Bank-Specific Determinants of Financial Stability in Participation Banks: Fresh Evidence from the Driscoll-Kraay Estimator

Abstract

Since its first introduction as a primary policy goal by a big central bank, financial stability has received a great deal of interest as a distinct matter, separate from price stability and the efficient functioning of the financial sectors. Accordingly, different financial analysts and scholars in the financial system have tried to unravel the complexity of financial stability and have conducted theoretical and empirical research at different levels. This study aims to reveal the internal factors affecting the financial stability of participation banks operating as Islamic banks in Turkey. Therefore, we consider the data of 6 participation banks for the 2019Q1-2023Q1 period. Moreover, we assess the stability of participation banks with the Z-score, one of the most popular financial stability indicators. As a result of the analyses with the Driscoll-Kraay robust standard errors estimator, firstly, we found a negative relationship between risk-weighted and non-risk-weighted capital ratios and bank stability. Secondly, we concluded that while there is a negative relationship between bank stability and bank size, there is a positive relationship between cost-to-income ratio, loan ratio and deposit (funds collected) ratio and bank stability. Finally, among the diversification indicators, we observed a negative relationship between asset and fund diversification and bank stability; in contrast, there is a positive relationship between income diversification and bank stability. This study shows that the factors affecting bank stability from most to least are income diversification, fund and asset diversification, deposits (collected funds) ratio, non-risk weighted capital ratio, cost-to-income ratio, loan ratio, risk-weighted capital ratio and bank size, respectively.