Islamic Banking and Macroeconomic Growth Nexus: Facts or Feint

Transcription

1. Pakistan Journal of Social Sciences (PJSS) Vol. 39, No. 4 (2019), pp. 1335-1347 Islamic Banking and Macroeconomic Growth Nexus: Facts or Feint Areeba Khan The Islamia University Of Bahawalpur Pakistan Email: areeba.khan@iub.edu.pk Imran Sharif Chaudhry Bahauddin Zakariya University Multan Pakistan, Email: imran@bzu.edu.pk Ali Azam The Islamia University Of Bahawalpur Pakistan, Email: ali.azam@iub.edu.pk Abstract: This paper aims to examine the impact of resilience and growth of the financial sector on the growth and resilience of the economy of a country. The paper also focuses on the segregated contribution of Islamic banks in economies hosting parallel banking systems and their respective significance. This study evaluates cross country panel data of 130 listed and non-listed licensed Islamic banks located in 6 countries over a period of 2004 to 2018. The data were collected through BANKSCOPE database and World Bank publications. Generalized-Method-of-Moments (GMM) was applied on data to analyze the extent of contribution of Islamic banks in the overall financial sector growth and in turn, the macroeconomic growth and resilience. The findings suggest that banking sector resilience measured through stable credit expansion may have a significant impact on economic growth and stability of a country and Islamic banks have a significant contribution in the same. The fast pace of growth of assets in the Islamic countries with parallel banking systems may not only support the economic growth of the country as an ethical and religious alternative but also an economic preference. This research is different from all past researches with respect to methodological, aeon and acclimatization perspective. Resilience is a relatively new phenomenon adopted from complex adaptive ecosystems and most studies in this area are of theoretical nature. Moreover, the fact that this research has considered segregate impact of Islamic and Conventional Commercial banks, adds to its overall value and originality. Keywords: Islamic banking, Comparison, Resilience, Z-Score, Macroeconomic growth I. Introduction The global financial crisis in 2008-9 brought escalated attention to the comparative studies of Islamic banks (IBs) and Conventional Banks (CBs). Khan (2010) developed a framework for avoiding such crisis based on shields provided by principles of Islamic Finance which contributed directly towards resilience of the economy. This
2. 1336 Pakistan Journal of Social Sciences Vol . 39, No. 4 model serves to be the premise and prime motivation of this paper whereby the researcher aims at evaluating the impact of comparative banking paradigms on economic growth and expansion. All through the late worldwide financial crisis, IBs have exhibited strength (Farook, Hassan & Clinch, 2014), confirm by moderately high development execution of this industry and a genuinely stable level of NPF. Be as it may, there are variables considered "protecting" the IBs from the immediate effect of stuns in the worldwide monetary framework i-e presentation of Islamic financing was still more outfitted to the residential economy. Furthermore, thusly, the level of reconciliation with the worldwide money related framework and the advancement level of exchange were viewed as low (Bank Indonesia, 2009). Then again, as Beck et al (2013) calls attention to, the IBs might have been strong in GFC first wave, they are presented to higher danger in the delayed repercussions of emergency inferable from their meeting with business banks, on a few practices that render them more powerless against financing cost stuns and expanded systemic danger. So far the world has seen the disappointment of extensive foundations of conventional banking system whereas IBs have not been put to a corrosive test of strength as their routine partners. Seen from a functional periscope, IBs are a subject to financing cost chance as well, notwithstanding intemperate liquidity hazard emerging from resource and obligation administration works on, inferable from the imprint up based contracts, the duality of agreements offered and reliance on traditional managing an account framework without a steady and all around created cash and capital business sector. Compound annual growth rate of assets (CAGR) of the banking sector presents a clear picture as to what is the pace of growth of the comparative banking streams. 14 of the 17 large Islamic banks which have at least US $ 1 bn or more in equity are located in 6 Muslim countries experiencing highest growth rate for Islamic Banking, namely Qatar, Indonesia, Saudi Arabia, Malaysia, UAE and Turkey (QISMUT). Since most of the Islamic banks are located in the Muslim countries, compound annual growth rates of assets of Islamic and Conventional commercial banks in Muslim countries are compared. Figure 1: CAGR of IBs and CBs (Source: World Bank Data)
3. Areeba Khan , Imran Sharif Chaudhry, Ali Azam 1337 Except for Pakistan, most of the countries experience a better compound annual growth rate in assets of Islamic banks than those of the Conventional commercial banks, being 23% and 24% respectively. The other Muslim countries with higher compound annual growth rates in Islamic banking are Bangladesh at 44%, Turkey at 25% and Qatar at 24%. This is a reflection on how efficiently these countries Islamic banks are operating, all other conditions being constant and how rapidly their real economy is growing. The average growth over the period of last 7 years (2012-2018) is taken to analyze the actual pace of growth after Global financial crisis. Jordan and Egypt have also been experiencing higher growth in the Islamic banking assets as compared to conventional banking assets, but since their economies are mucked by internal and regional conflicts, owing to which a reliable forecast of future growth in banking assets and its effect on real growth of the economy is hard to develop. Moreover, fiscal policy stability is derived from political stability, which is a little difficult to expect from a country like Egypt in the backdrop of its most morose political situation. Figure 2: CAGR and Market Share Matrix (Source: Earnest & Young Islamic banking competitiveness report 2016) Saudi Arabia on the other hand has a huge Islamic banking base, but most of the large Islamic banks are actually chapters Conventional commercial banks. Therefore, asset segregation and Shariah governance are two compelling issues for Saudi Arabia. Amongst the countries with burgeoning Islamic banking industry are Indonesia, Qatar, Turkey, Malaysia, Pakistan and Bahrain show more potential towards the pace of development and bridging the market share gap. Economic and fiscal data of all the above mentioned Muslims countries harbouring Islamic banks was taken to analyse the macroeconomic and financial growth nexus. It is helpful in determining how resilience and growth of the economic sector contributes towards growth in the real economy of the country. However, the situation changed after 2009 when IBs profitability faced decline, attributed to the second wave of crisis hitting real economy. Hassan & Dridi (2010) also confirmed the same results. Their analysis suggested that though IBs were better off than CBs in the global financial crisis, the distance between both decreased in the aftermath
4. 1338 Pakistan Journal of Social Sciences Vol . 39, No. 4 and eventually the second wave hit IBs to a greater extent. Therefore implying more resilience on part of IBs to counteract the effects of financial crisis implying an efficient fund cumulative practise, while indicating a worse off position in case IBs endure more exposure to interest rate pegged instruments. This macroeconomic growth nexus gains utmost importance when comparative banking paradigms are taken into consideration. The understanding of banking sector characteristics and the relative impact of Islamic and Commercial banking institutions on the real long term economic growth is the focus of policy research studies in transition economies. Interest free system could provide any economy viability and stability for a longer period of time, given high market power, collateralized operational structure and lower levels of securitization. The contingency reserves for Islamic banks are higher and the vulnerability to interest rate risk is supposedly lower. Considering these elements plausible projections of future performance, it could be argued that Islamic banks may provide a better support system for the economy at large. This study aims to examine the macroeconomic growth nexus and how different banking paradigms affect it through credit expansion. The implications of this study may be of interest to the Central bank, and may aid the prime regulating authority in developing reliable forecasts pertaining to introduction of a particular monetary policy. The focus is on the banking sector and its ability to create a more resilient economy that in turn makes the banking sector resilient as well. II. Literature Review Wilson (1997) states: "Islamic banking is no more viewed as a business element endeavouring just to satisfy the religious commitments of the Muslim group, yet all the more essentially, as a business that is ineluctably in requirement for winning over clients in the meantime as holding the old ones" (Wilson, 1997; Dusuki & Abdullah, 2007). In Egypt, first Islamic reserve funds bank was built up in light of the guideline of benefit sharing at Mit Ghamr in 1963. Earlier studies on Islamic banking primarily focused on the theoretical framework and conceptual analysis of Islamic banking paradigm. With the passage of time the focus shifted from exploration of underlying concepts, Shariah compliance and abolition of interest to comparison of alternative banking paradigms (Khan & Mirakhor, 1989; Haron, 1996) carried out a study on effects of competition in banking segment and external factors that have a significant impact on performance of banks. His study concluded that IBs tend to earn more in a competitive market than a monopolistic market. The research findings also showed that profit and loss sharing principle not only benefited the bank but also worked in favour of the depositors therefore having a positive impact on the economy of the country. In the advancement of hypothesis of Islamic finance, the late seventies and the eighties saw numerous critical commitments. Murabahah or cost in addition to financing, recognized just grudgingly in records, for example, the Islamic Ideology Council of Pakistan Report on Elimination of Interest from the Economy, earned full acknowledgment and additionally respectable method of reasoning. The debate around its authenticity (Warde 2000) or its adequacy scarcely had any effect on the velocity with which it vanquished the scene of Islamic money.
5. Areeba Khan , Imran Sharif Chaudhry, Ali Azam 1339 IBs are additionally confronted with operational risks in running a framework in compliance with Shariah rules. The majority of the analysts place IBs at a more risky position than the CBs with respect of operational and credit risks especially in markets where there is less acquiescence for religiosity (Hassan et al, 2009). For the most part, it was believed that if banks are efficient then the investors might expect enhanced earnings diverted into more noteworthy stabilizers by investments in capital cushions to decrease stuns and reduce risks (Berger et al, 1993). However, this assumption was rebuffed by failure of banks as witnessed in GFC and its stun waves. The inquiries ascended after GFC concentrated on bank versatility and steadiness rather than proficiency. This movement from productivity to versatility is the thing that prompted BASEL II and BASEL III accords. In the last decade and a half, similar to the study of Haron in 1996, many attempts aimed at comparison of alternative banking paradigms were undertaken, the focus however remained accounting profitability and efficiency. Hussein (2004) undertook efficiency studies of IBs versus CBs and maintained that IBs outperform their conventional counterparts. Where IBs are able to gain 75% of potential profits, the commercial banks earn 66% as the best practised bank. Making use of analysis on same pattern, Khan (2010) presents forth financial assets backed security embedded financial system to replace the traditional one, the essence of Islamic Finance. Hasan & Dridi (2010) in their research study conclude that where globalization of finance may have a negative effect on IBs in terms of strengthening competition, shrinking profit margins and autonomy, it may impact the performance of IBs in a positive manner also, as compared to Cbs, by providing diversified markets for their diversified and innovative financial products and increased scope for liability management instruments, provided they realize the potential and prepare themselves to enter the global market with a wider perspective. Two empirical studies conducted lately carried out by Khamis et al (2010) and Hassan & Dridi (2010) present a new dimension to comparison between IBs and CBs. Khamis et al (2010) studied banks in the GCC region and showed that IBs were less affected than CBs in the first wave of global financial crisis, sharing lesser proportion of the initial effect. ‘… A resilient bank enjoys the confidence of investors and customers. Thus it will receive funding-both wholesale and retail – at adequate prices even during periods of stress’ (Andreas Dombret , 2013). As per Basel II, resilience can be divided into two components; Long term financial resilience and Short Term financial resilience and could be constituted through Capital and Liquidity buffers, Profitability, Good Governance and Trust. Of these afore mentioned sources of resilience, capital and liquidity buffers are pivotal. It is a well-known fact now that before and during the times of crisis, the banks’ capital buffers were not enough to suffice to the changing market situation nor was liquidity position secure enough, which made them more vulnerable towards the debacle. 'Managing financial soundness is a noteworthy worry in systemic resilience context, considering that the saving money area is still the foundation of the banking industry in numerous nations and
6. 1340 Pakistan Journal of Social Sciences Vol . 39, No. 4 budgetary focuses in light of the huge budgetary exchanges through this part' (Sundararajan & Errico, 2002). By Nicolo & Kwast (2002), the on-going union and grouping of money related framework worldwide is a standout amongst the most striking components of the contemporary monetary scene. These creators express that the subsequent production of various huge and progressively complex monetary foundations has raised worries that the level of systemic danger in these money related frameworks might have expanded. Nicolo and Kwast (2002) are rightful in stating that with advent of more interconnected, more innovative financial institutions, the landscape of finance has completely altered, giving way to increased systemic risk having serious economic implications. Crisis breeds in non-crisis times ,therefore it is an ongoing struggle to keep a financial institution resilient during crisis and non-crisis, something at which the conventional financial institutions failed during GFC. However, as per Bourkhis and Nabi (2013) IBs were more resilient to crisis. The impact deepened however in the second wave of crisis. Beck et al (2013) also find some differences in stability comparison of Islamic and conventional banks, however the differences stay insignificant if spread over a greater period of time. Research shows that at least theoretically IBs stand more resilient to CBs owing to excess liquidity as a result of limited permissible options of investment, mutual risk sharing, relatively low speculation and leverage component on balance sheet (Hasan & Dridi, 2010). However, empirically the research stands inconclusive on the resilience difference between these two alternative regimes and their relative impact on economic growth and stability. In light of such studies it wouldn’t be wrong to assume that some sort of nexus exists between financial sector and overall economic growth, owing to the medium and magnitude of financial transactions (Sundararajan & Errico, 2002). The literature on this nexus can be classified into two distinct categories. First is the nature of dependence between financial sector and economic growth (Demiru, CKunt and Maksimovic, 1998). Ayadi et al (2015) discusses Islamic banking instruments and their implication for investors through regular financial intermediation. These studies provide support to the thesis that degree of development in financial sector is in coherence with economic growth, however the causal relationship between both is still undefined, therefore it cannot be said for sure if the resilience of financial sector or lack of it is a major cause of economic stability or an effect (Johnson, 2005). Abduh & Omar (2012) studied the relationship of economic growth and financial sector in the Indonesian economy. The research established significant causality between economic growth and financial sector development through error correction models. The findings corroborated with Abduh & Chowdary (2012) on the same variables of study in context of economy of Bangladesh. Mirza, Rahat & Reddy (2015) and Khediri, Charfeddine & Youssef (2015) found that Islamic banks had better asset quality and thereby exhibited more resilience and stability than their commercial counterparts. It was further argued by Kabir, Worthington& Gupta (2015) in a study carried out on Islamic and Conventional commercial banks in 13 countries that Islamic banks weren’t only better in profitability but also experienced less credit risk as compared to their commercial peers. This in turn could help strengthen the financial sector performance and consequently the economic
7. Areeba Khan , Imran Sharif Chaudhry, Ali Azam 1341 growth (Daly & Farikha, 2015; Ghassan & Fachin, 2016). There were however, studies claiming that there was more convergence than divergence in Islamic and Conventional commercial banks (Asbeig &Kassim 2015; Jawadi, Cheffou & Jawadi, 2015). Therefore, it is difficult to conclude if the Islamic banks do contribute to economic growth directly through efficient investment initiatives or indirectly through propelling the savings in Shariah based instruments. This link of financial sector resilience and economic stability has assumed greater importance post financial crisis especially for central banks and policy makers who have to take decisions on financial forecasts as financial sector instability and economic uncertainties always seem to co-exist. III. Methodology A time series data is non stationary if its properties are time variant and serial correlations may occur between variables, leading to biased results. However non stationary variable can be converted to a stationary process by differencing it properly (Dar & Presley, 2001). Thus, dynamic regressions are more apt in this case. GeneralizedMethod-of-Moments (GMM) was first introduced by Hansen in 1982. It encompasses many estimators in econometrics. It is a convenient method of estimating non-linear dynamic models without complete knowledge of the probability distributions of the data. While the cross-sectional strategies are standard ones for taking a gander at long-run connections, they likewise have different inadequacies. Absolutely cross-sectional investigations don't( (1) abuse the time-arrangement measurement of the information, (2) control for potential synchronization predisposition, or (3) control for nation particular impacts, which might incite excluded variable inclination. In this study dynamic-panel GMM estimator is used to control for potential biases induced by country-specific effects and endogeneity. The impact of banking sector growth on real output growth of economy is proposed to be measured through a panel vector autoregressive model. The novelty of the model is that it allows the variance of output to be dependent on the financial sector growth. The nexus between financial sector resilience and economic stability seems too obvious yet the causal relationship has not yet been explored in detail. To analyze this nexus, the fixed panel model will be used since determination of differences in level of financial sector resilience are larger over countries than over time. To analyze the finance- growth nexus, a fixed effects panel model will be used. Watchel (2001) criticizes the use of a country fixed effects model to determine causality between financial sector development and economic growth as banking sector develops quickly and the level of financial development changes over time. Goed & Saifullah (2010) applied GMM model to dynamic panel data in MENA region. Most of the work on GMM estimator has highlighted two step estimator a better option than single step estimator, owing to standard correlation matrix being robust to panel specific autocorrelation and heteroskedasticity in two step estimator. The standard errors however are biased in two-step estimation and are skewed downwards. GROWTH = β+ β 1 CREDIT+ β 2 [Condition Set] +u Eq. 3.1
8. 1342 Pakistan Journal of Social Sciences Vol . 39, No. 4 The objective of the study is to analyse the impact of banking sector growth on real output growth of economy. For this purpose, the dependent variable GROWTH is taken into consideration. GROWTH equals real GDP growth. This variable is added to test the convergence and divergence hypothesis related to the impact of Islamic banks and the banking sector as a whole. CREDIT represents rate of credit expansion symbolizing growth in finance sector and condition set represents the vector of conditioning information that controls for other factors associated with economic growth including inflation, non-performing loans rate, exchange rate and interest rate. Olson & Zoubi (2016) in their studies carried out in 22 MENASA region countries and 20 Middle and Far Eastern countries respectively, have established the premise that Islamic banking institutions were less likely to be affected by the Global financial crisis (GFC) owing to their presence in the regions which weren’t affected by the crisis first wave. Also, owing to the distinct operational structure, Islamic banks faced less credit risk and were less vulnerable to interest rate shocks as compared to the Conventional commercial banks (Rashid & Jabeen, 2016). Owing to the same reason, the study does not control for the effect of Global Financial Crisis (GFC) 2009 and onwards. All data are taken from the Word Bank Database on countries with burgeoning Islamic banking industry, which include are Indonesia, Qatar, Turkey, Malaysia, Pakistan and Bahrain over the period of last 15 years (2001-2016). These countries are shortlisted for analysis as they show more potential towards the pace of development and bridging the market share gap and have ample data available of Islamic banks. The relationship between credit expansion and GDP growth has been subject of controversy in the literature. Hence, the causality of these variables is being tested to determine if the macroeconomic growth may be a subsequent effect of credit expansion. IV. Results and Discussion This study hereby uses one step and two step estimators to control for downward bias of standard error. Before linear GMM, the Arellano and Bond test (Arellano & bond, 1991) is used for zero autocorrelation with a single lag. This test is important for linear GMM regressions on panel as the H0 in this case represents no autocorrelation. GROWTH = β+ β 1 CREDIT+ β 2 [Condition Set] +u GMM was run for estimating the effect of Credit expansion on real growth of the economy. Total credit expansion includes the credit expansion undertaken by the banking sector, inclusive of both Islamic and Conventional commercial banks. The model is estimated using macroeconomic variable data over the period of last 10 years. The model developed in this section is fairly simplistic. It is believed that there are countless macroeconomic variables that may have an impact on the GDP growth rate of the country, however, we were only able to separate a handful the impact of which was considered significant by the earlier researches, to add them to the condition set and study the impact of credit expansion with and without Islamic banks in an economy. The purpose is the to segregate the impact that banking sector resilience has on the growth and resilience of the economy, as well as determine if Islamic banks made a significant contribution to the banking sector and economy growth nexus.
9. Areeba Khan , Imran Sharif Chaudhry, Ali Azam 1343 Kolmogorov- Smirnoff test was conducted on the data to check for normality and most extreme differences. Table 4.1 exhibits the distribution in variable streams to be normal and the two data sets not significantly different with respect to the one dimensional probability distribution. Table 1: Kolmogorov-Smirnoff Test a) b) c) d) Test distribution is normal, Calculated from the data provided, Lilliefors significance correction, The lower bounds of true significance Table 1 shows that all data taken for the purpose of analysis were normal and not skewed as analysed by the Kolmogorov- Smirnoff test. The non parametric test shows equality of continuous non probability distributions, based on empirical distribution function (ECDF). Table 2: Credit Expansion without IB
10. 1344 Pakistan Journal of Social Sciences Vol . 39, No. 4 Table 3 exhibits the role of conventional commercial banking sector in credit expansion in an economy. The banking contribution is taken less of Islamic banks and Robust weight matrix of GMM is run on the data. The R2 is 23.95 % which accounts for the contribution of the CB towards credit expansion by explaining the variation in dependent variable. Scale reliability coefficient is around 58% which is relatively higher as all the economies under consideration are heavily reliant on conventional interest based system. Table 3: Total Credit Expansion Dependent Variable: GROWTH (GDP Growth) Predictors: (Constant), CONDITION SET [ INF (Inflation rate measured by CPI), INT (Interest Rate), NPL (Non-performing loans), CREDITDEP (Depth of credit information index), RISKPREM (Risk premium on lending)] BANKCREDIT (Domestic credit generated by banks) CREDITLESSIB (Domestic credit generated by banks less Islamic Banks). Table 4: Robust Estimates for the model Robust Statistics R-Squared Rw-Squared Akaike Info Criterion Deviance Rn-squared statistic 0.770 0.861 16.18 4.930 168.84 Adjusted R-Squared Adjusted Rw-Squared Schwarz criterion Scale Prob. (Rn-Squared stat.) 0.483 0.861 21.26 0.813 0.000 Table 4 exhibits the robust statistics on the model, while table 5 shows the results on condition set. As per the results, interest rate is a significant factor in GDP growth, while other variables in the condition set do not have a substantial impact in segregation. Table 5: Condition Set Variable Depth of credit info Inflation Interest Rate NPL Risk premium on lending Coefficient 0.27 0.63 1.12 0.28 -0.72 Std. Error 0.34 0.46 0.38 0.73 0.62 Prob. 0.43 0.16 0.00 0.69 0.24 GMM estimator controls for endogeniety in cases such as these where the variables in question are highly correlated with endogenous variables and it is difficult to estimate results in presence of such a powerful error term. It is therefore important to
11. Areeba Khan , Imran Sharif Chaudhry, Ali Azam 1345 separate out the effect of controlling variables and look at impact of credit expansion on GDP growth. It has been proved by the findings of analysis that credit expansion plays a direct role in GDP growth of economy and relationship between both is linear. The study also reveals the impact of Islamic banks on the growth of economy; the model was run in two stages. In the first stage, credit growth of banks was taken exclusive of the Islamic banks, while in the second stage, the credit growth of overall banking sector (inclusive of Islamic banks) was taken to segregate the contribution of Islamic banks to overall economic growth. The GMM estimates without Islamic banks’ contribution to the GDP growth rate, as exhibited in table 3, show a fairly lower R2 of 23.69, as compared to the R2 of 55.49, inclusive of Islamic banks inclusion in credit expansion in the economy. The Cronbach alpha also goes down from 72.62 to 58.69 when Islamic banks contribution to credit expansion is taken out of the calculation, reflecting on demented scale reliability of the model, shown in table 2. The credit expansion has a significant coefficient in both the cases, but the significance level goes down without Islamic banks, which reflects on the fact that growth in an economy is comparatively harder to explain without the contribution of Islamic banks in the economy hoarding Islamic banking system, along with Conventional commercial banks. This model also endorses the theoretical claim of Islamic banking paradigm, accentuating the fact that Islamic banks not only facilitate the savings and investment channel as intermediaries, but also foster economic growth by real investments and close supervision resulting in realization of returns from successful ventures. This contribution expands the role of Islamic banks from technical facilitators in intermediation to direct contributors to economic growth. V. Conclusion The objective was to evaluate if the level of banking sector resilience affected the macroeconomic resilience and stability in non-compelling times. It may be concluded that banking sector stability and resilience has a significant impact on the growth of an economy, thereby resulting in the economic stability. Since Islamic banks have a greater contribution in resilience of banking sector, as proved theoretically and empirically by this research, Islamic banks may be taken as resilience inducing institutions. The basics of Islamic finance are such that they preserve value for the stakeholders, thereby making it not only a moral alternative but also an economic preference. This study has several implications for the policy makers. Of foremost importance is the finding that financial sector doesn’t only act as a technical support mechanism for the economy of the country, but also as a direct contributor to its growth and stability. Therefore, policymaking must focus on not only the macroeconomic and governance indicators but also the resilience and stability enhancement of the banking sector. The study also identified Islamic banking paradigm as an economic imperative owing to its contribution towards the economy, as well resilience to overall banking sector.
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