Analysis of default behavior of borrowers under Islamic versus conventional banking

What is it about?

The authors double hurdle model to treat both the probability and quantum of default in a two-step approach. The authors explain the differences in default risk and quantum of default between Islamic and conventional banking borrowers from their behavioral perspectives following the Sharia principles in financial transactions between lenders and borrowers. The authors use borrower-specific information of two separate bank branches of the United Arab Emirates that solely deal with either Islamic or conventional banking products. The authors demonstrates that the probability of default and the quantum of default appear to be influenced by different set of client-specific factors. The results suggest that the probability of default does not vary significantly between Islamic and conventional banking borrowers. The evidence also shows that Islamic banking defaulters, compared to those in conventional banking, repay a large quantum of overdue when their financial leverage improves. However, they do not tend to reduce their outstanding quantum of overdue faster than conventional banking defaulters.

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Why is it important?

The study findings will enable the Islamic and conventional banks to appropriately address Basel Capital requirements based on the borrowers’ behavior.

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