Dual Banking and Financial Contagion

This paper builds a theoretical model based on Allen and Gale (2000) to analyse how unexpected shock affecting the banking assets in one region can generate bankruptcy in a second region. I also analyse the effect of the presence in a third region of an Islamic bank on the vulnerability of conventional banks to financial contagion. It is interestingly shown that the Islamic bank assets’ diversification strategy across the regions reduces the likelihood of financial contagion among conventional banks.