Islamic bank procyclicality in an emerging market economy: Do bank size and financing contracts matter?

Wahyoe Soedarmono and Inka Yusgiantoro

The Quarterly Review of Economics and Finance, 2023, vol. 92, issue C, 132-141

Abstract: Using a sample of Islamic banks in Indonesia, our empirical findings demonstrate a positive relationship between economic growth and financing growth in Islamic banks, indicating procyclical behavior. However, the degree of procyclicality varies depending on bank size, with small banks exhibiting a more pronounced procyclical behavior compared to large banks, which display a countercyclical pattern. Our deeper analysis reveals that consumption financing contracts through Murabahah and Istisna contribute to the countercyclical behavior observed in large Islamic banks. Moreover, Musharakah as a productive financing contract does not exhibit procyclical behavior regardless of bank size. In contrast, another productive financing contract, Mudharabah, can lead large Islamic banks to behave countercyclically. Additionally, Ijarah, a leasing contract used for either consumption or productive purposes, exhibits a procyclical pattern in large Islamic banks, indicating that it cannot serve as a hedge during economic downturns for these banks. Overall, these results underscore the importance of Islamic bank consolidation, as large Islamic banks tend to effectively overcome procyclicality throughout the business cycle by utilizing the majority of financing contracts.

Keywords: Financing contracts; Islamic banks; Procyclicality; Bank size; Bank consolidation (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:quaeco:v:92:y:2023:i:c:p:132-141

DOI: 10.1016/j.qref.2023.09.003

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