Corruption and Bank Risk-Taking in Dual Banking Systems

Abstract

Research Question/Issue

We investigate whether the risk-taking of Islamic banks is affected differently by corruption compared to conventional banks. We also examine whether the characteristics of the Shari'ah Supervisory Board (SSB) of Islamic banks and the characteristics of the board of directors of conventional banks play an effective role in moderating such an effect.

Research Findings/Insights

We find consistent evidence that banks in countries with higher corruption have higher bank risk for both conventional and Islamic banks. However, this association is attenuated by the size of the SSB, the presence of female board members, and higher academic qualifications of SSB members. For conventional banks, the moderating effect of the presence of female directors and academically qualified members on the board of directors is also prevalent but to a lesser extent.

Theoretical/Academic Implications

This study contributes to the corporate finance literature more generally by highlighting the role played by corporate governance, particularly the presence of female members and academically qualified members on the SSBs of Islamic banks and on the board of directors of conventional banks, in mitigating the effect of corruption on bank risk-taking for the two bank types.

Practitioner/Policy Implications

Our findings are based on a matched sample of banks operating in 10 OIC (Organization of Islamic Cooperation) countries and have important implications for bank stability and bank governance reforms. On the detrimental side, urgency of the anti-corruption campaigns in these countries is justified due to the significant effect of corruption on risk-taking for both conventional and Islamic banks. Overall, to better fight corruption in countries with dual banking systems, there is a need to enforce stricter rules for all types of banks.