Determinants of Deposits in Conventional and Islamic Banking: A Case of an Emerging Economy

Abstract

The main objective of present study is to examine the impact of selected macroeconomic variables (base lending rate, consumer price index, gross domestic product, money supply, Karachi stock exchange composite index, KIBOR and profit rate of Islamic banks) on deposits of both conventional and Islamic banks in Pakistan. Six years quarterly data i.e. 2006 to 2011 was obtained from 30 banks consist of 25 conventional and 5 islamic banks. Both short-run and long-run relationship among these variables were examined by utilizing advanced time series techniques of econometrics.

Full text

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Determinants of Deposits in Conventional and Islamic
Banking: A Case of an Emerging Economy
Beenish Akhtar
PhD Scholar, Department of Management Sciences,
COMSATS Institute of Information Technology, Lahore, Pakistan
E-mail: beenish.akhtar@yahoo.com
Dr. Waheed Akhter
Assistant Professor, Center of Islamic Finance,
Department of Management Sciences,
COMSATS Institute of Information Technology, Lahore, Pakistan
E-mail: drwaheed@ciitlahore.edu.pk
Dr. Muhammad Shahbaz
Assistant Professor, Department of Management Sciences,
COMSATS Institute of Information Technology, Lahore, Pakistan
E-mail: mshahbaz@ciitlahore.edu.pk
(Working Paper)
January, 2015
Pakistan

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Determinants of Deposits in Conventional and Islamic Banking:
A Case of an Emerging Economy
Abstract
The main objective of present study is to examine the impact of selected macroeconomic
variables (base lending rate, consumer price index, gross domestic product, money supply,
Karachi stock exchange composite index, KIBOR and profit rate of Islamic banks) on deposits of
both conventional and Islamic banks in Pakistan. Six years quarterly data i.e. 2006 to 2011 was
obtained from 30 banks consist of 25 conventional and 5 islamic banks. Both short-run and long-
run relationship among these variables were examined by utilizing advanced time series
techniques of econometrics. These techniques consisted of bounds testing approach of the
Autoregressive-Distributed Lag (ARDL), to find cointegration and error correction framework.
By applying advanced econometric technique, it was revealed that variables such as interest rate
of conventional banks, profit of Islamic banks, consumer price index, money supply and base
lending rate have different impact on both conventional and Islamic bank deposits. Depositors of
both conventional and Islamic banks are sensitive to the returns received on the deposits. Any
boost in interest rate increases the deposits of conventional banks and decreases the deposits of
Islamic banks. The study shows that an important element to attract the depositors towards the
Islamic banks is religious factor. This paper has important implications for Islamic banks offer
more competitive rates of profit with regard to the interest rate of conventional banks in order to
collect more deposits.
Keywords: Deposits, Conventional Banks, Islamic Banks, Pakistan
JEL CLASSIFICATION: E20, E41, E42, E51, E52

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Introduction:
It is considerably acknowledgable that finance is essential to stimulate economic growth. A huge
literature is available on the causality between economic growth and financial development
[Schumpeter (1939), McKinnon (1973) and Shaw (1973), Gregorio and Guidotti (1995), Arestis
and Demetriades (1997), Calderon and Liu (2003)]. However, the direction of relationship
between financial development and economic growth is very crucial. It is noted that financial
development is very inevitable to achieve higher economic growth. Various studies revealed that
development in financial sector is essential and it induces growth in an economy (Demetriades
and Hussein, 1996; Arestis et al. 2001). In case of Pakistan there exists pragmatic studies which
concentrate on the functions of financial development in economic growth. Khan et al. (2005)
determined the empirically causal relationship between financial development and economic
growth in Pakistan over the period 1971-2004. They found that real interest and financial depth
has positive effect on economic growth in long run. An established long-run causality is found
between financial depth and economic growth, which is according to the perspective that
“economic growth is an outcome of financial development” and same ineference is drawn by
Shahbaz (2012). Economic growth is enhanced by financial development whereas any instability
in financial sector will result a decline in economic growth of an economy. This entails that
financial instability deteriorates the positive effect of financial development on economic growth
(Shahbaz and Malik, 2010).
The main role of the banks is to generate funds and provide financial resources to the firms and
help them to grow. This not only enhances domestic production but also boosts economic
growth. The savings are significant participant in the development of economy and causes
general welfare of an economy. The major purpose of saving is to main future consumption and

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as a mean of investment. The main objective of people for saving in conventional banks is to get
rewarded and to earn profit for forgoing their current consumption. As a result the levels of
deposits in conventional bank are influenced by interest rate. Therefore conventional banks are
upheld on the principle of giving interest on their deposits (Kasri and Kassim, 2009). One of the
most discussed topics among the Muslims regarding the banking industry is the forbiddance of
interest. However, there is universal unanimity that interest paid on the bank deposit is regarded
as riba, which is purely prohibited in Islam. Due to the forbiddance of interest, Islam promotes
several types of investment, based on equity and trading (Usmani, 2006). In Pakistan, there exists
dual banking system and now seeing the growth of Islamic banking system, many conventional
banks are opening their Islamic windows and separate Islamic branches.
SBP (2010) reported that deposits have been increased from 7.9 million dollar to 5.2 billion
dollar. The growth rate in the deposits of Islamic banks is 38% per annum. For a developing
economy like Pakistan the importance of the banking system increases along with that Islamic
banking system is growing all over the world. Customers are now much more aware and are
moving towards Islamic banking. This study empirically assesses that whether the depositors are
regulated by the deposits’ return or by other gain related variables. This is done by finding out
the relationship between the deposit of Islamic banks and conventional banks and the factors
which determine these deposits. Factors consists of interest rate, the rate of return on Islamic
bank deposit, GDP, inflation, stock market composite index, M3 and base lending rate. For an
economy, the banking system is very important which is considered to be the blood circulation
system of the body. A competent blood circulation system guarantees a healthy body, just like
that a proficient and impartial banking system distribute justice and competence in an economy.

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These primary perceptions and objectives are the basis of both conventional and Islamic banking
system. The objectives of the conventional banks are met through the interest-based banking
whereas objectives of the Islamic banks are achieved through the equity-based contracts.
The rest of paper is organized as following: section-II present review of literature, section III
illustrates methodological framework, section IV provides results from statistical analysis and
discusses them in the light of previous studies. Section V gives conclusion and policy
recommendations.
II. Literature Review
Financail system is very important particularly both for developed and developing countries.
The banking system contributes 40 to 50 percent to the growth of Gross Domestic Product
(GDP) in developing countries (Adelakun, 2011). Bank helps in economic growth by giving
loans to growing sectors of an economy at cheaper cost. Banks also generates financial resources
via raising savings level. It is argued by Adelakun, (2011) that aggregate savings are key to the
process of economic growth because they are the basis of capital formation. Abduh et al. (2011)
examined the impact of selected variables that are ecnomic growth, interest rate and inflation on
the deposit of the Islamic banks. They also included the dummy variable for the financial crisis
to find its impact on the Islamic banks’ deposits. The cointegration technique and vector error
correction model were used. They found a insignificant effect of interest rate, profit rate and
growth of the deposits whereas inflation has a considerable negative impact on deposits. On
contrarily, the global financial crisis has a positive impact on deposits.

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Kasri and Kassim (2009) investigated the impact of determining factor of saving in Indonesian
Islamic banks. To find out the level of Islamic bank’s saving, they examined the impact of real
rate of return on Islamic deposit, interest rate of conventional deposit, real income and number of
Islamic bank branches on it. The Vector Autoregressive (VAR) and Impulse Response Function
are applied to examine relationship between the variables. Their results showed that the interest
rate of conventional banks has a very powerful negative effect on savings of Islamic banks.
Islamic bank deposit increases with an increase in rate of return and decrease in interest rate. As
the rate of return of Islamic banks decreases below the interest rate of the conventional bank, the
depositors of the Islamic banks transfer their deposits from the Islamic banks to the conventional
banks. Their results reveal the significance of the interest rate in influencing the saving behavior
of customers to save in Islamic banks.
Haron and Azmi (2008) conducted a study on the conventional and Islamic banks of Malaysia to
discover those factors which affect the deposit level of both Islamic and conventional banks.
They found that rate of return of Islamic banks, conventional bank’s interest rate, base lending
rate, Kualarumpur composite index, consumer price index, GDP and money supply are very
important determinants of both Islamic and conventional bank deposit. These determinants have
very unusual but significant impact on deposits. Inflation rate is inversely associated with the
saving account and fixed deposits of conventional banks. The interest rate has also a negative
relation with Islamic bank’s deposit but it is positively related to conventional bank deposit. A
boost in the conventional bank interest rate will raise the deposit of conventional bank but on the
other hand, the deposit level of Islamic banks decreases. On the contrary, the findings of
different empirical studies showed that customer of Islamic banks are not motivated by the
profits. Rather religion is recommended as the main motive for saving in Islamic banks. The

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results of these studies show that Islamic bank’s deposits have strong but positive relation to
profit, whereas has a strong and negative relation with interest rate of conventional banks.
Rachmawati and Syamsulhakim (2004) determined those factors which affect the mudaraba
deposits in case of Indonesia. Four variables were discovered which have a strong influence on
the deposit level of mudaraba. These variables are economic growth, number of Islamic bank
branches, profit and interest rate. Mudaraba deposit is selected to see the effect because 60% of
the total deposit of Islamic bank deposit in Indonesia consists of mudaraba account. They found
that the religious consideration is not only purpose which attracts individuals toward Islamic
banks rather they are also motivated by the welfare maximization purpose. Metawa and
Almossawi, (1998) noted that in Bahrain, the most important factor which affects the decision of
depositor regarding the bank selection is religious based, rate of return comes after it. Actually in
Bahrain, Muslims are in the majority, the religious aspect is the key variable which affects the
level of the deposit of Islamic banks and rate of return is not the basic variable that determines
the level of deposit. Religious feature is the most vital factor which increases the level of deposit.
Smilarly, Haron and Planisek, (1994) found that in Malaysia, the main objectives of customers to
deposit their money in Islamic banks are both religion and profit. Gerrard and Cunningham
(1997) probed the saving behavior of Muslims in case of Singapore. They found that although
Muslims are in minority in Singapore even then they are preserving their religious relief and
maintaining their deposit within Islamic banks. If Islamic banks are not able to earn profit even
in this condition Muslims hold their deposits with Islamic bank for at least one year.
Khoirunissa (2009) examined the factors which motivate customers to choose Islamic banks; it
also determines the relationship between religious and economic inclination in encouraging the
customers to save in Islamic banks. The results proved that economic factors which influence the

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decision of customers to deposit in Islamic banks are healthy financial systems, receiving
economic benefits, online facilities, quick services and easy reachable locations. Similarly, there
are religious factors which influence customers to deposit in Islamic banks, such as following
religious orders, better realization of Islamic principles and living in an environment which is
supporting religion. Furthermore, external factors such as family, peer group and motivating
Muslim scholars also influence the customer to open an account with the Islamic bank. Erol and
El-Bdour (1990) showed that Muslim customers are not attracted towards Islamic banks only on
the religious basis; rather they patronized Islamic banks due the returns, which they received on
their investments. In Islamic countries services presented by conventional banks and Islamic
banks are not being easily differentiated by the depositors. They mentioned that as belief is no
more the chief feature in magnetizing investors, Islamic banks should categorize that how
depositors perceive their products and services. Islamic banks should present quality product and
services which are well-matched with the product and services of conventional banks. Yousaf et
al. (2009) examineed the relationship between Islamic bank deposit and monetary policy
variables in Bahrain and Malaysia. The empirical evidence proposed that Islamic bank deposits
and monetary policy variables are cointegrated. In Bahrain, monetary policy variables affect
Islamic bank deposit negatively. While comparing the effect of monetary policy variables on
Malaysian and Bahrain Islamic banks, it is found that Bahrain’s Islamic bank deposit are more
responsive to macroeconomic shocks and interest rate fluctuations. In the short-run there isn’t
any relationship between Islamic bank deposits and monetary policy variables for both Malaysia
and Bahrain.

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Haron and Norafifah, (2000) found the outcome of interest rate on conventional bank deposit and
the effect of past dividend rates on Islamic bank deposit in Malaysia. They reported that interest
rates of conventional banks are negatively related to Islamic bank deposit. Moreover, it is noted
that the utility maximization theory exists within the Muslim customers, is proved by the inverse
association between conventional bank interest rate and Islamic banks interest-free deposit.
III. Methodological Framework
Sample and Data:
The total population for this research work consist of all the banks which are currently working
in Pakistan, under the categories i.e. public sector, commercial banks, specialized banks,
domestic private banks and foreign banks. Final sample contains only those banks which have
fulfilled the following standards:
1. For the whole study period banks must remain in business.
2. Data must be available for the whole study period.
After removing the missing data on the basis of the above standards, final sample contains a total
of 30 banks, for the quarter period of six years (i.e. 2006-2011). To conduct the study data has
been collected from the Quarterly reports of Banks, Economic Survey of Pakistan, Pakistan
Bureau of Statistics, and Publications of State Banks.
Description of Variables:
This section narrates the explanation of variables to be used in the present study. Determination
of the variables is done on the basis of previous studies. There are two dependent and seven
independent variables. KIBOR is taken as interest rate which represents the interest rate of
conventional banks. For Islamic banks, rate of profit offered by banks to its customers is taken to

10
check its effect on the deposits. The lowest interest rate which is charged by banks on its loans is
called Base lending rate (BLR). We use the Base Lending Rate issue by the State Bank of
Pakistan for all the conventional banks of Pakistan. Economic growth is proxy by the KCSE.
One of an important economic variable, whose impact on the bank deposits is examined in this
study, is the economic activity. We used consumer price index as an alternative for inflation.
Inflation affects savings and deposits through different transmission channels. First is postulate
theory which states that any increase in uncertainty would result in high saving rate. Secondly,
inflation effects saving by impacting real wealth and finally, any mistake made by the customers
in predicting price level should also affects the savings of customers. The State bank of Pakistan
(SBP) manages its monetary policy by using money supply (M3). M3 is the most imperative
tools of monetary policy. Any change in M3 will affect the economic condition of a country.
GDP is an important factor which represents the growth in an economy. According to a vast
empirical literature the affiliation among the growth of an economy and savings is very
ambiguous. It is known that interest is forbidden in Islam that’s why Islamic banks do not offer
interest on their deposit. Islamic bank works on the rule of profit sharing.
Research Methods:
Mostly the economic variables are trended and this trendiness’ causes the major problem of
spurious regression in the macroeconometric model. The cointegration becomes dominant
requirement for an economic model, utilizing time series data which is non-stationary. The
presence of cointegration is guaranteed if two stochastic trends cancel each other (Asteriou and
Hall, 2007). To officially test the non-Stationarity in a variable, Augmented Dickey and Fuller
(ADF) test is used. This test simultaneously examines non stationarity and the presence of a unit
root in a variable. To empirically examine the long-run relationship between the variables,

11
the model developed by Pesaran et al., (2001) has been used that is also called bounds testing
(or autoregressive distributed lag (ARDL)) approach to cointegration. The empirical equation of
the ARDL bounds testing is gven below:
We set k = 1
Vector X represents independent variable.
IV. Results and their Discussions
The cointegration approach entails that all variables involve in the method should be stationary at
I(0) or I(1) or I(0)/I(1). Thus, it is obligatory to find out the stationary properties of the variables.
Before taking the unit root test of the variable, most of the variables are lagged first. Log of
variables has been taken. The log is used to linearize a model which is non-linear in parameters
(Gujarati and Porter 1992). The results of unit root analysis are reported in Table-1. Our results
show that the null hypothesis of a unit root cannot be rejected for the majority of the variables at
level. Only TCD, GDP and KIBOR reject the null hypothesis of a unit root at level, it means
these variables are stationary at the level, whereas all remaining variables i.e. have a unit root at
the level. The remaining variables are found to be stationary at 1st difference i.e. total Islamic
bank deposits, base lending rate, consumer price index, Karachi stock exchange composite index,
money supply and profit rate. Total conventional bank deposits is also stationary at level. The

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values in the brackets show the lag length at which variable become stationary. We fndd that
time series data is a mixture of both I (0) and I (1).
---------Table-1: Unit Root Test----------
ARDL Bounds Testing Approach:
We applied the ARDL bounds testing approach to cointegration developed by Pesaran et al.
(2001) to examine the presence of the long run relationship between the variables. The ARDL
bounds testing has numerious merits over traditional cointegration approaches. Firstly, the
approach of ARDL can be used regardless whether the variables are integrated at level or
integrated at the 1st difference. The estimations of the long-run coefficients provided by the
bounds test are mostly unbiased and t-statistics are valid even in a situation when some variables
are endogenous (Inder, 1993; Banerjee et al. 1993; Pesaran et al. 2001). Thirdly, even if the
sample size is small, this test executes properly. The presence of cointegration among the
variables deposits and its determinants is examined by limiting the lagged levels variable equal
to zero. Hence, the null hypothesis of cointegration is
H₀ : ф₁ = ф₂ = ф₃ = ф₄ = ф₅ = ф₆ = ф₇ = ф₈ =0
And the alternative hypothesis of cointegration is
H₁ : ф₁ ≠ ф₂ ≠ ф₃ ≠ ф₄ ≠ ф₅ ≠ ф₆ ≠ ф₇ ≠ ф₈ ≠ 0
If the computed of F-statistic surpass the critical value of upper bound, then it means that
cointegration exists among the variables. Whereas if the value of F-statistic is lesser than lower
critical bound then cointegration between the variables does not exist. Our calculated F-statistiic
showed that when the total conventional bank variable is taken on as dependent variable then our
computed F-value is more than upper critical bound which implies there exist a long-term

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association i.e. cointegration among the variables at 5 per-cent and same inference is drawn once
we used total Islamic bank as dependent variables. This shows that variables are cointegrated for
long run relationship in case of Pakistan.
--------Table-2: Critical Values of Bounds Test-------
----------Table-3: Cointegration of Vectors---------
Results of Long-Run Relationship:
The long-run relationship among the explanatory variables and deposits of conventional banking
systems is measured in Table-4. The deposits of conventional banks are positively linked to
interest rate of conventional banks. The value of the coefficient of the KIBOR is 0.186 and it is
significant at 1 percent level. The deposits of conventional banks have a significant long-run
relationship with the profit rate of Islamic banks but it is negatively linked to deposits of
conventional banks. A 1 per-cent increase in profit rate of Islamic bank will decrease the deposits
of conventional banks by 7 %, all else is same. It is significant at the 5 percent level of
significance. Any increase in BLR will result a decrease in the amount of conventional bank
deposits. BLR is significantly affecting the deposits of conventional banks. The coefficient of
base lending rate has a negative sign and it is significant at 1 per cent level of significance. KSCI
indicates the growth and portfolio selection of depositors, a negative relation is found between
the KSCI and conventional bank deposits, although the relationship is insignificant. The CPI has
positive relation with the deposits of conventional banks and it is significant at 1 per-cent level of
significance. For M3, we found a negative relation between M3 and the deposits of conventional
banks which is significant at the 5 percent level of significance. Economic growth has a negative
but insignificant impact on deposits of conventional banks. This finding supports the theory of

14
permanent income hypothesis. The results show that depositors of conventional banks inclined to
dissave or withdraw their money from the deposits during high growth period.
----------Table-4: ARDL Long-Run Results of TCD--------
The long-run relationship among the explanatory variables and deposits of Islamic systems is
reported in Table-5. The deposits of Islamic banks are negatively related to the interest rate of
conventional banks and this relationship is significant at the 5 percent level of significance. The
value of the coefficient of the KIBOR is -0.28 at the 5 percent level of significance, negative sign
shows that it has an inverse relationship with deposits of Islamic banks. The deposits of Islamic
banks have a significant long-run relationship with the profit rate of Islamic banks. Their
relationship is significant at the 5 percent level of significance. BLR is significantly affecting the
deposits of Islamic banks. The coefficient of base lending rate has a positive sign and it is
significant at 5 per cent level of significance. KSCI indicates the growth and portfolio selection
of depositors, a positive relation is found between the KSCI and Islamic bank deposits, although
the relationship is statisticaly insignificant. The CPI has a significant negative relation with the
deposits of Islamic banks. For M3, we found a positive relation between M3 and the deposits of
Islamic banks which is significant at the 1 percent level of significance. The results show that
GDP has a negative but insignificant relation with the deposits of Islamic banks. This finding
supports the theory of permanent income hypothesis. The depositors of Islamic banks inclined to
dissave or withdraw their money from the deposits during high growth period.
-------------Table-5: The ARDL Long-Run Results of IBD----------

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Discussion:
The long-term correlation amongst the explanatory variables and deposits of both conventional
and Islamic systems is measured in Table-4 and 5. A contradictory behavior among the
customers of conventional and Islamic bank is examined. This behavior is revealed by the
reverse signs of the coefficient of the variables. Theoretically, it is assumed that customers of the
Islamic banks are not motivated by profits and hence, any change in the interest rate of the
conventional banks and profit rate of Islamic bank do not have any noteworthy affect on the
customer of Islamic banks. On the contrary, it is observed that any changes in the rate of interest
or in the rate of profit of Islamic bank significantly affect the level of deposit in conventional as
well as in Islamic banks. Consequently, customers of Islamic banks are motivated by profit,
while making their economic decisions they prefer profit motive over their religious motive. The
conventional bank interest rate has an impact on the customers of both conventional and Islamic
system. A boost in the interest of the conventional banks will give rise to the level of deposits at
conventional bank and decreases the Islamic bank deposits. Our result corresponds with the
results of Adelakun (2011). This signifies the normal behavior of customers. Hence, endure the
effect of substitution in the conventional system. The profit rate of the Islamic banks affects the
customers of both conventional and Islamic bank but it's not essentially benefiting for Islamic
banks. According to Shari’ah principle, rate of profit of Islamic bank deposits is known to the
customers of Islamic banks at the end of the maturity of the deposits, On the other hand, the
conventional bank rate of interest on deposits are known to the depositors in advance. Under
normal circumstances, rate of profit increases after a mount in the rate of interest of conventional
banks. Given this specification, there is a chance that customers of Islamic banks will liquidate
their deposits and for better returns will move towards conventional banks. Any change in the

16
rate of interest of conventional banks will have a noteworthy effect on the customers of both
conventional and Islamic banks. These results are uniformed with the previous studies conducted
by (Abduh et al. (2011); Haron and Ahmad (2000); Kasri and Kasim (2009) and Zainal et al.
(2009)).
Any increase in BLR will result a decrease in the amount of conventional bank deposits. BLR is
significantly affecting the deposits of conventional banks. During higher rental prices depositors
need more cash in hands in order to meet their needs and to fulfil their expense obligations.
Thus, directs the depositors to with drawl their money hence, results in reducing deposits. Kader
and Leong (2009) found the same results. KSCI indicates the growth and portfolio choice of
depositors, an inverse relation is found between the KSCI and conventional bank deposits,
although the relationship is insignificant. Depositors of Islamic banks are not much involved in
the stock market activity. It can be justified that it is the believe of Muslims that gambling and
speculation are important activities of the stock market and these two are strictly prohibited in
Islam. Depositor of conventional banks is involved in the activities of the stock market. Our
results are in accordance with the results of (Haron & Azmi, 2008) and Naceur & Ghazouani
(2007).
According to theories higher inflation rate will result into increased saving. Hence, we can say
that if there come an increase in inflation it will also increase the deposits. Our findings divulges
that this is true for conventional bank deposits in case of Pakistan. The CPI has a significant
positive relation with the deposits of conventional banks and an inverse relation with the deposits
of Islamic banks. Horika and Wan (2007) found the same results. As forecasted, the higher
growth means higher GDP will lead to lower saving due to higher anticipated future income.
Outcomes illustrate that GDP has a negative but insignificant relation with the deposits of

17
conventional banks. This finding supports the theory of permanent income and is also in a row
with the findings of Finger and Hesse (2009) and Zainal et al. (2009). Our results show that
depositors of conventional banks inclined to dissave or withdraw their money from the deposits
during high growth period. Whereas the depositors of Islamic banks inclined to save more during
the period of high growth. This behavior of Muslims is explained as that Muslims are persuaded
to save rather than to expend lavishly. M3 is negatively related to the deposits of Conventional
Banks but have a positive relation with the deposits of Islamic banks. It can be seen that
whenever there is an excess supply of money the profit rates of Islamic banks on its deposits are
high as compared to the conventional bank deposits. Same results are found by Yousef et al.
(2009). Hence, motivating depositors to choose Islamic banking to maintain their deposits.
-------------Figure-1: CUSUM of Square of TCB----------
---------------Figure-2: CUSUM of Square of IBD------------
V. Conclusion Remarks and Policy Recommendations
The presence of both conventional and Islamic banks in Pakistan shaped rigid competition
between banks to magnetize and maintain a larger quantity of clients by providing excellent
services. This study scrutinized the relationship of the deposit of conventional and Islamic banks
with base lending rate, consumer price index, gross domestic product, KIBOR, Karachi stock
exchange composite index, money supply, the profit rate of Islamic banks. This is the first study
which is conducted in Pakistan to examine this relationship. We used the econometric technique
of cointegration to empirically analyze that whether deposits of conventional and Islamic banks

18
are determined by religious factor or not. The findings validate that financial variables such as
BLR, CPI, KIBOR, M3 and PR have considerable long-run relation with the deposits of both
conventional and Islamic bank deposits. However, the strength and direction of the relationship
of both systems is different. With the exception of money supply other determinants those have
significant relation with the deposits of conventional banks are justified according to the saving
behavior theories of conventional banks. The relationship of BLR is not as expected. For CPI,
which is used as a substitute for inflation, research discover that it has an inverse relation with
the deposits of Islamic banks.
This result supports the hypothesis of permanent-income. In case of Islamic banks. Therefore at
any particular time when the economy is growing and there is a boom in the base lending rate,
money supply and profit rate of Islamic banks the deposits of Islamic banks will continue to
increase. Results show that the depositors of Islamic banks inclined to save more money in the
form of deposits during high growth period. whereas the depositors of conventional banks
inclined to dissave or withdraw their money from the deposits during high growth period. This
behavior of Muslims is explained as that Muslims are persuaded to save rather than to expend
lavishly. Depositors of both conventional and Islamic banks are sensitive to the returns received
on the deposits. Any boost in the rate of interest of conventional bank will amplify the deposits
of conventional banks whereas reduce the deposits of Islamic banks, and vice-versa. A
contradictory behavior among the customers of conventional and Islamic bank is examined in
this study. It is observed that any changes in the rate of interest or in the rate of profit of Islamic
bank significantly affect the level of deposit in conventional as well as in Islamic banks.
Consequently, this study signifies that customers of Islamic banks are motivated by profit. This
signifies the normal behavior of customers. Hence, endure the effect of substitution in the

19
conventional system. The profit rate of the Islamic banks affects the customers of both
conventional and Islamic banks. Depositors of Islamic banks are not much involved in the stock
market activity. It can be justified that it is the believe of Muslims that gambling and speculation
are important activities of the stock market and these two are strictly prohibited in Islam.
Depositor of conventional banks is involved in the activities of the stock market. According to
theories higher inflation rate will result into increased saving. Hence, we can say that if there
come an increase in inflation it will also increase the deposits. Our findings divulge that this is
true for conventional bank deposits in case of Pakistan. CPI has a significant positive relation
with the deposits of conventional banks and an inverse relation with the deposits of Islamic
banks. Finally, results show that an important element to attract the depositors towards the
Islamic banks is religious factor. That is why more conventional banks are offering their
customers with Islamic banking facilities and opening Islamic windows all over the world. In the
context of policy implications, in order to collect more deposits, Islamic banks should offer more
competitive rates of profit with regard to the interest rate of conventional banks. Furthermore,
Islamic banks can also focus on the religious dimension. This factor will help in attracting more
depositors.

20
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