Loan and financing diversification and bank stability in dual-banking systems

Our investigation of 46 conventional and 22 Islamic banks from the Gulf Cooperation Council (GCC) countries during 2008–2021 reveals that sectoral diversification effects on stability are nonlinear and different for the two bank types. While Islamic banks' stability is worsened only by moderate levels of diversification, conventional banks' stability is enhanced by high levels and impaired by low levels of diversification. Furthermore, diversification acted as a stabilizer during the global financial crisis but exacerbated the adverse effects of the Covid-19 pandemic. Although regulators usually call for bank diversification, our results imply that it can be a double-edged sword. © 2022

Digital payment and banking stability in emerging economy with dual banking system.

Previous studies provided limited conclusions on the relationship between digital payment and financial stability, particularly in an emerging economy with a dual banking system in which Islamic banking operates in parallel with its conventional counterpart, such as Indonesia. Therefore, this study aims to examine the impact of digitalisation on financial stability, particularly banking stability, in Indonesia. It uses Vector Error Correction Model (VECM) and Vector Autoregressive (VAR) models to investigate the relationship using monthly data during December 2013-July 2021 period. The digital payment transaction is proxied by payment penetration ratio (PPR); meanwhile financial stability is proxied by the value of Z-Score for the Indonesian banking industry. It also conducts a robustness check using Autoregressive Distributed Lag (ARDL) model. The study found a cointegrating relationship between PPR and Z-Score, suggesting that digital payment transactions have an equilibrium and long-run relationship with banking stability in Indonesia. Further examination shows a one-direction causality from digital payment to banking stability and a positive short-run relationship between the variables. Interestingly, despite being the largest Muslim country globally, the estimation result shows no significant causality between digital payment and Islamic banking stability in Indonesia. While this might be due to the small size of Islamic banking in the country, it is expected that the impact will be more significant as Islamic digital banking starts to emerge and gain strong support from society and government in the post-covid period. Overall, our findings support policies promoting a more supportive regulatory ecosystem for a resilient banking and financial system in an emerging economy with a dual banking system.

Loan and financing diversification and bank stability in dual-banking systems

Our investigation of 46 conventional and 22 Islamic banks from the Gulf Cooperation Council (GCC) countries during 2008-2021 reveals that sectoral diversification effects on stability are nonlinear and different for the two bank types. While Islamic banks’ stability is worsened only by moderate levels of diversification, conventional banks’ stability is enhanced by high levels and impaired by low levels of diversification. Furthermore, diversification acted as a stabilizer during the global financial crisis but exacerbated the adverse effects of the Covid-19 pandemic. Although regulators usually call for bank diversification, our results imply that it can be a double-edged sword.

Is excess of everything bad? Ramifications of excess liquidity on bank stability: Evidence from the dual banking system

After the 2008 financial crisis, the primary focus of global banking regulators has been to make banks more liquid by maintaining excess liquidity buffers. This paper investigates a paradox where high liquidity reduces bank stability instead of improving it by examining the relationship between excess liquidity and stability between Islamic and conventional banks. This paper uses data on 42 Islamic and 106 conventional banks from 6 emerging countries between 2009 and 2018, providing empirical evidence that excess banking liquidity impedes bank stability. The results show that conventional banks are more vulnerable to the adversities of excess liquidity, while Islamic banks exhibit more resilience. This study raises ‘red flags’ for policymakers and regulators advocating high liquidity as a source of financial stability. It suggests that regulators should be cautious when using the so-called ‘liquidity bazooka’ to guard banks against any economic downturn, such as during the COVID-19 era.

Systemic risk, Islamic banks, and the COVID-19 pandemic: An empirical investigation

While operating side-by-side with conventional banks, in a dual-banking system, the systemic risk profile of Islamic banks can be different due to their unique business model. The objective of this study is to understand the evolution of systemic risk in dual-banking systems and determine whether there are any differences in the systemic risk profiles of conventional and Islamic banks during the COVID-19 pandemic. This study also identifies the determinants of systemic importance (measured using spillover indices) of financial institutions. The sample includes ten countries where the Islamic banking sector is considered systemically important and covers the period from November 2015 to November 2020. The empirical results indicate a significant increase in systemic risk, in the sample countries, during the first half which is followed by a recovery in the second half of 2020. Comparative analysis shows that Islamic banks have similar systemic vulnerabilities to systematic and idiosyncratic factors during the exogenously induced real economic shock of the COVID-19. However, Islamic banks pose significantly less spillover to others relative to conventional banks while earning abnormal returns. The results are robust to the inclusion of macroeconomic factors and alternate estimation methodologies. The findings of this study provide valuable insights for the regulators of dual-banking systems.