The unique risk exposures of Islamic banks’ capital buffers: A dynamic panel data analysis

• Results reveal possible shortcomings in Islamic banks’ capital guidelines.
• Displaced commercial risk positively influences Islamic banks’ capital buffers.
• State owned Islamic banks seem to manage UPSIAs in line with juristic nature.
• Equity investment risk and capital buffer relationship seems to vary by region.
• Our findings support presence of regulatory forbearance during crisis periods.

The growing relevance of Islamic banking from a prudential perspective warrants the need to investigate the susceptibilities of Islamic banks’ capital buffers to unique risks emanating from their operating environments. We employ a panel model using two-step dynamic Generalized Method of Moments (GMM) on a data set comprising 128 conventional and Islamic banks. Our results tend to indicate privately owned Islamic banks, unlike their state owned counterparts, attempt to safeguard shareholders by independently mitigating the effects of displaced commercial risk through higher capital buffers. The relation between equity investment risk and bank capital buffers also seems to vary by region.