Monetary Policy Shocks and Islamic Banks Deposits in a Dual Banking System: Empirical Evidence from Malaysia and Bahrain

The objective of this paper is to empirically explore the dynamic interrelationshipsbetween deposits of Islamic banks with monetary policyvariables in Bahrain and Malaysia covering the period from January2001 to June 2006. Both these countries are being dubbed as the worlds largest International Islamic Financial Hubs (Qorchi, 2005). Acomparative analysis between these two countries highlights thedifferences and similarities of the impact of monetary policy shocks onthe Islamic banks deposits. The analysis comprises of two major testingapproaches. First, the auto-regressive distributed lag (ARDL) model isused to examine the long-run relationship among the variables. Second,the vector error-correction model (VECM) is adopted to explore theshort- and long-run dynamics among the variables. Compared to theMalaysian Islamic banks deposits, the study finds that the Islamic banks deposits in Bahrain are sensitive to monetary policy changes. Thisimplies that the Bahraini Islamic banks are less capable to offset the destabilizingimpact of monetary policy as compared to its Malaysiancounterpart.