On the role of Islamic banks in the monetary policy transmission in Saudi Arabia

Even though a significant strand of the literature has examined the transmission mechanisms of monetary policy in a conventional framework, very little research has directly addressed the role of Islamic banks in this transmission. Using a TVP-VAR model with stochastic volatilities, this paper attempts to fill this gap in the literature by examining the monetary policy transmission in Saudi Arabia, as well as the role of Islamic banks in this transmission over a period of approximately 25 years. Although Islamic banking is, in theory, different from conventional banking, our results provide robust evidence of the dependence of Islamic banking activity on oil revenues, and suggest that, in practice, there are few differences between the Islamic banks’ modus operandi and the methods used by conventional banks. However, the results do not provide clear evidence that Islamic banks are more stabilizing than conventional banks, even though the sensitivity of the non-oil economic activity to Islamic bank financing seems to be relatively less volatile than its sensitivity to conventional bank credits.