How Does Regulation Affect Banking Sector Performance, Risk Taking and Stability; Evidence from Dual Banking System
Faruqi, Rimsha Kiran (2016) How Does Regulation Affect Banking Sector Performance, Risk Taking and Stability; Evidence from Dual Banking System. [Dissertation (University of Nottingham only)]
Several countries around the world have been embarking on dual banking system with the rapid progression of Islamic banks as a substitute to established conventional banks. This study examines and compares efficiency, stability and risk taking with regulations and supervision, of 77 Islamic banks 141 conventional banks from 9 countries between 2005 and 2014. Data Envelopment Approach is used for the calculation of profit and cost efficiency scores. Stability of banks used two proxies: score and capitalization ratio. And loan loss provision ratio is used for measuring risk-taking behaviour of banks. In addition to regulatory factors, country-specific and bank-specific variables are also included in the study. Results show that while higher capital requirements improve cost efficiency of conventional banks, they seem to result in cost inefficiency among Islamic banks. Similarly, greater restrictions on activities of conventional banks enhance their performance but Islamic banks become cost inefficient under such regulatory environment. However both type of banks perform better under private monitoring as compared to when controlled by the supervisory agencies. Regarding stability it was found that conventional banks are more stable under official supervision whereas, Islamic bank’s become more stable under private monitoring. Furthermore, while capital requirements and official supervision increase the risk taking activities by the banks private monitoring and higher restrictions on the activities assist in controlling the risk taking in both banking systems. However, size of the bank and profitability ratio effect risk taking of conventional and Islamic banks differently indicating that as loans given by Islamic banks are backed by real assets,Islamic banks tend to have lower reserve for loan loss reserve as compared to the conventional banks.
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