Impact of bank regulation on risk of Islamic and conventional banks

Abstract

AbstractWe analyse the impact of bank regulation on the risks of Islamic banks (IBs) and conventional banks (CBs) between 2004 and 2015 by employing 455 CBs and 95 IBs from 22 countries where IBs and CBs coexist. Since the objective of Basel regulations is to achieve a stable banking sector by mitigating risks, we examine the impact of bank regulations on various risks of IBs and CBs by using a regression framework. We examine solvency risk, credit risk, idiosyncratic risk and systemic risk by using capital oversight, restriction on activities, private monitoring and supervisory power bank regulation data provided by the World Bank. The findings show that though the Basel regulations were originally developed for CBs, our results imply that they are effective for IBs as well as CBs. However, our study also shows that regulations affect IBs and CBs differently as their business models are different. More targeted regulations towards IBs would be necessary to support IBs. Additionally, in regions with higher economic freedom indexes, banking regulations can mitigate the risk of IBs and CBs to a greater extent. Our results imply that the combination of free economic policies and banking supervision addresses risks in banking effectively. Finally, the bank regulations did not appear to be able to control the risk of the sample banks during the 2007–2009 crisis. Hence, the Basel committee needs to rethink about regulations during crisis times.