Equity Financing at Islamic Banks: Do Competition and Bank Fundamentals Matter?

This article investigates the effects of market competition and Islamic banks’ fundamental conditions on Islamic banks’ equity (profit and loss sharing [PLS]) financing. We use a monthly data set on nine Indonesian Islamic banks from 2009 to 2014. Our empirical results show that competition significantly increases Islamic banks’ PLS financing activities, suggesting that Islamic banks use this mode of financing to attract more entrepreneurs. This argument is also strengthened by the negative association between bank fundamentals and equity financing. In addition, we also find that the effects of competition on equity financing decrease when Islamic banks are more stable. Our results call on policymakers to monitor the practices in Islamic banks’ equity financing because of the risk embedded in that mechanism and Islamic banks’ tendency to use such instruments in poor fundamental conditions.