Lending cyclicality in dual banking system: empirical evidence from GCC countries

Abstract

Purpose The purpose of this paper is to check if there is a procyclical lending behaviour in dual banking systems of the Golf Cooperation Council (GCC) countries. The study also tries to control for the role of Islamic banks in amplifying or mitigating the procyclicality of dual banking systems. Design/methodology/approach Estimation of a dynamic panel model using annual observations on a sample of 81 banks based in the GCC countries between 2005 and 2018. The study uses two business cycle indicators as dependent variables, namely, output gap and oil price gap. Findings The system generalilzed method of moments (GMM) estimator and robustness checks confirm the procyclical lending pattern of dual banking systems in the GCC. Estimation outputs also indicate that this procyclicality is more pronounced during economic slowdowns. However, it is found that Islamic banks’ lending is less procyclical, giving support for the stability view of Islamic banking systems. The authors think that the implementation and conduct of macroprudential policies are very challenging for banking authorities when Islamic banks and conventional banks operate under the same regulatory framework. Research limitations/implications The research paper may suffer from some limitations. Indeed, exploring panel data instead of country-case data may lead to a problem of heterogeneity that may underpin the credibility of the econometrical estimations. To deal with this problem by introducing a set of bank-specific and time-specific dummies. Furthermore, small N samples (N = number of individuals) may affect the reliability of the tests for the validity of instruments and autocorrelation used under the GMM estimator, leading to inefficient results. Consequently, the number of selected banks is extended as much as possible (81 banks), becoming important comparing to the time dimension of the panel. Practical implications Policymakers and regulators are incited to embed the perspectives of Islamic finance regarding lending cyclicality in dual banking systems, which promote the efficiency of resource allocation to the financing of assets and by consequence enabling financial stability. The stability view of the Islamic banking system could prompt policymakers and regulators to encourage the implementation and development of Islamic banks. Originality/value The present paper tries to overcome the lack of empirical studies on the procyclicality of dual banking. The study contributes to this novel literature in two ways. First, it focuses exclusively on GCC banking systems. In fact, compared to other emerging markets, business cycles characterizing GCC are specific because of the role played by the oil and gas revenues in the economic growth and financial system is crucial. Second, this paper brings into evidence the procyclicality of GCC banking systems also when the oil price is taken as a business cycle indicator.

Assessing the Islamic Bank Financing During Economic Recession: The Role of Stimulus Regulation POJK Number 11/POJK.03/2020

“…While the behaviour of Islamic bank financing was not detected pro-cyclicality behaviour during the study period. Saadaoui and Hamza (2020) estimate the lending cyclicality in dual banking system using annual observations on a sample of 81 banks in the GCC countries in the period of 2005 until 2018 using dynamic panel methods. The study used the business cycle indicators as dependent variables consist of output gap and oil price gap.…”

“…Ascarya et al (2016) states that pro-cyclicality behaviour in conventional banks creates bubbles, so that this condition has a negative impact on the economy. The size of the fluctuations that occur in the economic cycle is largely influenced by the credit mechanism (Saadaoui & Hamza, 2020).…”

“…However, the emergence of Islamic banking in the early 90s, attracted a lot of attention from academics and policy makers. The reason is, Islamic banks are considered more resistant to crisis shocks than conventional banks (Gamaginta and Rokhim, 2015;Hidayat and Abduh, 2012;Alzalabani and Nair, 2013;Saadaoui and Hamza, 2020;Bakar et al, 2012;Dridi and Hasan, 2010). Alzalabani and Nair (2013) stated that Islamic banking practices refer to the principles of Islamic law and its application which practically does not cause a crisis, and instead contributes positively to economic growth.…”

Does intellectual capital in Islamic banks outperform conventional banks? Evidence from GCC countries

“…, 2019). The dual-banking system that comprises Islamic and conventional banks operates in the same market in these countries (Saadaoui and Hamza, 2020). Although the Islamic banks are growing rapidly (Saif-Alyousfi, 2019), both banking sectors contribute significantly towards the growth of the GCC economies (Buallay, 2019).…”

Procyclicality of the Financial Systems in Emerging Economies

“…Procyclicality is evident in various dimensions of banking activity, including lending, loan-loss provisions, and accounting standards (Fatouh & Giansante, 2023). A common explanation for the procyclicality of the financial system lies in the presence of information asymmetries between borrowers and lenders (Saadaoui & Hamza, 2020). During economic downturns when collateral values are low, these information asymmetries can make it challenging for even creditworthy borrowers to secure financing.…”