Contribution of Islamic banks and macroeconomic variables to economic growth in developing countries: vector error correction model approach (VECM)

Abstract

PurposeThe purpose of this study is to examine the effect of Islamic banks (IBs) and macroeconomic variables on economic growth in Saudi Arabia, the United Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh.Design/methodology/approachBased on these criteria, 672 observations from 24 IBs in Saudi Arabia, the United Arab Emirates, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh were chosen for further investigation. Time series analysis is a well-known method for determining if model variables are stationary and how long-term relationships function through cointegration analysis. This study uses impulse response function (IRF) and variance decomposition (VD) methodologies to demonstrate how each macroeconomic variable shock influences the short-term dynamic path of all system variables.FindingsIslamic banking promotes economic growth, especially in Saudi Arabia, the UAE, Kuwait, Malaysia, Qatar, Bahrain and Bangladesh. The findings of the Islamic banking VDC test have a direct and long-term effect on economic growth.Research limitations/implicationsThe literature on this topic can be improved in a number of ways, including by adopting a more robust method to analyze over a longer time frame. By researching specific financing in various areas of the economy, one can gain a deeper understanding of Islamic financing. This will enable the identification of sectors that contribute to economic expansion. Future research should examine combining nations with pure Islam and dual-banking systems to acquire sufficient data.Practical implicationsThis paper has practice and research implications. It recommends adopting the nation’s successful experiment with the Islamic banking system as a model for attaining economic growth through Islamic financing. To replicate this successful experiment, government-based decision-makers and monetary policy experts must collaborate to make Islamic money flows simple and rapid through financial channels that enhance economic growth.Originality/valueThe study of the contribution of Islamic banking to economic growth in developing nations, particularly those with the highest total assets (TAs) and total deposits (TDs) in the world, remains of modest value. To the best of the authors’ knowledge, this is the first study to empirically assess the impact of IBs in developing nations, particularly those with the highest TAs and TDs in the world, on economic growth as measured by gross domestic product (GDP).