Islamic Banking System. Case of Malaysia Essay Example | Topics and Well Written Essays - 3250 words

Islamic Banking System. Case of Malaysia - Essay Example Similar to conventional banking, Islamic banks also collect the additional savings of people and then those savings are extended to those needy sectors of economy. In past, few researches have been developed to find out the relationship between the interest rate increase and funds flow from Islamic banking. This paper analyses the relationship between deposit returns of Islamic and conventional banks with an alternative econometric technique involving Units Root Test to estimate the presence of stationarity and Granger Causality test to estimate the linkage between the deposit returns of the two banking systems. The basic objective of this study is to find out the impact of the change in return deposits of one banking system on to the other. Thus, this study assists the policy makers in determining the role of Islamic banking in the overall economic, fiscal and monetary environment of the country. Introduction The purpose to conduct this study is to examine the level of substitutabil ity in the depository returns under Islamic and conventional banking system. This study comprises on the comparison of the data relating depository returns between the Islamic banking system and the conventional banking system which includes commercial, merchant banks and other financial institutions. Malaysia is considered as a case study in which both Islamic and conventional systems are aimed to be operated on parallel basis by the monetary authorities. In 1983, the first ever Islamic bank that was established in Malaysia was Bank Islam Malaysia Berhad (BIMB). The Islamic banks truly started competition with their conventional counterparts in 1993 when Islamic banking scheme (IMS) was introduced by the Government of Malaysia. This scheme permits the conventional banks to introduce and participate in the products and services initially designed by Islamic banks. By the end of 2002, Total Islamic banking deposits were 10.20% of the country’s total deposits. Since Malaysian f inancial system is under the sole control of Central Bank of Malaysia, therefore the evidence that there are relationships between TDRs of Islamic and conventional banks and the monetary policy is argued under this study. In case if the there is no substitutability between the rates of depositing and financing in both Islamic and conventional banking systems, then relatively lesser restrictive effects of monetary policy can be observed in this regard. For instance, interest rates are used as a tool by the Central banks to adjust the money supply flowing in the economy. Interest rates are increased or decreased to tighten or loosen the flow of money circulating in the economy respectively. The same phenomenon cannot be established in the Islamic banking system as the depositors are not offered a fixed rate of deposit returns. There is a likelihood that if the required rate of deposit returns on Islamic banking products is not ensured to at least the amount of that conventional bankin g products, the depositors of Islamic banks would switch to other financial instruments of the conventional banks because of fact that the Islamic banking products would be of little use for the monetary purposes. Literature Review The individual saving behaviours are mainly explained by the interest rates offered in the economy as one of the key considerations. The interest rate offerings are considered as a key element because different banks offer different rates of depository returns on varying schemes of deposits. Interest rates are determined mainly because of the concept of time value of money. The longer the time that deposits takes in maturity, the higher will be the yield required by the depositors. For examples, the