Investment Deposits, Risk-taking and Capital Decisions in the 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.