Comparative study on credit risk in Islamic banking institutions: Thecase of Malaysia

tThe study of credit risk is a great interest and the debate over the relative credit risk of Islamic banksremains open. The study aims at addressing this key question: Do Islamic banks (IBs) have higher creditrisk than conventional banks (CBs) in Malaysia? Accordingly, some papers tried to answer this questionbut they were performed using cross-country data. The cross-country data should have been treated morecautiously since every country has its own developmental backgrounds and regional resulting in differentcharacteristics of banking industry. Moreover, different financial systems that give support or limit theoperation of Islamic banks will also make more difficult to compare the data of each country. For thatreason, it is suggested to take suitable control for heterogeneity across countries to obtain consistentlygood conclusions about the credit risk. Different from the cross-country works, this study will focus onthe country-level data of Malaysia. A panel data model was applied and it was used the generalized leastsquares (GLS) model and a yearly bank level data to evaluate the credit risk of 22 conventional banksand 17 Islamic banks in Malaysia. In addition, the study period, which lasted from 2005 to 2015, seemsto be representative since it encompasses the period of the sub-prime crisis. This project is an extensionof the study begun byˇCihák and Hesse (2008) that used cross-country bank data such Malaysia. Theresults are particularly interesting and do not confirm the results generated by these researchers. Themain contribution that this work will hopefully make is to show the reasons which account for the Islamicbanks’ higher degree of credit risk, and particularly to provide additional insights and complement theexisting cross-country studies on Islamic bank stability