Financing Structures, Bank Specific Variables and Credit Risk ...

Capital adequacy requirement introduced by Basel committee with intention toreduces or control risk taking by the banks. Commercial banks including Islamicbanks are required to follow the capital adequacy ratio which is consisting of TIER 1and TIER 2 capital. All commercial banks must maintain a minimum total capital of8% from risk weighted assets (RWA) of the bank (Basel, 2001). Under thisframework, TIER 1 must exceed at least 4% of the risk weighted assets and 3% oftotal assets. In TIER 2, the amount must not exceed the amount of TIER 1. Thissystem therefore requires at least 50% of the amount of total capital to be suppliedby TIER 1 capital. There are mixed result regarding relationship between capitalratios (CAPR) with credit risk. Berger and DeYoung (1997) suggest that capital ratioswill have negative relationship with credit risk. While Ahmad and Ariff (2007) finds apositive relationship between regulatory capital and credit risk in Japan, Malaysiaand Mexico.Figure 1: Three Types of Financing in Islamic BanksSize of the bank is expected to have either positive or negative relationship withcredit risk. Previous study done by Rahman and Shahimi (2010), Al-Smadi andAhmad (2009), Ahmad and Ariff (2007), Ahmad and Ahmad (2004) and Konishi and4