Nexus between Economic Growth, Investment, and Islamic Banking Development: The Case of Dual Banking System

Abstract

This paper examines the impact of Islamic banking development on economic growth and domestic investment for a panel of 20 countries having dual banking system over the period 1995 to 2014 using two step system GMM. We also examine the differential impact of Islamic and conventional banking development on economic growth and domestic investment. We used four measures of banking sector development attributed to Islamic and conventional banks individually namely, depth of financial intermediation, size of financial intermediation, credit to private sector, and ratio of assets of banks to the total banking assets. Our findings suggest that Islamic banking development promotes economic growth and domestic investment by increasing the depth and size of their intermediation, and by extending more credit to the private sector. Islamic banking stimulates economic activity as their transactions are based on physical assets and linked to the real economy. Shariah promotes social justice and equity, and prohibits Islamic banks from undertaking harmful products and activities.