Academic journal article International Journal of Business

The Effectiveness of Monetary Policy Transmission Channels in the Presence of Islamic Banks: The Case of Saudi Arabia

Academic journal article International Journal of Business

The Effectiveness of Monetary Policy Transmission Channels in the Presence of Islamic Banks: The Case of Saudi Arabia

Article excerpt


Using a structural vector autoregressive models, this paper empirically investigates the effectiveness of monetary policy transmission in Saudi Arabia in the presence of Islamic banks over the period 1990 Q4-2013 Q3. The results indicate that bank lending channel is relatively effective in influencing non-oil private output, but less effective in influencing consumer prices. Indeed, a positive shock on bank financing extended by Islamic banks or on loans granted by conventional banks results in an improvement of the economic activity. While the empirical result show that conventional and Islamic banks react to each other, the reaction of conventional banks to a shock on the financing provided by Islamic banks seems to be more significant than the reaction of Islamic banks to a shock on the conventional banks credit.

JEL Classifications: E5, C01

Keywords: monetary policy: Islamic banks: Saudi Arabia: SVAR


The empirical evaluation of the effectiveness of the channels of monetary transmission provides to Central Banks information that can be useful for the improvement of their decisions in terms of monetary policy. If the monetary policy decision-makers' do not know accurately how influent are their decisions on different macroeconomic variables, if they do not identify well the sequence of reactions that may occur further to their actions, then they can't assess, with certainty, neither the required time for transmission nor the effectiveness of their decisions.

While all the studies that examine the transmission of the monetary policy in the GCC countries (in particular Saudi Arabia) have found that the exchange rate channel is not significant in the monetary policy transmission process, because of the fixed exchange rate regime adopted by these countries, they assert that other channels may play an important role in the transmission mechanism.

In two papers published in 2005 and 2008, Al-Jasser, the former governor of the SAMA (Saudi Arabian Monetary Agency), and Banafe have tried to explain analytically the transmission mechanisms of the monetary policy in Saudi Arabia. In their analysis, they consider that the bank-lending channel is potentially the only channel that plays an important role in the transmission of the monetary policy. Also, Al-Hamidy (2011:302) thinks that the interest rate channel is marginal in Saudi Arabia and that an increase of the real interest rate is not likely to contain the inflation because, according to him, the credit-to-GDP ratio is relatively low. In this paper, we will see that, for three main reasons, the analysis made by Al-Hamidy (2011) is put into perspective. First, the bank credit to non-oil GDP ratio has improved over the last three decades (it shows a positive trend since the 1970s), and, according to Westelius (2013:22), this should improve the effectiveness of monetary policy. Second, it is necessary to understand the structure of the value added in Saudi Arabia to understand to which compartment of the economic activity the monetary policy has to be interested. Third, economic theory suggests that the Saudi Monetary policy is, partially at least, not independent. Given its largely liberalized capital account and its fixed exchange rate against the US dollar, the Saudi Arabian Monetary policy is, de facto, dependent: it is propped up on the US monetary policy. Consequently, the improvement of the synchronization between the business cycles of Saudi Arabia and those of the United States is likely to improve the effectiveness of the interest rate policy of the SAMA.

The results found in the empirical literature that focuses on the monetary policy transmission in Saudi Arabia are quite stable. Unlike the analysis of Al-Jasser and Banafe (2005 and 2008) and Al-Hamidy (2011), empirical studies have found that the interest rate and the bank lending channels seems to be effective in the transmission process. …

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