The impact of monetary policy on Islamic bank financing: bank-level evidence from Malaysia

Abstract

Purpose This paper aims to examine the distributional differences of Islamic bank financing responses to financing rate across bank-specific characteristics in dual banking system. The study also aims to provide understanding of how efficiently Islamic banks perform their roles as suppliers of capital for businesses and entrepreneurs. Design/methodology/approach The study uses panel regression methodology covering all Islamic banks in Malaysia. The study estimates the benchmark model for Islamic bank financing with respect to bank characteristics and monetary policy. Findings The evidence suggests that bank-specific characteristics are important in determining Islamic financing behaviour. The Islamic financing behaviour is consistent with conventional lending behaviour that the Islamic bank financing operates depending on the level of bank size, liquidity and capital. There is no significant difference between Islamic bank financing and conventional bank lending behaviour with respect to changes in monetary policy. Originality/value Many problems and challenges relating to Islamic financing instruments, financial markets and regulations must be addressed and resolved. In practice, it would be a good idea if Islamic banks move away from developing debt-based instruments and concentrate more efforts to develop profit and loss sharing instruments.

Financing Channels and Monetary Policy in a Dual Banking System: Evidence from Islamic Banks in Indonesia

“…This evidence points to the fact that Islamic banks are able to protect their financing portfolios by drawing down their liquid assets and therefore are less likely to cut financing. The result is contradicted by Brooks () and Zulkhibri (), who find that liquidity is the main determinant of the supply of credit in Turkey and Malaysia. The insignificance of LIQUIDITY implies that Islamic banks in Indonesia do not experiencing significant liquidity shortages, thus do require to adjust their financing portfolio by drawing down cash and securities.…”

“…In a dual banking system, in which Islamic banks compete with conventional banks, the conventional interest rate may influence Islamic bank financing behaviour (Zulkhibri, ; Cervik and Charap, ). Eq.…”

“…. Furthermore, as in Zulkhibri (), in a dual banking system, changes in interest rates may influence bank financing because banks’ ability to insulate their supply of financing from changes in monetary policy will be restricted, particularly during periods of tight monetary conditions. Hence, we estimate the following model: …”

“…Zulkhibri () examines the distributional differences in the way that Islamic banks respond to base financing rates across bank‐specific characteristics in a dual banking system using panel regression methodology. The evidence suggests that the bank‐specific characteristics are important in Islamic bank financing behaviour, which is consistent with that of conventional banks in that it depends on the bank's level of size, liquidity and capital.…”

“…Although retail funding activities at Islamic banks are mainly carried out using the PLS paradigm, strong evidence indicates that they follow their conventional counterparts in creating assets using non‐PLS, debt like instruments with a predetermined fixed rate of return (Beck et al , ). As a result, the rate of return on retail PLS accounts is implicitly linked to conventional interest rates through debt like instruments on the asset side of the balance sheet (Chong and Liu, ; Zulkhibri, ). Cervik and Charap () explain the underlying reasons for similarities between the asset side of retail Islamic banks and conventional banks: (1) ex‐post information asymmetry in PLS instrument exposes Islamic financing to moral hazard problems; (2) the adoption of PLS financing is constrained by the ability to exercise management and control rights; (3) lengthy due diligence is required for PLS‐based instruments, therefore they are not always appropriate or cost effective for short‐term financing; and (4) liquidity and credit risk management at Islamic banks are complicated because of the lack of secondary markets for PLS‐based financial products.…”