A structural model of “alpha” for the capital adequacy ratios of Islamic banks

Kenneth Baldwin, Maryam Alhalboni and Mohamad Husam Helmi

Journal of International Financial Markets, Institutions and Money, 2019, vol. 60, issue C, 267-283

Abstract: The denominator of the capital adequacy ratio (CAR) for Islamic banks includes an adjustment factor, alpha, arising from the subsidisation of investment account holders’ returns using bank equity. The methodology established by the risk management standard-setting body for Islamic banks, the IFSB, estimates an alpha for each country using panel-data and normally distributed asset returns for its credit institutions. Consequently, the IFSB methodology precludes bank-specific alphas linked to the actual risk profile of underlying assets. There is also no discernible mapping between alpha and a bank’s own propensity to subsidise cash returns. This paper instead develops a new theoretical model for bank-specific alpha that is estimated for 43 Islamic banks in 11 countries. Our alpha values broadly correspond with those of the IFSB. However, a form of regulatory arbitrage is shown to exist which favors banks with relatively high alphas. This finding also has policy implications for bank efficiency and systemic risk.

Keywords: Islamic banking; Capital adequacy ratio; Regulation; Displaced commercial risk; Alpha; Islamic financial services board (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:60:y:2019:i:c:p:267-283

DOI: 10.1016/j.intfin.2018.12.015

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