Basel Compliance and Financial Stability: Evidence from Islamic Banks

IMF Working Papers, July 18, 2017

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The paper provides robust evidence that compliance with Basel Core Principles (BCPs) has a strong positive effect on the Z-score of conventional banks, albeit less pronounced on the Z-score of Islamic banks.
Using a sample of banks operating in 19 developing countries, the results appear to be driven by capital ratios, a component of Z-score for the two types of banks.
Individual chapters of BCPs, even though showing smaller effects for Islamic banks, suggest a positive effect on the stability of conventional banks.
The findings support the effective role of BCP standards in improving bank stability.
These implications motivated the Islamic Financial Services Board (IFSB) publication of new recommendations in 2015 to bring BCP standards in line with the Core Principles for Islamic Finance Regulation (CPIFRs) standards.
The paper suggests that because Islamic banks are benchmarked closely to BCPs, the implementation of CPIFRs should also positively affect their stability.

Compliance with Basel Core Principles (BCPs) has a strong positive effect on the Z-score of conventional banks.
The positive effect of BCP compliance on the Z-score of Islamic banks is present but less pronounced than for conventional banks.
Capital ratios are a primary driver of the observed results for both conventional and Islamic banks.
Individual BCP chapters indicate measurable positive effects on conventional bank stability; effects on Islamic banks are smaller by chapter.

Strengthening compliance with BCPs can improve bank stability, particularly for conventional banks.
Aligning BCP standards with CPIFRs, as recommended by the IFSB in 2015, is likely to have beneficial effects on the stability of Islamic banks.
Implementing CPIFRs in jurisdictions with Islamic banking should positively affect Islamic bank stability, given their benchmarking to BCPs.

IMF Working Paper: "Basel Compliance and Financial Stability: Evidence from Islamic Banks" — summary based solely on the reported content.

Basel Compliance and Financial Stability: Evidence from Islamic Banks
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