Interconnectedness and extreme risk: Evidence from dual banking systems

This study examines the interconnection structure of Islamic and conventional banks and how they transmit extreme risks to each other. This appears to be a particular problem because of the heterogeneous structure of dual banking systems, which raises major questions about systemic stability. We define extreme risk by the transmission of tail risk across banks for a panel of 20 Islamic and 34 conventional banks in six GCC member countries with dual banking systems over the period 2007-2021. Our results reveal the existence of tight connectivity, which increases significantly during periods of instability. We also provide an analysis of the topological structure of the interconnectedness of Islamic and conventional banks that suggests significant unidirectional and bidirectional spillovers of extreme risk at the inter-and intra-sectoral and bilateral country levels. Finally, by examining the individual systemic relevance, we find that there is an asymmetric effect of extreme risk spillovers between conventional and Islamic banks.

Automated summary

This study explores the interconnectedness between Islamic and conventional banks and their transmission of extreme risks. The heterogeneous structure of dual banking systems raises concerns about systemic stability. Using panel data from 20 Islamic and 34 conventional banks in six GCC member countries, we define extreme risk as the transmission of tail risk across banks from 2007 to 2021. Our findings indicate a tight connectivity that significantly increases during periods of instability. We also analyze the topological structure of interconnectedness between Islamic and conventional banks, revealing significant unidirectional and bidirectional spillovers of extreme risk at different levels.