FINANCIAL INTERMEDIATION COSTS IN A DUAL BANKING SYSTEM: THE ROLE OF ISLAMIC BANKING
Abstract
This paper empirically analyses the role of Islamic banking in financial intermediation costs as measured by net interest margins for a leading dual banking country, Malaysia. Controlling for theoretically motivated determinants of the margins, the paper compares the interest/financing margins of conventional and Islamic banks and examines the impacts of Islamic banking presence on bank margins. The analysis provides evidence of the higher margins of Islamic banks compared to those of conventional banks. Further, the difference in bank margins between the two types of banks can be attributed to differences in market power, operating costs, and diversification. Finally, Islamic banking presence or penetration, as represented by the ratio of Islamic financing to aggregate bank credit/financing and, alternatively, the share of Islamic banking assets, is robustly associated with lower bank margins, on average. These results bear important implications for the development of the Islamic banking industry and in fostering the efficient allocation of financial resources by the banking system.
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References
Abdul Kader Malim , N., Ibrahim, M. H., Mohd Rasid, M.E.S. (2017). Explaining
Intermediation Costs of Islamic Banks in OIC Countries. In Hassan, M. K. (ed),
Handbook of Empirical Research on Islamic and Economic Life, Cheltenham: Edward
Elgar, 395-410.
Abdul Karim, M., Hassan, M.K., Hassan, T., Mohamed, S. (2014). Capital Adequacy
and Lending and Deposit Behaviors of Conventional And Islamic Banks.
Pacific-Basin Finance Journal 28, 58-75.
Abdul Majid, M., Falahaty, M., Jusoh, M. (2017). Performance of Islamic and
Conventional Banks: A Meta-Frontier Approach. Research in International
Business and Finance 42, 1327-1335.
Abedifar, P., Hasan, I., Tarazi, A. (2016). Finance-Growth Nexus and Dual-Banking
Systems: Relative Importance of Islamic Banks. Journal of Economic Behavior and
Organization, 132, 198 -215.
Ahmad, R. (2007). A Note on the 1999-2002 Malaysian Banking Consolidation.
Banker’s Journal Malaysia, 131, 4-8.
Allen, L. (1988). The Determinants of Bank Interest Margins: A Note. Journal of
Financial and Quantitative Analysis, 23, 231-235.
Alqahtani, F., Mayes, D.G., Brown, K. (2017). Islamic Bank Efficiency Compared
to Conventional Banks During the Global Crisis in the GCC Region. Journal of
International Financial Markets, Institutions and Money, 51, 58-74.
Alqahtani, F., Mayes, D.G. (2018). Financial Stability of Islamic Banking and the
Global Financial Crisis: Evidence from the Gulf Cooperation Council. Economic
Systems, 42, 346-360.
Angbanzo, L. (1997). Commercial Bank Net Interest Margins, Default Risk, Interest-
Rate Risk, and Off-Balance Sheet Banking. Journal of Banking and Finance, 21,
55-87.
Archer, S., Karim, R.A.A. (2006). On Capital Structure, Risk Sharing and Capital
Adequacy in Islamic Banks. International Journal of Theoretical and Applied
Finance, 9, 269-280.
Beck, T., Demirguc-Kunt, A., Merrouche, O. (2013). Islamic vs. Conventional
Banking: Business Model, Efficiency and Stability. Journal of Banking and
Finance, 37, 433-447.
Beck, T., Hesse, H. (2009). Why Are Spreads so High in Uganda? Journal of
Development Economics, 88, 192-204.
Beck, N., Katz, J.N. (1995). What to Do (and not to Do) with Time-Series Cross-
Section Data. American Political Science Review, 89, 634-647.
Birchwood, A., Brei, M., Noel, D. M. (2017). Interest Margins and Bank Regulation
in Central America and the Caribbean. Journal of Banking and Finance, 85, 56-68.
Boukhis, K., Nabi, M.S. (2013). Islamic and Conventional Banks’ Soundness During
the 2007-2008 Financial Crisis. Review of Financial Economics, 22, 68-77.
Carbo-Valverde, S., Rodriguez-Fernandez, F. (2007). The Determinants of Bank
Margins in European Banking. Journal of Banking and Finance, 31, 2043-2063.
Chortareas, G..E., Garza-Garcia, J.G., Girardone, C. (2012). Competition, Efficiency
And Interest Rate Margins in Latin American Banking. International Review of
Financial Analysis, 24, 93-103.
Claessens, S., Coleman, N., Donnelly, M. (2018). “Low-For-Long” Interest Rates
and Banks’ Interest Margins and Profitability: Cross-Country Evidence. Journal
of Financial Intermediation, 25, 1-16.
Demirguc-Kunt, A., Laeven, L., Levine, R. (2004). Regulations, Market Structure,
Institutions, and The Cost of Financial Intermediation. Journal of Money, Credit,
and Banking, 36, 593-622.
Fungacova, Z., Poghosyan, T. (2011). Determinants of Bank Interest Margins in
Russia: Does Bank Ownership Matter? Economic Systems, 35, 481-495.
Gheeraert, L. (2014). Does Islamic Finance Spur Banking Sector Development?
Journal of Economic Behaviour and Organization, 103, S4-S20.
Gheeraert, L., Weill, L. (2016). Does Islamic Banking Development Favour
Macroeconomic Efficiency? Economic Modelling, 47, 32-39.
Ho, T., Saunders, A. (1981). The Determinants of Bank Interest Margins: Theory
and Empirical Evidence. Journal of Financial and Quantitative Analysis, 16, 581-
600.
Hossain, M. (2012). Financial Reforms and Persistently High Bank Interest Spreads
in Bangladesh: Pitfalls in Institutional Development? Journal of Asian Economics,
23, 395-408.
Ibrahim, M.H. (2016). Business Cycle and Bank Lending Procyclicality in a Dual
Banking System. Economic Modelling, 55, 127-134.
Ibrahim, M.H., Rizvi, S.A.R. (2018). Bank Lending, Deposits and Risk-Taking in
Times of Crisis: A Panel Analysis of Islamic and Conventional Banks. Emerging
Markets Review, 35, 31-47.
Imam, P., Kpodar, K. (2016). Islamic Banking: Good for Growth? Economic
Modelling, 59, 387-491.
Islamic Financial Services Board (IFSB). (2018). Islamic Financial Services Industry
Stability Report 2018, Kuala Lumpur: IFSB.
Iwanics-Drozdowska, M., Witkowski, B. (2016). Credit Growth in Central, Eastern,
and South-Eastern Europe: The Case of Foreign Bank Subsidiaries. International
Review of Financial Analysis, 43, 146-158.
Johnes, J., Izzeldin, M., Pappas, V. (2014). A Comparison of Performance of
Islamic and Conventional Banks 2004-2009. Journal of Economic Behaviour &
Organization, 103, s93-s107.
Kabir, M.N., Wothington, A., Gupta, R. (2015). Comparative Credit Risk in Islamic
and Conventional Bank. Pacific-Basin Finance Journal, 34, 327-353.
Kabir, M.N, Worthington, A.C. (2017). The ‘Competition-Stability/Fragility’ Nexus:
A Comparative Analysis of Islamic and Conventional Banks. International
Review of Financial Analysis, 50, 111-128.
Kafle, K., Jollife, D., Winter-Nelson, A. (2018). Do Different Types of Assets Have
Differential Effects on Child Education? Evidence from Tanzania. World
Development, 109, 14-28.
Kasman, A., Tunc, G., Vardar, G., Okan, B. (2010). Consolidation and Commercial
Bank Net Interest Margins: Evidence from the Old and New European Union
Members and Candidate Countries. Economic Modelling, 27, 648-655.
Lassoued, M. (2018). Comparative Study on Credit Risk in Islamic Banking
Institutions: The Case of Malaysia. The Quarterly Review of Economics and
Finance, 70, 267-278.
Lebdaoui, H., Wild, J. (2016). Islamic Banking and Financial Development. Review
of Middle Eastern Economics and Finance, 12, 201-224.
Lepatit, L., Meslier, C., Strobel, F., Wardhana, L. (2018). Bank Dividends, Agency
Costs and Shareholder and Creditor Rights. International Review of Financial
Analysis, 56, 93-111.
Maudos, J., Fernandez de Guevara, J. (2004). Factors Explaining the Interest Margin
in the Banking Sectors of the European Union. Journal of Banking and Finance,
28, 2259-2281.
Meslier, C., Risfandy, T., Tarazi, A. (2017). Dual Market Competition and Deposit
Setting in Islamic and Conventional Banks. Economic Modelling, 63, 318-333.
Olson, D., Zoubi, T., (2017). Convergence in Bank Performance for Commercial
and Islamic Banks During and After the Global Financial Crisis. The Quarterly
Review of Economics and Finance, 66, 71-87.
Poghosyan, T. (2013). Financial Intermediation Costs in Low Income Countries:
The Role of Regulatory, Institutional, and Macroeconomic Factors. Economic
Systems, 37, 92-110.
Poghosyan, T. (2010). Re-examining the Impact of Foreign Bank Participation on
Interest Margins in Emerging Markets. Emerging Markets Review, 11, 390-403.
Roodman, D. (2009). A Note on the Theme of too many Instruments. Oxford Bulletin
of Economics and Statistics, 71, 135-158.
Solarin, S.A., Hammoudeh, S., Shahbaz, M. (2018). Influence of Economic Factors
on Disaggregated Islamic Banking Deposits: Evidence with Structural Breaks
in Malaysia. Journal of International Financial Markets, Institutions and Money,
55, 13-28.
Sorwar, G., Pappas, V., Pereira, J., Nurullah, M. (2016). To Debt or not to Debt:
Are Islamic Banks Less Risky than Conventional Banks? Journal of Economic
Behaviour & Organization, 132, 113-126.
Sufian, F., Habibullah, M. S. (2013). Financial Sector Consolidation and Competition
in Malaysia: An Application of the Panzar-Rosse Method. Journal of Economic
Studies, 40, 390-410.
Sun, P. H., Mohamad, S., Ariff, M. (2017). Determinants Driving Bank Performance:
A Comparison of Two Types of Banks in the OIC. Pacific-Basin Finance Journal
42, 193-203.
Trad, N., Trabelsi, M.A., Goux, J. F. (2017). Risk and Profitability of Islamic Banks:
A Religious Deception or an Alternative Solution? European Research on
Management and Business Economics, 23, 40-45.
Trinugroho, I., Agusman, A., Tarazi, A. (2014). Why Have Bank Interest Margins
Been so High in Indonesia since the 1997/1998 Financial Crisis? Research in
International Business and Finance, 32, 139-158.
Trinugroho, I., Risfandy, T., Ariefianto, M.D. (2018). Competition, Diversification,
and Bank Margins: Evidence from Indonesian Rural Banks. Borsa Istanbul
Review, in press.
Were, M., Wambua, J. (2014). What Factors Drive Interest Rate Spread of
Commercial Banks? Empirical Evidence from Kenya. Review of Development
Finance, 4, 73-82.
Williams, B. (2007). Factors Determining Net Interest Margins in Australia:
Domestic and Foreign Banks. Financial Markets Institutions and Instruments, 16,
145-165.
Yanikkaya, H., Gumus, N., Pabuccu, Y.U. (2018). How Profitability Differs Between
Conventional and Islamic Banks: A Dynamic Panel Data Approach. Pacific-
Basin Finance Journal, 48, 99-111.
Zins, A.., Weill, L. (2017). Islamic Banking and Risk: The Impact of Basel II. Economic
Modelling, 64, 626-637.
Intermediation Costs of Islamic Banks in OIC Countries. In Hassan, M. K. (ed),
Handbook of Empirical Research on Islamic and Economic Life, Cheltenham: Edward
Elgar, 395-410.
Abdul Karim, M., Hassan, M.K., Hassan, T., Mohamed, S. (2014). Capital Adequacy
and Lending and Deposit Behaviors of Conventional And Islamic Banks.
Pacific-Basin Finance Journal 28, 58-75.
Abdul Majid, M., Falahaty, M., Jusoh, M. (2017). Performance of Islamic and
Conventional Banks: A Meta-Frontier Approach. Research in International
Business and Finance 42, 1327-1335.
Abedifar, P., Hasan, I., Tarazi, A. (2016). Finance-Growth Nexus and Dual-Banking
Systems: Relative Importance of Islamic Banks. Journal of Economic Behavior and
Organization, 132, 198 -215.
Ahmad, R. (2007). A Note on the 1999-2002 Malaysian Banking Consolidation.
Banker’s Journal Malaysia, 131, 4-8.
Allen, L. (1988). The Determinants of Bank Interest Margins: A Note. Journal of
Financial and Quantitative Analysis, 23, 231-235.
Alqahtani, F., Mayes, D.G., Brown, K. (2017). Islamic Bank Efficiency Compared
to Conventional Banks During the Global Crisis in the GCC Region. Journal of
International Financial Markets, Institutions and Money, 51, 58-74.
Alqahtani, F., Mayes, D.G. (2018). Financial Stability of Islamic Banking and the
Global Financial Crisis: Evidence from the Gulf Cooperation Council. Economic
Systems, 42, 346-360.
Angbanzo, L. (1997). Commercial Bank Net Interest Margins, Default Risk, Interest-
Rate Risk, and Off-Balance Sheet Banking. Journal of Banking and Finance, 21,
55-87.
Archer, S., Karim, R.A.A. (2006). On Capital Structure, Risk Sharing and Capital
Adequacy in Islamic Banks. International Journal of Theoretical and Applied
Finance, 9, 269-280.
Beck, T., Demirguc-Kunt, A., Merrouche, O. (2013). Islamic vs. Conventional
Banking: Business Model, Efficiency and Stability. Journal of Banking and
Finance, 37, 433-447.
Beck, T., Hesse, H. (2009). Why Are Spreads so High in Uganda? Journal of
Development Economics, 88, 192-204.
Beck, N., Katz, J.N. (1995). What to Do (and not to Do) with Time-Series Cross-
Section Data. American Political Science Review, 89, 634-647.
Birchwood, A., Brei, M., Noel, D. M. (2017). Interest Margins and Bank Regulation
in Central America and the Caribbean. Journal of Banking and Finance, 85, 56-68.
Boukhis, K., Nabi, M.S. (2013). Islamic and Conventional Banks’ Soundness During
the 2007-2008 Financial Crisis. Review of Financial Economics, 22, 68-77.
Carbo-Valverde, S., Rodriguez-Fernandez, F. (2007). The Determinants of Bank
Margins in European Banking. Journal of Banking and Finance, 31, 2043-2063.
Chortareas, G..E., Garza-Garcia, J.G., Girardone, C. (2012). Competition, Efficiency
And Interest Rate Margins in Latin American Banking. International Review of
Financial Analysis, 24, 93-103.
Claessens, S., Coleman, N., Donnelly, M. (2018). “Low-For-Long” Interest Rates
and Banks’ Interest Margins and Profitability: Cross-Country Evidence. Journal
of Financial Intermediation, 25, 1-16.
Demirguc-Kunt, A., Laeven, L., Levine, R. (2004). Regulations, Market Structure,
Institutions, and The Cost of Financial Intermediation. Journal of Money, Credit,
and Banking, 36, 593-622.
Fungacova, Z., Poghosyan, T. (2011). Determinants of Bank Interest Margins in
Russia: Does Bank Ownership Matter? Economic Systems, 35, 481-495.
Gheeraert, L. (2014). Does Islamic Finance Spur Banking Sector Development?
Journal of Economic Behaviour and Organization, 103, S4-S20.
Gheeraert, L., Weill, L. (2016). Does Islamic Banking Development Favour
Macroeconomic Efficiency? Economic Modelling, 47, 32-39.
Ho, T., Saunders, A. (1981). The Determinants of Bank Interest Margins: Theory
and Empirical Evidence. Journal of Financial and Quantitative Analysis, 16, 581-
600.
Hossain, M. (2012). Financial Reforms and Persistently High Bank Interest Spreads
in Bangladesh: Pitfalls in Institutional Development? Journal of Asian Economics,
23, 395-408.
Ibrahim, M.H. (2016). Business Cycle and Bank Lending Procyclicality in a Dual
Banking System. Economic Modelling, 55, 127-134.
Ibrahim, M.H., Rizvi, S.A.R. (2018). Bank Lending, Deposits and Risk-Taking in
Times of Crisis: A Panel Analysis of Islamic and Conventional Banks. Emerging
Markets Review, 35, 31-47.
Imam, P., Kpodar, K. (2016). Islamic Banking: Good for Growth? Economic
Modelling, 59, 387-491.
Islamic Financial Services Board (IFSB). (2018). Islamic Financial Services Industry
Stability Report 2018, Kuala Lumpur: IFSB.
Iwanics-Drozdowska, M., Witkowski, B. (2016). Credit Growth in Central, Eastern,
and South-Eastern Europe: The Case of Foreign Bank Subsidiaries. International
Review of Financial Analysis, 43, 146-158.
Johnes, J., Izzeldin, M., Pappas, V. (2014). A Comparison of Performance of
Islamic and Conventional Banks 2004-2009. Journal of Economic Behaviour &
Organization, 103, s93-s107.
Kabir, M.N., Wothington, A., Gupta, R. (2015). Comparative Credit Risk in Islamic
and Conventional Bank. Pacific-Basin Finance Journal, 34, 327-353.
Kabir, M.N, Worthington, A.C. (2017). The ‘Competition-Stability/Fragility’ Nexus:
A Comparative Analysis of Islamic and Conventional Banks. International
Review of Financial Analysis, 50, 111-128.
Kafle, K., Jollife, D., Winter-Nelson, A. (2018). Do Different Types of Assets Have
Differential Effects on Child Education? Evidence from Tanzania. World
Development, 109, 14-28.
Kasman, A., Tunc, G., Vardar, G., Okan, B. (2010). Consolidation and Commercial
Bank Net Interest Margins: Evidence from the Old and New European Union
Members and Candidate Countries. Economic Modelling, 27, 648-655.
Lassoued, M. (2018). Comparative Study on Credit Risk in Islamic Banking
Institutions: The Case of Malaysia. The Quarterly Review of Economics and
Finance, 70, 267-278.
Lebdaoui, H., Wild, J. (2016). Islamic Banking and Financial Development. Review
of Middle Eastern Economics and Finance, 12, 201-224.
Lepatit, L., Meslier, C., Strobel, F., Wardhana, L. (2018). Bank Dividends, Agency
Costs and Shareholder and Creditor Rights. International Review of Financial
Analysis, 56, 93-111.
Maudos, J., Fernandez de Guevara, J. (2004). Factors Explaining the Interest Margin
in the Banking Sectors of the European Union. Journal of Banking and Finance,
28, 2259-2281.
Meslier, C., Risfandy, T., Tarazi, A. (2017). Dual Market Competition and Deposit
Setting in Islamic and Conventional Banks. Economic Modelling, 63, 318-333.
Olson, D., Zoubi, T., (2017). Convergence in Bank Performance for Commercial
and Islamic Banks During and After the Global Financial Crisis. The Quarterly
Review of Economics and Finance, 66, 71-87.
Poghosyan, T. (2013). Financial Intermediation Costs in Low Income Countries:
The Role of Regulatory, Institutional, and Macroeconomic Factors. Economic
Systems, 37, 92-110.
Poghosyan, T. (2010). Re-examining the Impact of Foreign Bank Participation on
Interest Margins in Emerging Markets. Emerging Markets Review, 11, 390-403.
Roodman, D. (2009). A Note on the Theme of too many Instruments. Oxford Bulletin
of Economics and Statistics, 71, 135-158.
Solarin, S.A., Hammoudeh, S., Shahbaz, M. (2018). Influence of Economic Factors
on Disaggregated Islamic Banking Deposits: Evidence with Structural Breaks
in Malaysia. Journal of International Financial Markets, Institutions and Money,
55, 13-28.
Sorwar, G., Pappas, V., Pereira, J., Nurullah, M. (2016). To Debt or not to Debt:
Are Islamic Banks Less Risky than Conventional Banks? Journal of Economic
Behaviour & Organization, 132, 113-126.
Sufian, F., Habibullah, M. S. (2013). Financial Sector Consolidation and Competition
in Malaysia: An Application of the Panzar-Rosse Method. Journal of Economic
Studies, 40, 390-410.
Sun, P. H., Mohamad, S., Ariff, M. (2017). Determinants Driving Bank Performance:
A Comparison of Two Types of Banks in the OIC. Pacific-Basin Finance Journal
42, 193-203.
Trad, N., Trabelsi, M.A., Goux, J. F. (2017). Risk and Profitability of Islamic Banks:
A Religious Deception or an Alternative Solution? European Research on
Management and Business Economics, 23, 40-45.
Trinugroho, I., Agusman, A., Tarazi, A. (2014). Why Have Bank Interest Margins
Been so High in Indonesia since the 1997/1998 Financial Crisis? Research in
International Business and Finance, 32, 139-158.
Trinugroho, I., Risfandy, T., Ariefianto, M.D. (2018). Competition, Diversification,
and Bank Margins: Evidence from Indonesian Rural Banks. Borsa Istanbul
Review, in press.
Were, M., Wambua, J. (2014). What Factors Drive Interest Rate Spread of
Commercial Banks? Empirical Evidence from Kenya. Review of Development
Finance, 4, 73-82.
Williams, B. (2007). Factors Determining Net Interest Margins in Australia:
Domestic and Foreign Banks. Financial Markets Institutions and Instruments, 16,
145-165.
Yanikkaya, H., Gumus, N., Pabuccu, Y.U. (2018). How Profitability Differs Between
Conventional and Islamic Banks: A Dynamic Panel Data Approach. Pacific-
Basin Finance Journal, 48, 99-111.
Zins, A.., Weill, L. (2017). Islamic Banking and Risk: The Impact of Basel II. Economic
Modelling, 64, 626-637.
Published
2020-01-17
How to Cite
Ibrahim, M., & Law, S. (2020). FINANCIAL INTERMEDIATION COSTS IN A DUAL BANKING SYSTEM: THE ROLE OF ISLAMIC BANKING. Buletin Ekonomi Moneter Dan Perbankan, 22(4), 531 - 552. https://doi.org/10.21098/bemp.v22i4.1236
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Buletin Ekonomi Moneter dan Perbankan / Bulletin of Monetary Economics and Banking is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.
