Capital adequacy ratio and Islamic Bank competition-stability relations : evidence from Malaysia

Abstract

This thesis intends to fill in a void in the banking competition and stability nexus literature by (1) investigating the impact of competition on financial stability of dual-banking system, (2) exploring the possible contingent of capitalization on the bank competition and stability association and (3) demonstrating the impact of competition on stability across various types of banks. The consolidation exercises enforced by the Malaysian government after the 1997 /l 998 Asian financial crisis that resulting in concentrated market with fewer number of conventional banks and the growing significance number of Islamic banks after the conversions of "Islamic window" of conventional banks to the Islamic bank subsidiaries have tremendously changed the Malaysia's competitive landscape and its risk implications. This study uses two-step system GMM in estimating Malaysian dual-banking system covering 39 banks ( 15 Islamic and 24 conventional banks) from year 2008 till 2018. The findings reveal a strong significant positive relation between competition and financial fragility. Upon further analysis, the estimates demonstrated that capitalization or capital adequacy ratio is contingent to the association of competition and stability where the capitalization becomes significance after its level is approximately 25%. The finding also indicates that competition affect Islamic banks' stability differently as compared to conventional banks where market power has positive effect on stability for conventional banks and competition increases in Islamic banks but does not bring negative impact to stability. The further results uncover that bank size and diversification activities have insignificant impacts on stability while the cost inefficiency, bank lending behavior and capitalization have significant positive relations with stability. Overall, the main results of this current study support the "competition-fragility'' hypothesis.