The effects of formal institutions and national culture on equity-based financing in Islamic banks

Abstract

This study investigates the effects of formal institutions and national culture on equity-based financing across different countries. The sample is taken from 60 Islamic banks from 10 Middle East, South Asia and Southeast Asia countries between 2011 and 2019. Using generalized least squares (GLS) regression and two-way system Generalized Method of Moment (GMM) as a robustness check, we consistently find a positive and significant effect of formal institutions on equity-based financing. This finding indicates that the good quality of formal institutions plays an important role in promoting equity-based financing. In addition, we find that culture is important and even a key determinant of equity-based financing. Power distance has a more powerful impact than other cultural values, indicating that social trust greatly influences Islamic bankers' decisions to channel this particular financing. The link between formal institutions and equity-based financing is weaker in countries with cultural values that are more individualistic (less collectivist) and more uncertainty-avoidant. These findings suggest the necessity of enhancing the quality of formal institutions and taking culture into consideration when formulating policies to increase financing in accordance with the principles of Islam.