DOES ISLAMIC BANKING SECTOR MATTER FOR INCOME DISPARITY REDUCTION? EMPIRICAL EVIDENCE FROM INDONESIA

Abstract

Purpose: This empirical study aims to investigate the impact of the Islamic banking sector, economic growth, and inflation on the reduction of income disparities in Indonesia from the short-run and long-run perspectives. Theoretical framework: Since the 19th century, the interaction between the financial sector, economic growth, and income disparity has been intensively researched and received attention both from financial economists and practitioners. The linkages between the financial sector, including the banking industry, economic growth, and income inequality have been a debatable issue, whether the financial sector affects economic growth and income inequality or vice versa. Within this theoretical framework, the study builds an empirical model to examine the contribution of the Islamic banking industry to economic growth and income inequality in the context of Indonesia. Design/methodology/approach: An Autoregressive Distributed Lag (ARDL) method is adopted to analyse the monthly time-series data from January 2015 to December 2020 to measure the short-run and long-run effects of Islamic banking performance, economic growth, and inflation on income disparity in Indonesia. Findings: The results of the study revealed that Islamic banks contributed to the reduction of income disparity in Indonesia both in the short run and long run. In addition, economic growth and price stability also helped reduce income disparities in the country both in the short run and long run. Research, Practical & Social implications: The findings of the study suggest the importance for Islamic banks to provide quality of balanced, effective, affordable, and high-quality financing to the priority real sector to enhance their impacts on economic growth and income disparity reduction. The Indonesian Monetary Authority should continuously strengthen the policy mix through various innovations to continuously ensure banks' ability to channel financing to the real economic sector and build an effective financing allocation mechanism to promote inclusive economic growth that reduces income disparity nationwide. Originality/value: The study is among the first attempts to measure and evaluate the contribution of the Islamic banking industry to income disparity reduction in Indonesia using various indicators to measure Islamic banking performance and an Autoregressive Distributed Lag (ARDL) bounds testing approach to cointegration.