Performance of Islamic and Conventional Banks: The Impact of Basel III

Abstract

Purpose: To overcome the deficiencies of the Basel II and to respond the great depression of 2008, Basel III is designed to lower the default risk of banks. However, the unique business model and capital structure of Islamic banks is ignored at this point. A common banking regulation for two different types of banks may have a different impact on the profitability and cost efficiency of these banking types. In this regard, we address the question of the relative performance of both banking types in response to Basel III standards. Methodology: The study utilizes data of 79 banks, both Islamic and conventional, for the period of 2005 to 2019 from 10 different countries. For estimation, the study uses fixed-effect regression analysis. Findings: We find a positive impact of Basel III regulations on profitability and cost efficiency of the Islamic banks and a negative impact on conventional banks. The findings indicate that the favorable impact of Basel III on Islamic banks reduces the performance gap between both types of banks. Originality/Significance: This is perhaps the first paper which empirically explores the impact of Basel III regulations on the comparative performance of both types of banks. Policy Implications: The declining profitability and cost efficiency of conventional banks draw the attention of global and local banking regulators. Basel Committee on Banking Supervision (BCBS) and central banks of the countries with dual banking models should address this negative effect of the implementation of Basel III on conventional banks.