Islamic banks and capital buffer behavior: A view from the Gulf cooperation council markets

Anissa Naouar, Zakaria Boulanouar, Rihab Grassa

Research output: Contribution to journalArticlepeer-review

Abstract

This study explores the determinants of the capital buffer behavior (CB) of Islamic banks (IBs) using a sample of 42 IBs in the Gulf Cooperation Council (GCC) markets during 2009–2018. We also investigate the transmission mechanism, efficacy of the macroprudential policies, relationships between these policies, and financial stability of these banks. Unlike previous research, this study considers certain peculiarities of IBs, including the effects of profit–loss-sharing investment accounts (PSIAs); the impact of capital adjustment costs; external factors such as market power and competition; and institutional influences such as the rule of law and the potential corruption perceptions index. Overall, our results show that CB is countercyclical, which is in line with Basel III requirements. Furthermore, CB is positively affected by bank size, level of profitability, and competition and negatively impacted by nonperforming loans, credit risk, and displaced commercial risk (DCR). The regulatory determinants are important as well, suggesting that strengthening the official macroprudential supervision encourages banks to strengthen their CBs. Conversely, although banks have adequate capital, regulatory tools increase the burden, increasing banks' capital costs and forcing them to limit risk-weighted asset expansion and credit growth. Furthermore, the regulatory pressure, proxied by a discretionary countercyclical buffer, is not binding and does not increase CBs as they are already moving countercyclically, making macroprudential tools redundant for IBs. Other important implications suggest that IBs do not require additional CBs to cover the DCR associated with PSIAs, as PSIAs' provisions, profit equalization reserves, and investment risk reserves already cover this risk. Additionally, the positive relationship between IB size and CB might indicate that the “too big to fail” hypothesis does not apply to large IBs in the GCC.

Original languageEnglish
Article number102257
JournalPacific Basin Finance Journal
Volume83
DOIs
Publication statusPublished - Feb 2024

Keywords

  • Basel III
  • Capital buffer
  • Gulf cooperation council (GCC)
  • Islamic banks
  • Macroprudential policy

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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