Bank financing diversification, market structure, and stability in a dual-banking system

This paper examines the effects of bank financing diversification and market concentration on bank stability in Malaysia. Our study is unique as it investigates these effects within a banking industry that has undergone major restructuring due to the introduction and rapid penetration of a new banking type, Islamic banking. Despite its recent history, Islamic banking, having benefited from strong government support, has grown to command more than a third of the market share. The extensive realignment caused by such industry disruption makes the study of such effects on banking stability highly relevant and interesting. The study investigates 24 conventional and 18 Islamic banks in Malaysia from 2003 to 2019. Our results reveal differences in the above dynamics between the two bank types. Increasing diversification up to a moderate level enhances the stability of conventional banks, but only in less-concentrated markets. Very high diversification levels, however, impair their stability. For Islamic banks, stability seems unresponsive to financing diversification. Furthermore, while market concentration negatively affects the stability of conventional banks, Islamic banks appear to benefit from market concentration. These findings withstand our robustness tests using alternative measures of the key variables. Further examination suggests that these dynamics may have a temporal dimension. Our findings imply that a policy based on a single regulatory framework emphasizing increased diversification and competition across the industry may not be appropriate for all banks. Conventional and Islamic banks may require different regulatory treatment.