Impact and implications of capital adequacy ratio on the financing behaviour : evidence from Islamic banks in Pakistan

Abstract EN

The purpose of this study is to examine the impact of the Basel capital standards on financing behaviour of Islamic banks in Pakistan.

Literature has depicted mixed results on this issue (Bernanke and Lown, 1991; Ben Naceur and Kandil 2009, 2013).

This topic gains importance in the Islamic banking sector of Pakistan where capital adequacy ratio (CAR) is, on average, above than the minimum capital requirements (MCR) under Basel.

We have used Ben Naceur and Kandil (2013) model which is based on Berger and Udell (1994) approach with some adjustment to specifically convene to sample composition of 5 full-fledged Islamic banks for the period of 2005-2014 by using Panel data technique.

The results of the study confirmed a negative impact of capital adequacy ratio on the financing behaviour of Islamic banks in Pakistan.

It is also evident from the results that Islamic banks tend to reallocate their assets portfolio towards secured instruments e.g.

government securities like ╖uk┴k which led to their restricted financing activities and ultimately result in slower economic growth.

The study provides significant policy implications to regulators and bankers on the imposition of CAR and its trade-offs in terms of stability at the cost of the credit crunch and reallocation of assets portfolio by crowding out private sector financing in Pakistan.