Journal of Economic Cooperation and Development, 31, 3 (2010), 83-105 Credit Risk and Financing Structure of Malaysian Islamic Banks Aisyah Abdul Rahman 1 and Shahida Shahimi 2 This study examines the impact of financing structure on Islamic banks’ credit risk exposure via four measures: 1) real estate financing; 2) financing specialization; 3) short-term financing structure stability; and 4) medium-term financing structure stability. While controlling the bank-specific variables, our findings indicate that real estate financing and financing structure stability to some extent influence credit risk exposure. However, the significant effects disappear when we incorporated the macroeconomic variables in the framework. This implies that the impact of financing structure on credit risk exposure may be misleading when one ignores the role of macroeconomic fundamentals. Hence, it is hoped that our findings will help the policy makers as well as practitioners do make accurate judgements in the decision making process. 1. Introduction Many theoretical research have shown that Islamic banks have additional risks on top of the standard risk spectrum faced by the conventional banks [Iqbal and Mirakhor (2007); Harrington and Niehaus (2003), Greuning and Bratonovic (2000)]. In general, Islamic banks are exposed to several types of risk such as the systematic risk, credit risk, liquidity risk, investment risk, insolvency risk, hedging risk, displaced commercial risk and shariah non-compliance risk. Systematic risks such as market risk, mark-up risk and exchange rate risk arise from unfavourable price movements of benchmark rates, foreign exchange rates, and commodity prices. On the other hand, credit risk mainly arises from the inability or unwillingness of borrowers to repay monthly 1 Corresponding author. School of Business Management, Faculty of Economics and Business, Universiti Kebangsaan Malaysia. E-mail: eychah@ukm.my 2 School of Economics, Faculty of Economics and Business, Universiti Kebangsaan, Malaysia. E-mail: shahida@ukm.my