Leverage and balance-sheet size: a comparative study between Islamic and conventional banks

Abstract

ABSTRACT We carry out a comparative analysis of procyclical leverage between Islamic banks and conventional banks in the GCC countries and Malaysia. We collect an unbalanced panel data set including 57 conventional banks and 73 Islamic banks covering the period 2000–2019. First, we document strong evidence of procyclical leverage for our sample banks. Second, our results highlight that conventional banks have statistically stronger leverage procyclicality than Islamic banks, even after controlling for accounting profitability, economic conditions, bank regulations, and wholesale funding. Moreover, we document that the differential in the leverage procyclicality across Islamic banks and conventional banks has been stronger after the global financial crisis, and seems to be more pronounced in small banks compared with large banks. Our findings suggest that the differential in the leverage procyclicality across the two types of banks is related to their different business models. An implication of our results is that the low leverage procyclicality of Islamic banks is a key factor contributing to the stability of a dual banking system.