The effects of conventional interest rates and rate of profit on funds deposited with Islamic banking system in Malaysia

Interest rates have long been recognized, by classical neo-classical, and contemporary economists, as one of the factors that determine the level of savings in an economy. Although there are exceptions, it is a generally accepted that interest rate has a positive relationship with savings. Presumably, customers are guided by the profit maximization theory. Since there is no pre-determined rate of return involved in the Islamic banking system, it is unclear whether Islamic bank customers are subjected to the normal conventional theory of economic behavior. The management of Islamic banks is bound to follow the market rate when declaring the rate of profit to their customers, vice versa. Using the adaptive expectation model, one can examine the effect of interest rates of deposit account facilities of conventional banks and past dividend rates on funds deposited by customers on the Islamic deposit facilities of Malaysian banks.