Impact of interest rates on Islamic and conventional banks: the case of Turkey

Identifying the impact of the interest rates upon Islamic banks is a key to understand the contribution of such institutions to the financial stability, designing monetary policies and devising a proper risk management applicable to these institutions. This article analyses and investigates the impact of interest rate shock upon the deposits and loans held by the conventional and Islamic banks with particular reference to the period between December 2005 and July 2009 based on Vector Error Correction (VEC) methodology. It is theoretically expected that the Islamic banks, relying on interest-free banking, shall not be affected by the interest rates; however, in concurrence with the previous studies, the article finds that the Islamic banks in Turkey are visibly influenced by interest rates.