THE EFFECTS OF CONVENTIONAL INTEREST RATES AND RATE OF PROFIT ON FUNDS DEPOSITED WITH ISLAMIC BANKING SYSTEM IN MALAYSIA

Interest rate has long been recognized not only by classical and neo-classical economists but also by contemporary economists as one of the factors that determine the level of savings in the economy. Although there are cases of inconsistent findings, it is a generally accepted opinion that interest rate has a positive relationship with savings. In other words, customers are guided by the profit maximization theory. Since there is no pre-determined rate of return involved in Islamic banking system, it is unknown whether Islamic bank customers are subjected to the normal conventional theory of economic behavior. If this assumption is true, a conclusion can be made that both interest rate of deposit accounts of conventional banks and rate of profit declared by Islamic banks have strong relationship with the amount of deposits of Islamic banks. Therefore, the management of Islamic banks is bound to follow the market rate when declaring the rate of profit to their customers, vice versa. Using Adaptive Expectation Model, this paper examines 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.