Editor’s notes

International Journal of Islamic and Middle Eastern Finance and Management

ISSN: 1753-8394

Article publication date: 30 March 2012

392

Citation

Kabir Hassan, M. (2012), "Editor’s notes", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 5 No. 1. https://doi.org/10.1108/imefm.2012.35205aaa.001

Publisher

:

Emerald Group Publishing Limited

Copyright © 2012, Emerald Group Publishing Limited


Editor’s notes

Article Type: Editorial From: International Journal of Islamic and Middle Eastern Finance and Management, Volume 5, Issue 1

The first Islamic bank was opened in Egypt in 1963. Islamic banking operations began as deposit taking and lending facility. Since then, Islamic banking has gradually encompassed all operational fabrics of banking, money and capital market including full-fledged stock exchanges to meet the needs of Muslims. The growth of Islamic banking was further buoyed by the oil price boom of 1975 which generated large capital inflows to Islamic countries. Today, Islamic banking has been established worldwide. Its universal acceptance globally has made it a feasible alternative banking system to conventional banking system.

The founding of Dubai Islamic Bank in 1973 marked the most inspirational and significant development by an Islamic bank by embracing modern-day banking. Dubai Islamic Bank was the first private Islamic bank to accomplish profit maximization goal on commercial platform. It afforded commercial financial products to its consumers. This move was replicated by large domestic and prominent multinational conventional financial institutions and banks whereby the concept of “Islamic window” is implemented. This involves creation of a separate and distinct division that specializes Islamic banking by offering Syari’a compliant financial services and products.

The attractiveness of the “Islamic window” business has considerably stimulated the growth and expansion of Islamic banking industry. Studies show that the sector will maintain rapid growth in future. McKinsey & Co. project that Islamic banking sector will hit USD1 trillion in assets by 2010. Moody’s envisage assets of Islamic banking to be USD4 trillion by 2015 while Arabnews.com estimates a 20 per cent annual growth rate Islamic banking.

Although Islamic banking has witnessed significant development in the past four decades, there is dearth of empirical evidence touching on performance of the Islamic banking industry. Most past studies on Islamic banking have commonly focused on hypothetical issues while empirical studies have heavily hinged on descriptive statistics as opposed to thorough statistical methodology. There are many compelling reasons why the study of efficiency of Islamic banks is essential. First, if there is improvement in cost efficiency, there is potential for more profits and continued existence in a competitive and liberalized economy. This is mainly pertinent for Islamic banks since they need to aggressively compete with the conventional banks in several areas. Second, consumers are keen on pricing and quality of financial products and services offered by Islamic banks. These prices and quality largely depend on efficiency of bank’s operations. Third, policy makers use results of efficiency in the banking sector to design policies which impact the whole banking sector. In an attempt to measure efficiency in banking sector, numerous approaches, including but not limited to simple financial ratios, sophisticated econometric methods and mathematical programming have been used. However, efficiency assessment methods can be broadly classified into parametric and non-parametric methods.

The most popular non-parametric method is Data Envelopment Analysis (DEA) while the Stochastic Frontier Analysis (SFA) is the most universally recognized parametric (stochastic) model of measuring bank efficiency. The two methods contrast on the functional form of the benchmark frontier imposed by on the data. Each of the two methods has its own pros and cons. There is still no consensus on the best-practice frontier against which relative efficiencies are gauged. The techniques of frontier efficiency provide comparative and benchmarking information. While a ratio-based benchmarking is simple, it blithely ignores connections, switches, or trade-offs among the main variables. Furthermore, it yields a single dimension of a product, service or process. A more integrated multi-input, multi-output structure is crucial in evaluating productive efficiency to gather valuable benchmarking information to advance decision-making procedures.

As financial institutions become larger, they enjoy economies of scale. However, the larger the financial institution, the higher the cost of systemic instability the institution imposes on the economy. Therefore, it becomes necessary for policy makers to impose size costs (such as capital charges) on large and complex financial institutions whose size cost is higher than size benefit (economies of scale). Such institution inflicts higher cost on the economy. It is however imprudent to impose size penalty when size benefit is greater than size cost since banks will be forced to engage in moral hazard. Islamic banking system is gaining global acceptance and becoming more complex. This makes it imperative to improve macro-prudential supervision of the financial system.

Scale economies measures are most suitable for “average” firms in a given sector. The diverse sizes and business models in the banking sector dictate that scale efficiency measures may not be appropriate. This argument can be extended to Islamic banking sector. The mega Islamic banks engaged in varied business activities (relative to smaller Islamic bank) require the more informative extreme statistical efficiency measure rather than measures that deal with medium/average Islamic bank.

Islamic banking has gradually become the centre of attention as conventional banking try to weather the prolonged effects of recent financial crisis. Some countries have opened their banking system and allowed foreign Islamic banks to enter their banking system. Malaysia has liberalized its banking sector to permit entry and participation by foreign Islamic banks. Global financial centers in the vein of London, Singapore and Hong Kong have entered into business partnerships with Islamic banking institutions from Middle East.

Multinational financial institutions can ably and effectively mobilize Islamic banking funds from the Middle East due to their international presence, dynamic and innovative mechanism in launching and promoting new Islamic finance products and services, intrinsic economies of scale and competitive edge over existing banks. These benefits will enable large multinational banks to serve the needs of the domestic market. The entry and participation of foreign banks into the home markets will intensify competition. This will ultimately force smaller Islamic banks to merge to survive, remain profitable, and competitive. Such banks also have to improve their productivity and efficiency and smoothly transition to provision of Syari’a compliance products.

The first paper of this issue “The control of the Shari’a Supervisory Board (SSB) in the Islamic financial institutions” by Samy Nathan Garas contends the existence of Shari’a Supervisory Board (SSB) and Shari’a Control Department (SCD) ensures that Islamic Financial Institutions (IFIs) sustain better their business activities than Conventional Financial Institutions (CFIs). The study underscores the supremacy of Shari’a supervision over external audit on one hand and dominance of Shari’a audit over internal audit on the other hand. The study recognizes five explanatory variables that influence the SSB control, namely: ex post Shari’a audit, ex ante Shari’a audit, SCD reporting to the SSB, remedial actions taken by SSB in case of violations by the management, and the number of SSB members. The five variables are espoused in five hypotheses and then tested using ordinary least square regression. The study uses primary data gathered by distributing questionnaires to SSB members of 219 IFIs in the Gulf Cooperation Council (GCC) countries. The study provides evidence showing that reporting of SCD to SSB authority, ex ante Shari’a audit and ex post Shari’a audit significantly and positively affects SSB control. However, remedial actions and the number of SSB members have insignificant influence.

The second paper “Financial market risk and gold investment in an emerging market: the case of Malaysia,” by Mansor H. Ibrahim scrutinizes how gold return and stock market return are related and whether this relationship is invariant to consecutive negative market returns. The paper employs autoregressive distributed model and TGARCH/EGARCH error specification to relate gold returns to stock returns. Using daily returns spanning August 1, 2001 through March 31, 2010, the study finds low correlation but significantly positive relationship between gold and single lag stock returns. Moreover, contrary to empirical finding among national exchanges, successive negative market returns do not strengthen the association between the gold and stock markets during financial turmoil. Undeniably, evidence suggest that gold market become bullish in times of consecutive market slumps. In sum, investors should use these relationships to design investment portfolios during stock market declines.

The third paper “Islamic banking and economic growth: the Indonesian experience” by Muhamad Abduh and Mohd Azmi Omar utilizes quarterly data spanning January 2003 through February 2010 to evaluate the relationship between Islamic banking development and economic growth in Indonesia. The short-run and long-run relationship, cointegration and error correction mechanism in the relationship is examined within the autoregressive distributed lag (ARDL) econometric model. The paper reveals evidence of a major bidirectional association between Islamic financial development and economic growth in both short-run and long-run periods. Therefore, the relationship is neither Schumpeter’s supply-leading nor Robinson’s demand-following.

The fourth paper “A comparative study on the level of efficiency between Islamic and conventional banking systems in Malaysia,” argues that Islamic banking is now a well-accepted banking business model acknowledged by both Muslims and non-Muslims. Conventional banks are also opening up Islamic banking windows to capture this huge potential market. The authors have examined the performance differences of conventional and Islamic banks with DEA models. They do not find any significant differences in performances between Islamic banks and conventional banks.

In the last paper “Formulating withdrawal risk and bankruptcy risk in Islamic banking” Rifki Ismal, studies Indonesian Islamic banking industry and endeavor to identify both bankruptcy and withdrawal risk and mechanics of mitigating the same through equilibrium revenue sharing that accrue to depositors. Withdrawal risk results from displaced commercial risk while bankruptcy arises whenever banks fail to contain such withdrawal The study is a boon to all stakeholders and banking regulators in their concerted effort to deal with the risks and sustain the robust growth of the industry. The paper first assesses the use of revenue sharing ratio in Islamic banking sector. The author uses mathematical approach to model withdrawal and bankruptcy risk. Through mathematical exposition, the paper develops three dimensions of optimal revenue sharing ratio. The paper provides financial mathematical modeling to evaluate the different extreme conditions under which withdrawal risk arise and how such risk can be mitigated under different bankruptcy and solvency conditions. The main contribution of the paper is the devise of equilibrium area of the revenue sharing ratio under proper condition of no withdrawal risk and bankruptcy risk among Islamic banks.

M. Kabir Hassan

Further Reading

Sufian, F. and Hassan, M.K. (2011), “Efficiency and profitability of Islamic banking”, Global Islamic Finance Report

Related articles