From conflict to climate: dissecting external shocks to Islamic banking stability

Purpose This study aims to investigate how foreign geopolitical risk (FGPR) and climate risk (CR) shape the stability of Islamic banks. Design/methodology/approach Using panel data from 56 publicly listed Islamic banks across 16 countries from 2010 to 2024, the authors assess bank stability through the Z-score and non-performing financing ratio. The authors estimate using fixed effects, generalized least squares and two-step system generalized method of moments models and conduct several robustness checks to address endogeneity and sample consistency. Findings FGPR from export partners significantly weakens Islamic bank stability and increases credit risk, whereas import-based risks show more mixed effects. The effects of CR on Islamic bank stability are heterogeneous across climate indicators and stability measures. Practical implications The findings suggest that Islamic banks and regulators should pay greater attention to cross-border geopolitical exposure, particularly export-market exposure, when assessing banking vulnerabilities. Given the heterogeneous climate-risk results, the study does not provide sufficient evidence for specific climate stress-testing requirements. Continued monitoring of external risks may support early identification of vulnerabilities, while specific hedging, diversification and early-warning measures require further empirical investigation. Originality/value This is the first study, to the best of the authors’ knowledge, to examine geopolitics and CRs together as external pressures on Islamic bank stability. By disaggregating geopolitical and CRs into specific components, this study provides a more nuanced understanding of how these risks affect Islamic bank stability and credit risk. The findings also highlight the importance of developing risk management frameworks tailored to the distinct structural features of Islamic finance.