Are Islamic Banks More Resilient During Financial Panics?

Abstract

Islamic banking is one of the fastest growing segments of the financial sector in developing countries. Rapid growth of this segment is accompanied with claims about its relative resilience to financial crises as compared to conventional banking. However, little empirical evidence is available to support such claims. Using data from Pakistan, where Islamic and conventional banks co‐exist, we compare the behaviour of Islamic and conventional banks during a financial panic. Our results show that Islamic bank branches are less prone to deposit withdrawals during financial panics, both unconditionally and after controlling for bank characteristics. The Islamic branches of banks that have both Islamic and conventional operations tend to attract (rather than lose) deposits during panics, which suggests a role for religious branding. We also find that Islamic bank branches grant more loans during financial panics and that their lending decisions are less sensitive to changes in deposits. Our findings suggest that greater financial inclusion of faith‐based groups may enhance the stability of the banking system.