Comparative evaluation of credit risk determinants between Islamic and conventional banking
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AbstractThe successful co-existence of the dual banking system in Malaysia poses several claims that the Islamic and conventional banking operations are the same in their approach towards banking risks. This study aims to investigate this issue through fulfilling the research objectives, namely (a) to document the Islamic philosophy of risks that exists in the Quran and Hadith, and establish the differences from the conventional perspectives; (b) to conduct an empirical investigation on the credit-risk level and to determine the influence of fourteen bank specifics and six macroeconomic variables affecting the credit risk of the two banking streams and (c) to establish statistical difference between the credit-risk determinants of the Islamic and conventional banks. The study employs financial data from the annual reports of 15 Islamic banks and 13 conventional banks for the period of 11 years from 2000– 2010. The finding reveals that risk in Islamic banking refers to a wider interpretation covering the concepts gharar. mysir, mukhatarah, al ghunm bil ghurm and al kharajbil daman than the element of uncertainty as in the conventional finance. The credit-risk level was found higher in conventional banking in the early years of the study but gradually decreased to almost the same level for both banking streams in the later part of the study, against a backdrop of better economic performance, improved asset quality and risk management. Three determinants, namely risky sector financing, regulatory capital, and Islamic contract are found to be significant contributors to the credit risk of Islamic banks with the Islamic contract being the largest contributor. For conventional banks, a different set of variables such as loan- loss provision, debt-to-total asset ratio, regulatory capital, size, earning management, and liquidity are significant factors influencing their credit risk. At the macro level, only inflation and money supply aresignificant to credit risk for both the Islamic and conventional banks. However, the result shows that the Islamic banks’ unique investment structure provides a better buffer against risk since they are less affected by the economic factors. Since the factors examined showed different impacts on the credit risk of the Islamic and conventional banks, the findings imply that different risk-management strategies should be applied by each type of bank for better performance. While conventional banks engage in more off-balance sheet items as part of their risk-diversification strategy, Islamic banks should diversify their financing concentration in Bai-Bhithaman Ajil (BBA) and Murabahah contracts to high quality assets- backed-based projects.
Waemustafa, Waeibrorheem (2014) Comparative evaluation of credit risk determinants between Islamic and conventional banking. PhD thesis, Universiti Utara Malaysia.