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In spite of the popular notion on the Islamic bank, we do not know of any credible empirical work on the cyclicality behaviour of the Islamic bank financing to the fluctuations in the economic environment. Empirical study of the cyclical behaviour of the Islamic banking financing to economic fluctuations is so far insufficient hence, the topic discussed in this paper is essential.

As far as this study is concerned, it is the breaking ground attempt on providing empirical evidence of the cyclicality behaviour of the Islamic bank financing. It is vital to identify the cyclical behaviour of the Islamic banks financing for its future development and global acceptance. A well functioning Islamic banking system is

supposed to help smoothen the economic fluctuations or the business cycle and enhance the progress of economic growth. A pro-cyclicality of bank financing behaviour then again may worsen the economic fluctuations and hamper economic recoveries from recessions. This is vital because countries with lower macroeconomic volatility tend to grow faster. Gurley and Shaw (1967), Goldsmith (1969), McKinnon (1973), among others have provided considerable evidence for supporting this argument.

The Islamic banking industry is growing at an extreme pace after its introduction thirty years ago with an encouraging acceptance among the business community. With the absence of the interest instrument in the Islamic bank operation, it is crucial to have a good understanding of the Islamic bank cyclicality behaviour. It is important to provide empirical evidence for views made on the Islamic bank behaviour and capability. Apart from the theoretical framework explaining the nature of the Islamic banks, intense empirical evidence is necessary to prove the uniqueness of the Islamic bank. The interest instrument is a powerful tool of the monetary policy particularly in the interest rate regime in influencing the business cycle through the banking activities.

This particular study will bridge the gap between theoretical and conceptual literature and empirical evidence on the potential of the Islamic bank. By pooling various countries Islamic bank data, thus, the findings allowed us to make a generalisation on the Islamic bank cyclical behaviour. This will provide a better viewpoint on the operation and function of Islamic banks in improving the economic environment. The empirical evidence provided with this research is then able to support the scholars’ theoretical and conceptual views on the superiority of the Islamic banking system.

Empirical evidence for the capability of the Islamic bank to perform as one of the significant agents in stabilising the economy through its operations is yet to be studied.

Accordingly, this particular study will shed some light on the Islamic bank capability in stabilising the economy through its operation. This study also systematically documents a comprehensive theoretical foundation of an ideal Islamic bank financing behaviour. It also shows how Islamic bank should be operated, including multifactor explanations, not only the religious motivation but also its assets management factors. For a bank to perform as the economy stabilisation agent it has a lot to do with bank management on its contingency reserve, provisioning for loan losses and capital management policy.

Thus far, very few researchers have attempted to analyse empirically on the Islamic bank financing management particularly its relationship to the economic environment. Previous researchers mostly assess on the Islamic banks operational performances. In analysing the Islamic bank performances, they usually compare it with the performance of interest-based banks. They measure the Islamic bank success based on its capability to mobilise and pool the fund resources, then allocate and distribute the fund resources efficiently to generate comparable returns for the depositors and shareholders.

To the best of our knowledge, research focusing on the relationship between the Islamic bank financing activities to the economic activity fluctuation are scanty from the scene compared to the case of the interest-based banks. This is mainly to the recent nature of the Islamic bank. Therefore, this study contributes to enriching the empirical literature on the banking industry and especially for the Islamic bank in particular. It will also provide a deeper understanding of the issues relating to the risk management of the Islamic bank.

For the monetary authority, the information and knowledge on the relative behaviour of the Islamic bank is useful in policy decision making. The result of this research will be useful in gauging the financial standing of the Islamic banking industry, which in turn

can serve as the basis of decision-making. More importantly, the conclusion of this study might be useful in Islamic banking model building and policy making particularly in a volatile, complex, dynamic, and unpredictable economic conditions. Proper understanding of the Islamic bank financing behaviour is crucial to addressing important policy questions about the uniqueness of the Islamic financial system. Understanding of the issues may help in the selection of appropriate policy rule, and enable us to avoid the unexpected and sometimes undesirable consequences associated with the economic policy.

With the empirical evidence provided for the cyclicality behaviour of the Islamic bank financing operation, it will verify the superiority over the system and increase non- Muslims acceptance of the Islamic financial system. More importantly it is to build the confidence and readiness of the major non-majority Muslim countries to start providing the shariah compliant financial instrument and establishing the Islamic financial institutions. Although the market size of the Islamic banking industry today is still marginal, the dynamism and competitive environment will be able to stimulate the provision of new Islamic banking facilities. Therefore, it is crucial to evaluate the Islamic banking system in terms of its behaviour to the unpredictable and competitive economic atmosphere.

Monitoring the Islamic bank financing cyclicality behaviour is essential for managerial and regulatory purposes as well. On behalf of the Islamic bank regulators, they are concerned about the safety and soundness of the Islamic banking system itself and the economy as a whole. Without persistent monitoring of the Islamic bank financing cyclicality behaviour, existing problems can remain unnoticed and will lead to financial failure in the future. It is worth noting that the understandings on Islamic bank financing cyclicality behaviour will improve our knowledge on the Islamic bank’s ability to play

its role as the transmission mechanisms for monetary policy, which is important to the policy makers. The findings also will likely shed some lights on the issues of Islamic bank market stability. Through this study, it will show that the Islamic banking system outcomes may have important real effects on the economy and may have a significant contribution to the real economy.