Testing the Procyclicality and Financial Stability of Islamic Banking Industry

Abstract

The fnancial stability cyclical behavior is analyzed in this study which is seen as the risk taken by the Islamic banks for the period of 2013 to 2018. For this research study, researcher have used the dynamic panel data of 20 Islamic banks evaluated by the GMM (GMM) technique to investigate that whether the procyclicality in the fnancial stability of Islamic banks exist or not. The study found that there is no procyclicality or countercyclicality existing in the fnancial stability of Islamic banks which means that the risk taking behavior of Islamic banks is not infuenced either by the upturns or the downturns of the economy. In addition, the borrowing activities of the Islamic banks also have no infuence on the fnancial stability. Study found few signifcant results i.e. the proxy of insolvency risk i.e. Z sore of return on equity is found to be infuenced by the capitalization ratio and asset growth rate, risk adjusted asset returns is found to be infuenced by business cycle, capital measure i.e. CAPTA, BC*C and asset growth rate and risk adjusted market returns is infuenced by the capitalization ratio ETA and capital measure (CAPR). Study conclude that out of these three, asset growth rate affect the bank’s insolvency risk as compared to the others. This study is unique in nature and provide comprehensive model and added value to the previous researches. Study is helpful for the policymakers to understand the procyclicality testing and fnancial stability of Islamic banking sector