Financing and its determinants :comparison between Islamic banks and conventional banks in Malaysia and Indonesia

Abstract

Bank lending in Malaysia and Indonesia is thought to remain an important factor to generate the economy. In Malaysia, the ratio of bank lending to its GDP has increased steadily from about 80% in the 1980s, to about 100% the 1990s and about 125% in 2003 (Kassim, 2006). Similarly, in Indonesia, the banking sector continues to be the major source of domestic financing, reaching up to 80% of the region’s investment (Goeltom, 2007). Furthermore, the important role of bank lending is also attributed to the relatively less developed capital market. Studies on the determinant of loan have been put in greater attention by many researchers. However, most of the study was done in the context of conventional banks such as by Ibrahim (2006), Calza, Gartner and Sousa (2003), Vaithilingam, Guru and Shanmugarm (2003) Kim and Moreno (1994) and etc. To our knowledge, there has been only one study on that issue in the case of Iran which adopt full Islamic banking system Makiyan (2001). Yet, no study has been done in the case of dual banking system. This paper aims to fill that gap. It investigates the factors determining the Islamic Bank Financing in the case of Malaysia and Indonesia. This paper will also look into the determinant of conventional bank lending for comparison. This paper employs the standard time series analysis such as unit root test, cointegration, Vector Error Correction Models, Variance Decomposition and Impulse Response Function. Variables used in this study consist of Islamic bank financing, Conventional bank lending, Financing rate, Interest rate, Industrial Production Index, Price, Stock Market, Exchange Rate, Islamic deposit and Conventional deposit. Among the results is that the output as well as Islamic deposit significantly influence Islamic financing. Meanwhile, the role of stock market is found insignificant to Islamic financing in both countries. In the conventional counterpart, this study shows that the roles of output and stock market are significant in influencing conventional lending in both countries. However, conventional lendings do not seem to rely heavily to their deposit as the main source of lending. This study will provide the guidelines for the Malaysian and Indonesian governments to further develop and enhance the performance of Islamic banking system. Furthermore, it provides some important information for other countries which are about to adopt a similar system.