Why Do Large Firms Opt for Islamic Loans?

What is it about?

This paper examines the motivations for large firms to choose an Islamic loan over a conventional loan and the recent expansion of Islamic finance activities. We employ a dataset of Islamic and conventional syndicated loans from countries in the Middle East and Southeast Asia for the period 2001−2009, testing determinants for the choice of an Islamic loan at the facility, firm, and country level. From the lender’s standpoint, loan characteristics apparently do not influence the decision to offer Islamic loans nor are they rationed to borrowers in terms of maturity or amount. Moreover, firms taking Islamic loans do not appear to differ in terms of default risk from firms taking conventional loans. We identify three country-level determinants as potential driving forces expanding the preference for Islamic loans. The strongest determinant is the share of Muslim population in a country, but the quality of institutions and level of financial development also play substantial roles.

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Why is it important?

We find that loan and borrower characteristics do not appear to influence the choice of an Islamic loan. However, the share of the Muslim population in a country, the quality of institutions, and financial development play a role in this choice. This study hopefully offers insight into this interesting and evolving area of global finance. The results may even be of use to authorities seeking to understand some of the factors that might lead large firms to choose Islamic loans over conventional loans.