Abstract

This research aims to study the impact that banking development attributed to Islamic banks is instigating on the economic growth and domestic investment in a dataset consisting of 20 countries having Islamic and conventional banks operating side by side over the period 1995 to 2014, using the "two-step system GMM" technique. Furthermore, it also inspects the difference in the impact that Islamic banking development is asserting on economic activity as compared to the impact attributed to conventional banking development using four measures of banking sector development namely, depth of financial intermediation, size of financial intermediation, credit to the private sector, and the ratio of assets of banks to the total banking assets. Our findings suggest that Islamic banks promote economic growth and domestic investment by increasing the depth and size of their intermediation, and by extending more credit to the private sector. Conventional banking development also stimulates economic growth and domestic investment by increasing its assets as a percentage of total banking assets. Islamic banking has a more meaningful impact on economic activity as its transactions are based on physical assets and linked to the real economy. Shariah promotes social justice and equity and prohibits them from undertaking harmful products and activities.

Keywords

Financial Development, Islamic Banking Development, Conventional Banking Development, Economic Growth, System GMM.