Volatility of the returns and expected losses of Islamic bank financing

Abstract

Purpose The paper attempts to analyze the volatility of returns and expected losses of Islamic bank financing. In particular, it takes the case of Indonesian Islamic banking industry. Design/methodology/approach The paper uses Value at Risk (VaR) approach to compute the volatility (risk) of returns and expected losses of Islamic bank financing. In particular, it uses variance‐covariance method to calculate VaR of multi‐asset portfolios (groups of equity‐, debt‐ and service‐based financing). Findings First of all, equity and debt‐based financing produce sustainable returns of bank financing. Moreover, they are also very resilient during unfavorable economic conditions. Second, the performance of service‐based financing is very sensitive to the economic conditions. Lastly, VaR computation on the volatility of returns and expected losses of bank financing finds that risk of investment and expected losses are well managed. Practical implications The paper demands Islamic banks to keep intensifying equity‐based financing rather than only debt‐based financing and improve the banking services to support the performance of service‐based financing. Originality/value To the best of the author's knowledge, this is the first paper to assist the volatility of returns and expected losses of the Islamic banking financing in Indonesian.

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