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Constructing a banking fragility index for Islamic banks: definition impact on the predictive power of an early warning system

ABSTRACT This study aims to construct a banking sector fragility index for Islamic banks that gives substantial predictive power results. We develop various banking sector fragility indices using different combinations of proxies for credit, liquidity and market risk factors. Apart from the existing literature, we add profitability risk factor into fragility indices. Our results show that the predictive power of an Early Warning System (EWS) is highly sensitive to the proxies and combinations of the risk factors and, profitability risk has a positive impact on the predictive power results for Islamic banks.