Islamic financial stability factors: An econometric evidence

Joudar, Fadoua; Msatfa, Zouheir; Metwalli, Olaya; Mouabid, Maha; Dinar, Brahim Article Islamic financial stability factors: An econometric evidence Economies Provided in Cooperation with: MDPI – Multidisciplinary Digital Publishing Institute, Basel Suggested Citation: Joudar, Fadoua; Msatfa, Zouheir; Metwalli, Olaya; Mouabid, Maha; Dinar, Brahim (2023) : Islamic financial stability factors: An econometric evidence, Economies, ISSN 2227-7099, MDPI, Basel, Vol. 11, Iss. 3, pp. 1-13, https://doi.org/10.3390/economies11030079 This Version is available at: https://hdl.handle.net/10419/328704 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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Economies 11: 79. https://doi.org/10.3390/ economies11030079 Academic Editors: Mamdouh Abdulaziz Saleh Al-Faryan, Zahid Irshad Younas and Khaled Hussainey Received: 13 January 2023 Revised: 25 February 2023 Accepted: 27 February 2023 Published: 2 March 2023 Copyright: © 2023 by the authors. Licensee MDPI, Basel, Switzerland. This article is an open access article distributed under the terms and conditions of the Creative Commons Attribution (CC BY) license (https:// creativecommons.org/licenses/by/ 4.0/). economies Article Islamic Financial Stability Factors: An Econometric Evidence Fadoua Joudar 1,* , Zouheir Msatfa 1, Olaya Metwalli 1, Maha Mouabid 1and Brahim Dinar 2 1Faculty of Economics and Management Settat, Hassan First University, Settat 26000, Morocco 2Faculty of Law, Economics and Social Sciences Casablanca, University of Hassan II, Casablanca 20470, Morocco *Correspondence: [email protected] Abstract: This study empirically examines the internal and external factors of Islamic banks’ financial stability during the time frame from 2006 to 2017 in the Middle Eastern and North African (MENA) region. The stability of Islamic banks was determined by the Z-score, which is one of the most well-known financial stability indicators. Using multiple regression analysis, it is shown that capital adequacy ratio and liquidity positively impact the Z-score of Islamic banks, whilst size, governance and level of concentration have a negative impact. This study recommends raising the capital and the liquidity level of Islamic banks as it helps to promote the financial stability of Islamic banks. Keywords: financial stability; Islamic banking; Zscore; MENA region 1. Introduction Financial stability is a recurring need in contemporary economic history, as several episodes of financial instability have affected countries with varying intensity, resulting in massive unemployment and loss of economic output. One of the most prominent episodes of financial instability was the crisis of 1929–1933. At that time, prominent economists struggled to establish a banking system capable of preserving long-term financial stability. Their proposals became known as the Chicago reform plan. Unknowingly, their proposals were a natural reaffirmation of some of the fundamental pillars of Islamic principles and finance. In the wake of the Chicago Plan and in the literature that followed, it became clear that a financial system that conforms to Islamic principles is immune to instability (Askari et al. 2010). Once again, in 2007–2008, the world was hit hard by the financial crisis, characterized by a gargantuan number of bankruptcies and other financial distress. This crisis has, once again, brought to light the old thorny issue of the search for financial stability. Incisive questions came to the surface more urgently (Belouafi et al. 2015). Amid this heated debate, Islamic financial institutions and the principles that govern their operations have received much attention. Indeed, formal and structured Islamic banking institutions are of recent origin, although they were present in unorganized and private activities. Purely Islamic finance was first attempted in the 1940s. This experience took place in Malaysia and Pakistan, and it was known as a primitive attempt that was doomed to failure. In the late 1960s, Malaysia established the first institution whose main function was to manage pilgrimage funds, which is in accordance with Shariah guidelines (Iqbal and Molyneux 2005). Following the oil boom (a global oil price crisis), several Islamic financial institutions were inaugurated in the Gulf countries, the most important of which was the Islamic Development Bank, created in 1974. Subsequently, the launch of Islamic banks was built successively in several countries, including the Dubai Islamic Bank in 1975, the Kuwait Finance House (KFH) in 1977, the Jordan Islamic Bank in 1978, the Bahrain Islamic Bank (BIB) in 1979, the Qatar Islamic Bank (QIB) in 1982 and the Faisal Bank in Egypt in 1981. This achievement encouraged non-Muslim countries such as the United Kingdom to create Economies 2023,11, 79. https://doi.org/10.3390/economies11030079 https://www.mdpi.com/journal/economies Economies 2023,11, 79 2 of 13 the Islamic Bank of Britain, which is considered the first international Islamic banking institution. The experience has been adopted by several countries, and as a result, the Islamic banking industry is now experiencing unprecedented growth (Iqbal and Molyneux 2005). However, this industry has been the subject of several criticisms. In particular, Khan (2010) recognizes the existence of real divergences between the theoretical contributions of Islamic finance and its actual practice. Some theses question the origin of Islamic finance, as highlighted by Kuran (2004), who strongly believes that the emergence of this branch of finance was only intended to succeed the already existing Western practices to preserve the predominance of Islam and to consolidate the identity of Islam in all areas and not to design an alternative system to conventional finance. However, others are opposed to this reflection and explain that the similarity that may exist between the two models is justified by the desire to familiarize customers with the products offered by Islamic banking (Ahmad 1994;Yousef 2004). Along the same line, the banking and financial system were entirely affected by the subprime crisis; in fact, this deep crisis has profoundly transformed the face of global finance. Moreover, it highlighted a number of concerns regarding the financial stability of the major financial system components as well as the main causes of instability. Indeed, it has been surprisingly noticed that notwithstanding the financial crisis, the activity of Islamic banks has grown considerably and has reached a high rate. Due to their nature and fundamental principles, many deductions indicate that Islamic banks provide greater stability and are not affected by the financial crisis (Hussein 2010). However, the factors that determine this stability remain ambiguous. Several studies have been conducted to examine the determinants of banks’ financial stability focusing on both types of banks at the same time (Islamic and conventional) ( ˇ Cihák and Hesse 2008;Shahid and Abbas 2012;Rahim et al. 2012;Hassan et al. 2019;Parsa 2022;Wijana and Widnyana 2022). To our knowledge, the majority of research dealing with this subject compared the financial stability of conventional and Islamic banks while employing a single econometric model without differentiating between the determinants of Islamic financial stability and those of conventional financial stability. In this context, the present work is the first instance where a dedicated and separate econometric model for the financial stability of Islamic banks is described. The motivation to study this issue is due to two points. First, the average value of the financial stability of Islamic banks in the MENA region, according to the Z-score indicator during the period from 2006 to 2017, varies between − 0.351 and 156.669. This demonstrates the existence of significant differences with a standard deviation of 18.042%. These discrepancies raise the question of what exactly determines the financial stability of Islamic banks. Therefore, this study aims to fill this gap by examining the key variables that influence the financial stability of Islamic banks. Moreover, the analysis of previous studies concluded that these studies have focused on the comparison of financial stability between conventional and Islamic banks, and few studies have focused on the determinants of financial stability. Furthermore, previous empirical studies present conflicting results regarding the stability of the Islamic financial system. For example, Ibrahim and Rizvi (2017) focused on the impact of Islamic bank size on financial stability. Widarjono (2020), Daoud and Kammoun (2020) and Pambuko et al. (2018) studied, on the one hand, the impact of bank-specific variables such as capital adequacy ratio, liquidity ratio, bank size and cost efficiency. On the other hand, they introduced external variables such as inflation and economic growth. The importance of this study stems from several points. First, this study is essential because of the importance of financial stability. Indeed, the stability of the banking sector is the foundation for the stability of the entire financial system since banks play a central role in the money creation process, the payment system, the financing of investments and economic growth. Furthermore, to preserve monetary and financial stability, central banks and supervisory authorities have a particular interest in assessing the stability of the Economies 2023,11, 79 3 of 13 banking system. The financial stability of banks has become one of the most pressing issues on the policy agenda in both developed and emerging markets, as the crisis has severely affected the financial intermediation process. In addition, this study is important because it provides an opportunity to focus on the Islamic finance sector, whose asset size has increased to about USD 3.06 trillion in 2021 (compared to USD 2.75 trillion in 2020). The global Islamic financial services industry (IFSI) grew by 11.3% year-on-year and has so far proven resilience in the face of the COVID-19 pandemic (its first major test). The effects of a prolonged conflict between Russia and Ukraine on the dynamics of economic recovery and financial stability present another test of resilience (Islamic Financial Services Board 2022). Second, few studies have explored the determinants of the financial stability of Islamic banks in MENA countries. For example, ˇ Cihák and Hesse (2010) and Rajhi and Hassairi (2013) chose a sample that included MENA countries but introduced other countries from West Africa and South Asia. As a result, to our knowledge, no study has focused solely on the MENA region. Therefore, this study is important because it focuses on a region that is the largest contributor to Islamic banking assets (Islamic Financial Services Board 2022). The paper is structured as follows. Section 2presents the theory and literature review related to the financial stability of Islamic banks. Section 3presents the research hypotheses. Section 4highlights the research methodology. The results and discussion of the study are presented in Section 5. The last section concludes the paper. 2. Literature Review Previous studies have dealt with banking stability, and they were conducted to examine the factors of financial stability of the Islamic banking sector in several countries. Nevertheless, some have generally focused on conventional financial stability as well as the determinants of this stability, while others have assumed the importance of external factors. 2.1. Islamic Financial Stability Theories The debate on Islamic financial stability began with purely theoretical studies that sought to explain the Islamic finance elements that could make it stable finance. Indeed, the first factor is the structure of the bank balance sheet, which is an index for assessing the banking activity’s financial risks. Thus, demand deposits and investment accounts make up the liability side of the Islamic banking balance sheet, while accounts for Islamic financing and investments that resemble traditional bank loans constitute the asset side. Therefore, the Islamic banking balance sheet permits balance sheet transmission, and it is presumed that the maturities of the assets and liabilities are matched (Ghassan and Krichene 2017) Otherwise, it eliminates the mismatch between assets and liabilities because the deposit returns are inherent to asset returns. This risk of inadequacy was at the origin of several financial instabilities since it exposed banks to liquidity risks (Iqbal and Mirakhor 2011). According to Islamic banking theory, the second stabilizing factor is profit and loss sharing. Indeed, Chishti (1985) recognizes that profit and loss-sharing financing is endowed with stabilizing tools incorporated into invested projects. This reasoning was explained by the absence of a gap between cash flows and payment commitments. The presence of the gap was, for a long time, considered a source of financial instability. Islamic banking intermediation treats bank deposits in such a way that changes in the value of deposits on the liability side immediately absorb shocks on the asset side. Additionally, credit risk is transferred from assets to liabilities through the 3P mechanism since neither the principal nor the return on investment deposits is guaranteed, so any losses that occur on the asset side could be absorbed on the liability side (Bourkhis and Nabi 2013). Specifically, profit- and loss-sharing financing promotes financial stability because it spreads the bank’s risk over a larger number of parties involved in the funded project (Zarqa 1983). Economies 2023,11, 79 4 of 13 Moreover, profit and loss sharing allows the bank to actively participate in the investment, especially in productive sectors. The diversification of investments aimed at increasing projects, in addition to the careful monitoring by banks, leads to the reduction of potential risks (Khoutem and Nedra 2012;Said 2012). However, this argument remains questionable as several criticisms have been leveled at Islamic financial institutions because of their restricted use of PLS instruments (Khan 2010;Minhat and Dzolkarnaini 2016; Aggarwal and Yousef 2000). This situation is explained by several reasons. First, PLS instruments are very complex because of the procedures they require (Abedifar et al. 2013). Second, these instruments entail high risk (Šeho et al. 2020) as well as significant transaction costs (Louhichi and Boujelbene 2016). The third factor responsible for the financial stability of Islamic banks that comes up most, in theory, is the quality of banking assets. It appears that Islamic banks have better asset quality due to their equity maintenance in terms of savings and investment deposits, fewer loan loss provisions and non-performing loans (Prima Sakti and Mohamad 2018). This asset quality is firstly explained by the 3P agreements that do not require the investor to present collateral to reduce credit risk (Bourkhis and Nabi 2013); secondly, the prohibition of the sale of debt by Islamic finance in the case of debt-based agreements (Ahmed 2009); and finally, the involvement of Islamic banking institutions in projects that are financed through participation products such as Musharakah and Mudarabah allows better supervision of the default risk (Hassoune 2003). The connection between the financial sector and the actual economy was cited in the literature as another factor contributing to the stability of Islamic finance. Indeed, Islamic banking theory argues that Islamic banks can establish a connection between the financial sphere and the real economy, thanks to the Shari’ah obligation that requires all financial transactions to be backed by a tangible asset. As a result, financial flows can meet the financing requirements of actual movements of goods and services (Njima and Zouari 2012). 2.2. Financial Stability and Its Determinants This section discusses the main factors affecting the financial stability of Islamic banks established by empirical studies considered for this study. ˇ Cihák and Hesse (2008) reported that cost-to-income ratio, bank size, loan-to-asset ratio, banking market concentration, and governance indicators were the significant determinants of bank financial stability in 20 countries over the period from 1993 to 2004. They conclude that the cost-to-income ratio, the loan-to-asset ratio and the Herfindahl- Hirschman Index (HHI) (which measures banking concentration) negatively affect banking stability. At the same time, the size of the bank and the governance indicators have a positive influence on financial stability. Shahid and Abbas (2012) investigated the Pakistani case from 2006 to 2009. They noted a negative impact on the loan-to-asset ratio and the pace of inflation, while financial stability appears to be positively correlated with GDP growth. Rahim et al. (2012) explored the factors of the financial stability of Malaysian banks for the 2005–2010 period. They found that the loan-to-asset ratio negatively impacts financial stability. On the other hand, the empirical results suggest that the size of the bank measured by bank assets as well as GDP growth promotes the financial stability of banks. The banking stability in Turkey was studied by Elbadri (2015) over the period extending from 2006 to 2013. He considered external and internal factors as determinants of financial stability. The results demonstrated that the loan-to-asset ratio and total bank assets negatively impact financial stability. However, the study found a positive impact of cost-to-income ratio, inflation rate and GDP growth on financial stability. According to Rajhi and Hassairi (2013), a higher share of loans in the asset structure leads to rising insolvency. Since financial stability declines as the loan-to-asset ratio rises and vice versa. In addition, the cost-to-income ratio negatively impacts the financial stability of banks. Moreover, the findings showed that the size of the bank, the liquidity Economies 2023,11, 79 5 of 13 ratio, GDP growth and governance indicators are all variables that positively influence financial stability. For a panel of six countries during the period from 2003 to 2010, Altaee et al. (2013) determined the factors influencing the financial stability of banks. The loan-to-asset ratio, GDP growth and inflation rate were found to be positively linked to financial stability. Wahid and Dar (2016) used data from different variables from 38 banks in Malaysia; their study showed that bank size and cost-to-income ratio had a negative effect on the financial stability of Islamic banks. Moreover, the capital adequacy ratio and the return on assets ratio were found to be positively correlated to the stability of banks. In addition, based on a study of 54 banks in six countries from 2007 to 2010, the regression analysis conducted by Ouerghi (2014) shows that the banking variables are not significant. Yet, the size of the bank seems to have a negative influence on its financial stability. Alandejani et al. (2017) compared the resilience of Islamic banks to that of conventional banks while taking into account the global financial crisis. The results demonstrated that Islamic banks are more likely to fail, unlike their conventional counterparts. However, examining the resilience of each type of bank reveals differences in the explanatory variables and their effects. The return on assets ratio has been shown to negatively impact bank failure risk but only for Islamic banks. As for the quality of assets measured by the ratio (loan loss reserves/gross loans), it appears that this ratio has a negative impact on the risk of failure of Islamic banks. As for external variables, the study shows that a high bank concentration rate leads to a high risk of failure. The inflation rate positively impacts the risk of bank failure. In addition, the quality of regulation is negatively associated with bank failure risk. Ibrahim and Rizvi (2017) sought to examine the effect of Islamic banks’ size on their financial stabilities. They found that bank size has a positive impact on financial stability. Otherwise, large Islamic banks exhibit more financial stability than small banks. The analysis conducted by Pambuko et al. (2018) points out that the inflation rate is the main indicator of the financial stability of Islamic banks. It is found that the inflation rate, as well as liquidity, positively impact the financial stability of Indonesian Islamic banks. The results of the empirical study conducted by Widarjono (2020) provide evidence that capital adequacy ratio, cost efficiency, bank size and inflation positively impact the stability of Islamic banks. The results of the study conducted by Daoud and Kammoun (2020) prove that the non-risk weighted capital ratio is the main factor of the stability of Islamic banks, which positively impacts the stability of banks. Size, loan ratio, deposit ratio and overhead ratio have a negative effect on the stability of Islamic banks. While GDP positively impacts the stability of Islamic banks. Rashid et al. (2017) demonstrated that bank concentration ratio, profitability, loan-to-asset ratio and GDP positively impact the stability of Islamic banks. However, inflation is negatively related to the stability of Islamic banks. Importantly, the literature review above confirms the relation between bank stability and its external (macroeconomic variables) and internal determinants (bank-specific variables). However, previous studies show widely varying results. We admit that all the aforementioned empirical studies have not focused only on Islamic banks but rather compared Islamic banks and their conventional counterparts. In addition, previous studies were content to use a single econometric model including both types of banks at the same time. To fill this gap, we developed a specific econometric model for the financial stability of Islamic banks. This allowed us to explore the impact of each variable on Islamic banks’ stability in a very clear way. For the first time, this research work provides an analysis of the financial stability of Islamic banks in the MENA region. 3. Hypotheses Development Based on the previous discussion, it has been shown that the theoretical and empirical literature does not provide a coherent view of the determinants of Islamic financial stabil- Economies 2023,11, 79 6 of 13 ity. Thus, taking into account the objective of this study, the following hypotheses were developed: H1. The capital adequacy ratio has a significant impact on the stability of Islamic banks. H2. The ratio of financing to assets has a significant impact on the stability of Islamic banks. H3. The cost-income ratio significantly impacts the stability of Islamic banks. H4. The profitability ratio has a significant impact on the stability of Islamic banks. H5. The liquidity ratio is negatively associated with the stability of Islamic banks. H6. Bank size has a significant impact on the stability of Islamic banks. H7. Banking concentration significantly impacts the stability of Islamic banks. H8. GDP growth is positively associated with the stability of Islamic banks. H9. Inflation rate is negatively related to the stability of Islamic banks. H10. Governance is positively associated with the stability of Islamic banks. 4. Research Methodology 4.1. Sample Population To conduct this study, we adopted a quantitative approach. The sample utilized in this study consists of 31 Islamic banks from 12 MENA countries (United Arab Emirates, Saudi Arabia, Bahrain, Jordan, Kuwait, Qatar, Yemen, Palestine, Tunisia, Egypt, Turkey and Lebanon). The data set for this study covered the period from 2006 to 2017. This study employed a panel data set, and the used variables were based on previous empirical studies. 4.2. Data and Variables Policymakers and academic researchers have focused on several quantitative measures to assess financial stability, mainly the Z-score. The “safety first” principle was developed based on Roy’s (1952) dissatisfaction with the simple rule of maximizing returns and also his traumatic wartime experience. According to the safety first concept, the gross return should not be less than the disaster level, even in the face of a wide variety of potential outcomes, including disasters. The development of this principle leads to the Z-score measure, which indicates the distance to insolvency by combining the accounting measures of profitability, leverage and volatility (Rajhi and Hassairi 2013). The Z-score is inversely related to the probability of a bank’s insolvency, i.e., the probability that the value of its assets becomes lower than the value of the debt, which indicates that a higher Z-score corresponds to a lower risk of insolvency. Thus, the Z-score ratio is a popular measure of bank strength. It is denoted as follows: Z=(µ+K) σ(1) With µ denoting the bank’s average return on assets (ROA), K represents equity as a percentage of total assets and σ is the standard deviation of ROA as an indicator of return volatility (Bourkhis and Nabi 2013). Overall, at the level of this study and as a dependent variable, we implement the Z-score as a measure of bank financial stability. Indeed, the Z-score is widely used to measure the financial stability of banks in previous empirical studies through the panel data regression technique. The bank-specific variables include funding to assets ratio, capital adequacy ratio, cost-to-income ratio, profitability ratio, liquidity ratio and bank size, Whereas the external explanatory variables include bank concentration, GDP growth, inflation rate and governance. Table 1depicts the independent and dependent variables. Economies 2023,11, 79 7 of 13 Table 1. Formulas and coding of variables. Variables Measurement Formulae Dependent variables Financial Stability Z-SCORE ROA + CAR/SD of ROA Independent variables Capital adequacy ratio CAR Total equity/Total assets Financing-to-assets ratio FAR Total financing/Total assets Cost-to-income ratio CIR Operating expenses/Operating income Return on equity ROE Net income/Total equity Liquidity-to-assets ratio LIQ Liquid assets/Total assets Bank size SIZE Total banking assets of each Islamic bank for each year Bank concentration CONCR % of bank assets held by the top three banks in each country GDP growth GDP GDP growth (annual %) Inflation INF Inflation (annual %) Governance indicators GOV Calculated as the average of the six governance indicators Note: CAR, FAR, CIR, ROE and LIQ were self-calculated from the banks’ financial reports, while CONCR, GDP, INF and GOV were taken directly from databases. 4.3. Model Specification In order to detect the different factors that impact the financial stability of Islamic banks in the MENA region, a multivariate explanatory method was employed in this study, namely linear regression. This is indeed a balanced panel that has the same number of observations (12 observations from 2006–2017) for all individuals (31 banks representing the 12 countries). The regression model of this study is as follows: Z-SCOREit = α+β1CARit + β2FARit + β3CIRit + β4ROEit + β5LIQit + β6SIZEit + β7CONCRt + β8GDPt + β9 INFt + β10 GOVt + εit (2) where α is the constant value; β refers to a vector of exogenous variable coefficients; i indicates an individual bank; t refers to the time period (year); Z-SCORE is the financial stability proxy of the bank; CAR, FAR, CIR, ROE, LIQ, and SIZE are the bank-specific variables; CONCR, GDP, INF and GOV are the macroeconomic control variables; and ε it is the error term. 5. Empirical Results 5.1. Descriptive Analysis Table 2presents the descriptive statistics for all dependent and independent variables. The variable FAR is the most dispersed (857%). The mean for CAR of Islamic banks in the MENA region is 20.10%, which meets the level of capital requirements. The same ratio has a standard deviation of 18.17%, a maximum value of 1 and a minimum value of 0.01, which explains the variance that reaches 90.40%. The average FAR has a mean of 7.11% and a standard deviation of 6.09%. Some Islamic banks in the MENA region have poor asset quality, while others have better bank asset quality according to values ranging from 0.00012 to 117.895. Regarding the CIR, the average value is 64.1%, demonstrating that Islamic banks in the MENA region are not cost-efficient enough. A maximum value of 16.61 and a minimum value of −0.62 explain the value of the gap. Moreover, the mean for ROE is 11.79%, which indicates that Islamic banks in the MENA region have average profitability that should be improved. Economies 2023,11, 79 8 of 13 Table 2. Descriptive statistics. Variables Obs. Mean Std. Dev Min Max Z-SCORE 372 17.111 18.042 −0.351 156.669 CAR 372 0.201 0.181 0.010 1 FAR 372 0.711 6.096 0.000124 117.895 CIR 372 0.641 1.012 −0.627 16.611 ROE 372 0.117 0.604 −1.510 11.114 LIQ 372 0.172 0.141 −0.098 0.918 SIZE 372 92,233.720 9223.372 0.094 10,141,103.7 GDP 372 0.038 0.0462 −0.279 0.261 INF 372 0.047 0.0475 −0.048 0.304 GOV 372 −0.171 0.4871 −1.89 0.725 CONCR 372 0.695 0.1720 0.353 1 In terms of liquidity, the LIQ has an average of 17.20% and a standard deviation of 14.15%. This reflects the low liquidity of Islamic banks in the MENA region. This observation is confirmed by the maximum value of this ratio, which reaches 0.918, and the minimum value, which is −0.098. Additionally, the average for SIZE in our sample is 92,233.720; the minimum value is 0.094, while the maximum value is 10,141,103.7. This demonstrates that the selected sample of banks chosen is composed of different sizes. In regard to GDP, the average in the MENA region is 3.8%, which demonstrates a healthy economic situation. With a standard deviation of 0.0475 and a mean inflation rate of 4.7%, the inflation rate appears stable. The average score for GOV was − 17.14%, showing that the MENA region needs to make more efforts in this area. The MENA region’s average CONCR is 69.54%, which indicates a moderately concentrated banking industry. 5.2. Correlation Analysis This section presents the correlation between variables. According to Table 3, there is most likely no residual collinearity, as shown by the estimation of the residual collinearities. The independent variables’ low correlation with one another is problematic. Table 3. Correlation matrix. Variable Z-SCORE CAR FAR CIR ROE LIQ SIZE GDP INF GOV CONCR Z-SCORE 1 CAR 0.295 ** 1 FAR −0.045 0.004 1 CIR 0.026 0.061 −0.006 1 ROE −0.024 −0.072 −0.002 −0.061 1 LIQ 0.164 ** −0.001 0 −0.053 0.007 1 SIZE −0.138 ** −0.176 ** −0.028 −0.007 0.144 ** −0.053 1 GDP −0.067 0.058 −0.012 −0.001 0.044 −0.005 −0.012 1 INF 0.142 ** −0.180 ** −0.024 0.027 0.001 −0.021 −0.012 −0.188 ** 1 GOV −0.128 * 0.114 * 0.042 −0.194 ** 0.025 0.266 ** −0.106 * 0.318 ** −0.474 ** 1 CONCR −0.160 ** 0.1 0.018 0.133 * −0.012 −0.122 * 0.094 −0.062 −0.117 * −0.181 ** 1 Note: ** The correlation is significant at the 0.01 level, * The correlation is significant at the 0.05 level. The correlation coefficients in Table 3indicate a significantly negative relation between the Z-score and GOV, which means that the stability of Islamic banks decreases when the governance indicators are high. The CAR and GOV are positively and significantly correlated, indicating that when institutional quality is high, banks are better capitalized. Furthermore, the CIR seems to increase when the CONCR increases. In addition, the LIQ and CONCR are significantly and positively correlated, implying that bank liquidity is enhanced when the banking market is concentrated. On the other hand, the association between SIZE and GOV is negative, suggesting that bank assets increase when there is less