RESEARCH ARTICLE Does competition lead to financial stability or financial fragility for Islamic and conventional banks? Evidence from the GCC countries Mohamed Albaity 1 | Ray Saadaoui Mallek 1 | Hussein A. Hassan Al-Tamimi 1 | Abu Hanifa Md. Noman 2,3 1 Department of Finance and Economics, College of Business Administration, University of Sharjah, Sharjah, United Arab Emirates 2 Department of Finance and Banking, Faculty of Business and accountancy, University of Malaya, Kuala Lumpur, Malaysia 3 Department of Business Administration, Faculty of Business Studies, International Islamic University Chittagong, Chittagong, Bangladesh Correspondence Mohamed Albaity, Department of Finance and Economics, College of Business Administration, University of Sharjah, Sharjah 27272, United Arab Emirates. Email: malbaity@sharjah.ac.ae Abstract This paper investigates the nexus between stability and competition in the banking sector of the Gulf Cooperation Council. We examined a sample of 75 banks over the period 2006–2016. We found a U-shaped relationship between bank stability and competition suggesting competition-stability and competition-fragility nexus. Banking concentration was found to affect insta- bility negatively, which supported the “too important to be bailed out” view. Furthermore, we found that Islamic banks were less stable compared to con- ventional banks. We also found that bank size, profitability and capital regula- tion increase bank stability. In addition, the stock market return and the level of debt-to-GDP increase instability while the growth in oil price increase stabil- ity. Our findings are relevant to regulators to impose or release restrictions that boost financial stability. KEYWORDS concentration, Islamic-conventional banks, stability-fragility nexus 1 | INTRODUCTION Despite competition which makes banks innovative, pro- ductive, diversified and efficient, it may also make them fragile, exacerbating risk-taking behaviour which spills over to other banks in the market, and even to the entire economic system, possibly leading to financial crises, as observed during the recent 2007–2008 Global Financial Crisis (GFC) (Danisman & Demirel, 2019; Li, 2019; Noman, Gee, & Isa, 2018; Organisation for Economic Co- operation and Development, 2010; Phan, Anwar, Alexan- der, & Phan, 2019). Banks, as financial intermediary institutions, need to; remain stable to build public trust in the banking system, to ensure efficient mobilization of scarce funds from savers to productive units and to avoid financial crises. Crises not only distort the loan market, payment systems and freeze economic activities, but they also involve high fiscal costs, in the form of public safety net subsidies, through deposit insurance, the lender of last resort and crisis resolution programmes (Cubillas & González, 2014; World Bank, 2017). As a result, regula- tors, policymakers and academicians are very interested to know whether competition is good or bad for banking stability in their determination of appropriate banking regulations, and bank reform strategies, such as consoli- dation, to make the banking system more concentrated. However, both theory and evidence provide inconclusive findings on the relationship between banking competi- tion and stability. Theoretically, the relationship between competition and stability is controversial. Such as, the Competition- Fragility Theory of Keeley (1990) which claimed that banks enjoy more market power and a higher franchise value to earn monopoly rents in a less competitive Received: 6 January 2019 Revised: 5 December 2019 Accepted: 18 June 2020 DOI: 10.1002/ijfe.2037 Int J Fin Econ. 2020;1–17. wileyonlinelibrary.com/journal/ijfe © 2020 John Wiley & Sons, Ltd. 1