THE ROLE OF STRESS TESTS IN ENHANCING BANK TRANSPARENCY: A COMPARATIVE STUDY OF ISLAMIC AND CONVENTIONAL BANKS

Authors

  • Ines Khammassi College of Business Administration, King Faisal University, Al Ahsa 31982, Saudi Arabia
  • Talel Boufateh Department of Quantitative Methods at the High Business School of Tunis, University of Manouba (Tunisia)
  • Kamel Naoui Department of Finance at the High Business School of Tunis, University of Manouba (Tunisia)
  • Mahmaod Alrawad College of Business Administration, King Faisal University, Al Ahsa 31982, Saudi Arabia; College of Business Administration and Economics, Al-Hussein Bin Talal University, Ma’an 71111, Jordan
  • Abdalwali Lutfi College of Business Administration, King Faisal University, Al Ahsa 31982, Saudi Arabia; MEU Research Unit, Middle East University, Amman, Jordan; Applied Science Research Center, Applied Science Private University, Jordan: College of Business Administration, University of Kalba (UKB), Kalba, 11115, UAE; Department of Accounting, College of Business, Amman Arab University, Amman, Jordan

DOI:

https://doi.org/10.2478/eoik-2024-0003

Keywords:

Stress tests, Panel-VAR, credit risk, Islamic banking, macroeconomic and specific shocks, financial stability

Abstract

 The global financial crisis highlighted the crucial role of stress tests in evaluating a bank’s resilience to severe economic shocks. Accordingly, the purpose of the study was to examine the contribution of stress tests to credit risk in terms of hedging banking opacity and improving financial resistance against negative shocks in MENA countries, observed for the period from 2012 to 2022. Furthermore, , this study explores the impact of stress tests on enhancing bank transparency, particularly within the contexts of Islamic and conventional banking systems using the Panel-VAR and GMM approach. A conceptual framework is established to explain the connection between stress testing and bank transparency, emphasizing on the mechanisms through which stress tests can promote greater disclosure and accountability. A comparative analysis of stress testing practices across both banking sectors reveals similarities and distinctions in scenario selection, modeling techniques, and disclosure practices. In-depth case studies of Islamic and conventional banks illustrate the practical application of stress testing in fostering transparency. These results show that stress tests produce information about credit risk exposure and about the real conditions of financial institutions. Therefore, more transparency on bank losses and risks would have also enabled bank regulators to focus more attention on financial institutions and react early to take “corrective measures”. Policy recommendations are drawn to enhance the effectiveness of stress testing in promoting transparency and financial stability within both Islamic and conventional banking sectors. This study contributes to a deeper understanding of stress testing’s role in fostering a more resilient and stable financial system.

References

Abad, P., Robles, M.-D. and Alonso Orts, C. (2023). Stress testing programs and credit risk opacity of banks: USA vs Europe. Journal of International Financial Markets, Institutions and Money, 89. https://doi.org/10.1016/j.intfin.2023.101876

Abdymomunov, A. and Gerlach, J. (2014). Stress testing interest rate risk exposure. Journal of Banking & Finance, 49, 287–301. https://doi.org/10.1016/j.jbankfin.2014.08.013

Abid, L., Ouertani, M.N. and Zouari-Ghorbel, S. (2014). Macroeconomic and Bank-specific Determinants of Household’s Non-performing Loans in Tunisia: A Dynamic Panel Data. Procedia Economics and Finance, 13, 58–68. https://doi.org/10.1016/S2212-5671(14)00430-4

Abrigo, M.R.M. and Love, I. (2016). Estimation of Panel Vector Autoregression in Stata. The Stata Journal: Promoting Communications on Statistics and Stata, 16 (3), 778–804. https://doi.org/10.1177/1536867X1601600314

Acharya, V. V., Engle, R. F., & Melzer, M. (2012). Financial market reactions to stress tests. Journal of Monetary Economics, 59(1), 102-119. https://www.sciencedirect.com/journal/journal-of-monetary-economics

Agarwal, V., D. Chambers, and M. McQuinn. (2009). The impact of stress tests on bank lending and credit risk. Journal of Finance, 64(6), 2537-2572. https://onlinelibrary.wiley.com/journal/15406261

Akinlo, O. and Emmanuel, M. (2014). Determinants of non-performing loans in Nigeria. Accounting & Taxation, 6(2), 21–28. Stress testing in Islamic banking: Challenges and opportunities https://doi.org//10.14738/abr.51.2368

Al-Haddad, A., Haron, N. A., & Majid, M. Z. (2015). Stress testing in Islamic banking: Challenges and opportunities. Journal of Islamic Banking and Finance, 3(2), 163-179. http://jibfnet.com/vol-3-no-2-december-2015-jibf

Al-Hussainy, F., R. Hassan, and C. R. Nelson (2016). Stress testing in Islamic banking: Issues and challenges. Journal of Banking and Finance, 69, 389-400. https://www.sciencedirect.com/journal/journal-of-banking-and-finance/vol/69/suppl/C

Al-Khater, M. A., Al-Khater, H. H., & Jantan, M. N. (2019). Stress testing in Islamic banks: A review of the literature. International Journal of Financial Studies, 7(2), 24. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3840056

Ameer, W., Xu, H., Sohag, K., Halwan, M.M. and Amin, A. (2022). Research methods in economics and its implications for capital formation. Economic Research-Ekonomska Istraživanja, 35(1), 5536–5555, https://doi.org/10.1080/1331677X.2022.2030244

Amin, A., Bte Mohamed Yusoff, N.Y., Yousaf, H., Peng, S., Işık, C., Akbar, M. and Abbas, S. (2023). The influence of renewable and non-renewable energy on carbon emissions in Pakistan: evidence from stochastic impacts by regression on population, affluence, and technology model. Frontiers in Environmental Science, 11, 1182055, https://doi.org/10.3389/fenvs.2023.1182055

BCBS; Basel Committee on Banking Supervision (2009). Principles for sound stress testing practices and supervision, Bank for International Settlements. Working paper. https://www.bis.org/publ/bcbs147.pdf

Beck, R., Jakubik, P. and Piloiu, A. (2013). Non-Performing Loans: What Matters in Addition to the Economic Cycle? SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2214971

Blau, B.M., Brough, T.J. and Griffith, T.G. (2017). Bank opacity and the efficiency of stock prices. Journal of Banking & Finance, 76, 32–47. https://doi.org/10.1016/j.jbankfin.2016.11.026

Bofondi, M. and Ropele, T. (2011). Macroeconomic Determinants of Bad Loans: Evidence from Italian Banks. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1849872

Brown, S., R. F. Green, and M. Manely. (2011). Stress testing as a regulatory tool: How it has evolved and how it might be improved. Journal of Financial Intermediation, 20(2), 311-327. https://www.sciencedirect.com/journal/journal-of-financial-intermediation/vol/20/issue/3

Brunnermeier, M. K., Cherny, A., & Sundaresen, S. (2016). Stress testing. Handbook of Macroeconomics, 2, 209-272.

Castro, V. (2013). Macroeconomic determinants of the credit risk in the banking system: The case of the GIPSI. Economic Modelling, 31, 672–683. https://doi.org/10.1016/j.econmod.2013.01.027

Chaibi, H. and Ftiti, Z. (2015). Credit risk determinants: Evidence from a cross-country study. Research in International Business and Finance, 33, 1–16. https://doi.org/10.1016/j.ribaf.2014.06.001

Chakrabarti, M. (2015). Risk analysis and management in Indian banking sector: An overview. International Journal of Informative & Futuristic Research, 2 (7), 2133–2143. https://www.academia.edu/15832062/Risk_Analysis_And_Management_In_Indian_Banking_

Sector_An_Overview

Commission, U.S.F.C.I. (2010). The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, Government Printing Office. https://www.govinfo.gov/app/details/GPO-FCIC

De Mendonça, H.F., Galvão, D.J.C. and Loures, R.F.V. (2013). Credit and bank opaqueness: How to avoid financial crises?. Economic Modelling, 33, 605–612. https://doi.org/10.1016/j.econmod.2013.05.001

Darwez, F., Alharbi, F., Ifa, A., Bayomei, S., Mostfa, E., Lutfi, A. and Alrawad, M. (2023). Assessing the Impact of Oil Price Volatility on Food Prices in Saudi Arabia: Insights From Nonlinear Autoregressive Distributed Lags (NARDL) Analysis. ECONOMICS-Innovative and Economics Research Journal, 11(2), 5–23. https://doi.org/10.2478/eoik-2023-0056

Dluhopolskyi, O., Kozlovskyi, S., Popovskyi, Y., Lutkovska, S., Butenko, V., Popovskyi, T., ... & Kozlovskyi, A. (2023). Formation of the Model of Sustainable Economic Development of Renewable Energy. ECONOMICS-Innovative and Economics Research Journal, 11(2), 51-78. https://doi.org/10.2478/eoik-2023-0050

Ellahie, A. (2012). Bank stress tests and information asymmetry. Annual Meeting and Conference on Teaching and Learning Accounting, American Accounting Association, Washington Dc. https://aaahq.org/Meetings/2022/CTLA

Erkişi, K. and Boğa, S. (2023). Does Financial Inclusion Improve Income Equality? The Case of Türkiye. ECONOMICS- Innovative and Economics Research Journal, 11(2), 79–95. https://doi.org/10.2478/eoik-2023-0049

FCIR (2011). The Financial Crisis Inquiry Report, Final Report of The National Commission On The Causes Of The Financial And Economic Crisis In The United States. Official Government Edition. Réalisé par The Financial Crisis Inquiry Commission. https://www.govinfo.gov/app/details/GPO-FCIC

Flannery, M., Hirtle, B. and Kovner, A. (2017). Evaluating the information in the federal reserve stress tests. Journal of Financial Intermediation, 29, 1–18. https://doi.org/10.1016/j.jfi.2016.08.001

Flannery, M.J., Kwan, S.H. and Nimalendran, M. (2013). The 2007–2009 financial crisis and bank opaqueness. Journal of Financial Intermediation, 22 (1), 55–84. https://doi.org/10.1016/j.jfi.2012.08.001

Ghosh, A. (2015). Banking-industry specific and regional economic determinants of non-performing loans: Evidence from US states. Journal of Financial Stability, 20, 93–104. https://doi.org/10.1016/j.jfs.2015.08.004

Gick, W.H. and Pausch, T. (2012). Optimal Disclosure of Supervisory Information in the Banking Sector. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2006852

Goldstein, I. (2014). Should Banks’ Stress Test Results be Disclosed? An Analysis of the Costs and Benefits. Foundations and Trends® in Finance, 8 (1), 1–54. https://doi.org/10.1561/0500000038

Halwan, M.M., Bin, Z.Y., Ameer, W., Mumtaz, N., Mumtaz, A. and Amin, A. (2022). Research Methods in a Multinational Business Environment and Implications for Capital Formation: Application of Cross-Sectional Autoregressive Distributed Lag Methods. Frontiers in Psychology, 13. https://doi.org/10.3389/fpsyg.2022.867891

Hilbers, M.P.L.C., Jones, M.M.T. and Slack, M.G.L. (2004). Stress Testing Financial Systems: What to Do When the Governor Calls. International Monetary Fund.

Iqbal, Z., and P. Molyneux. (2015). Stress testing and Sharia-compliant banking. In Stress Testing in the Financial Industry, edited by F. Allen, R. Cont, and D. Gorton, 135-160. Springer, New York, NY.

Jawadi, F. and Louhichi, W. (2017). Overview on the recent developments of banking and risk management. Research in International Business and Finance, 39, 896–898. https://doi.org/10.1016/j.ribaf.2016.11.001

Jedidia, K.B. (2018). Do Islamic banking standards convey more financial transparency than conventional banking ones? Turkish Journal of Islamic Economics, 5 (1), 109–132. https://doi.org/10.26414/tujise.2018.5.1.109-132

Kasman, S., Vardar, G. and Tunç, G. (2011). The impact of interest rate and exchange rate volatility on banks’ stock returns and volatility: Evidence from Turkey. Economic Modelling, 28(3), 1328– 1334. https://doi.org/10.1016/j.econmod.2011.01.015

Khan, B. . (2023). CO2 Emissions and Economic Growth in Some Selected Countries of Ecowas: Panel Data Approach. ECONOMICS-Innovative and Economics Research Journal, 11(2), 245–256. https://doi.org/10.2478/eoik-2023-0055

Khaled m Alqudah, M. N. ., & Yusof, Y. . (2024). Improving Environmental Performance Through Innovative Academic Citizenship Behaviour: Green Training And Development, Green Recruitment And Selection As Antecedents In Jordanian Government University. ECONOMICS-Innovative and Economics Research Journal, 12(1). https://sciendo.com/article/10.2478/eoik-2024-0002

Khammassi, I. and Naoui, K. (2019). Credit risk and bank opacity: a comparative study of conventional and Islamic banks. American J. of Finance and Accounting, 6 (1), 56. https://doi.org/10.1504/AJFA.2019.104192

Khammassi, I., Boufateh, T. and Naoui, K. (2020). Do stress tests reduce liquidity risk opacity. American J. of Finance and Accounting, 6 (2), 135. https://doi.org/10.1504/AJFA.2020.110322

Kok, C., Müller, C., Ongena, S. and Pancaro, C. (2023). The disciplining effect of supervisory scrutiny in the EU-wide stress test. Journal of Financial Intermediation, 53. https://doi.org/10.1016/j.jfi.2022.101015

Kosmidou, K., Kousenidis, D., Ladas, A. and Negkakis, C. (2017). Determinants of risk in the banking sector during the European Financial Crisis. Journal of Financial Stability, 33, 285–296. https://doi.org/10.1016/j.jfs.2017.06.006

Kucukkocaoglu, G. and Altintas, M.A. (2016). Using non-performing loan ratios as default rates in the estimation of credit losses and macroeconomic credit risk stress testing: A case from Turkey. Risk Governance and Control: Financial Markets & Institutions, 6 (1). https://doi.org/10.22495/rgcv6i1art6

Louzis, D.P., Vouldis, A.T. and Metaxas, V.L. (2012). Macroeconomic and bank-specific determinants of non-performing loans in Greece: A comparative study of mortgage, business and consumer loan portfolios. Journal of Banking & Finance, 36 (4), 1012–1027. https://doi.org/10.1016/j.jbankfin.2011.10.012

Makri, V., Tsagkanos, A. and Bellas, A. (2014). Determinants of non-performing loans: The case of Eurozone. Panoeconomicus, 61(2), 193–206. https://doi.org/10.2298/PAN1402193M

Matthew T. et al (2004). Stress testing financial systems: What to do when the governor calls. Chicago: IMF.

Mayer, C., Pence, K. and Sherlund, S.M. (2009). The Rise in Mortgage Defaults. Journal of Economic Perspectives, 23(1), 27–50. https://doi.org/10.1257/jep.23.1.27

Mishkin, F.S. (1999). Global Financial Instability: Framework, Events, Issues. Journal of Economic Perspectives, 13 (4), 3–20. https://doi.org/10.1257/jep.13.4.3

Myers, S.C. and Majluf, N.S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187–221. https://doi.org/10.1016/0304-405X(84)90023-0

Petrella, G. and Resti, A. (2013). Supervisors as information producers: Do stress tests reduce bank opaqueness? Journal of Banking & Finance, 37(12), 5406–5420. https://doi.org/10.1016/j.jbankfin.2013.01.005

Rahman, A.A., Ibrahim, M.H. and Meera, A.K.M. (2009). Lending structure and bank insolvency risk: a comparative study between Islamic and conventional banks. World Business Institute.

Roland. B et al (2013) Non-performing loans: what matters in addition to the economic cycle?, ECB Working Paper No. 1515.

Salas, V. and Saurina, J. (2002). Credit Risk in Two Institutional Regimes: Spanish Commercial and Savings Banks. Journal of Financial Services Research, 22(3), 203–224. https://doi.org/10.1023/A:1019781109676

Schuermann, T. (2010). Stress tests and bank disclosure: The European experience. Journal of Financial Intermediation, 19(4), 587-602. https://www.sciencedirect.com/journal/journal-of-financial-intermediation

Shank, C.A. and Vianna, A.C. (2016). Are US-Dollar-Hedged-ETF investors aggressive on exchange rates? A panel VAR approach. Research in International Business and Finance, 38, 430–438. https://doi.org/10.1016/j.ribaf.2016.05.002

Singh. S.K et al (2021). The Effect of Non-Performing Loan on Profitability: Empirical Evidence from Nepalese Commercial Banks. Journal of Asian Finance, Economics and Business, 8 (4), 709– 716. https://doi.org/10.13106/jafeb.2021.vol8.no4.0709

Stephen Kingu, P., Macha, D.S. and Gwahula, D.R. (2018). Impact of Non-Performing Loans on Bank’s Profitability: Empirical Evidence from Commercial Banks in Tanzania. International Journal of Scientific Research and Management, 6 (1). https://doi.org/10.18535/ijsrm/v6i1.em11

Supervision, B.C. on B. (2009). Principles for sound stress testing practices and supervision. Bank for International Settlements Basel.

Sudhana Rao, K. ., Kolluru, M. ., & Hyams-Ssekasi, D. . (2022). Emerging Change: Exploring the New Economy Paradigm. ECONOMICS-Innovative and Economics Research Journal, 10(1). https:// doi.org/10.2478/eoik-2022-0011

Topić-Pavković, B., Kovačević, S. ., & Kurušić , D. (2023). The Impact of Innovative Financial and Banking Development on the Economic Growth of Bosnia and Herzegovina. ECONOMICS-Innovative and Economics Research Journal, 11(1), 251–267. https://doi.org/10.2478/eoik-2022- 0022

Ullah, A., Zhao, X., Amin, A., Syed, A.A. and Riaz, A. (2022). Impact of COVID-19 and economic policy uncertainty on China’s stock market returns: evidence from quantile-on-quantile and causality-in-quantiles approaches. Environmental Science and Pollution Research, 30 (5), 12596– 12607. https://doi.org/10.1007/s11356-022-22680-y

Ullah, A., Zhao, X., Sayed, A.A., Amin, A. and Riaz, A. (2023). Impact of COVID-19 on China’s business and economic conditions: the importance of quantile asymmetries. Environmental Science and Pollution Research, 30 (22), 61766–61777. https://doi.org/10.1007/s11356-023-26252-6

Ujkani, X., & Gara, A. (2023). Determinants of the Inflation Rate: Evidence from Panel Data. ECONOMICS-Innovative and Economics Research Journal, 11(2), 169–182. https://doi.org/10.2478/eoik-2023-0054

Vogiazas, S.D. and Nikolaidou, E. (2011). Investigating the Determinants of Nonperforming Loans in the Romanian Banking System: An Empirical Study with Reference to the Greek Crisis. Economics Research International, 1–13. https://doi.org/10.1155/2011/214689

Yu, Z., Kamran, H.W., Amin, A., Ahmed, B. and Peng, S. (2023). Sustainable synergy via clean energy technologies and efficiency dynamics. Renewable and Sustainable Energy Reviews, 187. https://doi.org/10.1016/j.rser.2023.113744

Downloads

Published

2024-04-05

How to Cite

Khammassi, I. ., Boufateh, T. ., Naoui, K. ., Alrawad, M. ., & Lutfi, A. . (2024). THE ROLE OF STRESS TESTS IN ENHANCING BANK TRANSPARENCY: A COMPARATIVE STUDY OF ISLAMIC AND CONVENTIONAL BANKS. ECONOMICS - INNOVATIVE AND ECONOMICS RESEARCH JOURNAL, 12(1), 71–100. https://doi.org/10.2478/eoik-2024-0003