Risk‐taking behaviour of Islamic banks: application of prospect theory

Abstract

Purpose The paper aims to gain an insight into behavioural characteristics of Islamic banks and how they influence the risk‐taking decisions of Islamic banks in financial markets within the prospect theory context. Design/methodology/approach The study employs review and application of prospect theory in Islamic banking industry across the globe, making use of 99 Islamic banks across 14 countries. Findings Empirical evidence shows that Islamic banks located above target risk level tend to show risk‐adverse behaviour, while banks below target risk level inclined towards risk‐seeking attitude. Results also highlighted that banks which have higher loans to total asset ratio tend to take on lower risk. Practical implications Islamic bank regulators will be better prepared to monitor the Islamic banking system if they understand risk‐taking behaviour of Islamic bank managers. The findings will provide more effective bank regulatory oversight, thus preventing Islamic bank failures in future. Originality/value Since there are relatively few studies conducted in risk‐taking behaviour of Islamic banks, specifically global Islamic banking, this study will broaden the scope of the literature by providing novel empirical evidence on risk‐taking practice of Islamic banks worldwide.