An empirical analysis of financial stability of Islamic banks : a case of Malaysia

Abstract

Financial stability of a bank is its ability to withstand any financial shocks or stress which might be due to liquidity risk, excessive leverage, nonperforming loans, etc. The present study explores the indulgence of most Islamic banks in Malaysia on financing in the form of debt-based financial products with a view to analysing its impacts on the financial stability of those banks. Relevant data were collected from the annual reports of sixteen (16) Islamic banks in Malaysia within the time-frame of 2008 to 2012. The study adopts Z-score analysis as a proxy to assess financial stability of Islamic banks while Liquidity ratio, Nonperforming financing as well as Credit risk ratio were used as a proxy to measure the debt-based model. Partial Least Squares (PLS) was used to analyse the relationship between the dependent variable (financial stability) and the independent variables (debt-based model). The outcome of the study shows that there is a negative relationship between Non Performing Financing (NPF) and financial stability on one hand and between credit risk and financial stability on the other. Liquidity however shows a positive and significant relationship with financial stability. In a nutshell, the study finds that Islamic banks are financially stable but grant excessive financing while the total assets invested on financing are on the increase year by year. Hence, this result reveals an impending financial crisis for Islamic banks if its financing mechanism is not revisited