Do the Islamic banks play a role in the monetary policy transmission in Pakistan? A comparative analysis with conventional banks using panel data analysis

Abstract

In Pakistan, bank lending plays a critical role in economic activities due to the scarcity of stocks and bond options. Islamic banks face an extra layer of difficulty with limited open market instruments and lender of last resort facilities, as well as tough competition with conventional banks. This study analyzes the differences in bank lending by Islamic and conventional banks in transmitting monetary policy by modeling bank credit as a dependent variable while bank-specific assets, liquidity, capital and growth, inflation, and policy rates as explanatory variables. Polled OLS fixed effect panel data models are used to analyze annual data for 2009-2018. The study finds that Islamic bank credit is influenced significantly by policy rates, inflation, and growth, as well as capital and liquidity. Conventional bank credit is significantly affected by the policy rates, growth, and inflation but capital and liquidity are less correlated. This paper concluded that Islamic banks are significant in policy transmission. However, policy tools and differences in operations and contracts affect Islamic bank equity and liquidity which may suffer long-term economic participation.