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Journal ArticleDOI

Risk in Islamic Banking

01 Nov 2013-Review of Finance (Oxford University Press)-Vol. 17, Iss: 6, pp 2035-2096
TL;DR: In this article, the authors investigated risk and stability features of Islamic banking using a sample of 553 banks from 24 countries between 1999 and 2009 and found that small Islamic banks that are leveraged or based in countries with predominantly Muslim populations have lower credit risk than conventional banks.
Abstract: This paper investigates risk and stability features of Islamic banking using a sample of 553 banks from 24 countries between 1999 and 2009. Small Islamic banks that are leveraged or based in countries with predominantly Muslim populations have lower credit risk than conventional banks. In terms of insolvency risk, small Islamic banks also appear more stable. Moreover, we find little evidence that Islamic banks charge rents to their customers for offering Sharia compliant financial products. Our results also show that loan quality of Islamic banks is less responsive to domestic interest rates compared to conventional banks.
Citations
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Journal ArticleDOI
TL;DR: In this paper, the authors examined whether the difference in governance structures influenced the risk taking and performance of Islamic banks compared to conventional banks and concluded that the governance structure in Islamic banks plays a crucial role in risk taking as well as financial performance that is distinct from conventional banks.
Abstract: We examine whether the difference in governance structures influences the risk taking and performance of Islamic banks compared to conventional banks. Using a sample of 52 Islamic banks and 104 conventional banks in 14 countries for the period from 2005 to 2013, we conclude that the governance structure in Islamic banks plays a crucial role in risk taking as well as financial performance that is distinct from conventional banks. Particularly, we show that the governance structure in Islamic banks allows them to take higher risks and achieve better performance because of product complexities and transaction mechanisms. However, Islamic banks maintain a higher capitalization compared to conventional banks. These results support the research on Islamic investment and risk taking. Our results add a new dimension to the governance research that could be a valuable source of knowledge for policy makers and regulators in the financial services sector.

218 citations


Cites background or result from "Risk in Islamic Banking"

  • ...The risk-sharing arrangements on the deposit side provide another layer of protection for the Islamic bank beyond its book capital (Abedifar et al. 2013)....

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  • ..., Obaidullah 2005) and excessive uncertainty (gharar) (Abedifar et al. 2013)....

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  • ...Abedifar et al. (2013) extend this finding by examining the relation between investor religiosity and a bank’s size....

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  • ...However, Islamic banking practices can also increase investors’ risk aversion due to the banks’ relatively limited access to wholesale funding (Abedifar et al. 2013)....

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  • ...By simultaneously analyzing both Islamic banks and conventional banks, we complement the works of Cihak and Hesse (2010), Hasan and Dridi (2010), Abedifar et al. (2013), Beck et al. (2013), and Mollah and Zaman (2015)....

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Journal ArticleDOI
TL;DR: In this article, the authors compare default rates on conventional and Islamic loans using a comprehensive monthly dataset from Pakistan that follows more than 150,000 loans over the period 2006:04 to 2008:12.
Abstract: We compare default rates on conventional and Islamic loans using a comprehensive monthly dataset from Pakistan that follows more than 150,000 loans over the period 2006:04 to 2008:12. We find robust evidence that the default rate on Islamic loans is less than half the default rate on conventional loans. Islamic loans are less likely to default during Ramadan and in big cities if the share of votes to religious-political parties increases, suggesting that religion – either through individual piousness or network effects – may play a role in determining loan default.

200 citations

Journal ArticleDOI
TL;DR: In this paper, the authors investigate whether stock market investors react differently to the announcements of sukuk and conventional bond issues, and they find that the stock market is neutral to announcements of conventional bonds issues, but it reacts negatively to announcement of SUkuk issues.

190 citations

Journal ArticleDOI
TL;DR: This article reviewed empirical studies on Islamic banking and concentrates on their main findings while highlighting future research directions, and discusses scholars' concerns that have led to a paradigm shift in the system and highlight practitioners' disquiet about recent practices.

172 citations

Journal ArticleDOI
TL;DR: In this article, the authors examine the recent empirical literature in Islamic banking and finance, highlight the main findings and provide a guide for future research, concluding that there are no major differences between Islamic and conventional banks in terms of their efficiency, competition and risk features.
Abstract: This paper examines the recent empirical literature in Islamic banking and finance, highlights the main findings and provides a guide for future research. Early studies focus on the efficiency, production technology and general performance features of Islamic versus conventional banks, whereas more recent work looks at profit and loss-sharing (PLS) behaviour, competition, risks as well as other dimensions such as small business lending and financial inclusion. Apart from key exceptions, the empirical literature suggests no major differences between Islamic and conventional banks in terms of their efficiency, competition and risk features (although small Islamic banks are found to be less risky than their conventional counterparts). There is some evidence that Islamic finance aids inclusion and financial sector development. Results from the empirical finance literature, dominated by studies that focus on the risk/return features of mutual funds, finds that Islamic funds perform as well, if not better, than conventional funds - there is little evidence that they perform worse than standard industry benchmarks. Some recent evidence, however, suggests that Islamic bond (Sukuk) issuance destroys value for shareholders.

163 citations


Cites background from "Risk in Islamic Banking"

  • ...Čihák and Hesse (2010) and Abedifar et al (2013) examine insolvency risk (using the Z-score measure) as well as other risks and typically find that small Islamic banks have lower default risk compared with small conventional banks....

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  • ...i) PLS Versus non-PLS Types of Finance As Abedifar et al (2013) note, Islamic banks often d to deviate from PLS financing principles and operate similarly to convetional banks....

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References
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Journal ArticleDOI
TL;DR: In this paper, the authors developed a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders, and presented a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary.
Abstract: This paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful for resolving incentive problems between borrowers and lenders. It presents a characterization of the costs of providing incentives for delegated monitoring by a financial intermediary. Diversification within an intermediary serves to reduce these costs, even in a risk neutral economy. The paper presents some more general analysis of the effect of diversification on resolving incentive problems. In the environment assumed in the model, debt contracts with costly bankruptcy are shown to be optimal. The analysis has implications for the portfolio structure and capital structure of intermediaries.

7,982 citations


"Risk in Islamic Banking" refers background in this paper

  • ...We include Capital_Asset_Ratio in the credit risk Equation, since on the one hand, an increase in equity can lower moral hazard problems and increase the monitoring incentives of banks (Diamond, 1984)....

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Journal ArticleDOI
TL;DR: In this paper, the authors conduct an empirical assessment of theories concerning risk taking by banks, their ownership structures, and national bank regulations, and show that bank risk taking varies positively with the comparative power of shareholders within the corporate governance structure of each bank.

1,965 citations

Journal ArticleDOI
TL;DR: In this paper, the authors show that government ownership is large and pervasive and higher in countries with low levels of per capita income, backward financial systems, interventionist and inefficient governments, and poor protection of property rights.
Abstract: We assemble data on government ownership of banks around the world. The data show that such ownership is large and pervasive, and higher in countries with low levels of per capita income, backward financial systems, interventionist and inefficient governments, and poor protection of property rights. Higher government ownership of banks in 1970 is associated with slower subsequent financial development and lower growth of per capita income and productivity. This evidence supports “political” theories of the effects of government ownership of firms. THIS PAPER DISCUSSES A NEGLECTED ASPECT of financial systems of many countries: government ownership of banks. It shows that such ownership is pervasive around the world, and has had significant consequences for economic and financial development. There are two broad views of the government’s participation in financial markets. The first, basically optimistic, “development” view is associated with Alexander Gerschenkron ~1962!, who focuses on the necessity of financial development for economic growth. Gerschenkron argues that privately owned commercial banks have been the crucial vehicle of channeling savings into industry in several industrializing countries in the second half of the 19th century, especially Germany. However, in some countries—most conspicuously Russia—economic institutions were not sufficiently developed for private banks to play the crucial development role. “The scarcity of capital in Russia was such that no banking system could conceivably succeed in attracting sufficient funds to finance a large scale industrialization; the standards of honesty in business were so disastrously low, the general distrust of the public so great, that no bank could have hoped to attract even such small capital funds as were available, and no bank could have successfully engaged in long term credit policies in an economy where fraudulent bankruptcy had been almost elevated to the rank of a general business practice” ~Gerschenkron ~1962! ,p . 19 !. In such countries, the government could step in and, through its financial institutions, jump start both financial and eco

1,780 citations

Journal ArticleDOI
TL;DR: In this paper, the authors argue that insufficient attention has so far been paid to the link between monetary policy and the perception and pricing of risk by economic agents - what might be termed the "risk-taking channel" of monetary policy.
Abstract: Few areas of monetary economics have been studied as extensively as the transmission mechanism. The literature on this topic has evolved substantially over the years, following the waxing and waning of conceptual frameworks and the changing characteristics of the financial system. In this paper, taking as a starting point a brief overview of the extant work on the interaction between capital regulation, the business cycle and the transmission mechanism, we offer some broader reflections on the characteristics of the transmission mechanism in light of the evolution of the financial system. We argue that insufficient attention has so far been paid to the link between monetary policy and the perception and pricing of risk by economic agents - what might be termed the "risk-taking channel" of monetary policy. We develop the concept, compare it with current views of the transmission mechanism, explore its mutually reinforcing link with "liquidity" and analyse its interaction with monetary policy reaction functions. We argue that changes in the financial system and prudential regulation may have increased the importance of the risk-taking channel and that prevailing macroeconomic paradigms and associated models are not well suited to capturing it, thereby also reducing their effectiveness as guides to monetary policy.

1,365 citations


"Risk in Islamic Banking" refers background in this paper

  • ...The existing literature shows that the level of domestic interest rates can influence banks’ risk appetite (Dell’ Ariccia and Marquez, 2006; Rajan, 2006; Borio and Zhu, 2008; Delis and Kouretas, 2010; Maddaloni and Peydró, 2011)....

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Journal ArticleDOI
TL;DR: In this paper, a bank with a fragile capital structure, subject to runs, is identified as a potential source of illiquidity in a bank relationship lender, where the relationship lender may demand to liquidate early or require a return premium when she lends directly.
Abstract: Loans are illiquid when a lender needs relationship‐specific skills to collect them. Consequently, if the relationship lender needs funds before the loan matures, she may demand to liquidate early, or require a return premium, when she lends directly. Borrowers also risk losing funding. The costs of illiquidity are avoided if the relationship lender is a bank with a fragile capital structure, subject to runs. Fragility commits banks to creating liquidity, enabling depositors to withdraw when needed, while buffering borrowers from depositors' liquidity needs. Stabilization policies, such as capital requirements, narrow banking, and suspension of convertibility, may reduce liquidity creation.

1,331 citations


"Risk in Islamic Banking" refers background in this paper

  • ...Diamond and Rajan (2000, 2001) also show that the issue of demand deposits encourages banks to monitor their lending activities....

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What are the challenges of sustainability in Islamic banks?

The provided paper does not discuss the challenges of sustainability in Islamic banks.