Risk and inefficiency: Behavioral explanation through overconfidence in Islamic and conventional banks

Purpose - The purpose of this paper is to conduct a behavioral analysis, through overconfidence, in order to understand how this cognitive bias could affect risk taking and inefficiency in Islamic and conventional banks operating in the MENA region. Design/methodology/approach - To achieve the objective, the authors considered two overconfidence proxies, namely loan growth rate and net interest margin. Using the generalized method of moments method regressions for panel data, the authors found that the two overconfidence proxies have an effect on the risk exposure and consequently on the efficiency level of Islamic and conventional banks. Findings - In general, overconfidence bias causes excessive risk taking and the degradation of the cost efficiency level. Moreover, these effects emerge with a delay of three to four years and have implications that are not too different for both types of banks. Originality/value - The main motivation underlying this research study is the relatively new field of behavioral finance way in treating the topic of overconfidence. The particularity of the overconfidence bias topic is its assumption that financial decisions can be influenced by cognitive biases, ignoring the fact of a predetermined risk-return calculation.