Failure Risk in Islamic and Conventional Banks

This study compares the hazard of failure in Islamic and conventional commercial banks using survival models. The sample consists of 421 banks from 20 Middle and Far Eastern countries observed during the 1995 to 2010 period. The conditioning variables are of both bank-level and country-level type. The analysis suggests that Islamic banks have lower failure risk and are less interconnected which reduces the likelihood of domestic co-failure. Di¤erences are revealed in the role played by various bank-level indicators. This has implications regarding the information that should be monitored by regulators to identify fragile banks. For instance, higher leverage increases the failure risk of conventional banks whereas the e¤ect is instead favorable for Islamic banks. At macroeconomic level, a relevant …nding for policymakers is that failure risk is more strongly driven by in‡ation for Islamic banks. JEL Classi…cation: C41; G21; G20. Keywords: Islamic banking; Conventional banking; Bank failure risk; Survival analysis; Accounting indicators. Corresponding author : Cass Business School, 106 Bunhill Row, London EC1Y 8TZ, E-mail: [email protected]. The paper has bene…tted from comments by Mehmet Asutay, Jerry Coakley, Rob Crouchley, Muhammed-Shahid Ebrahim, Ivan Paya, Phil Molyneux and Gerry Steele. We also thank participants at the 2011 Islamic Finance Summer School at Durham University, the 2011 PSUT Conference on Global Financial Crisis: Lessons and Challenges in Jordan, the 2012 BMRC-QASS Conference on Macro and Financial Economics in Brunel University, the 2012 IFABS Conference on Rethinking Banking and Finance: Money, Markets and Models in University of Valencia, Spain, and seminar participants at the University of Bangor, March 2011, Lancaster University Management School, February 2011, Manchester Business School, May 2012, for valuable suggestions. Financial support from Gulf One Investment Bank, Bahrain, is gratefully acknowledged.