Impact of capital inflows on bank profitability: a comparative analysis of dual banking systems

Osamah AlKhazali, Iness Aguir, Mohamad Husam Helmi and Ali Mirzaei

International Journal of Islamic and Middle Eastern Finance and Management, 2024, vol. 17, issue 3, 401-422

Abstract: Purpose - Using data on 739 banks from 22 countries with a dual banking system from 2012 to 2019, this paper aims to examine whether capital inflows affect banks’ profitability in recipient countries. Design/methodology/approach - The authors check the conjecture about the effect of capital inflows on the profitability of the host country’s banks by estimating the following regression:Pict=α0+α1·CFct+α2·Islamici+α3·CFct×Islamici+δ·Xict+θ·Yct+εict(1)where the dependent variable (Pict) refers to bank profitability, measured by eitherROAorROEfor banki, countrycand yeart.ROAis defined as the ratio of net profit to average total assets expressed as a percentage, which determines how efficiently a bank uses its assets to generate a profit.ROEis defined as the ratio of net profit to average total equity expressed as a percentage, which is a measure of increases in shareholders’ wealth. Findings - The authors find that capital inflows are generally positively associated with bank profitability. However, cross-border capital inflows reduce the rate of return in Islamic banks relative to their conventional counterparts. When decomposing inflows by instrument, the authors find that the enhancing role of capital inflows on bank profitability comes mainly from debt inflows and borrowers; the authors observe that the documented results emanate mostly from the inflows to the financial sector. These results remain unchanged if holding a bank’s risk constant. Overall, foreign funds in the form of debt inflows targeting the financial sector can disproportionately improve the performance of commercial banks in recipient countries. Originality/value - The paper is an original research project. The analysis contributes to the existing literature in several ways: the authors study whether the impact of capital inflows on bank profitability varies with the bank business model by looking at both the Islamic and conventional bank systems. The profitability of the banking system is an important catalyst for growth and stability. The authors also decompose capital inflows to recipient countries into their equity and debt components and study the differential impact of those components on the profitability of Islamic and conventional banks.

Keywords: Capital inflows; Bank profitability; Islamic banks; F21; F30; G21 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eme:imefmp:imefm-04-2023-0148

DOI: 10.1108/IMEFM-04-2023-0148

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