Does Capitalization Enhance Efficient Risk Undertaking? A Comparison between Islamic and Conventional Banks

30 Pages Posted: 30 Jul 2012

See all articles by Lucia Dalla Pellegrina

Lucia Dalla Pellegrina

Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS)

Date Written: July 1, 2012

Abstract

This paper investigates the relative impact of capitalization on risk-taking efficiency in Islamic and conventional banks. In particular, we test whether changes occurring to the capital structure of different types of banks unevenly affect their behavior in terms of risk-taking efficiency. Results, obtained both by regressions and a stochastic cost frontier analysis in the period 2000-2011 show that higher capitalized Islamic banks are associated to less risky policies in terms of their assets structure. In particular, they exhibit higher liquidity standards compared to other – less capitalized – Islamic banks. This corresponds to lower non-performing loans, leading to weak delayed positive effects on profitability and no substantial impact on efficiency. On the other hand, more capitalized conventional banks tend to shift from more traditional lending activities to investment in other assets, including off balance sheet items. Such policy provides higher profitability and profit efficiency although raising impaired loans. The analysis has important implications when considering capital adequacy as a regulatory tool for managing the risk of Islamic banks’ activity.

Keywords: Islamic banks, capital structure, capital adequacy, stochastic efficiency frontier

Suggested Citation

Dalla Pellegrina, Lucia, Does Capitalization Enhance Efficient Risk Undertaking? A Comparison between Islamic and Conventional Banks (July 1, 2012). Paolo Baffi Centre Research Paper No. 2012-121. Available at SSRN: https://ssrn.com/abstract=2119815 or http://dx.doi.org/10.2139/ssrn.2119815

Lucia Dalla Pellegrina (Contact Author)

Università degli Studi di Milano-Bicocca - Department of Economics, Management and Statistics (DEMS) ( email )

Piazza dell'Ateneo Nuovo, 1
Milan, 20126
Italy

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