THE IMPACTS OF CONVENTIONAL AND ISLAMIC

BANKING SECTORS ON REAL SECTOR

GROWTH: EVIDENCE FROM TIME-VARYING
CAUSALITY ANALYSIS FOR TURKIYE

Research Article
Abstract

Advocates of Islamic finance claim that it contributes to the development of the real economy, rather than focusing on growth in financial
assets by selling money to earn money, but no empirical evidence has been produced to support that view.

1. This study investigates the effects of conventional banking activities and Islamic banking activities, in particular in terms of their
contribution to economic growth and development. The study’s novelty is that it treats these relationships in terms of time-varying
causality supported by Fourier functions.
2. The study also seeks evidence of the possibility that the effect of conventional and Islamic banking on the dependent variables might
become U-shaped or inverted U-shaped over time.
3. This study uses three different datasets on the real economy in Turkiye for the period January 2005 to February 2023.
4. Study results reveal that loan volume in banking in general and Islamic banking, in particular, affects the sectors considered and that
causality varies over time.
5. The study shows that, in Turkiye, Islamic banking activities have a weaker impact than banking activities in general because Islamic
banking is still in its early stages of development, but it still has an impact on related sectors.
Introduction

1. The banking sector plays a crucial role in the financial system by acting as an intermediary between fund providers and
individuals/organizations in need of funds.
2. Banks make their resources available to those in need through credit transactions, which can help entrepreneurs transform savings into
new investments and contribute to higher production and economic growth.
3. Analyzing the impact of developments in the banking sector on economic growth is of great importance, as the banking sector is at the
core of the financial system and an indispensable part of modern economies.
4. Conventional and Islamic banking are two different approaches to banking, with the latter operating according to the principles of
Shariah which prohibits interest and other unethical practices.
5. In Turkey, both conventional and Islamic banks have played an important role in the country's development, steadily increasing the
volume and diversity of financial services.
6. Understanding and comparing the effects of conventional and Islamic banking sectors on real sector growth in Turkey has become a
growing research topic.
7. Fourier function econometric analysis and statistical methods can be used to track the causal relationship between the conventional and
Islamic banking sectors on real sector growth over time.
8. The results of such studies are valuable for understanding the effects of the banking sector in Turkey on real sector growth and
contributing to future policy decisions.
Literature Review Points

1. The literature on the impact of financial systems on economic development is divided into three groups for review.
2. The first group of studies focuses on the impact of the conventional banking sector on economic growth.
3. The second group discusses the impact of Islamic banking activities, and the third group addresses the impact of both groups of banks
on the real economy in detail.
4. The relationship between financial intermediaries' evolving activities and economic growth has been the subject of extensive research
since Schumpeter's seminal work in 1911.
5. Several studies have evaluated this relationship in depth, with some recent prominent studies summarized in the text.
6. These studies use various methods such as cointegration tests, Granger-causality analysis, and panel data analysis to identify the causal
relationship between banking sector activities and economic growth.
7. Results from these studies reveal a positive and significant effect of banking sector performance on economic growth in most cases.
8. However, some findings suggest a negative effect of banking sector development on the agricultural sector in highly developed
countries.
9. Overall, the literature highlights the importance of both conventional and Islamic banking sectors in the financial system and their
impact on economic growth.
Fig. Growth in the conventional and Islamic banking sectors in Turkiye, 2005–2023
Research Methodology Points:

The research methodology used in the study first the fractional frequency Fourier ADF test of stationarity of the series. Then, we use the
time-varying causality test developed by Hacker and Hatemi-J (2006) and used by Zeren and Ko¸c (2016) to analyze the causality
relationship between the variables.. The study analyzes the time-varying causality relationships between total banking and participation
banking in terms of the commercial loan and fund disbursement volume-dependent variables (mining; manufacturing; and electricity,
gas, steam, and air conditioning production and distribution) in Turkiye.

1. The dependent variables in the study are mining, manufacturing, and electricity, gas, steam, and air conditioning production and
distribution.
2. The independent variables are total banking and participation banking in terms of commercial loan and fund disbursement volume.
Results and Findings Points:

1. The fractional frequency Fourier ADF test revealed that all the variables contain a unit root at level, but the unit-root problem is
eliminated when we take the first difference of the variables, and they all become stationary.
2. The time-varying causality test developed by Zeren and Ko¸c (2006) showed that there is a causal relationship between the variables
with statistical values of more than 1, indicating a causal relationship.
3. The analysis developed by Lind and Mehlum (2010) revealed the existence of an inverted U-shaped relationship between the relevant
variables. The lower bound slope is positive, but the upper bound slope turns negative, indicating that the marginal impact of the
banking sector on the electricity and manufacturing sectors has tended to decrease over time.
4. The time-varying causality relationship between the banking sector and electricity, gas, steam, and air conditioning production and
distribution sector production volume index is generally weak, but more causality is found from ELEC to BNK. The causal relationship
intensified after the 2008 crisis, and the causality relationship from ELEC to BNK began early on in the crisis. No causality from BNK
to ELEC is seen until February 2010.
5. The time-varying causality relationship between the banking sector and the manufacturing sector is more intense from BNK to MAN.
Although there is significant causality from BNK to MAN before the 2008–2009 global financial crisis, the direction of causality turned
from MAN to BNK during the crisis. In 2010, when the effects of the global financial crisis started to diminish in Turkiye, the
relationship is predominantly from BNK to MAN, and a bilateral causal relationship is also observed.
Conclusion:

1. This study provides a detailed analysis of the relationship between banking and the real economy in Turkiye from January 2005 to
February 2023.
2. The study reveals that commercial loans and funds extended by banks, particularly participation banks, have a significant impact on
the real economy, specifically on production volume in the manufacturing sector.
3. The study also shows that macro- and micro-scale economic developments affect the relationship between the banking sector and the
real economy.
4. The study highlights the increasing impact of Islamic banking activities in particular, emphasizing the importance of Islamic banks
in the economy.
5. Policymakers are expected to develop policies that take into account the impact of banks and Islamic banks in particular.
6. Overall, the study makes unique and important contributions to the literature, providing insights that can inform policy decisions to
support economic development in Turkiye.