Editor's Notes

Citation

Hassan, M.K. (2014), "Editor's Notes", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 7 No. 1. https://doi.org/10.1108/IMEFM-02-2014-0021

Editor’s notes

Article Type: Editorial From: International Journal of Islamic and Middle Eastern Finance and Management, Volume 7, Issue 1

A central issue in Islamic finance is the degree to which risk, uncertainty and speculation may enter into economic transactions. Excessive speculation or serious gharar is generally not allowed under Islamic principles. However, exceptions can be made; for example, if the overall benefits to society outweigh the potential harm that is caused. This has precedent in Islamic teaching. For example, the Prophet allowed the sale of fresh dates in exchange for an agreed upon quantity of dried dates. While this transaction meets the typical definition of gharar, it has been interpreted that the needs of the people to alleviate hunger through the transaction make it permissible under Islamic law. The interpretation of this law to modern day financial market speculation is more challenging.

Financial market speculation involving monetary financial assets would typically meet the criteria of gharar under Islamic law. This is because it focuses on secondary resources, monetary instruments and away from primary economic investments, which are those that ultimately benefit society the most. From this perspective, it is clear why total prohibition of speculation would be warranted under Islamic law. However, speculation may provide some benefits that offset the misallocation of production resources caused by the speculative process. Speculation can provide a significant amount of liquidity to financial markets. Additionally, economic agents have more incentives to invest in primary transactions when they know there is a liquid and active secondary market. Thus, if the act of speculation has positive externalities on the primary markets for real goods and services, there may be a legitimate purpose for some speculation in Islamic finance.

Like the cost–benefit analysis conducted by the Prophet to determine the appropriateness of gharar, it may be necessary to strike a similar balance with regard to restrictions on secondary market transactions and speculation. Islamic financial markets should allow secondary market activities up until the point when the liquidity is more beneficial and primary market spillovers reach the point of diminishing returns. At that point, the deleterious effects to the economy in terms of stability and wealth concentration constitute gharar and are prohibited under Islamic law. Thus, there may be an optimal amount of regulation that needs to be established regarding the use of speculation and secondary markets in Islamic capital markets.

The fact that secondary market transactions can generate liquidity for primary markets motivates the concept that some form of monetary transactions in the secondary markets may be acceptable under Islamic law. However, more conservative Islamic scholars have often held that money-for-money transactions amount to essentially wasted resources that should be funneled to more productive socially beneficial endeavors. They argue that these types of transactions harm society in the form of opportunity costs in this manner and should therefore be prohibited from Islamic finance. However, this argument ignores the liquidity that is generated by speculation in secondary markets. The more moderate viewpoint asserts that it is beneficial for society to allow a certain amount to speculation. However, at some point, economic opportunities in the primary market decrease and secondary markets serve no purpose other than to transfer wealth through speculation and monetary transfers. Thus, the optimal regulatory policy is one in which the optimal amount of liquidity is generated in the secondary market. However, this optimal value of liquidity is a concept that is difficult to quantify.

For stock speculation in secondary markets to not be considered gharar under Islamic law, it must benefit society by generating primary market opportunities that offset the potential misallocation of resources. This optimal amount of liquidity can only be determined by an empirical investigation as to the relationship between secondary market liquidity and primary market transactions. Any estimation of this effect would be ambiguous at best. Therefore, there is still a great deal of argument regarding the applicability of speculation into Islamic capital market and any regulations attempting to establish an optimal amount of speculative behavior would be somewhat ad hoc. Thus, the use of speculation and the differentiation between speculation and gharar in Islamic capital markets is a key issue in the evolution of Islamic finance. It can be a valuable addition to Islamic society to capture the benefits that liquid secondary markets can have on the primary market transfer of goods and services. However, without a way to accurately measure the cost–benefit relationship present with gharar, a precise regulatory or monetary policy tool that solves this issue will be unlikely.

The first paper in this issue is by Ibrahim et al., and it examines the issues of hoarding and wealth accumulation, which have important implications in Islam. Islamic principles encourage the fair distribution of wealth, and thus discourage the hoarding of monetary assets. However, by its very nature as a store of value, money has the ability to be hoarded in a way that is inconsistent with the teachings of Islam. The paper presents the scholarly positions regarding the accumulation of excessive wealth, as it relates to Islamic doctrine. Furthermore, it examines how money plays a role in the modern application of wealth accumulation. In addition, it suggests that zakat (wealth tax) may be insufficient to satisfy the Islamic prohibition of hoarding in a modern sense. Also, the authors recognize the development of modern Islamic financial instruments, such as sukuk, as being important financial tools that can be used to alleviate hoarding and circulate wealth. The development of sukuk and other Islamic financial products can prove to be significant tools in fighting excessive wealth accumulation going forward. The issue of excessive wealth accumulation is important, and even Western economies are recognizing the damage that wealth inequality can cause on society. This paper brings to light the importance of understanding the extent to which hoarding wealth is prevalent in modern Islamic economies and highlights the importance of using modern financial products and practices to further Islamic goals.

The second paper is by Hasan and analyzes the internal governance of Islamic financial institutions (IFIs) from a Shari'ah compliance perspective. The intent of the study is to gather Shari'ah scholars' perception of banking governance across six areas:

1. internal framework, role and function of the Shari'ah board;

2. the attributes of the Shari'ah board members in terms of independence;

3. competency and transparency;

4. confidentiality;

5. operational procedures; and

6. performance assessment.

The authors conducted semi-structured interviews with scholars who are members of various IFIs and found that there are weaknesses in all of the six dimensions of governance under review. This is an important finding and sheds light on the relevance of the continued study and development of Shari'ah oversight practices within the Islamic financial industry.

The third paper, by Bekri et al., examines the issue of investing in the context of IFIs. Speculation in investing is generally forbidden under Islamic principles. Therefore, portfolio managers at IFIs must take great care to use reliable and relevant tools to mitigate the risk and uncertainty taken when investing. This paper examines the limitations of many of the standard models currently being used for this purpose. More importantly, the authors develop a framework for the development of more reliable models that focus specifically on accurately modeling the effects of extreme volatility. Empirical tests show that these models are able to mitigate a great amount of the risk exposure to Islamic stocks. This research has important potential applications to Islamic investment practices going forward.

In the fourth paper by Lahrech et al., the authors examine the managerial reporting in the context of sharing arrangement profits and losses with account holders. The goal of the paper is to access the degree of transparency with regard to Islamic bank's reporting of the shared losses and profits with account holders as well as whether the bank's performance affects management's incentives to distribute those profits and losses. The empirical framework consists of data from a sample of 25 Islamic banks from 2006 to 2010, and a generalized least squares methodology is used to test the impact of transparency. The results show that greater transparency reduces the degree to which banks can hide their profits (losses). Thus, investment account holders have more information and are in a better position to manage their assets and maximize their investments. Additionally, the results show that better operating results tend to induce managers to distribute profits (losses) to account holders. The study has significant governance implications. Internal and external regulators may be interested in establishing practices that make Islamic banking more transparent, thus giving account holders more information and control over their investments.

In the fifth paper, Nur Azura BT. Sanusi examines the impact of zakat (wealth tax) and corporate income taxes on firm capital structure. The study is unique in that, aside from adding the influence of zakat to the capital structure literature, it also contributes to the already vast literature on capital structure by showing the impact on Islamic-style debt and equity financing within firm capital structure. The empirical analysis uses a sample of Malaysian firms traded on the Kuala Lumpur stock exchange from 1996 to 2006. The 422 sample firms are all listed as Shari'ah compliant and thus pay the wealth tax. The results show that there is a positive relationship between the wealth tax and the level of debt financing, meaning that wealth taxes provide incentives for firms to finance with debt. Second, as the corporate tax rate is raised, there is an incentive for firms to utilize debt financing as well. This paper is similar to many studies on capital structure, with the addition of zakat as an additional tax on the firm, which has important implications for capital management, especially in Islamic economies.

In the sixth paper by Abdou et al., the authors use a neutral network framework in the UK to distinguish between good and bad borrowers in Islamic house financing market. Using a dataset of 487 applicants with 336 accepted and 151 rejected, the authors examine the crucial variables of these two groups of Islamic housing applicants that distinguish them. Out of three techniques such as discriminant analysis, logistic regression and multilateral perception neutral network, the authors find the neutral network has the lowest misclassification error between accepted and rejected applicants in Islamic housing finance market in the UK. In addition, the neutral network model identifies monthly expenses, age and marital status to be the most critical variables in differentiating these two groups.

The last paper in the issue, by Aladwan et al., discusses important issues in human resource management (HRM) in the country of Jordan. There are four key elements of HRM that the authors wish to analyze:

• recruitment and selection;

• training and development;

• performance appraisal; and

• reward and benefits.

The paper discusses these four issues and their relationship to social factors, political environment, economic issues and cultural values. The authors report that the Jordanian HRM practices are inefficient and deserve attention. The recruitment and selection process is found to be inadequate, and time spent on training and development is often thought to be unnecessary. Ineffective HRM practices can cause productivity to be suboptimal, even for highly skilled workers. Developing better HRM practices such as the training of skilled employees can increase human capital in Jordan and allow the workforce to be more productive. This paper highlights the need to focus on HRM development in this part of the world.

M. Kabir Hassan

Reference

Tag el-Din, S. and Kabir Hassan, M. (2007), “Islam and speculation in the stock exchange”, Chapter 15, in Kabir Hassan, M. and Lewis, M. (Eds), Handbook of Islamic Banking, Edward Elgar Publishing Company, Cheltenham.