Editor’s Notes

Citation

Hassan, M.K. (2013), "Editor’s Notes", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 6 No. 4. https://doi.org/10.1108/IMEFM-08-2013-0096

Editor’s Notes

Article Type: Editorial From: International Journal of Islamic and Middle Eastern Finance and Management, Volume 6, Issue 4

The development of innovative financial products has an important role in the global growth of both the financial and real sectors of the economy. New financial products help to service increasingly more complex global economies. The successful implementation of these innovations can play a key role in driving global market efficiency and new economic growth. The growth of financial innovations over the past several decades such as swaps, futures, and other derivative products has coincided with significant global economic growth, innovation, and prosperity. However, these innovations have not occurred without risk. The recent global financial collapse of 2008 occurred in part due to the severe mismanagement of financial innovations such as mortgage-backed derivatives and credit default swaps. The financial crisis brought to light the severe information asymmetries that can be present in these complex financial instruments, and the dramatic repercussions that may occur as a result.

Due to the potential risks involved with failing to account for all the risks inherent in financial innovation, financial service industries around the globe attempt to stem these risks through appropriate regulation and oversight. There can be significant differences in the regulatory apparatus across economies, however, and one the most stark contrasts is those of the conventional and Islamic banking systems. In the conventional, secular banking systems, financial institutions are overseen and regulated by policy-makers, practitioners, and scholars familiar with the financial sector. Islamic financial products are governed by similar authorities, except there is one key difference: Islamic banking products must also abide by the tenants of Islam and Shari’ah principles. The fact that Islamic financial innovations must conform to Shari’ah causes significant differences in that financial products that have been accepted in Islamic finance, compared to those that have been adopted by the conventional banking systems. As a result, differences in growth and riskiness between the two systems are observed.

A main principle in determining the acceptability of an Islamic financial product is that both the substance and form of a product must be consistent with Islamic Shari’ah customs in order for a product to be acceptable. In other words, there must be both acceptable means and ends. The substance is the end, or goal, of the financial product. The substance is given priority in determining the acceptability of a product; the product must be intended to serve a legitimate financial or economic goal, as defined by Islamic law, before the appropriate form should even be considered. Therefore, a Sharia’ah compliant financial product is unacceptable if its intended goal is not consistent with Islam. Once a legitimate, Islamic compatible goal has been determined, the form, or means, of the financial product must be developed that is also in accordance with Shari’ah principles.

A modern application of these principles in the context of Islamic financial products is the case of murābaha versus c einah (tawarruq). In murābaha transactions, the lender purchases a product and later sells it to the customer at a cash price for a profit. Under c einah (tawarruq), the lender sells a product to the borrower for a cash price, then either buys is back (c einah) or sells it on the customer’s behalf (tawarruq). Both these transactions take a similar form. They both provide goods to a borrower in the form of a cash transaction. However, the substance or goal of murābaha is essentially a deferred cash sale, while the substance of c einah is to provide liquidity and results in a type of debt financing. Hence, under Islamic law, the murābaha transaction is widely accepted by scholars and practitioners as an acceptable Islamic financial product, because its goal is consistent with Islam. However, c einah is quite controversial and not universally accepted, because its goals may constitute riba. In the above example, a Shari’ah compliant form of a murābaha transaction would meet the criteria of an Islamic financial product, but the c einah product would not be acceptable no matter what the form is.

The first article, by Richard Graff, suggests the use of an alternative, non-debt based version of fixed income securities that may help to avoid some of the problems inherent when debt instruments are securitized. Traditional debt-based financing has served an important role in financing economic growth in most developed economies. However, recent trends in financial innovation have led to the development of securitized debt instruments. As evidenced in the recent global financial crisis, these securities often pose a conflict between lenders and borrowers that can increase the risk and reduce the liquidity of these securities. This paper suggests using new fixed-income technology in order to base fixed-income securities on property law rather than contract law. The resulting fixed-income securities would be non-debt based. Thus, this framework has the potential to lower the risk, and thus the cost, of fixed income financing. Additionally, these securities may provide an opportunity to generate innovate new products in the Islamic finance system. The development of many recent financial products has not extended to Islamic finance, because they often contain debt or interest elements that are forbidden by Islam. The implementation of a non-debt, fixed income security could increase innovation and growth in the Islamic financial and real sectors.

The second article by Mohamad Akram Laldin and Hafas Furqani examines the applicability of maqasid al-Shari’ah in the context of Islamic financial products. The paper analyzes English and Arabic sources of both maqasid al-Shari’ah and primary texts like the Qur’an to develop a framework for interpreting the acceptability of Islamic financial products. The paper explores the dimensions of acceptability of financial products from the perspective of analysis of the products’ ends and means. The paper analyses three specific acceptable ends for financial products from the primary sources: wealth circulation, fair and transparent financial practices, and justice. These ends may be accomplished by several means, such as: facilitating financial contracts, establishing values and standards, and instituting social responsibility. This paper helps guide the knowledge on applying Shari’ah standards to Islamic financial products.

The third paper in this issue is by Takayasu Ito. The paper analyses the co-movement and transmission characteristics among Islamic rates of return, conventional Malaysian interest rates, and Kuala Lumpur Interbank Rate (KLIBOR). The study utilizes daily data, and standard non-stationary models are applied, such as cointegration and Granger causality tests. The results show that interest rates in the Malaysian deposit market and Islamic rates of return are cointegrated. Additionally, Islamic rates of return cause conventional interest rates for three-, six-, and 12-month maturity securities. The study finds that Islamic rates of return have a much larger impact in determining overall short term interest rates than conventional interest rates. This result has important implications in understanding and predicting the behavior of interest rates in this region.

The fourth paper, by Magda Ismail Abdel Mohsin, examines the role of waqf financing schemes across Muslim countries. The use of cash waqf, which can be used to finance the acquisition of goods and services, has become popular across many Muslin countries. This paper focuses on the different uses of cash waqf across Muslim countries, and primarily ignores funds provided by the government. The study highlights the potential of cash waqf to serve as a financing mechanism for not only religious purposes, but also for other essential goods and services, such as: education, health, social programs, commercial activities, and infrastructure. Cash waqf, therefore, has the potential to stimulate economic growth and employment in Muslim countries. Additionally, cash waqf has the potential to shift spending for major social programs away from governments, thus potentially alleviating the dependence of these programs on government budgets.

Lastly, in the fifth paper, Hanif Akhtar examines the cost efficiency scores of KSA banks before and after the financial crisis. This paper assumes the intermediation approach to banking services. Under this approach, banks are considered manufacturing units. From this perspective, the author applies a cost efficiency data envelopment analysis (DEA) and a second-stage Tobit regression model. The results yield some interesting results. First, it is shown that the KSA banks are relatively unaffected by the financial crisis, because the efficiency scores remain fairly constant during all time periods. Second, however, the KSA banks appear to be relatively inefficient in general, because the levels of inefficiency remain relatively high across all periods. The driver of the relative inefficiency of KSA banks appears to be inefficiency in allocation, rather than technology. The results have important implications for the management of KSA banks. The study suggests that the KSA banks need to reduce operating expenses in order to reduce the inefficiency average of 82 per cent and bring the banks closer to an efficient frontier.

I hope you will enjoy this special issue.

Sincerely,
M. Kabir Hassan

Further Reading

Al-Suwailem, S. and Kabir Hassan, M. (2011), “An Islamic perspective of financial engineering”, in Kabir Hassan, M. and Mahlknecht, M. (Eds), Islamic Capital Markets: Products and Strategies, Chapter 18, Wiley, London