Risk-taking behaviour of Islamic banks: application of prospect theory

Purpose - The paper aims to gain an insight into behavioural characteristics of Islamic banks and how they influence the risk-taking decisions of Islamic banks in financial markets within the prospect theory context. Design/methodology/approach - The study employs review and application of prospect theory in Islamic banking industry across the globe, making use of 99 Islamic banks across 14 countries. Findings - Empirical evidence shows that Islamic banks located above target risk level tend to show risk-adverse behaviour, while banks below target risk level inclined towards risk-seeking attitude. Results also highlighted that banks which have higher loans to total asset ratio tend to take on lower risk. Practical implications - Islamic bank regulators will be better prepared to monitor the Islamic banking system if they understand risk-taking behaviour of Islamic bank managers. The findings will provide more effective bank regulatory oversight, thus preventing Islamic bank failures in future. Originality/value - Since there are relatively few studies conducted in risk-taking behaviour of Islamic banks, specifically global Islamic banking, this study will broaden the scope of the literature by providing novel empirical evidence on risk-taking practice of Islamic banks worldwide.