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Can the islamic banks’ credit risk be explained by macroeconomic shocks? evidence from Malaysia

Rosle, Alia Nadira and Masih, Mansur (2018): Can the islamic banks’ credit risk be explained by macroeconomic shocks? evidence from Malaysia.

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Credit risk analysis is a key to a better financial risk management. This issue has been the primary focus of financial and banking industry since loans are the largest and most prominent source of credit risk. Unlike the conventional banking, there is a lack of empirical study on credit risk about Islamic banking. As such, further research regarding the vulnerability of the Islamic banking industry has become vital. Accordingly, this paper is aimed at determining and assessing the long run vulnerabilities of Malaysian Islamic banks proxied by non-performing loan ratio (NPLR) in term of its response to the macroeconomic variables that include Consumer Price Index (CPI), Production Price Index (PPI), Real Interest Rate (INT), Exchange Rate (EXCH) and Money Supply. The study is conducted on monthly data covering eleven years starting from January 2007. Malaysia is used as a case study. The techniques employed in this study are based on Vector Error Correction Modeling (VECM) and Variance Decompositions (VDC). In this study we found that the non-performing loan ratio, interest rate and money supply were relatively exogenous variables. In particular, the non-performing loan ratio being the most exogenous can’t be explained by any macroeconomic shocks. The results have strong policy implications.

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