Comparative credit risk in Islamic and conventional bank

Md Nurul Kabir, Andrew Worthington, Rakesh Gupta

    Research output: Contribution to journalArticle

    Abstract

    In this paper, we consider the levels of credit risk in Islamic and conventional banks. One problem with existing studies is the use of accounting information alone to assess credit risk, and this could be especially misleading with Islamic banking. Using a market-based credit risk measure, Merton's distance-to-default (DD) model, we evaluate the credit risk of 156 conventional banks and 37 Islamic banks across 13 countries between 2000 and 2012. We also calculate the accounting information-based Z-score and nonperforming loan (NPL) ratio for the purpose of comparison. Our results show that Islamic banks have significantly lower credit risk than conventional banks as based on DD. In contrast, and as expected, Islamic banks display much higher credit risk using the Z-score and NPL ratio. These findings suggest that the measure chosen plays a significant role in assessing the actual credit risk of Islamic banks.

    Original languageEnglish
    Pages (from-to)327-353
    Number of pages27
    JournalPacific Basin Finance Journal
    Volume34
    DOIs
    Publication statusPublished - 1 Sep 2015

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