Are Islamic Banks Truly Shariah Compliant? An Application of Time Series Multivariate Forecasting Techniques to Islamic Bank Financing

Umar Rafi and Abul Masih

MPRA Paper from University Library of Munich, Germany

Abstract: This paper analyzes the Shariah compliant nature of Islamic banks (IB) by using Time Series Multivariate Forecasting techniques to test the correlation and direction of causality between interest rates and IB financing . Islamic finance defines a 0% Interest rate, both on the asset and on the liability side. Thus, in a utopian Islamic financial system, any movement in interest rates should have no direct impact on any aspect of any Islamic bank. However, the supposition of IBs being genuinely Shariah compliant from a Credit Risk perspective has been challenged by many Shariah scholars. Using Malaysia as a test case, this paper measures changes in KLIBOR (Kuala Lampur Interbank Offer Rate) and tests them for correlations and directional causality with the IB Lending rate (used as a proxy measure for financing by Malaysian IBs). If a correlation and causality can be established between KLIBOR and financing by IBs, then it is an indication that IB’s may not be genuinely Shariah compliant. This research is original in that it attempts to relate an important issue of a fiqhi nature to data analysis, via some time series forecasting techniques. It also discusses the policy impacts of the results, and the subsequent risk faced by the Regulators in managing the Interest rate risks for a financial system structured on dual banking - Islamic and Conventional. The findings of the research tend to indicate a correlation and lead-lag causality relationship between Interest rate changes and Islamic bank financing.

Keywords: Islamic banks; Shariah compliant; Time series techniques; Malaysia (search for similar items in EconPapers)
JEL-codes: C22 C58 G21 G28 (search for similar items in EconPapers)
Date: 2014-07-27
New Economics Papers: this item is included in nep-for and nep-sea
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