Do Islamic banks have their benchmarks for financing rates in the dual-banking system?

Abstract

This study examines whether conventional bank lending rates influence Islamic bank financing rates in Indonesia and Malaysia that apply the dual-banking system. We employ the ARDL, the non-linear ARDL (NARDL) model, and the Pooled Mean Group (PMG). Evidence of the long-run link between Islamic financing rate and conventional lending rate is found. However, instead of symmetry, the link between them is asymmetry. The asymmetric pricing of the Islamic financing rate and some specific contracts such as Mudharaba and Murabaha rates in Indonesia strongly follow the decrease in conventional lending rate, but it is sticky against the increase in conventional lending rate. The asymmetric pricing of the Islamic financing rate in Malaysia is obviously pegged to the conventional lending rate. The PMG results strengthen the asymmetric findings where the effect of a reduction in the conventional lending rate is larger than the effect of an increase in the conventional lending rate on the Islamic financing rate. These findings imply that Islamic bank borrowers are profit-driven borrowers in a dual-banking system. Accordingly, the Islamic financing rate is pushed to follow the conventional lending rate due to the uncompetitive Islamic financing rate.

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