Pricing Deposit Insurance Premium in Islamic Banks

Abstract

This chapter determines the cost of deposit insurance premiums in a number of Islamic banks operating in Gulf Cooperation Council Countries (GCC), Malaysia, and Bangladesh and assesses the relevant insurance policy in each country with regard to risk-based versus flat rate premium policy. The study uses Merton (Journal of Banking and Finance 1(1):3–11, 1977) option pricing model and financial data from Bankscope data for 23 Islamic banks. Results indicate there is significant variation of insurance premiums within banks in each country. The highest variability of premiums is noticed in banks operating in Bahrain, Malaysia, and Bangladesh. Regression analysis of pooled cross-sectional method and least absolute error method indicates there is statistically significant evidence of positive association between insurance premiums and credit risk. These findings imply suitability of bank-specific risk-based insurance premium policy in Islamic banks rather than flat rate policy adopted in some Islamic countries. For further extension of this research, it is possible to utilize the findings of this research to assess moral hazard behavior in Islamic banks.

Appendix: Deposit Insurance Systems in Selected Countries

	Sudan law	Bahrain law	Jordan law
Board of Directors	1. The Governor of the Central Bank 2. The General Manager of the deposit insurance fund 3. Deputy Minister of Finance and National Economy 4. Director of the department of bank regulation at the Central Bank 5. Two members elected by the association of commercial banks 6. Two experts in banking chosen by the Minister of Finance and National Economy	1. Two experts nominated by the Governor of the Monetary Agency 2. Four members representing commercial banks nominated by the Governor of the Monetary Agency 3. A representative from each of: Ministry of Finance, Ministry of Justice and Islamic Affairs, Ministry of National Economy and Trade 4. A representative from a bank under liquidation	1. Governor of the Central Bank (chair) 2. Deputy Governor of the Central Bank 3. The General Manager of the Deposit Insurance Fund 4. Two members from the Ministry of Finance and the Ministry of Trade 5. Two members appointed by the Council of Ministers
Membership	All licensed commercial banks operating in the country	All licensed commercial banks operating in the country except those insured elsewhere outside the country	All commercial banks operating in the country, with exception of branches of Jordanian banks operating outside the country
Annual fees	Insured member pays annual fee of the rate 0.003 of its total current and saving accounts. And also 0.003 of its total investment account	Annual fee of 25 million Dinars divided between insured banks, based on proportion of each bank’s deposits	Annual fee of 0.0025 of the total insured deposits, and possibly a higher rate for banks with higher risks, or when under liquidation

1. Source: adapted from IADI (2010)