Investment Deposits, Risk-taking and Capital Decisions in Islamic Banks

This paper examines the relationship between the volume of investment deposits (profit sharing investment accounts–PSIA) and capitalization of Islamic commercial banks in a context of asymmetric information. Unlike current accounts holders, investment accounts holders may support part or all of the losses on assets value, which could be a source of moral hazard among bank managers and shareholders. To test these assumptions, we use the system generalized method of moments (System GMM) on a dynamic panel of 59 Islamic banks observed during the period 2005–2009. After controlling for a set of variables that may influence capital level, the results show a significant negative relationship between PSIA and regulatory capital ratio. This may indicates that the specific nature of PSIA can be a source of excessive risk –taking and higher leverage in order to maximize shareholders value. This behavior is likely to threaten the solvency of Islamic banks and shows that there may exist some deficiencies in their risk management and governance system. Following these results, we suggest some recommendations to better implement the principle of profit and loss sharing and to curb excessive risk-taking in Islamic banks. © Authors