Fair Value and Financial Instability: Comparative Study Between Islamic and Conventional Banks

In Gulf Cooperation Council countries, Islamic banks operate side-by-side with conventional banks. Both their operations are based on their own principles and frameworks although some regulations might overlap with each other. This study aims to explore the impact of fair value accounting on financial instability for both types of banks during the period 2003 to 2011. The paper discusses whether fair value affects capital adequacy ratio and risk-taking behavior of Islamic and conventional banks in the same way. The findings prove that regulatory capital of Islamic banks is less affected by fair value changes than conventional ones. However, they behave similarly with regard to the risk associated with fair value measurement. Only three-stage least squares estimation showed positive and significant impact of fair value changes on risk-taking behavior for all banks and Islamic banks, but not for conventional banks.