Stability versus fragility: new evidence from 84 banks

Abstract

Purpose This paper aims to examine whether competition from Islamic banks add to the financial stability and profitability of financial sector and to assess the sources of such (in)stability. Design/methodology/approach Using Herfindahl–Hirschman Index as a measure of competition and Z-score as a measure of stability, the authors run panel GMM regressions to assess their association with data from 84 banks in Indonesia and Malaysia over a period from 2005 to 2018. Findings Increasing competition from Islamic banks in East Asian banking industry adds to the stability of the system while it does not affect profitability. This stability is derived from both asset and liability side. Research limitations/implications While adding to the literature on banking and Islamic finance, this paper suggests to the policy makers that policies promoting Islamic banking will tend to assist in enhancing financial sector stability. Practical implications Growth in alternative financial instruments brings steadiness within the financial structure. Such growth and competition should be encouraged. Originality/value The paper exploits an interesting setting of dual-banking industry in two large Muslim-majority developing country for testing two competing theories: competition-fragility and competition-stability. Such a setting also allowed us to examine whether increasing stability of financial sector is driven by demand or supply.