CAMELS, risk-sharing financing, institutional quality and stability of Islamic banks: evidence from 6 OIC countries

Muhammad Rabiu Danlami, Muhamad Abduh and Lutfi Abdul Razak

Journal of Islamic Accounting and Business Research, 2022, vol. 13, issue 8, 1155-1175

Abstract: Purpose - This study aims to examine the nexus between CAMELS, risk-sharing financial performance and Islamic banks' stability. It also attempts to assess the conditioning effects of institutional quality in the relationship between risk-sharing contracts and the stability of Islamic banks. Design/methodology/approach - The quantitative research design was employed using secondary data from 20 Islamic banks in six countries over the period 2007–2019. The study utilized the feasible generalized least squares method for the analysis. Findings - The results indicate that not all CAMELS variables support the stability of Islamic banks. Themusharakahcontract induced stability of the banks, whereasmudarabahfinancing reduced it. The interaction between risk-sharing finance and the quality of institutions suggested that themudarabahcontract via institutional quality raises the stability of Islamic banks. On the other hand, the quality of institutions encourages the banks to offer moremusharakah, but it leads to an increase in their risk-taking. We show the impact of changes in risk-sharing variables on stability amplified by institutional quality. The results were robust when alternative measures of stability were used. Practical implications - Various stakeholders in banking activities could learn from the results of this study. Islamic banks could improve their positions in terms of screening for risk-sharing financing. They could also leverage more onmusharakah, as it promotes stability and could generate more returns for the banks. Themudarabahfinancing can be improved if there is a proper evaluation of entrepreneurs. Policymakers would learn more about the importance of institutional quality, as it provides a friendly environment for bothmudarabahandmusharakahbusinesses to thrive. This could increase the participation of Islamic banks in the real economy. Originality/value - Previous studies concentrated on the effects of CAMELS on the profitability of Islamic banks. This study shows that CAMELS alone might not necessarily capture the financial performance of Islamic banks. Therefore, the risk-sharing financing variables are included alongside CAMELS to determine their effects on stability. Second, unlike the past research, this study used the quality of institutions to moderate the nexus between risk-sharing financing and the stability of Islamic banks.

Keywords: Stability; CAMELS; Musharakah; Mudarabah; Quality of institutions; Risk-sharing financing; Risk-taking; Default risk; Leverage risk; Portfolio risk; Stability; Z-score; Islamic banks (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jiabrp:jiabr-08-2021-0227

DOI: 10.1108/JIABR-08-2021-0227

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