The literature on conventional finance is mixed in terms of its growth stability effects. The usurious contractual agreements working without any real economic activity do more harm than good to the economy. Islamic finance ensures that cash flow and returns are integrated with real economic activity and the productivity of assets. Private investment in Islamic finance is less prone to capital flight and more secure. This setup is expected to help the stabilization of production and prices. The purpose of the study is to investigate the empirical contribution of Islamic banking (IB) financing toward macroeconomic stability. This study aims to determine whether the relationship between IB financing and macroeconomic stability is linear or quadratic in terms of the marginal effect of financing.
This study has selected 12 countries for the analysis. The selection of countries is based on the availability of data on Islamic financing (IF). The data is taken from the Islamic Financial Service Board for the period of 2014Q1 to 2021Q4. The economic stability is estimated using the AR(1) volatility approach, and the Panel ARDL model is used to determine the IB relationship with output stability and price stability in the long run and short run. This study is panel data and focuses on generalizing the effect of IF on the stability of the countries, and it has used the quadratic effect.
This study has clarified that the empirical relationship between IB financing and macroeconomic stability is quadratic in terms of the marginal effect. Based on the analysis of the contribution of IBs to the macroeconomy and the risks associated with IF instruments, the theoretical policy recommendations for developing macro Maqasid ul Shari’ah include building standardized Shari’ah-compliant contracts, fostering financial inclusion, promoting ethical and socially responsible investment, adopting sound risk management practices and developing a regulatory framework that supports the growth and development of the IF industry.
This study is instrumental in aligning the IB financing with output and price stability to highlight its relevancy as a monetary policy instrument. Governments can use IB financing to achieve economic targets.
