Abstract
This dissertation formulates a research dissertation and strategy for a study into the impact of Islamic banking on the economic development of societies within which such banks operates. To this end, the research examines the major tools and impacts of Islamic banks on society by conducting a literature review. This is followed by the deduction of research questions and a hypothesis that will be used to form the parameters of the entire research. The purpose of this dissertation is to investigate the relationship between the growth of Islamic banking worldwide and economic development of countries wherein this growth is present.
The study proposes that a qualitative research will be conducted that will include the utilisation of a deductive research approach. This will lead to the use of positivist methods to examine and review various different elements of the features of Islamic banks and how they affect the society they operate within. For the purpose of this dissertation, a literature review of existing relevant publications is performed. Major advantages and disadvantages of Islamic banking and comparing it with conventional banks are analysed based on literature review. Consequently, research questions are formulated on the basis of proposed hypotheses to be used for further research.
Quantitative methodology represented by econometric technique is used to estimate the relationship between Islamic banking development and real GDP per capita growth, as one of the primary indicators of economic growth. Qualitative methodology implemented from World Bank and Bankscope is be used to assess contribution of Islamic banking in economic development of the states wherein it is present.
Introduction:
Islamic banking is gaining popularity in different parts of the world today. It is identified to be one of the fastest growing segments of the financial market industry, operating in over 75 countries through 300 institutions (Johnson, 2013). Traditionally, it was a form of banking that was only restricted to Islamic countries (Imam & Kpodar, 2015). However, with the migration of Muslims to non-Muslim countries, Islamic banks have become more popular in these countries and they have gained roots in different places and communities. Gewal (2013) estimated that in 2012, Islamic banking accounted for more than USD 1.6 trillion in assets and is expected to grow almost six fold to USD 6.1 trillion within the next ten years.
Islamic banking has elements of religious pointers that are divergent and different from banking in the western world. This includes aspects of Shariah Law which bind both the banker and the banking client (Foster, 2009). Most of these standards and regulations are steeped in laws and regulations in Islamic law and tradition that binds Muslims in their conduct with fellow Muslims.
Islamic banking introduces the concept of collective efficiency which is about putting collectivism ahead of self-interest, individualism and materialism or consumerism (Sahid, 2007). This comes with various views in the West. Many scholars in the western world view Islamic banking as an obstacle to development in Muslim countries (Sarwer, et al., 2013). Others see it as the main means through which Islamic nations in the world can develop and enhance their structures.
In spite of the relatively small volume of trade by Islamic banks, they are often positively associated with economic growth (Imam & Kpodar, 2015). Khan and Porzio (2010) identified that Islamic banking promotes savings, investments and the proper management of the resources of a given community. However, when compared to the west, it appears that Islamic banking promotes collectivism which encourages large family sizes and prevents people from saving and earning enough money to attain a higher quality of life. The fact that Islamic banking leads to high results but is based on a system of collectivism creates a paradox.
There is a positive relationship between financial development and economic growth (Khan and Porzio, 2010). If the financial sector directs its resources to productive areas, it leads to significant stimulation that leads to an overall economic growth. Economists agree that the level of general financial development is currently of more import than the organizational structure of financial system and whether it is focused on bank sector or market sector. In general, financial institutions perform five basic functions, which contribute to economic development: trading facilitation, resources allocation, corporate control performance, savings mobilization and promotion of goods, works and services exchange. The level of development of the financial sector, the amount of financial sources to be properly allocated, an increase in capital formation contributes to better and faster economic growth. From this perspective, Islamic banking represents a significant component of the financial system of both Muslim and non-Muslim countries and consequently becoming a driving force of economic development in a growing number of states.
The economic development is a complex economical and social process by which a country is gradually saved from economical underdevelopment and poverty, achieving higher and higher levels of growth. It consists of two fundamental components: 1) economic growth; 2) changes in the structure of economics. Economic growth signifies an increase in national production over time; it is displayed per capita and represents a narrower term comparing to the economic development. What is also important is human development “which is defined as an expansion of possibilites of choice, i.e. the increase of a number of options people have” (Human Development Report, 1990). The basis of this quantitative research analysis is conducted with the help of descriptive statistics. The value of this particular type of methodology is that it managed to enable some key insights concerning the present and possible future state of Islamic banking (Cozby 2009).
A great attention should be directed toward Islamic countries, because of their increasing growth and participation in world economy (Croasmun & Ostrom 2011). The important variables for observation are the following: 1) Development of Islamic banking; 2) Development of the overall banking system. A control of certain variables is also important (e.g. initial real GDP per capita and inflation).
Motivation and Purpose
The purpose of this dissertation is to design and formulate a research question and approach that can be used to study the contribution of Islamic banks to the economic development of societies. The aim of this dissertation is to establish the relationship between Islamic banking development and real GDP per capita growth as one of the primary indicators of economic growth design, and compose research questions, choose and justify a proper approach to be used in studying contribution of Islamic banking to economic development. This will include the review of relevant ideas and concepts that are relevant to Islamic banking and how it aids in improving the economic elements and aspects of the society within which it operates.
Chapter 1
Literature Review
Literature Review
Some scholars view Islamic banking as a form of banking that is based on Islamic law or Shariah which ensures that all banking activities in this form of banking is guided by Islamic laws and principles (Bellalah, 2014). Islamic law is bound by various schools of Islamic jurisprudence which answers some specific questions relating to how things must be done on some issues (Jonsson, 2006).
Features of Islamic Banking
This dissertation focuses on the distinct features of Islamic banking and its advantages over conventional banking and financial transactions. The peculiarities of these advantages are a possible explanation why under certain circumstances Islamic banks are able to deliver better results in terms of economic growth as compared to conventional banks. The benefits of Islamic banking include, but are not limited to, the following:
Encouraging Non-collateralized Loan:
-Islamic banks encourage non-collateralized loan facilities to. Compared to the banking system in Western countries characterised by availability of collateral or guarantee, Islamic banking is characterised by “risk-sharing”; simply put, this means that the bank and the customer agree to share the profits as well the losses without having to resort to guarantees. Risk sharing encourages increasing investments among individual borrowers who are unable to get a loan with conventional banks due to absence or lack of assets that can be used as collateral. From this perspective, Islamic banks can be classified into two major groups. The first group practices “profit-and-loss sharing (PLS), i.e., the granting of a loan in return for future profits if the venture succeeds (ISRA, 2012). PLS contracts include musharaka or “equitable participation,” and mudharaba or a “sleeping partnership.” The second group of banks is where the customer usually needs liquid assets to carry out a certain project. The bank acquires a productive asset the client needs and gives the client access to the asset, subject to specified fee. Honohan (2001) noted that this type of contracts concerns mainly ijarah or leasing, murabaha or instalment sale etc. According to Naceur et al. (2015), there is a marked increase in physical access to financial services within the member countries of the Organization for Islamic Cooperation, though the use of such services does not keep up with its offer.
Prohibition of Riba (Usury):
An additional advantage of this peculiar feature of Islamic banking is the prohibition of riba or interest rates. Islamic banking prohibits the collection of interest (riba) and considers it a wrongful appropriation of property belonging to others (Kettell, 2011). This is because the Quran states it in as many as four sections that giving loans with an interest is against the fundamental will of Islam. Therefore, a Muslim is meant to view it as a major prohibition and must not indulge in such an act. This ruling is consistent with the Christian and Judaic tradition that prohibits usury amongst coreligionists.
Islamic Law or Shariah Compliant
- Islamic banking is based on Islamic law or Shariah, which ensures that all banking activities are guided by Islamic laws and principles (Bellalah, 2014). Religiously devout Muslims do not use services of conventional banks owing to religious factors. Instead, pious Muslims prefer to put their savings in the Islamic banking system, as these are anchored on Islamic religious and conform to their religious beliefs. According to Demirguc-Kunt et al. (2013), only 24 per cent of Muslim adults from 64 countries explored have a bank account contrary to 44 per cent of non-Muslims with a bank account in the same countries. This means that further introduction of Islamic banking is likely to promote financial intermediation and satisfy the need of financial services of Muslims who live in non-Muslim countries and reject using the services of conventional banks. With growing population of Muslims in non-Muslim states, bringing them to banking sector with the help of introduction of financial products in a suitable form would contribute to general economic development of the country they live in.
Contribution to Financial Stability
- Islamic banking contributes to financial stability. The usage of complex financing instruments, wholesale financing and high level of leveraging contributes to the perceived weaknesses of conventional banks. On the other hand, Islamic banking prohibits speculative transactions and agreements that are characterised by a high level of uncertainty. Shariah generally prohibits derivative products due to their speculative nature. In addition, there are no balance sheet mismatches in Islamic banking. Mirakhor (2010) points out that the use of short-term deposits for short-term trading, and long-term deposits for long-term trading, ensures absence of asset-liability mismatch. Such an approach combined with risk-sharing feature creates a system with less inclination to crises (Hassan, M. and J. Dridi, 2010). Moreover, an added advantage attributed to Islamic banking is that this helps diversify the entire banking system of the given state, and promote financial stability and general economic development.
Forbidden of Immoral Projects
- Islamic banking is inextricably connected with religion. Consequently, Islamic banks are not allowed to finance immoral projects or projects, which might inflict harm to the society. For example, gambling and other “immoral” ventures are rejected in the practice of Islamic banking. The moral aspect is certainly the least aspect to be taken into account by Western financial systems and conventional banks; however, it is worth to mention that moral constraints inherent in Islamic banking are a foundational pillar. When united in a common financial system, conventional banks may certainly undertake unethical or ambiguous projects, Islamic banks can promote financing of morally acceptable projects (ISRA, 2012).
Islamic Banking & other form of Banking:
The Islamic Financial Service Board (IFSB) provides various regulatory and guidance support for Islamic banks and this is often based on Islamic jurisprudence and guidance which might be different from what the Basel Convention and its regulations might prescribe for other banks (Ahmed, 2010). This shows the distinction between Islamic banking and other forms of commercial banking known around the world.
There are different norms and incentives for Islamic banking and this causes the consumers to behave in different ways and achieve different results (Weill, 2011). However, the level of the institution of Islamic banking varies across nations around the world. In most countries, Islamic banking starts in an embryonic phase where a minimal presence exists within a given country (El-Ghattis, 2012). However, it grows into an emerging phase and then to a consolidating mature phase (El-Ghattis, 2012). Finally, Islamic banking matures and there is customer relationship management, competition which leads to differentiation and the specialization of specific banks (El-Ghattis, 2012).
Principles and Functions of Banks:
There are evident differences between Islamic banking and conventional banking. The major difference between the Islamic banking and conventional is the functions of operating. Islamic banking is based on the principles and the laws of Islamic religion (Hanif, 2014). They are commonly known as Shariah law. On the other hand, the functions and operating modes of the normal banks are all based on the principles that are made by persons. These principles are primarily from the capitalism theory. The normal economics theories and principles are applied on the conventional banks as opposed to Islamic banking. Again, the Shariah law aims at maximising the profits of the profits. However, the maximization are based on the Shariah restrictions (Hassan & Lewis, 2009). However, on the conventional banking, profit maximization is usually calculated and illustrated by use of the derivative trading. Therefore, the profit maximization of the customers is different.
Risk and loss sharing:
The other difference between the Islamic and convention banking is in the sector of risk sharing. The modes of risk sharing and between investor and the entrepreneur in both banks is different. In the Islamic banking, the bank promotes the risk sharing between the capital or the investor, or the user of funds (Abedifar, et al., 2013). On the other hand, the investor or the lender is guaranteed the repayment at agreed interest rate. That is the reason why conventional banks requires guarantee before lending any amount.
Provision of Fines on Default Payment:
Provision of fines to defaulters used to earn on extra money the other difference between Islamic and conventional banking. Islamic banking does not charge extra charge to the defaulters. Defaulter only pays the compensation of defaulted amount. This service is provided as a typical charity (Farahani & Dastan, 2013). The early settlement of the bank’s discretion is rebated. Conventional banks usually charge extra money to the known as penalty. The compounded interest may also be complied with the defaulter of the cash.
Fundamental Purpose of the Banks:
There is another notable difference in two type of banking that is the fundamental purpose of the banks. The fundamental purpose of Islamic banks is partnership in the in business with other business units (Hanif, 2014). Therefore, the banks should understand the venture and therefore the banks diversify. They operate on the mode called, know your customer orientation. The fundamental function of the conventional banking is lending money to business partners and getting them back at interest. The interest maybe either simple or compounded. Profit is the aim and the motivation of the conventional banking institution. Again, there is a changes in the Islamic banking system. The most common service oriented function associated with the Islamic of the Zakat collection centre (Sarwer, Ramzan & Ahmad, 2013). They also pay their Zakat. On the other hand, the conventional banks do not deal with the Zakat.
Conditions and Roles:
Many Islamic roles carried out by the Islamic banks are incorporated with the Islamic culture. Due to their importance, and the public interests attached to the Islamic banks, commonly known as Maslahah, its main aim is to ensure growth with the equity (Weill, 2011). Conventional banks often put the interest in the fore front. It therefore makes little or no effort to provide room for economic growth. The other Islamic culture requires that the Islamic bank be based on the Shariah underlying transaction (Uppal & Mangla, 2014). Therefore, it is relatively uneasy to borrow bank from Islamic banks compared to the conventional banks. Conventional banks are interest oriented and it is the reason why it is cheap to borrow money/loan from their banks. Since Islamic banks are required by the Islamic law to share the profit and the loss earned to the public, it pays great attention to the development project appraisal and evaluating the projects it has financed. Money from the conventional banks is obtained from fixed loan interests. (El-Ghattis, 2012) Therefore, less concentration is awarded to the project development appraisal projects. Risks of banks are transferable to the consumers through variations of process.
Islamic Banking & Economic Development
Islamic banking is development oriented because like all other financial institutions, they act as a point of encouraging savings and this helps to promote investment and development. Islamic banking is focused on mobilising deposits, providing finance and developing and Islamic capital markets to fund corporate endeavours (Venardos, 2012). This means that it is a vehicle through which money and resources of Muslims in a given community can be gathered and optimised for the achievement of the best results for the entire society and community.
Short and Long Term Economic Growth
There have been many studies conducted into the efficacy of Islamic banks in promoting development in various countries and economies. Results indicate that in the long-run, Islamic banks often has a positive correlation with economic growth (Farahani & Dastan, 2013). The study shows that Islamic banks’ activities’ correlation with economic growth is significant and this has a strong impact on the economy. There is additionally, a strong correlation with capital accumulation which aids in breaking the cycle of poverty in any country (Farahani & Dastan, 2013).
Although evidence exists that Islamic banking promotes economic growth in the short run and long run, it is apparent that long-run correlations are far stronger than the short-run correlations (Farahani & Dastan, 2013). This is often viewed in the relativistic sense where Islamic banking is compared with western or Eurocentric banking which often yields results by imposing interests or a cost of capital which leads to profits for people who led money.
However, other studies show that although Islamic banking might not be the most preferred choice for short-term earnings, it is apparent that the short-term inputs yield very good and cooperative long-term results (Abduh & Omar, 2012). This is because Islamic banking causes important stakeholders to forego some of the benefits of short-run lending and its related activities. On the other hand, these short-run sacrifices give room and impetus for long-term mobilisations and strong growth that influences and affects development in the most positive and most profound way and manner.
Positive Impact on the Economic Development of Poor Countries
Other studies show that Islamic banking has a positive impact on the economic development and growth of some of the poorest countries on the planet. Abduh and Chowdury (2012) identify that Islamic banking has a strong relationship with the development of Bangladesh although it was introduced just about three decades ago. The study shows that Islamic banking provides the atmosphere and economic situation in which money can be mobilised in some of the poorest countries on the planet. And this money can be used for the improvement of the lives of people in the community. Evidence shows that Islamic banking could be a policy alternative that a poor country’s government can utilise to improve income generation and develop the economy (Abduh & Chowdhury, 2012).
Additionally, Islamic banking is directly linked to poverty alleviation programmes in communities they operate within. This includes Islamic charities and other educational and community development ventures. These activities involve the provision of services for the poor and unfortunate in the society. This often leads to short-term reductions in profits. However, in the long-term, they help to build relationships with members of the community and form a strong social-security system for the society at large (Hassan & Lewis, 2009).
Definition of Economic Growth
Economic development is indicated by the increase of the quality of lifestyle of the citizens. Quality life is usually measure by human development index. It is an index that look beyond the financial quantity per person. It its measurement that considers the many personal factors commonly known as the intrinsic personal factors (Farahani & Dastan, 2013). These factors considered by the economic development are not included in the measurement of the economic growth. They include components such as literacy rates, life expectance, population growth and poverty growth among others (Johnson, 2013).
Economic Growth and Economic Development:
It is worth noting that in most cases, economic growth leads to economic development. However, economic growth, is indicated by an increase by the country’s rise in Gross Domestic product (Abduh & Omar, 2012). It does not consider the intrinsic factors considered in the measurement of economic development such as leisure time available for citizens, the quality of environment, and freedom from expression (Bellalah, 2014). Use of economic development index, life expectance and literacy level indicates a higher per capita.
The comparison of economic growth is different from the economic development in terms of measurement. Growth is usually limited to the increase in income per capita. Therefore, its man weakness is that it does not give the right picture of development of a given country. It measures the development quantitatively while economic development measures the development qualitatively (Sahid, 2007).
Features for Countries to have Economic Development:
Nowadays, for a country to be considered as growing there are features that are considered. There must be industries and people should be able to plan for their activities in long run, therefore the country should have both political and monetary stability. The investments of such country will not be sacrificed toward the immediate consumption of the people before the future consumption (Foster, 2009). The degree civilisation and the level of education must be high and growing for a country to be said to have economic development. Lastly, the decisions made takes care and protection of the eco-system. A country without these features cannot be said to have economic growth.
Financial development and growth in general and Islamic banks
The growth on the Islamic banking has raised interest in the latest economic literature. Islamic banking is associated with the financial growth most in the Islamic countries. The effect of Islamic banking is bringing to the Islamic countries is great that the impact of the conventional banks in non-Muslim countries (Sarwer, et al., 2013). Just like conventional bank’s role in the development, Islamic banks are playing great role in raising the GDP of Islamic countries. Islamic banking is more acceptable with large population. It is because it does not attach much interests on loans extended to customers (Jonsson, 2006). There is record of growth of Islamic banking and hence it represents financial growth to the Islamic countries. The Islamic banking is growing due to the mode of its operation.
Islamic banking encourages borrowing. It does not attach much interest on loan. They mostly depend on guarantee or collateral. In care of risk, the banker shares the risk with the customer. In so doing it encourages borrowing that eventually results to the economic and financial growth (Venardos, 2012). Again, financial banking is important the moral growth. Rules of banking are based on moral religious value; hence it finances the projects that are not harmful to the society. However, financing particular types of projects is disadvantage because it causes unbalanced in the economy (Hanif, 2014). Therefore, Islamic banks should work with conventional banks so that projects that are not financed by Islamic banking are financed by conventional banks, thus ensuring balanced growth of economies.
There is noticeable development in the Islamic banking. However, the shortcoming of Islamic banking is its size. The size of Islamic banking is small compared to the conventional banking (Iqbal & Molyneux, 2005). It will be difficult to bring large effect on financial growth with the current size. In spite of this, it is developing and thus there are many changes that are expected from its growth (Abduh & Chowdhury, 2012). Many counties are adopting Islamic banking. Countries with Islamic banking have some developments have been recorded such as improved standard of ratios of return on equity, and favourable return on assets. These are indicators of financial development. There is literature that supports that financial deepening in the sector of financial banking stimulating growth. Conventional banking is working on achieving increasing the financial development by controlling the ratio of credit by the banks and the Gross Domestics of respective countries (Foster, 2009).
Disadvantages of Islamic Banking:
Yet, Islamic banking also has certain disadvantages, which cannot be turned a blind eye to.
- Islamic banks are usually new and smaller in size, as compared to conventional banks. This results in higher cost structures (Hassan, M. and J. Dridi, 2010). Yet, this disadvantage is likely to be mitigated with time when industry grows.
- The lack of “liquid instruments” forces Islamic banks to have big liquidity buffers and puts them at a disadvantage as compared to conventional banks (Moody’s, 2009) . One of the solutions to this problem was the establishment of the “International Islamic Liquidity Management Corporation” in 2010. The main objective of this organization is the issuance of Shariah compliant financial instruments and enable provision of improved liquidity solutions for the management of institutions with available packages of Islamic financial services.
In conclusion, Islamic banking has both advantages and disadvantages. Risk-sharing and financial stability promote to general wellbeing of financial system and further economic development. Yet, the lack of liquid instruments and economies of scale aggravate position of Islamic banks worldwide. While there is a number of empirical studies related to cause and effect relations between financial growth and economic development, the role of Islamic banking in this interdependent system is still insufficiently studied. This dissertation aims at filling in this gap.
Hypothesis Development
H1: The activities of Islamic banks and intensification of the activities of Islamic banks directly increases real GDP per capita growth.
H2: Activities based on risk sharing like loans and equity asset management promotes financial growth and further economic development of the country wherein Islamic banks are present.
H3: Islamic banking positively influences government expenditure, trade, education and inflation and this leads to an improved economy.
Research Question
On the basis of the basic findings of the background of study, the central research question can be formulated. The aim of this study is to “ascertain how Islamic banking can help in the economic development of societies they operate within”. In order to achieve this purpose, the following objectives will be explored:
A critical review of the absolute and relativist features of Islamic banking and how it defines the operations of the system;
An evaluation of the short term social and economic contribution Islamic banking makes to society in relation to risk sharing and its related activities.
An assessment of the short term and long-term results of the performance of Islamic banking on macroeconomic trends of nations they operate within.
The research will first commence by identifying what Islamic banking is. This will include an absolute and relativist definition of Islamic banking. The goal is to try to deduce Islamic banking in space and time and show how it operates similarly or distinctively from other forms of banking. On the basis of this, there could be an inquest into how the uniqueness of Islamic banking influences the society within which it operates.
The short-term contributions that Islamic banking makes to the society will be reviewed. This will include the social, as well as economic contributions Islamic banking makes to the development of the society on a daily basis. This will review the operations and how uniquely Islamic banking transactions influences and affects communities and the people who benefit from it. The short-term trade-offs will be evaluated alongside the impacts.
Eventually, the long-term results of the performance of Islamic banking will be analysed in this study. This will include the implications and actual impact of the projects and activities that are carried out by Islamic banks. This will show how the performance and activities of Islamic banks affect the entire society and the community at large. This will show important trends and procedures that are carried out by Islamic banks and the society at large.
Methods and Procedures
This research is going to be a deductive research. Deductive research is done by writing a testable proposition and from there, establish the relationship between the two variables of the research (Collins, 2010). This study presents the proposition that Islamic banking contributes to the economic development of the society within which it operates. Obviously, every organisation or bank contributes something to the society. However, the essence of this study is to show and prove what exactly Islamic banking brings to the community and society within which it operates.
The research will be done through quantitative research. This is summarized as follows
The macroeconomic analysis will be represented by econometric technique will be used to estimate the relationship between Islamic banking development and real activities that determine macroeconomic indicators. Some indicators of Islamic banking development will be used for this purpose. The rate of trade, inflation, government expenditure and education will be critiqued and this will be used as an indicator of macroeconomic factors and how they relate to Islamic banks. The ratio of deposits in Islamic banks to real GDP per capita growth was chosen as an additional indicator aimed at estimating the extent of the ability of Islamic banks for savings’ mobilization. Quantitative methodology will utilize the following control variables: initial real GDP per capita, inflation, government spending, education, trade transparency, general terms of trade and quality of institutions,
The microeconomic assessment will review the contribution of Islamic banking in economic development of the clientele of the bank. This will be done by examining and evaluating the growth of investments and the rate at which the banking affects the financial wellbeing of clients. This will be done by the examination of the financial activities of the banks and how they promote better results including the assessment of deposits, net loans and asset management and its results.
Econometric Estimation
Data
The study will be mainly qualitative in outlook. Qualitative research is focused on examining the behaviours and perceptions that drive a given act in a given population (Qualitative Research Council Association, 2015). This research will therefore attempt to trace the patterns and the impact of Islamic banking on the development trends in the society.
Data will be collected from a blend of primary and secondary sources. The secondary sources will include sources from journals and books that will be collated to provide important trends and observations in the study. Data will be collected in three phases corresponding to the research questions of the study.
Phase 1: Secondary Data on Islamic Banking and macroeconomic growth
Phase 2: Secondary review of the asset growth and profitability to shareholders and bank clients in retail and investment banking units.
Phase 3: Primary and Secondary Data on the results of actions of Islamic banks in relation to risk-sharing and absence of profits (riba and PLS schemes).
Phase 1: The data for this section will include information from two main sources. The first source will be macrocosmic data of banks or ratio of Islamic banks and their assets and activities over a period of five years. This will be compared to the GDP, Personal Income, Corporate Profits and Industrial Growth over the period. The relationship between the two approaches will be reviewed. The banking information will be taken from Bankscope, Thomson Bank and national industry reports. Data for national performance will be taken from World Bank data and sources.
Phase 2: This will be concerned with the evaluation and analysis of a period growth of profitability and shareholder or bank clients in the countries under review. This will include the examination of profitability and shareholder and bank client increase in wealth. This will include the evaluation of a cumulative report relating to the Islamic banks in these countries and show in absolute terms, how the different banks in the countries under review are growing and contributing to economic growth and development amongst people who use their services.
Phase 3: This will be the identification of the results of specific drives and events in a sample of banks in the country under review. To this end, a sample of Islamic banks in 33 countries will be critiqued to identify how their risk-sharing and PLS schemes worked. This is because most banks and most processes have events and packages that are launched. A sample of few Islamic banks in each of these countries will have their financial statements critiqued in order to provide information about the benefits and the improvements they brought to their clients as per the events. This will be an analytical review and critical assessment of the different elements and features of the financial statements.
At this stage, our aim is to assess the impact of Islamic banks on Economic development.
I construct a panel of 173 Islamic banks, settled and located in 33 developing countries with data spanning the period 1992-2014 and dropping 1% and 99% outliers by a method of Winsorisation (dropping any data value above the ninety-ninth percentile and any value below the first percentile of the sample data). The sample size is constrained by data availability, in particular on variables capturing Islamic banking expansion and the quality of the institutional environment. Moreover, the sample is being restricted to the developing countries because it helps reduce sample heterogeneity and in fact the macroeconomic variables included in the growth model are more relevant to them.
Standard growth model is the main focus here, with a set of variables of interest measuring broad financial development and Islamic banking development, and control variables conventionally utilized in the growth literature. The data description for the variables are described in Appendix Table 1.
Methodology:
The baseline regression is as follows:
= α + β*+ δ+ ut + + eit
Where, is the GDP per capita growth rate, ISBI represents the three indicators of Islamic Banking development (Deposits of Islamic banks to GDP, Capital Ratio and Net Loans to Total Assets). X is the set of control variables (GDP per capita, Government consumption, Education, Inflation and Trade Openness); u is the country-specific effect; v is the time-specific effect and e the error term.
There are some econometric obstacles when we are estimating the impact of Islamic banking growth. First of all, although Islamic banking is growing very fast, the size of development of Islamic banking in connection with banking assets or GDP, is extremely small in the vast majority of countries that under study, which makes it difficult to spot any statistically significant effect. Secondly, there might be some measurement errors when we are measuring the indicators of Islamic bank development because we only cover full-fledged Islamic banks in our study while we do not cover Islamic windows (of traditional banks) due to lack of data and because traditional banks do not show in their income statement and balance sheet activities related to Islamic finance in clear separation from the non-Islamic business. Thirdly, there might a reverse causality between growth and Islamic finance, which leads to an endogeneity concern that has to be covered in the regressions. The underestimation of Islamic banking development will generate a bias in the estimated coefficients.
We need to test the two-way relationship the real GDP per capita and both of the two indicators of Islamic banking development (Deposits of Islamic banks to GDP, Capital Ratio and Net Loans to Total Assets), which dissertation if there is a positive or negative correlation between economic growth and Islamic banking development.
In consideration of the obstacles mentioned above, we use a variety of econometric methods as following: to control for the country-specific effect we use pooling and fixed effects estimators, while to control for the endogeneity bias we use the System GMM estimator, with regards to the problems they generate and they do not.
Main results
Appendix Table 2 shows that, an observation was conducted on the sample of 187 units. The results display that there is an unstable positive connection 0, 1563 between the inflation and GDP per capita. The largest positive, linear connection is between net loans and equity assets, followed by the positive connection between net loans and deposit. Trades and Government Expenditure (Raeesi et al. 2013) occupy the third place. Positive connection between the last two informs us of a direct connection which manifests in such a way that the increase of one leads to the increase of the other, and that they are on the increasing line of activity (Jasra et al. 2011). The strongest negative connection is seen between the following variables: govexp–inflation, trades–inflation, equity assets–trades. This connection is telling us that these variables are on a decreasing line. It can be noticed that there is virtually no connection between deposit and education as has been demonstrated throughout the literature (Farrell 2006).
Another research of the mentioned variables was also conducted in Appendix Table 3. The research data are the following: the investigation of GDPpc was conducted on the sample of 701 units. Arithmetic mean was equal to 1,9122, displaying an average. The next is standard deviation which was equal to 3,9520, which means that an average deviation GDPpc from the average number GDPpc is equal to 3,520. We have also obtained the data of minimal and extreme values, which do not have a significant effect on the arithmetic mean.
The analysis of inflation was conducted on the sample of 653 units. Arithmetic mean was equal to 1,7632, while the standard deviation was 1,124.
The analysis of education was conducted on the sample of 554 units. Arithmetic mean was equal to 99,2427, whereas the standard deviation was 14,123.
The analysis of govexp was conducted on the sample of 656 units. Arithmetic mean was equal to 15,045, while the standard deviation was 5,783.
The analysis of trades was conducted on the sample of 684 units. Arithmetic mean was equal to 80.64, and the standard deviation was 37.1318.
The analysis of deposit, equity assets and net loans was conducted on almost twice the smaller samples, which is why there won't be further information on them in this report.
A regression analysis was also conducted on the mentioned variables. It is crucial to bear in mind the difference between the explanatory and altering variable. What we have here is a model of multiple regression, done in the following formula:
= α + β*+ δ+ ut + + eit . In it we see the X representing GDP per capita, government consumption, education, inflation and trade openness.
The same steps were conducted for the remaining variables among pooled effects and for fixed effects, random effects, GMM.
Regression analysis is used to explain the effect of an independent variable in connection to the dependent variable, as well as to predict the value of dependent variable on the basis of at least one independent. One should pay close attention to this type of analysis and study it in detail in order to get more precise information. What should not be omitted is correlation analysis because these two are connected. The correlation analysis can provide us with more detailed information concerning the manner in which the variables are connected and the effect which they have on each other. High correlation displays the success rate.
We conducted a research with pooled effects, fixed effects, random effects and GMM.
Pooled effects:
The results of using the fixed-effect estimator allows control for country-specific effects to be time invariant which affect a country’s economic growth and of using random effect estimator to avoid having to estimate a separate coefficient (i in the fixed effects model) for every individual. These are depicted in the table given below. Pooling, fixed and random effect estimators may be biased in the presence of endogenity of the right hand side variables which is incidentally relevant for Islamic banking indicators, as their potential endogeneity does not only result from reverse causality to growth, but also from measurements errors when the full size of Islamic banking development is not captured in the data (Imam & Kpodar, 2015).
Note: Robust Ttest in brackets, * p<0.1; ** p<0.05; *** p<0.01
System- GMM
The issue of endogeneity for some other explanatory variables the System GMM estimator is used (Blundell & Bond, 1998).
The system GMM estimator uses both the difference in the panel data and the data from the original levels specification which increases both consistency and efficiency (Arellano & Bond, 1991). The one-stem system GMM estimator is used and validity of lagged variables as instruments is tested by using Hansen test of over-identifying restrictions (Imam & Kpodar, 2015). The results from the GMM estimator are similar to the results obtained for fixed-effect estimator.
Note: Robust Ttest in brackets, * p<0.1; ** p<0.05; *** p<0.01
The methodology of my research touched upon financial deepening matters, and the results show, as expected, that they are vital concerning the economic growth. What is even more surprising, Islamic banking has proved to be to a large extent effective in a significant manner concerning the economic growth. Significance level is noticed in pooled effects, varying between 0,01 and 0,1. What is particularly relevant for Islamic banking, though, are the estimators of both pooling and fixed effects, bearing in mind that their potential endogeneity does not only result from the reverse causality to growth, but also from the measurement errors, for the full size of the banking is not captured. I used the System-GMM estimator developed by Blundell and Bond to display the endogeneity for banking indicator as well as other variables. As they showed, the system produces significant raise concerning efficiency and consistency in comparison to the first-differenced model developed by Arellano and Bond. This method confirmed my assumptions that Islamic banking has interesting contributions concerning the economic growth.
Theorisation
The research will culminate in draw a generalised conclusion on what the role of Islamic banking in society’s economic development is. This will be based on the unique functions of Islamic banking and how it differs from other forms of banking and the findings of the case study and observations. The theory will be generalised for the global Islamic banking industry and inferences will be made.
Limitations of Study
This study is an academic study. It is meant to cover the trends and processes of Islamic bank and the developments that occur within an economy a country. This study will have to be simplified because Islamic banking does not follow the same pattern everywhere. There are some patterns accepted in the world of Sunni Islam and other patterns of Islamic banking that are accepted in the Shiite world. In spite of this, there are many sub-forms of Islamic banking in each country and this conforms to different forms of jurisprudence and views in the different countries within which Islamic banks operate. Therefore, the dissertation will have to simplify major elements and aspects of Islamic banking in order to interpret and analyse the information.
The research is going to be qualitative. This comes with inherent issues in research because it is going to study a form of behaviour and how it impacts on the society. This will lead to various findings and the findings could be influenced by bias. This could also vary in different contexts and elements in relation to the research methodology and the parts of the world that the study will be conducted. The bottom-line is that the study does not present one answer that can be universally acknowledged. Therefore, there is room for variation and differences.
Ethical Issues
Confidentiality is a major part and aspect of this study. This is because a sample bank will be studied in the research. There will be a legal obligation to ensure that information gathered from the respondent bank that is sensitive is not abused. Therefore, the data collection will be done within the context of the Data Protection Act 1998 and confidentiality guarantees will be given to all respondents who will partake in this research.
Conclusion
The main objective of this dissertation is to trace the influence of Islamic banking on economic development of the countries wherein they are located. The literature review has shown a number of unique advantages Islamic banking is characterized by as compared to conventional banks. The principal hypothesis of this dissertation is that introduction of Islamic banking promotes financial growth and further economic development of the country wherein Islamic banks are present. Further research requires detailed analysis of Islamic banking development by means of different economic estimators, and its correlation with general economic development.
The dissertation establishes the positive influence of Islamic banking on economic development. Recent global crises have shown weaknesses conventional banks suffer from. On the contrary, Islamic banks have a number of unique features, such as risk-sharing, which could be used for strengthening financial growth and economic development both in Muslim and non-Muslim states. Being one of the fastest growing segments of global banking and finance systems, Islamic banks represent a more flexible and sustainable banking system. Islamic banks stimulate investments and are less exposed to such risks as bubbles. This means that Islamic banking may become a vital component of financial and economic spheres of countries, which currently experience low growth and consequences of global economic crises.
The methodology of my research touched upon financial deepening matters, and the results show, as expected, that they are vital concerning the economic growth. What is even more surprising, Islamic banking has proved to be to a large extent effective in a significant manner concerning the economic growth. Significance level is noticed in pooled effects, varying between 0,01 and 0,1. What is particularly relevant for Islamic banking, though, are the estimators of both pooling and fixed effects, bearing in mind that their potential endogeneity does not only result from the reverse causality to growth, but also from the measurement errors, for the full size of the banking is not captured. I used the System-GMM estimator developed by Blundell and Bond to display the endogeneity for banking indicator as well as other variables. As they showed, the system produces significant raise concerning efficiency and consistency in comparison to the first-differenced model developed by Arellano and Bond. This method confirmed my assumptions that Islamic banking has interesting contributions concerning the economic growth.
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Appendix
Source: Bankscope
Appendix Table 2. Correlation Matrix
| gdppc linflation education govexp trades deposit equitya~ netloans
-------------+------------------------------------------------------------------------
GDPpc | 1.0000
linflation | 0.1563 1.0000
education | 0.0494 -0.1084 1.0000
govexp | -0.1195 -0.3733 0.2402 1.0000
trades | 0.0489 -0.3501 0.3188 0.3525 1.0000
deposit | 0.0332 0.0109 0.0016 0.0938 0.2026 1.0000
equityassets | 0.1285 0.0865 -0.0435 -0.0512 -0.1443 0.2990 1.0000
netloans | 0.1182 0.1592 0.0212 -0.1840 0.0897 0.5482 0.6316 1.0000
Robustness analysis
= α + β*+ δ+ ut + + eit
Pooled effects:
* p<0.1; ** p<0.05; *** p<0.01
Fixed effects:
* p<0.1; ** p<0.05; *** p<0.01
Random effects:
* p<0.1; ** p<0.05; *** p<0.01
GMM
* p<0.1; ** p<0.05; *** p<0.01
