Financial stability comparison between Islamic and conventional banks pre and post the 2007 financial crisis using the GARCH models

Abstract EN

This study aims to empirically examine and compare the financial stability of Islamic and conventional banks pre and post the 2007 financial crisis, using the daily returns for the period (02/04/1999 to 01/10/2015.).

The study covers a sample of fifteen conventional and fifteen Islamic banks.

The conditional variance (volatility) of returns was used to measure the stability.

The GARCH, E-GARCH and GJR-GARCH models are used to estimate volatility due to their ability to take into account the leverage effect but depending on the log likelihood results, the EGARCH is seemed to be the best model that captured the stability of banks followed by the GJRGARCH.

Before performing the analysis a set of preliminary tests are applied :( normality, unit root and ARCH Effects (or Heteroskedasticity) tests).

The results showed that Islamic bank were more stable than conventional banks, which may due to their links with the real economy and to the nature of Islamic banking that works on the basis of risk sharing.

The customer and the bank share the risk of any investment on agreed terms, which increases the confidence of investors in these banks.

Especially that it does not deal in debt trading or rely on bonds or stocks and distances itself from market speculation.

These are prohibited under Islamic Shariah law, unlike most conventional banks.

These features make Islamic banks’ activities more closely related to the real economy and tend to reduce their contribution to excesses and bubbles.