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The authors would like to thank Joseph Crowley, Sergei Dodzin, Christian Harm, Maher Hasan, Katerina Kalcheva, Hakan Kara, May Khamis, Subir Lall, Adnan Mazarei, Tigran Poghosyan, Faezeh Raei, David Robinson, Tahsin Saadi Sedik, Abdelhak Senhadji, Gabriel Sensenbrenner, Ahmet Tiktik, and Rachel van Elkan for their insightful comments and suggestions. Responsibility for any errors and omissions lies with the authors.
Islamic banking operates according to the principles of the sharia—the Islamic code of law and behavior based on the Quran, the sunnah, which incorporates the sayings, practices, and teachings of the Prophet Mohammed, and jurisprudence, which extends the application of the sharia, through comparative analogy and the consensus view of the religious scholars, to issues that are not directly addressed in the primary sources.
This paper examines retail Islamic banking, which relies on retail depositors seeking relatively stable returns and access to liquidity, rather than Islamic investment banks or investment companies.
Limitations in data availability prevented a comparable analysis for other countries.
It has been noted in the literature that the PLS model is susceptible to asymmetric information and agency problems, which increase the cost of screening, monitoring, and contract enforcement relative to other forms of financing (El-Gamal, 2005). Equity participation-based products are also not easily adaptable to consumer and government finance. Furthermore, PLS instruments suffer from the lack of secondary market trading.
It should be noted that Islamic banks in Malaysia (i) are subsidiaries of conventional banks; (ii) rely less on PLS accounts and more on reverse Murabahatype deposits with a fixed return; (iii) make greater use of smoothing mechanisms; and, (iv) benefit from a well-developed Islamic money market.
The interest rate data for Malaysia were obtained from the Central Bank website. For Turkey, the conventional bank deposit rates were obtained from the Central Bank of Turkey and the Islamic bank returns were obtained from the Participation Banks Association of Turkey.
As of end-2010, there were 17 banks licensed to engage in Islamic banking in Malaysia, including Islamic banking operations as part of a conventional commercial bank, while there were four “participation banks” in Turkey, where conventional banks are not permitted to have an Islamic banking window.
Although the analysis is based on one-year term deposit rates, an analysis of one- or three-month deposit rates does not change the main conclusions.
The objective of the ADF procedure is to test the null hypothesis that a series contains a unit root. If the null hypothesis can be rejected then the variable is stationary. If not, the series should be transformed through differencing until stationarity is established. The most common occurrence in macro-financial variables is that the first-differenced values are stationary, in which case the variable is integrated of order one.
Hamilton (1994) provides a comprehensive presentation of the cointegration framework and alternative tests.
In a two variable system with one cointegrating equation, as is the case with conventional and Islamic bank deposit returns, the VECM can be expressed in the following equations: ΔIBt = θ1(CBt– i – βIBt–i) + u1,t and ΔCBt = θ1(CBt-i – βIBt-i) + u2,t, where u1,t and u2,t are white noise disturbances and θ1 and θ2 represent the speed of adjustment.
Data limitations prevented the application of generalized autoregressive conditional heteroskedasticity (GARCH) models to estimate the conditional volatility of conventional and Islamic bank deposit returns.
The intercept is included because all the variables have a non-zero mean, while the trend term allows for the possibility of a deterministic time trend.
The expected rate of consumer price inflation would be a more appropriate metric, especially for investment returns, but limitations in data availability prevented the use of expected inflation rates.
The International Islamic Liquidity Management Corporation was founded on October 25, 2010, with the objective of issuing sharia-compliant financial instruments to facilitate more efficient and effective liquidity management solutions for institutions offering Islamic financial services, as well as to encourage investment flows of sharia-compliant instruments across borders.