Examining the relationship between bank stability and earnings quality in Islamic and conventional banks

Youssef Riahi

18 citations0/0 files storedInternational Journal of Islamic and Middle Eastern Finance and Management

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Islamic Finance and Banking Studies Banking stability, regulation, efficiency Auditing, Earnings Management, Governance

Abstract

Purpose The purpose of this paper is to investigate the effect of earnings quality on banking stability in Gulf Cooperation Council countries. First, the author isolates the discretionary loan loss provision (DLLP) to investigate the impact of total LLP, DLLP, discretionary accruals and a small positive variation in net income on bank stability. Second, the author investigates differences that may exist between Islamic banks (IBs) and conventional banks (CBs) in terms of the impact of DLLP on bank stability. Design/methodology/approach This research is based on unbalanced panel data for 39 IBs and 64 CBs in the six Gulf Cooperation Council countries over the 2000–2014 period. Findings The findings indicate that the extent of stability is negatively associated with the level of DLLP. This study also found significant differences between the two banking sectors in the effect of DLLP on bank stability. Practical implications This study has various practical implications. First, it provides insights for governments and regulators about introducing instruments like borrower restrictions and dynamic provisions to reduce LLP, because it negatively affects banking stability. Second, bankers should carefully assess the effects of their LLP strategies to overcome any negative effects. Third, the findings are also relevant to shareholders, investors and bank customers. More specifically, the results will help to improving their understanding of how LLP is not a financial strength and it is subject to managers’ opportunism that can lead to a financial instability. Finally, this study’s results encourage researchers to investigate an unexplored question, namely, the procyclicality of LLP and its determinants and effects. Originality/value To the best of the author’s knowledge, this is the first study to investigate differences that may exist between Islamic and CBs in terms of the impact of DLLP on bank stability.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1978Specification Tests in Econometrics 1980Agency Problems and the Theory of the Firm 1991Earnings Management During Import Relief Investigations 2003Earnings management and investor protection: an international comparison 2013Islamic vs. conventional banks: Business models, efficiency and stability 2008Islamic Banks and Financial Stability 2010THE EFFECTS OF THE GLOBAL CRISIS ON ISLAMIC AND CONVENTIONAL BANKS: A COMPARATIVE STUDY

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