۱- Introduction

۲- Literature review

۳- Variable selection and data

۴- Empirical approach

۵- Empirical analysis

۶- Conclusion

References

Abstract

Does market power condition the effect of bank regulations and supervision on bank risk taking? We focus on three regulatory tools: capital requirements, the restriction of activities, and official supervisory powers. Employing 10 years of unbalanced panel data on 123 Islamic and conventional banks operating in the Middle East and Asia, we arrive at the following conclusions. First, banking market power strengthens the negative impact of capital regulation on bank risk taking. Second, our empirical results suggest that the negative effect of activity restrictions on stability is diminished when banks have greater market power. Finally, we do not find strong evidence that the negative effect of supervisory power on banks’ risk taking is conditioned by their competitive behavior. In further analysis, we differentiate between Islamic and conventional banks regarding their competition, as well as their risk behavior. The results differ according to the banking business model. These findings could be useful for bank regulators in light of the accomplishment of Islamic banks’ regulatory framework. Indeed, the adoption of Basel III represents a significant regulatory challenge, given that it does not take into account the specificities of Islamic banks.

Introduction

The global financial crisis (GFC) of 2007–۲۰۰۹ highlighted just how fragile the banking system had become. Previous regulations failed to instill financial and systemic soundness and stability (Admati, 2014). Regrettably, not much has changed in the way of vigorous banking regulation. The question herein is why does banking regulation not work? Banking regulation aims mainly to mitigate systemic risk resulting from bank failure (Deli and Hasan, 2016) and, hence, protect depositors’ interests and maintain the financial health of the overall economy. Indeed, although regulators periodically set different levels of regulatory capital adequacy, the massive bank failures during the GFC and ensuing sovereign debt crisis revived the debate about regulatory norm effectiveness. An adequate bank regulation framework requires great appreciation of the bank behavior in the face of risk. It is a widespread view that such a framework involves a trade-off between capital regulation and bank risk taking. In this context, Altunbas et al. (2007) and Lee and Hsieh (2013) argued that this relation should be explored through two opposing hypotheses, namely, the moral hazard hypothesis and the regulatory hypothesis.