The Dynamic Link Between Islamic and Conventional Deposit Rates in a Dual Banking System

Purpose — This study empirically assesses the extent to which the conventional deposit rate (CDR) affects the Islamic deposit rate (IDR) in Indonesia and Malaysia within the dual banking system. Design/Methodology/Approach — This study uses non-linear autoregressive distributed lag (NARDL) and panel cointegration. Monthly data are employed, but the time period for the two countries examined is different because of data availability. The study thus covers the period 2009:M1 to 2020:M12 for Indonesia and 2000:M1 to 2020:M12 for Malaysia. Findings — The findings confirm evidence of the long-run link between IDR and CDR, where the IDRs in Indonesia and Malaysia asymmetrically respond to changes in CDRs. In addition, Indonesia’s IDRs adjust faster in response to the decline in CDRs compared to increases in CDRs. However, Malaysia’s IDRs adapt faster in response to increases in CDRs than their decreases. The panel cointegration results reinforce the asymmetric findings. Originality/Value — To the best of our knowledge, this paper is the first study to examine the extent to which IDRs asymmetrically respond to CDRs in a dual baking system in Indonesia and Malaysia. Practical Implications — Islamic banks (IBs) follow CDRs in determining IDRs due to uncompetitive IDRs, implying that IBs suffer from displaced commercial risk. Therefore, IBs may adopt a policy to address liquidity issues through investment risk reserves (IRR) and profit equalization reserves (PER) to reduce the distinctive gap between IDRs and CDRs.