The Relationship between Conventional Deposit and Islamic Profit Share Rates: An Analysis of the Turkish Banking Sector

Abstract

Islamic finance came to prominence in the last two decades and Islamic instruments have been regarded as an alternative to conventional instruments after the 2008 crisis. In this study, we tried to analyze the relationship between conventional deposit rates and profit share rates of participation banks (Islamic banks) in Turkey by employing both static modeling tools including ARDL, FMOLS and DOLS models and dynamic modeling tools including DCC-GARCH models using monthly data from Turkey covering the 1998-2016 period. According to our knowledge, this is the first study that employs a dynamic model to investigate the relationship between conventional deposit rates and profit share rates of participation banks. Accordingly, it is found that conventional deposit rates significantly affect profit share rates and the dynamic correlation between conventional deposit rates and profit share rates is generally stable around 0.9 when the markets are not disturbed by shocks or crises. Nevertheless, the correlation dramatically fluctuates during periods of stress. Our model managed to capture the effects of the two financial crises (2001 and 2008) on deposit and profit share rates indicating that the correlation between the two rates plummets during crisis periods. However, despite some similarities during the 2001 and 2008 crises, the behavior of the correlation completely differs during the two recovery periods. The correlation recovered pretty fast during the 2001 crisis and remained stable for almost 9 years. As for the 2008 crisis, the correlation recovered rather slowly (in 14 months) and has failed to stabilize since then. In our opinion, this distinction arises due to the ongoing unfavorable political and economic conditions in neighboring countries and the EU members who are the main trade partners of Turkey.