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Are Islamic Banks Truly Shariah Compliant? An Application of Time Series Multivariate Forecasting Techniques to Islamic Bank Financing

Listed author(s):
  • Rafi, Umar
  • Masih, Mansur

This paper analyzes the Shariah compliant nature of Islamic banks (IB) by using Time Series Multivariate Forecasting techniques to test the correlation and direction of causality between interest rates and IB financing . Islamic finance defines a 0% Interest rate, both on the asset and on the liability side. Thus, in a utopian Islamic financial system, any movement in interest rates should have no direct impact on any aspect of any Islamic bank. However, the supposition of IBs being genuinely Shariah compliant from a Credit Risk perspective has been challenged by many Shariah scholars. Using Malaysia as a test case, this paper measures changes in KLIBOR (Kuala Lampur Interbank Offer Rate) and tests them for correlations and directional causality with the IB Lending rate (used as a proxy measure for financing by Malaysian IBs). If a correlation and causality can be established between KLIBOR and financing by IBs, then it is an indication that IB’s may not be genuinely Shariah compliant. This research is original in that it attempts to relate an important issue of a fiqhi nature to data analysis, via some time series forecasting techniques. It also discusses the policy impacts of the results, and the subsequent risk faced by the Regulators in managing the Interest rate risks for a financial system structured on dual banking - Islamic and Conventional. The findings of the research tend to indicate a correlation and lead-lag causality relationship between Interest rate changes and Islamic bank financing.

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File URL: https://mpra.ub.uni-muenchen.de/57711/1/MPRA_paper_57711.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 57711.

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Date of creation: 27 Jul 2014
Handle: RePEc:pra:mprapa:57711
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  1. Etem Hakan, Ergeç & Bengül Gülümser, Arslan, 2011. "Impact of Interest Rates on Islamic and Conventional Banks: The Case of Turkey," MPRA Paper 29848, University Library of Munich, Germany.
  2. Chong, Beng Soon & Liu, Ming-Hua, 2009. "Islamic banking: Interest-free or interest-based?," Pacific-Basin Finance Journal, Elsevier, vol. 17(1), pages 125-144, January.
  3. Mansur Masih & Ali Al-Elg & Haider Madani, 2009. "Causality between financial development and economic growth: an application of vector error correction and variance decomposition methods to Saudi Arabia," Applied Economics, Taylor & Francis Journals, vol. 41(13), pages 1691-1699.
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