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The effect of interest rates and rate of profit on islamic investment deposits: evidence from Malaysia

Habib, Farrukh and Masih, Mansur (2017): The effect of interest rates and rate of profit on islamic investment deposits: evidence from Malaysia.

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An inimitable attribute of Islamic banking, in theory, is its risk sharing paradigm. However, even after almost three decades from its inception, the vital stratagem of Islamic banking is still to replicate the products/services offered by conventional banks. This means that deposit rates should also be analogous in both the systems. The inference is that, though Islamic rates of return are based on interest free principles, but they are still interest based. The spectacular augmentation of Islamic banking may seem to be the upshot of Islamic resurgence worldwide; rather by its distinctive trait of profit and loss sharing. In order to scrutinize this conception, this study investigates whether Islamic investment deposits rely more on Islamic profit rates or on conventional interest rates offered by their counterparts. It analyzes the impact of these two rates on investment deposits in Malaysian Islamic banking system, by applying recent econometric techniques on monthly data. The paper discovers that, in defining the amount of deposits, neither Islamic profit nor interest rates play a momentous role. It may be assumed that, rather, other macro economic factors, in fact, explain the variations in Islamic investment deposits. However, the results tend to indicate that the profit rates are positively related to the amount of investment in Islamic banking system; while, a negative relation is found with the interest rates. This implies that the customers of Islamic banking system are indifferent of the Islamicity of their investments; and are driven by profit-motives. Hence, this situation exposes the Islamic banks to interest rate risk and displaced commercial risk.

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