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Measurement of the displaced commercial risk in Islamic Banks

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  • Toumi, Kaouther
  • Viviani, Jean-Laurent
  • Chayeh, Zeinab

Abstract

The objective of the research is to quantify the displaced commercial risk (DCR) based on quantitative finance techniques. We develop an internal model based on the Value-at-risk (VaR) measure of risk to assess the DCR-VaR and the alpha coefficient αCAR in the capital adequacy ratio of Islamic banks. We identify first the scenarios of exposure of Islamic banks to DCR that depend on the actual return on unrestricted profit sharing investment accounts (PSIAU), the benchmark return as well as the level of the existing profit equalization reserve (PER) and investment risk reserve (IRR). Second, we quantify the DCR-VaR and the alpha coefficient αCAR−VaR for a given holding period and for given confidence level. We illustrate the DCR-VaR model on selected Islamic banks from Bahrain. Our model helps to better assess the needed equity to cover the DCR and an accurate capital adequacy ratio for Islamic banks. The model has also policy implications for regulators and the IFSB to develop better guidance on good practices in managing this risk.

Suggested Citation

  • Toumi, Kaouther & Viviani, Jean-Laurent & Chayeh, Zeinab, 2019. "Measurement of the displaced commercial risk in Islamic Banks," The Quarterly Review of Economics and Finance, Elsevier, vol. 74(C), pages 18-31.
    • Handle: RePEc:eee:quaeco:v:74:y:2019:i:c:p:18-31
    DOI: 10.1016/j.qref.2018.03.001
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    References listed on IDEAS

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    More about this item

    Keywords

    Displaced commercial risk; Value-at-risk; Extreme value theory; Profit equalization reserve; Investment risk reserve; Capital adequacy ratio;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • Z12 - Other Special Topics - - Cultural Economics - - - Religion

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