Islamic Financing and the Growth of National Products: The Malaysian Case

The most effective way to develop the economy of a country is to trade. Trade is an activity of exchanging goods and services between buyers and sellers on a voluntary basis through the medium of exchange such as money. Trade makes it possible for a country to enjoy goods and services from other countries, besides indirectly benefitting from a transfer of technologies, which can have a positive effect on the development of a country’s economy. However, commercial activities require funds to purchase premises, machinery, equipment, raw materials and others. From the viewpoint of security and amount loaned, the best option is to borrow from a bank compared to borrowing from family members or friends. The banking system is divided into conventional banking and Islamic banking. Islamic banking prohibits usury, while conventional banking practises interest rates. This article examines the relationship between Islamic financing and the growth of national products in Malaysia. It includes as variables that affect the output growth such factors as banking deposits and the rate of inflation. The study used co-integration tests and test vector error correction model (VECM) to examine the relationship between variables in both the long and short term. The study found that Islamic finance affects the growth of national products positively and has influence in the long and short term. Thus, in formulating national development strategies and risk management for the country’s economy, policy-makers and banking institutions should be mindful of this positive relationship.