Abstract
Since its inception, Islamic banking in Pakistan has shown remarkable growth and development. Most recent statistics reveal that industry has captured around 13% of the total banking market in Pakistan. This outstanding growth of the industry highlights the crucial role of Islamic banks for monetary policy considerations. This study aimed to evaluate the role of Islamic banks in the monetary transmission process in Pakistan. The study examined the role of two most crucial balance sheet items of Islamic banks in the monetary transmission process: (1) Islamic deposits and (2) Islamic financing. The paper employed time series techniques such as the J.J. co-integration test, Vector Auto Regression, Variance Decomposition Analysis and Impulse Response Function to investigate the role of Islamic banks in the monetary transmission process. The study sample covered the time period 2007–2017. The results revealed the significant role of Islamic banks in transmitting monetary decisions to the real economy. Moreover, the evidence demonstrated the active bank lending channel of Islamic banking in Pakistan. The findings also corroborated the functional role of Islamic banks along with their conventional counterparts for effective formulation of monetary policy in Pakistan.
Highlights
During the last four decades monetary policy has taken the spotlight in political and economic policy-making circles
This study was conducted to evaluate the role of Islamic banks in channelling monetary policy decisions to the real economy in Pakistan
The study focused on investigating the role of major balance sheet items (I.D. and I.F.) of Islamic banks in transmitting monetary policy decisions to the real economy
Summary
During the last four decades monetary policy has taken the spotlight in political and economic policy-making circles. Proponents of the significance of monetary policy have always asserted the decisive role of monetary policy in stabilising economic output and inflation. The existing economic literature on monetary policy covers the different realms of its impact on the real economy. The central focus of earlier studies was to capture the aggregate impact of monetary policy on the real economy. Monetary policy as a critical tool to stabilise the macro-economy was first recognised in the early study of Friedman and Schwartz (1963). The theoretical literature on monetary policy proposed the idea that the influence of monetary policy was ECONOMIC RESEARCH-EKONOMSKA ISTRAZIVANJA immediately transferred to the real economy without any lag and delay (Barro & Gordon, 1983; Cukierman, 1992)
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