Dynamic behaviour of Islamic banking financing in the real sector

One of the activities of Islamic banking is channelling financing to the real sector, comprising different characteristics, therefore appropriate management of the distribution process is needed. The purpose of this study is to analyse the effect of real sector financing on non-performing Islamic banking in the short and long terms and analyses its response in facing real sector financing shocks. This study uses a vector error correction model (VECM) with data collected monthly from Islamic commercial banks and business units from 2007 to 2020. The results showed no effect in the short term, with a significant effect in the long term on the industrial sector. Islamic banking stabilised the fastest when it responded to the agricultural sector financing shock. Furthermore, the transportation, warehousing, and communication sectors dominate the non-performing financing of Islamic banking, therefore a reserve fund is needed to create a portfolio and a priority scale.