Evaluating the Contribution of Islamic Banks' Financing to Economic Growth: Evidence from Indonesia

Transcription

1. Evaluating the Contribution of Islamic Banks ' Financing to Economic Growth: Evidence from Indonesia Indri Supriani1 1 Airlangga University/Indonesia/indri.supriani-2018@pasca.unair.ac.id ABSTRACT The purpose of this paper is to evaluate the contribution of Islamic banks financing on economic growth in the case of Indonesia. The increasing presence of Islamic banking in Indonesia through its distinctive characteristics that based on fair profit-loss sharing is supposed to have a stronger contribution to encourage real economic growth compared conventional banking which applies fixed interest rate with the main goal being maximizing profit without regard to clients business condition. Compared to the previous studies, this study provides empirical evidence in evaluating the contribution of Islamic financial development on performances of macroeconomic indicators focusing on the post-economic turmoil in 1998 and 2008. This study adopts the Auto-Regressive Distributed Lag (ARDL) approach on quarterly data set for Indonesia covering the period from 2011Q1 to 2019Q3. In the short-run, the result signifies a rejection of the hypothesis that Islamic banks’ financing significantly contributes to the acceleration of economic growth. In contrast, the result ascertains Islamic banks’ financing has a significant impact on the real economic activities in the long-run. To increase the role of Indonesian Islamic banks as financial intermediaries that facilitate the capital accumulation and the economic growth, the paper suggests that the government, society and especially firms to be more aware of commencing in using Islamic banking products that represent our values as Muslim ummah. Moreover, Islamic banks itself should be required to improve the percentage of mudharabah and musyarakah in the allocation of their financial deposit which is a differentiating contract from conventional banks. JEL Classification: G21, G24, O4. Keywords: Islamic Banking, Real Economy, Indonesia.
2. I . Introduction Islamic bank was first established in Egypt in 1963 (Gudarzi Farahani & Dastan, 2013), the presence of Islamic banking is a form of observance of Muslim in conducting financial transactions that based on sharia principles which emphasize ethical and moral values in carrying out all financial transaction (Imam & Kpodar, 2016). Nowadays, Islamic banking development is significant and has been universally accepted. Islamic Financial Services Board (IFSB) in 2018 released a report which stated that Islamic banking assets globally are forecast to increase to approximately USD 1.61 trillion in 2017. Although Islamic banking assets are still small to the overall of the world’s total assets, it has believable to have great potential to spur real economic activities since it is a fast expansion (Djennas, 2016). Amid the rapid growth of the Islamic finance industry globally, Indonesia as the country with the largest Muslim population is very much expected to have a significant contribution in encouraging the development of Islamic banking. The development of Islamic banking in Indonesia itself began in 1992 which was marked by the founding of Bank Muamalat Indonesia and was the only Islamic banking in Indonesia until the crisis of the global economy in 1998 (Abduh & Azmi Omar, 2012). The resistance of Islamic banking and finance in Indonesia to economic crises had been proved in 1998 when Bank Muamalat Indonesia was able to withstand the global crisis while conventional banks suffered losses. Beck, Demirgüç-Kunt, & Merrouche (2013) has found that in 22 countries including Indonesia, Islamic banks have higher intermediation ratios, asset quality, better capitalized and perform better during the crises compared to conventional banks. Furthermore, Sudarsono (2009) also revealed that Islamic banking is more stable when facing a global economic crisis in 2008, which shown by the higher Financial Deposito Ratio (FDR) of Islamic banks than a conventional bank. This fact indicated that the expected return in Islamic banks that based on Profit-Loss Sharing (PLS) is more profitable because it does not depend on the interest rate which vulnerable to the exchange rate fluctuation towards USD. Most recently study conducted by Ibrahim & Rizvi (2018) over the period from 2000- 2014 has proved that Islamic banks in 10 countries including Indonesia play an important role in stabilizing the economic condition during the crisis period. Moreover, Islamic banks are found to maintain their financing growth to allocate the funds for the customers, while conventional banks tend to decline their financing supply in the post-crisis period. Furthermore, at the global level, Boukhatem & Ben Moussa (2018) also demonstrated that there are no significant differences in Islamic banks’ performance during the crisis in 13
3. countries in the MENA region . In addition, Djennas (2016) portray that Islamic banks in 14 industrial countries slightly have a higher resistance level and become a potential alternative to create a stable business cycle during the economic crisis. In a nutshell, the economic crisis does not affect the Islamic banks' profitability significantly, which in turn, will impact on achieving economic stability in both the financial and the real sectors. After the crisis in 1998 and 2008, the development of Islamic banking experienced a rapid increase, from only one Islamic commercial banks (BUS) unit and nine Islamic rural banks (BPRS) in 1992 (Bank Indonesia; Abduh & Azmi Omar, 2012), then increased to 14 BUS units, 20 Sharia Business Units of a Conventional Bank (UUS) and 164 BPRS in June 2019 (Otoritas Jasa Keuangan, 2019a). The growth of Islamic banking is supported by the publication of The Blueprint of Islamic Banking Development in Indonesia in 2002 and the enactment of Act no. 21 of 2008 concerning Islamic Banking as a legal basis for the development of the national Islamic banking industry. The government's seriousness in building an inclusive environment for Islamic banking is also evidenced by the issuance of the Sharia Finance Architecture Masterplan in 2015 and the Sharia Financial Action Masterplan in 2019 by State Minister for Chairperson of the National Development Planning Agency (BAPPENAS). One of the policies implemented is to encourage UUS from conventional banks to spin-off to become Islamic banks that are ready to operate fully in 2023 (BAPPENAS, 2015). Al Arif (2018) stated that the several main reason to proposed spin-off policy is to push forward the growth of the Islamic banking industry and to stimulate the performance of Islamic bank. Besides, Indonesia established a National Committee for Islamic Finance (Komite Nasional Keuangan Syariah/KNKS) in 2017 which is directly chaired by the Indonesian president. The KNKS is mandated to help encourage the development of Islamic economics, including Islamic Banking. In 2017, Indonesian Islamic banks reached their highest growth levels with assets growing at 23.5%, while financing and deposits registered 19.4% and 25.1% growth rates, respectively. Notwithstanding, the increase was only able to contribute 1.8% of the global Islamic banking assets (Islamic Financial Services Board, 2018). While at the domestic level, the Islamic banking assets stood at IDR 444.43 trillion in June 2018, equivalent to 5.70% of the country's total banking sector assets (Otoritas Jasa Keuangan, 2018). In addition, Ismal & Haryati (2013) reveals that the increase of the Indonesian Islamic banking market share is predicted to be slow and becomes negative approximately 0.004% in October 2018. Furthermore, during the past decade, after the economic crisis in 1998 and 2008, as a whole,
4. it can be concluded that the development of sharia banking in Indonesia has experienced an alarming delay compared to the total assets of Islamic banking in other Muslim majority countries such as Malaysia (9.1%), Iran ( 34.4%), Saudi Arabia (20.4%) and United Arab Emirates (UAE) (9.3%) (Islamic Financial Services Board, 2018). The low Islamic banking assets reflect the weak contribution of Islamic banks to economic growth. Furthermore, a previous study conducted by Grassa & Gazdar (2014) and Caporale & Helmi (2018) had proved that Islamic banking has a greater contribution to economic growth compared to conventional banking because it is providing credit for productive investment which linked to real economic activities. Zarrouk, El Ghak, & Abu Al Haija (2017) explained that PLS mechanism in Islamic bank significantly related to the real economic sphere. Interestingly, in the Indonesia context, In addition, Hachicha & Ben Amar (2015) stated that the PLS mechanism is likely to boost economic growth trough the optimalization the firms’ productions level, consumption and exchange. Sukmana & Kholid (2013) revealed that Bank Indonesia designed a policy that leads the Islamic bank to boost the real sector compared to conventional ones. However, these facts do not automatically indicate that Islamic banks to have a strong position in the banking sector in Indonesia and enhance economic growth significantly. In addition, Indonesia is the largest economy in Southeast Asia and the 10th largest purchasing power parity in the world with GDP per capita risen from $823 in 2000 to $3.932 in 2018 (World Bank, 2019). As a country with a majority Muslim population, Indonesia presents us with an interesting case for study and evaluating the contribution of Islamic banks' financing to economic growth, especially after economic crises in 1998 and 2008. To the best of author knowledge, only limited studies focus on the evaluation of Islamic banking financing contribution to economic growth after the economic crisis, particularly in the Indonesian economic setting. Thus, this study aims to fill the literature gap and broaden the existing literature on Islamic banking and economic growth nexus after Indonesia’s economic crisis. Additionally, this study hopes to shed light on the relationship between Islamic banks’ financing and economic growth either in the short-run or in the long-run, thus contributing to the regulatory framework of Islamic banks towards better policy and practice of Islamic banking. Findings from this study would enable the regulator and Islamic bank institutions to evaluate their financial policy and business strategies with the main objective is to increase the contribution of Islamic banks to real economic activities.
5. II . Literature Review Jawad & Christian, (2019) conducted research that examines the interaction between Islamic Banking development (IDB) and economic growth. This study observes 24 countries including Indonesia, using annual data over the period from 2004-2014. The results portray that IDB has a positive impact on economic growth. The development of Islamic banking will enhance economic growth which implies there is a supply leading hypothesis between IDB and economic growth. These positive relationships remain steady even in the presence of Conventional Financial Development (CFD). However, this study also ascertains that Islamic banking still in the envolving stage. Which indicated Islamic banks do not have a significant impact on economic growth in almost countries under this study. Moreover, Ben Mimoun (2019) examines the nature relationship between Islamic Banks’ (IB) financing and the real performance in the non-oil private sector in Saudi Arabia by using quarterly data covering the period from 2007Q1 to 2016Q4. This study adopted Auto Regressive Distributive Lags (ARDL). This study reveals that there is a feedback hypothesis between IB’s financing and investment. This result implied that the expanding of IB’s financing positively will increase real investment and vice versa. Chowdhury, Akbar, & Shoyeb (2018) investigates the correlation between Islamic financial principles and Economic Growth (EG) in Bangladesh using annual data covering period from 1984-2014. This study applied ARDL approach to asses the long-run and shortrun relationship between the variables, while for the robustness check this study employed a continous wavelet transform approach. This study separated the PLS and non-PLS contract to analyzes the difference impact towards economic growth between those contracts. This study shows that PLS financing such as mudharabh and musharakah are positively correlated with economic growth, whereas non-PLS financing such as ijarah, ju’alah, salam, murabahah, etc are found to be negative significantly influence the economic growth. Furthermore, this study also reveals that non-PLS contract is positively related to Islamic banks’ perfomance.
6. Furthermore , Boukhatem & Ben Moussa (2018) also analyze the dynamic interaction between Islamic bankings’ loans and economic growth, covering the period from 2000 to 2014. This study demonstrated that the development of Islamic banks boosts economic growth in 13 countries of the MENA region. Atici (2018) explore the causal correlation between Islamic bank participation and economic growth in Tukey, using quarterly data covering the period from 2008:1 to 2018:1. This study employs a Vector Error Correction Model to test the correlation and reveals that the higher Islamic banks’ participation positive and significantly leads the economic growth to increase in the long-run. However, Islamic bank participation does not have a significant effect on Turkeys’ economic growth in the short-run. Moreover, Rafay & Farid (2017) investigates the relationship between the rapid expansion of Islamic banks towards real economic activities. This study using quarterly data from 2003-2015 and applied a Vector Auto Regression (VAR) approach. This study found that there is no relationship between Islamic banks’ finance and economic growth in the short-run. While, in the long-run, the development of an Islamic bank will expand the real economic activities in Pakistan. These results are in line with the fact that the market share of Islamic banks in Pakistan is still lower compared to the overall total bank industry. Tabash & Anagreh (2017) observed the role of Islamic banking in economic growth in Uni Emirat Arab (UEA) over the period from 1990 to 2014. This study utilizes the Error Correction Model (ECM). This study shows that there is a supply-leading relationship between Islamic banks’ investment and economic growth, which indicated that Islamic banking is efficiently expediting the flow of money and lead the economic growth to a higher level. Kassim (2016) investigates the impact of Islamic banking finance on Malaysia’s economic performance. This study using quarterly data over the period from 1998 to 2013 and employed the ARDL model. The results show that Islamic banks’ financing and economic growth tend to move in the same direction both in the short and long-run. Whereas the Islamic deposits do not significantly affect economic growth in the short-run, in contrast, it found that there is a positive relationship in the long-run. This results, in line with a research conducted by Imam & Kpodar (2016) that discover that there is a significant and positive relationship between Islamic banking and economic growth in 52 countries covering the period 1990-2010. Furthermore, Lebdaoui & Wild (2016) assess the linkage between the presence of Islamic bank in Southeast Asian countries over the period 2000q1-2012q4. This study finds that the large assets of Islamic banking tend to increase economic growth, which is a sign that Islamic banking allocate the fund effectively to real economic activities.
7. Zirek , Celebi, & Kabir Hassan (2016) observed the impact of Islamic banking and financial towards economic growth in Muslim majority 14 countries including Indonesia during 1999-2011 period and utilizes Vector Auto Regression (VAR). This study reveals that the increasing of Islamic financial affect economic growth positively both in the short-run and long-run. Hachicha & Ben Amar (2015) empirically asses the correlation between Islamic banks’ financing on economic growth over the period from 2000q1-2011q4 in Malaysia. This study shows that in the short-run, Islamic banks in Malaysia do not effectively contribute to the economic growth, thus reflects the lower percentage of PLS than the non- PLS contracts. Whereas in the long-run, positive movements of the Islamic finance ratio will lead to the increase of economic growth. In contrast with Abd. Majid & H. Kassim (2015) which reveals that Islamic banks’ deposits and financing are ascertained to have important roles in promoting the real economic activities. Grassa & Gazdar (2014) analyze the differential effect of Islamic and conventional financial development on economic growth in five GGC countries uses a panel data framework in the period 1996-2011. This study portrays that Islamic finance can encourage growth in five GGC countries, however, there is no significant relationship observed between conventional financial development and growth. Tabash & Dhankar (2014) also reveals that Islamic banks’ financing economic growth move in the same direction in selected Middle East countries such as Bahrain, Qatar, and UEA. Surprisingly, Igonina & Postaliuk (2014) has proved that the development of Islamic banking also plays a significant role in increasing economic growth in the Volga region, Rusia. Rajabi & Muhammad (2014) assess the relationship between Islamic banking and stock market development towards economic growth in 10 countries icnlude Indonesia over the period from 1990-2009. This study used dynamic panel pooled mean group techniques. The result demonstrated that Islamic bank development in the long run was found to contributed positively significant to the economic growth. Mohd. Yusof & Bahlous (2013) reveals that Islamic banking significantly influences the economic growth in GCC countries, Malaysia and Indonesia covering the period from 20002009. Moreover, Gudarzi Farahani & Dastan (2013) also conducted research to analyzes the correlation amongst Islamic financial and economic performance in Indonesia, Malaysia, Bahrain, Saudi Arabia, UEA, Kuwait, Qatar and Yemen covering period 2000q1- 2010q4 and adopted panel cointegration approach. This study shows that Islamic banking played is key role as financial intermediaries for the deficit to surplus households. Thus, it significantly affects the better economic performance either in the short-run or long-run.
8. Abduh , Brahim, & Omar (2012) also demonstrated that Islamic banks and economic growth in Bahrain appear to have a bi-directional relationship in Bahrain over the period from 20002010. This study also illustrates that the decreasing of Islamic bank financial systems will decline the economic growth level and vice versa, thus when the economy in recession will influence the Islamic banks’ performance as well. Based on these previous studies, the author concludes that Islamic bank has a positive impact on contributing to the increase of economic growth, whereas there are differences significant between the short-run and long-run relationship in each country. Additionally, the above studies are mostly conducted before the global crisis or used data which consist of before and after the crisis in 2008 and 2011 by using several macroeconomy variables. Thus, those results might suffer from data bias due to unstable domestic macroeconomic conditions caused by the economic crisis. Neglecting these realities is a limitation on the part of these studies. Therefore, this study aims to address this limitation by evaluating the contribution of Islamic banks’ finance towards real economic activities in Indonesia, particularly after the global economic crisis. III. Data and Research Method III.1 Data This study empirically evaluating the contribution of Islamic banks’ towards economic growth in Indonesia after the global economic crisis by utilizing quarterly data from 2011q12019q3. The data selection assumed that the data is stable and reflects real economic activities without the effects of the global economic crisis after 1998 and 2008. To represent the real economic activities by the companies, specifically the medium and large manufacturing, this study uses Industrial Production Index (IPI) as the dependent variable. IPI for the large manufacturers indicated that the manufacture engaged at least 100 or more workers, whereas for medium manufactures engaged between 20-99 workers (Badan Pusat Statistik Indonesia, 2019). IPI is the appropriate variable that theoretically explains the link between Islamic finance and economic growth (Kassim, 2016). While the Islamic banks’ total Financial Deposit Ratio (FDR) is adopted as the proxy of Islamic banks’ financial contribution to economic growth which reflects the percentage of funds that allocated by Islamic banks to private and non-private sector divided by Islamic banks’ total assets of deposit money. FDR variable is a measure to capture the Islamic banks’ size (Jawad &
9. Christian , 2019) and discloses the total of all financing contracts such as Murabaha, Mudarabah, Musharakah, Ijarah, Istihna, and Salam (Zarrouk et al., 2017). This study includes Gross Fixed Capital Formation (GFCF) as the control variable that represents the accumulation of net investment by the domestic enterprises in fixed capital assets during an accounting period (Abduh, Brahim, & Omar, 2012; Rafay & Farid, 2017; Atici, 2018). Besides, the high GFCF is likely to be associated with the increasing enterprise consumption and production. Thus, GFCF is expected to have a positive and significant impact on economic growth. The other control variables namely inflation (INF) and Trade Openness (TO) are also included in the model to avoid the problem of biases due to the ability to affecting economic growth. INF is an indicator of macroeconomic stability measured by the price volatility of products (Imam & Kpodar, 2016). The high level of inflation indicated there is depreciation of the exchange rate of Rupiah towards products and/ services generally, thus will increase the firms’ cost production and decrease the profit of firms. Summary, the hypothesis is that INF negatively influence economic growth. TO is the ratio of total exports and imports to nominal GDP (Abd. Majid & H. Kassim, 2015). The increasing of TO in a country reflects the higher probability of firms to expand their scale of production trough access the foreign market, boost the domestic market competitiveness and advantages from technological transfer. In a nutshell, TO is predicted to influence economic growth positively significant. The selection of the variables was determined by reviewing existing empirical studies in the context of Islamic banks’ finance towards economic growth. Thus, this study adopted four variables namely IPI, FDR, GFCF, INF, and trade openness. The data for the FDR variable is sourced from the Financial Services Authority of Indonesia, whereas the data for IPI, GFCF, INF and TO are sourced from the Indonesia Central Bureau of Statistics. III.2 Estimating Model The objective of this study is to evaluate the contribution of Islamic banks’ financing toward economic growth. The advantages of using ARDL approach includes the ability to distinguish between the independent and dependent variables, as the aim of the present study (Narayan, 2004). Moreover, the adopting of ARDL bound approach because it can access the econometric analysis of short-run and long-run relationships where the variables are not stationer in the same level or integrated of order I(1), I(0) or mutually cointegrated (Pesaran, 1999). This study uses time small sample series data for several macroeconomic variables
10. which vulnerable with the presence of the unit root, thus the adopting of ARDL is the compatible approach. This study uses Bound-test cointegration to test the existance of longrun relationship between Islamic banks’ finance and economic growth (Pesaran, Shin, & Smith, 2001). The ARDL approach to cointegration also involves the conditional Error Correction (EC) in the equation. Thus, ARDL approach in the long-run equation is: