Editorial notes

Citation

Kabir Hassan, M. (2013), "Editorial notes", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 6 No. 1. https://doi.org/10.1108/imefm.2013.35206aaa.001

Editorial notes

Article Type: Editorial notes From: International Journal of Islamic and Middle Eastern Finance and Management, Volume 6, Issue 1

A key component of financial engineering is the use of an integration strategy to develop a new financial product or improve upon one already in existence. Specifically, financial engineering integrates the financial and real sectors of the economy. ribā and gharar attempt to disconnect the subjective time preferences from the risk preferences of wealth. Since these two types of preferences are significant in financial activity, this disconnect segments the financial from the real sectors. However, this segmentation is not sustainable from an economic perspective. The purpose of integrating the financial and real sectors is to improve economic efficiency in the form of reduced transaction costs. Segmenting these two sectors, therefore, is increasingly costly. Thus, economic agents desire the benefits of integration in order to achieve sustainable economic growth.

The integration of the financial and real sectors can be thought of as placing a productive constraint on economic behavior, and it is important to note that not all constraints are inefficient from an economic perspective. Additionally, constraints can be used to lower transaction and information costs. In fact, specialization, a key economic principle, can be thought of as a type of self-imposed constraint on economic behavior, aimed at improving economic productivity. Accordingly, the integration of the financial and real sectors adds to the ability of economic agents to specialize and synchronizes the output across sectors.

Since derivative securities attempt to separate risk from the underlying assets, their proponents argue that they can be used to more efficiently manage risk. However, the concept of risk is a purely mental construct that cannot be defined without reference to human attitudes about the world. Therefore, the separation of risk is an abstraction from reality. This abstraction from reality removes many of the constraints and complexity of the real economy. Therefore, it is possible that the real sector may bear the costs of undisciplined behavior that occurs as a result of abstraction. Thus, the integration of the financial and real sectors from the beginning can avoid this serious problem.

The principle of integration is therefore inconsistent with money-for-money transactions performed for a profit. Transactions consistent with financial and real sector integration must incorporate a real component such as goods, utilities, or services. The inclusion of a real component is a necessary, but not sufficient condition for integration, however. Thus, it is possible to have transactions that involve real components that defeat the purpose of integration. This type of “artificial integration” is called ḥila (artifice) or ḥiyal (artifices). For example, to avoid usury, real components are used to facilitate lending. Real goods are used to obtain financing rather than financing being used to obtain real goods.

With artifices, there is a tension between the substance and form of financial agreements. The problem does not solely arise in Islamic laws. In the nineteenth century, the same problem came about in the West with regards to futures and options. Currently, this issue is relevant with regards to over-the-counter derivatives and the laws regulating them. Manipulation is common in this domain, as seen in the Enron scandal. The tension between the letter and spirit of the law, or the form and substance of the financial product is the key factor. Islamic law poses some key differences, however, because of its moral dimension. The intent to evade the commands of Allah is a major sin, regardless of whether it is proven in court.

The relation between form and substance has two extremes. One considers the form without regard for the substance, while the other considers the substance without regard to the form. Neither of these extremes is acceptable under Islam. Ibn Taymiah shows that ḥiyal were condemned by the companions of the prophet. Ibn al-Qayyim reports that no prominent Muslim scholar endorses all kinds of artifices. This implies that form or means cannot have an absolute precedence over substance or ends. Additionally, most scholars agree that good intentions are not enough for a certain transaction to get approved. It means that ends do not justify means. Accordingly, neither of the two extremes is acceptable, nor in fact practical. In the Islamic world, there is a general consensus that there must be a balance between form and substance. Scholars in this area sometimes disagree with regard to the degree of consistency, but not regarding the consistency principle in general.

In the first article in this issue, M. Kabir Hassan, Benito Sanchez and M.F. Safa show that the banking literature suggests that the entry of foreign banks improves domestic banking performance and increases the amount of credit available to the private sector. The paper analyzes the impact of financial liberalization and foreign Islamic bank entry on credit availability and domestic Islamic bank performance. The study follows the methodology suggested by Lee (2002), Demirgüç-Kunt and Huizinga (1999), Claessens et al. (2001) and Claessens and Lee (2003). The results show that foreign banks adopt an aggressive strategy and earn higher profit margins than the domestic banks. Returns to the banking sector is a major determinant in the presence of foreign banks. Not surprisingly, favorable macroeconomic conditions encourage the entrance of foreign banks, while taxes weaken the incentives for foreign bank entrance. The recent financial crisis does not appear to affect the propensity of banks to enter foreign countries. Tax policies and macroeconomic conditions play a major role in domestic banking performance. However, domestic banking performance has suffered significantly from the recent financial crisis. In addition, high tax rates and reserve requirements negatively affect the amount of credit available to the private sector. The results in this study indicate that host countries should focus on developing efficient capital markets with favorable economic conditions. This will result in better domestic bank performance as a result of foreign bank entry.

In the second article, Abraham analyzes the performance of Saudi banks as it relates to foreign ownership. The ownership structure of a firm undoubtedly has an impact on the governance and strategy decisions of the firm. This should be reflected in the operating performance of the firm. A drawback in the study of developing markets is data availability. This study focuses on the operating outcomes of ten publically traded Saudi banks for a two year period. The study analyses the operating differences between banks with foreign ownership and those without. The authors present results using both a standard parametric approach, and a non-parametric approach. It is expected that banks with foreign owners should exhibit more aggressive lending, liquidity, and cost management strategies, which should be reflected in better performance and higher valuation. The results are interesting. Foreign owned banks do exhibit more aggressive policies in terms of capital structure, loan portfolios holdings, and reserve capital. However, this does not translate into improved performance.

In the third article, Ahmad Bello Dogarawa examines the role the Hisbah institution plays in ensuring ethical business practices in Nigeria. It is commonly thought that the institution’s only motive is to serve spiritual or social purposes and does not have an economic contribution. The paper aims to discredit this view. The paper surveys the literature on the subject and analyzes the economic contribution that the institution plays by ensuring businesses abide by Islamic business ethical standards. The paper argues that the failure to highlight the economic contribution of the Hisbah institution has reinforced the perception that its sole purpose is to encourage specific social policies. Rather, the institution can play a complementary role to regulators and monitoring authorities. The goal should be to exploit this quality and maximize its economic value.

Finally, in the fourth article, Rasoul Amirzadeh and Mohammad Reza Shoorvarzy examine the quality elements of service in the banks by using a SERVQUAL instrument and other banking factors. The goal is to prioritize these factors based on Fuzzy TOPSIS. The analysis is based on information gathered from banking customers through the use of a questionnaire. The study uses fuzzy logic set theory to translate customers’ typically vague linguistic responses into a set of more defined service quality measures. The study finds that “short and suitable queue” and “confidant and reliable staff” are the most important bank service quality factors. Also, “being equal with Islamic doctrines” and “accessible branches” are the least important factors for Iranian customers. These results are useful in the management of financial institutions, as it allows management to focus on the most important service factors.

M. Kabir Hassan