Of Religion and Redemption: Evidence from Default on Islamic Loans

Abstract

Do religious beliefs affect real economic decisions? We investigate this fundamental question by comparing default rates on conventional and Islamic loans using a comprehensive monthly dataset from Pakistan that follows more than 150,000 loans over the period 2006:04 to 2008:12. We find robust evidence that the default rate on Islamic loans is less than half the default rate on conventional loans. The evidence comes from a variety of specifications that contain pertinent combinations of time-varying borrower, loan contract and bank characteristics, and time, borrower, bank and borrower bank fixed effects. For the same borrower taking both conventional and Islamic loans from the same bank, the hazard rate on Islamic loans drops to one fifth the hazard rate on conventional loans. Islamic loans are less likely to default during Ramadan and in big cities if the share of votes to religious-political parties increases, suggesting that religion - either through individual piousness or network effects - may play a role in determining loan default.

Keywords: Duration Analysis, Islamic Loans, Loan Default, Religion

JEL Classification: A13, G21, G32, G33, Z12