Unveiling interest rates and Islamic banking activity: empirical evidence from Saudi banks

Abstract

Purpose The purpose of this paper was to explore the impact of interest rate shocks on the deposits and financing of Islamic and conventional banks in Saudi Arabia. Design/methodology/approach The authors use impulse response functions (IRFs) and variance decomposition (VDC) analyses over the period 2008Q1–2020Q2. Findings The IRFs showed that increasing interest rates reduce loans and conventional deposits. For Islamic banks, the deposits are more affected by interest rate changes than the financing. The VDC analysis found that deposits contribute up to 61% of Islamic financing variations, compared to only 25% in conventional lending ones. Originality/value This research contributes to the field of Islamic economics and finance by providing empirical evidence on how interest rates likely impact Islamic and conventional deposits and financing in Saudi banking system.