Editor notes

Editor notes

Article Type: Editorial From: International Journal of Islamic and Middle Eastern Finance and Management, Volume 7, Issue 4

The idea of Islamic economics stems from a desire to strike a more appropriate balance between traditional economic goals and religious morals and practices. In traditional economics, models have evolved based on the maximization of one’s individual utility. As such, economic agents use their personal preferences to weigh the costs and benefits of economic decisions. Economic models based on this marginal utility analysis can be used to explain the behavior of economic agents, and its simplicity makes it a desirable model for economists engaged in analyzing economic decision-making. However, in the traditional economic model, any sense of moral or ethical standards as well as the consideration of social well-being is absent. Instead, the traditional economic model relies upon the external sources of secular laws and courts to impose ethical standards and hold economic agents accountable for their actions. The system of external secular laws does not include many of the spiritual tenants that are central to Islam. As an alternative, Islamic economics aims to impose ethical and spiritual standards internally, at the individual level, by making Shari’ah a key consideration in all economic transactions.

As a part of the Islamic economic model, individual agents act not only in their own self-interest, but also in the interest of serving God in accordance with Shari’ah principles. Islam encourages certain economic activities in a similar manner to that of the conventional economic model. For example, economic activities such as entrepreneurial ventures aimed at providing for the economic needs of the entrepreneur are encouraged and required by Islamic principles. In this sense, economic agents are encouraged to act in their own economic self-interest. In addition, Islam encourages the use of markets to facilitate economic transactions, as in conventional economics. However, the imposition of Islamic principles on economic behaviors requires that individual agents act not only in their own self-interest, but in the interest of society as well. In this sense, economic activities serve both a personal and a religious purpose under Islamic economics.

As part of the religious fulfillment of Islamic economic activities, agents act in accordance with the principles of Islam and Shari’ah law, which serves to guide economic activities in ways that are distinct from conventional economic outcomes. For example, the moral teachings of Islam forbid certain practices that are deemed economically unfair or destructive to society, such as usury, alcohol consumption and gambling. As a result, the Islamic economy is interest-free, and Muslims abstain from engaging in certain economic transactions. Additionally, Muslims are required to consider the impact of their actions on society, and, as a result, economic transactions within the Islamic system must have the additional benefit of helping society.

There are well over 1.5 billion Muslims in the world, and it is estimated that almost one in every four people on the planet practices Islam. Additionally, there are considerable Muslim populations on every major continent. Undoubtedly, Islam has a huge influence on culture and societies throughout the world; however, Islamic economic systems are relatively underrepresented in terms of global economic activity. There is an opportunity for economic and financial systems based on Islamic principles to expand Islamic influence to better represent the beliefs and values of economic constituents. Indeed, there has been some renewed interest in fostering the growth of Islamic economic systems. Over the past several decades, the Islamic finance industry has grown significantly, and Islamic financial institutions, such as commercial banks, insurance companies and mutual funds, now comprise a more substantial share of global financial assets. Additionally, part of the renewed interest in Islamic economics stems from the relative stability of the Islamic financial system illustrated during the recent global financial crisis. While the major financial systems in the USA and Europe were crippled during the recent financial crisis, the Islamic financial system remained relatively less affected. The fact that Islam encourages stability and prohibits the use of risky financial instruments is a main reason why Islamic finance remained relatively unscathed during the financial crisis, and increased financial system stability represents an additional advantage that may be incorporated into mainstream economics.

In the first paper, Professor Choudhury examines the long-term stability of the global financial systems and analyzes the potential for the development of an economic system that is more representative of the Islamic perspective. The paper asserts that the long-term stability of the world’s financial system is questionable, due to the interconnectedness of increasingly risky financial institutions. The potential negative consequences of the current system were made apparent during the recent financial crisis, and the financial crisis could serve as a warning of the consequences of the continued reliance on the current systems. As an alternative, a system based on Islamic thought and understanding is proposed as a more viable long-term solution. It is argued that such a system is more congruent with the real economic goals of generating a sustainable, stable and equitable society. Islamic principles foster stability and social fairness, and aligning economic and financial systems with these principles may create a more vibrant economy and prevent financial collapses like those seen during the recent crisis.

In the second paper, Dr Farooq examines Islamic market indexes in the context of several technical analysis techniques. There is often debate as to whether technical or fundamental analysis provides superior investment returns. This study examines the Dow Jones Islamic Market US Index relative performance when technical analysis is applied, compared with other popular indexes such as the Dow Jones Industrial Average, the S&P 500 and the NASDAQ 100 (NDX). The author performs technical analyses using several popular indicators, including, moving average convergence divergence (MACD) and stochastics. A comparative analysis shows that the application of technical analysis can improve the performance of the Islamic Index Fund. This paper expands the literature on technical analysis, particularly in the context of Islamic funds. The application of technical analysis to Islamic investing practices represents a potential new tool for Islamic investment analysis.

The third paper, by Wahyudi, examines issues surrounding strategic alliances between Islamic financial institutions. The study uses survey data from a sample of 89 strategic alliances between baitul maal wa tamwil (BMT) and Islamic banks. The results show that commitment to the alliance is a main contributor to the successful meeting of the alliance’s goals. Additionally, coordination and the initial agreement have a positive impact on the commitment between the Islamic institutions. Also, trust and commitment are found to improve the building of strategic alliances between Islamic banks and BMT. These strategic alliances between these two organizations also encourage knowledge-sharing in the economy. This paper expands the literature on strategic alliances and can help identify their key benefits, as well as the elements that help contribute to their success.

The fourth paper is by Ergec and Kaytancı and examines the sensitivity of Islamic banks to changes in interest rates. There has been empirical evidence that documents a sensitivity of Islamic bank operating performance to change in interest rates. This result is surprising, given the fact that Islamic banks operate on an interest rate-free basis. This study performs causality tests on a sample of Turkish Islamic banks from 2002 to 2010. The empirical analysis tests causality between the bank rates of return and time deposit interest rates. It is found that time deposit interest rates cause bank rates of return. In addition, the relationship appears to strengthen after 2006. This finding confirms that Islamic banks are sensitive to interest rate changes, and interest rate risk is still an important part of overall risk management for Islamic banks.

In the fifth paper, Zonouzi, Mansourfar and Azar examine the potential for achieving international portfolio diversification benefits from investing in Middle Eastern oil producing countries. It has been shown that there is the potential for diversification benefits from investing in international markets. Provided that international market returns are not perfectly correlated, diversification benefits can include higher returns and/or reduced risk. Given the fact that some oil-producing countries are segmented and have returns that are uncorrelated with other markets, there may be significant diversification benefits through investments in these markets. This paper improves the empirical methodology in this area by using a dynamic conditional correlation model that accounts for changes in the correlations among markets over time, which allows for the short-term benefits to be measured. The long-term benefits of diversification are measured using an autoregressive distributed lag framework. Results show that the returns among the Middle Eastern countries of Iran, Bahrain, Qatar, Kuwait, Oman, Saudi Arabia and the UAE are not perfectly correlated. Thus, both short- and long-term diversification benefits are possible. The study is unique in that the dynamic correlation model can control for changing correlations over time.

The sixth paper is by Mulcahy, and it examines the methodologies used to purify Shari’ah complaint equities that have been tainted. Purification in Islamic finance involves separating non-Shari’ah compliant components from Muslim investment alternative. One type of purification may involve separating interest tax shields from debt instruments to meet the Shari’ah prohibition of riba. However, current guidelines on purification have allowed many of these types of securities to be under purified. The identification of the failure to properly purify interest tax shields has important implications for Islamic financial practitioners and investors. Improving the ways in which Islamic securities can be purified can better satisfy the investing requirements of devout Muslims.

The seventh paper, by Muhamad and AB Rahman, conducts a literature review on the application of Tawarruq in the Islamic banking system. The review aims to identify and organize significant previous works on the topic, as well as identify areas for future research. A majority of research in the field focuses on issues surrounding jurisprudence, while other research has focused on issues related to application in the banking environment. However, no current research adequately addresses the operation process in sufficient detail. This topic is of particular importance considering issues may arise with respect to Shari’ah compliance. This area may lead to a significant expansion in the literature on this subject and, consequently, improve the ways in which new financial products are implemented in the Islamic banking system.

M. Kabir Hassan

Further reading

Hassan, M.K. and Lewis, M.K. (2014), Introduction, Handbook on Islam and Economic Life, Edward Elgar Publishing, UK and USA.