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Islamic Banking Development and Access to Credit

Feb 22, 2016
Islamic finance has considerably expanded with an increase of Islamic financial assets from $150bn in the mid-1990's to $1800bn at the end of 2013 (Kuwait Finance House, 2014), with Islamic banks being particularly active in Middle Eastern countries and in Southeast Asia but also in Africa (Sudan, Nigeria). An emerging literature has investigated the macroeconomic impact of Islamic finance and tend to support the view of a positive influence of Islamic banking development on economic development. A major potential effect of the growth of Islamic banking is its influence of access to credit, as countries with developed Islamic banking sectors are typically emerging countries in which access to credit is a major concern. In a recent paper, we investigate the influence of Islamic banking development on access to credit. The effect of Islamic banking development on credit availability is ambiguous. On the one hand, Islamic finance proposes specific financing instruments that may relax credit constraints. For instance, Islamic finance promotes risk-taking by banks and as such no collateral is supposed to be required when granting a loan. Therefore, as collateral requirements are a major obstacle to have financing, Islamic banking presence should favor access to credit. On the other hand, Islamic finance can also deteriorate access to credit as they can be more expensive than the conventional financing instruments. In addition, Islamic banks face refinancing constraints which can reduce their lending possibilities. To examine this question, we perform regressions of credit availability on a set of variables including the presence of Islamic banks in the country at the firm level for a sample of 15,309 firms from 52 countries for which we have information on credit constraints and on the presence of Islamic banks. Data on Islamic banking presence come from a unique database, "IFIRST" ("Islamic Finance Recording and Sizing Tool") which provides the assets of all active Islamic banks worldwide over the period 2000-2005. In comparison with other sources of data, this database is exhaustive and does not suffer from misclassification issues. Firm-level variables come from World Bank Enterprise Survey which includes information on credit constraints at the firm level on a large set of countries. We found that Islamic banking has overall no impact on credit constraints, while banking development and conventional banking development alleviate obstacles to financing. We consequently did not support the view that Islamic banking development would be associated as a whole to better access to credit thanks to the specific characteristics of this form of banking. However we observed that Islamic banking development exerts a positive impact on access to credit when conventional banking development is low. We therefore provided support to substitution effect between Islamic banking and conventional banking. In a nutshell, Islamic banking expansion would generate benefits in terms of access to credit for developing and emerging countries until a certain level but not for developed countries and the most advanced emerging countries in terms of financial development. Overall, our study suggests that Islamic banking development cannot always promote credit access. However, in the least financially developed economies, Islamic finance can be a substitute to conventional banking system. _________________________________________________________________ About the Authors Florian Léon is currently a postdoctoral research fellow at CREA (University of Luxembourg). He holds a PhD (2014) in economics at the Université d'Auvergne (France).
Laurent Weill is an Associate Professor of Economics
at EM Strasbourg Business School, University of

Strasbourg

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