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Financial soundness of single versus dual banking system: explaining the role of Islamic banks

Abstract

This paper empirically investigates the financial stability of the countries having both Islamic and conventional banks versus the countries having only conventional banks. It also examines the ability of Islamic banks to provide stability to the overall financial system. The analysis is carried out for a sample of 416 banks drawn from 39 countries over the period 1995–2014. The results provide sound evidence that the dual banking system is more stable than the single banking system. Higher stability is attributed to the presence of Islamic banks in the dual banking system. Furthermore, when only the dual banking system is investigated, the results strongly confirm the greater stability of Islamic banks as compared to their conventional counterparts. Although Islamic banks are mimicking conventional banking practices, their increased interactions with the real economy, investments in real assets, non-aggressive lending profile, and limited exposures to speculative activities make them more resilient and protected.

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Notes

  1. 1.

    Financial stability can be defined as a condition in which the financial system–comprising financial intermediaries, markets, and market infrastructure – is capable of withstanding shocks and the unraveling of financial imbalances, thereby mitigating the likelihood of disruptions in the financial intermediation process which are severe enough to significantly impair the allocation of savings to profitable investment opportunities” (ECB 2007)”.

  2. 2.

    These countries having a market share of more than 15% of total banking assets.

  3. 3.

    Countries with double banking system: (No. of Conventional Banks, No. of Islamic Banks) Egypt (10, 2), Indonesia (37, 1), Palestine (83, 85), Pakistan (19, 2), Turkey (12, 1), Bangladesh (22, 7), Jordan (11, 3), Kuwait (89),Oman (81, 91), Qatar (7, 3), Saudi Arabia (8, 4), United Arab Emirates (17, 7), Bahrain (12, 6), Brunei Darussalam (81), Maldives (81), Gambia (8, 1), Yemen (87, 89), Iraq (12, 7), Syria (13, 2), Mauritania (9, 2).

  4. 4.

    Countries with single banking system (Total numbers of Conventional banks) Portugal (87), Poland (14), Norway (23), Mexico (83), Malta (85), Italy (13), Hungry (81), Finland (83), Greece (7), Hong Kong (8), Austria (7), Belgium (85), Colombia (7), Sweden (87), Spain (8), Zimbabwe (81), Argentina (91), Taiwan (12), Ukraine (11).

  5. 5.

    ID is defined as \( \kern0.5em 1-\left[\frac{Net\ interest\ income- other\ operating\ income}{Total\ operating\ income}\right] \).

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Appendix

Appendix

Governance Measures:

Governance, the industry-specific variable, is the average of following six measures.

  1. 1.

    Voice and accountability

Reflects perceptions of the extent to which a country's citizens are able to participate in selecting their government, as well as freedom of expression, freedom of association, and free media.

  1. 2.

    Political stability

Political stability and absence of violence/terrorism measures perceptions of the likelihood of political instability and/or politically motivated violence, including terrorism.

  1. 3.

    Government effectiveness

Reflects perceptions of the quality of public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government's commitment to such policies.

  1. 4.

    Regulatory quality

Reflects perceptions of the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development.

  1. 5.

    Rule of law

Reflects perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence.

  1. 6.

    Control of corruption

Reflects perceptions of the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as "capture" of the state by elites and private interests.

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Nosheen, Rashid, A. Financial soundness of single versus dual banking system: explaining the role of Islamic banks. Port Econ J (2020). https://doi.org/10.1007/s10258-019-00171-2

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Keywords

  • Financial stability
  • Islamic banks
  • Conventional banks
  • Dual banking system
  • Differential impact
  • System GMM

JEL classifications

  • G20
  • G21
  • Z12