Economics of loan growth, credit risk and bank capital in Islamic banks

Abstract

PurposeThis study aims to analyze the moderating role of capital on the relationship between loan growth and credit risk for Islamic banks in the post-crisis era.Design/methodology/approachThe study used annual data of 217 Islamic banks from 38 countries and ranges from 2010–2019. The study applies a two-step system GMM method for hypotheses testing about the moderating role of bank capital on the relationship between loan growth and credit risk in Islamic banks.FindingsThe findings showed that an increase in loan growth increases the credit risk of Islamic banks, as evidenced by loan loss provisions, loan loss reserves and nonperforming loans. The results indicate that capital positively moderates the relationship between loan growth and credit risk in Islamic banking. The positive relationship between bank capital and risk-taking is in line with the “regulatory hypothesis” in banking. The findings predict lower impacts of capital on the relationship between loan growth and credit risk in the South Asian region than MENA, Africa, South, East and Central Asia regions. However, the impact of capital is higher for larger Islamic banks than medium and smaller ones.Practical implicationsThe findings of the study add value to the current debate on the role of bank capital to reduce risk-taking in Islamic banks. The study's findings have implications for policymakers, managers, especially in Islamic banking, for improving the Islamic financial system by managing the role of capital, loan growth and credit risk.Originality/valueThis is the first study to explore the moderating role of bank capital on the relationship between loan growth and credit risk in the post-crisis era, especially in Islamic banking. This is the first study in the Islamic banking context, which is providing empirical evidence for the impact of loan growth on the back looking and forward-looking proxies of credit risk under the moderating role of bank capitalization in the post-crisis era. This is the first study, which providing findings based on regions and size to compare the differences in Islamic banks for the impact of loan growth on credit risk under the moderating role of capitalization.