<![CDATA[This study examines the dynamic relationship between the Islamic financial sector and financial deepening in Indonesia and Malaysia by integrating two key components of the sharia financial system: the sharia capital market and Islamic banking. Using monthly pooled data from 2014-2024 and employing the Autoregressive Distributed Lag approach, the research investigates both short-term and long-term effects of corporate sukuk, sharia stocks, third-party funds, total assets, interest rates, and exchange rates on financial deepening. The findings reveal that corporate sukuk exert a negative influence on financial deepening in the short run, primarily due to their illiquidity and dominance by institutional buy-and-hold investors, while showing no significant long-term effect in either country. Sharia stocks positively affect financial deepening only in the short run, whereas long-term effects remain insignificant because of market volatility, limited liquidity, and structural constraints within the sharia capital market. Third-party funds demonstrate a contrasting pattern, showing negative short-run effects but a strong and positive long-run impact, indicating their growing role in supporting Islamic banking intermediation. Total asset contributes positively to financial deepening in the short term; however, their long-term effect becomes negative, reflecting inefficiency in translating asset growth into real-sector financing. Robustness test using Malaysia support the main model’s conclusion. The study underscores the importance of enhancing liquidity, strengthening intermediation efficiency, and improving cross-sector sharia financial integration to maximize the contribution of Islamic finance toward sustainable financial deepening in dual banking systems.]]>
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