1. Introduction

Financial crises are strongly related to financial and banking systems, given the international financial liberalization market, where a local financial system is no longer isolated from changes of the global system. In the last decade of the twentieth century, Islamic banks were first established and have had a growing role in the international financial system since then. In fact, CIBAFI (2010) indicates that total world Islamic finance had reached around one trillion US dollars at the end of 2009.

During the last financial crisis (2007-2009) a large number of conventional banks around the world have announced bankruptcy (140 U.S. Banks in 2009); while no single Islamic bank failure has been reported. The logical question to be raised here, is whether Islamic banks are immunized against financial shocks and if so, can this be explained by the free-interest system, or by the fact that the Islamic banks do not invest in derivatives, “Tawaruq” and loans sale? (Chapra, 2000a, 2000b; Siddiqi, 2000; Hassan, 2006). In other words, can the immunity of Islamic banks against international financial crises be due to its incomplete integration in the global financial system?

Studying the stability of Islamic banks requires the distinction between banks according to their asset structures in their budgets. Firstly Islamic banks adopted single layer Mudarabah, where they mobilize their liabilities directly in different investment opportunities. This model was faced with a lot of operational risks. Accordingly, Islamic banks switched to the use of multi-layer Mudarabah Islamic model, i.e., Mudarabah of assets (sources) and liabilities (uses), where all assets are financed through Profit Loss Sharing system (PLS).

The purpose of this paper is to test the hypothesis that Saudi Islamic banks are relatively less vulnerable to international financial crises, compared to Saudi conventional banks. The financial system and banking system in particular are always threatened by risks which lead to financial crises. The banking sector could be a major driver of financial crises or one of the channels transmitting the impacts of crises to other financial sectors and local or international real economies. Historical data shows that the banking sector was the most heavily damaged party by financial crises. During the last international financial crisis the banks’ losses in the world were estimated to be more than 1.8 trillion dollars, followed by insurance companies with around one trillion dollars. The importance of this paper stems from the perception that the stability of Saudi Islamic banks in response to financial shocks, due to the adoption of the PLS system, is expected to contribute positively to international financial stability.