The role of Islamic finance in fostering economic growth has been a subject of debate for decades. In recent years, a noticeable shift has emerged from conventional, interest-based banking systems toward Islamic financial frameworks. This study explores the dynamic interaction between Islamic financial depth (IFD), Islamic financial intermediation (IFI), and asset quality within a dual banking system, focusing on their contribution to sustainable economic growth.
Using quarterly data from Pakistan (2005–2019), the research employs the Autoregressive Distributed Lag (ARDL) regression, the Error Correction Model (ECM), and Granger causality tests to examine both short- and long-term linkages between finance and growth. Two comparative models both Islamic and conventional, were constructed to assess the relative importance of financial depth, intermediation, and asset quality across both systems.
The findings highlight that a long-run relationship exists, flowing from finance to economic growth in both models. Moreover, strong financial intermediation emerges as a crucial driver of growth across Islamic and conventional sectors. In the short run, a greater share of Islamic financial assets in the economy contributes positively to growth. Importantly, the study also suggests that asset quality serves as a key intervening factor in the overall finance growth nexus.
These insights emphasize the growing significance of Islamic finance in shaping sustainable development, while underlining the importance of sound financial intermediation and asset quality management for policymakers and practitioners.
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