Managing the Risks of Investment Deposit Account in Islamic Banks: An Examination of Mudharaba Contract Between MENA and International Markets

Abstract

According to the rule of Sharia, Islamic banks share profit and losses with their depositors through the principle of sharing risk. It should be noted that the monthly rate of return is fluctuating because it depends on real business and economic conditions. Therefore, to protect themselves from the withdrawal funds, the management of Islamic financial system creates specific practices that smooth the return paid to investment accounts holders (IAHs). The (. Guiding Principles of Risk Management for Institutions (Other than Insurance Institutions) Offering Only Islamic Financial Services. Islamic Financial Services Board.) suggests the use of profit equalization reserves (PER) to smooth the returns and investment risk reserves (IRR) in order to reduce potential losses on assets invested with investment account holders (IAHs) funds. This paper aims to examine the influence of the prudential reserves (PER-IRR) and mudharib share on rate of return paid to IAHs. We use the system generalized method of moments (GMM system) on a dynamic panel of 41 Islamic banks observed during the period extending from 2005 to 2016. The estimations indicate that the use of PER and mudharib share affects positively the rate of return paid to depositors. IRR is characterized by a moral hazard, asymmetric information and a high level of risk taking which could impact negatively the relationship between banks and IAHs. It is also revealed that small Islamic banks offer a better remuneration to their depositors. Bank age, Islamic deposit insurance, AAOIFI and crisis affect positively the rate of return paid to IAHs. However, deposit interest rate and Inflation have a negative coefficient.