A Structural Model of "Alpha" for the Capital Adequacy Ratios of Islamic Banks

Kenneth Baldwin; Maryam AlHalboni; Husam Helmi

doi:10.1016/j.intfin.2018.12.015

A Structural Model of "Alpha" for the Capital Adequacy Ratios of Islamic Banks

Kenneth Baldwin
, Maryam AlHalboni
, Husam Helmi

University of York
Durham University

Research output: Contribution to journal › Article › peer-review

34 Citations (Scopus)

514 Downloads (Pure)

Abstract

The denominator of the capital adequacy ratio (CAR) for Islamic banks includes an adjustment factor, alpha, arising from the subsidisation of investment account holders’ returns using bank equity. The methodology established by the risk management standard-setting body for Islamic banks, the IFSB, estimates an alpha for each country using panel-data and normally distributed asset returns for its credit institutions. Consequently, the IFSB methodology precludes bank-specific alphas linked to the actual risk profile of underlying assets. There is also no discernible mapping between alpha and a bank's own propensity to subsidise cash returns. This paper instead develops a new theoretical model for bank-specific alpha that is estimated for 43 Islamic banks in 11 countries. Our alpha values broadly correspond with those of the IFSB. However, a form of regulatory arbitrage is shown to exist which favors banks with relatively high alphas. This finding also has policy implications for bank efficiency and systemic risk.

Original language	English
Pages (from-to)	267-283
Number of pages	17
Journal	Journal of International Financial Markets, Institutions and Money
Volume	60
Early online date	28 Dec 2018
DOIs	https://doi.org/10.1016/j.intfin.2018.12.015
Publication status	Published - May 2019

Bibliographical note

© 2018, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International http://creativecommons.org/licenses/by-nc-nd/4.0/

Copyright © and Moral Rights are retained by the author(s) and/ or other copyright owners. A copy can be downloaded for personal non-commercial research or study, without prior permission or charge. This item cannot be reproduced or quoted extensively from without first obtaining permission in writing from the copyright holder(s). The content must not be changed in any way or sold commercially in any format or medium without the formal permission of the copyright holders.

Funder

Unfunded

Keywords

Alpha
Capital adequacy ratio
Displaced commercial risk
Islamic banking
Islamic financial services board
Regulation

ASJC Scopus subject areas

Finance
Economics and Econometrics

Access to Document

10.1016/j.intfin.2018.12.015

Post-PrintAccepted author manuscript, 1.41 MBLicence: CC BY-NC-ND

Cite this

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abstract = "The denominator of the capital adequacy ratio (CAR) for Islamic banks includes an adjustment factor, alpha, arising from the subsidisation of investment account holders{\textquoteright} returns using bank equity. The methodology established by the risk management standard-setting body for Islamic banks, the IFSB, estimates an alpha for each country using panel-data and normally distributed asset returns for its credit institutions. Consequently, the IFSB methodology precludes bank-specific alphas linked to the actual risk profile of underlying assets. There is also no discernible mapping between alpha and a bank's own propensity to subsidise cash returns. This paper instead develops a new theoretical model for bank-specific alpha that is estimated for 43 Islamic banks in 11 countries. Our alpha values broadly correspond with those of the IFSB. However, a form of regulatory arbitrage is shown to exist which favors banks with relatively high alphas. This finding also has policy implications for bank efficiency and systemic risk.",

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N1 - © 2018, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International http://creativecommons.org/licenses/by-nc-nd/4.0/ Copyright © and Moral Rights are retained by the author(s) and/ or other copyright owners. A copy can be downloaded for personal non-commercial research or study, without prior permission or charge. This item cannot be reproduced or quoted extensively from without first obtaining permission in writing from the copyright holder(s). The content must not be changed in any way or sold commercially in any format or medium without the formal permission of the copyright holders.

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N2 - The denominator of the capital adequacy ratio (CAR) for Islamic banks includes an adjustment factor, alpha, arising from the subsidisation of investment account holders’ returns using bank equity. The methodology established by the risk management standard-setting body for Islamic banks, the IFSB, estimates an alpha for each country using panel-data and normally distributed asset returns for its credit institutions. Consequently, the IFSB methodology precludes bank-specific alphas linked to the actual risk profile of underlying assets. There is also no discernible mapping between alpha and a bank's own propensity to subsidise cash returns. This paper instead develops a new theoretical model for bank-specific alpha that is estimated for 43 Islamic banks in 11 countries. Our alpha values broadly correspond with those of the IFSB. However, a form of regulatory arbitrage is shown to exist which favors banks with relatively high alphas. This finding also has policy implications for bank efficiency and systemic risk.

AB - The denominator of the capital adequacy ratio (CAR) for Islamic banks includes an adjustment factor, alpha, arising from the subsidisation of investment account holders’ returns using bank equity. The methodology established by the risk management standard-setting body for Islamic banks, the IFSB, estimates an alpha for each country using panel-data and normally distributed asset returns for its credit institutions. Consequently, the IFSB methodology precludes bank-specific alphas linked to the actual risk profile of underlying assets. There is also no discernible mapping between alpha and a bank's own propensity to subsidise cash returns. This paper instead develops a new theoretical model for bank-specific alpha that is estimated for 43 Islamic banks in 11 countries. Our alpha values broadly correspond with those of the IFSB. However, a form of regulatory arbitrage is shown to exist which favors banks with relatively high alphas. This finding also has policy implications for bank efficiency and systemic risk.

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JO - Journal of International Financial Markets, Institutions and Money

JF - Journal of International Financial Markets, Institutions and Money

ER -

A Structural Model of "Alpha" for the Capital Adequacy Ratios of Islamic Banks

Abstract

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Keywords

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