Market-power, stability and risk-taking: an analysis surrounding the riba-free banking

Analysis of the trade-off between competition and financial stability has been at the center of academic and policy debate for over two decades and especially since the 2007-2008 global financial crises. This study aims to provide particular attention to the Islamic banking system which principally involves with the riba-free instruments as compared to the conventional interest-based system. The results show that an increase in the concentration in the conventional banking sector can lead to the deterioration of stability through the increased prices. For Islamic banks, an increase of the market power can positively affect the banking stability.

Two complementary approaches, namely, one-step generalized method of moment (GMM) system analysis and panel vector autoregressive (PVAR) framework, were applied.

The results show the same effect of Islamic and conventional banks’ market power on banking soundness; yet, a different effect is displayed with non-performing loans (NPLs). In particular, the “competition–fragility” assumption for both banking industries is supported when considering z-score as the dependent variable. Including NPLs, this postulation is still approved for conventional banks; however, the “competition–stability” postulation is supported for Islamic banks.

The existent literature was scarcely interested in exploring the concept of competitivity in the context of Islamic banking sector as compared to the conventional one by applying two complementary approaches, namely, GMM and PVAR. This later allows to test the effect and the feedback effect of the competition and stability concepts.