Impact of financial liberalization and foreign bank entry on Islamic banking performance

Purpose This paper aims to examine the impact of financial liberalization and foreign Islamic bank entry on the performance of domestic Islamic banks, and credit availability to the private sector. Design/methodology/approach The authors use the weighted least squares method to estimate four models. These models are suggested by Lee. For this, the inverse of the number of domestic Islamic banks in each period is used to weight the observations in the regressions to correct for varying number of bank observations in each country. Findings The results indicate that foreign Islamic banks, on average, follow aggressive financing in host countries and enjoy higher net profit margin. Banking sector returns play an important role in the entry decision and presence of foreign banks. Moreover, favorable macro‐economic conditions play a supportive role while higher tax policies play a hostile role for the entry and presence of foreign Islamic banks. The recent financial crisis does not seem to affect the entry decision significantly. But the profitability of domestic Islamic banks has been seriously affected by the recent crisis. Also domestic tax policy and macro‐economic environment play important roles in determining the domestic Islamic bank performance. Results also indicate that private sector credit availability seems to suffer because of higher tax and reserve rate. Practical implications The authors' findings suggest that host Islamic economies should strive for an efficient capital market with supportive macro‐economic environment, which in turn helps the local banking sector to develop and benefit from the foreign Islamic bank entry. Originality/value This is the first paper to analyze the entry of foreign Islamic banks in the host countries with Islamic banking sector.