing the system GMM technique on 283 conventional banks and 60 Islamic banks for the period of 2006–2017, this paper explores the important impact of size and competition on the credit risk in 15 dual banking economies.FindingsThe authors found that as bank competition increases credit risk seems to be reduced. On the size effect, the authors found that big Islamic banks are less risky than big conventional banks whereas small Islamic banks are riskier than small conventional banks. The results are robust for different panel data estimation models and sub-samples of different size groups. The findings of this paper provide important insights into the competition-credit risk nexus in the dual banking system.Originality/valueThe paper is specifically focused on credit risk in dual banking environment and tries to fill the gap in the literature by studying (1) do the Islamic and conventional banks exhibit a different level of credit risk; (2) does competition in the banking system impact the credit risk of Islamic and conventional banks and finally (3) do the big and small banks exhibit similar levels of credit risk.

PurposeThe purpose of this study is to critically evaluate how conventional and Islamic banks trade off risk, efficiency and financial performance in their business models, to investigate how patterns of risk and efficiency vary between conventional and Islamic banks and to critically evaluate how the profitability of conventional and Islamic banks varies following the financial crisis.Design/methodology/approachThis study uses univariate and multivariate statistical techniques by investigating 12 Islamic banks and 34 conventional banks operating in the Gulf Cooperation Council (GCC) region has been studied over the period 2011–2018.FindingsThe results suggest that Islamic and conventional banks differ not in the levels of efficiency, risk and profitability, but rather in how risk and efficiency influence banks’ financial performance. Islamic banks are found to be less influenced by the adverse effects of credit risk, which is consistent with the risk-sharing nature of Islamic financing. However, the results only hold for return on assets (ROA) and return on equity (ROE) while the net interest margin is observed to be negatively influenced by credit risk. Lower cost-income efficiency is also found to boost ROA and ROE of Islamic banks which could be attributed to a larger share of non-interest revenues due to Sharīʿah-compliance.Research limitations/implicationsFrom a theoretical point of view, this study helps to understand the risk, efficiency and financial performance of Islamic banks in comparison with conventional banks.Practical implicationsThe results of this study can serve bank managers, regulators and shareholders. Policymakers should encourage a more risk-sharing structure of Islamic financing as it brings less adverse effects of credit risk and increases income sustainability for Islamic banks. The present study may help bank managers to improve the financial performance of their firms by controlling risk and efficiency. The study results also have implications for shareholders and depositors of Islamic and conventional banks as they should have a predetermined position about the level of credit risk and efficiency in each banking system.Originality/valueThe foremost contribution is that this is one of the few studies to compare risk, efficiency and financial performance of Islamic and conventional banks in the GCC region. By using the latest data, this paper hopes that the findings will be more relevant than previous studies to the current situation of the banking industry in the region.

This study aims to investigate the prominent determinants of Islamic and conventional banks’ profitability. The independent variables are bank size, loan, credit risk, and stability (measured by z-score). The profitability was measured by return on assets. The analysis of data was on annual data of Islamic banks (Islamic commercial banks and sharia business unit of conventional banks) and traditional commercial banks during the period 2014-2016. The statistical description showed that the profitability and loan of the sharia business unit are higher than Islamic and conventional commercial banks. Islamic commercial banks have the highest credit risk. Traditional commercial banks are more stable than Islamic banks. The regression test results found that credit risk and z-score have a significant and robust relationship with the profitability of Islamic and conventional banks. The higher z-score and lower credit risk will increase profitability. The bank size and loan variable do not affect the profitability of conventional banks. But vice versa, the bank size has a positive and significant relationship with the profitability of Islamic commercial banks and negative relationships with the sharia business unit profitability. Likewise, the loan variable has a negative and significant relationship with the profitability of Islamic commercial banks and a positive relationship with the sharia business unit profitability. It can be explained that the profitability of Islamic banks is influenced by all of the independent variables. While conventional bank profitability is only affected by two variables. Thus, it can be concluded that only stability and credit risk variable plays a vital role in increasing the profitability of Islamic and conventional banks.

PurposeThis paper aims to investigate the impact of regulation and market competition on the risk-taking Behaviour of financial institutions in the Middle East and North Africa (MENA) region.Design/methodology/approachThe empirical framework is based on panel fixed effects/random effects specification. For robustness purpose, this study also uses the generalized method of moments estimation technique. This study tests the hypothesis that regulatory capital requirements have a significant effect on financial stability of Islamic and conventional banks (CBs) in the MENA region. This study also investigates the moderating effect of market power and concentration on the relationship between capital regulation and bank risk.FindingsThe estimation results support the view that capital adequacy ratio (CAR) has no significant impact on credit risk of Islamic banks (IBs), whereas market competition does play a significant role in shaping the risk behavior of these institutions. This study report opposite results for CBs – an increase in the minimum capital requirements is followed by an increase in a bank’s risk level, which has a negative impact on their financial stability. Furthermore, the results support the notion of a non-linear relationship between banking concentration and bank risk. The findings inform the regulatory authorities concerned with improving the financial stability of banking sector in the MENA region to set their policy differently depending on the level of concentration in the banking market.Research limitations/implicationsThis study contributes to the literature on the effectiveness of regulatory reforms (in this case, capital requirements) and market competition for bank performance and risk-taking. In regard to IBs, capital requirements are less effective in requiring IBs to adjust their risk level according to the Basel III methodology. This study finds that IBs’ risk behavior is strongly associated with market competition, and therefore, the interest rates. Moreover, banks operating in markets with high banking concentration (but not necessarily, low competition), will decrease their credit risk level in response to an increase in the minimum capital requirements. As a result, these banks will be more stable compared to their conventional peers. Thus, regulators and policymakers in the MENA region should restrict the risk-taking behavior of IBs through stringent capital requirements and more intense banking supervision.Practical implicationsThe practical implications of these findings are that the regulatory authorities concerned with improving banking sector stability in the MENA region should proceed differently, depending on the level of banking market concentration. The findings inform regulators and policymakers to set capital requirements at levels that would restrict banks from taking more risk to increase their returns. They are also important for bank managers who should avoid risky strategies in response to increased regulatory pressure (e.g. increase in the minimum required capital level of 8%), as they may lead to an increase in the level of non-performing loans, and therefore, a greater probability of bank default. A future extension of this study will focus on testing the effect of bank risk-taking and market competition on the capitalization levels of banks in the MENA countries. More specifically, this study will investigates if banks raise their capitalization levels during the COVID-19 pandemic.Originality/valueThe analysis of previous research indicates that there is no unambiguous answer to the question of whether IBs perform differently than CBs under different competitive conditions. To fill this gap, this study examines the influence of capital regulation and market competition (both individually and interactively) on bank risk-taking behavior using a large sample of banking institutions in 18 MENA countries over 14 years (2005–2018). For the first time in this line of research, this study shows that the level of market power is positively associated with the level of a bank’ insolvency risk. In others words, IBs operating in highly competitive markets are more inclined to take a higher risk than their conventional peers. Regarding the IBs credit risk behavior, this study finds that market power has a limited impact on the relationship between CAR and risk level. This means that IBs are still applying in their operations the theoretical models based on the prohibition of interest.

This study assesses the non-performing loans of conventional and Islamic banks as well as the influence of ownership on the non-performing loans of conventional and Islamic banks. Due to fundamental differences in Islamic and conventional bank such as funding, non-performing loans might have differing effects on Islamic and conventional banks. This study utilised data of 26 conventional banks and 16 Islamic banks from Malaysia from 2012 to 2020. A Random Effect model was used to investigate the difference between conventional and Islamic banks’ non-performing loans as well as the influence of ownership on non-performing loans of conventional and Islamic banks. Results showed no significant differences for non-performing loans of conventional and Islamic banks. This result implies that despite the fact that Islamic banks may benefit from lower agency costs, this does not considerably decrease the likelihood of non-performing loans. Foreign Islamic banks shows higher non-performing loans in comparison to domestic Islamic banks. However, there were no significant differences for non-performing loans between foreign conventional and domestic conventional banks. This study suggests that Islamic bankers, particularly those intending to expand into other countries, investigate nonperforming loans, which can impact the risk of a foreign Islamic bank.

The impact of credit risk (CR) on bank-specific factors (BSF’s) and banks in the event of conventional and Islamic banks of Pakistan is an essential motivation behind this learning. These banks are chosen by their value commitment. The financial explanation investigation of chosen Islamic and conventional banks is contemplated from 2007 to 2017. Relapse examination of non-performing loan (NPL) proportion and Z-Score is utilized to discover the connections of BSF’s on chosen banks. The Islamic banking system consists of (return on equity (ROE), ROA, liquidity, spread and bank size) having a significant relationship toward credit risk. Therefore, the impact of the Z-score is less for Islamic banks relatively compared to conventional banks. The increased risk of bank debt reflects a strong NPL. In this examination bank, certain factors, for instance, efficiency, return on assets (ROA) and bank dimension, have a significant liaison through credit card risk in the conventional selected banking system, and this process affects overall banking performance. These findings provide valuable insights for policymakers, regulators, and banking professionals to manage credit risk effectively in the context of Pakistan's banking system. The originality of this study lies in its focus on the comparison between conventional and Islamic banks in Pakistan, which has yet to be extensively explored in the literature.

PurposeThis study aims to investigate the differences in the credit profiles of Islamic and conventional banks in the Gulf Cooperation Council (GCC) region and attempts to identify the factors responsible for those differences.Design/methodology/approachFinancial data sourced from the Bankscope database for a sample of 25 Islamic and 56 conventional banks headquartered in the GCC region between 1987 and 2014 are used. The credit risk of Islamic versus conventional banks is compared using a variety of univariate (mean difference test and correlation analysis) and multivariate tests (pooled ordinary least squares (OLS) regressions with robust standard errors and year fixed effects, regressions with interaction variables and logistic regressions).FindingsPooled OLS regressions find that Islamic banks have lower credit risk than conventional banks. Robustness checks using logistic functions and interaction variables confirm this result. Using multiple econometric specifications, we also find that higher capitalization, greater liquidity and cost inefficiency contribute to the lower risk profile of Islamic banks.Research limitations/implicationsThe study is unable to disaggregate data for banks offering both Islamic and conventional banking services and hence does not include conventional banks with Islamic windows. In addition, there are differences across countries even within the GCC region as to what is considered Sharia’h-compliant and what is not.Practical implicationsThe results are of potential interest to not only researchers, but also market participants, regulators and legislators. The methods used in this study could be extended to other two-tiered banking systems and, in the case of Islamic and conventional banking, to other markets.Originality/valueThe authors use a unique sample of banks headquartered in the GCC countries, whose banking markets are similar, if not homogeneous, thus excluding operations of multinational banks. By focusing on the Gulf region, differences in the credit profiles of Islamic and conventional banks can be examined without the confounding effects of unobserved factors like culture, accounting regime or regulatory environment.

The purpose of this research is to compare critically the performance of Islamic and conventional banks in Syria. Moreover, explore the impact of capital adequacy, liquidity, efficiency and risk management on assets performance. This study analyzed the entire private banking sector in Syria comprises 11 conventional banks and 3 full-fledged Islamic banks, over the period 2011-2017. We used paired sample t-test, correlation and multiple Regression to meet our objectives. The results suggest that Islamic banks were better in term of capital adequacy, efficiency, risk management and liquidity. While conventional banks better in terms of profitability. However, results depict that risk management performance same in Islamic and conventional banks. Private banks started in Syria since 2004. It is quite time to examine its performance because Syria is getting out of conflict era and it is important to analyze its solvency position for future prospects. This study is a pioneering attempt for analyzing banking sector in Syria, therefore, has significance for academicians, researchers and policymakers in planning works for future directions.

Does the Financing Model of Islamic Banks make them More Stable: A Comparative Analysis of Returns, Stability and Risk in Between Diversified, Interest, and Inventory Based Earning?

This study aims to identify variables which determine credit risk in Islamic and Conventional banks. Panel data fixed effect model employed to analyze which belongs to three Islamic Banks in Turkey for the period 2008 Q1 to 2017 Q4. While for conventional banks, previous studies that has been conducted in Turkey used to compare Islamic to Conventional banks (CB). Non-performing Loans (NPL) ratio was used as a proxy for credit risk. Result from fixed effect model showed that NPL in Islamic Banks is positively affected by Loan Loss Provision and Proportion of Loans to Deposits, and it is negatively affected by Assets Size. While literature showed that conventional bank’s credit risk is positively affected by Net Interest Margin, Loan Loss Provision, and Capital Adequacy Ratio and it is negatively affected by Proportion of Loan to Deposits, Proportion of Loans to Assets and Size. There were clear differences between both Islamic and Conventional banks related to all variables of study except Loan Loss Provision and Proportion of Loan to Assets ratios.

Comparative Analysis of Credit Risk of Islamic and Conventional Banks: (A Case Study of Pakistan)