M. Shahid Ebrahim

Islamic banking in Brunei Darussalam

This paper studies the current realities of the Islamic banking system of Brunei Darussalam from the perspective of the theories of modern financial intermediation and Islamic financial contracting. The limited information on the banking system of Brunei Darussalam reveals that the first phase of the Islamic banking experimentation has been successful, as Islamic banks command roughly 11.5 per cent of the market share. The financial services industry, however, remains extremely competitive and Islamic banks face formidable challenges from conventional banks. Islamic banks can proliferate if they: advance towards the second phase by gradually consolidating retail banking with investment banking; establish vital links with local and foreign institutions; and use ijtihad in modern financial engineering to optimally design loans while simultaneously reducing their risk exposure. An efficient Islamic financial system can allocate limited capital resources to the most profitable ventures and assist in wealth creation. This can foster the growth not only of Negara Brunei Darussalam but also of the regional economies, particularly at this crucial juncture when Asian economies are reeling from the current financial crisis.

On the Design and Pareto-Optimality of Participating Mortgages

This paper develops a micro-economic model and proceeds with numerical simulation to demonstrate that participating mortgages can improve social welfare when the real estate ownership is shared among the different taxable entities. The optimal distribution of real estate ownership and lending will tend to be concentrated in taxable and nontaxable hands, respectively, with lending conducted via participating mortgages. This paper also demonstrates the violation of the well-known, risk-neutral valuation argument of the Black and Scholes (1973) model because of the lack of a riskless hedge due to the uniqueness of real estate.

Investor heterogeneity, market segmentation, leverage and the equity premium puzzle

Abstract Financial economists for the past two decades have attempted to explain why the equity premium is so high, now known as the equity premium puzzle (EPP). We model investor heterogeneity, market segmentation and optimal leverage, using the time separable standard power utility, market completeness and ignoring transaction costs to explain the EPP. We explain both the EPP and the related risk-free rate puzzle without resorting to preference modification. Furthermore, we show a unique interior equilibrium for the debt ratio, contrary to the work by F. Modigliani, M.H. Miller (The cost of capital, corporation finance and the theory of investment, American Economic Review 48 (1958) 261–297; Corporate income taxes and the cost of capital, American Economic Review 53 (1963), 433–443) and S.C. Myers (Presidential address: The capital structure puzzle, Journal of Finance 39 (1984), 575–592). Our simulations show the relevance of our models.

On the design and efficiency of a participating growth bill

Abstract A Participating Growth Bill (PGB) is an innovative hybrid financial vehicle employed by Western institutions and governments in lieu of short-term debt instruments. This study proposes PGB to be considered as an alternative way of raising funds for open market operations by the governments of Muslim countries constrained by religious regulations against fixed-interest debt ( ribawi ) financing. The security (PGB) is developed using partial equilibrium analysis under the assumption that the assets backing the financial package do not trade in a secondary market—a situation which invalidates the risk-neutral pricing of the well-known Black and Scholes (1973) model. The study finally demonstrates the efficiency of a PGB over a conventional ( ribawi ) debt vehicle thereby providing results contrary to assertions of the (i) Capital Structure Irrelevance Theorem (see Modigliani and Miller, 1958 ) and (ii) Capital Asset Pricing Model (CAPM) (see Sharpe, 1964 ).

The Political Economy and the Perennial Underdevelopment of the Muslim World

The ongoing political turmoil in the Muslim world necessitates an investigation of the factors leading to centuries of underdevelopment. This essay studies the various perspectives (for and against) attributing Islam as a factor holding back the progress of the Muslim economies. We critically appraise why ‘Islamic’ banking is not truly Islamic to identify: (i) the retrograding outlook of the jurists (fuqah�?’); and (ii) their flawed ijtih�?d (interpretation or deduction of the divine sources of law) as the prime factors responsible for the paucity of development of financial instruments, markets and institutions. We also scrutinize co-option of the jurists by the ruling elite, thereby legitimizing their autocracy. Finally, we conclude the paper recommending the rectification of these issues to develop institutions fostering economic growth and development.

THE PRICING OF DEBT AND PARETO-OPTIMAL FINANCING UNDER ENDOGENOUS BANKRUPTCY

Using an agency theoretical framework, this paper extends the optimal capital structure literature by modeling the rivalry between equity and debt to arrive at some very fundamental results involving endogeneity of bankruptcy, equilibrium interest rates, pricing of risk-free/risky debt and pareto-optimal financing techniques.