Volume 30, Issue 3 (Autumn 2025) JEPR 2025, 30(3): 0-0 | Back to browse issues page

Mohammadbeigi S. (2025). The Nonlinear Relationship Between Capital Structure and Performance of Islamic Banks: Evidence from Selected Countries. JEPR. 30(3),
URL: http://eprj.ir/article-1-2321-en.html

The Nonlinear Relationship Between Capital Structure and Performance of Islamic Banks: Evidence from Selected Countries

Saeid Mohammadbeigi ^*

, beigi.1992@gmail.com

Abstract: (385 Views)

This paper assesses the nonlinear relationship between capital structure and financial performance of Islamic banks in selected OIC countries during the period 2010-2020. Using a balanced data panel of 125 banks and 1375 annual observations, first, fixed and dynamic effects panel linear models were estimated to test the direct effect of equity to assets ratio on return on assets and return on equity. Then, using the dynamic threshold panel regression model, two breakpoints were identified at the levels of 12% and 18%, indicating a positive and significant effect of capital ratio up to the first threshold, a slight decrease at the middle threshold, and a noticeable slowdown at the higher threshold. Structural stability tests, random resampling with 1000 resamplings, and alternative estimates with NIM and Z Score criteria have confirmed the validity and stability of these findings. Regional analyses show that the magnitude of the impact of capital on performance is greater in the Gulf region than in other regions, and regulatory differences and market depth affect the optimal capital thresholds. The results of this study indicate that in determining the target capital ratio, Islamic banks should balance the benefits of tax shields and agency costs at medium levels with the effects of increased bankruptcy costs and operational complexity at high levels. The findings of this study are important from two theoretical and practical aspects: first, they are useful for setting flexible regional regulatory policies and improving the capital frameworks of Islamic banks. Second, these findings confirm the efficiency risk hypothesis (the possibility of reduced operational efficiency) and the royalty value hypothesis (the value inherent in competitive advantages and brand).

Keywords: capital structure, Islamic banks, optimal capital structure, Islamic economy

Type of Study: Research | Subject: Islamic economoics
Received: Apr 23 2025 | Accepted: Dec 28 2025 | ePublished: May 23 2026

References

1. Alabdulkarim, N., Kalyanaraman, L., & Alhussayen, H. (2024). The impact of firm size on the relationship between leverage and firm performance: evidence from Saudi Arabia. Humanities and Social Sciences Communications. [DOI:10.1057/s41599-024-04211-x]

2. Al Tamimi, H. (2010). Determinants of Capital Structure: Evidence from UAE Banks. Journal of Risk Finance.

3. Arellano, M., & Bond, S. (1991). Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations. Review of Economic Studies. [DOI:10.2307/2297968]

4. Barnett, V., & Lewis, T. (1994). Outliers in Statistical Data. Wiley.

5. Bashir, A. H. M. (2003). Determinants of profitability in Islamic banks: Some evidence from the Middle East. Islamic Economic Studies, 11(1), 31-57.

6. Beck, N., & Katz, J. N. (1995). What to Do (and Not to Do) with Time-Series Cross-Section Data. American Political Science Review. [DOI:10.2307/2082979]

7. Beck, T., Demirgüç Kunt, A., & Merrouche, O. (2013). Islamic vs. Conventional Banking: Business Model, Efficiency and Stability. Journal of Banking & Finance. [DOI:10.1016/j.jbankfin.2012.09.016]

8. Berger, A. N., & Bonaccorsi di Patti, E. (2006). Capital structure and firm performance: A new approach to testing agency theory and an application to the banking industry. Journal of Banking & Finance, 30(4), 1065-1102. [DOI:10.1016/j.jbankfin.2005.05.015]

9. Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics. [DOI:10.1016/S0304-4076(98)00009-8]

10. Bolarinwa, S. T., Olayeni, R. O., & Vo, X. V. (2021). Is there a nonlinear relationship between nonperforming loans and bank profitability? Managerial and Decision Economics. [DOI:10.1002/mde.3262]

11. Boss, M., et al. (2006). Macro-Financial Risks of Banking System in Switzerland. Swiss National Bank Working Papers.

12. Bukair, A. (2014). Determinants of the Capital Structure of Islamic Banks. Jurnal Ilmiah Ekonomi Islam, 7(01), 152.

13. Central Banks Reports (National Statistical Agencies of OIC Countries).

14. Cheikh Tourad, B. (2024). The Impact of Capital Structure on Islamic Bank's Profitability Evidence from the Top Islamic Finance Countries for the Period 2003-2022.

15. Çolak, G., & Aysan, A. F. (2013). The Impact of Sukuk and Market Competition on Islamic Bank Performance: A Regional Analysis. International Journal of Islamic and Middle Eastern Finance and Management.

16. Doornik, J. A., & Hansen, H. (2008). An omnibus test for univariate and multivariate normality. Oxford Bulletin of Economics and Statistics, 70(s1), 927-939. [DOI:10.1111/j.1468-0084.2008.00537.x]

17. Dusuki, A. W., & Abdullah, N. I. (2007). Why do Malaysian customers patronise Islamic banks?. International Journal of Bank Marketing.

18. Financial performance and stability in Islamic banks: Evidence from GCC countries. (2017). Corporate Ownership & Control, 14(4). [DOI:10.22495/cocv14i4art9]

19. Risk and performance of Islamic and conventional banks under capital regulation. (2023). Asian Journal of Sustainable Banking and Finance.

20. Gujarati, D. N., & Porter, D. C. (2009). Basic Econometrics (5th ed.). McGraw-Hill.

21. Hansen, B. E. (1992). The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP. Journal of Applied Econometrics, 7(S), S61-S82. [DOI:10.1002/jae.3950070506]

22. Hansen, B. E., & Seo, B. (2002). Testing for two-regime threshold cointegration in vector error-correction models. Journal of Econometrics. [DOI:10.1016/S0304-4076(02)00097-0]

23. Ho, T. S. Y., & Wong, S. K. (2001). A Study of the Relationship between Corporate Governance Structures and the Extent of Voluntary Disclosure. Journal of International Accounting, Auditing and Taxation. [DOI:10.1016/S1061-9518(01)00041-6]

24. Ibrahim, M., & Abdul‐Latiff, A. R. (2014). Capital structure and risk-return trade‐off: Evidence from the GCC Islamic bank market. International Review of Financial Analysis, 36, 145-152.

25. Iqbal, M., Molyneux, P., Iqbal, M., & Molyneux, P. (2005). Efficiency in Islamic banking. Thirty Years of Islamic Banking: History, Performance and Prospects, 88-104. [DOI:10.1007/978-0-230-50322-9_6]

26. Iqbal, Z., & Mirakhor, A. (2011). An Introduction to Islamic Finance: Theory and Practice. Wiley Finance. [DOI:10.1002/9781118390474]

27. Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360. [DOI:10.1016/0304-405X(76)90026-X]

28. Meero, A. A. (2015). The relationship between capital structure and performance in Gulf countries banks: A comparative study between Islamic banks and conventional banks. International Journal of Economics and Finance, 7(12), 140-154. [DOI:10.5539/ijef.v7n12p140]

29. Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. American Economic Review, 48(3), 261-297.

30. Myers, S. C. (1984). The capital structure puzzle. Journal of Finance, 39(3), 575-592. [DOI:10.2307/2327916]

31. Myers, S. C. (2001). Capital structure. Journal of Economic Perspectives. [DOI:10.1257/jep.15.2.81]

32. Pasiouras, F., Tanna, S., & Zopounidis, C. (2008). Evaluating Bank Profitability: Evidence from European Banking Sector. European Journal of Operational Research.

33. Pathan, S., & Faff, R. (2013). Does it pay to be different? An analysis of alternative bank business models. Journal of Banking & Finance, 37(8), 3049-3067. [DOI:10.1016/j.jbankfin.2012.12.016]

34. Pesaran, M. H. (2004). General diagnostic tests for cross section dependence in panels. Cambridge Working Papers in Economics, No. 0435. [DOI:10.2139/ssrn.572504]

35. Rabaa, S., & Younes, Z. (2016). Economic growth and financial performance of Islamic banks. econstor.

36. Rahman, M. M., & Hasan, I. (2013). Comparative corporate governance of Islamic and conventional banks: International evidence. Journal of Corporate Finance.

37. Sheikh, N. A., & Qureshi, T. (2017). Capital Structure in Islamic and Conventional Banks. [DOI:10.1108/IMEFM-10-2015-0119]

38. Shleifer, A., & Vishny, R. W. (1997). A Survey of Corporate Governance. The Journal of Finance. [DOI:10.1111/j.1540-6261.1997.tb04820.x]

39. Siegel, S., & Castellan, N. J. (1988). Nonparametric Statistics for the Behavioral Sciences (2nd ed.). McGraw-Hill.

40. Srairi, S. (2010). Cost and profit efficiency of conventional and Islamic banks in GCC countries. Journal of Productivity Analysis, 34(1), 45-62. [DOI:10.1007/s11123-009-0161-7]

41. Toumi, K., Viviani, J.-L., & Louhichi, W. (2012). Alternative Financial Decision Principles: Theoretical Foundations of Islamic Banks' Capital Structure. In Recent Developments in Alternative Finance. [DOI:10.1108/S1571-0386(2012)0000022013]

42. Wooldridge, J. M. (2010). Econometric Analysis of Cross Section and Panel Data. MIT Press.

43. Alabdulkarim, N., Kalyanaraman, L., & Alhussayen, H. (2024). The impact of firm size on the relationship between leverage and firm performance: evidence from Saudi Arabia. Humanities and Social Sciences Communications. [DOI:10.1057/s41599-024-04211-x]

44. Al Tamimi, H. (2010). Determinants of Capital Structure: Evidence from UAE Banks. Journal of Risk Finance.

45. Arellano, M., & Bond, S. (1991). Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations. Review of Economic Studies. [DOI:10.2307/2297968]

46. Barnett, V., & Lewis, T. (1994). Outliers in Statistical Data. Wiley.

47. Bashir, A. H. M. (2003). Determinants of profitability in Islamic banks: Some evidence from the Middle East. Islamic Economic Studies, 11(1), 31-57.

48. Beck, N., & Katz, J. N. (1995). What to Do (and Not to Do) with Time-Series Cross-Section Data. American Political Science Review. [DOI:10.2307/2082979]

49. Beck, T., Demirgüç Kunt, A., & Merrouche, O. (2013). Islamic vs. Conventional Banking: Business Model, Efficiency and Stability. Journal of Banking & Finance. [DOI:10.1016/j.jbankfin.2012.09.016]

50. Berger, A. N., & Bonaccorsi di Patti, E. (2006). Capital structure and firm performance: A new approach to testing agency theory and an application to the banking industry. Journal of Banking & Finance, 30(4), 1065-1102. [DOI:10.1016/j.jbankfin.2005.05.015]

51. Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics. [DOI:10.1016/S0304-4076(98)00009-8]

52. Bolarinwa, S. T., Olayeni, R. O., & Vo, X. V. (2021). Is there a nonlinear relationship between nonperforming loans and bank profitability? Managerial and Decision Economics. [DOI:10.1002/mde.3262]

53. Boss, M., et al. (2006). Macro-Financial Risks of Banking System in Switzerland. Swiss National Bank Working Papers.

54. Bukair, A. (2014). Determinants of the Capital Structure of Islamic Banks. Jurnal Ilmiah Ekonomi Islam, 7(01), 152.

55. Central Banks Reports (National Statistical Agencies of OIC Countries).

56. Cheikh Tourad, B. (2024). The Impact of Capital Structure on Islamic Bank's Profitability Evidence from the Top Islamic Finance Countries for the Period 2003-2022.

57. Çolak, G., & Aysan, A. F. (2013). The Impact of Sukuk and Market Competition on Islamic Bank Performance: A Regional Analysis. International Journal of Islamic and Middle Eastern Finance and Management.

58. Doornik, J. A., & Hansen, H. (2008). An omnibus test for univariate and multivariate normality. Oxford Bulletin of Economics and Statistics, 70(s1), 927-939. [DOI:10.1111/j.1468-0084.2008.00537.x]

59. Dusuki, A. W., & Abdullah, N. I. (2007). Why do Malaysian customers patronise Islamic banks?. International Journal of Bank Marketing.

60. Financial performance and stability in Islamic banks: Evidence from GCC countries. (2017). Corporate Ownership & Control, 14(4). [DOI:10.22495/cocv14i4art9]

61. Risk and performance of Islamic and conventional banks under capital regulation. (2023). Asian Journal of Sustainable Banking and Finance.

62. Gujarati, D. N., & Porter, D. C. (2009). Basic Econometrics (5th ed.). McGraw-Hill.

63. Hansen, B. E. (1992). The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP. Journal of Applied Econometrics, 7(S), S61-S82. [DOI:10.1002/jae.3950070506]

64. Hansen, B. E., & Seo, B. (2002). Testing for two-regime threshold cointegration in vector error-correction models. Journal of Econometrics. [DOI:10.1016/S0304-4076(02)00097-0]

65. Ho, T. S. Y., & Wong, S. K. (2001). A Study of the Relationship between Corporate Governance Structures and the Extent of Voluntary Disclosure. Journal of International Accounting, Auditing and Taxation. [DOI:10.1016/S1061-9518(01)00041-6]

66. Ibrahim, M., & Abdul‐Latiff, A. R. (2014). Capital structure and risk-return trade‐off: Evidence from the GCC Islamic bank market. International Review of Financial Analysis, 36, 145-152.

67. Iqbal, M., Molyneux, P., Iqbal, M., & Molyneux, P. (2005). Efficiency in Islamic banking. Thirty Years of Islamic Banking: History, Performance and Prospects, 88-104. [DOI:10.1007/978-0-230-50322-9_6]

68. Iqbal, Z., & Mirakhor, A. (2011). An Introduction to Islamic Finance: Theory and Practice. Wiley Finance. [DOI:10.1002/9781118390474]

69. Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360. [DOI:10.1016/0304-405X(76)90026-X]

70. Meero, A. A. (2015). The relationship between capital structure and performance in Gulf countries banks: A comparative study between Islamic banks and conventional banks. International Journal of Economics and Finance, 7(12), 140-154. [DOI:10.5539/ijef.v7n12p140]

71. Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. American Economic Review, 48(3), 261-297.

72. Myers, S. C. (1984). The capital structure puzzle. Journal of Finance, 39(3), 575-592. [DOI:10.2307/2327916]

73. Myers, S. C. (2001). Capital structure. Journal of Economic Perspectives. [DOI:10.1257/jep.15.2.81]

74. Pasiouras, F., Tanna, S., & Zopounidis, C. (2008). Evaluating Bank Profitability: Evidence from European Banking Sector. European Journal of Operational Research.

75. Pathan, S., & Faff, R. (2013). Does it pay to be different? An analysis of alternative bank business models. Journal of Banking & Finance, 37(8), 3049-3067. [DOI:10.1016/j.jbankfin.2012.12.016]

76. Pesaran, M. H. (2004). General diagnostic tests for cross section dependence in panels. Cambridge Working Papers in Economics, No. 0435. [DOI:10.2139/ssrn.572504]

77. Rabaa, S., & Younes, Z. (2016). Economic growth and financial performance of Islamic banks. econstor.

78. Rahman, M. M., & Hasan, I. (2013). Comparative corporate governance of Islamic and conventional banks: International evidence. Journal of Corporate Finance.

79. Sheikh, N. A., & Qureshi, T. (2017). Capital Structure in Islamic and Conventional Banks. [DOI:10.1108/IMEFM-10-2015-0119]

80. Shleifer, A., & Vishny, R. W. (1997). A Survey of Corporate Governance. The Journal of Finance. [DOI:10.1111/j.1540-6261.1997.tb04820.x]

81. Siegel, S., & Castellan, N. J. (1988). Nonparametric Statistics for the Behavioral Sciences (2nd ed.). McGraw-Hill.

82. Srairi, S. (2010). Cost and profit efficiency of conventional and Islamic banks in GCC countries. Journal of Productivity Analysis, 34(1), 45-62. [DOI:10.1007/s11123-009-0161-7]

83. Toumi, K., Viviani, J.-L., & Louhichi, W. (2012). Alternative Financial Decision Principles: Theoretical Foundations of Islamic Banks' Capital Structure. In Recent Developments in Alternative Finance. [DOI:10.1108/S1571-0386(2012)0000022013]

84. Wooldridge, J. M. (2010). Econometric Analysis of Cross Section and Panel Data. MIT Press.

Rights and permissions
	This work is licensed under a Creative Commons Attribution 4.0 International License.