Islamic banking presence and economic growth in Southeast Asia

Purpose The purpose of this study is to empirically assess the relationship between Islamic banking presence in Southeast Asian countries and the economic growth. Design/methodology/approach The presence of Islamic banks is measured by the ratio of Islamic to conventional banking assets as well as the ratio of deposits of Islamic to conventional banking. This study starts by checking the presence of cointegration using Pedroni’s and Westerlund’s specifications; short- and long-run dynamics are further analyzed with the panel autoregressive distributed lag model (ARDL)-based estimators: pooled mean group (PMG), mean group (MG) and dynamic fixed effect (DFE). Furthermore, a two-stage regression two-stage least squares (2SLS) was constructed to measure the sensitivity of economic growth to the Islamic banking presence. Quarterly data from Southeast Asian countries cover the period between 2000Q1 and 2012Q4. Findings A long-run relationship is evident between economic growth and the Islamic banking presence in the selected region, but not in the short run. Furthermore, the Muslim population share in a given country plays a positive and statistically significant role in fueling the contribution of Islamic banking share in the financial sector on the economic growth. Social implications The results of this study show that Sharia-compliant banks succeeded in mobilizing additional resources for the financial sector, which may increase the stability of the banking system and the efficiency of the whole banking sector. The authors believe that the inclusion of Islamic banking products in the financial systems will, along with the diversification effect, stimulate financial deepening and, therefore, improve the financial stability in the countries under investigation in particular, and all countries with significant Muslim population in general. Originality/value This study empirically assesses the contribution of Islamic banking presence on the economic growth with a focus on Southeast Asia, as this region encompasses the most developed and experienced institutions in the field of Islamic finance. Error correction-based models such as PMG, MG and DFE lend itself to the analysis of the panel data. This study also uses the instrument-based 2SLS to cope with the endogeneity problem between the real and financial sectors.