Capital Structure and Performance in GCC Islamic Banks: A Two-Stage Approach

Abstract

This paper investigates the relationship between capital structure and performance of Islamic banks operating in the GCC region. The objective of this study provide critical insights to bank managers regarding their capital structure decisions. The paper investigates the effect of capital structure of GCC Islamic banks on their performance, and the significance of various capital structure determinants that may determine the level of capital held by Islamic banks in GCC. Employing a robust two-stage approach, the study analyzes data from a sample of 20 Islamic banks across the GCC region for the period 2010 to 2020. The Two-Stage Least Squares (2SLS) method is utilized to address the potential issue of reverse causality, where performance might influence capital structure decisions. Additionally, Ordinary Least Squares (OLS) is employed to examine the factors shaping the capital structure of these Islamic banks. With the broader macroeconomic environment in context, the findings reveal a positive correlation between Islamic bank performance and equity capital. On the reverse causality effect of performance on capital structure, it was found that Islamic banks with higher profitability tend to employ higher leverage. In conclusion, the study finds that capital structure is relevant for Islamic banks in the GCC, and emphasizes on the importance of identifying the right debt-equity balance for optimized performance and sustainable growth.