Dynamic relation between Islamic and conventional lending rates in Malaysia

Abstract

Conceptually, the Islamic and conventional banking rates are supposedly determined based on different premises, and empirical evidence appears to suggest that they are closely related. However, the findings are not unanimous. This paper offers Malaysian evidence of the extent of relatedness between Islamic and conventional lending rates in a dual-banking system. Our data consists of two pairs of Islamic and conventional lending rates: the base lending rates and the average lending rates. To test the relation, we use the standard methodologies of the Johansen cointegration, Granger causality, variance decomposition, and impulse response function. Our results indicate that there is no long-run relation between the Islamic and conventional lending rates for base lending rates; however, the average lending rates do indicate a cointegration between them. In the short-run the averages are independent. In general it may be concluded that Islamic borrowing may be considered a viable alternative to conventional bank borrowing.