Do Bank Size and Liquidity Position Matter in the Monetary Policy Transmission Mechanism? Evidence from Islamic and Conventional Banks in Pakistan

Abdul Rashid, Muhammad Abdul Rehman Shah
Published Online: December 2019

An empirical examination of the tight monetary policy effects on the financing decisions of Islamic banks is of significance for an in-depth understanding of the credit channel of monetary policy. Therefore, this paper aimed at examining the relative role of Islamic and conventional banks in transmitting the effects of monetary tightening in Pakistan. It also examines whether the effects of tight monetary policy on banks’ credit expansion differ across bank size and liquidity position. The empirical analysis is based on a sample of five full-fledged Islamic banks, six Islamic branches of conventional banks, and seventeen conventional banks. The robust two-step system-Generalize Method of Moments estimator is applied on an unbalanced annual bank-level panel dataset covering the period 2005-2016. The results reveal that both types of banks significantly cut their financing in periods of tight monetary policy, confirming the existence of the credit channel. The results also indicate that Islamic banks are affected less by the tight monetary policy as compared to their conventional peers. The results also provide evidence that large-sized and more-liquid Islamic as well as conventional banks respond less to the monetary policy tightening. The findings suggest that the monetary policy authorities may take into consideration the type of banking, bank size, and liquidity position while devising any monetary policy instruments to effectively manage credit supply in the economy.


Monetary policy tightening; Islamic banks; Conventional banks; Monetary Transmission mechanism; Bank size; Bank liquidity. .