Islamic Banking and Economic Growth: Empirical Evidence from Malaysia

This paper examines the dynamic interactions between Islamic banking and economic growth of Malaysia by employing the Cointegration test and Vector Error Model (VECM) to see whether the financial system influences growth and growth transforms the operation of the financial system in the long-run. We use time series data of total Islamic bank financing (IBFinancing) and real GDP per capita (RGDP), fixed investment (GFCF), and trade activities (TRADE) to represent real economic sectors. We found that in the short-run only fixed investment that granger cause Islamic bank to develop for 1997:1-2005:4. Where as in the long-run, there is evidence of a bidirectional relationship between Islamic bank and fixed investment and there is evidence to support ‗demand following‘ hypothesis of GDP and Islamic bank, where increase in GDP causes Islamic banking to develop and not vice versa.