The determinants of capital ratios in Islamic banking

Abstract

We investigate the determinants of capital ratios in contemporary Islamic banking using a sample comprising 122 Islamic banks (IBs) spanning the period 2000-2014. We measure IBs' capital holdings using the capital-to-total assets ratio, the capital adequacy ratio, and the tier 1 capital ratio. We use the system Generalized Method of Moments estimator to tackle any possible issues of endogeneity and omitted variable bias. The results show that IBs' capital ratios are persistent over time, revealing the existence of short-term adjustment costs. In addition, protection of shareholder rights seems to have a positive and robust effect on IBs' capital holdings, whereas bank size, deposit structure, and bank competition are significantly negatively related to IB's capital ratios, thus confirming the "too-big-to-fail" effect. We also show that generous deposit insurance systems lead to lower IB's capital ratios.