THE INFLUENCE OF BASEL III ON ISLAMIC BANK RISK

Abstract

This paper investigates the impact of bank regulatory capital on Islamic bank risk using bank-level data from 29 countries and covering the period from 2004 to 2020. Applying the Generalized Method of Moments technique for dynamic panels, we discover that, on average, Islamic bank regulatory capital ratios exceed the level required by Basel III. Our findings provide evidence in support of the Moral Hazard Hypothesis; that is, there is a negative relationship between capital and risk. These findings indicate that Islamic banks are better protected against risk when they fulfil Basel III and IFSB regulatory capital requirements. According to our findings, authorities that aim to improve the financial stability of the banking industry should reinforce their policies and oblige banks to adhere to regulatory capital requirements during a crisis, such as COVID-19. Finally, we observe that different risk indicators have diverse correlations with regulatory capital, and our findings are robust across a variety of estimation methodologies.