Abstract
This paper examines the bank lending channel of monetary transmission in Malaysia, a country with a dual banking system including both Islamic and conventional banks, over the period 1994: 01-2015:06. A two-regime threshold vector autoregression (TVAR) model is estimated to take into account possible nonlinearities in the relationship between bank lending and monetary policy under different economic conditions. The results indicate that Islamic credit is less responsive than conventional credit to interest rate shocks in both the high and low growth regimes; however, the sub-sample estimation shows that its response has increased in more recent years becoming quite similar to that of conventional credit. Moreover, the relative importance of Islamic credit shocks in driving output growth is notable in the low growth regime, their effects being positive. These findings can be interpreted in terms of the distinctive features of Islamic banks.
Highlights
The transmission mechanism of monetary policy has been analysed extensively in numerous studies focusing on countries with conventional banking systems (e.g., Bernanke & Gertler, 1995; Çatık & Martin, 2012; Pacicco, Vena, & Venegoni, 2019; among others)
Empirical studies on Malaysia have not explored yet whether the reaction of both Islamic and conventional banks differs during economic expansion and contraction phases, even though Khalid, Ahmad, and Hamidi (2018) more recently confirmed that using the Markov Switching Vector Autoregression model nonlinear framework is more appropriate for the Taylor rule in Malaysia
Notes: The AIC refers to the minimum value of Akaike Information Criterion, C(d) statistics is based on the arrangedregression model introduced by Tsay (1998), d is the delay parameter, m0 refers to the number of initial observations, and γ represents the optimum values of the threshold variable, magr
Summary
The transmission mechanism of monetary policy has been analysed extensively in numerous studies focusing on countries with conventional banking systems (e.g., Bernanke & Gertler, 1995; Çatık & Martin, 2012; Pacicco, Vena, & Venegoni, 2019; among others). This paper contributes to the existing literature on Islamic finance by adopting a more suitable and sophisticated econometric framework to analyse monetary transmission in a country with a dual banking system (Islamic and conventional banks) It applies for the first time in this context a nonlinear model to study the possibly asymmetric responses to shocks by policymakers in Malaysia: it estimates a Threshold VAR model (TVAR) with the output gap as the threshold variable. The present study aims to fill this gap by allowing for nonlinearities in the bank lending channel in the case of Malaysia.3 It analyses the role of both Islamic and conventional credit during the different phases of the business cycle. The paper is organised as follows: Section 2 reviews Islamic finance and the different role of Islamic and conventional banks in the bank lending channel of monetary policy; Section 3 describes the data and provides a preliminary analysis; Section 4 outlines the methodology; Section 5 discusses the empirical results; Section 6 offers some concluding remarks
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