The Macrotheme Review A multidisciplinary journal of global macro trends

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1 The Macroheme Review A mulidisciplinary journal of global macro rends Analysis of Shor-Term Deposi Marke in Malaysia: Formaion of Islamic Raes of Reurn and Convenional Ineres Raes Takayasu Io Meiji Universiy, School of Commerce, Tokyo Japan Absrac This paper has analyzed he formaion of convenional ineres raes and Islamic raes of reurn in Malaysian deposi marke. Convenional ineres raes and Islamic raes of reurn on all mauriies co-move in he long-run equilibrium. Islamic raes of reurn propel over convenional ineres raes on hree-, six-, and 12-monh mauriies. This resul is differen from he resuls of Chong and Liu (2009), and Cevik and Charap (2011), which sae ha convenional ineres raes unilaerally Granger-cause Islamic raes of reurn. Chong and Liu (2009) used a sample covering he period from April 1995 o April 2004, and Cevik and Charap (2011) used a sample period from January 1997 o Augus The sample period of his paper is from May 16, 2005 o Ocober 17, Bu he resul is consisen wih Io (2013), which shows ha Islamic raes of reurn propelled convenional ineres raes on hree-, six-, and 12-monh mauriies beween May 16, 2005 and January 12, 2012.The convenional and Islamic deposi markes are compeiive in Malaysia, where Islamic banking has a srong influence over convenional banking. This is consisen wih he fac ha he share of Islamic deposis in Malaysia rose from 5% o 24.5% beween 1999 and Keywords: Convenional Finance, Formaion of Deposi Rae, Islamic Finance, Malaysia 1. Inroducion In Malaysia, he share of Islamic deposis in he deposi marke has grown since 2000, especially since 2005, and has grown rapidly, reaching 24.5% a he end of 2014 from 5% in 1999, as shown in Figure 1. The philosophies and principles of Islamic banking are based on Shariah, which proecs Islamic communiies and socieies from aciviies ha are forbidden in Islam. Shariah is also inended o encourage companies o engage in business aciviies ha are accepable and consisen wih Islamic principles. Islamic banking differs from convenional banking in ha ineres (riba) is prohibied. Islamic banks use raes of reurn in place of ineres raes. This paper analyzes co-movemen of convenional ineres raes and Islamic raes of reurn o invesigae he formaion of convenional ineres raes and Islamic raes of reurn in he Malaysian deposi marke by exending he sample period from Io (2013). 95

2 Y1999 Y2000 Y2001 Y2002 Y2003 Y2004 Y2005 Y2006 Y2007 Y2008 Y2009 Y2010 Y2011 Y2012 Y2013 Y2014 Takayasu Io,The Macroheme Review 6(1), Spring 2017 % Figure 1 The share of Islamic deposis in oal deposis Noe: Sample Period : from 1999 o 2014 (year end) Source : Bank Negara Malaysia Monhly Saisical Bullein Chong and Liu (2009), Cevik and Charap (2011), Io (2003), Ergec and Arslan (2013), and Sarac and Zeren (2015) have analyzed he relaionship beween convenional ineres raes and Islamic raes of reurn in he deposi marke. Chong and Liu (2009) analyzed he co-movemen and ransmission of convenional ineres raes and Islamic raes of reurn in Malaysia. They concluded ha co-movemen is observed and ha convenional ineres raes influence Islamic raes of reurn. They also concluded ha Islamic banking is no very differen from convenional banking. Cevik and Charap (2011) analyzed he co-movemen and ransmission of convenional ineres raes and Islamic raes of reurn in Malaysia and Turkey using monhly daa. They concluded ha he raes of convenional and Islamic deposis co-move and ha convenional ineres raes influence Islamic raes of reurn. Io (2013) concluded ha convenional ineres raes and Islamic raes of reurn co-move in he Malaysian deposi marke, and ha Islamic raes of reurn propel he convenional ineres raes of hree-, six-, and 12-monh mauriies. Ergec and Arslan (2013) invesigaed and analyzed he impac of ineres rae shock upon deposis and loans held by convenional and Islamic banks and found ha Islamic banks in Turkey are manifesly influenced by ineres raes. Sarac and Zeren (2015) economerically invesigaed he long-erm relaionship beween convenional banks (CB) erm-deposi raes (TDRs) and paricipaion banks (PB) TDR in Turkey. Their findings show ha he TDRs of hree of four PBs are significanly coinegraed wih hose of CBs. In addiion, permanen causaliy is found from CBs o all PBs. 96

3 2005/5/ /8/ /12/6 2006/3/ /6/ /10/4 2007/1/ /5/2 2007/8/8 2007/11/ /3/4 2008/6/ /9/ /12/ /4/ /7/ /10/ /2/5 2010/5/ /8/ /12/3 2011/3/ /6/ /9/ /1/ /4/ /7/ /10/ /2/ /5/ /9/9 2013/12/ /4/4 2014/7/16 Takayasu Io,The Macroheme Review 6(1), Spring 2017 This paper makes a conribuion o he lieraure. This paper analyzes he co-movemen and ransmission of convenional ineres raes and Islamic raes of reurn in a sample from May 16, 2005 o Ocober 17, Io (2013) used he daily daa of a sample covering he period from May 16, 2005 o January 12, The exended period from Io (2013) is almos wo years and a half. Chong and Liu (2009) used he monhly daa of a sample covering he period from April 1995 o April 2004, and Cevik and Charap (2011) used he monhly daa of a sample covering he period from January 1997 o Augus The remainder of his paper is srucured as follows. Secion 2 describes he daa and provides summary saisics. Secion 3 discusses mehodology. Secion 4 presens he resuls. Secion 5 concludes. 2. Daa Convenional ineres raes and Islamic raes of reurn in he deposi marke are used. The mauriies of deposis are se a hree, six, and 12 monhs. The daa are daily. The sample period runs from May 16, 2005 o Ocober 17, The convenional ineres raes and Islamic raes of reurn on hree-, six-, and 12-monh mauriies are provided by Bloomberg. The movemen of he six-monh Islamic rae of reurn is shown in Figure 2, and he descripive saisics are provided in Table % Figure 2 Movemen of six monh Islamic rae of reurn Noe: Sample period is from May 16, 2005 o Ocober 17, Daa source is Bloomberg. 97

4 Table 1 Descripive saisics of daa for analysis Variable Average SD Min Max Median IS3M IS6M IS12M CO3M CO6M CO12M Sample period is from May 16, 2005 o Ocober 17, Mehodology Uni Roo Tes Because empirical analysis from he mid-1980s hrough he mid-1990s shows ha such daa as ineres raes, foreign exchanges, and socks are non-saionary, i is necessary o check wheher he daa used in his paper conain uni roos. The Augmened Dickey-Fuller (ADF) es and he Kwiaowski-Phillips-Schmid-Shin (KPSS) es are used 2. The ADF defines he null hypohesis as uni roos exis and he alernaive hypohesis as uni roos do no exis. Fuller (1976) provides a able for he ADF es. The KPSS es defines he null hypohesis as uni roos do no exis and he alernaive hypohesis as uni roos exis. Firs, he original daa are checked o verify wheher hey conain uni roos. Nex, he daa wih firs difference are analyzed o deermine wheher hey have uni roos o confirm ha hey are I (1) process. 3.2 Engle-Granger Coinegraion Tes Afer confirming ha all daa are non-saionary I (1) processes in secion 3.1, a coinegraion framework is presened o analyze he relaionship beween he convenional ineres rae and he Islamic rae of reurn. Equaion (1) is esimaed by OLS o deermine wheher he residual conains uni roos. ISD COD u (1) ISD = Islamic rae of reurn 1 The same mehods as in Io (2013) are used. 2 See Dickey and Fuller (1979), Dickey and Fuller (1981), and Kwiakowski e al. (1992). 98

5 COD = convenional ineres rae The coinegraion vecor, β in equaion (1), is checked using he dynamic OLS mehod developed by Sock and Wason (1993). Equaion (2) is used o es wheher β = 1 can be rejeced. ΔCOD -i is he lead and lag variables of convenional ineres rae 3. If β = 1 canno be rejeced, he Islamic rae of reurn changes o he same degree as he convenional ineres rae. The es of he coinegraion vecor is only conduced on a pair of samples when hey are in a coinegraion relaionship. ISD p COD b COD u (2) i i p i Analyses of he pair-wise relaionship beween he convenional ineres rae and he Islamic rae of reurn on hree-, six- and 12-monh mauriies are conduced. The co-movemen of he Islamic rae of reurn wih he convenional ineres rae is invesigaed using he coinegraion es. Wheher he convenional ineres rae and he Islamic rae of reurn are in a one-o-one relaionship is esed using he coinegraion vecor es. An inerpreaion of he resuls divided ino hree cases can be made in he following way. Case coinegraion coinegraion vecor Ⅰ no -- Ⅱ yes β=1 canno be denied Ⅲ yes β=1 can be denied Ⅰ The convenional ineres rae does no co-move wih he Islamic rae of reurn. The deposi marke is segmened ino convenional and Islamic banking. There is no compeiion beween hem. Ⅱ The convenional ineres rae co-moves wih he Islamic rae of reurn. The convenional ineres rae is in a one-o-one relaionship wih he Islamic rae of reurn. The compeiion beween hem is keen. Ⅲ The convenional ineres rae co-moves wih he Islamic rae of reurn. The convenional ineres rae is no in a one-o-one relaionship wih he Islamic rae of reurn. The compeiion beween hem is observed. 3 As for he number of lead and lag erms, 12 is used. Hirayama and Kasuya (1996) provide empirical analysis using Ras procedure SWDYNAMIC.PRG. 99

6 3.3 Granger Causaliy Tes Wih regard o he variables ISD (Islamic rae of reurn) and COD (convenional ineres rae), he Granger causaliy es checks wheher ISD affecs COD, COD affecs ISD, or ISD and COD affec each oher muually in a ime series model. The original daa are usually ransformed ino a change raio o avoid spurious regression, bu using hese daa causes errors. In his paper, he null hypohesis H 0 regarding he influence of COD on ISD and he influence of ISD on COD is esed using he original daa of convenional ineres rae and he Islamic rae of reurn pair-wise in he same mauriy. In his mehod proposed by Toda and Yamamoo (1995), rend erm and p + 1 (original lag plus one) are added for he esimaion. Original lag lengh is decided by he AIC sandard. p+1 p+1 ISD = u 0 + u + α i ISD i + β i COD i + u (3) i=1 i=1 H 0 : β 1 = β 2 = β p = 0 H 1 : Eiher β i 0 (i = 1,2,, p) p+1 p+1 COD = u 0 + u + α i ISD i + β i COD i + u (4) i=1 i=1 H 0 : γ 1 = γ 2 = γ p = 0 H 1 : Eiher γ i 0 (i = 1,2,, p) The F es is conduced by esimaing (3) and (4) hrough OLS and summing he squared error. If he null hypohesis of H 0 in equaion (3) is rejeced, COD is considered o explain ISD. In oher words, he convenional ineres rae Granger-causes he Islamic rae of reurn. If he null hypohesis of H 0 in he equaion (4) is rejeced, ISD is considered o explain COD. In oher words, he Islamic rae of reurn Granger-causes he convenional ineres rae. 4. Resuls 4.1 Uni Roo Tes Firs, ADF and KPSS ess are conduced on he original series. The resuls do no eliminae he doub ha he original daa have uni roos because boh ess show non-saionariy. The resuls are shown in Table 2 and Table 3. Nex, ADF and KPSS ess are conduced for he daa wih a firs difference. The resuls show ha all variables are saionary. Even hough some ess of rend saionariy show significance a he 5% level, none of hem are significan a he 1% level. Thus i is appropriae o hink ha all of he variables used for he analysis are non-saionary I (1) variables and o judge ha nonsaionary ime series can be used. The resuls are shown in Tables 4 and

7 Table 2 ADF uni roo es (Original Series) Variable Wihou Trend Wih Trend IS3M IS6M IS12M CO3M CO6M CO12M * indicaes significance a he 5% level. 5% criical values are 2.86 (wihou rend) and 3.41 (wih rend). Table 3 KPSS uni roo es (Original Series) Lag = 4 Lag = 12 Variable Level Saionary Trend Saionary Level Saionary Trend Saionary IS3M 5.146* 4.716* 1.988* 1.823* IS6M 4.957* 4.661* 1.918* 1.804* IS12M 4.722* 4.348* 1.828* 1.684* CO3M 4.725* 4.551* 1.827* 1.760* CO6M 5.067* 4.688* 1.961* 1.815* CO12M 5.008* 4.509* 1.941* 1.748* * indicaes significance a he 5% level. 5% criical values are ( level saionary) and ( rend saionary). 101

8 Table 4 ADF uni roo es (firs difference series) Variable Wihou Trend Wih Trend IS3M * * IS6M * * IS12M * * CO3M * * CO6M * * CO12M * * * indicaes significance a he 5% level. 5% criical values are 2.86 (wihou rend) and 3.41 (wih rend). Table 5 KPSS uni roo es (firs differenced series) Lag = 4 Lag = 12 Variable Level Saionary Trend Saionary Level Saionary Trend Saionary IS3M * IS6M * IS12M CO3M * CO6M CO12M * indicaes significance a he 5% level. 5% criical values are ( level saionary) and ( rend saionary). 1% criical values are (level saionary) and (rend saionary). Level Saionary (Lag=4) is no significan a he 1 % level. 102

9 4.2 Engle-Granger Coinegraion Tes Pair-wise analyses on he convenional ineres rae and Islamic rae of reurn on hree-, six-, and 12-monh mauriies are conduced because hese daa were confirmed o be I (1). Convenional ineres raes and Islamic raes of reurn on all mauriies co-move in he long-run equilibrium. The resuls are shown in Table 6. Table 6 Coinegraion es Variable IS3M, CO3M IS6M, CO6M IS12M, CO12M Tes Saisics * 8.429* 7.523* * indicaes significance a he 5% level. 5% criical value is from MacKinnon (1991). 10% criical value is from MacKinnon (1991). A one-o-one relaionship is no confirmed in each mauriy. The size of β (he impac of he convenional ineres rae on he Islamic rae of reurn) is larger han 1. This indicaes ha Islamic raes of reurn are higher han convenional ineres raes in he long-run equilibrium. The resuls are repored in Table 7. Table 7 Coinegraion vecor es Variable β Modified SE Modified Value IS3M, CO3M IS6M, CO6M IS12M, CO12M * means ha β = 1 canno be rejeced since modified value is smaller han 5% criical value (1.96). 103

10 4.3 Granger Causaliy Tes Pair-wise Granger causaliy ess are conduced on convenional ineres raes and Islamic raes of reurn. Muual causaliies beween hem are confirmed. When hese causaliies are compared, he size of he causaliy from he Islamic rae of reurn o he convenional ineres rae is higher han ha from he convenional ineres rae o he Islamic rae of reurn. The resuls are repored in Table 8. Table 8 Granger causaliy es Variable Islamic o Convenional Variable Conveional o Islamic IS3M CO3M * CO3M IS3M * IS6M CO6M * CO6M IS6M * IS12M CO12M * CO12M IS12M 4.542* * indicaes significance a 1 % level. As for he number of lags, one ia added o AIC selecion. 5. Concluding Remarks This paper has analyzed he co-movemen and ransmission of convenional ineres raes and Islamic raes of reurn. Convenional ineres raes and Islamic raes of reurn on all mauriies comove in he long-run equilibrium. Islamic raes of reurn propel over convenional ineres raes on hree-, six-, and 12-monh mauriies. This resul is differen from he resuls of Chong and Liu (2009), and Cevik and Charap (2011), which sae ha convenional ineres raes unilaerally Granger-cause Islamic raes of reurn. Chong and Liu (2009) used a sample covering he period from April 1995 o April 2004, and Cevik and Charap (2011) used a sample period from January 1997 o Augus The sample period of his paper is from May 16, 2005 o Ocober 17, Bu he resul is consisen wih Io (2013), which shows ha Islamic raes of reurn propelled convenional ineres raes on hree-, six-, and 12-monh mauriies beween May 16, 2005 and January 12, The convenional and Islamic deposi markes are compeiive in Malaysia, where Islamic banking has a srong influence over convenional banking. This is consisen wih he fac ha he share of Islamic deposis in Malaysia rose from 5% o 24.5% beween 1999 and As he Associaion of Islamic Banking Insiuions Malaysia (AIBIM) saes, he ulimae objecive of he Malaysian model of an Islamic financial sysem is o operae in parallel wih he convenional financial sysem, coexising and compeing wih convenional banking in Malaysia. A he same ime, Islamic banking is exering increasing influence on he formaion of shor-erm ineres raes. So far, he Malaysian governmen s policy o promoe Islamic finance in he counry has been successful. 104

11 References Cevik, S. and Charap, J. (2011), The Behavior of Convenional and Islamic Bank Deposi Reurns in Malaysia and Turkey, IMF Working Paper, WP/11/156. Chong, B.S. and Liu, M.-H. (2009), Islamic Banking: Ineres-free or Ineres-based?, Pacific-Basin Finance Journal,17, Dickey, D.A. and Fuller, W.A. (1979), Disribuion of he Esimaors for Auoregressive Time Series wih a Uni Roo, Journal of he American Saisical Associaion,74, Dickey, D.A. and Fuller, W.A. (1981), Likelihood Raio Saisics for Auoregressive Time Series wih a Uni Roo, Economerica, 49, Engle, R.F. and Granger, C.W.J. (1987), Co-inegraion and Error Correcion: Represenaion, Esimaion and Tesing, Economerica, 55, Ergec, E.H. and Arslan, B.G. (2013), Impac of Ineres Raes on Islamic and Convenional Banks: The Case of Turkey, Applied Economics, 45, Fuller, W.A. (1976), Inroducion o Saisical Time Series, John Wiley & Sons, Inc. Hirayama, K. and Kasuya, M. (1996), Financial Deregulaion and Divisia Moneary Aggregaes in Japan, Mullineux, A (ed.), Financial Innovaion, Banking and Moneary Aggregaes, Edward Elgar, Io, T. (2013), Islamic Raes of Reurn and Convenional Ineres Raes in he Malaysian Deposi Marke, Inernaional Journal of Islamic and Middle Easern Finance and Managemen, 6, Kwiakowski, D., Phillips, P.C.B., Schmid, P., and Shin, Y. (1992), Tesing he Null Hypohesis of Saionariy agains he Alernaive of a Uni Roo, Journal of Economerics, 54, MacKinnon, J. (1991), Criical Values for Coinegraion Tess, Engle, R.F. and C.W.J. Granger (ed.), Long-Run Economic Relaionships: Readings in Coinegraion, Oxford Universiy Press, Sarac, M. and Zeren, F., (2015), The Dependency of Islamic Bank Raes on Convenional Bank Ineres Raes: Furher Evidence from Turkey, Applied Economics, 47, Sock, J.H. and Wason, M.W. (1993), A Simple Esimaor of Coinegraing Vecors in Higher Order Inegraed Sysems, Economerica, 61, Toda, H.Y. and Yamamoo, T. (1995), Saisical Inference in Vecor Auoregressions wih Possibly Inegraed Processes, Journal of Economerics, 66,