Oil structural shocks, bank-level characteristics, and systemic risk: Evidence from dual banking systems

Abstract

• Investigates the impact of structural oil shocks on the systemic risk of banking in the GCC countries. • The impact of bank-level variables on systemic risk is small relative to oil price shocks. • Islamic banks are less risky in terms of systemic risk exposure to all sources of oil price shocks. • Systemic risk is more exposed to oil price shocks for large banks. • The effect of structural oil shocks on the systemic risk are more significant during the global financial crises than the COVID-19 pandemic. By performing a structural VAR analysis on oil price shocks, we provide an evidence on how the origins of oil price shocks impact the risk level of banks in oil-exporting countries and whether bank-level characteristics can influence the sensitivity of risk to oil shocks. When conducting panel regression analysis, we document the following findings. First, not all shocks have the same effect on bank risk. Due to oil supply shocks, the increase in oil price raises bank risk, whereas the similar increase in price due to economic expansion or oil-market specific demand reduces that risk. Second, the business model (whether the bank is Islamic or conventional), size, income diversification, profitability, and financial leverage influence the bank risk exposure to oil shocks differently. Third, the two major recent crises (global financial crises and COVID-19 pandemic) magnified bank risk exposure to oil supply shocks and speculative oil demand shocks. Overall, the structural oil shocks explain a large fraction of the variation in financial stability in GCC countries.