Abstract:

Purpose – The study aims to determine whether Islamic banks' debt financing and equity financing are procyclical or counter-cyclical. Methodology – The data used in this study cover eight Islamic commercial banks and span from 2008 to 2020, thereby including 72 observations. The analysis employs the dynamic panel data model estimated using the GMM method (Generalized Method of Moments). Findings –The debt-based financing, under murabahah, salam, istishna, and ijarah contracts, did not display clear procyclical or counter-cyclical behavior. In contrast, equity financing based on mudharabah and musyarakah contracts demonstrated procyclical characteristics concerning economic fluctuation. Implications – Policymakers need to pay more attention to Islamic banks with a greater proportion of equity financing for both micro and macroprudential policy purposes since procyclicality is likely to be associated with higher risks. Similarly, Islamic banks with greater proportion of equity financing need to watch carefully the behavior of their equity financing concerning its effect on risks for the purpose of their risk management and prudential policy. Originality – This research paper fills in the absence of studies that examine which category of Islamic bank financing – debt-based or equity-based financing - is more procyclical.

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