Are Islamic Banks Suffering From A Model Misfit? A Comparison With Cooperative Banks

For the first time, this study investigates whether, in mimicking conventional banks, Islamic banks have become less stable than their theoretical equivalent: cooperative banks in Europe. Theoretically, the prohibition of interest should have pushed Islamic banks towards mutuality and profit-sharing, which have been argued as stabilising. In practice, however, banks are pushed for growth under a debt-driven commercial banking model, which is not only antithetical to the Shariah but is also destabilising. This may explain why empirical findings are still divergent in Islamic banking stability studies. Our study employs the generalised method of moments (GMM) system to compare the stability of 37 Islamic banks against 1,536 cooperative banks in Europe during the 2008 crisis and post-non-crisis years. Interestingly, we found consistent and significant evidence that Islamic banks are less stable than cooperative banks in both macroeconomic conditions. This has significant policy implications, the most important of which is to steer reform efforts away from refurbishing Islamic commercial banks and towards building an entirely new Islamic cooperative bank, based on the model in Europe.