This paper examines the bank lending channel of monetary transmission in Malaysia, a country with a dual banking system including both Islamic and conventional banks, over the period 1994: 01-2015:06. A two-regime threshold vector autoregression (TVAR) model is estimated to take into account possible nonlinearities in the relationship between bank lending and monetary policy under different economic conditions. The results indicate that Islamic credit is less responsive than conventional credit to interest rate shocks in both the high and low growth regimes; however, the sub-sample estimation shows that its response has increased in more recent years becoming quite similar to that of conventional credit. Moreover, the relative importance of Islamic credit shocks in driving output growth is notable in the low growth regime, their effects being positive. These findings can be interpreted in terms of the distinctive features of Islamic banks.
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