Life after Debt: The Effects of Overleveraging on Conventional and Islamic Banks

Abstract

It is generally argued that Islamic banks are safer than conventional banks. The prime reason is that their product structure is essentially asset-backed financing, while conventional banks rely heavily on leveraging, which was considered one of the main causes of the 2008 global financial crisis. This paper examines the riskiness of Islamic and conventional banks during the 2008 global crisis by measuring overleveraging, defined as the difference between actual and optimal debt. This research conducted empirical analysis on the overleveraging of 20 banks (10 conventional and 10 Islamic banks) from five different countries, namely, Bahrain, Kuwait, Malaysia, the United States, and the United Kingdom. The analysis is double-folded: on the one hand, the results in this paper suggest that excess debt, rather than the mere holding of debt, was the reason behind the severe financial meltdown in 2007–2009; on the other hand, this paper shows that Islamic banks, in most of the countries in context, performed better during the recent crisis, but were subject to the second-round effect of the global crisis around the years of 2011–2013.

Shariah review of Brownian motion of Islamic stock market elements: establishing the benchmarks of Islamic econophysics

“…The fluctuations in stock markets have been predicted using various models. A model that has been used is geometric Brownian motion, which suggests that stock price movement has mathematical properties (Alijani et al , 2021; Issa, 2020). The observance of mathematical properties in stock market movements reduces the elements of gambling and makes the stocks more attractive for the investors who are more inclined to Shariah compliant investments.…”

“…Mnif et al (2020) use Brownian motion to forecast effect of news in behavioral aspect of Islamic financial analysis. Issa (2020) uses Brownian motion to compare risk and default of Islamic banks during crises and report that Islamic banks are better resilient toward crises. Besides, a more popular application of Brownian motion is in the area of Islamic stock markers.…”

The Impact of Liquidity, Credit, Financial Leverage Risks on Financial Performance of Islamic Banks: The Case of Sudanese Banking Sector

“…Also, the influence of bank's financial leverage or gearing on bank's ROA has been identified by Khalil and Khalil (2017) as insignificant while it has a positive influence on the ROE of Islamic banks in Pakistan from 2007 to 2015. Moreover, due to the expansion of Islamic banking, a comparative study conducted by Issa (2020) to compare the riskiness between Islamic and conventional banks during the 2008 global crisis. The author measured the overleveraging by the difference between actual and optimal debt by using a sample of 10 conventional and 10 Islamic banks from five countries.…”

Financial Crises and Business Cycle Implications for Islamic and Non-Islamic Bank Lending in Indonesia

“…In other words, the measure of overleveraging is defined as the difference between actual and optimal debt. The model presented in this paper follows Stein (2012b) and Issa (2020), and it focuses on the solution of the dynamic version of the Stein (2012b) model that allows us to use time-series data on banks in order to calculate the excess debt of eleven banks in Indonesia.…”