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Does Islamic Finance Promote Real Economic Growth? Evidence from Malaysia 

Lee Dick Shen, Alken Aidana*, Mikail Abiodun Sanusi & Zhang Hengchao
School of Graduate and Professional Studies, INCEIF University, Malaysia.

Abstract: Research Question: This paper investigates the relationship between Islamic finance and economic growth in Malaysia. Motivation: The research is motivated to provide recent country-specific evidence on the Islamic finance–growth nexus, highlighting the role of Islamic finance in supporting Malaysia’s economic expansion. The research is significantly built upon the following three key papers: Kassim (2016), Gani and Bahari (2021), and Manap et al. (2012) which emphasized the need for continuous re-evaluation of Malaysia's experience, investigated the dual capital accumulation productivity through which Islamic financial intermediation supports growth, and utilized the Toda–Yamamoto test to show causality from Islamic finance to economic growth in Malaysia. Determining the answer to this research question remains vital because Malaysia’s experience informs the strategic path for many other developing nations with significant Muslim populations. Idea: It examines the impact of Shariah-compliant financing (aggregate and disaggregated into PLS and non-PLS financing) on Malaysia’s real GDP. Data: The study employs Q1 2015 to Q1 2024 data from IFSB and the Department of Statistics Malaysia (DOSM) using the volume of Sharia-compliant financing as the independent variable, real GDP as dependent variable, and government expenditure and inflation as control variables. Method/Tools: An Autoregressive Distributed Lag – Error Correction model (ARDL-ECM), bounds testing, and Toda-Yamamoto tests were employed while controlling for government operational expenditure and inflation. Findings: Findings reveal a robust long-run relationship between Shariah-compliant financing and real GDP across all financing types, though short-run Granger causality is weak or absent, particularly for equity-based financing. This suggests Islamic finance supports Malaysia's long-term development through structural rather than immediate channels, and policy efforts should focus on sustaining a balanced debt- and equity-based financing ecosystem rather than expecting short-term growth effects. Contributions: This study provides updated evidence of the long-run influence of Islamic financing on Malaysia's economic growth.