Does Islamic bank financing lead to economic growth: An empirical analysis for Malaysia

The purpose of this paper is to empirically examine the impact of the Islamic Bank Financing on Malaysia’s economic growth. Using Malaysia as a case in point, this paper employs Advance time-series ARDL bound testing technique, Vector error correction model (VECM) and variance decompositions (VDCs) to explore short-and long-run relationship and causal relationships between the development of Islamic banks and the economic growth using Islamic bank financing to the private sectors, gross domestic product as a proxy of economic growth, Gross fixed capital formation and the consumer price index variables. The paper documents significant role played by the economic growth to the development of Islamic Banks in Malaysia, supporting the growth-Islamic finance led hypothesis or the demand following view. The policy implication of this paper is to improve the efficiency of Malaysian Islamic banks as financial intermediaries that facilitate the capital accumulation and the economic growth; moreover the paper suggests strengthening the weight of the profit loss sharing instruments in the loan portfolios of the Malaysian Islamic banks.