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The IFSB issues its 17th Research Paper in the Working Paper Series

Date posted: 27 August 2021

27 August 2021, Kuala Lumpur - The Islamic Financial Services Board (IFSB) today issues the seventeenth research paper in the working paper series titled “Effectiveness of macroprudential tools for Islamic banking.” The paper is a collaboration between IFSB, Saudi Central Bank (SAMA) and Bank Indonesia (BI) with focus on examining the behavioural response of Islamic banks to the implementation of macroprudential policy tools and measures. 

Working Paper 17 applied both qualitative and quantitative methods in its investigation. The qualitative method (i.e survey) describes countries’ experiences on macroprudential tools/measures, taken into account country-specific factors and circumstances of their usage. This working paper makes a reference to cases of Saudi Arabia and Indonesia to showcase the country-specific contexts relating to implementation of the macroprudential policy framework. 

In this paper, quantitative method was performed using both static and dynamic panel data model baseline and robustness check respectively, to assess the effectiveness of macroprudential policy stance with regard to household credit growth. For this analysis, a set of macroprudential indices comprising an aggregate index and sub-group indices were developed from 17 macroprudential tools to measure the overall macroprudential policy stance in 10 countries where Islamic banks operate alongside with conventional banks. Data on household credit growth was drawn from the IFSB’s PSIFIs database which represent the dependent variable.

The paper finds that: (i) the overall macroprudential measures have a negative relationship with household credit growth even though not statistically significant, (ii) each of the indices in the subgroup category of macroprudential measures (e.g. all-credit targeted, demand-related vs. supply-side tools) shows a decline in household credit growth and statistically significant. The analysis not only suggests the impact of macroprudential tools in dampening household credit growth, but also enables a comparison of the relative effects of different instruments. The overall analysis suggests that Islamic banks also respond appropriately to the implementation of macroprudential policy tools. This demonstrates the importance of macroprudential tools for managing potential risks associated with the high financing exposure of Islamic banks. Thus, a relatively high financing exposure of Islamic banks to household credit (the real sector), which could probably make them vulnerable to macroeconomic dynamics, can be effectively controlled.

The IFSB Secretary-General, Dr. Bello Lawal Danbatta stated that, “this paper is intended to contribute to better understanding of how macroprudential policy tools/measures are to be applied to banking system where Islamic banks operate. He noted that, notwithstanding the extensive use of the macroprudential tools/measures in many jurisdictions where Islamic banking operates, there seems to be a limited understanding about their efficacy to Islamic banks.”

Islamic banking is currently operating in at least 39 jurisdictions, has attained systemic importance in 15 jurisdictions based on 2021 IFSB’s IFSI Stability Report. The similar pattern in the financing concentration exhibited by Islamic banks in many of these jurisdictions necessitate the need to conduct a study to examine the behavioural response of Islamic banks to the implementation of macroprudential policy tools. Islamic banks’ financing, in many of these jurisdictions, are concentrated mostly in wholesale, retail trade financing and household sector, driven by factors which support households’ repayment capacity.

Experience in the wake of COVID-19 pandemic has shown that macroprudential policy tools/measures can be use in parallel to the action taken by the monetary and fiscal authorities to maintain financial system stability.

WP-17 is available for download from the IFSB website: www.ifsb.org

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