Macroeconomic Policy and Islamic Banks’ Lending and Investment Decisions: An Empirical Assessment of Crowding out Effect of Private Credit.

Abstract

The aim of this study is to investigate the impact of Bank specific and Macroeconomic variables on Islamic Banking financing and investment decisions. Specifically, this study sets to test the lazy banking hypothesis for Islamic Banks of Pakistan. Tightening of Monetary policy by raising policy rates crowds out private investment through its dampening effect on private credit. Data of all 4 Full fledge Islamic banks of Pakistan were taken for the period of 2006 to 2018. Banks’ lending and investment variables were taken as a dependent. That included advances and investment to deposits and assets ratios. Predictors included macroeconomic variables like inflation, GDP, Exchange Rate and Interest Rate, as well as Bank specific variables like Deposit, Size of Bank, Net interest margin, Bank spread, and Credit Risk. The results suggested that interest rates have a significant and negative effect on private lending (both Advance to deposit and advances to total assets). Investment and financing seem to be mutually exclusive. Both investment and financing have an inverse and significant effect on each other. Size has a positive and significant effect on both financing and investment. Findings also suggested both advances and investment decisions are positively and significantly affected by their lags. Higher spread represented by net interest margin significantly affects both financing and investment. Interestingly, GDP has a significant effect on investments as compared to financing. This study will help regulator, policymakers and bank management to better understand the key drivers that affect Islamic bank financing and investment decisions so they can properly structure the policies that will create an efficient, effective, and robust financial system which will ultimately benefit the economy as well.