Examining the Threshold Effects of Financial Development on the Relationship Among Cryptocurrencies, Financial Stability, and Banking Performance in Selected Islamic Countries, with Emphasis on Institutional Quality

Ali Asghar  Tahanpour; Mohammadreza Mirzaei Nejad; Khashayar  Seyed Shokri

Authors

Ali Asghar Tahanpour Department of Economics, CT.C., Islamic Azad University, Tehran, Iran Author https://orcid.org/0009-0002-8899-585X
Mohammadreza Mirzaei Nejad Department of Economics, CT.C., Islamic Azad University, Tehran, Iran https://orcid.org/0009-0004-9779-2581
Khashayar Seyed Shokri Department of Economics, CT.C., Islamic Azad University, Tehran, Iran Author https://orcid.org/0000-0003-1351-9314

Keywords:

Cryptocurrencies, Financial Stability, Banking Performance, Financial Development, Institutional Quality, Threshold Effects

Abstract

The present study aimed to examine the threshold effects of financial development on the relationship among cryptocurrency activities, financial stability, and banking performance, with emphasis on the role of institutional quality, in selected Islamic countries belonging to the Developing-8 (D-8) group, including Iran, Türkiye, Pakistan, Bangladesh, Indonesia, Malaysia, Egypt, and Nigeria. The study data covered the period from 2013 to 2024. Financial stability was measured using the logarithm of the Z-score, whereas banking performance was measured using return on assets. Cryptocurrency market capitalization, Bitcoin price volatility, and the ratio of cryptocurrency trading volume to gross domestic product were considered the main explanatory variables, while financial development, institutional quality, bank size, inflation, and economic growth were included as explanatory and control variables. To identify the nonlinear behavior of the variables and determine how the effects of cryptocurrencies change across different levels of financial development, a Panel Smooth Transition Regression (PSTR) model with a logistic transition function was employed. The results of the Levin–Lin–Chu unit root test indicated that all variables were stationary at level, while the Kao cointegration test confirmed the existence of a long-run equilibrium relationship among the variables in both models. The Wald, Fisher, and likelihood-ratio tests rejected the null hypothesis of linearity, and the results of the remaining nonlinearity tests and model-selection criteria demonstrated the adequacy of a single transition function with one threshold parameter for both models. The findings from the financial stability model indicated that cryptocurrency market capitalization, Bitcoin price volatility, and the ratio of cryptocurrency trading volume to GDP exerted negative and statistically significant effects on financial stability. In contrast, financial development, bank size, institutional quality, and economic growth improved financial stability, whereas inflation had a negative effect. The financial development threshold in this model was estimated at \(-0.211146\), and the slope parameter was estimated at \(0.735776\). In the banking performance model, cryptocurrency activity indicators also had negative and statistically significant effects on banks’ return on assets, whereas financial development, bank size, institutional quality, and economic growth improved banking performance. The financial development threshold in this model was estimated at \(0.139098\), and the slope parameter was \(0.177326\). Overall, the expansion of cryptocurrency activities may weaken bank stability and profitability through deposit outflows, reduced financial intermediation, increased liquidity and credit risks, higher regulatory and compliance costs, and lower fee-based revenues. However, higher levels of financial development and institutional quality mitigate the banking system’s vulnerability to these adverse effects by enhancing transparency, supervisory effectiveness, and risk-management capacity.

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