Impact of the global financial crisis on Islamic and conventional stocks and bonds

This study explores the impact of the global financial crisis (GFC) on Islamic and conventional stock and bond indices in 11 Islamic and eight non‐Islamic countries. We find that there are benefits of Islamic stocks during the GFC, particularly during the early stage of the crisis because Islamic institutions are prohibited from holding sub‐prime mortgage securities and derivatives. The strongest benefits of Islamic stocks are in the UK and USA. We conclude that there are benefits of risk reduction and stability for Islamic stocks during a financial crisis, although not necessarily during a global recession.     

Islamic investing

Using a large international sample of 35 developed and emerging markets, we analyze whether Islamic indices exhibit a different performance to conventional benchmarks. While there is no compelling evidence of performance differences in robust Sharpe ratio tests and after controlling for market risk, we find a significantly positive four-factor alpha for the aggregate developed markets region. This outperformance stems, however, mainly from the U.S. and is largely attributable to the exclusion of financial stocks in Sharia-screened portfolios. As the extensive downturn of financials is related to the recent financial crisis, we do not argue that this outperformance will continue over time. The style analysis reveals that Islamic indices invest mainly in growth stocks and positive momentum stocks. This, for a passive portfolio intriguing result can, however, be explained by the strong sector allocation towards energy firms and their strong momentum characteristic during the sample period.     

International Islamic funds

Internationally‐investing Islamic equity funds from developed Islamic and non‐Islamic markets perform in general similar to the market. However, analyzing different market conditions, we provide evidence that funds domiciled in Islamic markets outperform their peers and funds from non‐Islamic markets during market turmoil, irrespective of the applied performance measurement model. We suggest that this outperformance is owed to the expertise of fund managers from developed Islamic markets who operate in a financial environment that is driven by Islamic principles. Our results are robust with respect to the standard Fama‐French three‐factor and four‐factor models as well as to the novel five‐factor model.     

Islamic finance and economic growth: The Malaysian experience

The increasing presence of Islamic banking and finance in Malaysia's financial sector and the country's exemplary role in the global Islamic finance industry has called for an evaluation of the contribution of Islamic finance to the real economic activity. In order to empirically investigate the impact of Islamic finance on performances of major macroeconomic indicators, this study applies the ARDL approach on quarterly data set for Malaysia covering the period from 1998 to 2013. The results suggest that Islamic finance has started to make important contributions to the real economy by effectively carrying out the financial intermediation role of pooling and channeling funds to the investment activities. In view of the important contributions of Islamic finance to the Malaysian economy, continuous efforts need to be undertaken to further expand the industry. This includes refinement of the legal and regulatory framework to enable healthier growth of the industry, thus further strengthens Malaysia's position as the leader in the Islamic finance industry at the global level.     

Islamic and Conventional Equity Market Movements During and After the Financial Crisis: Evidence from the Newly Launched MSCI Indices

This paper examines the relationship between the Islamic and conventional equity indices by employing the newly launched MSCI Global Islamic Indices which began in 2008. We argue for the case of cointegration supported by fundamental, category and habitat theories, and against cointegration due to the fundamental difference between Islamic and conventional stocks in terms of debt ratio, accounts receivable and interest bearing securities. We find Islamic and conventional equity markets move together despite fundamental differences and given that market microstructure, dividends, capital gains, taxation and governance systems are different across the markets. Almost simultaneous movement of the permanent and cycle components of Islamic and mainstream equity indices has been supported by the application of the Beveridge Nelson (BN) time series decomposition technique. Theoretically, the volatility of Islamic equities should be lower due to their low leverage ratio. Surprisingly, permanent parts of the Islamic indices appear to be more volatile during the crisis period and less volatile during the post‐crisis period.     

A Market Efficiency Comparison of Islamic and Non-Islamic Stock Indices

This article examines the martingale difference hypothesis (MDH) and the random walk hypothesis (RWH) for nine conventional and nine Islamic stock indices: Asia-Pacific, Canadian, Developed Country, Emerging, European, Global, Japanese, UK, and United States. It investigates whether Islamic stock indices are more, less, or as efficient as their conventional counterparts. We test four sub-periods of bullish and bearish stock markets, together with the financial meltdown and its recovery, over the period 1997–2012. We use the Escanciano and Lobato’s (2009) automatic portmanteau test (AQ) and Deo’s (2000) test for the MDH. We also apply the automatic variance ratio test (AVR) developed by Choi (1999) and Kim (2009) for the RWH. Over the period from 1997 to 2012, we find that three conventional indices (Europe, Japan, and UK) are efficient, but that none of the Islamic indices are efficient in these markets. During the recent financial crisis, our results indicate slightly more efficiency for the Islamic indices than their conventional counterparts. Our study finds that overall the conventional indices are more efficient than their Islamic counterparts. Nevertheless, during periods of general downturns the Islamic indices have shown the same level of efficiency as their counterparts. Furthermore, it appears that during the last two sub-periods under study, the Islamic indices have moved toward efficiency, displaying the same level of efficiency as their counterparts.     

Is it costly to be both shariah compliant and socially responsible?

Positive ethics associated with socially responsible investments (SRI) is challenging the limits of Islamic investments' conservative approach to promote corporate social responsibility. In this study, we test the integration of social performance measures (companies the most virtuous or high-rated in terms of environmental, social, and governance (ESG) issues) in Islamic portfolios using KLD social ratings. We seek to determine the financial price of complying both to Islamic investment and SRI principles. To do so, we measure the financial performance of self-composed Islamic portfolios with varying ESG scores. The results indicate no adverse effects on returns due to the application of ESG screens on shariah-compliant stocks during the 2007–2011 periods while reporting substantially higher performance for the portfolios with good records in governance, products, diversity, and environment issues. On the opposite, a negative performance is associated with an SRI strategy of disengagement from shariah-compliant stocks with community and human rights controversies. Our performance measures are controlled for market sensitivity, investment style, momentum factor, and sector exposure.     

Sukuk market development and Islamic banks’ capital ratios

This paper investigates the impact of Sukuk market development on Islamic banks’ capital ratios using a sample comprising 230 Islamic banks spanning the period 2005–2014. We characterize Islamic bank capital along multiple dimensions, namely: capital adequacy ratio, Tier 1 capital ratio, and capital-to-total assets ratio. We employ both the Prais-Winston technique and the system GMM estimator to tackle potential omitted variable bias, endogeneity, and simultaneity issues. The evidence shows that Sukuk market development has had a negative effect on capital ratios of Islamic banks. We argue that the development of Sukuk markets may have stimulated the competition between Islamic Banks, inducing them to hold lower capital ratios. Our results also show that trade openness and bank liquidity are positively and significantly related to capital ratios, while bank size and loan loss reserve ratio are negatively and significantly related to capital ratios, as expected.     

A Comparative Literature Survey of Islamic Finance and Banking

There has been large-scale growth in Islamic finance and banking in Muslim countries and around the world during the last twenty years. This growth is influenced by factors including the introduction of broad macroeconomic and structural reforms in financial systems, the liberalization of capital movements, privatization, the global integration of financial markets, and the introduction of innovative and new Islamic products. Islamic finance is now reaching new levels of sophistication. However, a complete Islamic financial system with its identifiable instruments and markets is still very much at an early stage of evolution. Many problems and challenges relating to Islamic instruments, financial markets, and regulations must be addressed and resolved. In this paper, we provide a comprehensive comparative review of the literature on the Islamic financial system. Specifically, we discuss the basic features of the Islamic finance and banking. We also introduce Islamic financial instruments in order to compare them to existing Western financial instruments and discuss the legal problems that investors in these instruments may encounter. The paper also gives a preliminary empirical assessment of the performance of Islamic banking and finance, and highlights the regulations, challenges and problems in the Islamic banking market.     

Islamic Banks and Financial Stability: An Empirical Analysis

The relative financial strength of Islamic banks is assessed empirically based on evidence covering individual Islamic and commercial banks in 19 banking systems with a substantial presence of Islamic banking. We find that (a) small Islamic banks tend to be financially stronger than small commercial banks; (b) large commercial banks tend to be financially stronger than large Islamic banks; and (c) small Islamic banks tend to be financially stronger than large Islamic banks, which may reflect challenges of credit risk management in large Islamic banks. We also find that the market share of Islamic banks does not have a significant impact on the financial strength of other banks.     

What do we know about the price spillover between green bonds and Islamic stocks and stock market indices?

This paper investigates the risk transmission, linkages, and directional predictability between green bonds, Islamic stocks, and other asset classes. Using daily data from November 2008 to August 2020, we use the Standard & Poor's (S&P) Green Bond Index to represent the green bond market and the Dow Jones Islamic World Index and the S&P Global Shariah Indices to represent Islamic stocks. The other asset classes considered include the S&P 500 Stock Composite, S&P 500 Bond, and S&P 500 Energy indices. This paper uses the novel quantile cross-spectral (coherency), the windowed scalogram difference (WSD), and the cross-quantilogram (CQ) correlation approaches. The results from the quantile coherency analysis reveal a negative spillover effect from green bond price returns to Islamic stocks in the long run, which indicates that the green bond market poses a long-run systemic risk to Islamic stocks. From the WSD analysis, the results show that the integration between green bonds and Islamic stocks, the S&P 500 Stock Composite, and the S&P 500 Bond index is weaker during volatile market conditions. The CQ correlation suggests that the dependency between green bonds and other asset returns is concentrated in the lower quantiles and that this dependency is weaker at longer lags. Our results underscore the significance of green bonds in investor portfolios as a new investment asset class.     

Using partial least square discriminant analysis to distinguish between Islamic and conventional banks in the MENA region

The deterioration of bank profitability poses a threat not only to the interests of consumers and internal staff members but also affects investors who may equally suffer from significant financial losses. It is important to establish an effective system which assists investors in their investment choices. In prior literature, traditional models have been developed, but achieved short‐term performances such as logistic regression and discriminant analysis. This paper applies a partial least squares discriminant analysis (PLS‐DA) to distinguish between conventional and Islamic banks in the Middle East and North Africa (MENA) region based on the financial information for the period 2005–2011. This method can successfully identify the non‐linearity and correlations between financial indicators. The results demonstrate superior performance of the proposed method. On one hand, our model can select all financial ratios to distinguish between banks and at the same time identify the most important variables in the distinction process. On the other hand, the proposed model has high levels in terms of accuracy and stability.     

Cross‐region and cross‐sector asset allocation with regimes

Cross‐region and cross‐sector asset allocation decisions are one of the most fundamental issues in international equity portfolio management. Equity returns exhibit higher volatilities and correlations, and lower expected returns, in bear markets compared to bull markets. However, static mean–variance analysis fails to capture this salient feature of equity returns. We accommodate the nonlinearity of returns using a regime switching model across both regions and sectors. The regime‐dependent asset allocation potentially adds value to the traditional static mean–variance allocation. In addition, optimal allocation across sectors provide greater benefits compared to international diversification, which is characterized by higher returns, lower risks, lower correlations with the world market and a higher Sharpe ratio.     

Do Muslim CEOs and Muslim stakeholders prefer Islamic debt financing?

This study examines the relationship between religiosity and Islamic debt financing based on Malaysian non-financial listed firms from 2012 to 2018. We find that Muslim CEOs allocate more Islamic financing in their debt financing compared to non-Muslim CEOs, which support the upper echelons theory. However, we find that the sociological pressure from Muslim Stakeholders display no significant effect on Islamic financing. Interestingly, we further find that Islamic debt financing will incline no matter whether the Muslim population is high or low if the CEO was a Muslim. This implies that our findings support the upper echelon theory, but not the stakeholder orientation theory.     

Islamic versus conventional banks in the GCC countries: A comparative study using classification techniques

This paper contributes to the empirical literature on Islamic finance by investigating the feature of Islamic and conventional banks in Gulf Cooperation Council (GCC) countries over the period 2003–2010. We use parametric and non-parametric classification models (Linear discriminant analysis, Logistic regression, Tree of classification and Neural network) to examine whether financial ratios can be used to distinguish between Islamic and conventional banks. Univariate results show that Islamic banks are, on average, more profitable, more liquid, better capitalized, and have lower credit risk than conventional banks. We also find that Islamic banks are, on average, less involved in off-balance sheet activities and have more operating leverage than their conventional peers. Results from classification models show that the two types of banks may be differentiated in terms of credit and insolvency risk, operating leverage and off-balance sheet activities, but not in terms of profitability and liquidity. More interestingly, we find that the recent global financial crisis has a negative impact on the profitability for both Islamic and conventional banks, but time shifted. Finally, results show that Logit regression obtained slightly higher classification accuracies than other models.     

Islamic and conventional banks' soundness during the 2007–2008 financial crisis

The recent global financial crisis has induced a series of failure of many conventional banks and led to an increased interest in the Islamic banking business model. This paper attempts to answer empirically the following question: What was the effect of the 2007–2008 financial crisis on the soundness of Islamic banks and their conventional peers? Using the Z-score as an indicator of bank stability, our regression analysis (covering a matched sample of 34 Islamic Banks (IBs) and 34 conventional banks (CBs) from 16 countries) shows that there is no significant difference in terms of the effect of the financial crisis on the soundness of IBs and CBs. This finding reveals that IBs are diverging from their theoretical business model which would have allowed them to keep the same level of soundness even during the crisis.     

Productivity,technology and efficiency of De Novo Islamic banks: Empirical evidence from Malaysia

The impact of foreign banks’ entry on the conventional banking sector has been well documented in the literature. However, empirical evidence on the impact of foreign banks’ entry on the Malaysian Islamic banking sector is completely missing from the literature. By employing the Malmquist Productivity Index method, the article provides, for the first time, empirical evidence on the impact of foreign banks’ entry on the efficiency and productivity of the Islamic banking sector. The empirical findings indicate that the De Novo foreign Islamic banks have been relatively more efficient and productive compared to their domestic and foreign Islamic bank counterparts. The results also suggest that the Malaysian Islamic banking sector has exhibited a higher level of total factor productivity during the post De Novo foreign Islamic banks’ entry period.     

TRADING COSTS OF NON‐U.S. STOCKS ON THE NEW YORK STOCK EXCHANGE: THE EFFECT OF INSTITUTIONAL OWNERSHIP,ANALYST FOLLOWING,AND MARKET REGULATION

We investigate the differences in market microstructure between U.S. and non‐U.S. stocks cross‐listed on the New York Stock Exchange using a sample of 316 pairs of matched stocks. We find that non‐U.S. stocks have wider spreads and larger adverse‐selection costs than U.S. stocks even after controlling for macro‐level institutional differences. Regression analysis shows that spreads and adverse‐selection costs are negatively correlated with institutional ownership and analyst followings. Thus, the higher spreads and adverse‐selection costs for non‐U.S. stocks can be partly explained by the lower institutional ownership and analyst following of non‐U.S. stocks. In addition, we find that although the spreads and adverse‐selection costs for non‐U.S. stocks are significantly higher before the implementation of Regulation Fair Disclosure (FD), the differences become even greater after Regulation FD, suggesting that Regulation FD has improved the information environment for U.S. stocks.     

Volatility and correlation of Islamic and conventional indices during crises

We examine the correlation and volatility of Islamic indices and their conventional counterparts during the 2008–2009 Global Financial Crisis as well as the Covid-19 pandemic. We provide evidence that the volatility of Islamic indices is relatively lower than that of conventional peers during turmoil periods. Consistent with the decoupling hypothesis, our results indicate that the volatility of Islamic and the volatility of conventional indices tend to move in tandem in tranquil times but diverge in times of crises. Our results also indicate that the correlation between Islamic and conventional indices is a priced risk factor for Islamic index returns.