Macroeconomic Indicators and Pakistan’s Banking Industry’s Shock Absorbing Capacity A Case Study of Conventional and Islamic Banks

Abstract

The capacity of conventional and Islamic banks, operating in Pakistan, to absorb macroeconomic shocks is compared in this study. The study examines data from ten conventional and four Islamic banks from 2007Q1 to 2018Q4. The macroeconomic uncertainty is the volatility of inflation, interest rate, and output/GDP measured through GARCH (1,1). All macroeconomic variables have a significant impact on the performance of Conventional Banks (CB) which is shown by the panel estimation results, but in Islamic Banking (IB) only the rate of interest has a considerable impact on its performance; indicating a competitive relationship between the two banking systems. Furthermore, shock-absorbing models reveal that the volatility of the three macroeconomic factors does not affect the volatility of Islamic banks. The conventional banks' volatility model, on the other hand, shows that production volatility has a considerable positive impact on conventional bank volatility, implying that the conventional banking system is more vulnerable to economic uncertainty.