Ethical Investments and Performance of Islamic Banks

Ethical Investments and Performance of Islamic Banks Kym Brown1 Michael Skully2 Abstract This paper employs non-parametric cost efficiency analysis using data envelopment analysis (DEA) and ratio analysis on a cross country sample of Islamic banks to examine their profitability and economic efficiency and then compares these results with their involvement in Islamic finance. Using a sample of 20 banks from 11 countries, we had anticipated that those banks more active in Islamic transactions would be more successful, but no obvious pattern was found between the profitability, Islamic financing and efficiency. These findings, however, may more reflect the differing stages of development across the banks concerned, their regulatory environments, and other country specific matters rather than the impact of their Islamic practices. JEL: G21 Keywords: Islamic banking, efficiency, performance

1. Introduction There is a long historical connection with the development of conventional commercial banking practice and religion. Some of the earliest financial transactions began with the storage of gold in religious temples. These early financial practices expanded rapidly enabling the ancient Greeks to write credit notes that were honoured throughout Greece. Formal banking has now existed for almost a thousand years with the world's oldest surviving bank, Italy’s Banca Monte dei Paschi di Siena, dating to 1472. So in comparison, Islamic banking is relatively new phenomenon as the first Islamic bank, Mit Ghamr Local Savings Bank of Egypt, was only established in 1963. Even then, the real growth of Islamic finance did not begin until the 1980s when Middle East countries experienced a large growth in surplus funds. Since then Muslim investment has spread throughout Europe and Asia, and Islamic finance is still expanding. Direct Islamic financing methods, such as with Islamic bonds, are gaining popularity in the West as is Islamic based funds management. 1

Monash University, P.O. Box 197, Caulfield East, Vic 3145, Ph: 61 3 9903 1053, Fax: 61 3 9903 2422, Email: [email protected] 2 Monash University

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Journal of Islamic Economics, Banking and Finance, Volume-5 Number-1

While many countries have large Muslim populations, Islamic banks often account for only a minimal share of local banking. Brunei and Iran are seemingly the only economies where the Islamic banks perform proportionately to their Muslim populations (refer to Appendix A). Nevertheless Islamic banks are gaining acceptance and competing with their commercial counterparts. They are also expanding internationally with many countries, like Malaysia and Indonesia, now permitting, even encouraging, the entry of foreign Islamic banks. Further expansion is expected given the limited presence of Islamic banks currently in many Muslim countries. Islamic banks remain in a privileged position to access large Muslim populations given their activities are based on the philosophies of the Koran or Shariah law. What are the special features of Islamic banking? Interest or riba is avoided and leasing, mark-up or profit/loss sharing contracts are often used instead. Investments in gambling, alcohol or pornography are avoided as per the Koran. More importantly, Islamic banks operate under Islamic ethical and religious ideals. They were established not only to provide Shariah based financial solutions (Yaquby, 2005) but also to promote certain social objectives such as assisting the disadvantaged and poor (Hassan and Lewis, 2007). Thus Islamic banks usually have a Shariah Board to ensure their bank practices follow the Koran. For example, as part of their social responsibilities, Islamic banks must pay a zakat, or donation to charitable purposes. Another special feature of Islamic banks is their ability to take equity participations in their clients’ projects. Such direct investments can potentially help people with limited funds (especially developing countries), but with good projects and ideas, to obtain finance. Given these special features one might expect that the more active an bank becomes in these Islamic financing techniques, the more success it would have in attracting Muslim clients and so perhaps the better its performance. The remainder of this paper is structured as follows. The next section provides a brief review of some prior studies of Islamic bank efficiency. This is followed by a discussion of the data and methodology, the results, and conclusion.

2. Literature Review Many Islamic bank studies have examined the Shariah principles behind offering such finance (ulamas) but historically limited financial analysis was performed, often due to data availability limitations (e.g. Ariff, 1988). Data still remains a problem and so cross sectional studies tend to dominate the literature. One such efficiency performance study by Yudistira (2003) revealed that non-Middle Eastern Islamic banks were more efficient than Middle Eastern banks which, given the development of Islamic banks in that region, was surprising. Also larger Islamic banks were more efficient than smaller ones. Iqbal (2003) found further support for size as larger banks tended to rate better; perhaps they could hold more diversified portfolios as a result. Of specific note is that when compared with the world’s top 10 commercial banks,

Ethical Investments and Performance of Islamic Banks

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the Islamic banks had higher capital levels. This may be a reflection of their high levels of ethical Islamic investments. The evidence as to whether Islamic banks are actually more efficient than conventional banks remains quite mixed. Yudistira (2004), for example, with a global sample of 18 Islamic banks, found Islamic banks to be more efficient than conventional banks. In contrast, Hassan (2006) in a larger study of 43 Islamic banks found them somewhat less cost efficient than conventional banks. Mokhtar, Abdullah and Al-Habshi, similarly, in a study of Malaysian Islamic banks found that while Islamic banks had grown faster, their overall efficiency was lower than the conventional banks. Finally, while not examining efficiency, Cihak and Hesse (2008) found smaller Islamic banks tended to be financial stronger than larger ones. One issue in Islamic banking is the degree to which Shariah law is actually followed> Some equity products are certainly Shariah based while others, which appear very similar to those of conventional banks, are at best Shariah compliant. The latter are seemingly easier to provide as well as less risky. The challenge then is the potential conflict between the two. As Hassan and Lewis (2007) noted they must at the same time be concerned about operating efficiently as banks while ensuring these operations follow Shariah based principles. Haron and Azmi (2008) argue that the "religious dimension" plays an important role in attracting savings into Islamic banks. The problem, however, knows the degree to which Islam really impacts on their banking operations. Chong and Liu (2009), for example, raise some doubts from their findings that the returns on Islamic deposits appear to be closely linked to those of conventional banks rather than the Islamic banks’ actual performance. Similarly, while Islamic banking is supposed to be highly connected with ethics, Haniffa and Hudaib (2007) and their ethical identity study of Islamic banks in Malaysia found only one bank had above average results in terms of ethics. This Islamic issue is more obvious perhaps on the investment side as Dar and Presley (2000) reported that Islamic banks were failing in their profit and loss sharing (PLS) investments via Mudarabah and Musharak financing. They suggested a number reasons why this PLS mode was not more popular. Firstly the agency issue that the entrepreneur lent the funds under such a basis will not necessarily work as hard if they were fully self-funded. Secondly, property rights in many Muslim countries are not always well enforced. Thirdly, Islamic banks need to compete with commercial banks, and prefer to offer less risky short term finance. Fourthly, as a project partner the bank takes on a silent role rather than an active member. Also PLS is not feasible for short term projects and tax implications also need to be considered. More recently, Brown, Hassan and Skully (2006) examined the Islamic investments by a number of banks worldwide and found only one Sudanese bank, Tadamon Islamic Bank reported a high level of equity investments, perhaps indicating a high level of long term profit and loss sharing investments with clients.

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3. Methodology The method employed in this paper is ratio analysis on the structure of the Islamic banks and non-parametric cost efficiency analysis using Data Envelopment Analysis (DEA). The relative cost or input efficiency for the banks is measured. Each banks’ costs are measured against banks producing a similar output, to obtain a relative efficiency ranking for each bank (see Figure 1). So the measure of performance is based on the peers within the same sample, meaning that efficiency results from one sample are not directly comparable to the scores using another sample given that the efficiency frontier will differ. Some 20 Islamic banks from 11 countries including Bahrain, Egypt, Iran, Jordan, Malaysia, Kuwait, Pakistan, Qatar, Russia, Sudan and United Arab Emirates are analysed. The bank level data is obtained from the Bankscope database. One limitation to this study is that each country may use domestic generally agree accounting standards rather than international standards. The evaluation of Islamic banks across countries is valid, however, given the limited numbers of true Islamic banks within any one country, and the assumption under Data Envelopment Analysis that all decision making units (DMUs) or banks are similar in nature. Their requirement to follow Shariah law should help ensure this. Figure 1: DEA: Projection of an Inefficient Unit Outputs O

D1 I

D

Efficient Frontier

D0

Inputs I = Input-oriented model – given amount of outputs, with smallest possible inputs O = Output-oriented model – given amount of inputs, with smallest possible outputs

Source: Cooper, Seiford, Tone, 2000

Originally developed by Banker, Charnes and Cooper (1984) (BCC), the input model attempts to solve the problem:


Min θ subject to θ ,τ

63

Yτ >Y0

Xτ 0 n

[1]

where Y is the matrix of output vectors; X is the matrix of input vectors; (X0,Y0) is the unit being rated; eT denotes a row-vector of 1’s; τ is the vector of intensity variables; and θ is the efficiency score – a quantity between 0 and 1. The BCC(I) method assumes a variable return to scale (VRS) meaning that as inputs increase the model does not expect a correspondingly same increase in outputs. The constant return to scale (CRS) model does however. The results for the samples used within this study indicated that most banks had a VRS cost behaviour.

4. Results Initial evaluation of the performance of Islamic banks is via typical ratio analysis (refer to Table 1). The largest bank in our sample is Al Rajhi Bank in Saudi Arabia with some US $25.3 billion. Evaluation of the performance of these Islamic banks leads to some concern over two particular banks, both with negative profitability returns and cost to income ratios over 100%, being Bank Albilad in Saudi Arabia and the Islamic Bank of Britain Plc in the United Kingdom. Nevertheless although this initially appears to be a poor performance, this may in fact reflect their ethical Islamic investment levels as both banks’ equity to total assets figures were comparatively high in the sample at above 40%. When an Islamic bank invests for the longer term as a partner in a long term project, the initial set up costs are likely to be very high for the first few years as the project is investigated and established. As the project continues, the expected costs of maintaining a partnership in the project by the Islamic bank would be expected to fall, and hence future profits should increase. Unfortunately these two banks were not included in a prior study of Islamic operations (see Table 2). Based on profitability, the best performing Islamic bank was the International Investor Company from Kuwait and with a low cost to income ratio of just 34.7%. Generally banks prefer to report a lower cost to income figure given increased competition and the impetus to decrease costs. While this Islamic bank performed well on traditional profitability grounds, it reported (as per Table 2) low levels of Islamic investments. Islamic banks have often preferred to offer consumer finance with a sale and mark-up type arrangement instead of taking a riskier long term position as a ‘partner’ in a true profit and loss situation. One of the hallmarks of Islamic banking should be the ability of the bank to ethically go beyond just providing finance, for the good of society and take on the ‘partnership’ type risk involved in such projects.

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The two banks from Qatar, the Qatar International Islamic Bank and Qatar Islamic Bank SAQ, both reported very good profitability but their cost to income ratios are suspiciously low. This could be due to the accounting standards used in that country. Perhaps the reported costs are not necessarily consistent with Islamic banks elsewhere. But even for commercial banks, a cost to income ratio around 45% would be considered as excellent. Given the specifics of Islamic finance, the reportedly good returns may in fact reflect the maturity level in these banks’ long term Islamic investments. An analysis indicates that around 50% of their total assets are Islamic. Also on a comparative scale, the income from the Islamic assets appears to be good, but long term equity investments for Qatar International Islamic Bank was reported at 7.1% of total assets. Although this figure alone seems relatively small, it appears quite good in relation to many of the other banks (which often do not report any Islamic equity investments). Hence the Islamic banks from Qatar are seemingly trying to invest ethically in Islamic projects, with some emphasis on the important profit and loss aspect. The two banks which obtained negative profitability ratios earlier, Bank Albilad in Saudi Arabia and Islamic Bank of Britain plc can not be effectively examined without some data on their investment strategies. On the use of funds side of the balance sheet as reported in Table 3, both banks have high net loan ratios with the latter bank having no other earning assets. The difficulty of assessing the types of Islamic finance provided is difficult as the reporting standards do not require it, and few banks report their specific types of Islamic transactions separately. If banks had an equity relationship however, the ‘shares’ in the project would be listed as ‘other earning assets in column 4 of Table 3. This is not the case for these banks. Their equity levels shown in Table 4, however, indicates high levels of equity, and hence lower leverage or debt than most other Islamic banks. Again under the use of funds (in Table 3) the Shamil Bank of Bahrain appears to have few ‘loans’ and so perhaps it invests in Islamic assets with the Other Earning Assets to Total Asset figure of 70.26%. In the prior year it was reported that nearly 25% of its operations were Islamic in nature (refer to Table 2) and that the average income from Islamic transactions as a percentage of total assets was 2.7%. The major source of funds for Shamil Bank of Bahrain appears to be deposits and other short term finance (Table 4). The question is whether Islamic banks are able to use customer funds effectively to take equity investments or do they need to use their own equity sources? If more of the later is required, Islamic banks might need to issue or obtain some long term capital, perhaps perpetual or term subordinated debt, such as with Islamic bonds, and this would perhaps enable them to take a longer term investment strategy.


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Table 1: Islamic Bank Ratio Performance Bank name Arcapita Bank B.S.C. Gulf Finance House Commercial Bank BSC Shamil Bank of Bahrain EC Bank Syariah Mandiri International Investor Company, K.S.C. (The) Kuwait Finance House Albaraka Islamic Bank BSC (EC) - Pakistan Branches Meezan Bank Limited Qatar International Islamic Bank Qatar Islamic Bank SAQ Al Rajhi Bank Bank Albilad Sudanese Islamic Bank Abu Dhabi Islamic Bank - Public Joint Stock Co. Dubai Islamic Bank plc Sharjah Islamic Bank Islamic Bank of Britain Plc Saba Islamic Bank Shamil Bank of Yemen & Bahrain Tadhamon International Islamic Bank

Total Assets millions USD

ROAA

ROAE

Bahrain Bahrain

1,865.2 189.0

6.74 8.10

29.04 12.89

37.50 29.31

Bahrain Indonesia Kuwait

1,526.4 841.6 367.4

2.58 1.11 19.61

11.87 14.19 24.20

43.80 61.48 34.75

Kuwait Pakistan

16,030.8 244.3

3.18 2.60

27.82 16.31

34.74 33.80

Pakistan Qatar

521.8 1,740.5

2.81 8.22

24.75 69.92

43.49 14.47

2,624.0 25,377.3

6.31 6.52

31.06 47.63

17.94 22.72

1,898.5

-2.07

-5.08

160.00

153.9 6,042.0

1.43 1.98

8.93 23.21

72.25 32.06

11,708.1

2.89

35.88

32.69

1,442.5

4.25

13.53

31.92

153.7 307.9 1,526.4

-7.17 0.77 2.49

-15.76 15.37 15.43

386.36 45.08 55.27

684.8

0.75

15.99

41.54

Country Name

Qatar Saudi Arabia Saudi Arabia Sudan United Arab Emirates United Arab Emirates United Arab Emirates UK Yemen Yemen Yemen

Source: Bankscope Database for the year 2005

Cost to Income Ratio

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Table 2: Islamic Financial Structural Results of Islamic Banks Percentage

Country Bahrain Bahrain Bahrain Bahrain Bahrain

Bank

Income From Islamic Equity Islamic Operations/ Investments / Transactions / Total Assets Total Assets Total Assets 65.2 n.a. 6.4 23.9 22.9 n.a. 66.4 n.a. 2.5 n.a. n.a. 0.3 53.4 n.a. 2.7

$US millions Total Assets

Al Amin Bank 270.6 Arcapita Bank BSC 1,228.3 Bahrain Islamic Bank 677.7 Gulf Finance House 501.6 Kuwait Finance House 466.40 (BHD) Bahrain Shamil Bank of Bahrain 24.5 n.a. 2.7 1,613.7 Egypt Faisal Islamic Bank of 79.8 14.7 3.5 2,546.90 Egypt Iran Bank Sepah 59.6 n.a. 5.4 13,913.50 Jordan Jordan Islamic Bank for 48.4 0.2 2.4 1,591.8 Finance and Investment Kuwait International Investor 9.9 1.2 0.1 279.60 Company Kuwait Kuwait Finance House 46.5 n.a. 3.9 11,734.30 (Kuwait) Malaysia Bank Islam 60.9 0.6* n.a. 3,410.1 Pakistan Meezan Bank Limited 62.6 7.3 2.7 333.2 Qatar Qatar International 53.6 7.1 3.8 1,363.3 Islamic Bank Qatar Qatar Islamic Bank 57.8 n.a. 4.4 2,111.8 Russia Badr Forte Bank 33.7 0.0 n.a. 26.20 Sudan Sudanese Islamic Bank 12.8 n.a. n.a. 100.40 Sudan Tadamon Islamic Bank 17.4 28.3 1.4 173.30 UAE Abu Dhabi Islamic Bank 61.4 6.0 3.4 3,454.60 UAE Dubai Islamic Bank plc 59.5 1.1 3.8 8,335.80 UAE Emirates Islamic Bank 79.5 n.a. 0.2 628.7 Based on mudahraba (profit sharing) and musharaka (profit and loss sharing) Note: Islamic operations include all types of Islamic investments for the year 2004 Source: Brown, Hassan and Skully (2006)

The bank with the highest equity sources proportion was the International Investor Company, K.S.C. in Kuwait with equity to asset ratio of nearly 75%. Given this high equity levels, this bank would seem well placed to invest longer term. Table 2, however, reveals that its Islamic operations were low at just 9.9% of total assets and low equity investments, suggesting little if any profit and loss sharing investments. Generally for most Islamic banks listed, their funding was predominantly from deposits and other short term financing methods. Given the matching principle


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preference, Islamic banks wishing to make more profit and loss investments should try to extend the duration of their liabilities to match their duration of assets. Seemingly the International Investor Company was in the best position to do this whilst a few banks from Yemen and United Arab Emirates and the only Indonesian bank appeared to have the least capability to undertake longer term finance given their financial structure. Finally the cost efficiency performance of the sample is analysed using data envelopment analysis (DEA). The production process is examined using a number of inputs and outputs. Outputs include loans, deposits and other earning assets, whilst inputs are personnel expenses and non-interest expenses (excluding personnel expenses). The descriptive statistics for this data are reported in Table 5 in millions of US dollars. Comparison other than size or amount is difficult. The largest bank based on these figures is Al Rajhi Bank in Saudi Arabia. In fact they had over US $25.3 billion in assets. Meanwhile the smallest Islamic bank in our sample is the Sudanese Islamic Bank with loans and other earning assets of US $20 million respectively. As shown in Table 6, the Islamic banks vary considerably in terms of their cost efficiency. For example, the International Investor Company has a low level of Islamic operations (please refer back to Table 2) and a very low cost efficiency of just 14.4%. In contrast, while the Arcapita Bank from Bahrain also had a low cost efficiency score of 24.8%, it had reportedly high levels of Islamic operations and equity investments. Given their effort to invest in Islamic operations including equity investments, the reported low cost efficiency is not of such a concern. Equity investments involve more time and therefore costs on the part of the bank. Hence, these banks would be expected to show lower cost efficiency as a result. The best performer in terms of efficiency and Islamic operations was the Abu Dhabi Islamic Bank from United Arab Emirates. It proved fully cost efficient and had Islamic operations accounting for over 60% to total assets, and had equity investments at 6% of total assets. The Qatar International Islamic Bank was also fully cost efficient and with Islamic investments of some 53.6% of total assets. The average efficiency of listed banks is slightly higher than non listed banks at 75.2% as compared to 71.87%. It may be that public shareholders expect a higher performance including cost efficiency.

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Table 4: Islamic Banks: Sources of Funds - Liabilities and Equity US dollars (millions)

%

Bank name Arcapita Bank B.S.C. Gulf Finance House Commercial Bank BSC Shamil Bank of Bahrain EC Bank Syariah Mandiri International Investor Company, K.S.C. (The) Kuwait Finance House Albaraka Islamic Bank BSC (EC) - Pakistan Branches Meezan Bank Limited Qatar International Islamic Bank Qatar Islamic Bank SAQ Al Rajhi Bank Bank Albilad Sudanese Islamic Bank Abu Dhabi Islamic Bank Public Joint Stock Co. Dubai Islamic Bank plc Sharjah Islamic Bank Islamic Bank of Britain Plc Saba Islamic Bank Shamil Bank of Yemen & Bahrain Tadhamon International Islamic Bank

Bahrain

50.63

Other (noninterest bearing funding) / Total Assets 4.37

Bahrain Bahrain Indonesia

52.06 71.55 89.57

0.37 4.55 2.39

47.51 23.90 7.64

189 1,526.40 841.6

Kuwait Kuwait

0.00 74.15

25.34 11.03

74.66 13.25

367.4 16,030.80

Pakistan Pakistan

81.09 82.45

2.74 6.32

16.13 11.21

244.3 521.8

Qatar Qatar Saudi Arabia Saudi Arabia Sudan

81.84 72.16 79.79 55.07 53.22

4.22 5.30 6.03 4.15 20.86

13.92 21.21 14.17 40.77 16.89

1,740.50 2,624.00 25,377.30 1,898.50 153.9

UAE UAE UAE UK Yemen

88.93 87.19 58.00 53.42 83.21

1.95 5.27 2.23 1.11 11.24

7.47 7.54 38.72 45.48 4.87

6,042.00 11,708.10 1,442.50 153.7 307.9

Yemen

71.55

3.66

16.65

1,526.40

Yemen

92.86

2.22

4.42

684.8

Country Name

Deposits and ST funding/TA

Source: Bankscope database for the year 2005.

Equity / Total Assets

Total Funding (Debt + Equity)

21.11

1,865.20


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Table 5: Summary Statistics for Islamic Banking Outputs and Inputs Outputs Bank name Arcapita Bank B.S.C. Gulf Finance House Commercial Bank BSC Shamil Bank of Bahrain EC Bank Syariah Mandiri International Investor Company, K.S.C. (The) Kuwait Finance House Albaraka Islamic Bank BSC (EC) Pakistan Branches Meezan Bank Limited Qatar International Islamic Bank Qatar Islamic Bank SAQ Al Rajhi Bank Bank Albilad Sudanese Islamic Bank Abu Dhabi Islamic Bank - Public Joint Stock Co. Dubai Islamic Bank plc Sharjah Islamic Bank Islamic Bank of Britain Plc Saba Islamic Bank Shamil Bank of Yemen & Bahrain

Country Name

Total Customer Loans

Total Deposits

Inputs Total Other Earning Assets

Personnel Expenses

Noninterest expenses

Bahrain

505.4

944

794

49

68

Bahrain

145.4

98

41

1

3

Bahrain

262.5

1,092

1,073

18

13

Indonesia

589.0

734

196

16

20

Kuwait

52.0

0

130

12

22

Kuwait

9,741.0

11,887

5,614

148

114

Pakistan

123.6

198

113

2

2

Pakistan

331.8

430

101

6

6

Qatar

948.9

1,425

762

12

9

Qatar

1,705.2

1,893

881

20

12

16,140.6

20,250

8,492

211

231

1,419.5

1,046

372

28

40

20.1

82

20

2

11

UAE

3,637.6

5,373

2,276

40

19

UAE

9,829.2

10,209

1,522

91

59

UAE

1,246.1

837

203

17

6

UK

142.0

82

0

6

7

Yemen

126.8

256

100

2

1

Yemen

769.3

1,092

566

18

15

Saudi Arabia Saudi Arabia Sudan

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Tadhamon International Islamic Yemen 402.9 636 116 Bank Source: Bankscope Database for the year 2005 in USD millions.

Table 6: Islamic Bank Cost Efficiency Results Country DMU Bahrain Indonesia Kuwait Pakistan Qatar Saudi Arabia Sudan United Arab Emirates United Kingdom Yemen

Arcapita Bank Gulf Finance House Commercial Bank BSC Shamil Bank of Bahrain EC Bank Syariah Mandiri International Investor Company Kuwait Finance House Albaraka Islamic Bank BSC Pakistan Branches Meezan Bank Limited Qatar International Islamic Bank Qatar Islamic Bank SAQ Al Rajhi Bank Bank AlBilad Sudanese Islamic Bank Abu Dhabi Islamic Bank Public Joint Stock Co Dubai Islamic Bank plc Sharjah Islamic Bank Islamic Bank of Britain Plc Saba Islamic Bank Shamil Bank of Yemen & Bahrain Tadhamon International Islamic Bank

3

2

Score 0.248027 1 0.957929 0.296662 0.144435 1 1 0.405081 1 0.850611 1 0.45186 0.664887 1 1 1 0.301521 1 0.486453 1

5. Conclusions This paper examined the profitability and economic efficiency of Islamic banks and then compared these results with the same bank's involvement in Islamic financing activities as well as the nature of those activities. Using a sample of 20 banks from 11 countries, we found no obvious pattern existed between the profitability, Islamic financing and efficiency. This outcome, however, may more reflect differences in the development of the banks concerned, the impact of their regulatory environment, accounting practices and other country specific matters rather than their Islamic practices. The differences in their type of Islamic financing may prove just as important. Investments by Islamic banks, for example, have tended to be short term in nature and yet a major ethical importance and significance of Islamic banks is their ability to share in the profits and losses of long term projects. Unlike most commercial banks, Islamic banks are able to provide equity finance to entrepreneurs with excellent ideas, but limited funds. Given their predominance and potential expansion possibilities in a


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number of less-developed and large Muslim population countries, such as Indonesia, the importance of this venture capital type funding cannot be overlooked. Islamic banks taking a longer viewpoint and the additional equity risks in these projects should be held in high esteem as an equitable means to fund entrepreneurs with good ideas, that perhaps due to circumstances of their country’s economic development (beyond any individual’s control), are still able to develop profitable projects. Unfortunately, the typical types of transactions for an Islamic bank include leasing, purchase and resale transactions (Murabaha and Ijarah). Less than 2% of most Islamic bank’s investments are in the form of equity finance where they engage in profit and loss sharing (Mudarabah- trust financing or limited partnership and Musharakah – joint venture (investment not required to be paid back). As part of their social significance should be their ethical consideration, care needs to be taken to examine them in relation to not only traditional measures such as profitability and cost minimisation, but also with their ethical investments such as Islamic operation and profit and loss sharing based on the higher risk equity relationship with customers. The later requires more time and hence more costs involved, especially initially as the project is set up. Although a number of banks with equity investments reported low cost efficiency results, these banks should still be applauded for their stance.

References Ariff, M., (1988), Islamic banking, Asian-Pacific Economic Literature, Vol. 2 (2), pp. 48-64. Banker, R.D., Charnes, A. and Cooper, W.W., (1984), Some models for estimating technical and scale inefficiencies in data envelopment analysis, Management Science, Vol. 30 (9), pp. 1078-1092. Brown, K. (2003), Islamic banking comparative analysis, Arab Bank Review, 5 (2), 43-50. Brown, K., Hassan, M.K., & M. Skully (2007), Operational Efficiency and Performance of Islamic Banks, in the Handbook of Islamic Finance, Edward Elgar, London, Edited by M. Kabir Hassan, and Mervyn K. Lewis., 96-115. Chong, B. and M. Liu (2009), Islamic banking; Interest-free or interest based? Pacific Basin Finance Journal, 17:125-144. Cihak, M. and H. Hesse (2008), Islamic Banks and Financial Stability: An empirical analysis, IMF Working Paper No. 08. Cooper, W.W., Seiford, L.M., and K. Tone, (2000), Data Envelopment Analysis, Kluwer Academic Publishers, Massachusetts. Dar, H.A. and Presley, J.R., (2000), Lack of profit loss sharing in Islamic banking: Management and control imbalances, International Journal for Islamic Financial Services, 2(2): 1-16. Haniffa, R., and M. Hudaib, (2007) Exploring the Ethical Identity of Islamic Financial Institutions via Communication in the Annual Reports, Journal of Business Ethics, 76(1): 103-122. Haron, S. and W. Azmi (2008), Determinants of Islamic and conventional deposits in the Malaysian banking system, Managerial Finance, 34(9): 618-643. Hassan, M., (2006), The X Efficiency of Islamic banks, Islamic Economic Studies, 13(2): 49-78. Hassan, M. and M. Lewis, (2007) (editors), Handbook of Islamic Banking, Cheltenham: Edward Elgar.

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Iqbal, M. (2003), Islamic Banking In Theory and Practice, presented at the International Islamic Banking Conference 2003, Prato, 9-10th September. Kahn, M and M. Bhatti (2008), Islamic banking and finance: on its way to globalization, Managerial Finance, 34(10): 708-725. Mokhtar, H., N. Abdullah and S. Al-Habshi (2006), Efficiency of Islamic banking in Malaysia: A stochastic frontier approach, Journal of Economic Cooperation, 18(1): 5-22. Yudistira, D. (2004), Efficiency in Islamic Banking: An empirical analysis of eighteen banks, Islamic Economic Studies, 12(1): 1-19.

Appendix A: Concentration of Islamic Banks vs. Muslim Population

Source: Brown (2003)