AN ARDL APPROACH TO THE DETERMINANTS OF NONPERFORMING LOANS IN ISLAMIC BANKING SYSTEM IN MALAYSIA

Abstract

This paper explores the factors propelling Islamic banks' nonperforming loans (NPLs) in Malaysia for the period 2007:1 to 2009:12. We utilised the ratio of NPLs to total financing in Islamic banks to measure the extent of NPLs in Malaysia. The study employs ARDL of Pesaran and Shin (1999) and Pesaran et al. (2001) to examine the effects of some macroeconomic variables which include industrial production index, interest rate and producer price index. The findings indicate two long run relationship among the variables and note that interest rate has significant positive long run impact on NPLs. Industrial production index turns out with a positive but nsignificant sign. This reflects the popular believe that Islamic banking system in Malaysia is not fully motivated by profit and loss mechanism, as the impact of interest rate is stronger relative to productivity. Producer price index appears to have negative and significant impact on NPLs. The outcomes of this study are similar to the findings of previous studies including Bofondi and Ropele (2011) work on conventional banks in Italy.