http://ijfr.sciedupress.com International Journal of Financial Research Vol. 11, No. 1; 2020 Published by Sciedu Press 361 ISSN 1923-4023 E-ISSN 1923-4031 Does Financial Instability of Conventional Banks Affect Financial Stability of Islamic Banks in GCC Countries? Hamid Abdulkhaleq Hasan Al-Wesabi 1 & Rosylin Mohd. Yusof 1 1 Islamic Business School (IBS), University Utara Malaysia, Sintok, Kedah, Malaysia Correspondence: Hamid Abdulkhaleq Hasan Al-Wesabi, Islamic Business School (IBS), University Utara Malaysia, Sintok, Kedah, Malaysia. Received: October 11, 2019 Accepted: November 16, 2019 Online Published: November 26, 2019 doi:10.5430/ijfr.v11n1p361 URL: https://doi.org/10.5430/ijfr.v11n1p361 Abstract Purpose: The main purpose of this paper is to investigate the relationship between financial stability in Islamic banks and financial stability and soundness in conventional banks for five GCC countries. Design/methodology/approach: By using time series data, this study employs Pedroni‟s panel cointegration to test the long-run relationship between financial stability of Islamic banks and financial stability of conventional banks in GCC countries during the period of (2000-2017). Besides, the study also employs Granger causality to test the causal link between stability of two types of banks (Islamic and Conventional). As well as employing Generalized Least Squares (GLS) to examine the effects between independent variables which are financial stability of conventional banks and their profitability, impact of period of financial crisis (2008/2009), oil prices fluctuations, banking concentration and financial sector development and financial stability of Islamic banks (as the dependent variable). Findings: The findings of this research suggest that there is a long-run, significant and positive relationship between the financial stability of conventional banks and its Islamic counterpart. At the same time, the financial stability of conventional banks is found to Granger caused the stability of Islamic banks. Originality/value: The results of the study contribute towards understanding the determinants of the financial stability of both Islamic banks and conventional banks and how they affect each other. This is important for policy ramifications by the Central Banks in GCC in terms of treating both types of banks differently to mitigate against future financial crises. Keywords: financial stability of conventional and Islamic banks, Pedroni‟s panel cointegration test, Granger causality test, Generalized Least Squares (GLS), GCC countries 1. Introduction Financial stability of an institution in a financial system of a country has become a challenge in light of significant changes in the entire economy, the financial system, and within the institution itself. The concept of „financial stability‟ generally came about in the last decade to indicate the importance of the main functions of financial authorities led by Central Banks (Allen & Wood, 2006). Banks‟ stability - whether Islamic banks (IBs henceforth) or conventional banks (CBs henceforth) - has been defined by Miah, M. D., and Uddin, H. (2017) as However, the best is to define financial stability of banks as the period when the instability of banks is absence (Allen & Wood, 2006). However, Iqbal, Mirakhor, Krichenne, and Askari (2010) opined that financial stability is an accounting concept, representing the concept of solvency or equilibrium. It means that financial stability is described by the position of the liquid treasury, which shows whether the use of funds exceeds the sources of funds to be covered internally at abnormal times or during financial crises. The global financial crisis is a lesson for bankers to be more cautious in the future, as no bank was immune to this crisis. During the financial crisis (2008/2009), many CBs suffered bank runs and announced bankruptcy, but no Islamic bank went bankrupt (Ghassan, Fachin, & Guendoz, 2012). Nevertheless, that does not mean that IBs are immune to financial crises; they are affected, even indirectly influenced by the adverse impacts of the financial crises. One of these effects was the fall in oil prices, which mainly affected the IBs of Gulf Cooperation Council (GCC) (Zarrouk, 2012). Thus, this paper attempts to explore the impact of conventional bank instability, also its profitability on the financial stability of IBs and the financial soundness in GCC countries in the long run.