An Empirical Analysis of the Flow of Islamic Banking and Economic Growth in Bahrain

Islamic banking and finance is one of the most rapidly growing segments of the global financial system and was expected to have a significant relationship and contribution towards the economic growth of any country. This paper explores empirically the relationship between the development of Islamic finance system and economic growth in kingdom of Bahrain. Using econometric analysis, annually time-series data of economic growth and Islamic banks’ financing from 1990 to 2008 were used. We use Islamic banks’ financing credited to private sector through modes of financing as a proxy for the development of Islamic finance system and Gross Domestic Product (GDP), as a proxy for economic growth. For the analysis, the unit root test, cointegration test and Granger causality tests were done. Our empirical results generally signify that in the long run Islamic banks’ financing is positive and significantly correlated with economic growth in Bahrain which reinforces the idea that a wellfunctioning banking system promotes economic growth. The results obtained from Granger causality test reveals a positive and statistically significant relationship between economic growth and Islamic banks’ financing in the long-term