The response of monetary policy shocks on Islamic bank deposits: evidence from Malaysia based on ARDL approach

As much as it is important in a conventional system, monetary policy also plays a critical role in governing the Islamic economic system. However, in a dual banking system, things may have to be designed and devised differently to cater to the needs of both. Thus, assessing the impact of monetary policy shocks on the Islamic banking system is the key to understanding the addition of the industry towards financial stability and the extent of quality of the industry. The purpose of this paper is to initially revisit the issue of monetary policy shocks on the Islamic banking system, in the case of Malaysia. Our paper extends the previous study by using the most recent monthly data available which is from the year 2010 to the year 2016. Additionally, we incorporate the use of a robust time series technique, ARDL, and paired our analysis with an analysis of variance decomposition to strengthen our findings. Based on the results, we find evidence that despite being in the industry for almost half a century, the monetary policy shocks still have an influence on the Islamic banking deposit in Malaysia. Additionally, the Islamic banking deposits are also highly influenced by the level of inflation which comes out to be the most exogenous variable amongst all. An important implication from our analysis is that it is very critical for the central bank to help maintain the resiliency of the system by designing an appropriate monetary policy that could cater to both system and start devising legitimate risk management procedures that is applicable to these Islamic institutions.