1. Will Islamic Banking make the World Less Risky
Will Islamic Banking make the World Less Risky? An Empirical Analysis of Capital Structure, Risk Shifting and Financial Stability
Moazzam Farooq
Central Bank of Oman
Sweder van Wijnbergen University of Amsterdam Sajjad Zaheer State Bank of Pakistan
March ,

2. The views expressed here are those of the authors and do not necessarily represent or reflect the views of Central Bank of Oman, or State Bank of Pakistan or its subsidiaries.

3. Risk Seeking Behavior in Limelight since GFC
Motivation
Risk Seeking Behavior in Limelight since GFC
Claims that Islamic Finance is Augers Well for Financial Stability
Same/Similar Capital Requirements & Regulations
Higher Loss Absorption Capacity because of Quasi Equity PLS Accounts
Does it Affect Asset Mix? Risk Shifting Incentives Differ? 17

4. Islamic Banking Gaining Momentum
Motivation
Islamic Banking Gaining Momentum
Impact on Stability of Financial Sector
Islamic banks gaining higher share, more than trebled during last 5 years. These questions are relevant to the policy makers as Islamic Banking is gaining more systemic importance.
Whether the stability of the financial sector will be altered when the Islamic segment of the banking sector becomes even more important. 17

5. What We Do
Use a Classic Merton Credit Risk Framework to Determine if IBIs can be Expected to Take Lower Risks in Comparison to CBIs.
We Test it in Empirically Using a Dataset Covering Conventional Banks (CBIs), Islamic Banks (IBIs), and Islamic & Conventional Branches of Mixed Banks in Pakistan. 17

6. What We Find
Islamic Banking Institutions (IBIs) have Less Incentive to Shift / Take Risks.
Risk Sharing: More Risk Sharing on Liability Side ~ Lower equity price volatility, given asset side volatility, because of
IBIs also have less volatile asset returns, NPLs and lower loan loss provisioning. IBs are better capitalized and more stable than their conventional counterparts. 17

7. DATA Quarterly Data submitted to the SBP.
Both Islamic & Conventional Operations
32 quarters, 06:2002 to 03: conventional banks (CBs), 6 full-fledged Islamic banks (IBs) and 13 mixed banks with both Islamic as well as conventional operations. .
Returns on Islamic Deposits depend negatively on volatility of assets 17

8. Descriptive Statistics17

9. Descriptive Statistics17

10. Estimation
Dependent variable is one of the measures corresponding to asset quality and stability of bank i, branches/operations type j, in quarter t.
ISLj is the dummy for Islamic banking institutions, which includes both IBBs and IBs. The dummy is one when the IBI is Islamic and zero otherwise.
Bijt are banking characteristics as control variables. Specifically, we include log of assets, non-lending operations and fixed assets of the banks to control size and asset structure of banks. 17

11. Estimation
Also, we also split the dummy for IBIs into dummy for Islamic banks (IBs) and Islamic banking branches (IBBs).
And, bank fixed effects 17

12. Results [EQ 2] 17

13. Results [EQ 2] 17

14. Results [EQ 2] 17

15. Results [EQ 2] 17

16. Results – Bank Fixed Effects17

17. Results – Bank Fixed Effects17

18. Less Incentives for More Risk Sharing Contract on Asset Side.
Conclusions
Islamic Banks have not only better asset quality but also are more stable than CBIs.
Islamic Banking Branches of Conventional banks though have higher z-score, do not differ significantly from conventional banking institutions.
IBBs on average, are more profitable, have less volatility in ROAs and have lower NPLs and lower loan loss provisioning than CBIs.
Less Incentives for More Risk Sharing Contract on Asset Side. 17

19. Thank you!