Granger-causality between islamic finance and growth: evidence from Malaysia

The focus of this paper is to investigate the Granger-causality between Islamic finance and economic growth. The standard time series techniques are employed with the long-run theoretical relation (i.e., cointegration) tested through the ARDL method rather than the Johansen procedure which suffers from the pre-test biases and the rigidity of I(1) or non-stationarity of all variables. Malaysia is used as a case study. The findings tend to indicate that the economic growth leads Islamic finance through the investment channel. Our analysis shows an absence of Islamic finance-led growth nexus and instead showed a unidirectional Granger-causality from growth to the development of Islamic finance. The contribution of Islamic financial sector is weak. The GDP is not dependent on the Islamic finance. The GDP variable behaves exogenously. We also find that the extent of the Granger- causality among the variables depends on whether we are in the short-run or long-run. As a check of the robustness of the results, alternative methods allow drawing the same conclusions as the ARDL bounds testing approach, implying that the ARDL method seems to be appropriate for examining the causal link between the variables. The paper documents a significant role played by the economic growth for the development of Islamic Banks in Malaysia, supporting the growth-led Islamic finance hypothesis rather than the other way around.