Are profit rate of Islamic banks and interest rate of conventional banks cointegrated? the case of Indonesia

Abstract

This paper tries to investigate the correlation between Islamic bank profit rate and conventional bank interest rate in Indonesia and the possibility oflong run relationship of these rates by employing cointegration test. To capture the short run behaviour of those variables, the impulse response function and variance decomposition are utilized. The data used in this study is taken from Islamic banking statistics and economy and monetary statistics published by Bank Indonesia. We take the I-month profit rate of mudaraba investment deposit and I-month interest rate of fixed deposit. We use 109 pairs of monthly data from February 2000 to February 2009.Based on the descriptive statistics analysis; the mudaraba investment deposits profit rate has a mean which is lower than fixed deposits interest rate. By employing Engle-Granger two steps cointegration test and Johansen procedure, we found that there is a long run relationship between these two series. Granger Causality test result, confirms the conventional interest rate does influence the Islamic profit rate and we can reject the null hypothesis that the change of conventional bank interest rate does not cause adjustment in the Islamic bank profit rate. The result of impulse response function suggests that the profit rate of mudaraba deposits responds positively and significantly to interest rate of fixed deposits.