PhD Thesis (book) -Ahmad Abu-Alkheil

216 Pages·2012·4.23 MB·English

Abu-Alkheil, Ahmad

"Ethical Banking and Finance: A Theoretical and Empirical Framework for the Cross-
Country and Inter-bank Analysis of Efficiency, Productivity, and Financial Performance"

This thesis was accepted as a doctoral dissertation in fulfilment of the requirements for the
degree of Doctor (Ph.D.) of Economics and Business Administration Sciences (Dr.Oec)
"Banking and Financial Studies" by the faculty of Business, Economics, and Social Sciences
at the University of Hohenheim on July 2, 2012.

Supervisor:

Prof. Dr. Hans-Peter Burghof
University professor, chair of the Banking and Finance Department
The University of Hohenheim

Examination committee members:

1. Professor Dr. Christian Ernst
Chair of Economics and Management of Social Services

2. Professor Dr. Michael Schramm
Chair of Catholic Theology and Business Ethics

Date of the Doctoral oral examination (Dissertation Defenses):
July 17, 2012
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I, Ahmad M. Abu-Alkheil, declare that this thesis is solely and originally my own work other
than where I have clearly indicated that it is the work of others or carried out jointly by me and
any other person. This thesis is being submitted for the degree of Doctor of Economic and
Business Administration Sciences (Dr. Oec)-Banking and Financial Studies at the University of
Hohenheim, Stuttgart-Germany. This thesis contains no material that has been submitted
previously, in whole or in part, for the award of any other academic degree.

Stuttgart, den 01.01.2012

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After all these years of hard work, it is necessary to express my gratitude to those people who
in one way or another contributed and extended their support and valuable assistance in the
preparation and completion of this academic work.

First and foremost, my utmost gratitude to the one above all of us, the omnipresent only God,
for giving me the strength to plod on despite my desire to give up, thank you so much my Allah,
(the) One. I would also like to heartily thankful to my supervisor Prof. Dr. Hans-Peter Burghof,
whose encouragement, supervision and moral and unfailing support, from the preliminary to the
concluding level, enabled me to develop an understanding of my thesis.

Additionally, I want to show and offer my regards, gratitude and blessings to Prof. Walayet A.
Khan, from the University of Evansville–USA, who has shared valuable insights in the relevance
of the study despite of the distance. Prof. Khan has closely and jointly worked with me and my
supervisor as a third co-author in (my) three proposed research papers.

I am really very much and sincerely grateful to the hidden support of my father's soul, my great
mother, my patient and lovely wife, and not to forget my little angel "Eleen" and my son "Elias",
who have been my inspiration as I hurdle all the obstacles in the completion of this work.

I am ultimately thankful to the German Jordanian University (GJU) for providing me with a
scholarship to help me to pursue this post-graduate study in Islamic banking and finance.

Ahmad M. Abu-Alkheil
Stuttgart-Germany

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DECLARATION ……………………………………………………...……………………….... ii
ACKNOWLEDGEMENTS……………………………………………………………………… iii
TABLE OF CONTENTS………………………………………………………………….….... iv
LIST OF TABLES…………………………………………………………………………....... vii
LIST OF EXHIBITS AND FIGURES……………..…………………………........................... ix
LIST OF APPENDICES……………………………………………………….......................... xi
LIST OF ABBREVIATIONS AND VARIABLES…………………………………….…… xii
ABSTRACT- ENGLISH……………………..……………….................................................. xvi
ABSTRACT- GERMANY.……………………………………………..................................... xx
GENERAL INTRODUCTION……………………………………………………………….... xxiv
Chapter 1. Understanding Islamic Economics, Finance, and Banking: A Basic Guide

1.1. Background ……..…………………………………………………………………………... 1
1.2. Basic principles of Islamic Economics, Finance and Banking…………………………….. 2
1.2.1. Prohibition of interest: Rationality and economic wisdom ………………………… 2
1.2.1.1. Profit-rate in Islamic banking: The use of interest rate as a benchmark ... 4
1.2.1.2. Zero interest rates: An economic point of view …………………..…….……. 6
1.2.2. Commitment on paying Al-Zakah "the social duty to benefit society"…..…...…. 7
1.2.3. Prohibition of uncertainty or speculation (Gharar)…..…........................................…… 7
1.2.4. Islam discourages heavy debt …..……………………………………………………..…. 8
1.2.5. Prohibition of financing certain economic sectors …………………………...…...…. 8
1.2.6. Profit and loss sharing (PLS): No Pain, No gain …..….............................................…. 9
1.2.7. Asset-backing principle …..…............................................................................................…. 9
1.2.8. Money as “potential” capital: characteristics of money and commodities……. 10
1.3. Islamic Financing Contracts (Modes of operation) …………………………………….….. 11
1.4. Islamic Financial Services ………………………………………….…………………….... 13
1.4.1. Islamic Banking ………………………………………………………………... 13
1.4.2. Islamic investment funds ………………………………………………………. 14
1.4.3. Islamic insurance "Takaful"….…………………………………………………. 15
1.4.4. Islamic bonds (sukuk)……………...…………………………………………… 17
1.5. Risks and challenges associated with Islamic finance and Banking …………………….... 18
1.5.1. Risks facing Islamic banking ……………………...………………………..….. 19
1.5.1.1. Market Risks………………...……………………………………….…. 19
1.5.1.2. Liquidity Risks……………...……………………...……………….….. 20
1.5.1.3. Operational Risks……………...……………………...………………... 22
1.5.1.4. Credit Risk………………...…………………………………………..... 23
1.5.2. Challenges facing Islamic banking ……………………...……………...…..….. 23
1.5.2.1. Shari’ah arbitrage…………...…………………………………………. 23
1.5.2.2. Shari’ah compliance throughout the product life cycle……………….. 24
1.5.2.3. Shortage of experts in Islamic banking………………………………... 24
Appendix……………………………………………………………………………..………….. 25
References……………………………………………………………………………………….. 28

Chapter 2. The Global Emergence and Growth of Islamic Finance

2.1. Foreword ……..………………………………………………………………...…………… 33
2.2. International Islamic financial market (IIFM): An overview ……………...………...……... 33
2.3. Demand for Islamic Financial Products in Europe …………………………..………..…… 44

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TABLE OF CONTENTS

2.3.1. Islamic banking and finance in the UK ………...…………….…......….....…...... 45
2.3.2. Islamic banking products in France ………………..……………......….....…...... 49
2.3.3. Islamic finance gaining ground in Germany ……………...…………….............. 51
2.3.4. The considerable room for growth of Islamic finance in Turkey ……………..... 55
Appendix……………………………………………………………………………..………….. 58
References………………………………………………………………………………………… 62

Chapter 3. Islamic Finance and the Global Financial Crisis

3.1. Preface ……..…………………………………………………………………………….... 69
3.2. The roots of the global financial crisis of 2007……………………………………….......… 70
3.3. The impact of the global crisis on Islamic finance: the case of Dubai debt crisis….......…. 71
3.4. The Islamic solution to the global financial crisis ………………………….………......... 73
3.5. Stability and potential of Islamic finance during and beyond the financial crisis……........ 74
Appendix…………………………………………………………………………..…………… 81
References……………………………………………………………………………………… 83

Chapter 4. Islamic Commercial Banking in Europe: A Cross-Country and Inter-Bank
Analysis of Efficiency Performance

4.1. Abstract ……..…………………………………………………………………..…………. 86
4.2. Introduction …………………………………………………………………….…….....…. 87
4.3. Literature review …........................................................................................................… 89
4.4. Research methodology ………………………………………..…………….………......... 92
4.4.1. Technical efficiency measurement using "Data Envelopment Analysis"……… 92
4.4.2. Data and variables ……………………………………………………………....………… 94
4.4.3. Selection of inputs and outputs variables ………………………………………...…… 95
4.4.4. The DEA model …………………………………………………………………….……… 97
4.4.5. Adjustment to the environmental influences: A 2-stage DEA-based estimation…. 100
4.5. Empirical results …………………………..…………………..…………….……….......... 101
4.5.1. Efficiency of Islamic banking sector...…………………………………………….…… 101
4.5.2. Determinants of bank’s efficiency: The "OLS" regression analysis..…………... 104
4.5.3. An overview on the bank’s Financial Ratios Based Analysis (FRA)..………...... 108
4.5.4. Correlation of DEA efficiency scores with financial Performance..….….…........ 109
4.5.5. The efficiency – profitability matrix…..………………………………………….……. 110
4.6. Conclusions …………………………..…………………..…………….…………........... 111
Appendix……………………………………………………………………………..…………. 113
References…………………………………………………………………………..…….…… 118

Chapter 5. Comparison of efficiency and productivity changes of Islamic and conventional
banks: Evidence from Europe and Muslim-Majority countries

5.1. Abstract ……..…………………………………………………………………………...… 121
5.2. Introduction ……………………………………………………………………...…........… 122
5.3. Literature review …........................................................................................................… 124
5.4. Research methodology ………………………………………..…………….……............. 125
5.4.1. Data description and variables ………………………………………………………..… 125
5.4.2. The empirical specifications ………………………………………………………..…… 129
5.4.2.1. The DEA Model …………...……………...……………………......… 129
5.4.2.2. The Malmquist productivity index …...……...…………………….… 130
5.4.2.3. The DEA-Second Stage: Regression approach ……...…………….… 132

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TABLE OF CONTENTS

5.5. Empirical results ………………………………………………………………………..…. 133
5.5.1. Cross-country analysis of banks efficiency performance: DEA-based analysis… 133
5.5.2. Cross-country analysis of banks productivity growth: DEA-based MPI analysis… 135
5.5.3. Inter-bank analysis of banks productivity growth: DEA-based MPI analysis …… 138
5.5.3.1. The banking industry in Bosnia and Herzegovina ……………...….… 138
5.5.3.2. The banking industry in UK ………………………………………..… 139
5.5.4. Adjustment to the environmental differences: (OLS)-Regression results ……... 140
5.5. Conclusions ……………………………………………………………………………..… 143
Appendix……………………………………………………..……………………..………….. 145
References……………………………………………………………………..……………….. 150

Chapter 6. X-efficiency and Financial Performance of Islamic versus Conventional Banks:
Evidence from Europe

6.1. Abstract ……..…………………………………………………………………………..…. 153
6.2. Introduction …………………………………………………………………...………...…. 154
6.3. Literature review …........................................................................................................… 155
6.4. Research methodology ………………………………………..…………….………......... 157
6.4.1. (cost) X- efficiency of Islamic banks ……………………………………………….…… 157
6.4.1.1. Data description and variables ……………………………….......….… 157
6.4.1.2. DEA approach for measuring bank’s X-efficiency …………………..… 159
6.4.1.3. Mathematical formulation....................................................................... 161
6.4.2. The financial performance of EIIB: Accounting ratios-based approach ………… 162
6.5. Empirical results …………………………..………………..…………….…………......... 163
6.5.1. Bank’s efficiency based on the "DEA" approach... ……………………………..….… 164
6.5.2. The EIIB financial performance: Accounting ratio-based approach ……………… 167
6.6. Conclusions …………………………..…………………..………………………….......... 171
Appendix…………………………………………………………………………..…………..... 173
References…………………………………………………………………………………....… 175

Chapter 7. Summary Conclusions and scope for further Work

7.1. Introduction ……………………………………………………………………………..…. 177
7.2. Summary and Conclusions …………...………………...………………...…….......…. 178
7.2.1. Summary of preliminary results based on the market analysis……………….. 178
7.2.2. Summary of empirical results ………………………………………………...…….…… 179
7.2.2.1. Results related to proposed paper 1…………………………......…..… 179
7.2.2.2. Results related to proposed paper 2…………………………......…..… 181
7.2.2.3. Results related to proposed paper 3…………………………......…..… 182
7.3. Further work …………………………..………………..………………….…………......... 183

Hint. The reader will notice that the thesis (chapter 4, 5 and 6 in particular) includes some repeated ideas and sometime
redundant discussions. This is mainly because these chapters are originally proposed papers for publication.

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Table 1.1 The difference between (Riba) and (Profit) in Islamic perspective……... 4
Table 1.2 Overview of main Islamic Modes of Financing…………………………. 12
Table 1.3 Distinguishing features of Islamic banking from conventional banking… 15
Table 1.4 Types of Islamic investment funds, Sukuk, and derivatives…………….. 25

Table 2.1 Islamic finance by country: banking, takaful and fund assets $bn………. 42
Table 2.2 Shari’ah compliant assets in the UK, $ m……………………………….. 48
Table 2.3 Islamic banking and finance in Europe, USA, and the rest of the world... 58

Table 3.1 Lending from Western banks to the UAE-2008 and 2009……………… 71

Table 4.1 Summary statistics of the study population and the selected sample…… 94
Table 4.2 The inputs-outputs used in the DEA models…………………………….. 96
Table 4.3 Correlation coefficients between DEA scores and accounting measures 110
Table 4.4 The efficiency – profitability matrix……………………………………. 110
Table 4.5 Summary of the bank’s DEA-efficiency scores in model (M1)………… 113
Table 4.5.1 Summary of the IBB’s DEA- slacks and targets (IBB: model-M1)…….. 114
Table 4.6 Summary of the bank’s DEA-efficiency scores in model (M2)………… 113
Table 4.6.1 Summary of the IBB’s DEA- slacks and targets (IBB: model-M2)…….. 114
Table 4.7 Summary of the bank‘s DEA-efficiency scores in model (M3)………… 114
Table 4.7.1 Summary of the DEA slacks and targets (IBB: model-M3)…………….. 114
Table 4.8 Summary of the bank‘s DEA-efficiency scores in model (M4)………… 114
Table 4.8.1 Summary of the DEA slacks and targets (IBB: model-M4)…………….. 115
Table 4.9 Summary results of the regression analysis……………………………… 115
Table 4.10 Summary statistics of the variables employed in DEA…………………. 115
Table 4.11 Correlation matrix between inputs and outputs………………………… 116
Table 4.12 Summary of the exogenous variables used in DEA- 2 stage…………….. 116
Table 4.13 Results from testing the "OLS" main assumptions................................... 116
Table 4.14 Summary statistics for "Mean" values of the independent variables…… 117

Table 5.1 Summary statistics of the population and the selected sample………….. 128
Table 5.2.1 DEA scores: IBB & BBI in comparison to small Islamic banks (M1)…. 145
Table 5.2.2 DEA scores: IBB & BBI in comparison to large Islamic banks (M2)….. 145
Table 5.2.3 DEA scores: (BBI) relative to small conventional banks in BiH (M3)…. 145
Table 5.2.4 DEA scores: (IBB) relative to small conventional banks in UK (M4)….. 145
Table 5.3.1 Banks Total Factor productivity change (TFPch) over 2005–2008…….. 146
Table 5.3.2 Banks technological efficiency change (TECch) over 2005-2008…….... 146
Table 5.3.3 Banks technical efficiency change (TEch) over 2005-2008…………….. 146
Table 5.3.4 Changes in technical efficiency components over 2005-2008………….. 146
Table 5.4 Summary statistics of variables employed in the DEA analysis………... 147
Table 5.5.1 Banks Total Factor productivity change (TFPch) over 2005–2008…….. 147
Table 5.5.2 Banks technological efficiency change (TECch) over 2005-2008……… 147
Table 5.5.3 Banks technical efficiency change (TEch) over 2005-2008…………….. 147
Table 5.5.4 Changes in technical efficiency components over 2005-2008………….. 147
Table 5.6.1 Banks Total Factor productivity change (TFPch) over 2005–2008…….. 148
Table 5.6.2 Banks technological efficiency change (TECch) over 2005-2008……… 148

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Table 5.6.3 Banks technical efficiency change (TEch) over 2005-2008…………….. 148
Table 5.6.4 Changes in technical efficiency components over 2005-2008………….. 148
Table 5.7 Summary of the exogenous variables in two-stage method ……………. 148

Table 6.1 Brief description of the tested banks……………………………………. 158
Table 6.2 A brief definition of the input / output factors……………………...…... 160
Table 6.3 A brief definition of the input prices and output prices……………...….. 161
Table 6.4 Bank’s TE , TE , SE, TE, CE, and AE over 2005-2008………...…. 164
CRS VRS
Table 6.5 Brief description of the financial performance measures……………...... 173
Table 6.6 Financial performance of the EIIB pre- and post- crisis: T-test………… 174

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