Co-participation of Islamic and Conventional Banks in Monetary Policy Transmission through the Bank Lending Channel in Pakistan. A Panel Data Comparative Analysis.

Abstract

The role of bank lending in Pakistan’s economy is critical due to the scarcity of investment options like stocks and bonds. Continuous interest rate movements put extra pressure on banks to transmit the monetary policy through the credit channel. Islamic banks face an extra layer of difficulty while operating with limited open market instruments, lender of last resort facilities and tough competition with conventional banks. This paper aims to examine the co-participation of Islamic and conventional banks in monetary policy transmission and to explore factors that differentiate the lending of the two bank types. For descriptive statistics, Pearson correlation and panel data techniques for regression analysis such as the random and fixed effect regression models were considered after conforming to the Hausman specification (1978) test. The quarterly data for the ten years of 2009-2018 was analyzed to understand the impact of monetary policy changes on bank lending. This paper modeled bank financing as a dependent variable while three bank-specific variables (total assets, liquidity, and capitalization) and three macroeconomic variables (Growth, inflation, and policy rates) were used as explanatory variables. The analysis in this paper concluded that policy rate changes do not influence bank lending by Islamic banks. However, conventional bank lending is significantly affected by policy rates and growth. This paper concluded that Islamic banks have an insignificant role in policy transmission due to limited Shariah investment opportunities. Influenced by conventional monetary policy, tools and differences in operations and contracts affect the bank’s equity and liquidity which may suffer long-term participation in the economy. Keywords: Monetary Policy, Central Bank, Bank Lending Channel, Islamic Banks.