Islamic Banking: Expanding Financial Depth?

Abstract

Recent studies suggest that the growth of financial sector depth and access can drive poverty reduction and economic growth, popularizing the idea that financial development can be used as a development tool. Combined with a growing awareness in the West of Islamic taboos against lending at interest and speculation and the rapid growth of global Islamic finance, Islamic-compliant banking is increasingly being seen as a potential key to unlocking growth and reducing poverty among the Islamic poor. Using 1990-2007 panel data across 26 Organization of Islamic Cooperation (OIC) states with majority Muslim populations, this paper examines the theoretical assumption that Islamic banking growth is due to increased participation in the financial system. The analysis finds evidence that growth of an existing Islamic banking sector within countries that possess one does have a positive effect on the rate of growth of financial depth, but produces more ambiguous findings when comparing states with Islamic banking sectors to those without such sectors. This may suggest that current Islamic banking growth is effective at expanding financial access and mobilizing new resources, but that there may be certain unobserved prerequisites such as human capital or information infrastructure that are necessary for both traditional and Islamic finance to be successful.