The Impact of External Governance and Regulatory Settings on the Profitability of Islamic Banks: Evidence from Arab Markets

Abstract

This study specifically investigates the effects of external governance mechanisms and regulatory settings on the profitability of Islamic banks operating in the Arab markets from 2003 to 2017. The empirical results underscore that the external governance mechanism and its dimensions in particular the political stability, regulatory quality, rule of law, and control of corruption impact Islamic banks’ profitability positively. However, the regulatory settings and its sub-indices particularly the extent of disclosure and ease of shareholder suits have the opposite effect. Likewise, the results of traditional determinants indicate that the profitability of Islamic banks is shaped by the bank-specific, industry-specific, and country and global-level determinants. Results are robust and consistent with alternative estimation procedures and also support for the negative and positive effect of voice and accountability external governance’s dimension and inflation, respectively. The findings of this study have important policy implications for regulators, policymakers, and banks’ managers.