Market development of Islamic banking in Pakistan and its economic impact

PurposeThis study aims to examine the dynamics of the market development of Islamic banking in Pakistan. This study investigates how shocks to the economy in the form of changes in benchmark rate and exchange rate and internal factors such as efficiency, profitability and asset quality affect the development of Islamic banking. The study also evaluates the impact of Islamic banking on the real economy in the macro perspective and society at large in terms of inclusiveness, competitiveness and fairness. Design/methodology/approachAutoregressive distributed lagged model method is used for analysing the short-run and long-run determinants of market development of Islamic banking and the economic impact of Islamic banking on the real economy. FindingsProfitability and exchange rate have a positive effect on market development of Islamic banking while higher inefficiency and interbank rate have a negative effect. On the other hand, financing intensity and profitability in Islamic banking positively affect the large-scale manufacturing sector. Practical implicationsStable profits, high asset quality, efficiency and rising import demand with low policy rate environment complement Islamic banking growth. Moreover, the economic assessment shows that Islamic banks have been able to achieve the financial inclusion of those who want to avoid Riba, but they need concerted efforts to improve competitiveness and distinction with regard to distributional impact. Originality/valueTo the best of the authors' knowledge, this is the first study in Pakistan to evaluate determinants of market development of Islamic banking taking 16-year quarterly data and assessing the economic effects of Islamic banking on inclusiveness, competitiveness and fairness.