Does Islamic banking matter in transmitting monetary policy? empirical evidence from Indonesia and Malaysia

Muhammad Thariq Audah, Rahmatina Awaliah Kasri

Research output: Contribution to journalArticlepeer-review

Abstract

As an interest-free banking system shows tremendous growth in many countries nowadays, the question of how Islamic banks contribute to monetary policy transmission is increasingly important for policymakers. This study aims to investigate and compare the role of Islamic banks in transmitting monetary policy to the real economy in Indonesia and Malaysia, two countries with established dual banking systems and a growing number of Islamic banks. To achieve its objective, the study relied on Impulse Response Functions and Variance Decomposition Analysis, based on Vector Autoregressive (VAR) methodology. The model consisted of four variables (Islamic banks' deposits, Islamic banks' financing, overnight interest rates, and economic output), while the monthly data used cover the period between January 2007 and December 2016. The principal conclusion is that deposits and financing of Islamic banks play an important although a modest role in transmitting monetary policy to the economies of Indonesia and Malaysia. A plausible explanation of this result is the relatively low market share of Islamic banks in both countries. Additionally, the lower significance of Islamic financing in Malaysia, compared to Indonesia, is due to Malaysia's smaller proportion of profit-loss sharing (PLS) financing. As a result, PLS financing has a smaller impact on Malaysian economic growth. The results suggest that to enhance their economic impact, Islamic banks need to increase their PLS-based financing. This study overall findings contribute to policy information about how Islamic banks can contribute to achieving both economic and monetary policy goals in Indonesia and Malaysia.

Original languageEnglish
Pages (from-to)679-694
Number of pages16
JournalPertanika Journal of Social Sciences and Humanities
Volume28
Issue number1
Publication statusPublished - 19 Mar 2020

Keywords

  • Economy
  • Indonesia
  • Islamic banks
  • Malaysia
  • Monetary policy transmissions

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