Abstract:

An important aspect of the new financial landscape is the increased focus on financial stability. A deposit insurance (DI) system accomplishes this purpose. While there are a great number of earlier studies that analyze the impact of DI on the conventional banking system, there is a lack of study that takes into account the moral hazard problem of DI on the Islamic banking system. Our paper aims to investigate the moral hazard implication by way of bank risk taking trailing the introduction of DI for the Islamic banks using the random effect model estimation for panel data. Malaysia is chosen as a sample for an Islamic banking system due to data availability and being the most advance country in Islamic banking. Our empirical study offers novel findings on the impact of the introduction of DI in both financial and operational risks taking for the Islamic banks. Our study reveals that Islamic banks have significantly higher operational risk after the introduction of DI. Added to that, our finding suggests that the risk-based premium method will significantly mitigate the moral hazard problem. We also find that management efficiency can be an alternative measure of operational risk

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