Risk Situation of Islamic Banks

Prof. Dr. Roland Kirstein (Economics of Business and Law, FWW, OvGU Magdeburg) and Prof. Dr. Zeki Akrawee (Department of Economics, College of Administration and Economics, University of Duhok) will carry out research into the impact of Basel equity regulation on Islamic banks.

Conventional banks usually do not take up more equity than stipulated by Basel equity regulation for internationally active banks. This observable preference for deposit funding is easily explained by the Capital Asset Pricing Model: As equity investments are more risky than deposits, their required rate of return is higher.

Islamic laws prohibit taking deposits and giving credit against interest. Hence, they force Islamic banks to fund their activities by equity and to invest into equity alone. On the one hand, their cost of funding, therefore, exceeds that of conventional banks. On the other hand, their return on investments may be higher as well.

One goal of the research project is to evaluate the net effect on the risk situation of Islamic banks, compared to conventional banks. We will draw on Portfolio theory to analyze this question.

The next research goal is to figure out whether Islamic banks have a competitive advantage (or disadvantage), compared to conventional bank that are active in the same market (if this market is subject to Islamic law, or not). This question will be analyzed using Oligopoly theory.

Thirdly, we want to empirically figure out how Islamic banks actually react to the twofold regulatory framework under which they operate. Do they accept differences in their profit, risk, and market situation, or do they develop idiosyncratic financial instruments as a response to the regulation? We will run interviews to prepare an explorative, qualitative study and employ Econometrics methods to evaluate market data.