Creditor Rights and Bank Capital Decisions: Conventional vs. Islamic Banking

Abstract

Using a sample of banks operating in 24 countries, we provide robust evidence that stronger creditor rights are associated with higher capital adequacy ratios of conventional banks but not of Islamic banks. Such results are more effective on bank core capital, suggesting that bank managers tend to increase pure equity to signal better monitoring efforts and avoid losing control in an environment characterized by strong creditor protection. Except in less religious countries with less competitive markets, Islamic banks appear to be less affected by creditor protection possibly because of the profit loss sharing (PLS) principle that considers depositors as investors who agree to share profits and losses with the bank, thus making the effect of creditor protection weaker or irrelevant in an Islamic banking context.