Scores Analysis and Discussion
5. Analysis and Discussion
To separate the financial stability impact of the Islamic nature of a bank from the impact of other bank-level characteristics, and from macroeconomic and other system-level impacts, author turn to regression analysis, following the methodology described in Section III. Author runs several specifications. The results for the OLS estimation are shown in Table 4, while Table 5 shows results of a robust estimation technique, which assigns lower weights to observations with large residuals, thereby making the estimation less sensitive to outliers.
The regressions confirm the result from the simple comparison of z-scores that large Islamic banks tend to be less stable than large commercial banks, while small Islamic banks tend to be more stable than small commercial banks. The sign of the Islamic dummy variable is predominantly negative and significant at the 1 percent level in the regressions for large banks both for the OLS regression and for the robust regressions (see specifications (5) to (8) in Tables 4 and 5). For small banks, the sign of the Islamic dummy is consistently positive across all regressions (see specifications (9) to (12) in Tables 4 and 5), and significant at the 5 percent level in all the OLS regressions and one of the robust regressions. Looking at the full sample regressions in Tables 4 and 5, the comparison of Islamic and commercial banks becomes less clear-cut, reflecting the opposite signs of differences for large and small banks.
As to the control variables, they have generally the expected signs. In particular, banks with higher loan to asset ratios tend to have lower z-scores. This slope coefficient is consistently negative with two exceptions across all specifications; it is significant in eleven of the robust estimate specifications and in four OLS specifications. Similarly, higher cost-to-income ratios have a consistently negative link to the z-scores; the sign is consistently significant except for several regressions for small banks.
Z-scores tend to increase with bank size for large banks, but decrease with size for the small banks. Greater income diversity tends to increase z-scores in large Islamic banks, suggesting that a move from lending-based operation to other sources of income might improve stability in those banks.
The governance variable tends to be positive in all regressions in which it is entered, and is strongly positive in some. This is the expected sign, suggesting that better governance is generally correlated with higher z-scores.
In the OLS model specification, a higher presence of Islamic banks in a banking system has a negative impact on z-scores in large commercial banks, but a positive impact on z-scores in commercial banks in general. The above findings become less strong in the robust estimation. Interestingly, a higher presence of Islamic banks in a banking sector tends to weaken the Islamic banks’ own z-scores.
The impact of the Herfindahl index is significantly negative. This is in line with the part of the literature on banking sector concentration and stability that finds higher concentration to be associated with lower stability (e.g., Schaeck, Čihák, and Wolfe, 2006). However, the result becomes less significant in the robustness regressions, so overall the effect of the Herfindahl is less clear.
In terms of the macroeconomic variables, depreciation tends to lead to significantly higher banking risk, which also makes sense since banks' balance sheet positions that are denominated in foreign currency will be eroded with a depreciating domestic currency. Real GDP growth and inflation do not appear to have significant separate effects on stability in our sample. In addition to testing different estimation methods, author has conducted several additional checks to test the robustness of our results. In particular, author has estimated the regressions without Iran and Sudan, two countries with fully Islamic banking systems. It had no significant impact on our main results. Author have also run the same estimates using only unconsolidated or only consolidated data, and again found that the results were consistent with, but less strong than those presented in the paper. Finally, author has also tested for the robustness of the lagged effects by restricting the explanatory variables to contemporaneous effects, finding again no substantive change in the main results.
5.1 Winds of Change
The world is becoming weary of the instabilities, inflation and poverty that are a gift of the present economic system. Islamic finance gives an economic system for sustainable development. Slowly and gradually, without realizing it, the world is moving towards discovering the concepts that form the bases of Islamic economics. A case in point is introduction of euro and the five convergence criteria for the European countries, to become a member of the euro-block. European Union, if not disturbed by political factors, will mark the beginning of a new economic era of stability and growth. The five convergence criteria which every member of the European Union is bound to follow are stability oriented. Four of these criteria require member countries to have a low average annual inflation rate, low long term interest rate, low government budget deficit and low government debt. Introduction of the new single currency for the region, Euro, may also remove much economic inefficiency related to exchange rate uncertainties between economies of the region, giving rise to increased investment and production. Low interest rate will cause the inflation to be low. Reducing budget deficits and making budgets in which expenses would be met by largely by revenues, will lead to low government debt, which would result in low inflation. These convergence criteria are themselves a shift towards Islamic economic concepts, although a very slight and in deliberate shift.
