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.