Non-linear Analysis of Stability in the Islamic Banking Industry

Stability analysis is one of the most important fields of study in the Islamic banking and finance industry. For measuring stability in Islamic banking, we introduced, for the first time, an Islamic banking stability index (IBS) during 2013 to 2016 which use all CAMEL factors and so seems to be more comprehensive than Z-score stability index which dominantly used in the existing literatures. To find the macroeconomic determinants of Islamic banking stability on IBS index, we have developed Generalized Additive Models (GAMs) using smoothing splines. GAMs provide a general framework for extending a standard linear model by allowing non-linear functions of each of the variables, while maintaining additivity. The results show that the proposed models have more predictability when compared by a linear counterpart. It is also concluded that Money Growth and Domestic Credit as a percentage of GDP in each year are inversely related to the Islamic banking stability of the next year.