Conceptualization of the real economy and Islamic finance: Transformation beyond the asset‐link rhetoric

A key factor behind the chronic crises in modern economies is the growing dominance of financialization and the resulting disconnect between the real economy and the financial sector, to which conventional financial industry is a key contributor. In contrast, Islamic finance claims to be real‐economy‐oriented, as all transactions must be asset‐linked (asset‐backed or asset‐based). However, is Islamic Finance based on proper conceptualization of the real economy? What is the real economy and its dynamics? How Islamic finance is interfaced with the real economy? In this article, the claimed real‐economy‐orientation is examined by presenting a conceptualization of the real economy and then evaluating the related discourse accordingly. The analysis presented, especially for noneconomists, exposes a serious gap between the claims about Islamic finance and the real economy it is supposed to advance. Appropriate conceptualization of the real economy can help the industry to be relevant and effective for broader socioeconomic transformation.     

Islamic business research

The Islamic finance industry, which is deeply rooted in Islamic law (Sharia), will undoubtedly have an increasingly large impact on modern finance in the years to come. Since its formal establishment in the 1970s, the industry has already grown to US$2.2 trillion, with a growth rate that outpaces that of conventional finance. The purpose of this special issue is to inspire academic researchers, regulators and standard setters, and providers and users of Islamic funding to advance the research of critical issues related to the efficiency of Islamic finance.     

Western Financial Agents and Islamic Ethics

This paper investigates Western professional bankers’ perceptions of Islamic finance. Exploiting data from an original survey, we carry out a principal component analysis (PCA) to characterize the main dimensions on which financial agents diverge. The PCA extracts five dimensions—accounting for 61 % of the variance in the agents’ answers—that we interpret with the help of a pilot field survey. In addition to confirm the increased association of Islamic financial values with ethical practices in the West, our results allow us to understand how the observed growth of the industry has been conceptualized by conventional agents. The five dimensions identified shed light on the multitude of constructs that have informed the diffusion of Islamic financial ideas to international markets. This supports the fact that Islamic finance cannot be seen as a single movement but is characterized by opposing and concurrent logics in global markets.     

Islamic finance and market segmentation: Implications for the cost of capital

This paper considers the impact of full Islamic shari’ya compliance on developing stock exchanges in their effective provision of development capital. Evidence from a unique study focussing on the Sudan telecommunications company and its listings on the Khartoum as well as Arabian Gulf stock exchanges reveals that costs of capital are considerably higher in the former than latter markets. While there are firm governance benefits arising from Islamic finance monitoring costs are substantial and the banking system is better placed to administer financing arrangements. Larger firms are better placed to circumvent this segmentation through cross-listing on regional exchanges.     

The role of the stock market in the provision of Islamic development finance: Evidence from Sudan

This paper assesses the impact of stock exchange funding in the Shari'ya compliant Islamic economy of Sudan. Evidence suggests that while Islamic financial instruments have considerable potential in facilitating development finance through their emphasis on partnership this is better achieved by the banking system rather than the Khartoum Stock Exchange. A case study of the Sudan Telecommunications company shows that larger firms able to cross-list elsewhere are likely to choose regional markets in preference to their domestic one thus benefiting from lower costs of equity. However, governance preferences are likely to favour block shareholders following the Islamic finance partnership concept.     

Ethical Foundations of the Islamic Financial Industry

Journal of Business Ethics - This paper examines the ethical foundations of the Islamic financial industry which is strongly criticized for its similarity with conventional finance. In this paper,...     

Some remarks on the phenomenon of Islamic revivalism

There are several indications that in at least some parts of the Islamic world a process of cultural and political change has begun, with the tendency towards a reassertion of Islamic values. Amongst other things, this involves formulating a concept of modern Islamic economics, the principles of which are derived from the ethical norms of Islam. Is a specifically Islamic economy really likely to develop? What form might this take?     

Permissibility and use of options for hedging purposes in Islamic Finance

The debate concerning permissibility and use of options in Islamic finance is ongoing, and the issue is far from settled. Current analyses on this issue appear to focus on taking of unnecessary risks ( gharar), the perceived lack of a physical asset in an options contract, and the possibility of exploitation of the ignorant. To the extent that these factors are involved, options are not permitted under Islamic teachings (the Shariah). In this article, we investigate whether options may be permitted for hedging purposes in Islamic finance. We use equity options as an example in our analysis. After providing a brief overview of options markets, we review the existing literature and critically examine other work such as the religious decrees (fatwas). We also provide two examples, one each of call and put options, to illustrate the managerial issue of use of options for hedging purposes. Our analysis shows that options may be permitted for hedging purposes in Islamic finance as long as the underlying economic activities are themselves permissible (halal) from an Islamic point of view. The analysis also indicates that one of the key issues is related to unnecessary risk taking. The avoidance or reduction of such risks in hedging situations is largely dependent on the settlement and clearing function of the exchanges trading options, which effectively provides a guarantee of delivery. Mutual consent for entering into or canceling contracts and the issue of intangible assets also play a role in determining if options are permissible under the Shariah. We conclude the article by urging experts of Islamic jurisprudence to understand the theory and mechanics of options and use group ijitihad (consensus opinion of Islamic scholars) in conjunction with academics and experts in financial markets and instruments on this vital issue in contemporary finance for the benefit of the Islamic world as well as those trading with the Islamic world. © 2006 Wiley Periodicals, Inc.     

Promotion mix management: A consumer focused Islamic perspective†

Religion penetrates deep into our social and cultural life but its significance in developing marketing theories has rather been disregarded. Islam has well-established business, economic and social systems and its influences are interwoven with the daily life of Muslims. Therefore, it is vital for the companies to comprehend the impact that religion makes on Muslim societies before designing their marketing strategies. Off late, Islamic perspective has been well appreciated in the form of Islamic banking and finance, with many western financial institutions incorporating Islamic ideologies in their operations. This paper aims to extend the application of Islamic values in development of Marketing theories, specifically promotion mix management. This study argues that Islam offers a parallel paradigm of conducting business and proposes a distinctive set of principles that can conceptualize the marketing field in its own inherent manner.     

Islamic Corporate Governance: Risk-Sharing and Islamic Preferred Shares

The recent financial crises (including the Asian and subprime crises) indicated the need to reinforce corporate governance mechanisms in emerging and developing market economies. Corporate governance refers to all the factors that affect firm processes (including, among others, financing strategies). Firms must avoid debt financing instruments and adopt financing instruments that allow for “risk-sharing” rather than “risk-shifting” because all recent financial crises were, in essence, debt crises. The primary objective of this paper is to examine the principles of risk-sharing promoted by Islamic finance and study their implications for corporate governance. The secondary objective of this paper is to propose a pricing model for a new risk-sharing financial instrument (Islamic preferred shares, IPS) that was recently discussed by Zarka and Al-Suhaibani (Shariah-compatible preference shares: The Sharia Basis and Economic Rationale. Working paper, SABIC Chair for Islamic Financial Market Studies, 2012). We study the implications of this new instrument as a powerful tool for corporate governance in the case of Islamic markets. We explain the possible contribution of IPS to agency cost reduction, Sharia screening costs and ethical corporate governance.     

Islamic financial services industry: Aspirations and achievements

Islamic Financial Services Industry (IFSI) crosses the age of 40 years, and sufficient empirical evidence exists to evaluate in light of the distinctive aspirations. This study fills the gap in the literature by evaluating the performance of IFSI in light of Islamic finance objectives—financial stability, equitable distribution of wealth and social responsibility; Shari’ah principles, and professional practices. Our investigation documents the achievements based on real accounting data from 23 countries, and the suitability of tools in practice to achieve the stated objectives by promotors of IFSI. Findings suggest that the objectives of IFSI have been achieved to an extent. However, visible contribution to the achievement of socio-economic justice is yet to emerge. Practical application of tools shows divergence (in spirit) from the original design, primarily to achieve integration and coherence with the prevailing conventional financial system. IFSI needs collaborative efforts to overcome the challenges at hand.     

The structure of Islamic economics: A comparative perspective on markets,ethics and economics

A comparative examination of mainstream economic doctrines and their recent developments is undertaken with a view to find out how ethics has been treated in these. The principal focus here is to identify the new paradigm that can treat ethics endogenously in preference formation, the market and the economic order. The quest for this paradigm leads us to an examination of Islamic economics. Islamic economics is presented in terms of its epistemological roots. Thereby, a general systems view of interactions, integration and creative evolution among economic and social possibilities is shown to lead to the paradigm of Islamic political economy. Some Islamic financial and economic instruments are examined to bring out the pervasive causality of the principle of universal complementarity across diversity in a general systems perspective of Islamic political economy as premised on its epistemological roots.     

Dividend policy and religion: International evidence from firms with Islamic Label

This paper builds on prior research and argues that religion, as an informal cultural institution, may impose constraints on corporations. The framework of Shariah-compliant firms presents a unique opportunity to investigate this assertion and checks whether firms with Islamic label pay out more or less dividend. Since Islamic Law narrows the investment opportunity sets for Shariah-compliant firms, one would expect Shariah-compliant firms to pay out more dividends to shareholders (investment constraint hypothesis). On the other hand, the prohibition of interest-bearing financing, make of retained earnings an appealing alternative to finance projects, hence resulting in lower dividend payouts (financing constraint hypothesis). Tests on a sample of 13,249 firm-year observations from 17 Islamic countries support the investment constraint hypothesis: Shariah-compliant firms pay out more dividends than non-Shariah compliant ones. Our results are robust to various specifications and after controlling for different variables and addressing potential endogeneity concerns.     

Can Islamic banks have their own benchmark?

This paper attempts to answer whether Islamic banks can have their own benchmark rate. In so doing, the paper investigates the nature of the relationship Islamic interbank benchmark rate (IIBR) and its comparable conventional counterpart, London interbank offer rate (LIBOR). The dynamics of the two series are investigated to examine the stability of the spread between IIBR and LIBOR, referred to as ‘Islamic premium’ or ‘piety premium’. The findings suggest that there are both long-term and short-term dynamic relationships between the two rates providing significant evidence of their convergence and co-movement. Our results also show that the existence of the IIBR-LIBOR spread is a reflection of the cost of funding and profit potential of the participating IIBR rate-setters. We find that, in addition to the determinants of the credit spreads, fundamental news of the panel banks are dominant factors driving the ‘piety premium’. We argue that the Islamic banking industry is operating in a global context, where it is highly improbable that its rates can decouple from the global benchmarks. Given that Islamic banking products and their risk return profile are similar to conventional products, arbitrage activities force Islamic rates to converge with the global benchmark rates.     

Islamic legal methodologies and Shariah screening standards: Application in the Indonesian stock market

This article provides a framework for applying the principles of Islamic legal methodology to determine the optimal Shariah screening standards for Islamic equity markets. It is argued that using maslahah mursalah (unrestricted benefit) is an appropriate method for identifying appropriate financial standards and its principles stipulate that the benchmark that yields the best economic returns to investors should be chosen. The methodological framework is applied to the Indonesia equity market where the economic implications of the Islamic stock screening standards of the Indonesian Islamic Shariah Stock Index and four global indices are assessed. Portfolios are constructed by applying Islamic stock screening standards for each of the indices by using data on 377 stocks listed in the Indonesian stock market for 5 years. The performances measured by the Sharpe ratio, Treynor index, and Jensen alpha reveal that the Dow Jones Islamic Index screening criteria performs the best. Based on the method of maslahah mursalah, the article recommends using the screening standard of this index in the Indonesian stock market to maximize benefits to investors. While the approach used in this article is applied to Islamic equity markets, the methodological framework can also be used for other similar cases in Islamic finance.     

Setting standards for Shariah application in the Islamic financial industry

The global growth of Islamic banking is taking advantage of the diversity and flexi‐bility in the fiqh opinions (often referred to as Shariah) to meet the challenges of growth. While the flexibility in fiqh opinion is presently contributing to global growth, it may soon become a constraining factor in the global growth of the industry if the challenges arising out of the use of diversity and flexibility in fiqh are not properly rec‐ognized and regulated. Though the infrastructure for standardizing the supervision and monitoring of the global expansion of the Islamic finance industry is rapidly growing, institutional arrangement for a regulated use of diversity and flexibility in Shariah rules is still a missing link. Such an institutional arrangement is needed not only to prepare the industry to play a bigger role in the development of global economy but also to ensure the adherence to the very specific element that makes the industry an “Islamic” industry. © 2007 Wiley Periodicals, Inc.     

The effects of Shariah board composition on Islamic equity indices' performance

Based on a sample of 54 Islamic indices over the period 2007–2014, we investigate the effect of Shariah board members' educational background on Islamic indices' risk and return characteristics via the screening criteria. Using a capital asset pricing model benchmark analysis, we assess the sensitivity of Islamic indices to their conventional peers in terms of beta and derive a measure of return (Jensen's alpha). First, we observe that the higher the number of members in common among the boards, the higher the risk–return profile of Islamic indices. Second, commonalities among board members lead to standardization of the screening criteria and to similar Islamic indices' performance. Third, we show that different betas across providers depend on the screening criteria, while the economic educational background of board members affects performance in terms of Jensen's alpha. Our study aims at contributing to the governance literature related to board composition and its importance as a possible driver of performance. In addition, given the impressive growth that Islamic finance has experienced during the last decade, this topic is of great interest to the asset management industry.     

Islamic takaful: Business models,Shariah concerns,and proposed solutions

Islamic insurance (takaful) is nearly as old as the Islamic banking system and dates back to 1979, when the concept was launched in Sudan and later in Saudi Arabia. Yet, unlike its banking counterpart, takaful has been covered less in the literature on Islamic finance, and its workings are not fully understood. Shariah scholars have raised a num‐ber of concerns about the Shariah permissibility of the business models employed in the industry. This article examines the basic principles of takaful and then analyzes the mechanics of the two models most commonly used in the industry— namely, the mudarabah system that was developed by the Malaysians and the wakala (agency) system that is now being used by most takaful operators and has achieved tremendous popularity and acceptance in recent years even in countries where the mudarabah model was earlier implemented. Shariah scholars have, however, expressed some misgivings about both approaches, but because of its wider acceptability among Shariah scholars in the case of the wakala approach, this is more urgent. With regards to the mudarabah model for risk management, there are major discrepancies that have been highlighted by Shariah scholars effec‐tively rendering it inappropriate to apply this for insurance contracts. For this reason, the article outlines a third model, a wakala with waqf fund, that seeks to remain within the wakala framework while incorpo‐rating modifications that may render it more acceptable from a Shariah perspective. © 2007 Wiley Periodicals, Inc.     

Systemic risk,Islamic banks,and the COVID-19 pandemic: An empirical investigation

While operating side-by-side with conventional banks, in a dual-banking system, the systemic risk profile of Islamic banks can be different due to their unique business model. The objective of this study is to understand the evolution of systemic risk in dual-banking systems and determine whether there are any differences in the systemic risk profiles of conventional and Islamic banks during the COVID-19 pandemic. This study also identifies the determinants of systemic importance (measured using spillover indices) of financial institutions. The sample includes ten countries where the Islamic banking sector is considered systemically important and covers the period from November 2015 to November 2020. The empirical results indicate a significant increase in systemic risk, in the sample countries, during the first half which is followed by a recovery in the second half of 2020. Comparative analysis shows that Islamic banks have similar systemic vulnerabilities to systematic and idiosyncratic factors during the exogenously induced real economic shock of the COVID-19. However, Islamic banks pose significantly less spillover to others relative to conventional banks while earning abnormal returns. The results are robust to the inclusion of macroeconomic factors and alternate estimation methodologies. The findings of this study provide valuable insights for the regulators of dual-banking systems.