Political systems and the financial soundness of Islamic banks

We investigate whether and how political systems affect the financial soundness of conventional andIslamic banks. Using factors extracted from principal component analysis, we find that Islamic banksunderperform their conventional counterparts in more democratic political systems but outperformthem in hybrid and Sharia’a-based legal systems. The findings reflect the challenges Islamic banks facein Western countries in terms of perception, financial infrastructure, and regulatory constraints whilemirroring the recognition of their specificities and their cultural and religious compliance with Sharia’alaw in Muslim countries. The findings are robust to a battery of alternative estimation techniques andmethods of correcting standard errors.