Islamic Banking and Firm Performanc e: Costs, Benefits, and Lessons from the Global Financial Crisis
Abstract:
The roles played by Weste
rn-oriented banks in creating and exacerbating the Global Financial Crisis
invite investigation of alternative banking arrangements. The dual-banking
system in Turkey allows us to obtain a better understanding of Islamic bank
s in resolving the two fundamental finance problems — transferring funds fr
om savers to borrowers and efficiently allocating those funds among competi
ng borrowers. We are particularly concerned with the effects of that resolu
tion on real activity by non-financial firms. Islamic banking relations are
analyzed in terms of secular, Western-oriented, finance concepts. Islamic
banking relationships attenuate financial frictions and shift risk from fir
ms to banks (where risk can be borne more efficiently). The extent to which
these features of Islamic banking relationships affect firms and improve o
r impair real economic performance are evaluated empirically. With a unique
dataset of 100,000 firm/year observations, we document the advantages of a
n Islamic banking relation in normal times in terms of increasing investmen
t and expanding the size of the firm. During abnormal times, we find that f
irms with an Islamic banking relationship investment less, suggesting the d
ark side of an Islamic banking relationship. Religiosity is an important fa
ctor in the adoption decision by firms for an exclusive Islamic banking rel
ationship. We use this ”instrument” to re-examine the sensitivity of invest
ment and firm growth to an Islamic banking relationship. Propensity score m
atching estimates confirm our previous findings.