The Effect of Financial Leverage on The Islamic Banks’s Performance in The Gulf Cooperation Council (GCC) Countries

Abstract

This study examines the impact of the financial leverage on the Islamic banks’ performance in the GCC countries during the period from 2005-2017. The population of this study included the Islamic banks in the GCC countries. Thirteen years data of 25 listed Islamic banks in the GCC countries were used, wereby these data were retrieved from the Thomson Reuters DataStream. This study utilized the fixed effect regression model. The findings show that the financial leverage a has significant impact on the performance of the Islamic banks’ performance in the GCC region. More specifically, the financial leverage has a positive and significant impact on ROA, ROE, and Tobin’s Q of the Islamic banks in the GCC countries, thus indicating that the higher is the financial leverage the higher is the performance of the Islamic banks in the GCC region. However, the results of this study do not provide evidence to support the Agency Cost Theory that implies a decrease in the performance when equity ratio is increased. On the other hand, the findings provide evidence to support the Signaling Theory that argues that banks are expected to have a better performance credibly in transmitting this information through the higher capital. The findings imply that the level of financial leverage committed by the Islamic banks depends on their flexibility in adjusting their debt value and earning power.