Abstract
It is generally argued that Islamic banks are safer than conventional banks. The prime reason is that their product structure is essentially asset-backed financing, while conventional banks rely heavily on leveraging, which was considered one of the main causes of the 2008 global financial crisis. This paper examines the riskiness of Islamic and conventional banks during the 2008 global crisis by measuring overleveraging, defined as the difference between actual and optimal debt. This research conducted empirical analysis on the overleveraging of 20 banks (10 conventional and 10 Islamic banks) from five different countries, namely, Bahrain, Kuwait, Malaysia, the United States, and the United Kingdom. The analysis is double-folded: on the one hand, the results in this paper suggest that excess debt, rather than the mere holding of debt, was the reason behind the severe financial meltdown in 2007–2009; on the other hand, this paper shows that Islamic banks, in most of the countries in context, performed better during the recent crisis, but were subject to the second-round effect of the global crisis around the years of 2011–2013.
Highlights
Over the last decade, Islamic banks’ annual growth rate reached 15%, and Islamic banks are currently present in over 51 countries (Juan Sole 2007)
This paper addresses if and how excess debt defined by Stein (2012a) can be considered as an early warning signal for banks, and takes an additional dimension by comparing the excess leverage between Islamic and conventional banks before and during the recent global financial crisis
The authors used a sample of 761 banks in 19 countries for the years of 1999–2013. Their findings suggested that the Basel core principle (BCP) index is positively associated with the stability of conventional banks, while the effect is less noticeable for Islamic banks
Summary
Islamic banks’ annual growth rate reached 15%, and Islamic banks are currently present in over 51 countries (Juan Sole 2007). Most research studies on Islamic and conventional banks used neither statistical techniques to assess the leveraging of banks, nor made cross-country intertemporal comparisons of debt levels. A literature review revealed that there is no empirical evidence of excess leverage in the case of Islamic banks in the countries examined in this paper. This paper addresses if and how excess debt defined by Stein (2012a) can be considered as an early warning signal for banks, and takes an additional dimension by comparing the excess leverage between Islamic and conventional banks before and during the recent global financial crisis. This paper is organized as follows: Following the introduction and rationale of this study, Section 2 gives the literature review about Islamic bank performance, and a comparison with their conventional counterparts in the examined countries. The appendices provide the technical background and calculations of excess debt
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