Monetary transmission through the debt financing channel of Islamic banks: Does PSIA play a role?

This paper examines the monetary transmission mechanism through Islamic banks’ debt financing channel. Its purpose is to test if this channel effectively works and to verify whether the reaction of Islamic banks to interest rates depends on their specific characteristics. The research main focus is on the possible mitigating effect that profit sharing investment accounts (PSIA) could exert on the debt financing channel, since that this source of funding, specific to Islamic banks, is expected to be more stable than deposit accounts for conventional banks. The study uses a quite representative sample composed of 50 Islamic banks and the estimation of a dynamic panel model observed between 2005 and 2014 using the system GMM estimator. Empirical findings confirm the presence of a debt financing channel of monetary policy since that interest rates variation affects Islamic bank financing. PSIA growth, capitalization, assets liquidity and size are among major determinants of Islamic banks’ debt assets supply. Besides, using several robustness tests, we show that, in addition to asset liquidity and bank size, growth rate of PSIA significantly mitigate the negative effect of interest rates on debt financing growth, which highlights the importance of this specific category of deposits in monetary transmission especially for countries where Islamic and conventional banking systems coexist.