Cost of capital of Islamic banking institutions: an empirical study of a special case

Purpose - The paper's purpose is to ascertain how computing the cost of capital for Islamic banks may differ from the case of conventional ones. Design/methodology/approach - The published accounts of four major Islamic banks were analysed, so as to test the set hypotheses. Also, two surveys were undertaken on this issue, one for banking officials; the other for depositors at a major Islamic bank. Findings - For Islamic banks, it became clear that deposit accounts were not a liability, as these fell within the definition of "profit-and-loss sharing" instruments. In fact, a high-positive correlation coefficient was apparent between an Islamic bank's market value and the size of its deposits. Also, the market value of Islamic banks was clearly independent of its cost of capital. Research limitations/implications – The two surveys expressed the views of respondents, and these could be subjective. Also, the core sample studied in depth was limited to four banks, and this could be widened in subsequent research. Practical implications - Risk associated with deposit-taking needs to be looked at differently in the case of Islamic banking institutions. Also, return provided to shareholders came out higher than for depositors. Originality/value - The paper sheds new light on how the cost of capital may be computed in the case of Islamic banks. Also, the relationship between depositors and shareholders is investigated, though additional research is required on this aspect