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IRTI Working Paper Series WP/2016/10

Are Islamic Banks Any Different in Financial Stability? An Empirical Investigation Dawood Ashraf, Mohamed Ramady, Khalid Albinali

24 Rajab 1437H | May 1, 2016

Islamic Economics and Finance Research Division

IRTI Working Paper 2016-10 Title: Are Islamic Banks Any Different in Financial Stability? An Empirical Investigation Author(s): Dawood Ashraf, Mohamed Ramady, Khalid Albinali

Abstract

This paper investigates the role that ownership structure and diversification of income plays in the financial stability of banks from the GCC region. We find evidence that suggests that higher concentration of ownership in any type of shareholding is associated with higher insolvency risk. However, this higher insolvency risk is not associated with any specific type of shareholders. Higher financial fragility is also associated with the size and whether the bank is an Islamic bank. Banks engaged in substantial fee-based activities are more financially stable as compared with banks that predominantly generate their incomes from traditional intermediation activities. Keywords: Emerging markets, GCC, banks, financial stability, ownership structure, income diversification. JEL Classification: G21, G28, G32

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IRTI Working Paper Series has been created to quickly disseminate the findings of the work in progress and share ideas on the issues related to theoretical and practical development of Islamic economics and finance so as to encourage exchange of thoughts. The presentations of papers in this series may not be fully polished. The papers carry the names of the authors and should be accordingly cited. The views expressed in these papers are those of the authors and do not necessarily reflect the views of the Islamic Research and Training Institute or the Islamic Development Bank or those of the members of its Board of Executive Directors or its member countries.

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Are Islamic Banks Any Different in Financial Stability? An Empirical Investigation

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Introduction

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During the recent global financial crisis (GFC) the fragility of the financial system and elevated

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risk-taking behavior of banks became more pronounced especially for banks located in the more

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financially open and globally integrated economies. At the time when international banks were

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facing a financial turmoil, banks from the GCC1 region exhibited a lower probability of default as

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compared with most of their Western counterpart. The banking sector of the GCC region is roughly

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10% of the US banking sector in terms of asset size2 with comparable income streams from non-

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traditional fee-based activities3. The ownership of banks is most developed countries is widely

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held. However, the ownership structure of banks in the GCC region is concentrated either through

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significant government, institutional, or family-group membership. Aside from a dissimilar

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ownership structure a sizeable proportion of banks in the GCC region are Islamic banks adhering

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to Shari’ah principles for their investment and financing activities. These differences warrant an

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investigation into whether there is any association between the financial stability of banks in the

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GCC region with that of their ownership structure, the type of bank (Islamic or conventional) and

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their respective income diversity. T