Munich Personal RePEc Archive

Dual Banking Systems and Interest Rate Risk for Islamic Banks

Bacha, Obiyathulla I. (2004): Dual Banking Systems and Interest Rate Risk for Islamic Banks. Published in: The Journal of Accounting, Commerce & Finance – Islamic Perspective , Vol. 8, No. 1 (December 2004): pp. 1-42.

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In introducing Islamic banking in Malaysia, the basic strategy was to replicate the products/ services offered by conventional banks. The successful implementation of such a strategy has meant that Malaysia today has a truly dual banking system. Islamic banks in Malaysia not only have product similarity with conventional banks but share the same overall economic environment and a common customer base.

The ability of non Muslim customers/depositors to switch between the two banking systems, means that deposit / financing rates have to be similar – else give rise to arbitrage flows. The implication is that, though Islamic banks operate on interest free principles, the economic environment in a dual banking system inevitably exposes them to the problems of conventional banks; in particular interest rate risk. Using monthly data over the 10 year period 1994 – 2003, the paper argues that, paradoxical as it may seem, Islamic banks operating within a dual banking system may also be subject to interest rate risk.

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