Investment deposits, risk‐taking and capital decisions in Islamic banks

Purpose - This paper aims to examine the relationship between the volume of investment deposits and capitalization of Islamic commercial banks. Design/methodology/approach - Unlike current accounts holders, investment accounts holders may support part or all of the losses on assets value, which could be a source of moral hazard among bank managers and shareholders. To test these assumptions, the authors use the system generalized method of moments (system GMM) on a dynamic panel of 59 Islamic banks observed during the period 2005‐2009. Findings - After controlling for a set of variables that may influence capital level, the results show a significant negative relationship between PSIA and regulatory capital ratio. This may indicate that the specific nature of PSIA can be a source of excessive risk‐taking in Islamic banks. This behavior is likely to threaten the solvency of Islamic banks and shows that some deficiencies may exist in their risk management and governance system. Practical implications - This paper suggests some recommendations to better implement the principle of profit and loss sharing and to curb excessive risk‐taking in Islamic banks. Originality/value - The originality of this paper is to give empirical responses to theoretical assumptions of a relationship between PSIA and moral hazard in Islamic banks.