Accepted Manuscript

Bank lending, deposits and risk-taking in times of crisis: A panel

analysis of islamic and conventional banks

Mansor H. Ibrahim, Syed Aun R. Rizvi

PII: S1566-0141(17)30241-8
DOI: https://doi.org/10.1016/j.ememar.2017.12.003
Reference: EMEMAR 540
To appear in:
Received date: 23 June 2017
Revised date: 12 October 2017
Accepted date: 16 December 2017

Please cite this article as: Mansor H. Ibrahim, Syed Aun R. Rizvi , Bank lending, deposits
and risk-taking in times of crisis: A panel analysis of islamic and conventional banks.
The address for the corresponding author was captured as affiliation for all authors. Please
check if appropriate. Ememar(2017), https://doi.org/10.1016/j.ememar.2017.12.003

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 ACCEPTED MANUSCRIPT

BANK LENDING, DEPOSITS AND RISK-TAKING IN TIMES OF CRISIS: A PANEL

ANALYSIS OF ISLAMIC AND CONVENTIONAL BANKS

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BANK LENDING, DEPOSITS AND RISK-TAKING IN TIMES OF CRISIS: A PANEL

ANALYSIS OF ISLAMIC AND CONVENTIONAL BANKS

ABSTRACT

In this study, we conduct a panel analysis of Islamic and conventional banks to ascertain
whether Islamic banks are able to sustain financing supply and whether its growth is higher
than conventional bank lending growth in times of stress. For concreteness, we also assess
whether the sustained financing supply of Islamic banks is justified by a concomitant increase
in Islamic deposit growth and is not linked to excessive risk taking. Utilizing a panel sample

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of 25 Islamic banks and 114 conventional banks from 10 dual-banking countries, we observe
sustained financing supply by Islamic banks but significant reduction in the lending growth by
conventional banks during the crisis period. The results further suggest that the financing

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growth of Islamic banks is higher than the lending growth of conventional banks during the
crisis period. However, we find no clear evidence that the deposit growth of Islamic banks

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behaves differently during the period. Finally, there is no indication to suggest that Islamic
banks exhibit excessive risk taking in times of stress. Our results contribute to the evidence
supporting the contributive role of the Islamic banking system to financial and economic
stability.
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Keywords: Dual-Banking System, Credit Growth, Deposit Growth, Credit Risk, Crisis
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JEL Classification: G21, G01, C33

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1. INTRODUCTION
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Credit provision is essential in ensuring sustained real production and in stimulating

economic activities. Thus, it is not surprising that, facing crises, policymakers resort to various
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mechanisms so that banks are able to maintain their credit supply. These include
nationalization of distressed banks, deposit guarantees, fund injections and revision of capital
requirements (Chen et al., 2016). In parallel, scholarly studies have searched for factors that
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allow banks to perform and function reasonably well in times of stress to inform policymakers
what might be appropriate policy actions to stabilize bank credit. They have brought into their
focus various bank-specific characteristics, notable among which are bank ownership (Brei and
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Schclarek, 2013; Cull and Martinez-Peria, 2013; Chen et al., 2016), bank types or business
orientation (Chiaramonte et al., 2015; Merilainen, 2016) and bank capital (Kosak et al., 2015;
Altunbas et al., 2016).

In search for solutions to the problem of bank-originated financial instability, some studies
have turned their attention to the Islamic banking business model. Drawn by its rapid
development even during the recent global financial crisis, they make comparative assessments
of Islamic banks and conventional banks using a variety of bank performance metrics. As
regards Islamic bank financing, few studies are available (Hasan and Dridi, 2011; Beck et al.,
2013; and Ibrahim 2016). In general, they paint a bright picture of Islamic banks for their
stable or even increasing supply of credit during crisis episodes. Still, despite the alleged
resiliency of Islamic banks, whether the Islamic banking sector is relatively more stable than
its conventional counterparts remains contentious (Mejia et al., 2014; Kabir and Worthington,
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2017). Accordingly, it is still an open empirical question whether Islamic banking can be a
stabilizing force in times of stress.

This paper builds upon these studies by providing further empirical assessments of Islamic
and conventional banks in times of crisis. In this paper, we contend that a look at
lending/financing per se would not lead to a reliable conclusion about the ability of a bank to
be a stabilizing force in times of crisis. Expansion of credit, especially during crisis episodes,
necessarily requires funding and entails additional risks. Further, with intensified asymmetric
information problem, credit expansion during the crisis period may signify excessive risk
taking. Thus, we would be more confident of a bank’s ability to be a stabilizing force if (i) it
has the ability to expand credit in times of crisis and (ii) its credit expansion does not lead to

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excessive risk in the future. The present study considers these aspects in the analysis to arrive
at a more concrete answer to the potential role of Islamic banks in the economy.

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Our contribution to the literature is threefold. First, we add to the strand of research on
bank behaviour in times of stress by bringing into the fore the potential role of the Islamic

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banking sector. Second, we contribute to the on-going debate on the relative stability of Islamic
banks vis-à-vis conventional banks. In the literature, there are two competing views – the
stability view and the skeptic view (Ibrahim, 2016). The stability view posits that the Islamic
banking sector is amiable to banking stability, which is rooted in their distinct features of being
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Shariah-compliant (Farooq and Zaheer, 2015)1. By contrast, emphasizing no distinct
differences between Islamic banks and conventional banks in practice, the “skeptic” view
doubts the Islamic banks would make a difference (Chong and Liu, 2009; Khan, 2010). We
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bring into the picture the financing decisions by banks to ascertain whether Islamic banks are
able to stabilize credit during crisis episodes.

And third, from the analytical perspective, we provide a more comprehensive evaluation of
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bank financing by synthesizing various aspects of banking studies to bring about concrete
inferences as to whether the Islamic banking system contributes favourably to stability. We
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take lead from the recent contribution by Chen et al. (2016) that not only looks at loan growth
during the global financial crisis but also assesses how loan increases during the crisis affect
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bank performance and aggregate activities. We broaden our analysis to include deposit growth
and credit risk. The former is to assess, if Islamic banks did have higher credit growth, whether
higher credit growth was accompanied by higher deposit growth as an indicator of their ability
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to expand credit. Meanwhile, the latter is to verify whether credit expansion was accompanied
by higher future risk and whether it can be construed as excessive risk taking by Islamic banks.
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The rest of this paper is structured as follows. Section 2 provides background information
and develops empirical hypotheses. Section 3 details model specifications. Section 4 presents
the data and discusses estimation results. Finally, section 5 contains a summary of the main
findings and concluding remarks.

2. BACKGROUND AND HYPOTHESES DEVELOPMENT

To place the present study in its context, we first provide background information of the
Islamic banking. The emphasis is on the (theoretical) differences of the Islamic banks from
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According to Farooq and Zaheer (2015), the distinct features of the Islamic banking include prohibition of
interest rate, speculative activities and of excessive uncertainty and Islamic banking transactions being linked
fundamentally to the real sector.
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their conventional counterparts and the theory-practice divide in Islamic banking and resulting
arguments whether the Islamic banking system contributes to stability. Then, on the bases of
various contentious views and of existing literature, we develop hypotheses to be tested.

2.1 Islamic Banking

The Islamic banking industry has evolved to be a material part of the global financial
industry. While figures differ according to sources, the growth of Islamic banking assets has
outpaced that of conventional banking assets even during the global financial crisis. Indeed,
as noted by Hasan and Dridi (2011), the asset growth of Islamic banks was more than double
that of conventional banks during 2007-2009, i.e. the global financial crisis period. Starting in

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only few Muslim-majority countries in the 1960s and 1970s, the Islamic banking presently
operates in more than 75 countries. Such multinational conventional banks as Chase
Manhattan, Citibank, and HSBC have also participated in the provisions of the Islamic banking

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services by establishing Islamic banking windows or Islamic bank subsidiaries.

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Islamic banking differentiates itself from the existing conventional banking through its
adherence to the Islamic laws (Shari’ah). A key feature of the Islamic banking operations is
the prohibition of interest rate (riba). According to Islam, charging interest rate is a form of
injustice since it allows financiers to gain benefits simply by transferring their money to others
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without being involved in real activities. In other words, it is unlawful for money to beget
money without real sector contributions (Ariff, 2014). In addition, Islamic banks must not be
involved in transactions characterized by extreme uncertainties (gharar) and gambling
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(maysir). Thus, they must not expose themselves to such toxic assets as collateralized debt
obligation (CDO) and mortgage-back security (MBS) and derivative products (Mollah et al.,
2017). Moreover, the parties to Islamic financial transactions must honour the sanctity of
contracts to their best ability such that asymmetric information and morally hazardous
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behaviour are contained. Needless to state, the Islamic banks must confine their activities to
those allowable by Islam. Accordingly, financing related to the production and sales of
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alcoholic beverages, gambling and prostitution is prohibited.

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As a manifestation of their conformance to the Shari’ah, Islamic banks arrange their

financial transactions at both ends of the balance sheet on the basis of profit-and-loss sharing
and real-sector linkages. The profit-and-loss sharing arrangement either through mudarabah
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or musharakah contract identifies depositors on the liability side and banks on the asset side as
investors. Under these contracts, they share ex post in the outcomes of business transactions
on the basis of a pre-agreed ratio. Thus, Islamic banking departs completely from its interest-
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based conventional counterpart where, in conventional banking, financiers are lenders deriving
rewards from taking purely financial risks and not real-sector risks. Islamic banks also offer
financing on the basis of sales or leasing contracts, known respectively as Murabahah and
Ijarah. Under these contracts, the banks specify instalment payments over a specified period
of the goods they sell or lease to clients after taking into consideration the costs and mark-up
profits. Thus, in Islamic banking, interest rate is completely absent and real-sector linkages
are foundational.

These features of Islamic banking serve as theoretical arguments for its relative stability as
compared to the conventional banking system. At the bank level, Khan (1987) demonstrates
theoretically the relative soundness of an Islamic bank as compared to a conventional bank.
According to Khan (1987), the real sector linkages of the Islamic bank immediately align its
assets and liabilities across business cycle phases. By contrast, the separation of assets and
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liabilities under the conventional banking system makes it harder for the conventional bank to
recover its balance sheet during adverse shocks. Accordingly, the Islamic bank would be
relatively more stable. The absence of speculative and toxic financial products further firms
up the resiliency of the Islamic banking system during financial shocks, as manifested during
the recent global financial crisis. Ariff (2014) further mentions inter-connectivity between the
real sector and financial sector, with the latter provides a supporting role for real activities, to
be central to economic stability and growth. In other words, the real-sector linkages of the
Islamic banking system fosters economic stability.

While few would argue against the relative stability of the (theoretical) Islamic banking
system, some raise doubts whether the Islamic banking is in practice markedly different from

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the conventional banking on three grounds. These are (i) concentration on Murabahah
financing; (ii) pricing of Islamic banking products; and (iii) lack of truly distinct Shari’ah-
based products.

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While portrayed to be a distinct feature of the Islamic banking business model, Mudarabah

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and Musharakah financings make up only a small percentage of Islamic banking assets.
Islamic financing comprises predominantly Murabahah or sale-based financing, which is
estimated to be more than 80% since the early years of Islamic banking operations in the 1970s
(Al-Harran, 1995; Chong and Liu, 2009; and Khan, 2010). Moreover, the pricing of especially
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Murabahah-based products is also an issue since Islamic banks resort to the interest rate
benchmark. Finally, some view Islamic products merely as imitation of prevailing
conventional products but adapted and modified to be Shari’ah compliant. As examples, as
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noted by Ariff (2014), murabahah financing, bai’ bithaman ajil (BBA), al-ijarah thumma al-
bai’ (AITAB) and tawarruq munazzam offered by Islamic banks are mirror images of
respectively conventional fixed-rate home loans, conventional floating-rate home loans, hire-
purchase, and conventional personal loans. According to Ariff (2015), to be truly distinct, the
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Islamic banks must leap away from Shari’ah-compliant mode to Shari’ah-based mode in the
development of Islamic products.
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The theory and practice divide in Islamic banking is at the centre of the debate whether the
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adoption of the Islamic banking system can help stabilizing the prevailing fragile system.
Based on the Islamic banking practices, the skeptic view sees no differences in Islamic banks.
However, counter-arguments to the skeptic view are also available. The criticisms of the
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Islamic banking practices notwithstanding, the Islamic banking financial products possess real
sector linkages and hence the real – financial decoupling is unlikely. In addition, Islamic
banking differentiates itself not only on the basis of the prohibition of interest rates but also on
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the importance of the sanctity of contracts. The presence of Shari’ah board in addition to the
standard board of governance plays a crucial role in ensuring conformity to the principles of
the Shari’ah and hence curtailing Islamic banks’ excessive risk taking.

The debate on whether Islamic banking is distinguishable from conventional banking and
whether it is relatively more stable especially during the crisis episodes has spilled into an
empirical front, with available evidence ranging from no significant difference to some key
differences between them. Employing a non-parametric test, Bourkhis and Nabi (2013) find
no differences in bank capital, profitability, asset quality, costs and lending activities of Islamic
and conventional banks. Beck et al. (2013) and Alqahtani et al. (2016) find some differences
between Islamic and conventional banks, particularly in terms of intermediation ratio and cost
inefficiency. The recent study by Jawadi et al. (2016) also documents a few significant
differences between the two types of banks in terms of financial risk. Evaluating convergence
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in performance of Islamic and conventional banks, Olson and Zoubi (2017) document evidence
indicating convergence of their profitability. Still, as they demonstrate, the convergence does
not apply to other financial ratios, namely net income margins and risk characteristics. Thus,
Islamic banks are different. In light of these findings, it seems that the issues remain open to
further empirical investigation.

2.2 Hypotheses Development

In the aftermath of the recent global financial crisis, many studies have emerged to identify
bank characteristics that would limit the tendency of the banking system to amplify financial
shocks in a pro-cyclical manner. One interesting aspect that has been highlighted in the

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literature is the importance of banks’ objectives and principles in constraining bank lending
behaviour. Some have argued and forwarded evidence that government-owned banks and
cooperative banks are more likely willing and able to maintain their lending when facing

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shocks. Unlike commercial banks, these banks are not strictly profit-oriented. According to
Chen et al. (2016), government-owned banks have social-welfare agendas and their liabilities

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are implicitly guaranteed. Accordingly, they would be more willing to continuously extend
loans during crises even if they may not be profitable and would be able to do so since they
have liquidity strength. Being stakeholders’ banks, cooperative banks are oriented towards
long term relationships with their members or clients and, consequently, are likely to behave
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in a less cyclical manner (Merilainen, 2016).

Islamic banks are essentially commercial banks. However, while they are profit-oriented,
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they may behave differently from the conventional commercial banks when facing adverse
shocks. The Shari’ah principles that these banks adhere to means that the social-welfare
agendas would assume priority during crunch times. The capital and asset strength of the
Islamic banks, as a result of the above-mentioned Shari’ah principles, may enable them to
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extend financing even during crisis periods. Religion and profit-loss sharing arrangements are
other potential reasons that Islamic banks would be less pro-cyclical (Mollah et al., 2017).
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Given the alignment between bank assets and liabilities as demonstrated by Khan (1987) and
religious convictions of Islamic bank depositors (Farooq and Zaheer, 2015), Islamic banks are
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less immune to deposit withdrawals and hence are in a better position to maintain financing
supply in the wake of adverse shocks.
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Several studies find support for higher financing or intermediation of Islamic banks during
the global financial crisis and economic downturns. Assessing the effects of the recent global
financial crisis on Islamic and conventional banks using a sample of 120 conventional and
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Islamic banks from 8 countries, Hasan and Dridi (2011) find the credit growth of Islamic banks
to be higher. Beck et al. (2013) document higher intermediation ratio of Islamic banks as
compared to that of conventional banks and the difference is even more significant during local
crises. Alqahtani et al. (2016) further reaffirm that Islamic banks intermediate more. Finally,
according to Ibrahim (2016) in his analysis of Malaysia’s dual banking system, Islamic
financing is less pro-cyclical or even counter-cyclical as compared to conventional lending.
Despite these favourable findings, it remains uncertain whether Islamic banks can maintain
their credit supply in times of stress given the noted arguments that the Islamic banking is not
practically different from conventional banking, which is empirically supported by Bourkhis
and Nabi (2013). Due to their distinct features, Islamic banks face unique risks, e.g. Shariah
compliant risk, equity investment risk, rate of return risk, and displaced commercial risk, and
hence may be exposed to higher risk as compared to conventional banks (Mejia et al., 2014).
Kabir et al. (2015) offer empirical evidence suggesting that Islamic banks have higher non-
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performing loans while Alandejani et al. (2017) indicate that Islamic banks have a higher
incidence rate of failure. These risks, coupled with the underdeveloped Islamic money
markets, may affect their function as financial intermediaries during the crisis period. In views
of these, we test the following hypotheses related to the financing growth of Islamic banks:

H01: There is no significant reduction in the financing growth of Islamic banks during the crisis
period.

H02: There is no difference in the lending/financing growth of Islamic banks and conventional
banks during the crisis period.

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Based on the above hypotheses, a strong case for the ability of Islamic banks to stabilize credit
can be made if they can sustain financing supply in times of stress, i.e. non-rejection of H01,
and the financing growth of Islamic banks is higher than the lending growth of conventional

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banks during the period, i.e. rejection of H02.

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The ability of Islamic banks to maintain financing supply during the crisis period depends
crucially on the stability of their deposits. However, whether Islamic bank deposits are resilient
to the crisis has not been much investigated. On one hand, the presence of displaced
commercial risk, which is unique to the Islamic banking sector, means that deposit withdrawals
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would be highly likely in the face of adverse shocks (Khan and Ahmed, 2001; Mejia et al.,
2014). On the other hand, the “religious branding” and “asset-liability” alignments of Islamic
banks would mean that Islamic deposits would be less sensitive to shocks (Khan, 1987; Farooq
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and Zaheer, 2015).

In perhaps the only study on the resiliency of Islamic deposits during a financial panic.
Farooq and Zaheer (2015) document evidence supporting fewer deposit withdrawals from
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Islamic banks as compared to conventional banks. Indeed, some Islamic banks even attracted
more deposits during the period. The findings, however, relate only to the case of Pakistan
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and, as a result, there is a need to look at the subject from a wider perspective. The present
study draws a sample from 10 major dual-banking countries to evaluate deposit growth of
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Islamic and conventional banks as stated in the following hypotheses.

H03: There is no significant reduction in the deposit growth of Islamic banks during the crisis
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period.

H04: There is no difference in the deposit growth of Islamic banks and conventional banks
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during the crisis period.

A non-rejection of H03 and rejection of H04 and findings that the deposit growth of Islamic
banks is higher would further strengthen the ability of Islamic banks to stabilize credit.
However, if the deposit growth of Islamic banks is more severely affected by the crisis, then
there would be a concern that the Islamic banks overstretch its credit expansion, a behaviour
that may likely breed future risk.

From the lens of finance – growth nexus, credit expansion is applauded as a driver for
economic growth. Moreover, continuous expansion of credit during crisis or recessionary
periods is viewed necessary for speedy economic recovery. However, the recent global
financial crisis serves as a reminder that overexpansion of credit can be disastrous. The rapid
growth of bank credit is likely to worsen moral hazard and adverse selection problems and,
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consequently, increases the probability of a banking crisis (Schularick and Taylor, 2012).
According to Corsetti et al. (1999) and Goldstein (1998), credit growth in excess of economic
growth characterizes crisis-hit Asian countries during years leading up the Asian financial
crisis in 1997. Following the eruption of the global financial crisis, various studies have
documented a significant link between a banking crisis and rapid credit growth, see Davis et
al., (2016) and references therein. Schularick and Taylor (2012), for instance, estimate the
marginal effect of a 1 percentage point increase in the credit to GDP ratio to be 0.3 percentage
point increase in the probability of the crisis. At the individual bank level, Foos et al. (2010)
indicate the importance of loan growth in driving bank riskiness through higher loan loss
provisions, lower risk-adjusted interest income and lower capital ratios.

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While these studies link the crises to overexpansion of credit during good times prior to
crisis occurrence, Chen et al. (2016) hypothesize potential link between credit growth and bank
performance during the global financial crisis. They focus on whether government banks have

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higher loan growth rates than private banks during the global financial crisis and how the higher
loan growth by government banks is associated with their performance. Using bank-level data

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from 56 countries, they find significantly higher loan growth rates of government banks during
the crisis period. Whether their higher loan growth rates impact positively or negatively on
bank performance, however, depends on the level of corruption of the countries under study.
More precisely, the bright side of government is uncovered only in the countries with low
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corruption level in that government banks are able to stabilize credit to speed up economic
recovery without sacrificing performance. In high corruption countries, it seems that lending
decisions by government banks are distorted, resulting in underperformance relative to private
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banks.

In addition, facing heightened credit risk, banks may take risk by lending in excess of the
optimal level. As suggested by Jensen and Meckling (1976), a managerial rent-seeking and a
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conflict of interest between shareholders and creditors may encourage managers or

shareholders to make risky loans and shift the risk to depositors. This behaviour is highly likely
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when banks are engulfed with immense credit problems (Bernanke and Gertler, 1986;
Koudstaal and Wijnbergen, 2012). In addition, during the crisis episode, the adverse selection
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problem is likely at work, where firms that are highly risky are the ones that actively seek
financing and secure financing from banks. In a recent paper, Zhang et al. (2016) demonstrate
that the lending decisions by banks do exhibit moral hazard in their examination of the Chinese
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commercial banking system.

In the context of a dual banking system, the risk implications of Islamic financing has not
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been closely scrutinized. This is surprising given the rapidly growing Islamic financing, which
has been far exceeding the growth of conventional loans. Moreover, by expanding financing
during a period when asymmetric information is surmountable, Islamic banks may expose
themselves to excessive risk. This means that the higher expansion of financing during the
crisis period by Islamic banks as compared to conventional banks, if it is true, must be assessed.
On the basis of the literature reviewed above, we state the following hypotheses:

H05: There is no effect of financing/lending growth of Islamic and conventional banks on future
bank risk.

H06: There is no significant difference in the effect of financing/lending growth of Islamic and
conventional banks on future bank risk.
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H07: Financing growth of Islamic banks during the crisis period is not related to excessive risk.

We test these hypotheses to offer a more concrete answer to whether the Islamic banking sector
plays a stabilizing role during the crisis period. Hypothesis 5 and hypothesis 6 are to establish
the link between lending/financing growth and bank risk. Meanwhile, Hypothesis 7 is to test
specifically whether Islamic banks behave in a morally hazardous manner in their expansion
of credit during the crisis.

3. MODEL SPECIFICATIONS

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3.1 Lending and Deposit Growth

To evaluate whether Islamic banks are able to sustain loan (deposit) growth and have higher

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loan growth (deposit growth) than conventional banks especially during the global financial
crisis, i.e. Hypothesis 1 to Hypothesis 4, we specify the following model for loan growth

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(deposit growth):

∆𝐿𝑖𝑡 (∆𝐷𝑖𝑡 ) = 𝛽0 + 𝛽1 𝐼𝐵𝑖𝑡 + 𝛽2 𝐺𝐹𝐶𝑡 + 𝛽3 (𝐼𝐵𝑖𝑡 × 𝐺𝐹𝐶𝑡 ) + ∅𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 + 𝜇𝑖 + 𝜀𝑖𝑡 (1)

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where L is the growth rate of gross loans/financing (D is the growth rate of deposit), IB is
the Islamic bank dummy, GFC is the global financial crisis dummy, Control is a vector of
controlled variables comprising bank-specific, macroeconomic and regulation variables, i is
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a bank-specific effect, and it is the standard error term. In line with existing literature, the
bank-specific variables include bank size, capitalization, liquidity, profitability, funding ratio,
cost efficiency and credit risk. These variables are lagged once to address the endogeneity
issue. As for the macroeconomic variables, we include economic growth, inflation and
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financial development. Finally, as for the regulation, we control for activity restrictions, capital
requirement, supervisory power and private monitoring2.
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Since GFC is key in our analysis, its definition requires deliberation. While the span of
recent US recession identified by the National Bureau of Economic Research (NBER) is
December 2007 to June 2009, some view the financial crisis to start much earlier (Iley and
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Lewis, 2013). Indeed, in the literature, the global financial crisis has been referred as the 2007-
2009 financial crisis (Akbar et al., 2017; Flannery et al., 2013) as well as the 2008-2009
financial crisis (Coleman and Feler, 2015; Cull and Martinez-Peria, 2013; and Feldkircher,
2014). According to Berglof et al. (2009), the effects of the crisis that started mid-2007 was
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confined mainly to advanced economies during the first year of the crisis. In a similar vein,
Mishkin (2011) relates the first phase of the crisis from August 2007 to August 2008 to the
losses in one relatively small segment of the US financial market before it turned global. This
means that, for the analysis of countries other than the US and advanced economies, it is more
appropriate to designate 2008-2009 as the crisis years. Accordingly, GFC takes the value of 1
for years 2008-2009 and 0 otherwise, in line with various studies comparing Islamic and

2
We also consider the oil price as a controlled variable given that most of the countries in our sample are oil-rich
economies, as suggested by a referee. Following Alqahtani et al. (2016), we include the natural logarithm of the
annual average oil price in all regressions that we perform. While Alqahtani et a (2016) find strong evidence for
the significant effects of oil price on bank performance, the oil price is significant in less than half of the
regressions that we perform. This is not surprising given that the countries in our sample are not confined only to
oil-rich countries. More importantly, the main conclusions that we make are not materially affected by the
inclusion of oil price. These results are not reported but are available upon request.
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conventional banks (Abedifar et al., 2013; Louchini and Boujelbene, 2016; Olson and Zoubi,
2017)3.

The key parameters of the model are 𝛽1 , 𝛽2 , and 𝛽3. To clarify their interpretation, Table 1
summarizes the specification of (1) conditional on whether the bank is Islamic or conventional
and whether the period is a normal or a crisis period (error terms omitted). It is clear from
Table 1 that 𝛽2 captures the difference of expected lending (deposit) growth by conventional
banks during the crisis period as compared to the normal period, all else equal. If it is negative
and significant, we may conclude that the expected lending (deposit) growth of conventional
banks drops during the crisis period. Meanwhile, 𝛽2 + 𝛽3 provides a corresponding figure for
Islamic banks and hence serves a basis for testing hypothesis 1 and hypothesis 3. The

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comparison between Islamic banks and conventional banks is given by 𝛽1 and 𝛽1 + 𝛽3 ,
respectively for normal time and crisis time. The significance of these coefficients would mean
the financing (deposit) growth of Islamic banks is different from that of conventional banks

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during respectively normal and crisis times, the latter of which pertains to hypothesis 2 and
hypothesis 4.

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Specification (1) considers years surrounding the global financial crisis to be normal years.
One may argue that the post-crisis period is different from the pre-crisis period. The global
economy has witnessed a much volatile oil market during the post global financial crisis. This
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might have affected bank performance and behaviour as the dual-banking countries under study
are mostly oil-rich countries. In addition, the global economy is still wary of the consequences
of the European sovereign crisis that followed the global financial crisis. Accordingly, for
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robustness, we modify (1) by allowing the lending (deposit) growth to be potentially different
during the pre-crisis, crisis, and post-crisis periods as:

∆𝐿𝑖𝑡 (∆𝐷𝑖𝑡 ) = 𝛽0 + 𝛽1 𝐼𝐵𝑖𝑡 + 𝛽2 𝐺𝐹𝐶𝑡 + 𝛽3 (𝐼𝐵𝑖𝑡 × 𝐺𝐹𝐶𝑡 ) + 𝛽4 𝑃𝐹𝐶𝑡 +

D

𝛽5 (𝐼𝐵𝑖𝑡 × 𝑃𝐹𝐶𝑡 ) + ∅𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 + 𝜇𝑖 + 𝜀𝑖𝑡 (2)

E

where PFC is the post financial crisis dummy variable taking the value of 1 after 2009 and 0
PT

otherwise.

In the empirical implementation, we estimate equations (1) and (2) using a combined
sample of conventional and Islamic banks as well as separately for the two types of banks.
CE

Obviously, estimating the equations separately for conventional banks and Islamic banks
means that the Islamic bank dummy and Islamic bank – crisis interaction are dropped from the
equations. In this case, the coefficient of the GFC captures the lending/financing (deposit)
AC

growth during the crisis period as compared to its growth during normal time or pre-crisis
period for the respective types of banks. If it is negative, we can infer that the lending/financing
(deposit) growth drops during the crisis period. The results from these separate regressions
would serve as a confirmatory evidence on the relative credit (deposit) growth of Islamic banks
vis-à-vis conventional banks.

Take note that we opt for static panel specifications of the loan and deposit growth
equations. While some studies have allowed dynamics in the lending/deposit growth, our static
specification follows Bhaumik et al. (2011), Cull and Martinez-Peria (2013), Kosak et al.

3
Defining the global financial crisis years to be 2007-2009 as in Kabir et al. (2015) leads to insignificant effect
of the crisis on bank behaviour, which may be due to considering 2007 to be the beginning of the crisis year
when, as noted in the text, the effect of the crisis was confined mainly to the advanced economies during 2007.
 ACCEPTED MANUSCRIPT

(2015) and others. Our choice is justifiable on the basis that we find no persistence in the
lending or deposit growth, i.e. the lagged dependent variables incorporated in (1) and (2) carry
insignificant coefficients4. Moreover, since the loan level normally exhibits a unit root
property, we have no reason to believe that its first difference would be persistent. We estimate
the equations using the random-effect panel estimator with robust standard errors clustered at
the bank level. With the presence of the Islamic bank dummy, the fixed-effect panel estimator
would not be appropriate. Still, we experiment with the fixed-effect panel estimator when we
estimate the equations separately for conventional and Islamic banks. Since the results are
largely similar, they are not reported to conserve space.

3.2 Bank Risk

PT
Next, we intend to assess whether lending growth is associated with future risk for both
Islamic banks and conventional banks and whether there is difference between the two, i.e.

RI
Hypothesis 5 and Hypothesis 6. Finally, observing higher financing growth of Islamic banks
during the crisis, we examine whether it is related to excessive risk, i.e. Hypothesis 7.

SC
To test hypotheses 5 and 6, we follow the dynamic specification as in Foos et al. (2010)
but with some adjustments to fit our research objective, written as:
NU
𝑁𝑃𝐿𝑖𝑡 = 𝛽0 + 𝛽1 𝑁𝑃𝐿𝑖𝑡−1 + ∑𝑚
𝑗=1 𝛽2𝑗 ∆𝐿𝑖𝑡−𝑗 + ∅𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 + 𝜇𝑖 + 𝜀𝑖𝑡 (3)

𝑚 𝑚
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𝑁𝑃𝐿𝑖𝑡 = 𝛽0 + 𝛽1 𝑁𝑃𝐿𝑖𝑡−1 + ∑ 𝛽21𝑗 ∆𝐿𝑖𝑡−𝑗 𝐼(𝐼𝐵𝑖 = 0) + ∑ 𝛽22𝑗 ∆𝐿𝑖𝑡−𝑗 𝐼(𝐼𝐵𝑖 = 1)

𝑗=1 𝑗=1
+∅𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 + 𝜇𝑖 + 𝜀𝑖𝑡 (4)
D

where NPL is the ratio of non-performing loans to gross loans, I(.) is a bank type indicator and
it equals 1 when the argument is true, and other variables are as defined before. In line with
E

Foos et al. (2010), we expect credit growth to affect bank credit risk or non-performing loans
PT

with time lags since it is unlikely that borrowers will default immediately in the first year of
the loans they receive. Equation (3) restricts risk – loan growth relations to be the same for
conventional banks and Islamic banks while equation (4) relaxes the restriction. Based on (3)
and (4), we test the null hypotheses (i) ∑𝑚 𝑚 𝑚
𝑗=1 𝛽2𝑗 = 0, (ii) ∑𝑗=1 𝛽21𝑗 = 0 and (iii) ∑𝑗=1 𝛽22𝑗 = 0
CE

that there is no future risk implications of financing/lending growth respectively for all banks,
conventional banks and Islamic banks. In addition, we also test whether there is significant
difference in the risk – credit growth relations of conventional and Islamic banks, i.e. ∑𝑚𝑗=1 𝛽21𝑗
AC

𝑚
∑
= 𝑗=1 𝛽22𝑗 . We include a larger set of controlled variables than the one used by Foos et al.
(2010). These include bank-specific variables (bank size, capitalization, liquidity),
macroeconomic variables (GDP growth, inflation, financial development, and crisis dummy),
and regulation (activity restrictions, private monitoring, supervisory power, and capital
stringency).

For Hypothesis 7, i.e. financing growth of Islamic banks during the crisis period is not
related to excessive risk, we focus specifically on Islamic banks. Taking insight from Zhang
et al. (2016) and Vithessonthi (2016), we specify the model as:

4
We estimate the dynamic specifications of (1) and (2) using the system GMM estimator.
 ACCEPTED MANUSCRIPT

𝑚 𝑚

𝑁𝑃𝐿𝑖𝑡 = 𝛾0 + 𝛾1 𝑁𝑃𝐿𝑖𝑡−1 + ∑ 𝛾2𝑗 ∆𝐿𝑖𝑡−𝑗 + ∑ 𝛾3𝑗 (∆𝐿𝑖𝑡−𝑗 × 𝐺𝐹𝐶𝑡−𝑗 )

𝑗=1 𝑗=1
+∅𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 + 𝜇𝑖 + 𝜀𝑖𝑡 (5).

In line with Zhang et al. (2016), we can infer from the link between loan growth and non-
performing loans whether Islamic financing growth during the crisis constitutes excessive risk
taking. As we have noted, asymmetric information abounds in times of crisis. Prudential banks
would be more cautious in their lending through, for example, more stringent lending
standards. This, according to Vithessonthi (2016), would weaken the link between credit
growth and credit risk. If we accept this argument, we may also state that the credit growth –

PT
risk relation would be stronger if banks take excessive risk in times of crisis. Moreover, in the
presence of asymmetric information and resulting adverse selection problem, lending growth
during the crisis period may likely be granted to low quality borrowers, since they are the ones

RI
actively seeking loans, or to those rejected by other banks. As a result, loan growth would be
translated to higher risk in the future. On the basis of these arguments, we may infer whether

SC
Islamic banks behave prudentially or undertake excessive risk from the significance and sign
of ∑𝑚 𝑚
𝑗=1 𝛾3𝑗 . If ∑𝑗=1 𝛾3𝑗 is significantly positive, then financing growth of Islamic banks during
the crisis is construed as excessive risk taking.
NU
The dynamic specification of risk equations (3) to (5) renders the traditional panel
estimators inappropriate. Even we can assume exogeneity of all explanatory variables, the
lagged dependent variable is correlated with the bank-specific effect by construction. The
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standard and widely-adopted approach in dealing with this endogeneity issue is to apply the
GMM estimators developed by Arellano and Bond (1991), Arellano and Bover (1995) and
Blundell and Bond (1988). In line with the literature, we utilize the GMM estimators for our
purpose. We also take note that the GMM estimators may suffer from instrument proliferation.
D

In addition, they have poor finite sample properties and hence are less suitable when the number
of cross-sectional unit is small (Meschi and Vivarelli, 2009). Since the estimation of equation
E

(5) involves only 25 Islamic banks, we follow Roodman(2009) by limiting the number of
PT

instruments such that it is less than the number of cross-section units. We also apply the biased-
corrected LSDV (LSDVC) as proposed by Kiviet (1995), Judson and Owen (1999), Bun and
Kiviet (1995) and Bruno (2005) to deal with the small micro panel of Islamic banks.
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4. DATA AND ESTIMATION RESULTS

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4.1 Data Descriptions

We gather bank-level data for dual-banking countries that have significant presence of the
Islamic banking sector or exhibit fast-growing Islamic banking in recent years. Our initial
sample comprises 296 banks (225 conventional banks and 71 Islamic banks) from 13 countries.
Since our objectives are to assess lending growth, deposit growth, and risk of Islamic banks
during the global financial crisis not only relative to those of conventional banks but also
relative to those during the normal or pre-crisis period, we require a sufficient number of
observations in the pre-crisis period such that meaningful comparison can be made.
Accordingly, our sample includes countries that have both conventional and Islamic banks
having relevant bank-level data available starting no later than 2005. This criterion filters out
all banks from Egypt and Pakistan since Islamic banking data are available only after 2005. In
addition, we also require data availability of the macroeconomic and regulation variables
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included in the analysis. This leads the exclusion of Yemen due to the unavailability of
regulation variables. By applying these sample selection criteria, we arrive at a sample of 114
conventional banks and 25 Islamic banks from 10 countries. These countries are Bangladesh,
Bahrain, Indonesia, Jordan, Kuwait, Malaysia, Qatar, Saudi Arabia, Turkey and the United
Arab Emirates. The data are unbalanced covering the period 2000 to 2014. We admit that
other studies tend to have larger sample size. However, their sample selection criteria are less
stringent. For instance, in their analysis of the 6 GCC countries, Alqahtani et al. (2016) requires
that, to be included in the sample, a bank must have observations on all variables for at least
one year. Meanwhile, Kabir et al. (2015) requires data availability of a least 3 consecutive
years. Still, it should be noted that a small sample than ours is not uncommon (Bourkhis and
Nabi, 2013). Louchini and Boujelbene (2017) employ unbalanced data covering 2005-2012

PT
from the MENA and South-East Asian countries. Despite shorter time span, they end up with
only 117 banks in their sample. The bank-level data are sourced from the Bankscope while
macroeconomic and regulation variables are from respectively World Development Indicators

RI
Database and Barth et al. (2006).

SC
Table 2 provides definition and descriptive statistics of the variables used in the present
study. On average, the Islamic banking sector has higher financing and deposit growth rates
and, at the same time, higher credit risk. In line with Beck et al. (2013), Islamic banks are on
average better capitalized but less cost efficient. As compared to conventional banks, Islamic
NU
banks are less liquid and rely more on customer deposits. While Islamic banks are on average
smaller, they are more profitable. As far as the macroeconomic environments of these
countries are concerned, these countries record respectable growth, averaging over 5% over
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the sample period. Indeed, the average annual growth exceeds 4% for all countries in the
sample. However, there are large variations in the inflationary experience across these
countries. As reflected by the ratio of credit to the private sector to GDP, the financial sector
is not well developed. The average credit-to-GDP ratio is 56.6%. Five countries, i.e.
D

Bangladesh, Indonesia, Qatar, Saudi Arabia, and the United Arab Emirates, have average
credit-to-GDP ratio below 50% and only Malaysia records the ratio above 100%. Finally,
E

except supervisory power, the regulation indices in these countries are on average slightly
above the mid-level. We also compute the correlation coefficients among the variables and
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find no indication of multicollinearity problem. All correlations are below 0.60, among which
only two are above 0.505.
CE

4.2 Lending Growth

This section presents the estimation results for lending/financing growth to ascertain
AC

whether Islamic banks are able to sustain financing supply and whether there is significant
difference between Islamic banks and conventional banks in the provision of credit during the
crisis period. These results are reported in Table 3. The key coefficients are the coefficients
of the Islamic bank dummy (IB), the crisis dummy (GFC) and the Islamic bank – crisis
interactions (IB × GFC), whose interpretation is explained earlier (see Table 1). These are
presented in Panel (a) of the Table. In the same panel, we provide the p-values for testing the
(i) null hypothesis that there is no significant difference in the financing growth of Islamic
banks and the lending growth of conventional banks during the crisis (i.e. 𝛽1 + 𝛽3 = 0), and
(ii) null hypothesis that there is no significant difference in the financing growth of Islamic
banks during the non-crisis and crisis periods (i.e. 𝛽2 + 𝛽3 = 0), which are the focus of the

5
The correlation coefficients are not reported to conserve space. They are available from the authors upon
request.
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present study. Panel (b) of the Table presents the coefficient estimates of the controlled
variables. Regressions (1) and (2) refer to the estimation of equation (1) while regressions (3)
and (4) the estimation of equation (2).

The insignificance of the IB dummy in all regressions suggests no significant difference in

the lending/financing growth of Islamic banks and conventional banks during the normal
period. However, during the crisis period, the lending growth of conventional banks drops
significantly as reflected by the significant and negative coefficients of the crisis dummy. As
compared to the non-crisis years, i.e. regressions (1) and (2), the lending growth of
conventional banks are lower by roughly 4 to 5 percentage points. But, when we compare to
the pre-crisis years, i.e. regressions (3) and (4), the drop is roughly 8 percentage point. By

PT
contrast, the results indicate no significant reduction in the financing growth of Islamic banks.
That is, we fail to reject the null hypothesis 𝛽2 + 𝛽3 = 0 in all regressions. This means that
Islamic banks are able to sustain their supply of financing during the crisis. Finally, as should

RI
be expected from the above results, we find financing growth of Islamic banks to be
significantly higher than the lending growth of conventional banks during the crisis period.

SC
The null hypothesis 𝛽1 + 𝛽3 = 0 is rejected in all regressions.

To reaffirm our findings, we re-estimate equations (1) and (2) separately for conventional
banks and Islamic banks6. The results, as reported in Table 4, echo well the conclusions made
NU
earlier. As may be noted from the Table, the crisis dummy carries a negative and significant
coefficient for conventional banks while it is not distinguishable from zero for Islamic banks.
Consistent with the results in Table 3, the lending growth of conventional banks drops by
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roughly 5 to 8 percentage points during the crisis period. Our finding that Islamic banks
maintain their financing during the crisis is in line with earlier results by Hasan and Dridi
(2011), Beck et al. (2013), and Ibrahim (2016).
D

Turning to bank-specific controlled variables, we find bank size, liquidity, profitability,

funding ratio, credit risk, and cost efficiency to be significant. Larger banks tend to have lower
E

lending growth, regardless of whether the banks are conventional or Islamic. Likewise, Islamic
and conventional banks with higher credit risk have lower credit growth. While we find the
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effect of bank liquidity, profitability, funding ratio and cost efficiency to be positive and
significant in a combined sample of conventional and Islamic banks (Table 3), they seem to
have differential effects on the lending growth of conventional and Islamic banks (Table 4).
CE

More precisely, bank profitability and funding ratio significantly affect the lending growth of
only conventional banks while liquidity and cost efficiency are significant in explaining the
financing growth of Islamic banks.
AC

As regards macroeconomic and regulatory variables, the results generally indicate their
significance in explaining credit growth of Islamic and conventional banks. Both GDP growth
and inflation affect lending growth of these banks positively. By contrast, financial
development tends to slow down credit growth of especially conventional banks. We also
document differential effects of regulatory variables on lending growth. While activity
restrictions and capital stringency tend to depress lending growth of conventional banks,
private monitoring and supervisory power tend to stimulate their credit growth. As for Islamic
banks, the supervisory power significantly contributes to their financing growth. Apart from
these results, we also find a slowdown in credit growth of conventional banks after the financial

6
Estimating the equations separately for conventional banks and Islamic banks relaxes the assumption of common
coefficients across the two types of banks.
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crisis. By contrast, Islamic banks in the sample maintain their financing supply post-crisis
period, as reflected by the insignificant coefficient of the post-crisis dummy (Table 4).

4.3 Deposit Growth

As in the case of lending growth, we estimate equations (1) and (2) for deposit growth using
a combined sample as well as separately for Islamic banks and conventional banks. The results
are reported in Table 5 and Table 6.

Focusing on our main theme, we find the results quite puzzling. Using the combined
sample, we find no significant difference in the deposit growth of Islamic banks and

PT
conventional banks during the global financial crisis as reflected by the non-rejection of 𝛽1 +
𝛽3 = 0. Against this finding, it is puzzling to observe significant reduction in the deposit
growth of conventional banks during the crisis as suggested by the significance of the crisis

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dummy and yet insignificant drop in the deposit growth of Islamic banks as indicated by non-
rejection of the null 𝛽2 + 𝛽3 = 0. Then, when we estimate the equations separately for

SC
conventional banks and Islamic banks, we find significant reduction in deposit growth of both
types of banks during the crisis period albeit at only 10% significance level for Islamic banks.
From these results, we are unable to draw conclusion that the financing growth of Islamic banks
during the crisis is supported by a concomitant growth in their deposits.
NU
Perhaps, Islamic banks draw down their liquidity holdings to maintain their financing
during the crisis episode. We observe that, during the pre-crisis period, their liquid asset-to-
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asset ratio was 25.9%. During the crisis period, it dropped to 19.8%. At the same time,
observing the increase in capitalization from 13.4% to 14.5% over the periods, we contend that
Islamic banks exhibit prudential behaviour by building capital amidst higher financing growth.
While these might be the answer for higher financing growth of Islamic banks during the crisis,
D

we leave them for future research. Here, we examine next whether financing growth of Islamic
banks during the crisis period is linked to their future credit risk and to excessive risk taking.
E

As for the controlled variables, we find consistent findings for negative and significant
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effects of bank size and credit risk on deposit growth of both Islamic banks and conventional
banks. Given that larger banks tend to have better access to alternative sources of funds, they
are less likely to depend on bank deposits as a source of funds or they are less aggressive in
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sourcing funds from deposits. This result is not in line with Farooq and Zaheer (2015), who
document insignificant relation between deposit growth and bank size for Pakistan. As regards
bank credit risk, our result conforms to the finding by Farooq and Zaheer (2015) that banks
AC

with higher credit rating experience higher deposit growth. For other bank-specific variables,
we find bank liquidity and funding to be significant only for conventional banks, suggesting
that banks that are more liquid and have higher level of funding deposits tend to have lower
deposit growth. Finally, it is very interesting to observe that Islamic bank deposits are not
responsive to business cycle, macroeconomic uncertainty and the level of financial
development. These results may reflect the notion of “captive customers” in Islamic banking
(Azzam and Rettab, 2013). By contrast, deposit growth in conventional bank is influenced by
macroeconomic cycle and financial development.

4.4 Credit Risk

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We first estimate equation (3) by setting the lag order of the credit/financing growth to 37.
The first-difference and system GMM results, reported in Table 7, provide evidence that there
are lagged effects of credit growth on credit risk. More precisely, credit growth bears
significant risk implications after two years, as reflected by significant coefficients of credit
growth lagged two and three years. This finding conforms well to Foos et al. (2010). As
regards the controlled variables, capitalization, liquidity, economic growth and inflation appear
significantly and negatively related to credit risk while the remaining controlled variables are
not significant. Thus, the better-capitalized and more liquid banks are less risky. Moreover,
economic growth tends to improve credit risk. Finally, under an inflationary environment,
banks are likely to be more cautious and accordingly have better credit risk.

PT
Having verified that credit growth anticipates future risk, we proceed to assessing whether
the credit growth – risk relations are the same for Islamic banks and conventional banks as
specified in (4) as a further check of the link between credit growth and future risk. The results

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from the GMM estimators are given in Table 8. The credit growth – risk relations of
conventional banks mimic closely those reported in Table 7. As for Islamic banks, only

SC
financing growth lagged two years is statistically significant. When we test the null hypothesis
∑𝑚 𝑚
𝑗=1 𝛽21𝑗 = ∑𝑗=1 𝛽22𝑗 , however, we fail to find significant difference between the credit growth
– risk relations of conventional and Islamic banks. As for the controlled variables, the results
are in conformity to those documented previously.
NU
The key result that we have established here is that the financing growth of Islamic banks
does in general lead to future risk. The next question is: Does financing growth of Islamic
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banks during the crisis, which we find earlier to be higher than the credit growth of
conventional banks and which we observe to be indistinguishable from the level recorded prior
to the crisis, amounts to excessive risk taking? To this end, we estimate equation (5) using a
sample of only Islamic banks. The results using the system GMM and bias-corrected LSDV
D

estimators are provided in Table 98. The lag order of financing growth is set to 2, in line with
the finding we document in Table 8 that only financing growth lagged two years is significantly
E

different from zero.

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Regressions (1) and (2) of Table 9 relook at the link between credit risk and past credit
growth of Islamic banks. As in the combined sample, the coefficient of financing growth
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lagged two years is positive and statistically significant. The results of estimating equation (5)
using the system GMM are given in regressions (3) and (4). While we find financing growth
to be related to future risk, we find no evidence that the crisis makes Islamic banks to be more
prudent or to be riskier. As reflected by the insignificance of the credit growth – crisis
AC

interactions, financing growth during the crisis does not affect risk differentially beyond its
documented effect during the normal period. In other words, there is no evidence of excessive
risk taking by Islamic banks. Using the biased-corrected LSDV, we find that the once-lagged
financing growth turns significant. Similar to the system GMM estimation results, the
financing growth – crisis interactions are statistically insignificant. Thus, our conclusion that
Islamic financing during the crisis is not the result of excessive risk-taking stands. Among the
controlled variables, only capitalization remains robust. Indeed, the negative coefficient of
capital suggests that capital adequacy requirements would serve as a risk-mitigating

7
We also experiment with the lag order of 4 as in Foos et al. (2010) but find credit/financing growth lagged 4 to
be insignificant.
8
The first-difference GMM estimator and using longer lags yield similar results. These results are not reported
to conserve space.
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mechanism. In addition, we also note the significance of private monitoring and supervisory
power in respectively reducing and increasing bank risk.

These results strengthen the ability of Islamic banks to play a stabilizing role during the
crisis period. Facing the crisis, Islamic banks sustain their financing supply and have higher
financing growth as compared to conventional banks. While we are not able to verify whether
there is a parallel increase in Islamic deposits, we find no evidence that Islamic banks exhibit
excessive risk taking in their financing expansion during the crisis.

5. CONCLUSION

PT
Whether a nascent but fast-growing Islamic banking sector has the ability to be a stabilizing
force in times of crisis is a subject that has attracted substantial research attention especially

RI
since the global financial crisis. We contribute to this area of research by analysing lending
growth, deposit growth and risk of Islamic and conventional banks covering 10 major dual-

SC
banking countries from 2000 to 2014. Our main aim is to empirically evaluate whether
financing and deposit growth of Islamic banks is resilient to the crisis and whether the Islamic
financing growth during the crisis is related to future risk and can be construed as excessive
risk-taking. The evaluation is made in comparison not only to normal years but also to
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conventional banks.

From the analysis, we observe no significant reduction in Islamic financing growth during
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the crisis period. In addition, there is strong evidence that the growth of Islamic financing is
higher than the growth of conventional lending during the period. However, we are unable to
draw conclusion that the financing growth of Islamic banks during the crisis is supported by a
concomitant growth in their deposits. Finally, while we find evidence that financing/lending
D

growth of both Islamic and conventional banks is related to future risk, we find no evidence to
suggest that the sustained and higher financing growth of Islamic banks during the crisis period
E

is related to excessive risk taking. That is, there is no increased financing growth – risk
relations beyond their observed relation during the normal period. The implication from these
PT

findings is straightforward. Given that the Islamic banking system has the ability to contribute
positively to financial and economic stability, its development should be further bolstered.
Still, safeguard measures are needed to be in place even for the Islamic banking sector.
CE

Although we find no evidence that Islamic banks behave in a morally hazardous manner, they
do face risk from their intermediation activities. Particularly, encouraging the build-up of bank
capital should be facilitated as it would constrain Islamic bank risk.
AC

Having stated these, we believe that the ability of the Islamic banking system to inject
the much needed financial stability requires further investigation. In the present study, focusing
specifically on the effects of the global financial crisis on Islamic and conventional banks, we
define the crisis period to be common for all countries in the sample. The documented better
performance of Islamic banks may be due to the fact that they are less integrated and less
exposed to developments in the global financial market as compared to the longer-established
conventional banks and not due to the Islamic principles underlying their operations. Thus,
extending the present analysis by assessing the implications of country-level indicators of
financial crises as in Doumpos et al. (2015) on bank performance in a dual banking system
would provide a firmer evidence for the stabilizing role of the Islamic banking system. In
addition, our analysis on the moral hazard behaviour of Islamic banks relies exclusively on the
strengthened link between bank financing and bank risk. To be more concrete, this must be
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further evaluated and extended to whether Islamic banks really share risk or they, as
conventional banks do, shift risk. Finally, a more focus and thorough analysis on the
determinants of Islamic bank risk is required since, by the very nature of banking, Islamic
banks do face risk. The fact that there are risks unique only to Islamic banks such as the
Shariah-compliant risk or displaced business risk, the issue of risk determinants requires deeper
evaluation.

PT
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SC
NU
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E D
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CE
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E

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Table 1: Conditional Models

Bank/Period Normal Crisis

Conventional 𝛽0 + ∅𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 (𝛽0 + 𝛽2 ) + ∅𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡

Islamic (𝛽0 + 𝛽1 ) + ∅𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡 (𝛽0 + 𝛽1 + 𝛽2 + 𝛽3 ) + ∅𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑖𝑡

PT
Table 2: Variable Definition and Descriptions

(a) Bank-specific Variables

RI
All Banks IBs CBs
Variable Definition Mean Std D Mean Std D Mean Std D

SC
Loan Growth Logarithmic difference of gross 0.156 0.201 0.182 0.210 0.151 0.199
loans, L
Deposit Logarithmic difference of 0.142 0.246 0.183 0.435 0.34 0.186
Growth customer deposits, D
NU
Credit Risk Ratio of non-performing loans to 6.792 10.53 7.242 10.24 6.918 10.60
gross loans, NPL
Capitalization Equity to asset ratio, EQA 12.61 7.815 13.03 8.434 12.53 7.686
Liquidity Ratio of liquid assets to total 24.87 15.70 21.85 11.11 25.48 16.40
MA

assets, LIQA
Size Natural logarithm of total assets, 15.17 1.612 15.01 1.419 15.20 1.650
Ln(TA)
Profit Return on average assets, ROAA 1.709 2.072 1.797 2.890 1.691 1.867
D

Funding Ratio of customer deposits to 67.32 16.07 71.16 18.07 66.56 15.54
Ratio total liabilities, FUNDING
E

Cost Cost to income ratio, CIR 46.16 33.14 51.34 48.20 45.13 29.13
Efficiency
PT

(b) Macroeconomic and Regulatory Variables

Variable Definition Mean Std Dev
Economic Growth rate of real gross domestic product, GDP 5.400 3.674
CE

Growth
Inflation CPI inflation rate, INF 5.933 7.506
Financial Ratio of credit to the private sector to GDP, FMD 56.573 31.642
Development
AC

Activity The degree to which banks are restricted or 2.567 0.671

Restrictions permitted to activities related to securities,
insurance and real estate markets and to ownership
and control of non-financial firms, AR
Private The degree to which regulations facilitate 5.778 1.648
Monitoring incentives and ability for private monitoring of
banks, PM
Supervisory The degree to which the country’s bank 11.044 2.490
Power supervisory agency has the power to take specific
actions, SUP
Capital The degree of capital stringency regulation, CR 4.806 1.774
Stringency
 ACCEPTED MANUSCRIPT

Table 3: Bank Lending Growth – All Banks

Independent Variables Regressions
(1) (2) (3) (4)
(a) Key Variables
IB 0.941 0.410 -0.958 -1.623
(0.504) (0.776) (0.661) (0.463)
GFC -3.909*** -5.443*** -7.927*** -7.805***
(0.002) (0.000) (0.000) (0.000)
IB × GFC 4.366 4.589 6.339* 6.642**
(0.176) (0.136) (0.060) (0.044)
Tests (p-values)

PT
𝜷𝟏 + 𝜷𝟑 = 𝟎 0.0488 0.0511 0.0446 0.0536
𝜷𝟐 + 𝜷𝟑 = 𝟎 0.8762 0.7645 0.6093 0.7088

RI
(b) Controlled Variables
Ln(TA)t-1 -1.456*** -1.824*** -0.931*** -1.405***
(0.000) (0.000) (0.010) (0.000)

SC
EQAt-1 -0.037 -0.026 0.114 0.083
(0.778) (0.850) (0.412) (0.561)
LIQAt-1 0.139*** 0.091* 0.082* 0.062
NU
(0.003) (0.065) (0.089) (0.223)
ROAAt-1 1.844*** 1.532*** 1.465*** 1.358***
(0.000) (0.000) (0.000) (0.001)
FUNDINGt-1 0.101*** 0.112*** 0.114*** 0.121***
MA

(0.008) (0.004) (0.002) (0.001)

NPLt-1 -0.466*** -0.457*** -0.513*** -0.490***
(0.000) (0.000) (0.000) (0.000)
CIRt-1 0.105*** 0.095*** 0.102*** 0.095***
(0.000) (0.000) (0.000) (0.000)
D

GDP 0.639*** 0.530*** 0.568*** 0.526***

(0.000) (0.000) (0.000) (0.000)
E

INF 0.410*** 0.304** 0.399*** 0.327***

PT

(0.001) (0.013) (0.001) (0.008)

FMD -0.069*** -0.071*** -0.057*** -0.064***
(0.001) (0.001) (0.004) (0.002)
AR -2.672*** -2.486***
CE

(0.004) (0.007)
PM 0.698 0.279
(0.108) (0.511)
AC

SUP 0.458** 0.349

(0.040) (0.107)
CR -0.693** -0.264
(0.016) (0.374)
PFC -7.654*** -6.002***
(0.000) (0.000)
IB × PFC 4.109 4.434
(0.143) (0.116)
Constant 21.722*** 31.424*** 16.942** 27.589***
(0.003) (0.000) (0.021) (0.001)
Observations 1766 1766 1766 1766
Number of Banks 139 139 139 139
R2 0.187 0.207 0.207 0.215
p-values in parentheses
*
p < 0.1, ** p < 0.05, *** p < 0.01
 ACCEPTED MANUSCRIPT

Table 4: Bank Lending Growth – Separate Samples

Independent Conventional Banks Islamic Banks
Variables (1) (2) (3) (4)
(a) Key Variables
GFC -5.495*** -7.874*** 0.551 0.506
(0.000) (0.000) (0.804) (0.863)
(b) Controlled Variables
Ln(TA)t-1 -1.864*** -1.392*** -2.992** -2.978**
(0.000) (0.000) (0.022) (0.014)

PT
EQAt-1 -0.109 0.017 0.467 0.468
(0.390) (0.899) (0.228) (0.234)
LIQAt-1 0.082 0.045 0.344*** 0.344***

RI
(0.108) (0.401) (0.003) (0.005)
ROAAt-1 1.634** 1.395** 0.551 0.546

SC
(0.012) (0.033) (0.344) (0.353)
FUNDINGt-1 0.116*** 0.122*** 0.041 0.041
(0.004) (0.002) (0.684) (0.687)
NPLt-1 -0.421*** -0.455*** -0.799*** -0.800***
NU
(0.000) (0.000) (0.000) (0.000)
CIRt-1 0.061 0.059 0.112*** 0.112***
(0.142) (0.146) (0.002) (0.002)
MA

GDP 0.540*** 0.532*** 0.660* 0.661*

(0.000) (0.000) (0.067) (0.067)
INF 0.331** 0.366** 0.345* 0.346*
(0.026) (0.013) (0.085) (0.080)
FMD -0.083*** -0.074*** 0.032 0.032
D

(0.001) (0.001) (0.501) (0.504)

E

AR -3.263*** -3.039*** -0.662 -0.652

(0.002) (0.003) (0.669) (0.680)
PT

PM 0.770* 0.317 -1.384 -1.392

(0.078) (0.465) (0.290) (0.295)
SUP 0.370* 0.229 2.293*** 2.292***
CE

(0.084) (0.285) (0.001) (0.001)

CR -0.799** -0.272 0.489 0.496
(0.017) (0.431) (0.530) (0.527)
PFC -6.098*** -0.111
AC

(0.000) (0.973)
Constant 37.198*** 32.807*** 19.615 19.468
(0.000) (0.000) (0.448) (0.437)
Observations 1466 1466 300 300
Number of Banks 114 114 25 25
R2 0.208 0.218 0.262 0.262
p-values in parentheses
*
p < 0.1, ** p < 0.05, *** p < 0.01
 ACCEPTED MANUSCRIPT

Table 5: Bank Deposit Growth – All Banks

Independent Regression
Variables (1) (2) (3) (4)
(a) Key Variables
IB 4.188*** 3.844*** 0.347 0.072
(0.001) (0.006) (0.927) (0.984)
GFC -2.689** -5.153*** -6.954*** -7.892***
(0.042) (0.001) (0.000) (0.000)
IB × GFC -0.595 0.023 3.248 3.758
(0.868) (0.995) (0.357) (0.282)
Tests (p-values)

PT
𝜷𝟏 + 𝜷𝟑 = 𝟎 0.2735 0.2486 0.2913 0.2676
𝜷𝟐 + 𝜷𝟑 = 𝟎 0.3658 0.1995 0.2421 0.1947

RI
(b) Controlled Variables
Ln(TA)t-1 -2.115*** -2.461*** -1.646*** -2.048***
(0.000) (0.000) (0.000) (0.000)

SC
EQAt-1 0.084 0.052 0.238 0.170
(0.776) (0.858) (0.432) (0.555)
LIQAt-1 -0.032 -0.087** -0.091** -0.120***
NU
(0.450) (0.039) (0.031) (0.005)
ROAAt-1 0.821* 0.755* 0.482 0.596
(0.083) (0.095) (0.316) (0.181)
FUNDINGt-1 -0.157* -0.165* -0.144 -0.155*
MA

(0.076) (0.068) (0.106) (0.087)

NPLt-1 -0.562*** -0.573*** -0.609*** -0.607***
(0.002) (0.002) (0.001) (0.001)
CIRt-1 0.081* 0.086* 0.081 0.088*
(0.095) (0.077) (0.116) (0.086)
D

GDP 0.312* 0.227 0.243 0.222

(0.079) (0.304) (0.168) (0.305)
E

INF 0.178 0.189 0.164 0.211*

PT

(0.163) (0.117) (0.205) (0.092)

FMD -0.048** -0.050** -0.036* -0.043*
(0.031) (0.039) (0.091) (0.070)
AR -0.115 0.028
CE

(0.889) (0.973)
PM 2.193*** 1.746***
(0.000) (0.003)
AC

SUP -0.390 -0.505

(0.384) (0.240)
CR -0.276 0.178
(0.485) (0.674)
PFC -8.234*** -6.897***
(0.000) (0.000)
IB × PFC 8.022 7.973
(0.242) (0.228)
Constant 55.299*** 57.211*** 51.552*** 53.972***
(0.000) (0.000) (0.000) (0.000)
Observations 1762 1762 1762 1762
Number of Banks 139 139 139 139
R2 0.092 0.106 0.107 0.114
p-values in parentheses
*
p < 0.1, ** p < 0.05, *** p < 0.01
 ACCEPTED MANUSCRIPT

Table 6: Bank Deposit Growth – Separate Samples

Independent Conventional Banks Islamic Banks
Variables (1) (2) (3) (4)
(a) Key Variables
GFC -4.065*** -6.480*** -7.691* -8.279*
(0.002) (0.000) (0.079) (0.090)
(b) Controlled Variables
Ln(TA)t-1 -2.887*** -2.332*** -3.855** -3.664**
(0.000) (0.000) (0.018) (0.015)
EQAt-1 -0.203** -0.067 1.084 1.102
(0.034) (0.536) (0.239) (0.227)

PT
LIQAt-1 -0.093** -0.131*** 0.364 0.355
(0.035) (0.003) (0.209) (0.211)
ROAAt-1 0.719 0.479 -1.740 -1.798

RI
(0.195) (0.390) (0.326) (0.312)
FUNDINGt-1 -0.154* -0.142* -0.546 -0.549
(0.070) (0.093) (0.148) (0.152)

SC
NPLt-1 -0.397*** -0.430*** -1.905*** -1.919***
(0.000) (0.000) (0.008) (0.009)
CIRt-1 -0.016 -0.019 0.143** 0.143**
(0.711) (0.652) (0.030) (0.032)
NU
GDP 0.413*** 0.404*** -0.553 -0.545
(0.004) (0.004) (0.400) (0.412)
INF 0.266** 0.305** 0.443 0.453
MA

(0.045) (0.019) (0.140) (0.114)

FMD -0.054** -0.043* 0.031 0.033
(0.033) (0.076) (0.700) (0.679)
AR -1.395* -1.182 2.215 2.335
(0.059) (0.118) (0.343) (0.336)
D

PM 1.598*** 1.173*** 2.773* 2.659

(0.000) (0.003) (0.081) (0.152)
E

SUP -0.062 -0.216 0.676 0.660

PT

(0.809) (0.394) (0.587) (0.590)

CR -0.232 0.278 0.685 0.777
(0.369) (0.276) (0.580) (0.558)
PFC -6.068*** -1.461
CE

(0.000) (0.772)
Constant 71.237*** 65.022*** 70.263* 68.341**
(0.000) (0.000) (0.054) (0.040)
AC

Observations 1463 1463 299 299

Number of Banks 114 114 25 25
R2 0.136 0.149 0.195 0.195
p-values in parentheses
*
p < 0.1, ** p < 0.05, *** p < 0.01
 ACCEPTED MANUSCRIPT

Table 7: Risk and Bank Lending Growth

Independent First-Difference GMM System GMM

Variables (1) (2) (3) (4)
NPLt-1 0.641*** 0.638*** 0.742*** 0.738***
(0.000) (0.000) (0.000) (0.000)
Lt-1 0.001 -0.003 0.003 0.001
(0.929) (0.776) (0.772) (0.957)
Lt-2 0.014*** 0.011** 0.025*** 0.023***
(0.008) (0.038) (0.000) (0.000)
Lt-3 0.013*** 0.010** 0.024*** 0.021***
(0.000) (0.010) (0.000) (0.003)

PT
Ln(TA)t-1 -0.239 -0.016 0.525 0.673
(0.673) (0.976) (0.362) (0.282)
EQAt-1 -0.237* -0.236* -0.172 -0.165

RI
(0.081) (0.080) (0.141) (0.159)
LIQAt-1 -0.021 -0.028 -0.035* -0.040**
(0.344) (0.244) (0.072) (0.035)

SC
GDP -0.053** -0.053** -0.084** -0.081***
(0.016) (0.012) (0.012) (0.009)
**
INF -0.057 -0.046* -0.042 -0.035
NU
(0.044) (0.054) (0.153) (0.173)
FMD 0.007 0.005 -0.025 -0.022
(0.699) (0.784) (0.155) (0.220)
GFC 0.225 0.190 0.258 0.269
MA

(0.222) (0.376) (0.228) (0.271)

AR -0.022 0.174
(0.944) (0.784)
PM 0.010 -0.086
(0.963) (0.818)
D

SUP 0.093 0.142

(0.534) (0.577)
E

CR 0.009 0.008
PT

(0.914) (0.932)
Constant -2.919 -6.852
(0.779) (0.584)
Observations 1267 1267 1406 1406
CE

Number of Banks 139 139 139 139

P(Hansen) 0.109 0.176 0.074 0.152
P(AR1) 0.005 0.005 0.005 0.005
AC

P(AR2) 0.976 0.886 0.925 0.983

p-values in parentheses
*
p < 0.1, ** p < 0.05, *** p < 0.01
 ACCEPTED MANUSCRIPT

Table 8: Risk and Conventional and Islamic Lending Growth

Independent First-Difference GMM System GMM

Variables (1) (2) (3) (4)
NPLt-1 0.646*** 0.644*** 0.747*** 0.745***
(0.000) (0.000) (0.000) (0.000)
Lt-1 I(IB = 0) -0.002 -0.005 -0.001 -0.003
(0.827) (0.511) (0.912) (0.713)
Lt-2 I(IB = 0) 0.013** 0.010** 0.022*** 0.020***
(0.013) (0.033) (0.000) (0.003)
Lt-3 I(IB = 0) 0.015*** 0.013*** 0.023*** 0.022***
(0.001) (0.008) (0.001) (0.004)

PT
Lt-1 I(IB = 1) 0.023 0.018 0.037 0.033
(0.457) (0.513) (0.234) (0.267)
Lt-2 I(IB = 1) 0.024* 0.018 0.044*** 0.041***

RI
(0.098) (0.203) (0.006) (0.010)
Lt-3 I(IB = 1) 0.007 0.003 0.024 0.022
(0.429) (0.717) (0.103) (0.136)

SC
Ln(TA)t-1 -0.230 -0.082 0.519 0.639
(0.681) (0.876) (0.335) (0.292)
EQAt-1 -0.216 -0.214 -0.145 -0.139
NU
(0.154) (0.142) (0.275) (0.321)
LIQAt-1 -0.019 -0.026 -0.033* -0.038**
(0.420) (0.289) (0.077) (0.046)
GDP -0.057** -0.059*** -0.087 ***
-0.088***
MA

(0.011) (0.006) (0.009) (0.006)

INF -0.057** -0.043* -0.043 -0.034
(0.043) (0.073) (0.101) (0.195)
FMD 0.008 0.007 -0.024 -0.020
D

(0.650) (0.684) (0.171) (0.269)

GFC 0.233 0.221 0.268 0.290
E

(0.229) (0.319) (0.181) (0.235)

AR 0.002 0.233
PT

(0.994) (0.731)
PM -0.013 -0.106
(0.952) (0.794)
CE

SUP 0.097 0.139

(0.494) (0.594)
CR 0.013 0.005
(0.884) (0.961)
AC

Constant -3.282 -6.874

(0.747) (0.583)
P-value:
∑𝑚 𝑚
𝑗=1 𝛽2𝑗 = ∑𝑗=1 𝛽3𝑗
0.5340 0.6190 0.1801 0.1913
Observations 1267 1267 1406 1406
Number of Banks 139.000 139.000 139.000 139.000
P(Hansen) 0.096 0.152 0.073 0.143
P(AR1) 0.007 0.006 0.006 0.006
P(AR2) 0.866 0.782 0.960 0.879
p-values in parentheses
*
p < 0.1, ** p < 0.05, *** p < 0.01
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Table 9: Risk and Financing Growth of Islamic Banks

Independent System GMM LSDVC

Variables (1) (2) (3) (4) (5) (6)
NPLt-1 1.034*** 0.946*** 1.038*** 0.990*** 1.094*** 1.075***
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
Lt-1 0.034 0.026 0.035 0.012 0.036*** 0.027**
(0.208) (0.259) (0.371) (0.688) (0.008) (0.045)
Lt-2 0.037*** 0.023** 0.045** 0.031*** 0.036*** 0.027**
(0.000) (0.016) (0.010) (0.003) (0.008) (0.049)
Lt-1 × GFCt-1 -0.007 -0.006 0.016 0.003

PT
(0.791) (0.772) (0.507) (0.898)
Lt-2 × GFCt-2 -0.024 0.004 -0.026 -0.030
(0.657) (0.915) (0.252) (0.192)

RI
Ln(TA)t-1 0.492 -0.080 0.407 0.183 0.474 0.462
(0.669) (0.972) (0.729) (0.907) (0.393) (0.480)
EQAt-1 -0.229*** -0.164 -0.244* -0.205* -0.130** -0.163***

SC
(0.006) (0.131) (0.051) (0.058) (0.014) (0.002)
LIQAt-1 0.033 0.025 0.031 0.001 0.018 0.004
(0.685) (0.603) (0.741) (0.975) (0.567) (0.910)
NU
GDP -0.116 -0.039 -0.108 -0.003 -0.039 -0.038
(0.318) (0.638) (0.332) (0.976) (0.626) (0.633)
INF -0.018 -0.006 -0.020 -0.002 -0.037 -0.045
MA

(0.350) (0.830) (0.387) (0.968) (0.437) (0.343)

FMD 0.003 0.031 0.011 0.025 0.058* 0.082**
(0.952) (0.508) (0.766) (0.484) (0.092) (0.022)
GFC -0.582 0.368 -0.843 0.064 -0.517 -0.084
D

(0.546) (0.633) (0.597) (0.969) (0.443) (0.907)

AR 1.823 -0.693 1.294**
E

(0.170) (0.761) (0.014)

PM -1.881** -1.360** -1.039***
PT

(0.027) (0.048) (0.001)

SUP 1.218** 1.163** 0.783***
(0.015) (0.024) (0.000)
CE

CR 0.057 0.106 -0.229

(0.755) (0.549) (0.111)
Constant -6.609 -7.521 -5.585 -7.021
AC

(0.659) (0.825) (0.750) (0.787)

Observations 251 251 251 251 251 251
Number of 25 25 25 25 25 25
Banks
P(Hansen) 0.977 0.999 0.963 1.000
P(AR1) 0.077 0.118 0.078 0.053
P(AR2) 0.843 0.862 0.978 0.935
p-values in parentheses
*
p < 0.1, ** p < 0.05, *** p < 0.01
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HIGHLIGHTS
 Investigate the lending growth, deposit growth and credit risk of Islamic and
conventional banks during the crisis
 Lending growth of Islamic banks is resilient to the crisis
 No different in deposit growth of Islamic and conventional banks during the crisis
 No evidence of excessive risk taking by Islamic banks in their expansion of lending

PT
RI
SC
NU
MA
E D
PT
CE
AC