Determinants of deposits in conventional and Islamic banking: a case of an emerging economy

The purpose of this paper is to examine the impact of base lending rate (BLR), consumer prices, gross domestic product, money supply (M₃), Karachi stock exchange composite index, KIBOR, and profit rate of Islamic banks on deposits of both conventional and Islamic banks in Pakistan.

Quarterly data of six years (2006-2011) are obtained from 30 banks, consisting of 25 conventional and five Islamic banks. The short-run as well as long-run relationships among these variables are examined by utilizing advanced time series approach. Bounds testing and autoregressive distributed lag have been used to examine cointegration and error correction framework for short-run dynamics.

The empirical results reveal that variables such as interest rate of conventional banks, profit of Islamic banks, consumer prices, M₃, and BLR have different impact on conventional and Islamic bank deposits. Depositors of conventional and Islamic banks are sensitive to the returns received on deposits. A boost in interest rate increases the deposits of conventional banks but decreases those of Islamic banks.

This study signifies that customers of Islamic banks are motivated by profit. This indicates the normal behavior of customers, hence endures the substitution effect in conventional system. The study has important implications for Islamic banks to offer more competitive rates of profit with respect to the interest rate of conventional banks in order to collect more deposits. It also identifies relevant policy implication for the central bank of the country.