Are Shari'ah Compliant Banks Good For Economy? Granger Causality Approach

Abstract

This paper aims at examining the cause and effect relationship between banks´ efficiency performance and countries´ economic growth. Data Envelopment Analysis DEA is used to estimate the banks' efficiency scores. The sample banks consists of 44 Islamic banks and 44 matched sample of conventional banks from 20 countries from Asia, Africa, the Middle East, Gulf region, and Europe. This paper utilizes the Granger-causality test to achieve the study objectives over the sample period from 2005 to 2016.Findings show that Islamic banks albeit on average inefficient are more technically efficient than conventional banks and seemed to be relatively immune to the effects of the global crisis of 2008. Islamic banks show also a lower volatility on their performance over time and operate most of the time very close to the efficient frontier of DEA.Banks inefficiencies were driven by banks´ poor management practices for choosing the optimal mix of inputs and outputs. Inappropriate Scale of operations contributes also to the overall inefficiency.In terms of the analysis of Granger causality relationship between banks´ efficiency performance and economic growth, results reveal that Granger causes run both directions between banks´ performance and growth on economic GDP for Islamic banks in the short and long run for the entire period. While, a strong evidence of only a short-run relationship without causation effect is found between conventional banks´ performance and economic growth.Findings suggest that investors, financial institutions, and countries alike should encourage the Islamic business model and activities as they could help in financing businesses to induce economy and link financial expansion to the growth of the economy.