Impact of financial shocks on Islamic banks

Abstract

PurposeThe purpose of this paper is to provide empirical evidences on the impact of financial shocks on the Islamic banks vis‐a‐vis the conventional banks. Based on the Malaysian experience over two major financial crises, namely the 1997 Asian financial crisis and 2007 financial crisis, the study aims to test the validity of the proposition that the Islamic banks are more resilient to the financial shocks compared to the conventional banks.Design/methodology/approachFocusing on the Malaysian data covering three sub‐periods, namely, the 1997 Asian financial crisis period (July 1997‐September 1999), the non‐crisis period (October 1999‐June 2007) and the 2007 financial crisis period (July 2007‐September 2009), the study employs the impulse response functions and variance decomposition analysis based on the vector auto‐regression (VAR) method.FindingsThe results indicate that both the Islamic and conventional banking systems are vulnerable to financial shocks. This is contrary to the popular belief that the Islamic financial system is sheltered from the financial shocks due to its interest‐free nature.Research limitations/implicationsThe results of this study have important implications for the risk management practices of both the Islamic and conventional banks.Originality/valueThis paper contributes in providing the empirical evidence on the impact of financial shocks on the Islamic banks. To the authors' knowledge, there have been no studies comparing of the impacts of the two major financial crises on the Islamic banking sector.