Displaced Commercial Risk in Islamic Banks Before and During Covid-19 Pandemic

Abstract

Islamic banks are exposed to several specific risks, including Displaced Commercial Risk (DCR). DCR typically occurs in a dual banking system or competitive environment within the banking industry, forcing Islamic banks to distribute a portion of profits to Investment Account Holders (IAHs) who deposit their funds in Islamic banks under profit & loss sharing (PLS) contracts. The purpose of this study is to identify the determinants of DCR in Islamic banks and to calculate and measure the influence of these determinants before and during the COVID-19 pandemic period. This study observed nine Islamic banks in three countries with dual banking systems: Indonesia, Malaysia, and Turkiye, from 2016Q1 to 2023Q2. The results indicate that DCR occurred in the Islamic banks observed during the study period. This study found that DCR was significantly influenced by the size of third-party funds from investors who deposited their funds in Islamic banks under PLS-based contracts (UPSIA) and the Rate of Return on Assets (RA). This study also found that several factors often suspected of significantly influencing DCR, namely the benchmark market interest rate and the size of third-party funds from customers with non-PLS-based contracts, did not significantly affect DCR. This study concludes that the Covid-19 pandemic did not have a significant impact on changes in DCR in Islamic banks, so that the DCR before and during the pandemic was relatively at the same level. This study recommends the importance of transparency regarding the profit and loss sharing calculation mechanism for Islamic bank depositors to maintain trust and fairness for Islamic bank stakeholders.