Each and every finding demonstrates that the only significant factor of the financial performance of Islamic finance, which affects the endogenous economic growth, is profitability through return on equity (ROE). The experimental findings also indicate the necessity of stimulating other financial performance factors of Islamic finance to achieve a significant contribution to economic growth.
The analysis fill up the literature gap by investigating the link between financial performance of Islamic finance and economic growth, as the study serves as a guide for the academians, researchers and decision-makers who want to achieve economic growth through stimulating Islamic finance in the banking sector.
First we have to investigates the link between financial performance of Islamic finance and economic growth
Islamic finance has been one of the fastest rising industries over the last ten years, which was estimated to be worth US$2.4 trillion in 2017 and forecast to grow by 6% CAGR to reach US$3.8 trillion by 2023 . This optimistic tall growth degree of Islamic finance assets year after year attracts the attention of all policymakers, bankers and financial academics to look into the Islamic finance industry. Lately, in the last decade, one of the main debates among financial scholars and policymakers besides the relationship between Islamic finance and economic growth is whether the financial performance of Islamic finance contributes to economic growth. According to Bourke (1989), high profitability banks persist well-capitalized and their access to funds is easy.
Certainly, the financial institutions that operate well play a weighty role in economic growth and financial performance. Moreover, the banking sector performance and profitability power the economy’s growth and boost it to contain negative shocks, also state a positive supportive relationship between economic growth (GDP) and the performance of banks. Furthermore, Islamic banks have effected significantly the growth of GDP and investments of countries in the Middle East.
Currently, the Islamic banking sector comprises 71% of all Islamic finance assets with a portion of 1.721 trillion US$ and could reveal its stability in and after the 2008 global financial crisis
According to Reuters (2020), Malaysia is the leading country in Islamic finance’s best performance with a Global Islamic Economy Indicator (GIEI) score equal to 111 and an Islamic Finance Development Indicator (IFDI) score equal to 132 according to Islamic Finance Development Report 2018 (2018). Besides, Brunei and Indonesia were the most improved performers in Southeast Asia, Brunei was the biggest gainer in Southeast Asia and finished in 9th position with an IFD indicator score of 50 while Indonesia ranked 10th. Moreover, the 2018 global Islamic economy report state that Saudi Arabia ranked fourth as one of the best Islamic finance countries with a GIE indicator score of 54, while Turkey ranks in the top 15 countries with a GIE indicator score of 31.
Furthermore, this enormous success of the Islamic finance industry in Malaysia, Indonesia, Brunei, Turkey and Saudi Arabia synchronized a high level of economic growth, while Malaysia economy enhanced 4.9% year-on-year in the second quarter of 2019, succeeding a 4.5% rise in the earlier three-month cycle and a 4.8% spreading business prospects (Trading Economics Report, 2019a), although Indonesia economy is predictable to expand at 5.1% in 2019 and then increase to 5.2% by 2020 (World Bank, 2019). In addition, Brunei GDP rose by 0.1% compared with 2017 while the GDP in Turkey rose by 1.20% over the previous quarter in the second quarter of 2019; the GDP growth rate in Turkey ranged 1.09% between 1998 and 2019. Although GDP in Saudi Arabia extended 1.66% year-on-year in the opening quarter of 2019, it diminished from 3.59% in the previous period.
Because of the limited studies that investigated the link between financial performance of Islamic finance and economic growth and the lack of understanding this link, the contribution of this study is to investigate this link in a framework of endogenous growth model through international evidence from Malaysia, Indonesia, Brunei, Turkey and Saudi Arabia as the top pioneer Islamic finance countries. Therefore, this study answers the following question: “Does the financial performance of Islamic finance affect economic growth in the frame of the endogenous growth model?”
Endogenous growth theory was established in the 1980s by Romer; the endogenous growth model is described with the lasting growth pace which well-defined by factors inside the model and not by the exogenous degree of technological advancement as in the neoclassical growth model clarify that the endogenous growth model reinforces technical evolution emerging from the investment degree and the human capital stock size, and both Tabash and Anagram (2017) have confirmed that Islamic finance has affected significantly the economic growth and investments of countries in the Middle East. Thus, based on the endogenous growth model, when investments are increased due to the finance and banking performance that leads to higher economic growth
In a similar study, Yazdani (2011) explored the effect of private banks’ financial performance on economic growth in Iran. He adopted GDP, ROA, cash and investments as research variables. His results showed that bank performance had a positive effect on the economic growth of Iran.
Concerning studies of the financial performance of Islamic finance determinants measured by the profitability, Khan et al. (2014) have examined factors that affect Islamic banking profitability which was adopted as a measure for the financial performance in Pakistan. They employed a sample of five Islamic banks in Pakistan from 2007 to 2014. They employed capital adequacy ratio, bank size, nonperforming loans (NPL) ratio, gearing ratio, asset composition, operational efficiency, asset management, deposit ratio, (GDP) and (CPI) as exogenous variables, ROE, ROA, earnings per share (EPS) as endogenous variables. Their results showed that the profitability of Islamic banking was impacted by bank-specific aspects such as asset management, NPL ratio, deposit ratio and exterior factors such as CPI.
Another study of Zarrouk et al. (2016), investigate whether Islamic banks profitability is motivated by the same factors of conventional banks in the MENA. They used panel system GMM on a simple of 51 Islamic banks in all of Jordan, UAE, Turkey, Egypt, Yemen, Kuwait, Sudan, Bahrain, Saudi Arabia and Qatar from 1994 to 2012, and they adopted bank-specific factors (risk and solvency, efficiency ratios, liquidity, asset quality, annual stock data and capital), macroeconomic factors (gross domestic product, consumer price index, investment ratio of GDP, dummy variable of inflation) as exogenous variables and profitability ratios (ROA, ROE, NPM) as dependent variables. They resolved that profitability was affected by the asset quality, cost-effectiveness and capitalization of both banks.
According to the research, which measures the financial performance of Islamic finance using the profitability (earnings) of Islamic finance is the real explanatory factor that contributes to economic growth. Therefore, by adopting only the profitability as a measure of the financial performance of Islamic finance, the study concludes that there is a positive relationship between financial performance of Islamic finance and economic growth in general consistently with what Tabash (2019) and Rabaa and Younes (2016) had determined. When they employed only the profitability as a measure for the financial performance of Islamic banking sector, they found a positive relationship between the financial performance of Islamic banking sector and economic growth.