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Does a one-size-fits-all approach to financial regulations alleviate default risk? The case of dual banking systems

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Abstract

Financial regulations are developed to curb financial and economic fragility costs without undermining the economic contributions of banks to economic development. To understand the impact financial regulations have on reducing the financial fragility of banks we use the probability-of-default of banks as a proxy for bank failure. After analyzing data collected from 15 countries with a dual banking system for the period 2000–2015, we find convincing evidence that not all financial regulations have risk-reducing benefits for banks and the impact of financial regulations on default risk is not the same for conventional banks (CBs) and Islamic banks (IBs). The empirical evidence suggests that regulations that lessen overall default risk have a greater impact on IBs while those increasing default risk have a greater impact on CBs. Based on our findings we recommend that regulators should consider the different natures of CBs and IBs and tailor financial regulations to suit these operationally distinct financial intermediaries.

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Notes

  1. A dual banking system allow both conventional banks (CBs) and Islamic banks (IBs) to operate in conjunction with each other.

  2. See for example Laeven and Levine (2009) and Delis and Staikouras (2011).

  3. See Ronn and Verma (1986).

  4. In its simplest form equity and debt holders have contingent claims on the assets of a firm.

  5. This module has been accessed from copulafit from Mathworks: https://www.mathworks.com/help/stats/copulafit.html.

  6. The extreme example is the trading of credit derivatives without knowing the risk of underlying assets.

  7. Refer table 1 on page 23 of Ramalho et al. (2011) for specifications of these distributional functions.

  8. Data is publicly available and has free access. It can be accessed from data section at: http://www.globalbanking.org.

  9. Data is publicly available and has free access. It can be accessed from data section at: http://www.globalbanking.org.

  10. These surveys are available online in the data section of http://econ.worldbank.org. We also cross checked the data from the Global Banking database with the original surveys.

  11. The endogenous nature of systemic risk and financial regulations is out of the scope of our paper and we refer readers to Prasch and Warin (2016), Korinek (2011), Alexander et al. (2005), and Kaufman and Scott (2003).

  12. For detailed discussion on these functional forms please see Ramalho et al. 2011, 2014.

  13. For interested readers, the results of other models are available from the corresponding author.

  14. Table 6 reports the estimation results of all variables used in Table 5 and interactive slope variables except for the macroeconomic control variables to conserve space. However, the results of other models are available on demand from the corresponding author.

  15. We used macroeconomic controls but these are not reported for the sake of brevity.

  16. See for example, Ashraf et al. (2016) and Laeven and Levine (2007).

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Acknowledgements

We would like to thank the Editor of the Journal of Regulatory Economics, and the anonymous referee for their helpful comments and suggestions that enabled us to improve the quality of this paper considerably. The authors acknowledge and are grateful for financial support and encouragement from the Islamic Research and Training Institute, Jeddah, Saudi Arabia and the Deanship of Graduate Studies and Research at Prince Mohammad Bin Fahd University, Saudi Arabia. The views expressed in this paper are those of the authors and do not necessarily reflect the views of the Islamic Research and Training Institute or the Islamic Development Bank Group. All errors are the responsibility of the authors.

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Authors and Affiliations

  1. NUST Business School (NBS), National University of Sciences and Technology (NUST), Islamabad, Pakistan

    Muhammad Suhail Rizwan

  2. Electrical and Computer Engineering Department, King Abdulaziz University, Jeddah, Kingdom of Saudi Arabia

    Muhammad Moinuddin

  3. College of Business Administration, Prince Mohammad Bin Fahd University, Al Khobar, 31952, Kingdom of Saudi Arabia

    Barbara L’Huillier

  4. Islamic Research and Training Institute (A member of Islamic Development Bank Group), Jeddah, Saudi Arabia

    Dawood Ashraf

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  1. Muhammad Suhail Rizwan
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Correspondence to Dawood Ashraf.

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The views expressed in this paper are those of the authors and do not necessarily reflect the views of the Islamic Research and Training Institute or the Islamic Development Bank Group.

Appendix A

Appendix A

See Table 8.

Table 8 Explanation of regulatory variables used in the paper
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Rizwan, M.S., Moinuddin, M., L’Huillier, B. et al. Does a one-size-fits-all approach to financial regulations alleviate default risk? The case of dual banking systems. J Regul Econ 53, 37–74 (2018). https://doi.org/10.1007/s11149-017-9340-z

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