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Purpose In line with the IFSB and BCBS methodology, the purpose of this study is to undertake a comparative analysis of dual banking systems for asset-liability management (ALM) practices with the duration gap, in Islamic Commercial Banks (ICBs) and Conventional Commercial Banks (CCBs). Based on the research objective, two research questions are developed: How do the duration gaps of ICBs compare with those of similar sized CCBs? Are there any country-specific and regional differences among ICBs in terms of managing their duration gaps? Design/methodology/approach The research methodology comprises two-stages: stage one uses a duration gap model to calculate the duration gaps of ICBs and CCBs; stage two applies parametric tests. In terms of the duration gap model, the study determines the duration gap with a four-step process. The study selected a sample of 100 banks (50 ICBs and 50 CCBs) from 13 countries for the period 2009-2015. Findings The paper provides empirical insights into the duration gap and ALM of ICBs and CCBs. The ICBs have more variations in their mean duration gap compared to the CCBs, and they have a tendency for a higher (more) mean duration gap (28.37 years) in comparison to the CCBs (11.79 years). The study found ICBs as having 2.41 times more duration gap compared to the CCBs, and they are exposed to increasing rate of return (ROR) risk due to their larger duration gaps and severe liquidity mismatches. There are significant regional differences in terms of the duration gap and asset-liability management. Research limitations/implications Future studies also consider “Off-Balance Sheet” activities of the ICBs, with multi-term duration measures. A larger sample size of 100 ICBs with 10 years’ data after the GFC would be more beneficial to the industry. In addition, the impact of an increasing benchmark rate (e.g. 100, 200 and 300 bps) on the ICBs as per the IFSB 20 per cent threshold can also be established with the duration gap approach to identify the vulnerabilities of the ICBs. Practical implications The study makes profound contributions to the literature and suggests various policy recommendations for Islamic banks, regulators, and standard setters of the ICBs, for identifying and measuring the significance of the duration gaps; and management of the ROR risk under Pillar 2 of the BCBS and IFSB, for financial soundness and stability purposes. Originality/value To the best of the authors’ knowledge, this is a pioneer study in Islamic banking involving a sample of 100 banks (50 ICBs and 50 CCBs) from 13 countries. The results of the study provide original empirical evidence regarding the estimation of duration gap, and variations across jurisdictions in terms of vulnerability of ICBs and CCBs in dual banking systems.

Post-global financial crisis scenario has presented extraordinary challenges to the global economy, in general, and the banking industry, in particular. This has brought the financial industry to a set of new challenges including risk management in changing benchmark rates risk for Islamic banks. Thus, in recent years, the management of benchmark rates (or interest rates) received considerable prominence in the banking sector due to a number of reasons including supervision of banks' benchmark rates under Basel II Pillar II. Taking into account the specific features of Islamic banks, the purpose of the paper is to theoretically and empirically review the possible prudential implications of lowly and increasing benchmark rates risk, and provide a sturdy risk management and regulatory perspective for Islamic banks and supervisors. For low rates perspective, policy rates of 12 central banks were collected and analyzed. However, for increasing rates scenario, we used duration gap and stress testing approaches, with a sample of 50 Islamic banks from 13 countries, for the period 2009-2015. Our empirical results indicate that persistently low benchmark rate regime carries strategic implications for Islamic banks including pressure on profitability, excessive risk taking and distortion in credit allocations. On the other hand, an increasing benchmark rate regime indicates the significant loss of the capital base, emergence of displaced commercial risk causing early withdrawals by the customers due to higher expectations in dual banking systems. This study concludes that implications under both scenarios call for a better risk management with appropriate tools and effective supervisory oversight for Islamic banks.

Purpose This paper aims to provide a methodology for designing and conducting solvency stress tests, under the standardised approach as per IFSB-15, including the establishment of macro-financial links, running scenarios with variation of assumptions and stress scenario parameters; apply and illustrate this methodology by providing a stylised numerical example through a tractable Excel-based framework, through which Islamic Commercial Banks (ICBs) can introduce additional regulatory requirements and show that they would remain in compliance with all capital requirements after a moderate to severe shock; and identify the potential remedial actions that can be envisaged by an ICB. Design/methodology/approach The paper uses the data of the one of the groups to which certain amendments and related assumptions are applied to develop a stylised numerical example for solvency stress-testing purposes. The example uses a Stress Testing Matrix (STeM; a step-by-step approach) to illustrate the stress-testing process. The methodology of the paper uses a two-stage process. The first stage consists of calculating the capital adequacy ratio (CAR) of the ICB using the IFSB formulae, depending on how the profit sharing investment account (PSIA) are treated in the respective jurisdiction. The second stage is the application of the stress scenarios and shocks. Findings Taking into account the specificities of ICBs such as their use of PSIA, the results highlighted the sensitivity of the CAR of an ICB with respect to the changes in the values of alpha and the proportion of unrestricted PSIA on the funding side. The simulation also indicated that an ICB operating above the minimum CAR could be vulnerable to shocks of various degrees of gravity, thus bringing the CAR below the minimum regulatory requirement and necessitating appropriate remedial actions. Practical implications The paper highlights various implications and relationships arising out of stress testing for ICBs, including the vulnerability of an ICB under defined scenarios, demanding appropriate immediate remedial actions on future capital resources and capital needs. The findings of the paper provide a preliminary discussion on developing a comprehensive toolkit for the ICBs similar to what is developed by the International Monetary Fund Financial Sector Assessment Programme. Originality/value This paper focuses on the gap with respect to the stress testing of capital adequacy. The main contribution of the paper is twofold. The first is the development of an STeM – a step-by-step approach, which provides a method for simulating solvency (i.e. capital adequacy) stress tests for ICBs; the second is the demonstration of the potentially crucial impact of profit-sharing investment accounts and the way they are managed by ICBs (notably the smoothing of profit payouts) in assessing the capital adequacy of the ICBs.

With the current cross-border growth in Islamic finance, Islamic commercial banks (ICBs) are looking forward to being perceived as an industry in the process of becoming mature. This would require the establishment of some basic infrastructure, including sophisticated risk management tools that enhance the soundness and resilience of the ICBS. This paper focuses on the latter that is the role and significance of stress testing as a risk management tool. The stress testing has become part of the regulatory and supervisory authorities within the financial stability analysis. The global financial crisis (2008) has placed the spotlight squarely on stress tests. Though, ICBs operate within the similar financial environment, and their balance sheet composition, however, calls for different treatment in stress testing. Apart from the specificities of ICBs, there are key issues and challenges that should be given due considerations in developing an appropriate stress testing regime. This paper explores key specificities and challenges. The paper argues that in the beginning, conducting the stress testing may not appear a simple task for the ICBs. However, a proper consideration to the challenges identified in the paper would certainly tend to improve the overall effectiveness and credibility of the stress testing programmes.