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Market discipline and capital buffers in Islamic and conventional banks in the MENA region

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Abstract

This paper examines the effectiveness of market discipline in motivating banks to mitigate their default risk by using capital buffers against adverse effects in portfolio risk. Using a large sample of 126 banks from 9 MENA countries from 2009 to 2014, we study whether support, funding, and risk disclosure motivate banks to hold larger capital buffers to cover potential portfolio risk or not; and whether it affects differently Islamic and conventional banking sectors. Our paper findings provide evidence of the contradictory effects of these factors on Islamic banks compared to conventional banks. While government support results in higher capital buffers, stronger market discipline resulting from uninsured liabilities and disclosure results in larger capital buffers. Most factors look effective only for the conventional banking industry and ineffective for the Islamic banking industry due to its risk-sharing characteristic. Our paper findings provide evidence of the effectiveness of market discipline mechanisms, especially for the conventional banking industry. Moreover, high government support reinforces the disclosure and uninsured funding effects, especially for conventional banks. Finally, competition minimizes bank’s risk incentives.

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Notes

  1. https://www.gulfbase.com/ScheduleReports/33f7047f_BankruptcyintheGCC-MarkazResearch.pdf.

  2. The BankScope database provided information for the years 2009–2014.

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The authors did not receive support from any organization for the submitted work.

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Authors and Affiliations

  1. Higher Colleges of Technology, Abu Dhabi, UAE

    Rihab Grassa

  2. LIGUE-ISCAE, University of Manouba, Manouba, Tunisia

    Rihab Grassa & Nejia Moumen

  3. Tunis Business School, University of Tunis, Tunis, Tunisia

    Nejia Moumen

  4. University of New Orleans, New Orleans, LA, 70148, USA

    M. Kabir Hassan

  5. Portsmouth Business School, Portsmouth University, Portsmouth, UK

    Khaled Hussainey

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  1. Rihab Grassa
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  2. Nejia Moumen
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  3. M. Kabir Hassan
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Correspondence to Rihab Grassa.

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Appendix

Appendix

See Appendix Tables 7, 8, 9.

Table 7 Country-wide distribution of sample
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Table 8 Variable definitions and data sources
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Table 9 Credit rating classifications
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Grassa, R., Moumen, N., Kabir Hassan, M. et al. Market discipline and capital buffers in Islamic and conventional banks in the MENA region. Eurasian Econ Rev 12, 139–167 (2022). https://doi.org/10.1007/s40822-021-00195-0

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  • DOI: https://doi.org/10.1007/s40822-021-00195-0

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