Black Gold’s Price Plunge: Are Conventional and Islamic Banks Equally Vulnerable?

Abstract

Regarding the vulnerability of the banking industry to oil price plunges, we investigate the effects of oil price declines on credit and insolvency risks for the banking industry within specific bank specializations (conventional, Islamic, and conventional banks with Islamic windows), from 2000 through 2016, at both the aggregate and country levels in the Gulf Cooperation Council (GCC). Our findings show that falling oil prices significantly increase the credit risk for the banking industry, particularly for banks operating in Kuwait, Qatar, Saudi Arabia and the United Arab Emirates. Commercial banks with Islamic windows are also prone to oil price shocks. However, falling oil prices do not affect the credit risk of Islamic banks. Utilizing accounting-based and marked-based proxies for the insolvency risk, our analysis shows that oil price plunges do not increase the insolvency risk of the banking industry or bank specializations. We argue that bailout packages given by the wealth funds to GCC banks is a probable cause for counter intuitive results with respect to solvency risk. Our research findings will be of interest to various stakeholders, particularly the regulators who look for empirical evidence to develop deeper insights to the sound functioning of the banking systems.