Panel 1c. Islamic Finance: Financial and Social Performance

Chair: Mehmet Asutay

Nonperforming Loans Within the GCC Islamic Banking and Islamic Financing Contributing to the NPL in the GCC’s Banking System
Dr Maha Alandejani, Faculty of Economics and Administration King Abdulaziz University & Professor Mehmet Asutay, Durham University

This paper aims to identify the macro- and micro-level factors determining nonperforming loans (NPL) in Islamic banking industry in the GCC via the panel data econometrics model for the period of 2005 to 2011. In doing so, the impact of the sectoral distribution of Islamic financing on the NPL in the GCC banking system as a whole is also considered by utilising dynamic panel data models. The findings indicate that the relationship between efficiency and NPL supports the ‘bad management’ and ‘bad luck’ hypotheses. Further, the sectoral distribution of Islamic financing extended by the GCC Islamic banks shows an adverse impact on NPL, thus demonstrating that Islamic bank financing, which is related to real estate and construction projects, increases the credit risk exposure. It is concluded that the growth influence of fixed-income debt contracts could increase NPL more than profit-and-loss-sharing contracts.

An Analytical Exploration and Assessment of the Social Risks Faced by Islamic Banks and Financial Institutions: Credibility, Legitimacy, Shari’ah, Trust and Sustainability Risks
Alija Avdukic, Al-Maktoum College of Higher Education & DUBS, Durham University

The experience of Islamic banking and finance over the years, and in particular since the financialisation stage commenced in late 1990s, suggests that Islamic finance has been converging towards conventional finance in its operations, institutionalisation and product level. This study, hence, aims to locate the growing convergence from Islamic finance to conventional finance through identifying that each of the professed features of Islamic finance has been compromised. In understanding this observed convergence of IF towards conventional finance, specialised areas of risk beyond financial, operational and managerial risk areas are conceptualised and considered in reference to the aspirational objectives of IF. Therefore, there is a need to internalise such social risks areas as: credibility, legitimacy, Shari’ah trust and sustainability risks. Implicit social risks, which determine the viability of the Islamic finance, as an authentic financing method should also be explored and examined. Henceforth, this paper aims to explore such implicit risk areas by identifying them and locating the sources of such risk. In developing such a novel approach, the paper aims to bring to surface unconsidered risk areas which are argued as inherently part of IF in an aspirational sense. Thus, by developing an expanded nature of risk, this study brings into analysis the social risks in the form of credibility, legitimacy, trust and sustainability risks. These are essential and existential risk areas, which have been taken granted by the Islamic finance industry, and this requires a careful and critical debate. This research, hence, suggests that for Islamic finance to remain a robust alternative financing paradigm (as opposed to financial paradigm) with the elimination of such a risk area, it should express itself within the aspirational definition of Islamic finance as provided by Islamic moral economy rather than compromising its foundational claims by going back to the basics.

Integrated Early Warning Prediction Model for Islamic Banks: The Malaysian Case
Jaizah Othman, Faculty of Business Management, Universiti Teknologi MARA, Malaysia

It is increasingly becoming important to predict the performance of Islamic banks in order to anticipate a problem before it materializes and negatively affects banks’ performance and financial standing. Benefiting from the earlier research on the subject, this study aims to develop a preliminary integrated early warning model for Islamic banks in Malaysia to assess their financial standing by using quarterly data for the 2005 to 2010 period. Factor analysis and three parametric models (discriminant analysis, logit analysis, and probit analysis) are used in this study. Out of 29 variables used in the early stage of study, only 13 were selected as predictor variables in this study. Results show that, overall, classification accuracy is relatively high in the first few quarters before the benchmark quarter (2010 Q3) for all the estimated models. Correct classification rates are high during the first few quarters and decrease subsequently. Based on these results, therefore, it is obvious that the first few quarters before the benchmark quarter are the most important for making a correct prediction. These results show the predictive ability of the integrated model to differentiate healthy and non-healthy Islamic banks, thus reducing the expected cost of bank failure.

An Exploratory Examination into the Relationship between Corporate Governance and Risk Management in Islamic Banks
Dr Hanimon Abdullah, Durham Centre for Islamic Economics and Finance

Financial failures are always linked to issues of corporate governance (CG) as the latter is continuously perceived as being the triggering factor for such fallout. Being inadvertently famous for its adverse effects, corporate governance is also associated with, and has implications on, risk management (RM) practices of corporations. This paper, hence, aims to examine the correlation between CG and RM by identifying disclosure levels within each dimension contained within CG and RM indices developed to measure the CG and RM disclosure performance. By exploring the disclosure levels of CG and RM practices as well as the potential relationship between the two, this paper also attempts at examining the type of correlation between CG and RM, i.e. to identify whether there is a positive or negative relationship between the two. Thus, an attempt is made by locating the correlation between CG and RM practices through annual reports, as it is expected that good CG practices should moderate risk exposure and establish an effective risk management process. Thus, this study is predicated on the notion that if banks have high corporate governance disclosure, the disclosure of risk management should similarly be high.

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