Risk exposure and performance in the banking sector : a comparative investigation of Islamic, conventional, and Islamic window banks

The core business of banks involves the operation of a payment system. They are also perceived as primary sources of credit and a safe location for individuals and businesses that want to deposit cash. As a system, the banks play the role of facilitating resources from those who have more than they require (depositors) to those who need them (borrowers). Through playing this role, banks deliver benefits to all involved and the economy in general. However, there are inherent risks in this process which could leave the banks exposed to numerous kinds of threat that could have a severe impact on the banks themselves and the economy where they operate. Risk is a critical issue for banks as they act as risk intermediaries. Failure to manage this risk may result in a global market failure such as the recent financial crisis 2007-2009, which showed empirically how damaging a banking crisis can be. Upper and Worms (2004) showed that failure in a single bank might lead to a 15 percent breakdown of the entire banking sector in terms of assets.Focusing on the differences between Islamic, conventional, and Islamic window banks, this study investigates credit, liquidity, operating and solvency risk and its determinants for these three types of banks. It uses a sample of 950 banks from 55 countries during three periods: 2006-2015 (full sample period), 2007-2009 (global financial crisis), and 2010-2013 (sovereign debt crisis). The study proves, empirically, that risk in Islamic banks is substantially different from that in other types of banks. Islamic banks were stronger in credit position than conventional banks during the global financial and sovereign debt crises. The results also suggest that Islamic banks are less stable with respect to liquidity-based risk, particularly during sovereign debt crisis. The results also reveal Islamic banks have more operating and insolvency risk. Furthermore, the findings suggest that risk in Islamic banks is generally determined differently from conventional and Islamic window banks by the bank-specific factors and the macroeconomic factors of the countries in which the banks operate.Another main focus of this study is to investigate the drivers of financial institutions’ performance. In particular, this study examines the effect of four different types of risk (credit, liquidity, operating, and insolvency risk) on performance. We employed a large sample of 950 banks from 55 countries; we divide the periods into three periods: 2006-2015 (full sample period); 2007-2009 (global financial crisis); and 20110-2013 (severing debt crisis). Remarkably, it can be noted from the statistical regression that operating risk is the most substantial risk, and credit risk is the least significant driver of bank's performance