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Abstract
The pre-eminence of Islamic finance from the perspective of economic growth has been a long-standing debate. In recent decades, there has been a paradigm shift from interest-based banking to Islamic financial system. This study intends to examine the dynamic interaction of Islamic financial depth (IFD), Islamic financial intermediation (IFI), and asset quality with economic growth in a dual banking system. The paper employs autoregressive distributive lag regression (ARDL), error correction model (ECM) and Granger causality to examine the long and short run linkage by using the quarterly data of Pakistan from 2005 to 2019. The authors run two models to analyze the relative importance of financial depths (Islamic and conventional), financial intermediation (Islamic and conventional), and asset quality of both financial systems. A long-run relationship flowing from finance to growth in both Islamic and conventional finance models has been observed in our study. Furthermore, the findings recommend that strong financial intermediation plays an imperative role in driving economic growth by both financial sectors. The presence of a higher degree of Islamic financial assets in the economy contributes towards economic growth in the short-run. The results show that asset quality possibly plays an important intervening role in the overall finance-growth nexus.
Highlights
The financial sector plays an imperative role in channeling financial resources towards corporate sector where growth opportunities are higher
This study examines the contribution of the Islamic financial system towards economic growth in a dual banking system
As the financial sector of Pakistan is governed in a dual banking system, our study focuses on two parallel models examining the impact of Islamic financial depth and conventional financial depth on economic growth
Summary
The financial sector plays an imperative role in channeling financial resources towards corporate sector where growth opportunities are higher. The debate on financial intermediation and economic growth is rooted back in the theory of Schumpeter (1912), which became the topic of discussion by many economists and researchers. Productive allocation of resources combined with the well-functioning intermediation of financial sector plays a vital part in furthering economic growth (Demirguc-Kunt et al 2003; King and Levine 1993; Love 2003). Contrary to supply-leading theory, Robinson (1952) and Jung (1986) proposed that a developed economy accelerates financial growth. The instigation of Islamic finance in the late nineteenth century opened a new paradigm in the financial world. As per the facts highlighted by Ernst and Young (2016), nine core markets constitute 93% percent of international Islamic finance, the major share includes a 33% share by Saudi Arabia, 15.5% contribution from Malaysia, and 15.4% by UAE. Qatar, Indonesia, Kuwait, Bahrain Pakistan, and Turkey are among the nine core
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