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Capital Adequacy Ratios, Efficiency and Governance: a Comparison Between Islamic and Western Banks

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Author Info
Lucia Dalla Pellegrina
Abstract

The profit and loss sharing principle that is peculiar to Islamic finance reformulates the allocation of risk between stakeholders. Since in Islamic banks depositors are closer to stockholders in terms of residual claiming on profits, the relationship between capitalization and efficiency should in principle be weaker than in their Western counterparts. Results, obtained by means of a stochastic cost frontier analysis on samples of European-15 and Islamic banks during the period 1996-2002, show that the ratio of equity to deposits negatively affects inefficiency in both types of banks, but this effect is considerably undersized in Islamic banks as compared to European ones. This supports the reluctance that has accompained the proposal of capital adequacy ratios for Islamic banks in accordance to Basel Agreements.

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Paper provided by Università degli Studi di Milano-Bicocca, Dipartimento di Statistica in its series Working Papers with number 20070402.

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Length: 27 pages
Date of creation: Apr 2007
Date of revision: Apr 2007
Handle: RePEc:mis:wpaper:20070402

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Related research
Keywords: Islamic Banks capital governance.

Find related papers by JEL classification:
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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  1. Maudos, Joaquin & Pastor, Jose M. & Perez, Francisco & Quesada, Javier, 2002. "Cost and profit efficiency in European banks," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 12(1), pages 33-58, February. [Downloadable!] (restricted)
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  2. Dadang Muljawan & Humayon A. Dar & Maximilian J. B. Hall, 2004. "A capital adequacy framework for Islamic banks: the need to reconcile depositors' risk aversion with managers' risk taking," Applied Financial Economics, Taylor and Francis Journals, vol. 14(6), pages 429-441, March. [Downloadable!] (restricted)
  3. Cornwell, Christopher & Schmidt, Peter & Sickles, Robin C., 1989. "Production Frontiers With Cross-Sectinal And Time-Series Variation In Efficiency Levels," Working Papers 89-18, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
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  4. Douglas W. Diamond & Raghuram G. Rajan, 2000. "A Theory of Bank Capital," Journal of Finance, American Finance Association, vol. 55(6), pages 2431-2465, December. [Downloadable!] (restricted)
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  5. Kwan, Simon H. & Eisenbeis, Robert A., 1995. "An analysis of inefficiencies in banking," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 733-734, June. [Downloadable!] (restricted)
  6. Arturo Estrella & Sangkyun Park & Stavros Peristiani, 2000. "Capital ratios as predictors of bank failure," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 33-52. [Downloadable!]
  7. El-Hawary & Dahlia & Grais, Wafik & Iqbal, Zamir, 2004. "Regulating islamic financial institutions : The nature of the regulated," Policy Research Working Paper Series 3227, The World Bank. [Downloadable!]
  8. Concetta Chiuri, Maria & Ferri, Giovanni & Majnoni, Giovanni, 2002. "The macroeconomic impact of bank capital requirements in emerging economies: Past evidence to assess the future," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 881-904, May. [Downloadable!] (restricted)
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  9. Greene, William H., 1990. "A Gamma-distributed stochastic frontier model," Journal of Econometrics, Elsevier, vol. 46(1-2), pages 141-163. [Downloadable!] (restricted)
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