The dependency of Islamic bank rates on conventional bank interest rates: further evidence from Turkey

The nexus between Islamic banks’ returns on term deposits (participation accounts) and conventional banks’ (CBs) interest rates on term deposits is one of the controversies with regard to Islamic finance. The obvious correlation between two sides is considered a convergence of Islamic banking to the conventional mode and the breach of the ‘risk sharing’, the underlying principle of Islamic finance. The aim of this study is to econometrically investigate the long-term relationship between CBs’ term-deposit rates (TDRs) and participation banks’ (PBs) TDR in Turkey. We undertake an elaborate analysis of the dependency of each PBs in Turkey on interest rates utilizing the most recent econometric techniques including Maki cointegration tests with multiple breaks and frequency domain causality tests. Findings show that TDRs of three PBs are significantly cointegrated with those of CBs, while one is not. In addition, permanent causality is found from CBs to all PBs.     

Bank overall financial strength: Islamic versus conventional banks

A number of recent studies compare the performance of Islamic and conventional banks with the use of individual financial ratios or efficiency frontier techniques. The present study extends this strand of the literature, by comparing Islamic banks, conventional banks, and banks with an Islamic window with the use of a bank overall financial strength index. This index is developed with a multicriteria methodology that allows us to aggregate various criteria capturing bank capital strength, asset quality, earnings, liquidity, and management quality in controlling expenses. We find that banks differ significantly in terms of individual financial ratios; however, the difference of the overall financial strength between Islamic and conventional banks is not statistically significant. This finding is confirmed with both univariate comparisons and in multivariate regression estimations. When we look at the bank financial strength within regions, we find that conventional banks outperform both the Islamic banks and the banks with Islamic window in the case of Asia and the Gulf Cooperation Council; however, Islamic banks perform better in the MENA and Senegal region. Second stage regressions also reveal that the bank overall financial strength index is influenced by various country-specific attributes. These include control of corruption, government effectiveness, and operation in one of the seven countries that are expected to drive the next big wave in Islamic finance.     

Religiosity versus rationality: Depositor behavior in Islamic and conventional banks

This study investigates the behavioral aspects of Islamic bank depositors in a dual banking system. By categorizing depositors into groups based on the amount of their deposited funds, we estimate the responses of these groups to interest rate changes. We take the findings of conventional banks as a comparative baseline and investigate the extent to which the changes in different Islamic depositor groups differ from conventional depositor groups. The findings show that depositors in both Islamic and conventional banks respond to interest rate changes. The analysis indicates that Islamic bank depositors are more responsive when their deposit sizes are larger. When Islamic bank depositors’ opportunity costs rise due to a rise in the interest rate, they do not hesitate to withdraw deposits. The relation between interest rate changes and deposits is more robust in Islamic banks than in conventional banks.     

Dual market competition and deposit rate setting in Islamic and conventional banks

This paper addresses the issue of competition in dual banking markets by analyzing the determinants of deposit rates in Islamic and conventional banks. Using a sample of 20 countries with dual banking systems over the 2000–2014 period, our results show significant differences in the drivers of Islamic and conventional banks' pricing behavior. Conventional banks with stronger market power set lower deposit rates but market power is not significant for Islamic banks. In predominantly Muslim environments, conventional banks set higher deposit rates and further higher when their market power is lower. Whereas conventional banks are influenced by the competitiveness of Islamic banks, Islamic banks are only affected by their peers in predominantly Muslim countries. Our findings have important implications regarding competition and bank stability in dual banking markets.     

Monetary policy on interest rates: a retrospective analysis since Thornton

Abstract

In response to the affirmation by certain authors and critics of a recent return to an interest-rate policy that, in their opinion, resembles a throwback to the nineteenth century theory of monetary policy on interest rates, I pose the question of the difficulties of interest-rate policy in a retrospective analysis beginning with the current that founded the short-term interest rate policy within classical analysis and by focusing my discussion on several key authors (Thornton, Banking School, Bagehot, Wicksell, Keynes, contemporary authors such as Woodford). To this end, I study the importance that the interbank money market plays for these authors, which determines the target rate for the central bank.     

Market power versus efficiency under uncertainty: conventional versus Islamic banking in the GCC

In this article we estimate the effect of concentration on intermediation margins in Gulf Cooperation Council's (GCC) Islamic and conventional banking under the assumption that margins are uncertain. The empirical model, which we formally derive from an expected utility maximization problem, allows us to test for risk aversion as well as competitive conduct in loan and the deposit markets. The model also yields an expression showing that the effect of concentration on margins is the sum of its respective effects on market power, marginal cost of intermediation and marginal cost of uncertainty. The expression allows us to test whether concentration is welfare enhancing, reducing or neutral. We find Islamic banks to be risk-averse and conventional banks to be risk-neutral. We also find that concentration is welfare-neutral in Islamic loans and deposits, welfare-enhancing in conventional loans and welfare-neutral in conventional deposits. We used Nonlinear Two-Stage Least Squares (N2SLS) and Nonlinear Three-Stage Least Squares (N3SLS) to check for robustness.     

Monetary and banking policy transmission through interest rates: an empirical application to the USA,Canada, the UK and the Eurozone

The main purpose of this paper is an examination of the pass‐through interest rate transmission from the wholesale rates (central bank and/or money market rates) to the retail rates (deposit and lending rates) of the banking system. Knowledge of the transmission substantially helps us to calculate the pass‐through interest rate margin or mark‐up in the banking systems under examination (USA, Canada, the UK and the Eurozone). The selection of the wholesale interest rate is also an important part of this pass‐through transmission framework because it is related to the money supply process and therefore the central bank's policy capabilities. In the empirical part, a Johansen (1988) cointegration based error‐correction procedure (ECM‐GE) is implemented for the wholesale interest rate selection. Then an LSE–Hendry general‐to‐specific model (GETS) is applied, for the revelation of the banking sector pass‐through interest rate behaviour. In the empirical part, on the issue of the wholesale interest rate selection, the USA and the Eurozone seem to favour the Money Market rate while the UK and Canada favour the central bank policy rate. The results indicate two types of interest rate pass‐through behaviour, with market structure implication – namely, the US and UK banking systems contrasted with Canada–Eurozone.     

Islamic Banking in Malaysia: Unchartered Waters

This paper explores the Islamic banking business in Malaysia since its beginning in 1983. The Islamic banking sector has achieved its target of 20% market share in assets and deposits in 2010. To boost the industry's competitiveness and efficiency, the demands of the market forces will have to be delicately balanced with the dictates of the Shari'ah. The search for niche Islamic banking products warrants enhancements in the current regulatory, legal, and fiscal infrastructure for Islamic banking, without which these products cannot be a viable alternative to the conventional ones. While the prevailing infrastructure is conducive to Islamic banking products that hold similar characteristics with interest‐bearing loans, Shari'ah compliance can be a futile exercise when the purpose of the law (maqasid al‐shari'ah) is overlooked, for there is much more to Islamic banking than the elimination of interest.     

Tail dependence risk exposure and diversification potential of Islamic and conventional banks

This paper undertakes a rolling window comparative analysis of risks for portfolios consisting of GCC Islamic and conventional bank indices. We draw our empirical results by employing canonical, drawable and regular vine copula models, as well as by implementing a portfolio optimization method with a conditional Value-at-Risk constraint. We find evidence of higher riskiness in the group of Islamic banks relative to the group of conventional banks across each of the financial rolling window scenarios under consideration. Specifically, a greater negative (nonlinear) tail asymmetric dependence is observed in the pairs of Islamic banks’ relationships. The results also show that the optimal portfolio model supports a clear preference towards the group of conventional banks in regard to risk minimization and diversification benefits.     

Monetary transmission with multiple policy rates: evidence from Turkey

Quantitative easing policies have led to persistent divergence between officially announced policy rates and short-term money market rates in many economies, making it challenging to assess the stance of monetary policy in the aftermath of the global financial crisis. Lack of data variation in short-term interest rates across time dimension has made it difficult to identify the monetary transmission mechanisms. In order to shed some light on this topic, we make advantage of a specific period from Turkey during which the central bank deliberately allowed the policy rates to diverge frequently from the interbank rates due to capital flow management purposes. Using bank-level flow data from this episode, we investigate the relationship between various short-term interest rate measures and bank loan/deposit rates through panel estimation methods. Our findings suggest that interbank rates are more relevant than central bank’s officially announced rates for the transmission of monetary policy when the two diverge from each other persistently. Interbank rates particularly play a key role in the pricing of loans and deposits. These findings provide helpful guidance for evaluating the monetary stance under unconventional policies.     

The impact of (un)conventional expansionary monetary policy on income inequality – lessons from Japan

ABSTRACT

This paper analyzes the impact of conventional and unconventional monetary policy on income inequality in Japan, using hitherto unexplored data from the Japan Household Panel Survey. Empirical evidence shows that expansionary monetary policy in Japan has contributed to diminishing the gender pay gap through an increase in working time of women relative to men, but also to increasing the education pay gap. These effects may have materialized via the aggregate demand channel and the labour productivity channel. In contrast, expansionary monetary policy has had no significant impact on the development of the age pay gap.     

Searching for the natural rate of interest: a euro area perspective

A time-varying natural rate of interest is estimated for the euro area using a multivariate unobserved components model. The problem of aggregating interest rate data for the pre-EMU period is directly addressed, and a simple method is proposed in order to adjust the risk premia in the interest rate data prior to 1999. We show that, for the pre-EMU period, using risk-unadjusted policy rates leads to periods of high risk premia being erroneously taken as monetary policy replies to the output gap; in contrast, using risk-adjusted policy rates yields an estimate of the reaction of monetary policy to the output gap corresponding approximately to an increase of 40 basis points for a 1%positive deviation of output from potential output. A positive deviation of inflation from its trend of 1%is estimated to have triggered an approximately 1.2%increase in short-term interest rates.     

Banking market integration in the SADC countries: evidence from interest rate analyses

This study investigates the state, development and drivers of banking market integration in the member countries of the Southern African Development Community (SADC). A Principal Component Analysis (PCA) of national retail interest rates indicates increasing integration in loan and deposit markets. These integration processes are not developing uniformly and we can identify a convergence club. When investigating the interest rate pass-through from central bank onto retail rates for this convergence club, we find both, genuine and monetary-integration driven processes though the latter dominate. We thus conclude that a selective expansion of the Common Monetary Area (CMA) is possible.     

Optimal monetary policy with the cost channel and monopolistically-competitive banks

This paper studies the optimal nominal policy interest rate in a model with the cost channel and imperfect competition in the banking sector. Due to this market power, the interest rate on deposits is relatively low; in particular it is lower than the policy interest rate. This, in turn, leads to a suboptimal level of deposits and, as a result, to a low level of intermediation. Deviations from the Friedman Rule are optimal in this setup regardless of the assumption about price rigidity; since households can hold their assets in the form of cash or deposits, taxing money, which is an imperfect substitute for deposits, is optimal in order to increase the level of deposits and encourage intermediation. The main results of the paper are robust to the introduction of market power in the loan market as well as stickiness in both the deposit and the loan markets.     

Non-core liabilities and interest rate pass-through: bank-level evidence from Indonesia

The policy importance of non-core liabilities (bank liabilities other than equity and retail deposits) has risen to prominence in recent years with a number of studies highlighting it as a useful indicator of financial procyclicality and vulnerability. In this paper, we look at non-core liabilities in relation to its role in the transmission of monetary policy, particularly by examining how the interest rate channel of monetary policy is affected by non-deposit liabilities. We analyse this issue in the context of an emerging economy experience of Indonesia, which in recent years, has seen an increased reliance of its banking sector on non-core funding. Our investigation employs available bank-level data on non-core liabilities and lending rates in Indonesia over the period October 2011 to July 2016. We find that including non-core liabilities in the estimation has an effect, relative to the baseline, of stronger overall and immediate pass-through, albeit with a more sluggish adjustment towards the correction of disequilibrium in the next period. The overall effect is that non-core liabilities make the duration longer for the monetary policy rate to transmit to bank lending rates in Indonesia.     

Demographics and real interest rates: Inspecting the mechanism

The demographic transition can affect the equilibrium real interest rate through three channels. An increase in longevity—or expectations thereof—puts downward pressure on the real interest rate, as agents build up their savings in anticipation of a longer retirement period. A reduction in the population growth rate has two counteracting effects. On the one hand, capital per-worker rises, thus inducing lower real interest rates through a reduction in the marginal product of capital. On the other hand, the decline in population growth eventually leads to a higher dependency ratio (the fraction of retirees to workers). Because retirees save less than workers, this compositional effect lowers the aggregate savings rate and pushes real rates up. We calibrate a tractable life-cycle model to capture salient features of the demographic transition in developed economies, and find that its overall effect is a reduction of the equilibrium interest rate by at least one and a half percentage points between 1990 and 2014. Demographic trends have important implications for the conduct of monetary policy, especially in light of the zero lower bound on nominal interest rates. Other policies can offset the negative effects of the demographic transition on real rates with different degrees of success.     

Budget deficits and interest rates: a fresh perspective

We extend the literature on budget deficits and interest rates in three ways: we examine both advanced and emerging economies and for the first time a large emerging market panel; explore interactions to explain some of the heterogeneity in the literature; and apply system Generalized Method of Moments (GMM). There is overall a highly significant positive effect of budget deficits on interest rates, but the effect depends on interaction terms and is only significant under one of the several conditions: deficits are high, mostly domestically financed, or interact with high domestic debt; financial openness is low; interest rates are liberalized; or financial depth is low.     

Monetary policy, macroeconomic adjustment and currency speculation under floating exchange rates: the case of Bulgaria

This paper deals with the Bulgarian experience with exchange rate policy and the related macroeconomic adjustment in the transition period. It is argued that in the context of the Bulgarian macroeconomic environment, the exchange rate regime and the exchange rate policy (or the lack of such) did play a crucial role in determining the patterns of macroeconomic adjustment in this period. A simple general equilibrium model is suggested that provides some insights into the stylized performance of an economy under certain assumptions, similar to those characterizing the transitional state of the Bulgarian economy. Finally, some aspects of Bulgarian macroeconomic performance in recent years are analysed on the basis of the available empirical information and using the framework of the theoretical model. The paper concludes with the policy lessons of this experience.     

The role of exchange rate in inflation targeting: the case of Turkey

ABSTRACT

The role of the exchange rates in emerging market economies that have adopted inflation targeting (IT) is a critical and contentious issue in the relevant literature. This article investigates whether an exchange rate-augmented Taylor rule describes the Central Bank of Republic of Turkey’s (CBRT) monetary policy. Covering the period from 2002:1 to 2017:8 it also explores possible nonlinearities in the reaction function of the CBRT by employing a Threshold Vector Autoregressive (TVAR) model. The linear estimation of the model highlighted the importance of the exchange rate in monetary policy under IT. The results of the nonlinear model indicate that the stance of monetary policy was asymmetric with respect to exchange rate movements during the conventional IT period. However, the asymmetric monetary policy stance disappeared in the aftermath of the Global Financial Crisis. Increasing considerations of financial stability undermined the asymmetric policy stance of the CBRT in the post-crisis period.