Interconnectedness and extreme risk: Evidence from dual banking systems

This study examines the interconnection structure of Islamic and conventional banks and how they transmit extreme risks to each other. This appears to be a particular problem because of the heterogeneous structure of dual banking systems, which raises major questions about systemic stability. We define extreme risk by the transmission of tail risk across banks for a panel of 20 Islamic and 34 conventional banks in six GCC member countries with dual banking systems over the period 2007–2021. Our results reveal the existence of tight connectivity, which increases significantly during periods of instability. We also provide an analysis of the topological structure of the interconnectedness of Islamic and conventional banks that suggests significant unidirectional and bidirectional spillovers of extreme risk at the inter- and intra-sectoral and bilateral country levels. Finally, by examining the individual systemic relevance, we find that there is an asymmetric effect of extreme risk spillovers between conventional and Islamic banks.