ARE ISLAMIC BANKS SUFFERING FROM A MODEL MISFIT? A COMPARISON WITH COOPERATIVE BANKS

  • Rosana Gulzar Singapore
  • Mansor H. Ibrahim INCEIF, Malaysia
  • Mohamed Ariff INCEIF, Malaysia
Keywords: Islamic, Commercial, Cooperative, Banking, Stability

Abstract

For the first time, this study investigates whether Islamic banks, in mimicking conventional banks, have become less stable than their theoretical equivalent, which is the cooperative banks in Europe. Theoretically the interest prohibition should have pushed Islamic banks towards mutuality and profit-sharing, which have been argued to be stabilising. In practice however, the banks are pushed for growth under a debt-driven commercial banking model which is not only antithetical to the Shariah but also destabilising. This may explain why the empirical findings are still divergent in Islamic banking stability studies. Our study employs system GMM to compare the stability of 37 Islamic banks against 1,536 cooperative banks in Europe during the 2008 crisis and post-non-crisis years. Interestingly, we found consistent and significant evidence that the Islamic banks are less stable than the cooperative banks in both macroeconomic conditions. This has significant policy implications, main of which is to steer reform efforts away from refurbishing Islamic commercial banks and towards building an entirely new Islamic cooperative bank, based on the model in Europe.

References

Abedifar, P., Molyneux, P., & Tarazi, A. (2013). Risk in Islamic banking. Review of Finance, 17(6): 2035–2096.

Abedifar, P., Giudici, P., & Hashem, S. Q. (2017). Heterogeneous Market Structure and Systemic Risk: Evidence from Dual Banking Systems. Journal of Financial Stability, 33, 96–119.

Alandejani, M., Kutan, A. M., & Samargandi, N. (2017). Do Islamic Banks Fail more than Conventional Banks? Journal of International Financial Markets, Institutions and Money, 50, 135–155.

Allen, F. & Gale, D. (1997). Financial Markets, Intermediaries, and Intertemporal Smoothing. Journal of Political Economy, 105(3), 523–546.

Al-Muharrami, S. M., & Hardy, D. (2013). Cooperative and Islamic Banks: What can they learn from each other? International Monetary Fund.

Alqahtani, F., Mayes, D. G., & Brown, K. (2017). Reprint of Economic Turmoil and Islamic Banking: Evidence from the Gulf Cooperation Council. Pacific-Basin Finance Journal, 42, 113–125.

Altunbas, Y., Evans, L., & Molyneux, P. (2001). Bank Ownership and Efficiency. Journal of Money, Credit and Banking, 926–954.

Araújo, B. C., Bogliacino, F., & Vivarelli, M. (2011). Technology, Trade and Skills in Brazil: Evidence from Micro Data. CEPAL Review, (105).

Arellano, M. & Bond, S. (1991). Some Tests of Specification for Panel Data: Monte Carlo evidence and An Application to Employment Equations. The Review of Economic Studies, 58(2): 277–297.

Arellano, M. & Bover, O. (1995). Another Look at The Instrumental Variable Estimation of Error-Components Models. Journal of Econometrics, 68(1): 29–51.Ariff, M. (2014). Whither Islamic Banking? The World Economy, 37(6): 733–746.

Ashraf, D., Ramady, M., & Albinali, K. (2016). Financial Fragility of Banks, Ownership Structure and Income Diversification: Empirical Evidence from the GCC region. Research in International Business and Finance, 38, 56–68.

Ayadi, R., Llewellyn, D. T., Schmidt, R. H., Arbak, E., & Pieter De Groen, W. (2010). Investigating Diversity in the Banking Sector in Europe: Key Developments, Performance and Role of Cooperative Banks. Centre for European Policy Studies.

Azmat, S., Skully, M., & Brown, K. (2015). Can Islamic Banking ever become Islamic? Pacific-Basin Finance Journal, 34, 253–272.

Baltagi, B. (2005). Econometric Analysis of Panel Data. John Wiley & Sons.

Bank for International Settlements. (2010). Basel III: A Global Regulatory Framework for more Resilient Banks and Banking Systems [PDF file]. Retrieved from https://www.bis.org/publ/bcbs189.pdf

Barth, J. R., Caprio Jr, G., & Levine, R. (2001). Supervision: What works and what doesn’t, Banking Systems around the Globe: Do Regulation and Ownership Affect Performance and Stability? (pp. 31–96). University of Chicago Press.

Bashir, A., Darrat, A. F., & Suliman, M. O. (1993). Equity Capital, Profit Sharing Contracts, and Investment: Theory and Evidence. Journal of Business Finance & Accounting, 20(5): 639–651.

Beck, T., H. Hesse, T. Kick and N. von Westernhagen (2009). Bank Ownership and Stability: Evidence from Germany. [Online article]. Retrieved from http://voxeu.org/article/bank-ownership-and-stability-evidence-germany

Beck, T., De Jonghe, O., & Schepens, G. (2013a). Bank Competition and Stability: Cross-Country Heterogeneity. Journal of Financial Intermediation, 22(2): 218–244.

Beck, T., Demirgüç-Kunt, A., & Merrouche, O. (2013b). Islamic vs. Conventional Banking: Business Model, Efficiency, and Stability. Journal of Banking & Finance, 37(2): 433–447.

Bhattacharya, S., & Thakor, A. V. (1993). Contemporary Banking Theory. Journal of financial Intermediation, 3(1): 2–50.

Blagrave, P. & Furceri, D. (2015). Lower Potential Growth: A New Reality. IMF Survey Magazine, April7.

Blundell, R. & Bond, S. (1998). Initial Conditions and Moment Restrictions in Dynamic Panel Data Models. Journal of Econometrics, 87(1), 115–143.

Blundell, R., & Bond, S. (2000). GMM Estimation with Persistent Panel Data: An Application to Production Functions. Econometric Reviews, 19(3), 321–340.

Bourkhis, K. & Nabi, M. S. (2013). Islamic and Conventional Banks’ Soundness during the 2007–2008 Financial Crisis. Review of Financial Economics, 22(2), 68–77.

Brambor, T., Clark, W. R., & Golder, M. (2005). Understanding Interaction Models: Improving Empirical Analyses. Political Analysis, 14(1), 63–82.Business Cycle Dating Committee, National Bureau of Economic Research. (September 20, 2010). Retrieved from http://www.nber.org/cycles/sept2010.html

Butzbach, O. & von Mettenheim, K. (2015a). Alternative Banking and Financial Crisis, Introduction (pp. 1–9). Pickering & Chatto (Publishers).

Butzbach, O & von Mettenheim, K. (2015b). Alternative Banking and Financial Crisis, Explaining the Competitive Advantage of Alternative Banks: Towards an Alternative Banking Theory? (pp. 51–69). Pickering & Chatto (Publishers).

Chapra, M. U. (1985). Towards a just Monetary System(Vol. 8). International Institute of Islamic Thought (IIIT).

Chiaramonte, L., Poli, F., & Oriani, M. E. (2013). Are Cooperative Banks a Lever for Promoting Bank Stability? Evidence from the recent Financial Crisis in OECD countries. European Financial Management, 21(3), 491–523.

Chong, B. S., & Liu, M. H. (2009). Islamic Banking: Interest-free or Interest based? Pacific-Basin Finance Journal, 17(1), 125–144.

Čihák, M. & Hesse, H. (2010). Islamic Banks and Financial Stability: An Empirical Analysis. Journal of Financial Services Research, 38(2–3), 95–113.

Darrat, A. F. (1988). The Islamic Interest-free Banking System: Some Empirical Evidence. Applied Economics, 20(3), 417–425.

Demirgüç-Kunt, A., Detragiache, E., & Tressel, T. (2008). Banking on the Principles: Compliance with Basel Core Principles and Bank Soundness. Journal of Financial Intermediation, 17(4), 511–542.

El-Gamal, M. A. (2006a). A Simple Fiqh-And-Economics Rationale for Mutualization in Islamic Financial Intermediation. Houston: The Rice University. Retrieved December 25, 2017.

El-Gamal, M. A. (2006b). Islamic Finance: Law, Economics, and Practice. Cambridge University Press.

El-Gamal, M. A. (2017). “Islamic Finance” After State-Sponsored Capitalist Islamism. Rice University’s Baker Institute for Public Policy. Retrieved from https://www.bakerinstitute.org/research/islamic-finance-after-state-sponsored-capitalistislamism/

Farooq, M., Zaheer, S. (2015). Are Islamic Banks more Resilient during Financial Panics? Pacific Economic Review, 20(1), 101–124.

Ferri, G., Kalmi, P., & Kerola, E. (2014). Does Bank Ownership Affect Lending Behavior? Evidence from the Euro area. Journal of Banking & Finance, 48, 194–209.

Filardo, A. et al. (2010). The International Financial Crisis: Timeline, Impact and Policy Responses in Asia and the Pacific. BIS Papers, 52, 21–82.

Fiordelisi, F. & Mare, D. S. (2014). Competition and Financial Stability in European Cooperative Banks. Journal of International Money and Finance, 45, 1–16.

Fonteyne, M. W. (2007). Cooperative Banks in Europe: Policy Issues (No. 7–159). International Monetary Fund.

Foo, Y. N. Special Report: The Shariah Debate on Islamic Financing (October 30, 2015), The Edge Financial Daily. Retrieved from http://www.theedgemarkets.com/article/special-report-shariah-debate-islamic-financing

Ghatak, M. (2000). Screening by the Company you keep: Joint Liability Lending and the Peer Selection Effect. The Economic Journal, 110(465), 601–631.

Goglio, S. & Y. Alexopoulus (2014, Eds.), Special Issue on Cooperative Banks, Journal of Entrepreneurial and Organisational Diversity, 3(1), Trento, Italy.

Goodhart, C. A. E. (2004). Some New Directions for Financial Stability? (Vol. 27). Bank for International Settlements.

Groeneveld, H. M. (2014a). Features, Facts and Figures of European Cooperative Banking Groups Over Recent Business Cycles. Journal of Entrepreneurial and Organizational Diversity, Special Issue on Cooperative Banks, 3(1), 11–33.

Groeneveld, H. (2014b). Alternative Banking and Financial Crisis, A Qualitative and Statistical Analysis of European Cooperative Banking Groups (pp. 71–100). Pickering & Chatto (Publishers).

Groeneveld, H.M. (2017b). European Co-operative Banks in 2016: A Concise Assessment. Retrieved from http://www.eacb.coop/en/studies/external-studies/european-co-operative-banks-in-2016-a-concise-assessment-tias-school-for-business-amp-society.html

Gulzar, R. (2016) “German Banks: More Islamic than Islamic Banks?” NUS-MEI Islamic Finance Special.

Hegazy, W. S. (2006). Contemporary Islamic Finance: From Socioeconomic Idealism to Pure Legalism. Chicago Journal of International Law, 7, 581.

Hesse, H., & Čihák, M. (2007). Cooperative Banks and Financial Stability. International Monetary Fund.

Hossain, M. (2012). Financial Reforms and Persistently High Bank Interest Spreads in Bangladesh: Pitfalls in Institutional Development? Journal of Asian Economics, 23(4), 395–408.

Hussain, H.A. & Al-Ajmi, J. (2012). Risk Management Practices of Conventional and Islamic Banks in Bahrain. The Journal of Risk Finance, 13(3), 215–239.

Iannotta, G., Nocera, G., & Sironi, A. (2007). Ownership Structure, Risk and Performance in The European Banking Industry. Journal of Banking & Finance, 31(7), 2127–2149.

Ibrahim, M. H. (2016). Business Cycle and Bank Lending Procyclicality in A Dual Banking System. Economic Modelling, 55, 127–134.

Ibrahim, M. H. & Rizvi, S. A. R. (2017). Do We Need Bigger Islamic Banks? An Assessment of Bank Stability. Journal of Multinational Financial Management, 40, 77–91.

Ibrahim, M. H. & Rizvi, S. A. R. (2018). Bank Lending, Deposits and Risk-Taking in Times of Crisis: A Panel Analysis of Islamic and Conventional Banks. Emerging Markets Review.

IFSB. (2016). Islamic Financial Services Industry Stability Report.

Jha, Y. (2013). From Goldsmiths to Modern Banking: A Frank Look at Money-Creation Process and Its Relevance to Islamic Banking. Islam and Civilisational Renewal (ICR), 4(3).

Jha, Y. (2014). The Destructive Logic of Interest: The Fallacy of Perpetual Growth (With a Discussion of Reformist Action by Islamic Bank). Islam and Civilisational Renewal (ICR), 5(3).

Kabir, M. N., Worthington, A., & Gupta, R. (2015). Comparative Credit Risk in Islamic and Conventional Bank. Pacific-Basin Finance Journal, 34, 327–353.

Kalmi, P. (2007). The Disappearance of Cooperatives from Economics Textbooks. Cambridge Journal of Economics, 31(4), 625–647.

Kay, J. (2016). Other People’s Money: Masters of the universe or Servants of the people?Profile Books Limited.Khan, F. (2010). How “Islamic” is Islamic Banking? Journal of Economic Behavior and Organization, 76, 805–820.

Kuran, T. (1995). Islamic Economics and the Islamic Subeconomy. The Journal of Economic Perspectives, 9(4), 155–173.

Laeven, L. & Levine, R. (2009). Bank Governance, Regulation and Risk taking. Journal of Financial Economics, 93(2), 259–275.

Liu, H., Molyneux, P., & Wilson, J. O. (2013). Competition and Stability in European Banking: A Regional Analysis. The Manchester School, 81(2), 176–201.

López-Espinosa, G., Moreno, A., Rubia, A., & Valderrama, L. (2012). Short-term Wholesale Funding and Systemic Risk: A Global CoVaR Approach. Journal of Banking & Finance, 36(12), 3150–3162.

Mansour, W., Ben Jedidia, K., & Majdoub, J. (2015). How Ethical is Islamic Banking in the Light of the Objectives of Islamic Law? Journal of Religious Ethics, 43(1), 51–77.

McAllister, P. H. & McManus, D. (1993). Resolving the Scale Efficiency Puzzle in Banking. Journal of Banking & Finance, 17(2-3), 389–405.

Meriläinen, J. M. (2016). Lending Growth during the Financial Crisis and the Sovereign Debt Crisis: The Role of Bank Ownership Type. Journal of International Financial Markets, Institutions and Money, 41, 168–182.

Mian, A. & Sufi, A. (2015). House of debt: How they (and you) caused the Great Recession, and how we can prevent it from happening again. University of Chicago Press.

Mobarek, A. & Kalonov, A. (2014). Comparative Performance Analysis between Conventional and Islamic Banks: Empirical Evidence from OIC countries. Applied Economics, 46(3), 253–270.

Naceur, M. S. B., Barajas, M. A., & Massara, M. A. (2015). Can Islamic Banking Increase Financial Inclusion? (No. 15–31). International Monetary Fund.

Niu, J. (2012). An Empirical Analysis of the Relation between Bank Charter Value and Risk taking. The Quarterly Review of Economics and Finance, 52(3), 298–304.

Pappas, V., Ongena, S., Izzeldin, M., & Fuertes, A. M. (2017). A Survival Analysis of Islamic and Conventional Banks. Journal of Financial Services Research, 51(2), 221–256.

Roodman, D. (2006). How to do Xtabond 2: An Introduction to Difference and System GMM in Stata. Center for Global Development.Siddiqi, M. N. (1983a). Banking without Interest (Vol. 5). Islamic Foundation.

Siddiqi, M. N. (1985). Partnership and Profit-Sharing in Islamic Law (Vol. 9). Islamic Foundation.Siddiqi, M. N. (2006). Islamic Banking and Finance in Theory and Practice: A Survey of State of the Art. Islamic Economic Studies, 13(2), 1–48.

Solomon, D. (November 20, 2014). The Recovery from the Global Financial Crisis of 2008: Missing in Action. [Blog post]. Retrieved from https://blog.euromonitor.com/2014/11/the-recovery-from-the-global-financial-crisis-of-2008-missing-in-action.html

Sorwar, G., Pappas, V., Pereira, J., & Nurullah, M. (2016). To Debt or Not To Debt: Are Islamic Banks Less Risky than Conventional Banks? Journal of Economic Behavior & Organization, 132, 113–126.The Financial Crisis – Full timeline.(n.d.). Retrieved from https://www.stlouisfed.org/financial-crisis/full-timeline#2010

Valnek, T. (1999). The Comparative Performance of Mutual Building Societies and Stock Retail Banks. Journal of Banking & Finance, 23(6), 925–938.

Windmeijer, F. (2005). A Finite Sample Correction for the Variance of Linear Efficient Two-Step GMM Estimators. Journal of Econometrics, 126(1), 25–51.

Published
2020-05-21
How to Cite
Gulzar, R., Ibrahim, M., & Ariff, M. (2020). ARE ISLAMIC BANKS SUFFERING FROM A MODEL MISFIT? A COMPARISON WITH COOPERATIVE BANKS. Journal of Islamic Monetary Economics and Finance, 6(2), 325 - 352. https://doi.org/10.21098/jimf.v6i2.1086
Section
Articles