Lead-lag relationship between GIA deposit and GIA profit rate in islamic banks:evidence from Malaysia

What actually determines the level of savings in the banking system? According to the classical and neo-classical economists, interest rate has long been recognized as one of the factors that determine savings in the economy. This notion has been supported by the contemporary economists who are of the opinion that interest rate leads the level of savings. However, the situation is quite different in the Islamic banking environment as there is no predetermined rate of return hence it is unknown whether Islamic banks are indeed subjected to this conventional theory of savings. As such, this paper attempts to fill in the gap of the existing studies which mostly support the conventional theories that the rate of return determines the level of deposits even in the Islamic banks. The methodology employed uses the standard time series techniques. Our results tend to suggest that in the Granger-causality (i.e.,in the lead-lag) sense, the endogenous variable is the GIA profit rate, while the level of deposits(or savings), FD Rate and GDP are the exogenous variables. The Granger-causal chain implied by our evidence tends to suggest that GIA deposits predominantly lead the GIA profit rate. This is consistent with the mudarabah contract whereby how much profit each depositor earns depends on the final outcome of the bank's own investment strategies on the deposited amount. From the LRSM test, the result shows that the GIA profit rate has positive relationship with the GIA deposit and GDP; while negative relationship with the real interest rate on conventional deposit (FD Rate). The findings of this study have two main important implications - on the risk management practices - as banks will be facing with displaced commercial risks which will trigger a need for a higher PER and IRR to accommodate expected return of depositors. And - a good asset-liability management practice – where while maintaining competitiveness, the banks are not to forgo efficiency and profitability.