A Structural Model of ‘Alpha’ for the Capital Adequacy Ratios of Islamic Banks

35 Pages Posted: 8 Aug 2022

See all articles by Kenneth Baldwin

Kenneth Baldwin

Nottingham Trent University

Maryam Alhalboni

University of York - The York Management School

Mohamad Husam Helmi

Durham University Business School

Date Written: July 28, 2022

Abstract

The denominator of the capital adequacy ratio (CAR) for Islamic banks includes an adjustment factor, alpha, arising from the subsidisation of investment account holders’ returns using bank equity. The methodology established by the risk management standard-setting body for Islamic banks, the IFSB, estimates an alpha for each country using panel-data and normally distributed asset returns for its credit institutions. Consequently, the IFSB methodology precludes bank-specific alphas linked to the actual risk profile of underlying assets. There is also no discernible mapping between alpha and a bank’s own propensity to subsidise cash returns. This paper instead develops a new theoretical model for bank-specific alpha that is estimated for 43 Islamic banks in 11 countries. Our alpha values broadly correspond with those of the IFSB. However, a form of regulatory arbitrage is shown to exist which favors banks with relatively high alphas. This finding also has policy implications for bank efficiency and systemic risk.

Keywords: Islamic banking Capital adequacy ratio, Regulation, Displaced commercial risk, Alpha, Islamic financial services board

JEL Classification: G21, G28

Suggested Citation

Baldwin, Kenneth and Alhalboni, Maryam and Helmi, Mohamad Husam, A Structural Model of ‘Alpha’ for the Capital Adequacy Ratios of Islamic Banks (July 28, 2022). Journal of International Financial Markets, Institutions and Money, Vol. 60, 2019, Available at SSRN: https://ssrn.com/abstract=4175418

Kenneth Baldwin

Nottingham Trent University ( email )

Nottingham, NG1 4QF
United Kingdom

Maryam Alhalboni (Contact Author)

University of York - The York Management School ( email )

Sally Baldwin Buildings
Heslington
York, North Yorkshire YO10 5DD
United Kingdom

Mohamad Husam Helmi

Durham University Business School ( email )

Mill Hill Lane
Durham, DH1 3LB
United Kingdom

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