“How using derivative instruments and purposes affects performance of Islamic banks? Evidence from CAMELS approach”

Abstract

The increase of the use of derivative instruments by Islamic banks for different purposes motivate us to conduct this study. This work has twice objective: firstly, to investigate the effect of each derivative instrument (forwards, futures, swaps or options) on the performance of Islamic banks, and secondly to examine the effect of each derivative purpose (hedging or trading) on the performance of Islamic banks.To reach this end, dynamic panel data econometrics with GMM system are conducted on 32 Islamic banks during the period from 2007 to 2017. The CAMELS approach is used to measure the performance of sample banks.Statistics on sample banks reveal that Islamic banks are substantial users of derivatives, prefer using derivatives for trading purpose than for hedging purpose, and have acceptable level of performance.The main results confirm that using options affects positively and moderately the performance of sample banks. In the same way, we find that swaps have positive and weak impact on the performance of sample banks. However, the results reveal that using forwards decrease the performance of sample banks. Finally, we find that futures have ambiguous and marginal effect on the performance of sample banks.As regards derivative purposes, results do not see which purpose mainly motivate the Islamic banks to invest in the derivatives market.As theoretical implication, we suggest for further studies to explore more the differences between using derivatives by Islamic banks for trading and hedging purpose.Finally, as practical implications, we recommend for managers of Islamic banks to enlarge their use of options and swaps, to supervise their use of forwards and to stop their use of futures.