The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1086-7376.htm

Stability
Stability versus fragility: new versus
evidence from 84 banks fragility
Mohsin Ali
Taylor’s Business School, Taylor’s University, Subang Jaya, Malaysia
Omair Haroon and Syed Aun R. Rizvi
Suleman Dawood School of Business, Lahore University of Management Sciences, Received 13 April 2020
Revised 10 July 2020
Lahore, Pakistan, and 30 July 2020
31 July 2020
Wajahat Azmi 8 August 2020
Accepted 9 August 2020
Taylor’s Business School, Taylor’s University, Subang Jaya, Malaysia

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.
Keywords Profitability, Stability, Competition, Dual banking economies
Paper type Research paper

1. Introduction
Islamic banking has become a rapidly growing phenomenon over the past decade.
Especially in the aftermath of the global financial crisis in 2008, the fragility of conventional
banking system has become evident, urging policymakers, regulators and researchers to
shift their focus to Islamic banking, which was contended as being more stable because of
its inherent resilience. Mirakhor (2008), Hasan and Dridi (2011), Beck et al. (2013) and
Ibrahim and Rizvi (2017, 2018) have empirically found Islamic banks to be better performers
than their conventional counterparts during the crisis. However, a limited number of studies
have concluded that Islamic banks did not outperform conventional banks during the crisis
period (Azmi et al., 2019; Narayan and Phan, 2019). Nonetheless, the Islamic banking sector
Studies in Economics and Finance
© Emerald Publishing Limited
1086-7376
JEL classification – G21, G33, G38 DOI 10.1108/SEF-04-2020-0109
SEF has since become a significant component of financial systems in several countries and is
becoming increasingly attractive, as it is found to be less fragile because of its asset-backed/
based business model (Cihak and Hesse, 2010).
One of the major markets for Islamic banking is the East Asian economies, especially
Malaysia and Indonesia, both Muslim-majority countries that share a language, culture,
history and demographic dynamics. Islamic banks have been gaining traction in Indonesia,
which has the world’s largest Muslim population (Rizvi et al., 2019), but, in terms of Islamic
Banking share still remains in the single digits. Meanwhile, across the border, in Malaysia,
with its much smaller population, Islamic banking has been steadily gaining ground, with
nearly a quarter share of the overall banking sector. Although the share of Islamic banking
is still small in both countries relative to conventional banking, its growth potential raises
questions that need answers. Our paper is in response to these questions. We investigate
whether competition from Islamic banks adds to overall financial stability and profitability.
We then test the source of any such stability/instability. The results at this stage seem to be
leaning toward competition–stability theory, where the presence of Islamic banks has not
impacted profitability but has made the banking industry more stable. Figures 1 and 2 show
the growth of Islamic banking indicators (assets, financing and deposits) in Indonesia and
Malaysia, respectively.
The presence and growth of Islamic banks in the East Asian market have put into
questions whether conversion toward a dual banking system (i.e. Islamic and conventional
banks) enhances the stability of the banking sector. This leads one to further question
whether this stability/instability is asset driven or liability driven. These questions are
crucial, as the stability of the financial sector is essential to a country’s economic growth
(Levine, 2005; Wolde-Rufael, 2009; Creel et al., 2015; Pradhan et al., 2015).
This paper explores these above-mentioned questions within the novel dimension of the
dual banking system of Indonesia, East Asia’s largest economy, and Malaysia, the major
Islamic financial destination. The study focuses on whether the banking sector has become
more stable, given the introduction and growth of Islamic banks over the past decade. The

20.00%

15.00%

10.00%

5.00%
Figure 1. 0.00%
Islamic banking Years 2013 2014 2015 2016
growth in Malaysia
Assets Financing Deposits

30%

20%

10%

Figure 2. 0%
Islamic banking Years 2013 2014 2015 2016
growth in Indonesia Assets Financing Deposits
evidence suggests a more stable banking industry, which is further evidence that Islamic Stability
banking assets and liability growth are stable and contribute to the positive reinforcement versus
of the financial system.
This study finds similar findings as the broader study of Azmi et al. (2019), who examine
fragility
all dual banking countries. This study is the first to focus on Southeast Asian countries. It
contributes to the literature in two ways, with a unique focus on the banking industry of the
world’s largest Muslim population. First, it adds to the debate on competition and banking
stability, which is currently split between two opinions. Two theories have focused on
fragility and stability, namely, competition–fragility theory and competition–stability
theory. Competition–fragility theory has suggested that the entry of new players into the
market can lead to a drop in the market share of financial institutions, and hence lower
profitability. This result leads to banks increasing their risky assets to offset the losses
(Allen and Gale, 2000; Hellmann et al., 2000). This theory has been empirically examined in
the recent works of Jiménez et al. (2013) and Weill (2013), who find evidence supporting
competition–fragility theory. Contrary to this line of argument, competition–stability theory
argues that the increase in market power leads to an increase in bank risk. As Stiglitz and
Weiss (1981) propose, lower competition results in an increase in loan rates, and borrowers
therefore tend to move to riskier projects (Leroy and Lucotte, 2016). Empirical evidence
supports this theoretical paradigm (Fiordelisi and Mare, 2014; Schaeck and Cihak, 2014;
Pawłowska, 2015).
Second, this study adds to the debate on the source of stability provided by Islamic banks
in the system. Only a few studies have explored the topic of Islamic banking stability
overall. Hasan and Dridi (2011), Beck et al. (2013) and Ibrahim (2016) paint a bright picture of
Islamic banks, due to their increasing supply of credit during crisis episodes. However,
points of contention remain, as highlighted by Mejia et al. (2014) and Kabir and Worthington
(2017).
The contradictory empirical evidence in both streams of the literature creates a dilemma
regarding the ways competition can be used by the central bank as an effective policy
measure to enhance banking stability and performance. This study first attempts to
ascertain whether the presence of Islamic banks adds to the stability and performance of the
banking system in East Asia. It then examines, whether asset side or liability side, how
stability is provided by the presence of Islamic banks.
The remainder of the study is organized as follows. Section 2 describes the data and the
measures that have been calculated to explore the research objectives. An empirical analysis
follows in Section 3, and Section 4 concludes the study with a policy analysis.

2. Data and methodology

The data used in this study were collected from the Fitch Connect database and verified
through the individual financial reports of the banks in both Indonesia and Malaysia. The
sample comprises 84 banks, with 70 conventional banks and 14 Islamic banks. The data
span from 2005 to 2016. The banks were chosen based on two main parameters: first, the
bank had to have at least five years of data after 2005 available from the Fitch Connect
database and, second, the data could be verified through cross-checking with the financial
statements of the individual banks. Although this approach could have restricted our
sample size, the reliability of the data is of primary importance.
To explore the stability and profitability of the banking sector in the presence of
competition from Islamic banks, the study creates measurements of the competition,
stability and profitability, as discussed below.
SEF 2.1 Measurement of competition
In this paper, the main approach to estimate competition is based on the Herfindahl–
Hirschman Index (HHI), and we use the Boone (2008) index for robustness. We estimate the
HHI as the sum of the squares of the market shares of each bank:

X
j
HH Index ¼ ðMarket sharen Þ2 (1)
n¼1

The reason for relying on the Boone index as the robustness variable is its apparent
advantage over traditional measures, such as H-statistics, the Lerner index and the
concentration ratio. The intuition underlying the Boone index is rooted in the efficiency
hypothesis, which argues that performance is correlated with efficiency (Demsetz, 1973).
Specifically, this hypothesis maintains that banks with a lower cost-to-income ratio (CIR),
that is, banks with cost advantages, can gain superior performance and grow at the cost of
their less efficient counterparts. Relaxed entry restrictions strengthen this effect further.
CIR, also termed profit elasticity, is an estimation of the percentage loss due to an
increased marginal cost of 1%. Hence, the intuition is that an increase in competition, due to
either products becoming close substitutes or relaxed entry restrictions, will lead to the
superior performance of efficient banks, compared to the performance of less efficient banks.
Hence, the Boone index takes the following form:

p it ¼ a þ b lnMCit þ e it (2)

where p it is the profit of bank i at time t, b is the Boone index or profit elasticity, and MC is the
marginal cost. As marginal cost is unobservable, we follow Schaeck and Cihak (2012, 2014) and
approximate it by using average costs [1]. As competition strengthens this negative relation,
the greater the bank competition, the more negative the Boone index will be.

2.2 Measurement of stability

To measure stability, we use the Z-score, following the banking literature (Lepetit et al.,
2008; Laeven and Levine, 2009; Cihak and Hesse, 2007, 2010). For robustness purposes, we
use the ratio of the alternative loan loss provision (LLP) to the bank’s equity. The Z-score is
estimated as follows:

ROA þ TA
E
Z  score ¼ (3)
s ROA

where ROA is the return on assets, E/TA is the ratio of equity to total assets and s ROA is
the standard deviation of the return on assets. The Z-score reflects the probability of banks
becoming insolvent, with a higher Z-score indicating a lower probability.
After estimating the competition and stability measures, we run the following
specification to test stability, using two proxies for our stability measure:
Stabilityi;j;t ¼ a þ b 1 Stabilityi;j;t1 þ b 2 Competitionj;t ; þ b 3 GDP per capitaj;t
þ b 4 Islamic banking sharejt þ b 5 Zi;j;t þ þ « i;t
(4)
where Stabilityi,j,t refers to the Z-score and the ratio of the LLP to the equity of bank i at time Stability
t in a country; Competitioni,j refers to our estimated HHI and the Boone index; Islamic versus
banking share refers to the share of Islamic banks in terms of assets in the banking industry;
Z refers to the control variables, such as the cost-to-income ratio, total assets, the
fragility
diversification index, and the ratio of loans to total assets; and Islamici,j is a dummy variable
that takes the value of one if bank i is an Islamic
h bank [2]. Following Cihakiand Hesse (2010),
Net interest income  other operating income
the diversification index is given by 1  Total operating income , where a higher
number indicates a higher degree of diversification. Operating income includes trading
income, fee-based income, income from investments and so forth.

2.3 Measurement of profitability

To explore profitability, we use two alternative measures: ROA and the return on equity,
ROE. The control variables in the above two equations are the same. A dummy variable is
used for the crisis period, interacting with the Islamic bank dummy, to investigate the
impact of the crisis on the stability and performance of Islamic banks. Following Azmi et al.
(2019), we present the following equation to explain bank profitability, where we expect
competition to negatively impact profitability and the GDP per capita and the Islamic
banking share are expected to increase bank profitability:

Profitabilityi;j;t ¼ a þ b 1 Profitabilityi;j;t1 þ b 2 Competitionj;t þ b 3 GDP per capitaj;t

þ b 4 Islamic banking sharejt þ b 5 Zi;j;t þ « i;t
(5)

We use the generalized method of moments (GMM), because it suits our data set with a
smaller time span and a large number of banks, and it addresses cross-sectional dependence
and heterogeneity. We use system GMM because it is considered superior to difference
GMM, because it helps overcome the issue of weak instruments. For the purpose of
robustness, we use different proxies of stability, profitability and competition.

3. Analysis
3.1 Stability and competition through Islamic banks
Our analysis begins by exploring whether the presence of Islamic banks adds to the stability
of the banking system. The results of our panel system GMM are presented in Table 1. The
results suggest that the cost-to-income ratio has a significant negative relation with
stability, as expected for all the models. This finding highlights that competition has
reduced the cost function of the banking industry. Further, specific to Islamic banks, the
interaction term between the Islamic bank dummy and the diversification variable is
significantly positive, which suggests that diversification brings greater benefits to Islamic
banks in general. This could be due to the range and characteristics of the tools (contracts)
used by Islamic banks in performing nontraditional activities. The types of nontraditional
activities of Islamic banks mostly differ from those of their conventional counterparts,
which could be the reason for the stronger impact of diversification on the stability of
Islamic banks. Size has a negative impact on the stability and profitability of banks.
According to Boyd et al. (2006), one of the possible reasons for this could be the issue of
endogeneity. As bank size and competition are endogenously determined, without an
instrumental variable approach, they could be negatively associated. However, as we are
using panel GMM, which takes care of endogeneity, we can rule out the endogeneity issue.
SEF Panel A (Z Score) Panel B (LLP)
Competition proxy HH index Boone index HH index Boone index

Z Score (1) 0.0652 0.0659**

–0.1 -0.031
Loan loss provision (1) 0.0513*** 0.0450***
0 0
CIR 0.9236*** 1.2923*** 0.1211*** 0.1225***
0.001 0 0 0
LTA 0.021 0.1099 0.3756*** 0.3918***
0.862 –0.641 0 0
SIZE 0.2018 0.3927*** 0.1595*** 0.1735***
0.109 0.008 0 0
Diversification index 0.3831 0.5182* 0.0165*** 0.0249***
0.15 0.069 0 0
Diversification index * IB dummy 1.5438** 1.4539** 0.1242 0.2145***
0.021 0.027 0.015 0
Islamic banking share 1.2911* 0.6741 0.7555*** 0.3123***
0.093 –0.173 0 0
Islamic banking share * IB Dummy 1.2968*** 1.7060*** 0.4001*** 0.3123***
0.002 0 0 0
GDP per capita 0.1545 1.5124 0.6110*** 0.4117***
0.92 0.374 0 0
Competition 0.0095*** 12.6667 0.0008*** 0.2112**
0.001 –0.175 0 0.042
Competition * Islamic dummy 0.0023* 14.0879 0.0003*** 2.1994***
0.097 –0.514 0 0.004
Constant 22.4609 39.9456 10.2307*** 7.5432***
–0.431 –0.17 0 0
Hansen (p-values) 0.1629 0.1578 0.1994 0.1357
ar1p 0 0 0.3285 0.3005
ar2p 0.5003 0.409 0.6833 0.5881

Table 1. Notes: This table presents the GMM estimations for the Stability and competition nexus for the equation
(4). Panel A presents the findings with Z -score as measure of Stability while Panel B uses Loan loss
Stability through provision to equity (LLP) as stability measure. While the (1), and (2) in each panel represents the three
competition from alternative measures of competition; HH Index and Boone Index respectively. The superscripts ***, **, and
*
Islamic banks denote significance at the 1, 5 and 10% levels, respectively

Finally, irrespective of the proxy used (Z-score or LLP), the interaction between the Islamic
banking share and the Islamic banking dummy is positive and significant, suggesting that
an increase in the number of Islamic banks increases the stability of conventional banks.
This could the reason why the central banks of both Indonesia and Malaysia are pushing for
the growth of Islamic banking in their respective countries.

3.2 Profitability and competition through Islamic banks

Now that we have established that Islamic banks lend stability to the banking industry, we
explore whether they also contribute to enhanced profitability. In terms of using different
proxies for profitability, our findings remain inconclusive in terms of suggesting the higher
profitability of Islamic banks, compared to their conventional counterparts (Table 2). This
result is in contrast to the literature, which suggests that Islamic banks are more profitable
compared to conventional banks (Samad, 1999; Samad and Hassan, 1999; Iqbal, 2001;
 Panel A (ROA) Panel B (ROE)
Stability
Competition proxy HH index Boone index HH index Boone index versus
fragility
ROA (1) 0.0625*** (0.000) 0.0599*** (0.000)
ROE (1) 0.0441*** (0.000) 0.1111*** (0.000)
CIR 3.3155*** (0.000) 3.5100*** (0.000) 14.6114*** (0.000) 16.2536*** (0.000)
LTA 0.8421*** (0.000) 0.8412*** (0.000) 39.4521*** (0.000) 43.2584*** (0.000)
SIZE 0.0925 (0.107) 0.1041** (0.018) 23.1142*** (0.000) 13.5421*** (0.000)
Diversification index 0.8412*** (0.000) 0.8981*** (0.000) 0.6125 (0.321) 1.9522** (0.021)
Diversification index
* IB dummy 2.4114*** (0.000) 2.1120*** (0.000) 14.9933*** (0.002) 45.1254*** (0.005)
Islamic banking
share 0.3126** (0.031) 1.4127*** (0.000) 70.0145*** (0.000) 34.0012*** (0.000)
Islamic banking
share * IB dummy 0.5140 (0.289) 0.4113 (0.315) 23.5412 (0.104) 2.4512 (0.736)
GDP per capita 3.1127*** (0.000) 4.9998*** (0.000) 35.7422*** (0.000) 195.4520*** (0.000)
Competition 0.0035*** (0.000) 19.5414*** (0.000) 0.3452*** (0.000) 995.5521*** (0.000)
Competition *
Islamic dummy 0.0011 (0.608) 7.1422 (0.360) 0.4251*** (0.007) 250.4411 (0.311)
Constant 73.1513*** (0.000) 115.4121*** (0.000) 749.2356*** (0.000) 3451.2441*** (0.000)
Hansen (p-values) 0.1360 0.1223 0.1892 0.1882
ar1p 0.0033 0.0040 0.2951 0.2988
ar2p 0.0397 0.0389 0.5583 0.9511
Notes: This table presents the GMM estimations for the profitability and competition nexus for the Table 2.
equation (5). Panel A presents the findings with ROA as measure of Profitability while Panel B uses ROE as
profitability measure. While the (1), and (2) in each panel represents the three alternative measures of Performance through
competition; HH Index and Boone Index respectively. The superscripts ***, **, and * denote significance at competition from
the 1, 5 and 10% levels, respectively Islamic banks

Hassoune, 2002). It is important to note that most of these studies are nearly two decades
old, and Islamic banks in Indonesia are still small. However, our results are in line with those
of Turk-Ariss (2010), who suggests that Islamic banking operations do not necessarily bring
more rewards compared to their conventional peers. More importantly, there are very few
Islamic banks, in terms of satisfying the demand for Islamic banking products.
Additionally, our results suggest that the impact of diversification on profitability is
nonsignificant for Islamic banks.
Our findings indicate that greater competition is associated with higher stability. This
result conforms to the competition–stability paradigm. On the other hand, the findings
suggest that greater competition leads to lower profitability. The results could be justified,
as competition tends to decrease profits, whereas greater concentration in terms of market
share (lower competition) is associated with higher profitability. This result also shows that
the saturation of the banking industry in both countries has helped increase competition
and, in turn, improved stability.

3.3 Asset or lending-based stability

Now that we have established the stability that Islamic banks bring to the banking industry,
we further explore whether Islamic banks have greater stability in terms of lending and
their asset base. The few recent studies on this topic (Hasan and Dridi, 2011; Beck et al.,
2013; Ibrahim 2016) paint a bright picture of Islamic banks, for their stable and even
increasing supply of credit during crisis episodes. However, despite the alleged resiliency of
SEF Islamic banks, whether the Islamic banking sector is more stable than its conventional
counterpart remains debatable (Mejia et al., 2014; Kabir and Worthington, 2017).
To evaluate whether Islamic banks are able to sustain the growth of loans (deposits) over
time and have higher loan growth (deposit growth) than conventional banks, we test the
following model for loan (deposit) growth:

DLit ðDDit Þ ¼ b 0 þ b 1 IBit þ 1Controlit þ « it (6)

where DL is the ratio of the growth rate of gross loans to financing (DD is the growth rate of
deposit), IB is the Islamic bank dummy, Control is a vector of control variables comprising
bank-specific and macroeconomic variables and « it is the standard error term. The results
are presented in Table 3.
The positive and significant Islamic banking dummy suggests that Islamic banks
behave differently and have also been able to have a positive impact on their lending
and deposit growth rates over the sample period. These results suggest a positive
impact for Islamic banks in East Asia. Regarding the bank-specific control variables,
we find only bank size to have a significant and negative relation with lending and
deposit growth rates, suggesting that the larger the bank, the more challenges it has in
terms of growth. However, the relations for the control variables of liquidity,
profitability and cost efficiency are nonsignificant. The macroeconomic variables
generally have a significant and negative impact on lending and deposit growth rates,
which could be due to the political instability in Indonesia and Malaysia over the past
two decades affecting macroeconomic conditions.

4. Implication and direction for future research

While our findings support the stability argument for the dual banking economies, a major
factor which is critical for the financial sector in Malaysia and Indonesia is the energy mix.

Loan growth Deposit growth

Loan growth (1) 0.0515 (0.324)

Deposit growth (1) 0.1313*** (0.003)
Islamic bank 0.6711*** (0.004) 0.9015*** (0.000)
Size 0.1601*** (0.000) 0.1540*** (0.000)
Equity to total assets 0.0069 (0.186) 0.0116 (0.106)
Liquidity 0.0009 (0.908) 0.0001 (0.229)
ROAA 0.0119 (0.492) 0.0511* (0.100)
NPL 0.0102 (0.673) 0.0039 (0.626)
CIR 0.0004 (0.480) 0.0041** (0.033)
GDP growth 0.03338* (0.068) 0.0801*** (0.001)
Inflation 0.0017 (0.103) 0.0011 (0.870)
cons 2.1450*** (0.000) 2.4120*** (0.000)
Hansen (p-values) 0.1457 0.1880
ar1p 0.0000 0.0000
ar2p 0.3574 0.4120
Table 3.
Exploration of Notes: This table presents the GMM estimations for equation (6). The following table explores whether
growth in lending for IB is different in the banking system by using IB dummy in Column 1 and Column 2
lending and deposit explores whether Lending (deposit) growth is different for Islamic banks. The superscripts ***, ** and
growth of Islamic vs * denote significance at the 1, 5 and 10% levels, respectively. p-values in brackets *p < 0.1, **p < 0.05,
conventional banks ***
p < 0.01
Both countries are heavily energy dependent and, therefore, energy prices matter to the Stability
performance of their financial system (Ji et al., 2019; Mohsin et al., 2018). As a result, the versus
COVID-19 pandemic has put strains on the financial sectors of Malaysia and Indonesia. Oil
fragility
market uncertainty has heightened due to COVID-19 which has created economic
uncertainties. Devpura and Narayan (2020) show that daily oil price volatility has jumped to
nearly 20% owing to COVID-19. Several other recent studies demonstrate how the energy
market has changed in response to the COVID-19 pandemic; see, for instance, Apergis and
Apergis (2020), Gil-Alana and Monge (2020); Liu et al. (2020), Narayan (2020); Qin et al.
(2020), Huang and Zheng (2020); Iyke (2020a); and Prabheesh et al. (2020).
The related literature on recent COVID-19 and its effect on economies, despite being at a
nascent stage is exhaustive in terms of issues covered. The rising volatility due to COVID-19
has created uncertainty in the financial markets (Ali et al., 2020; Haroon and Rizvi, 2020a;
Haroon and Rizvi, 2020b; He et al., 2020a, 2020b; Chen et al., 2020; Mishra et al., 2020; Phan
and Narayan, 2020; Baig et al., 2020), and the labor market and global trade has been
influenced in different ways due to COVID-19 (Yu et al., 2020; Vidya and Prabheesh, 2020),
and the reactions of exchange rates have been studied by Iyke (2020b). These studies
highlight the critical nature of the recent pandemic and how it has impacted economies
across the world.
The main message of this literature is the increase in economic uncertainty which is
likely to exert stress on the banking sector. Gu et al. (2020), He et al. (2020a, 2020b), Shen
et al. (2020) and Qin et al. (2020) have documented how the pandemic has strained
businesses and the insurance industry. With a constrained corporate sector, the
Malaysian and Indonesian banks are expected to be under stress too and, we argue, that
the premise of the competition-stability theory presented in this paper can be revisited
in future research. Further research on the stability versus fragility arguments in the
banking sector should be developed along the lines that captures the effects of the
COVID-19 pandemic.

5. Conclusion
This paper adds to the complex debate about competition in the banking sector and its effect
on banking sector stability. The study adds to the novel dimension of Islamic banking
adding to competition in the cases of Indonesia and Malaysia. The results lend credibility to
the competition–stability theory argument and support the results of previous studies
(Fiordelisi and Mare, 2014; Schaeck and Cihak, 2014; Pawłowska, 2015). The findings
suggest that, first, the presence of Islamic banks adds to the stability of the banking
industry system, but does not affect profitability, and, second, the stability is derived from
both the asset and liability sides.
This paper provides insights for policymakers because it highlights that the
banking sector becomes more stable with the growth of Islamic banking. This is
finding is in line with the broader economic objectives of financial sector stability.
This could well be the reason why the central banks of both Malaysia and Indonesia
have been pushing to enhance the share of Islamic banking in their respective
countries (Table 3).

Notes
1. Another way of estimating the marginal cost is to calculate the translog cost function (Van
Leuvensteijn et al., 2011).
SEF 2. For the set of control variables, we refer to Angkinand and Wihlborg (2010), Jeon et al. (2011), and
Lee and Hsieh (2013, 2014).

References
Ali, M., Alam, N. and Rizvi, S.A.R. (2020), “Coronavirus (COVID-19) – an epidemic or pandemic
for financial markets”, Journal of Behavioral and Experimental Finance, Vol. 27,
p. 100341.
Allen, F. and Gale, D. (2000), Comparing Financial Systems, MIT Press, Cambridge, Massachussetts.
Apergis, E. and Apergis, N. (2020), “Can the COVID-19 pandemic and oil prices drive the US
partisan conflict index?”, Energy Research Letters, Vol. 1 No. 1, p. 13144, doi: 10.46557/
001c.13144.
Azmi, W., Ali, M., Arshad, S. and Rizvi, S.A.R. (2019), “Intricacies of competition, stability, and
diversification: Evidence from dual banking economies”, Economic Modelling, Vol. 83.
Angkinand, A. and Wihlborg, C. (2010), “Deposit insurance coverage, ownership, and banks’ risk-
taking in emerging markets”, Journal of International Money and Finance, Vol. 29 No. 2,
pp. 252-274.
Baig, A., Butt, H.A., Haroon, O. and Rizvi, S.A.R. (2020), “Deaths, panic, lockdowns and US equity
markets: the case of COVID-19 pandemic”, Finance Research Letters, doi: 10.1016/j.
frl.2020.101701.
Beck, T., Demirgüç-Kunt, A. and Merrouche, O. (2013), “Islamic vs conventional banking:
Business model, efficiency and stability”, Journal of Banking and Finance, Vol. 37 No. 2,
pp. 433-447.
Boone, J. (2008), “A new way to measure competition”, The Economic Journal, Vol. 118 No. 531,
pp. 1245-1261.
Boyd, J.H., De Nicolo, G. and Jalal, A. (2006), “Bank risk-taking and competition revisited”, IMF
Working Paper, WP/06/297.
Chen, C., Liu, L. and Zhao, N. (2020), “Fear sentiment, uncertainty, and bitcoin price dynamics: the case
of COVID-19”, Emerging Markets Finance and Trade, Vol. 56 No. 10, pp. 2298-2309, doi: 10.1080/
1540496X.2020.1787150..
Cihak, M. and Hesse, H. (2007), “Cooperative banks and financial stability”, IMF Working Paper
WP/07/2.
Cihak, M. and Hesse, H. (2010), “Islamic banks and financial stability: an empirical analysis”, Journal of
Financial Services Research, Vol. 38 No. 2-3, pp. 95-113.
Creel, J., Hubert, P. and Labondance, F. (2015), “Financial stability and economic performance”,
Economic Modelling, Vol. 48, pp. 25-40.
Demsetz, H. (1973), “Industry structure, market rivalry, and public policy”, The Journal of Law and
Economics, Vol. 16 No. 1, pp. 1-9.
Devpura, N. and Narayan, P.K. (2020), “Hourly oil price volatility: the role of COVID-19”, Energy
RESEARCH LETTERS, Vol. 1 No. 2, p. 13683, doi: 10.46557/001c.13683.
Fiordelisi, F. and Mare, D.S. (2014), “Competition and financial stability in European cooperative
banks”, Journal of International Money and Finance, Vol. 45, pp. 1-16.
Gil-Alana, L.A. and Monge, M. (2020), “Crude oil prices and COVID-19: Persistence of the shock”,
Energy Research Letters, Vol. 1 No. 1, p. 13200, doi: 10.46557/001c.13200.
Gu, X., Ying, S., Zhang, W. and Tao, Y. (2020), “How do firms respond to COVID-19? ”, First Evidence
from Suzhou, China, Emerging Markets Finance and Trade, Vol. 56 No. 10, pp. 2181-2197, doi:
10.1080/1540496X.2020.1789455..
Haroon, O. and Rizvi, S.A.R. (2020a), “Flatten the curve and stock market liquidity – an inquiry into Stability
emerging economies”, Emerging Markets Finance and Trade, Vol. 56 No. 10, pp. 2151-2161, doi:
10.1080/1540496X.2020.1784716.
versus
Haroon, O. and Rizvi, S.A.R. (2020b), “COVID-19: media coverage and financial markets behavior – a
fragility
sectoral inquiry”, Journal of Behavioral and Experimental Finance, Vol. 27, p. 100343.
Hasan, M. and Dridi, J. (2011), “The effects of the global crisis on Islamic and conventional banks: a
comparative study”, Journal of International Commerce, Economics and Policy, Vol. 02 No. 02,
pp. 163-200.
Hassoune, A. (2002), “Islamic banks’ profitability in an interest rate cycle”, International Journal of
Islamic Financial Services, Vol. 4, pp. 1-13.
He, P., Niu, H., Sun, Z. and Li, T. (2020a), “Accounting index of COVID-19 impact on Chinese industries:
a case study using big data portrait analysis”, Emerging Markets Finance and Trade, Vol. 56
No. 10, pp. 2332-2349, doi: 10.1080/1540496X.2020.1785866..
He, P., Sun, Y., Zhang, Y. and Li, T. (2020b), “COVID-19’s impact on stock prices across different
sectors – an event study based on the Chinese stock market”, Emerging Markets Finance and
Trade, Vol. 56 No. 10, pp. 2198-2212, doi: 10.1080/1540496X.2020.1785865..
Hellmann, T.F., Murdock, K.C. and Stiglitz, J.E. (2000), “Liberalization, moral hazard in banking, and
prudential regulation: are capital requirements enough?”, American Economic Review, Vol. 90
No. 1, pp. 147-165.
Huang, W. and Zheng, Y. (2020), “COVID-19: structural changes in the relationship between investor
sentiment and crude oil futures price”, Energy RESEARCH LETTERS, Vol. 1 No. 2, p. 13685,
doi: 10.46557/001c.13685.
Ibrahim, M. (2016), “Business cycle and bank lending procyclicality in a dual banking system”,
Economic Modelling, Vol. 55, pp. 127-134.
Ibrahim, M.H. and Rizvi, S.A.R. (2017), “Do we need bigger Islamic banks? An assessment of bank
stability”, Journal of Multinational Financial Management, Vol. 40, pp. 77-91.
Ibrahim, M.H. and Rizvi, S.A.R. (2018), “Bank lending, deposits and risk-taking in times of crisis: a
panel analysis of Islamic and conventional banks”, Emerging Markets Review, Vol. 35,
pp. 31-47.
Iqbal, M. (2001), “Islamic and conventional banking in the nineties: a comparative study”, Islamic
Economic Studies, Vol. 8 No. 2, pp. 1-28.
Iyke, B.N. (2020a), “COVID-19: the reaction of US oil and gas producers to the pandemic”, Energy
RESEARCH LETTERS, Vol. 1 No. 2, p. 13912, doi: 10.46557/001c.13912.
Iyke, B.N. (2020b), “The disease outbreak channel of exchange rate return predictability: evidence from
COVID-19”, Emerging Markets Finance and Trade, Vol. 56 No. 10, pp. 2277-2297, doi: https://doi.
org/10.1080/1540496X.2020.1784718.
Jeon, B.N., Olivero, M.P. and Wu, J. (2011), “Do foreign banks increase competition? Evidence from
emerging Asian and Latin American banking markets”, Journal of Banking & Finance, Vol. 34
No. 4, pp. 856-875.
Ji, Q., Zhang, H.Y. and Zhang, D. (2019), “The impact of OPEC on East Asian oil import security: a
multidimensional analysis”, Energy Policy, Vol. 126, pp. 99-107.
Jiménez, G., Lopez, J.A. and Saurina, J. (2013), “How does competition affect bank risk-taking?”, Journal
of Financial Stability, Vol. 9 No. 2, pp. 185-195.
Kabir, M.N. and Worthington, A.C. (2017), “The ‘competition-stability/fragility’ nexus: a comparative
analysis of Islamic and conventional banks”, International Review of Financial Analysis, Vol. 50,
pp. 111-128.
Laeven, L. and Levine, R. (2009), “Bank governance, regulation and risk taking”, Journal of Financial
Economics, Vol. 93 No. 2, pp. 259-275.
SEF Lee, C.C. and Hsieh, M.F. (2013), “The impact of bank capital on profitability and risk in Asian
banking”, Journal of International Money and Finance, Vol. 32, pp. 251-281.
Lee, C.C. and Hsieh, M.F. (2014), “Bank reforms, foreign ownership, and financial stability”, Journal of
International Money and Finance, Vol. 40, pp. 204-224.
Lepetit, L., Nys, E., Rous, P. and Tarazi, A. (2008), “Bank income structure and risk: an empirical
analysis of European banks”, Journal of Banking and Finance, Vol. 32 No. 8, pp. 1452-1167.
Leroy, A. and Lucotte, Y. (2016), “Structural and cyclical determinants of bank interest-rate pass-
through in the Eurozone”, Comparative Economic Studies, Vol. 58 No. 2, pp. 196-225.
Levine, R. (2005), “Finance and growth: theory and evidence”, in Aghion, P. and Durlauf, S. (Eds),
Handbook of Economic Growth, Elsevier Science, Amsterdam.
Liu, L., Wang, E.Z. and Lee, C.C. (2020), “Impact of the COVID-19 pandemic on the crude oil and stock
markets in the US: a time-varying analysis”, Energy Research Letters, Vol. 1 No. 1, p. 13154, doi:
10.46557/001c.13154.
Mejia, A.L., Aljabrin, S., Awad, R., Norat, M. and Song, I. (2014), “Regulation and supervision of Islamic
banks”, IMF Working Paper #WP/14/219.
Mirakhor, A. (2008), “Risk sharing and the systemic fragilities of debt-economy”, Intellectual Discourse,
Vol. 26.
Mishra, A.K., Rath, B.N. and Dash, A.K. (2020), “Does the Indian financial market nosedive
because of the COVID-19 outbreak, in comparison to after demonetisation and the GST? ”,
Emerging Markets Finance and Trade, Vol. 56 No. 10, pp. 2162-2180, doi: 10/1080/
1540496X.2020.1785425.
Mohsin, M., Zhou, P., Iqbal, N. and Shah, S.A.A. (2018), “Assessing oil supply security of South Asia”,
Energy, Vol. 155, pp. 438-447.
Narayan, P.K. (2020), “Oil price news and COVID-19 – is there any connection?”, Energy Research
Letters, Vol. 1 No. 1, p. 13176, doi: 10.46557/001c.13176.
Narayan, P.K. and Phan, D.H.B. (2019), “A survey of Islamic banking and finance literature: Issues,
challenges and future directions”, Pacific-Basin Finance Journal, Vol. 53, pp. 484-496.
Pawłowska, M. (2015), “On competition in the banking sector in Poland and Europe before and during
the crisis”, Bank–CASE Seminar Proceedings No. 134/2014.
Phan, D.H.B. and Narayan, P.K. (2020), “Country responses and the reaction of the stock market to
COVID-19—a preliminary exposition”, Emerging Markets Finance and Trade, Vol. 56 No. 10,
pp. 2138-2150, doi: 10.1080/1540496X.2020.1784719..
Prabheesh, K.P., Padhan, R. and Garg, B. (2020), “COVID-19 and the oil price – stock market nexus:
Evidence from net oil-importing countries”, Energy Research Letters, Vol. 1 No. 2.
Pradhan, R.P., Arvin, M.B. and Bahmani, S. (2015), “Causal nexus between economic growth, inflation, and
stock market development: the case of OECD countries”, Global Finance Journal, Vol. 27, pp. 98-111.
Qin, M., Zhang, Y.C. and Su, C.W. (2020), “The essential role of pandemics: a fresh insight into the oil
market”, Energy Research Letters, Vol. 1 No. 1, p. 13166, doi: 10.46557/001c.13166.
Qin, X., Huang, G., Shen, H. and Fu, M. (2020), “COVID-19 pandemic and firm-level cash holding –
moderating effect of goodwill and goodwill impairment”, Emerging Markets Finance and Trade,
Vol. 56 No. 10, pp. 2243-2258, doi: 10.1080/1540496X.2020.1785864..
Rizvi, S.A.R., Narayan, P.K., Sakti, A. and Syarafuddin, F. (2019), Role of Islamic Banks in Indonesian
Banking Industry: An Empirical Exploration, Pac. Basin Finance J. Forthcoming.
Samad, A. (1999), “Relative performance of conventional banking vis-à-vis Islamic bank in Malaysia”,
IIUM Journal of Economics and Management, Vol. 7, pp. 1-25.
Samad, A. and Hassan, M.K. (1999), “The performance of Malaysian Islamic bank during 1984–
1997: an exploratory study”, International Journal of Islamic Financial Services, Vol. 1,
pp. 1-14.
Schaeck, K. and Cihak, M. (2012), “Banking competition and Capital ratios”, European Financial Stability
Management, Vol. 18 No. 5, pp. 836-866.
versus
Schaeck, K. and Cihak, M. (2014), “Competition, efficiency, and stability in banking”, Financial
Management, Vol. 43 No. 1, pp. 215-241. fragility
Shen, H., Fu, M., Pan, H., Yu, Z. and Chen, Y. (2020), “The impact of the COVID-19 pandemic on
firm performance”, Emerging Markets Finance and Trade, Vol. 56 No. 10, doi: 10.1080/
1540496X.2020.1785863.
Stiglitz, J.E. and Weiss, A. (1981), “Credit rationing in markets with imperfect information”, The
American Economic Review, Vol. 71 No. 3, pp. 393-410.
Turk-Ariss, R. (2010), “Competitive conditions in Islamic and conventional banking: a global
perspective”, Review of Financial Economics, Vol. 19 No. 3, pp. 101-108.
Van Leuvensteijn, M., Bikker, J.A., Van Rixtel, A.A. and Sorensen, C.K. (2011), “A new approach to
measuring competition in the loan markets of the euro area”, Applied Economics, Vol. 43 No. 23,
pp. 3155-3167.
Vidya, C.T. and Prabheesh, K.P. (2020), “Implications of COVID-19 pandemic on the global trade
networks”, Emerging Markets Finance and Trade, Vol. 56 No. 10, pp. 2408-2421, doi: 10.1080/
1540496X.2020.1785426.
Weill, L. (2013), “Bank competition in the EU: how has it evolved?”, Journal of International Financial
Markets, Institutions and Money, Vol. 26, pp. 100-112.
Wolde-Rufael, Y. (2009), “Re-examining the financial development and economic growth nexus in
Kenya”, Economic Modelling, Vol. 26 No. 6, pp. 1140-1146.
Yu, Z., Xiao, Y. and Li, Y. (2020), “The response of the labor force participation rate to an epidemic:
evidence from a cross-country analysis”, Emerging Markets Finance and Trade, Vol. 56 No. 10,
pp. 2390-2407, doi: 10.1080/1540496X.2020.1784717.

Further readings
Xiong, H., Wu, Z., Hou, F. and Zhang, J. (2020), “Which firm-specific characteristics affect the market
reaction of Chinese listed companies to the COVID-19 pandemic?”, Emerging Markets Finance
and Trade, Vol. 56 No. 10, pp. 2231-2242, doi: 10.1080/1540496X.2020.1787151.
Yue, P., Korkmaz, A.G. and Zhou, H. (2020), “Household financial decision making amidst the COVID-
19 pandemic”, Emerging Markets Finance and Trade, Vol. 56 No. 10, pp. 2363-2377, doi: 10.1080/
1540496X.2020.1787149.

Corresponding author
Syed Aun R. Rizvi can be contacted at: aun@rizvis.net

For instructions on how to order reprints of this article, please visit our website:
www.emeraldgrouppublishing.com/licensing/reprints.htm
Or contact us for further details: permissions@emeraldinsight.com