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Contribution of Islamic banks and
macroeconomic variables to
economic growth in developing
countries: vector error correction
model approach (VECM)
Early Ridho Kismawadi
Department of Islamic Banking, Faculty of Islamic Economics and Business IAIN Langsa,
Aceh, Indonesia
Abstract
Purpose –The purpose of this study is to examine the effect of Islamic banks (IBs) and macroeconomic variables
on economic growth in Saudi Arabia, the United Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh.
Design/methodology/approach –Based on these criteria, 672 observations from 24 IBs in Saudi
Arabia, the United Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh were chosen for further
investigation. Time series analysis is a well-known method for determining if model variables are stationary
and how long-term relationships function through cointegration analysis. This study uses impulse response
function (IRF) and variance decomposition (VD) methodologies to demonstrate how each macroeconomic
variable shock influences the short-term dynamic path of all system variables.
Findings –Islamic banking promotes economic growth, especially in Saudi Arabia, the UAE, Kuwait,
Malaysia, Qatar, Bahrain and Bangladesh. The findings of the Islamic banking VDC test have a direct and
long-term effect on economic growth.
Research limitations/implications –The literature on this topic can be improved in a number of
ways, including by adopting a more robust method to analyze over a longer time frame. By researching
specificfinancing in various areas of the economy, one can gain a deeper understanding of Islamic financing.
This will enable the identification of sectors that contribute to economic expansion. Future research should
examine combining nations with pure Islam and dual-banking systems toacquire sufficient data.
Practical implications –This paper has practice and research implications. It recommends adopting the
nation’s successful experiment with the Islamic banking system as a model for attaining economic growth
through Islamic financing. To replicate this successful experiment, government-based decision-makers and
monetary policy experts must collaborate to make Islamic money flows simple and rapid through financial
channels that enhance economic growth.
Originality/value –The study of the contribution of Islamic banking to economic growth in developing
nations, particularly those with the highest total assets (TAs) and total deposits (TDs) in the world, remains of
modest value. To the best of the authors’knowledge, this is the first study to empirically assess the impact of
IBs in developing nations, particularly those with the highest TAs and TDs in the world, on economic growth
as measured by gross domestic product (GDP).
Keywords Islamic banking, Economic growth, VECM, SDGs, Panel data
Paper type Research paper
1. Introduction
Afinancial system that is founded on Sharia law is known as Islamic banking (Islamic law).
They offer financial services in accordance with Islamic Sharia. Islamic banking’s primary
characteristic is its interest-free nature. The majority of the Muslim community wants to use
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Received 28 March2022
Revised 19 September2022
Accepted 20 December2022
Journal of Islamic Accounting and
Business Research
© Emerald Publishing Limited
1759-0817
DOI 10.1108/JIABR-03-2022-0090
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1759-0817.htm
the goods and services provided by Islamic banking. Islam absolutely forbade interest and
encouraged people to develop alternate methods of profit-making (Mansour et al.,2021). In
Muslim nations, IBs prioritize functioning in accordance with Islamic law over producing
substantive financial results (Ur Rehman et al.,2022).
For Muslims, engaging in prohibited practices, such as uncertainty (gharar), gambling
(maysir) and usury (usury) is considered a serious sin. To deal with this problem, Sharia
scholars have set certain limits for institutions to conduct their business activities by setting
up a framework for purifying sinful incomes (Mansour et al.,2021). Various Islamic financial
issues, become a global concern that is widely discussed and researched by various parties,
especially those in Muslim-majority countries. These elements are intended to advance the
theory, conceptualization and application of Islamic banking to real-world issues such as
service innovation, and the functioning of banking organizational structures and maximize
the contribution of Islamic banking to the nation’s economic development and social
empowerment (Mansour et al.,2021).
Numerous studies have been conducted in recent years to examine the relationship
between the financial industry and the real economy. In the last two decades, extensive
research on the relationship between financial and economic development has yielded
contradictory conclusions (Agiropoulos et al.,2020). Two perspectives have been offered in
response, one demonstrating the beneficial influence of banking and financial market
expansion on economic growth, while the other argues for the diametrically contrary
position (Jamel Boukhatem, 2018). There is conflicting data on the effect that finance has on
economic growth, despite the fact that recent research has focused on the existence of a
nonlinear connection between economic expansion and financial markets (Ruiz, 2018).
Investigating the influence of Islamic banking on the economic growth of developing
countries is important for several reasons.First, several developing countries (namely, Saudi
Arabia, UAE, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh) have IBs with the largest
total assets (TAs) globally. Second, examining the influence of Islamic banking on economic
growth will further enhance understanding of the contribution made by Islamic banking to
the economy. Third, several studies have found that banking development has a positive
impact on economic growth (Chowdhury et al.,2018;Abd. Majid and H. Kassim, 2015) and
revealed a direct and positive correlation between Islamic finance and economic expansion.
In addition, Boukhatem and Ben Moussa (2018a) have demonstrated that Islamic financial
depth [finances/gross domestic product (GDP)] drives long-term economic growth (GDP per
capita) in Middle East and North Africa nations.
Studies evaluating the relationship between the expansion of Islamic banking and
economic growth have not produced reliable findings in the literature. But from the
standpoint of developing countries, this topic has received little attention.
There are three things that this study adds to the existing body of knowledge in this
field. In the first place, it looks at how different financial regimes affect economic growth
and the impact of Islamic banking development on global macroeconomic factors. What this
means for governments that want to expand their Islamic banking sector has a number of
ramifications. Islamic countries especially emerging countries, where the Islamic banking
sector is demonstrating an exceptional growth tendency, should be considered as a second
option. As a result, the assets of IBs in these nations are rising at a higher rate than those of
their conventional counterparts. Time series analysis, which is a well-known method for
discovering if model variables are stationary and how long-term relationships function by
using cointegration analysis, is used in this research. The short-term dynamic path of all
system variables is shown to be affected by each macroeconomic variable shock using the
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IRF and VD approaches. An Islamic bank’s long-term behavior in connection to economic
growth can be assessed using this method under a variety of economic scenarios.
I identified the unique setting of the countries in which Islamic banking in the countries
studied played an important role globally. First, the countries studied have the largest TAs
globally. Second, the countries studied have the majority of the Muslim population, so
Islamic banking is expected to contribute to the economy positively. Using this unique
setting, the researcher aims to provide empirical evidence on the effect of Islamic banking on
economic growth. For empirical analysis, I sampled banks located in countries that have the
largest TAs globally (i.e. Saudi Arabia, UAE, Kuwait, Malaysia, Qatar, Bahrain and
Bangladesh) from 2013 to 2020. Based on these criteria, 640 observations were identified for
further analysis. The research sample includes 20 banks from seven countries with the
highest assets globally. There is still a lot of disagreement in the academic literature about
the impact of Islamic financing. Policymakers need to know whether permitting Islamic
financial institutions to function has positive or negative effects on the economy before they
can make decisions.
By affecting financial stability, bank profitability can have an impact on economic
growth. Numerous studies have demonstrated the link between financial stability and
economic growth (Klein and Weill, 2022). The impact of financial sector development on a
country’s economic growth has been widely theorized by empirical literature (Asteriou and
Spanos, 2019). Despite current emphasis in the literature on the nonlinear relationship
between finance and economic growth, there is undoubtedly a wide range of opinions
regarding how the former affects the latter (Ruiz, 2018). The empirical research also shows
the debate about the true effect of financial development on economic growth. According to
certain research, the rise of the banking industry is helpful to the economy (Ruiz, 2018).
Comparing IBs to their conventional equivalents, it was discovered that they were more
economically efficient. This was based on production and intermediation banking practices
(Musa et al.,2020). Hence, IBs are reactive in promoting real economic activity by
participating with their clients as a trading partner, which is essential for economic growth.
Literature concerning Islamic finance and economic growth is inconclusive and ambiguous
so far (Ledhem and Mekidiche, 2022).
Islamic banking serves at least four purposes: it increases lending, saves money,
stabilizes the financial system and helps fund projects that adhere to Islamic morals (Imam
and Kpodar, 2016). Islamic finance is thought to be a stable way to get money that can help
businesses grow and create jobs for the long term. A law that does not allow for interest or
speculation or hoarding or contractual uncertainty or the secondary debt market is in favor
of productive activities that are good for the real economy. It was not affected by the rise in
credit and did not lead to the speculation that was common in traditional loans (Moussa,
2018).
Given the size of the Islamic banking sector’s assets, its growing market share and its
active involvement in financial intermediation, both in Malaysia and globally, it is timely
and critical to examine Islamic finance’s contribution to the real economy (Kassim, 2016).
This is especially true in countries where Islamic finance is poised to play a growing role in
the economy and now accounts for a sizable portion of banking sector assets. More
importantly, the countries (Saudi Arabia, the United Arab Emirates, Kuwait, Malaysia,
Qatar, Bahrain and Bangladesh) have regularly served as a model for numerous other
countries seeking toestablish their Islamic banking and finance industries.
The fastest-growing sector of the global financial sector is Islamic banking. The Islamic
Finance Development Report (2020) claims that there was an annual growth rate of 14–20%
in Islamic banking and finance from 2010 to 2018, and by the end of 2019, the TAs held by
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IBs had risen to US$2.88tn. As a result of the industry’s rapid expansion and the intense
competition within it, IBs are becoming increasingly knowledge-based to stay ahead of the
curve (Ur Rehman et al., 2022). Over the past three decades, the Islamic finance sector has
grown rapidly. A combination of factors, including the global financial crisis of 2007–2009, a
rise in uncertainty and more globalization, have pushed Islamic banking in particular
toward rapid expansion. The assets of IBs around the world have grown from US$1.3tn in
2012 to US$1.76tn in 2018 and are projected to reach US$2.175tn by 2024 (ICD-REFINITIV,
2020).
A rapidly expanding industry, Islamic banking provides goods and services in
accordance with Sharia law (Hoque et al., 2022). Islamic finance and Islamic bank
investment have grown to be one of the fastest growing sectors in 75 developed and
developing countries. According to Board (2019) IBs’TAs currently exceed US$1.75tn and
are expected to exceed US$2.2tn by 2022. In addition, it is expected to continue growing in
the coming years. This demonstrates that customers have sought out alternative financial
institutions to meet their needs, not just conventional banks but also IBs.
Islamic banking is different from traditional banking because it focuses on risk sharing
and, for some products, gives loans without collateral. This fits the needs of the poor and
microentrepreneurs, which encourages them to start their own businesses, so bringing
Islamic banking to the poor could help development if it is used in the right way. Islamic
banking also has loan products that are based on things like a person’s experience and
character (Abasimel, 2022). A stable Islamic policy can reduce the risk of a bank going
bankrupt. This makesIslamic banking able to keep the economy growing even during crises
such as the COVID-19 pandemic (Dibooglu et al.,2022).
IBs have recently accounted for more than 20% of the global banking system (Board,
2019). In addition, IBs maintained remarkable stability during the global financial crisis,
owing to their realized assets, which were not available to conventional lenders (Setyowati,
2019).
With the growing presence of Islamic banking and finance in the financial landscape, the
time has come to examine the industries’relationship to the economy. The industry’s rapid
growth and growing investor interest necessitate a more thorough reassessment of IBs’
contribution to the economy as a whole. Information on the relevance and importance of IBs
to the country’s growth process is highly sought afterby industry players and policymakers
to chart the future course of healthy industrial growth.
This study aims to contribute to the enrichment of empirical research on the finance–
growth nexus in Saudi Arabia, the United Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain
and Bangladesh. To assess Islamic finance’s contribution to economic growth in Saudi
Arabia, the United Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh, this
study addresses the following research questions:
RQ1. What role does IBs play in promoting economic growth in Saudi Arabia, the
United Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh?
RQ2. How is the relationship between IBs and economic growth in Saudi Arabia, the
United Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh
structured?
RQ3. Do IBs have a significant impact on Saudi Arabia, the UAE, Kuwait, Malaysia,
Qatar, Bahrain and Bangladesh in the short and long run?
By conducting an empirical analysis of the relationship between Islamic finance and
economic growth, we hope to provide an objective assessment of the relationship. To arrive
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at conclusive findings, we use several econometric tests, including the autoregressive
distributed lag (ARDL)-bound testing approach, the vector error correction model (VECM)
and variance decompositions (VDs). In addition, the study incorporated the most recent
available data to reflect recent economic and industry developments and changes. The
study’s specific objective is to conduct an empirical examination of the short- and long-run
relationships between Islamic banking and economic growth in Saudi Arabia, the United
Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh. In addition, it attempts
to investigate the nexus between Islamic banking and finance and growth using Granger
causality tests within the VECM framework. Finally, the paper uses VDCs within a
structural vector autoregression (VAR) framework to investigate the relative strength of
variables affecting economic growth.
At both the empirical and theoretical levels, the effect of Islamic banking development on
economic growth remains ambiguous. Theoretically (Naz and Gulzar, 2022) The Islamic
banking system and Islamic capital markets as potential tools may lead to financial stability
and eventually, economic growth, IBs’financing has a positive influence on economic
growth. It is backed by Islamic banking-sharing instruments, the majority of which are
equity-based and actively pursue the causality of economic growth in both directions.
Chowdhury et al. (2018). the distinct nature of its financing, which is interest-free, is
documented to boost the real sector (M. Anwar et al.,2020). This means that the
development of Islamic banking is one of the policies that the government should consider to
improve the future (Ullah, 2021). Caporale (2018) examined the effects of the development of
Islamic banking on the credit–economic growth nexus. The findings indicate a significant
long-run causal relationship between credit and GDP in economies with IBs. Other findings
indicate a positive relationship between Islamic financing and economic growth, both in the
short and long run. On the other hand, the long-run relationship is stronger than the short-
run relationship. They have discovered a relationship that is neither “Schumpeterian”
supply-led nor “Robinsonian”demand-following. It appears to be a two-way street. Still, it
should be noted that some remain skeptical whether Islamic finance will bring better
benefits to the real sector than conventional finance (Masrizal and Trianto, 2022).
The following is the organization of this study. Section 2 conducts a brief review of the
literature on the relationship between finance and economic growth. Section 3 discusses the
empirical framework and data used in the study, whereas Section 4 discusses the empirical
findings and their discussion. Finally, Section 5 summarizes the significant findings and
discusses the policy implications.
2. Literature review
2.1 Banking sector intermediation development and economic growth
Financial intermediation is a crucial component in family and corporate investment and
savings decisions. Evaluation of financial sector improvements and their impact on
economic growth is contingent on a number of variables, including sector breadth,
efficiency, stability and accessibility (Khatri Chettri, 2022). A functional financial system is
seen as one of the primary pillars upon which sustained economic development can be
constructed (Bist, 2018).
A sophisticated financial system needs a reliable financial intermediary, and vice versa,
one that is able to support local investment, encourage foreign direct investment and foster
economic expansion (Hunjra et al., 2022). Financial development is advocated to enhance
economic growth through the financial system’s numerous roles (Hunjra et al.,2022).
Financial growth generates demand for new infrastructure, reduces credit costs, enables
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access to funds, boosts economic activity, generates new employment opportunities, boosts
labor participation rates and enlarges markets (Hunjra et al.,2022).
2.2 Economic growth and Islamic bank deposits
The total amount of deposits is a source of funds that banks can channel as credit. There are
also deposits from other banks, in addition to deposits from clients. After receiving cash
from the public in the form of deposits (current accounts, savings accounts and time
deposits), banks route the funds back into the economy through a variety of financing
mechanisms. The bigger the number of deposits held, the greater the capacity to give
financing to clients, which will ultimately have a favorable effect on economic growth via
production or consumption channels.
IBs play a crucial role as economic growth’sfinancial intermediaries. These include
contributing to morally acceptable project finance, encouraging loans, fostering financial
stability and encouraging savings. IBs encourage economic activity, such as the provision of
business capital in the actual economy, which is more efficient than pure lending. In
addition, they have a more positive effect on economic expansion (M. Anwar et al.,2020).
The expansion of total deposits (TDs) in Islamic banking enables banks to expand
investment, hence fostering economic expansion. High regulatory and prudential criteria
about changes in macroeconomic variables will also have a good effect on bank asset
structure management and increase national income (Mohamad et al., 2018).
2.3 Creating Economic growth through Islamic bank assets
TAs are an indicator of the size of a firm; the larger the organization, the greater the TAs.
The same holds true for IBs; the more assets possessed, the greater the capacity to channel
finance and the more financing disbursed, the greater the favorable impact on economic
activity. And conversely, if a bank has inadequate assets, the financing it may provide will
not be optimal, as the vast majority of large-scale financings require banks to have adequate
assets.
Expansion and depth of Islamic finance is measured by TAs (Al-Silefanee et al.,2022). A
well-developed banking system must contain a number of high-capacity institutions that
contribute to the nation’s economic progress. Moreover, such major capital banks must have
an equal number of branches in both rural and urban areas to be able to mobilize funds from
the surplus sector of the economy for efficient allocation to the deficit sectors of the economy
for productive investment, so promoting economic growth (Al-Silefanee et al.,2022). The
asset quality of IBs has more resilience than conventional banks (Al-Silefanee et al.,2022).
Even during economic volatility, IBs strive to preserve the quality and consistency of their
holdings. As indicated previously, Islamic bank practices resemble those of regular banks.
However, they differ in several respects, and their superior performance appears to be
attributable to variations in their provisioning techniques, nonaggressive lending profiles
and investments in real assets (Al-Silefanee et al.,2022). Islamic banking contributes to
economic growth by its ability to channel better finance so that genuine economic activities
can be maximized, as well as its ability to sustain economic stability in the face of shocks,
when its asset performance is strong (Rizwan et al.,2022). In addition, IBs limit their
exposure to derivatives and speculative trading, which contribute to financial instability
(Alqahtani and Mayes, 2018). In addition, Islamic banking’s profit-sharing system will
entice investors to engage in the real sector, and these investments will generate activity in
the real sector (Masrizal and Trianto, 2022).
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2.4 Financial sector, economic growth and macroeconomic Islamic finance and economic
prospects
Strong interdependencies between financial sector stability and macroeconomic factors
have been observed in recent trends in industrialized nations. There is mounting evidence
that the financial sector plays a critical role in economies today, and as a country develops,
the sector tends to become more sophisticated and more extensive, opening up a wide
variety of transmission channels that can have a significant impact on economic
performance. The provision of capital by the financial sector to increase family and business
consumption and investment is thought to stimulate economic growth; yet, crisis in the
financial market can lead to substantial macroeconomic downturn (Zabavnik and Verbi
c,
2021).
In the field of finance, there has been a significant amount of research conducted on the
correlation between financial progress and economic growth. Recent years have seen an
increase in the use of a wide variety of econometric methods, including individual country
analysis, cross-country analysis, time series analysis, panel data analysis and threshold
analysis. However, there is a lack of consensus among the data concerning the effect that
financial development has on economic growth (Ruiz, 2018). The theory of economics
explains the process that underlies the relationship between financial progress and
accelerated economic expansion. The cross-country empirical evidence has generated
conflicting results on the analyzed relationship throughout the course of the past decade as a
result of the new methodological advancements and the diverse data samples that were used
(Agiropoulos et al.,2020).
It is common practice for firms to use profit sharing as a means of rewarding employees
and distributing risk to shareholders and other stakeholders (Ozdenoren and Rubanov,
2022). Profit-sharing investment accounts, as opposed to traditional deposits, are equity
contracts with no return assurance (Ozdenoren and Rubanov, 2022).
When compared to the research on the relationship between financial development and
economic growth, the theoretical and empirical literature on the link between Islamic
banking and economic growth is extremely scarce. In fact, the majority of studies look at
how the banking system as a whole affects economic growth. Nevertheless, a small number
of research look at how IBs actively contribute to economic growth generation. Questions
have been raised concerning Islamic finance’s ability to spur expansion in financial
intermediation given the rise of the Islamic financial system and its worldwide standing.
There are several advantages to using Islamic banking in Muslim-majority nations as well
as countries with lower and middle-income populations. This may explain why Islamic
banking can drive growth more effectively than conventional banking in some situations
(Boukhatem and Ben Moussa, 2018).
Furthermore, Islamic banking is not limited to Muslims alone, but all economic actors in
society, instead of traditional financial institutions. Just because it must structure its
products by Shari’a principles, it is referred to as “Islamic.”It is possible to lower the
percentage of those who do not have financial services by using Islamic financial services.
Because of this, Islamic financing can help reduce inequities and improve economic
prospects for those in poverty who have a lot of value to add.
2.5 The financial sector’s contribution to the real economy
Financial cycles play a crucial part in the macroeconomic dynamics of contemporary
countries and have a substantial impact on real economic activities worldwide (Qin et al.,
2021). Numerous studies have been conducted on the connection between Islamic finance
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and economic growth. Regarding international studies that found a positive effect of Islamic
finance on economic growth, a recent study by Gani and Bahari (2021).
The significant role of financial institutions in actual economic growth has been the
subject of numerous discussions, including Asteriou and Spanos (2019),Dinger et al.(2022);
Naz and Gulzar(2022) and Ruiz(2018). Nonetheless, the results of the research are still
ambiguous, particularly regarding the impact of Islamic finance and banks on economic
growth. Given the growing number of banks and countries that implement Islamic finance,
it is crucial to conduct this research to demonstrate the impact of IBs on economic growth.
Liquidity supply, the construction of financial instruments that enable enterprises and
consumers to store wealth while retaining access to these assets to fulfil unforeseen
financing needs, is an important job of financial intermediaries (Kreamer, 2022). One of the
main reasons why financial markets were opened up was so that businesses could get the
financing they needed to grow (Zabavnik and Verbi
c, 2021).
The study’s analysis of issues concerning the relationship between the economy’s
financial and innovative sectors indicates a correlation between indicators of financial sector
development, genuine innovation and economic growth (Majeed et al., 2019). For instance, a
study of 6,422 businesses in 22 emerging economies discovered that a lack of credit
resources inhibits innovation. This is especially true for businesses with limited access to
alternative sources of financing (Qi, 2020)(Spatareanu et al.,2019) studies emphasize the
critical role of bank financing in British firms’innovative activities. The authors discovered
that bank stability issues during the 2008 and 2011 financial crises negatively affected
businesses’innovative development (Spatareanu et al., 2019).
It is important to note that Shari’a does not allow the traditional bank–borrower–lender
relationship. Instead, the financial transaction’s participants form a new “participatory
associative relationship.”Legally, this framework thinks that profit and loss sharing
between fund managers and labor providers is the only just and fair way to avoid interest
rates. This risk allocation structure encourages fund providers to get information about the
project and the person who wants to get money for it and keep an eye on the projects they
fund afterward.
2.6 The contribution macroeconomic to the real economy
Financial sector stability and macroeconomic variables have been increasingly intertwined
in recent trends throughout industrialized nations. There is mounting evidence that the
financial sector plays a crucial role in economies today, and as a country develops, the sector
tends to become more sophisticated and larger in scale, opening up a plethora of
transmission channels via which economic performance can be influenced (Zabavnik and
Verbi
c, 2021).
There is no agreement on how monetary policy influences economic activity, despite the
fact that understanding this mechanism is crucial to attaining the central bank’s primary
goals and improving macroeconomic stability. Because Islamic banking has a unique
function in the financial system by providing interest-free financial products to markets, the
monetary policy transmission mechanism in a dual-banking system, where Islamic and
conventional banking coexist, is intriguing. As a result, central bank policies that affect
interest rates may have unequal impacts on IBs due to the unique link between the two.
Islamic banking services are premised on the PLS concept, which is similar to but distinct
from interest. There is no justification for Islamic financial institutions to increase their cost
of financing for borrowers whenever the basic interest rate is adjusted by central banks
(Boukhatem and Djelassi, 2022).
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The GDP is a way to figure out how well a country is doing financially. In addition, this
could lead to more business for traditional banks, because banks act as money exchangers
when they make money from their businesses or have better financial performance. Bank
loan demand is expected to be affected by the GDP growth rate (GDPGR). This is one way to
figure out the state of the economy. Adding more information about GDPGR, it is the annual
change in GDP and that changes in GDPGR directly affects the amount of loans and savings
available and how much people want to save. Demand for loans is expected to rise as the
economy grows, and the quality of the loans is also expected to improve, which means that
banks will make a lot of money. The empirical findings demonstrated that the expansion of
Islamic banking contributed to GDP per capital growth (Boukhatem and ben Moussa, 2018).
2.7 Inflation on economic growth
The influence of inflation on economic growth has been the topic of research and
macroeconomic discussion for a considerable amount of time (Sequeira, 2021;Moosavi
Mohseni and Cao, 2020). The empirical evidence indicates that inflation has a detrimental
impact on economic expansion (Sequeira, 2021). Real GDP expansion equals nominal GDP
expansion minus inflation. Therefore, if inflation is underestimated, actual GDP growth will
be exaggerated (Lai and Zhu, 2022). Inflation is damaging to financial development,
according to a study on the link between inflation, economic growth and financial
development (Ehigiamusoe et al.,2022). Because inflation has led the exchange rate to rise
and the domestic currency to devalue quicker than foreign currencies, high inflation will
lead to an increase in government countries’external debt (Doan Van, 2020). When the real
income equals the nominal income minus the inflation rate, inflation grows but the nominal
income does not, causing the real income of workers to decline. The more money they
borrow, the more money they will spend, which will lead to undesirable inflation
(Subramaniam and Masron, 2022).
The money supply has an effect on GDP growth and inflation; hence, the tools of
monetary policy should always be set with a high degree of correlation to other variables
within a medium-term framework. On its foundation, we can precisely calculate the demand
for money to maintain an adequate supply of money and prevent an oversupply of money in
the economy. If the gauge of money supply growth is more accurate, it will assist curb
inflation and stabilize the native currency’s value (Doan Van, 2020).
2.8 Exchange rate and economic development
The impact of exchange rate policy on economic development is still the subject of extensive
debate. There are two important and interrelated challenges surrounding exchange rate
management in the macroeconomic era of developing countries in the last few decades,
relating to the interaction between the balance of payments, macro stability and growth
(Guzman et al., 2018).
Studies in the past have paid a lot of attention to how exchange rates change and how
well the economy as a whole does. Several studies have shown that exchange rate flexibility
is good for economic growth because it helps the economy adjust to shocks. Other studies,
on the other hand, have shown that exchange rate volatility hurts international trade,
investment and employment, all of which can affect economic growth (Barguellil et al.,2018;
Combes et al.,2019;Sharma et al., 2018;Solarin et al., 2018).
Money policy is important and has a direct effect on how fast the economy grows. But if
the government wants to build a sustainable economy, it needs to make sure that
macroeconomics and prices are stable (Doan Van, 2020;Combes et al.,2019). The standing of
a nation on the global market is determined by its exchange rate. Multiple studies have
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demonstrated that a stable exchange rate can contribute to a nation’s economic development
(Sharma et al.,2018). Additionally, a country’s standing on the worldwide market is
determined by its long-term exchange rate stability. Multiple studies have demonstrated
that a stable exchangerate can contribute to a nation’s economic development (Sharma et al.,
2018). The exchange rate channel is when the amount of money goes up, which hurts the
interest rate and causes the value of the currency to go down. Currency devaluation
increases net exports, which raises RII’s GDP (Anwar and Nguyen, 2018).
3. Research methodology
Due to the study’s objective of examining the empirical impact of Islamic banking, inflation
and currency rates on economic growth in Saudi Arabia, the United Arab Emirates, Kuwait,
Malaysia, Qatar, Bahrain and Bangladesh spans the years 2013–2021. In total, 672
observations were selected for further analysis based on this criteria. The survey sampled
24 banks from seven of the world’s wealthiest countries. Data are collected quarterly. Please
refer to Table 1 for more information regarding the research variables used.
The data for this study were gathered from the bank’sofficial website and the OSIRIS
Database website (www.bvdinfo.com/), in addition to economic growth data received from
the World Bank at www.data.worldbank.org/. We specifically concentrate on the influence
of IBs, inflation and currency rates on economic growth in this study. In summary, we focus
on two models:
GDP ¼fTA;TD;EXR and INF
ðÞ (1)
where:
GDP = gross domestic product;
TA = total asset Islamic banking;
TD = total deposits Islamic banking;
INF = inflation; and
EXR = exchange rate.
We use time series analysis, which is a well-known way to figure out if model variables are
stationary and how long-term relationships work by using cointegration analysis. Impulse
response function (IRF) and variance decomposition (VD) techniques are used in this study
to show how each macroeconomic variable shock affects the short-term dynamic path of all
system variables. These techniques are based on the VAR model (Table 2).
3.1 ARDL-bound testing approach
Stationarity of variables is critical in time series analysis, as using least squares regression to
nonstationary variables might result in inaccurate parameter estimates. The unit root test is used
to determine if a variable is stationary at its initial value, I(0), or at its initial difference, I. (1).
Table 1.
Descriptive
information of
variables
Variable Description Measurement Source
TA Total asset Islamic banking Total Islamic bank’s assets per quarter OSIRIS
TD Total deposits Islamic banking Total Islamic bank’s deposits per quarter OSIRIS
GDP Economic growth Real GDP per quarter World Bank Data
INF Inflation Real inflation per quarter World Bank Data
EXR Exchange rate Real exchange rate per quarter World Bank Data
JIABR
Numerous cointegration strategies exist for empirically establishing long-run relationships
between variables. The most-often used approaches are Engle et al.’s (1987) two-step residual-
based procedure, Johansen’s (1991) system-based reduced rank regression and Pesaran et al.’s
(1996) ARDL model. This article demonstrates how to use ARDL to test hypotheses about
coefficients when the variables are I(0) or I. (1). In addition, the ARDL model applies to studies
with small finite samples and is resistant to simultaneous equation bias and autocorrelation
problems when the ARDL model’s orders are appropriately chosen apriorior estimated using a
model selection procedure such as the Akaike information criterion (AIC) or Schwarz–Bayesian
criterion. Considering these factors, the ARDL model was chosen as the best appropriate for this
investigation.
In this investigation, we estimate two ARDL models. Models 1 and 2 of the ARDL used in
this study can be stated as follows:
GDP ¼
a
0þ
a
1TAtþ
a
2EXR2þ
a
3INF3þ2
t(2)
GDP ¼
a
0þ
a
1TD1þ
a
2EXR2þ
a
3INF3þ2
t(3)
The following is the error-correction representation for the ARDL models used in this study:
Din GDP ¼
a
0þXk1
j¼1bjDln GDPtjþXk2
j¼0cjDln TAtjþXk3
j¼0ejDln EXRtj
þXk4
j¼0fjDINFtjþn1ln GDPtjþn2ln TAtj
þn3ln EXRtjþn4ln INFtjþ2
t(4)
Din GDP ¼
a
0þXk1
j¼1bjDln GDPtjþXk2
j¼0djDln TDtjþXk3
j¼0ejDln EXRtj
þXk4
j¼0fjDINFtjþn1ln GDPtjþn3ln TDtjþn3ln EXRtj
þn4ln INFtjþ2
t(5)
The short-run dynamics are represented by terms with summation signs in the foregoing
equations (5) and (6), whereas the long-run relationship is represented in the second section,
and trefers to the random error factor.
The ARDL-bound testing procedure is carried out using the Ftest, which determines the
joint significance of the coefficients on the variables’one-period lagged levels (Pesaran et al.,
Table 2.
Research objectives
and analysis
techniques
Research objectives Time series analysis techniques
1. To determine whether GDP TA, TD, INF and EXR exhibit
long-run cointegration
ARDL (GDP testing cointegration approach)
2. To determine whether GDP TA, TD, INF and EXR have a
short run relationship
Variance decomposition (VD) short run
3. To determine the relative importance of each GDP TA, TD,
INF and EXR
a. ARDL (long-run coefficient estimates)
b. Variance decomposition (VD) short run
Vector error
correction
model
approach
2001; Narayan, 2005). The Ftest has a nonstandard distribution that is dependent on the
following factors:
whether variables are I(0) or I(1);
the number of regressors;
the number of observations; and
whether the ARDL model has an intercept and/or a trend (Narayan, 2005).
The AIC is used to pick models for this investigation. The error correction model (ECM)
coefficient indicates the rate at which equilibrium is restored following a disturbance in the
long-run equilibrium relationship. A significant negative ECM coefficient indicates the rate
at which variables revert to their initial state. A comparatively large absolute value for the
ECM coefficient indicates a more rapid adjustment process.
3.2 Variance decompositions
This variance decomposition (VD) will provide information about the magnitude and
duration of a variable’s shock to the variable itself, as well as the magnitude and duration of
the shocking percentage of other variables to that variable. Variance decomposition is a
technique for describing the contribution of each variable in a VAR model to the response to
a shock.
Variance decomposition is a method for analyzing the VAR equation to determine the
components of the forecasting variance that arise when the variance decomposition follows
the contemporaneous structure: the variance decomposition or forecast error value. Variance
decomposition (VD) is always 100%; a more significant VD value indicates that
the contribution of one transmit variable’s variance to the variance of another transmit
variable is more significant. Sims (1980) innovation accounting approach is used to analyze
the economic implications of VD findings. This approach decomposes each variable’s
forecast error variance into components due to its innovations and system-wide shocks.
4. Results
To get reliable and robust results from a conventional regression analysis, the data to be
analyzed must be stable. Thus, the Augmented Dickey-Fuller (ADF) and Phillips-Perron
(PP) stationarity tests are done on a model with a steady trend. Table 3 shows the ADF and
PP tests statistics for unit roots (nonstationary) in all variables. The study found that all
variables had a unit root, which means that even at the 1% level of significance, the H0 of a
Table 3.
Unit root tests
Level Firs difference
Variable ADF PP ADF PP
Total asset 3.570 3.125 28.301* 32.070*
Total deposits 4.765 3.906 42.021* 40.501*
Inflation 7.046 9.174 10.630* 27.531*
Exchange rate 3.638 3.796 27.640* 27.640*
GDP 3.434 3.664 27.547* 27.559*
Notes: *Denotes significance at the 1% level; the lag lengths included in the models are based on the
Akaike Information Criteria (AIC); the above tests of ADF (Augmented Dickey-Fuller) and PP (Phillips-
Perron) are based on model with constant and trend
Source: Research findings
JIABR
unit root at level cannot be thrown out. Because the indices are not stable at certain levels,
the first differences for all whole models are taken. When you make the first difference, the
same tests are used. They show that all the variables become stationary after being changed
once. This shows that all variables are integrated of the order 1, I(1), so we can now move on
to the cointegration analysis with these variables because they are all integrated in the same
order as needed. Before we can do our cointegration analysis, we need to ensure that we can
do it with the ARDL bound-testing method.
Before we can estimate the short- and long-run link between Islamic banking, exchange
rate inflation and economic growth for an economy using the ARDL limit testing approach
for cointegration, we must first determine the duration of the lag on the first-difference
variable (M. Anwar et al., 2020;Mandeya and Ho, 2021;Sharma et al.,2018). The result of
this first stage is often lag dependent. To check this, we enter the lag length in the first-
difference variable between 1 and 4. Table 4 includes the derived Fstatistic for each gap
length and the crucial values at the bottom of the table. As previously stated, the
significance level test results vary according to the lag length used. Only lag lengths 1 and 2
were found to be significant at the 90% and 95% levels, respectively, whereas lag lengths 3
and 4 were not found to be significant in either model. The findings establish a long-term
correlation between economic growth, Islamic banking, inflation and exchange rates in
Saudi Arabia, the UnitedArab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh.
In other words, it is discovered that these variables exhibit a long-run equilibrium in which
they tend to move in lockstep over time.
In the second stage, we estimated equations (3) and (4) using the optimal lag length of three as
suggested by the highest significance Fstatistic value (4). After that, the long-term ARDL model
estimates were chosen using the AIC criteria, the results of which are summarized in Table 5.
According to the ARDL [1, 0, 0, 0]-Model 1, all other variables except TD were found to be
insignificant in driving economic growth in Saudi Arabia, the United Arab Emirates, Kuwait,
Malaysia, Qatar, Bahrain and Bangladesh. ARDL [1, 2, 2, 0]-Model 2 provides similar evidence
that total asset contributes positively and significantly to the economic growth of Saudi Arabia,
the UAE, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh.
According to the findings of the two ARDL models presented in Table 4, Islamic banking
institutions contribute significantly to the economies of Saudi Arabia, the United Arab
Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh. Deposits and assets provided
by Islamic banking institutions in Saudi Arabia, the United Arab Emirates, Kuwait,
Malaysia, Qatar, Bahrain and Bangladesh have been shown to boost economic activity
(Ledhem and Mekidiche, 2022;M. Anwar et al., 2020;Zabavnik and Verbi
c, 2021).
Table 4.
Bounds test for
cointegration
Computed Fstatistics
Lag length Model 1: total deposits Model 2: total asset
1 82.578 83.124
2 82.625 83.172
3 82.670 83.241
4 82.298* 83.199
Notes: The relevant critical value bounds are taken from (Pesaran and Shin, 1998) [Case III with
unrestricted intercept and no trend and number of regressors = 3]; they are 5.333–7.063 at the 99%; 3.710–
5.018 at the 95%; and 3.008–4.150 at the 90% significance levels, respectively. *denote that F-statistics falls
above the 90% and 95% upper bound, respectively
Source: Research findings
Vector error
correction
model
approach
Although Islamic banking institutions’market share of TAs in the banking system is still
small in many countries,the interest-free nature of Islamic banking financing is documented
to encourage the real sector, these results are in line with Boukhatem and Ben Moussa
(2018). In addition, the lower volatility or high stability of the Islamic finance industry, as
reflected in the Islamic stock market, has been documented to play a significant role in
driving the country’s economic growth; these results are in line with (Alqahtani and Mayes,
2018;Dibooglu et al., 2022;Mansour et al.,2021;Mohamad et al., 2018;Zabavnik and Verbi
c,
2021) whether during normal or crisis periods. This finding implies that one viable option
for boosting the country’s economic growth is to further improve the efficiency and
development of the Islamic banking industry in the country.
After examining the long-run relationship between economic growth (GDP), total Islamic
bank assets, total Islamic bank deposits, inflation and exchange rates, we apply the Granger
causality test using the first-differed variable based on VECM which distinguishes between
short- and long-run causality. It is critical to note at this point that cointegration between
variables indicates their long-term relationship and, while it implies causality, it does not
reveal the direction of causality between them. Granger causality is reported in Table 6
between the focus variables, including economic growth (GDP), TAs, TDs, inflation and
exchange rates.
Table 6 summarizes the Granger causality findings between IBs and economic growth in
Saudi Arabia, the UnitedArab Emirates, Kuwait, Malaysia, Qatar, Bahrain, and Bangladesh
using VECM. Fstatistics represent short-term causality in this analysis, whereas error
Table 5.
Long-run ARDL
model estimate
Regressor Model 1: ADRL [1,0,0,0] Model 2: ADRL [1,2,2,0]
C1.058 (0.290) 1.074 (0.282)
Total asset 6.142 (0.000)**
Total deposits 3.711 (0.000)***
Inflation 4.252 (0.000)** 4.179 (0.000)**
Exchange rate 1.059 (0.289) 0.341 (0.732)
Diagnostic Adjusted R
2
0.061 Adjusted R
2
0.033
Statistics D-W= 2.034 D-W= 2.057
Notes: ** and *** denote significantly at 10% and 5% levels of significance, respectively; figures in the
parentheses and squared parentheses are the t-statistics values and the selected ARDL models; D-W
denotes Durbin–Watson test for autocorrelation
Source: Research findings
Table 6.
Granger causality
results based on
vector error
correction model
Financial indicator
Finance-led growth
Short run ECT
t–1
Total asset 3.841** (0.000)* 1.868 (0.114)
Total deposits 3.842** (0.000) 0.952 (0.433)
Notes: The symbols ***, **, and * denote significance at the 1%, 5% and 10% levels, respectively; ECT
t-1
is calculated by normalizing the cointegrating vectors of the dependent variables, yielding r. We obtain
F-statistics for each coefficient in all equations by restricting the coefficients of each variable and
conducting the Wald test; the figures in the squared parentheses and parentheses represent probabilities for
F- and t-statistics, respectively
Source: Research findings
JIABR
correction term (ECT) t-statistics are used to represent long-term causality. It is worth noting
that all ECTs for TAs and TDs were statistically significant at the 5% level.
The significance of ECT shows that there is a long-term connection between economic growth
and the development of IBs, as shown by the results of the ARDL study. If there is a big change
from the long-term equilibrium relationship in the economies of Saudi Arabia, UAE Kuwait,
Malaysia, Qatar, Bahrain and Bangladesh because of scorched GDP and Islamic banking, it is
most likely because of those two things. In other words, these variables pay a lot of the price in
making short-term changes to long-term equilibrium in the short term. In light of the data, there
are at least two possible conclusions. First, the term “dynamic lagging”refers to the fact that
short-term changes in IBs are partly responsible for future changes in economic growth;
specifically, the development of IBs have played a significant role in driving higher economic
growth in Saudi Arabia, the United Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain and
Bangladesh. Second, the ECT modificationhadaconsiderableandpropersignimpactongrowth,
with each variable having a significant impact (positive). A high ECT suggests that there is a
mechanism in place to remedy the discrepancy between the performance of IBs and the broader
economy. Therefore, this finding reaffirms the stable long-term positive relationship between
economic growth and development of IBs. The results of this study are in accordance with
research conducted by Alqahtani and Mayes (2018),Ledhem and Mekidiche (2022),Masrizal and
Trianto (2022),Naz and Gulzar (2022).
As evidenced by the two indicators for IBs (TAs and TDs), Islamic banking and financial
institutions have the potential to become an effective leader in channeling and transferring
financial resources between surplus and deficit units in the economy. Until now, the success
of developing IBs to spur economic growth has been attributed to a favorable policy
environment created by the government, among others, to encourage and strengthen IBs’
economic contribution. A merger is one way to increase assets. The merger is intended to
bolster Islamic banking’s performance in the future so that IBs can make an even more
significant contribution. IBs with large asset bases are required to move in that direction.
In addition, this research is continued by testing the VDC to better understand the
dynamic interaction between the development of Islamic finance and economic growth. The
VDC findings, detailed in Table 7, shed light on the relative importance of Islamic bank
development, inflation and exchange rates in determining economic growth variations.
Simulating VDC requires orthogonalizing innovation in the VAR equation using (Sims,
1980) Cholesky decomposition with the following order of variables: GDP or TA, TD,
inflation and exchange rate.
According to the VDC findings, innovation in TA and TD accounts for a sizable portion of the
variation in economic growth in Saudi Arabia, the United Arab Emirates, Kuwait, Malaysia,
Qatar, Bahrain and Bangladesh (GDP). While the impact of IBs on the economy is positive,
additional attention is needed to expand their role in the economy; channeling financing to the
productive sector is one way to ensure that the impact of Islamic banking on the economy
continues to grow. In addition, the long-term impact of IBs on TAs is increasing. Thus, increasing
the TAs of IBs may be an immediate priority to maximize their long-term role.
The results of this study are in line with research (Antypas et al.,2020), (Hamza and
Saadaoui, 2018)(Abasimel, 2022;Asteriou and Spanos, 2019;Bernard Azolibe, 2022;Bist,
2018;Boukhatem and Ben Moussa, 2018;Klein and Weill, 2022;Naz and Gulzar, 2022;
Saleem et al., 2021;Sharma et al.,2018). Islamic banking is favorably associated with
economic growth, even when other growth variables are taken into account. Farmers and
small- and medium-sized businesses can benefit from Islamic banking, which helps promote
inclusive economic growth. Interest-free financing may also entice investment from the Gulf
Vector error
correction
model
approach
region, according to a convincing case. Credit can be more easily accessed through IBs when
traditional banks are underdeveloped.
The GDP response to a shock of TAs of IBs, TDs of IBs, inflation and exchange rates over 50
quarters can be estimated using the IRF processed in Cholesky’s decomposition. On the other
hand, this function’s output is sensitive to the sort parameter. The growth of the Islamic banking
sector, measured by the sum of IBs’assets and deposits, has a substantial positive correlation of
moments with GDP over the study period, as shown in the table above. This has both immediate
and long-term effects on economic growth. This means that the error correction model’s
coefficients tend to converge to a steady state. The TAs of IBs and the TDs of IBs are used as
proxies for the country’s economic growth in the ARDL model’s estimation of both the short-term
and long-term links between IBs and economic growth. From the table above, it can also be seen
that the contribution of the exchange rate and inflation to economic growth is dominated by the
exchange rate for the first model while for the second model inflation dominates the contribution
to economic growth. Meanwhile, the contribution of exchange rates and inflation to TAs is
dominated by exchange rates and economic growth. On the other hand, the contribution of the
exchange rate, inflation and economic growth to TDs is dominated by GDP and exchange rates,
specifically for the exchange rate to contribute in the long term.
5. Conclusion and policy implications
We contribute to the existing empirical literature on the contribution of IBs and
macroeconomic variables to economic growth in developing countries, by comprehensively
Table 7.
Variance
decompositions
Explained by innovations in:
Horizon
(quarterly)
GDP TA EXR INF GDP TD EXR INF
Model 1: total asset Model 2: total deposits
Variance decomposition of GDP
1 100.00 0.00 0.00 0.00 100.00 0.00 0.00 0.00
3 98.86 0.29 0.57 0.25 99.41 0.07 0.00 0.51
6 96.66 0.47 1.94 0.91 98.75 0.09 0.00 1.13
9 96.03 0.58 2.61 0.77 98.74 0.08 0.00 1.15
12 95.64 0.67 3.01 0.66 98.72 0.07 0.00 1.18
18 95.19 0.76 3.53 0.50 98.79 0.06 0.00 1.13
20 95.09 0.78 3.65 0.46 98.80 0.06 0.00 1.11
30 94.76 0.84 4.04 0.35 98.85 0.05 0.00 1.07
40 94.57 0.88 4.25 0.28 98.88 0.05 0.00 1.05
50 94.46 0.90 4.38 0.24 98.89 0.05 0.00 1.04
Variance decomposition of total asset/total deposits
1 3.98 92.31 92.31 2.39 2.57 97.42 0.00 0.00
3 3.57 91.56 91.56 2.55 2.43 96.56 0.80 0.18
6 3.34 90.15 90.15 2.72 3.10 94.20 2.43 0.29
9 3.09 89.68 89.68 2.69 3.12 93.53 3.00 0.35
12 2.91 89.37 89.37 2.70 3.18 92.98 3.47 0.41
18 2.66 89.04 89.04 2.64 3.20 92.26 4.09 0.45
20 2.51 88.96 88.96 2.63 3.24 92.09 4.24 0.46
30 2.42 88.71 88.71 2.59 3.27 91.50 4.75 0.49
40 2.37 88.57 88.57 2.56 3.29 91.15 5.05 0.51
50 3.98 88.48 88.48 2.55 2.57 90.92 5.25 0.53
Source: Research findings
JIABR
examining the determinants of IBs proxied by TAs and TDs of IBs while macroeconomic
variables are represented by inflation and exchange rates. There is still very little literature
that examines the impact of Islamic banking and macroeconomic variables on economic
growth, especially in developing countries that have the largest IBs in the world in terms of
TAs and TDs.
In conclusion, this study shows the successful experimentation of Islamic finance in
developing countries, which can be beneficial for many countries that are still at the
beginning of adopting financial Islam as an engine of economic growth.
This article empirically examines the short- and long-term relationship between the
development of IBs and economic growth in Saudi Arabia, the United Arab Emirates,
Kuwait, Malaysia, Qatar, Bahrain, and Bangladesh, using a series of statistical tests
between 2013:Q1 and 2020:Q4. In addition, it attempts to empirically investigate Granger
causality between Islamic bank development and economic growth using VECM, reexamine
the model in the form of levels and generate VDCs to assess their relative strength
relationship further to assess further their relative strength relationship draw firm
conclusions. This article establishes a long-run equilibrium relationship between IBs and
economic growth using the defined ARDL model. This finding implies that developing
Islamic banking and finance is a viable policy option for promoting economic growth in
Saudi Arabia, the UnitedArab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh.
IBs will be important in driving economic growth in countries that have adopted Islamic
banking and Continue to promote a financial environment conducive to long-term growth.
This study demonstrates a unidirectional causal relationship between Islamic finance
development and economic growth in terms of dynamic causality between variables. This
empirical evidence supports the financial growth-led or supply-led view, implying that IBs
can be viewed as a compelling leading sector in channeling and transferring financial
resources between surplus and deficit units in the economies of Saudi Arabia, the United
Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh.
The VDC results corroborate the previous findings. This study discovers that total
Islamic bank deposits and financing play a significant role in explaining economic growth
variations in Saudi Arabia, the United Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain
and Bangladesh. As a result of their significant contribution to the country’s economic
growth, these findings provide additional motivation to advance the development of Islamic
banking and financial institutions.
At least two significant implications can be drawn from this study’sfindings. To
begin, sustained efforts must be made to promote the growth of the Islamic banking
industry, which contributes significantly to the economic growth of Saudi Arabia, the
United Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh. Efforts to
strengthen the Islamic banking industry’s long-term capacity, in particular, will
contribute to long-term economic growth. This will include measures such as further
development of the Islamic finance infrastructure and expansion of human resources
to meet the anticipated demand for human capital in the Islamic banking industry.
Providing a favorable legal environment will also aid the industry’s long-term
development.
Second, because our findings indicate that the stability of the Islamic finance
sector is also critical for economic growth, it will benefit policymakers to ensure the
sector’s stability. Indeed, we continue to emphasize the critical nature of maintaining
the Islamic finance sector’s stability to preserve macroeconomic stability. After
learning from previous financial crises, policymakers should continue to monitor
Vector error
correction
model
approach
macroeconomic conditions to implement proactive macroeconomic policies that
mitigate the economic impact of financial shocks.
WhilethisstudyprovedthatIslamicbankingandfinance is important to the economy, there
are still a lot of things that could be done to improve the literature in this field. This includes
doing more detailed analysis and making the study last longer. Islamic finance can be looked at
in more detail by looking at financing for different types of businesses. This makes it easier to
figure out which parts of the country’s economy are growing. In future studies, other countries
and IBs should be involved to better understand Islamic finance and banking. This will give
policymakers a complete picture. Many more Islamic banking and macroeconomic variables can
be examined in many other countries, allowing for cross-country comparisons that will help
policymakers and the Islamic banking and finance industry understand what needs to be done
and how the industry can grow over time, thus contributing to the economy.
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Corresponding author
Early Ridho Kismawadi can be contacted at: kismawadi@iainlangsa.ac.id
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Vector error
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