Banking system and economic growth linkages in MENA region: complementarity and substitutability between Islamic and conventional banking

Purpose - The purpose of this paper is to investigate empirically the channels through which Islamic and/or conventional banking can spur economic growth in MENA region. Design/methodology/approach - The study uses a range of developed econometric approaches, including panel cointegration technique, panel Granger causality test and a panel-based vector error correction model (VECM), to analyze explicitly all the causal relationships among Islamic banking, conventional banking development and economic growth in a unified framework. Findings - The empirical results show that Islamic banking in MENA countries not only leads to economic growth but also affects positively and significantly conventional banking development. Thus, Islamic banking has an active role and could be classified as “supply-following” since its development only leads to economic growth, whereas conventional banking, with passive role, could be classified as “demand-following” since it only reacts to economic growth in long run. Research limitations/implications - The study has two principal limitations. It is conducted within a relatively limited time period and sample of countries. Also, the used models did not take into account the impact of others financial and macroeconomic variables like stock market development, interest rate, inflation and financial crisis. Practical implications - The results have two main implications. First, in MENA countries, well-functioning Islamic banking sector could not only promote economic growth but also can be served as a development factor for their conventional one. Second, unlike conventional banks, the customer of Islamic banks seems not to be motivated by interest and profits. Rather religious factors are recommended as the main motive for investing and saving in Islamic banks. Originality/value - The study tries to perceive whether there exists a substitution or complementarity effect between Islamic and conventional banking in promoting economic growth for MENA countries. This situation is neither revealed nor clarified in the relevant literature.