Islamic Bank Capital Steering

The emergence of financial crises has emphasized the need for more stringent Basel standards in the banking sector. Among the key risks, capital risk has been a major contributor to the collapse of major financial institutions worldwide. This study focuses on the Islamic banking sector in Malaysia, aiming to identify the key determinants of capital risk. Using an unbalanced panel dataset of 14 Islamic banks, the study framed as a post-crisis historical analysis covering from 2007 to 2015. The study applies a fixed effects model (FEM) to analyze the data. A financial crisis interaction model is developed to empirically examine the significant role of financial crises in shaping capital risk. The findings indicate that financial crises significantly interact with the relationship between profitability and capital risk during both crisis and non-crisis periods. Specifically, banks with higher profitability face lower capital risk during the global financial crises, whereas the opposite holds true in non-crisis periods. Furthermore, the interaction model confirms the presence of moral hazard in too-big-to-fail institutions, as larger Islamic banks tend to hold lower equity capital, thereby increasing their capital risk exposure, particularly during financial crises. The study also highlights other key determinants of capital risk in Malaysian Islamic banks, including asset quality and bank liquidity.