Islamic vs. Conventional Banking Role in Non-Oil Growth: A Causal Analysis in the Case of Bahrain

This paper aims to investigate the type of relationship between Islamic vs. Conventional banking and non-Oil economic growth in the case of Bahrain by using annual data 1990-2012 retrieved from Islamic banks and financial institutions information (Ibis-Online) of the Islamic Bank of Development (IDB), World Bank development indicators (WB), and the Central Bank of Bahrain (CBB) annual reports.This study employs the Johansen and Juselius Cointegration test and Vector Error Correction Model (VECM) as well as Vector Autoregressive model (VAR) to reveal the long run and short-run causality between the dual banking development and non-Oil GDP growth. The VECM results of the conventional banking show that there is long-run bidirectional causality between all the conventional banking selected indicators and the non-Oil GDP. For the Islamic banking VAR model, there is a unidirectional causality from Islamic banking indicators to the non-oil GDP. There is no evidence on the role of non-oil GDP on the Islamic banking development. Impulse response functions in the two models shows that through one standards deviation positive shock in Islamic vs. Conventional Credit provided to private sector, the non-Oil GDP will be much higher in the next five years if we stimulate the Islamic credit provided to private sector than the conventional banks.Moreover, the Islamic credit provided to the private sector appears to be more procyclical than the credit provided by the conventional banks. However, the fluctuations in the conventional credit are sharper than the Islamic banks’ private credit. This study provides the policy makers in Bahrain with the appropriate evidences to design their policies in fostering the non-Oil sector.