Bank stability measures for selected OIC countries with dual banking system

Abstract

A robust and comprehensive measure of bank stability is crucial to identify healthy banks and save troubled banks from deteriorating in order to avoid banking crises. Potential crises in the banking sector should be detected early and prevented as they risk having a systemic effect on the overall financial system of the country. The aim of this study, therefore, is to develop a comprehensive measure of bank stability for selected Organization of Islamic Cooperation countries that have dual banking systems, namely, Bahrain, Bangladesh, Egypt, Kuwait, Indonesia, Malaysia, Pakistan, United Arab Emirates, Saudi Arabia, Turkey and Qatar. The measure is in the form of a composite index, comprehensively adopts relevant indicators from the existing literatures from central bank’s stability reports, International Monetary Fund’s (IMF) practice, Islamic Financial Services Board (IFSB) and journal articles. Annual data from 1999 to 2015 are obtained from the Bankscope database, and the World Bank Indicators’ country macroeconomic database. The study then, extends to compare the bank stability index of Islamic and conventional banks, including introducing the conventional banks with Islamic subsidiary banks and subsidiary Islamic banks. Next, the differences between these bank models are analyzed to determine the impact of crisis indicators on their stability. The factor analysis method used by the Organization of Economic Co-operation and Development is adopted to develop the index. Nonparametric multiple comparison is then performed to compare the Bank Stability Index for different bank models. The study also employed the dynamic panel data of generalized method of moments (GMM) in analyzing the impact of crisis indicators on the stability of each bank models. The study finds that bank stability index is the comprehensive measure of bank stability for all bank models for selected countries in the dual banking system. The study also reveals that the Islamic banks are relatively less stable than the conventional banks, in general. However, there are mixed results given different crisis periods and for different bank models. The impact of crisis indicators on bank stability also produced mixed results. The findings from the study have the implication for the regulatory to use similar measure of bank stability to monitor and report the stability of different bank models. The policymakers need to ensure strong macroeconomics fundamental to mitigate the impact of crisis on the stability of the banks.