Salman Ahmed Shaikh

Proposal for a New Economic Framework Based on Islamic Principles

This book provides a holistic socio-economic framework working in conformity with the Islamic principles. Chapter 2 builds the ground for the proposed framework by discussing the foundations of the ethical precepts of Islam. It discusses the thesis of religion, answers some of the questions in the comparative study of religion and tries to resolve few of the misconceptions about the faith of Islam. Chapter 3 outlines the economic teachings of Islam with regard to earning and spending. It discusses at length the ideals Islam set before its adherents in the ethical sphere of life. The ethical principles are discussed based on the study of relevant Quranic text and the narrations of Prophet Muhammad (PBUH). Chapter 4 studies the comparative economic systems. It analyzes Capitalism, Socialism, Mixed Economy and Islamic economic system. Chapter 5 introduces the salient features of the proposed economic framework with special focus on fiscal reforms. It discusses the potential of the institution of Zakat to meet fiscal needs of the government and to assist it in doing away with deficit financing, fiscal bleeding, crowding out private sector and reducing deadweight loss by parting the way with private sector so as to ensure market economy operating on its own as far as possible and playing an active regulatory role. Chapter 6 introduces the monetary reforms. It discusses how savings would feature despite discontinuation of interest, how inflation will be checked with central banks not having at their disposal conventional OMO, how liquidity will be managed in banking sector when a central bank wants to inject liquidity or mop up funds. How and to what extent the institution of Zakat would enable the government to meet its fiscal targets and does not crowd out private sector with public borrowing. How balance of payments and exchange rate stability can be managed in an interest free economy. If in the short term, the government or central bank needs alternative source of revenue other than Zakat, they can issue GDP linked bonds. This could replace T-bill and provide a base instrument for OMO and liquidity management in the banking and financial sector. Chapter 7 introduces the currently practiced Islamic Banking and Finance. Since Islamic economic principles have more prominently been used in banking and finance, much of the discussion centers on Islamic banking and finance in lieu of analyzing the existing practices and then in the next chapter, preferable alternatives in areas where shortcoming is observed and need for improvement is felt are suggested. Chapter 8 discusses the financial system in the proposed framework with the role of institutions and the discussion on comprehensive need fulfillment mechanisms to serve every major need of a sophisticated contemporary financial system. Some important novel changes are recommended, such as introduction of options in mortgage financing, which will allow the bank to separate the tenancy and sale contract in a distinctive way. This will still ensure that it locks the sale with the borrower or with the third party without making both contracts dependent on each other. It will benefit the bank as well as the borrower, who will have an option but not an obligation to buy the asset at maturity. The modified role of bank entering in a Mudarabah contract as a “Rabb-ul-maal” (investor) will ensure that the bank takes on operational risk. It will enable the resources to go into productive avenues rather than in financial instruments. This modification will generate employment and productive activities in the economy in a more direct manner. The division of Mudarabah corporate and Mudarabah consumer will target two very distinct markets and will result in channeling of funds from saving surplus units to saving-deficient units. Reforms in equity markets and alternatives for insurance are also suggested. Chapter 9 introduces feasibility and structure of Micro credit as an alternative for interest based micro finance. It discusses how the potential obstacles in the form of lack of trust, funding commitment, lack of collateral arrangement, lack of documentation etc would be handled.

Role of Islamic Banking in Financial Inclusion: Prospects and Performance

According to Global Financial Development Report 2014, the proportion of adult population holding bank accounts in 25 out of 48 Organization of Islamic Cooperation (OIC) member countries surveyed stands below 20 %. Part of the reason is Muslims’ voluntary exclusion of interest-based financial services. On average, 28 % adults in the OIC countries hold a bank account at a formal financial institution. On the other hand, only 7.7 % of the poorest 40 % people in the OIC countries borrow from financial institutions. Furthermore, in the OIC countries, like Guinea-Bissau, Gabon, Chad, Sudan, Syria, Mozambique, Gambia, and Iraq, microfinance outreach are not even catering to the 1 % of the poor people in these countries. In 26 out of 36 OIC countries where sufficient data are available, we find that not even 10 % of the poor people are under the microfinance radar. Thus, this presents a challenge as well as an opportunity for Islamic banks to increase their outreach toward fostering inclusive finance in the OIC countries.

Analysis of challenges and opportunities in Islamic banking

Islamic banking has achieved exceptional growth in the last two decades and has been able to sustain it even during the recession and afterwards. In this paper, we highlight that lack of flexible financing options, incomplete product mix, scale diseconomies, contractual frictions and constraints in liquidity management are potential future challenges for this industry. The study also highlights growth opportunities by noting that Islamic banks in many jurisdictions are yet to enter into infrastructure financing for development spending, energy financing, investment banking and sovereign financing.

Intertemporal consumption behaviour in OIC countries

This study aims to examine the consumption behaviour in Organization of Islamic Cooperation countries.,Using time series and panel data, this study estimates rational expectations permanent income hypothesis model and the intertemporal elasticity of substitution, and examines the response in consumption to expected and unexpected changes in income.,The evidence supports the phenomenon of loss aversion. The response of consumption to unexpected income changes is statistically significant in only one-third of the countries in the sample. Conversely, the response of consumption to expected income changes is statistically as well as economically significant in one-fourth of the countries in the sample. The intertemporal elasticity of substitution is also statistically insignificant in majority of OIC countries in the sample.,The evidence in support of loss aversion in preferences could help in explaining the low penetration of equity-based risk sharing instruments in Islamic finance.,The excess sensitivity of consumption to income suggests that redistribution efforts to enhance incomes of poor households could help in enhancing their consumption levels.,The study takes a comprehensive sample across time and space for OIC countries as compared to previous studies and also adjusts the budget constraint for Zakat.

Application of waqf for social and development finance

Purpose This paper aims to discuss the application of waqf (endowment) in the social finance sector for funding social and development projects and services. Design/methodology/approach The study is qualitative. It reviews literature and provides descriptive data to present its main idea. Findings Most Muslim-majority countries are generally income-poor, and the governments are generally weak in their tax collection, effective governance and capacity for development spending. Private sector financial institutions are scarce and mostly cater to the people who can meet the income-based lending criteria. Thus, the institution of waqf can fill the gap as a social finance institution by providing intermediation services for effectively utilising perpetual social savings. Flexibility in the rules of waqf enables it to serve beneficiaries directly or through financial institutions and to provide a wide range of social services. Research limitations/implications This conceptual research highlights the need and potential of waqf without discussing the regulatory and operational details of how to effectively institutionalize it in different regions. Practical implications The institution of waqf can harness the potential of selfless charitable giving in an effective way for better economic impact in the targeted social segments of society. Originality value The paper suggests the establishment of waqf-based training and vocational centres which will increase opportunities of self-employment and contribute in upward social mobility of beneficiaries.

Towards an integrative framework for understanding Muslim consumption behaviour

Purpose - This paper aims to integrate Islamic and mainstream economics framework towards a more realistic understanding of Muslim consumption behaviour. Design/methodology/approach - The model incorporates some of the Islamic institutions like period-wise deduction of Zakat from endowments. It also includes bequests which could be significant given the Islamic injunctions on inheritance distribution and the significance placed on the institution of family. Furthermore, the model integrates the assumption that consumption opportunity set will axiomatically filter out the prohibited consumption goods from the consumption set in both contemporaneous and inter-temporal consumption. Findings - Zakat ensures contemporaneous redistribution from endowment surplus households (those having Zakatable endowments above Nisab) to endowment-deficient households (those having Zakatable endowments below Nisab). The lifetime resources are scaled down for endowment surplus households because of the payment of Zakat in both periods and leaving bequests in old-age period, while the lifetime resources are scaled up for endowment deficient households because of the receipt of Zakat in both periods and receiving the bequests in youth. Originality/value - The authors show how some of the Islamic principles and institutions can be integrated in the mainstream economics framework, especially in research studies where the objective is to understand and describe reality rather than persuasion and idealization.

Exploring Efficiency, Co-integration, Causality and Volatility Clustering in Unrestricted and Islamic Portfolios

Unlike unrestricted portfolios, Islamic portfolios have a narrow opportunity set for investment. They also face trading restrictions due to the prohibition of futures, short selling, options and day trading which can potentially create significant limits to arbitrage. In this study, we explore weak-form market efficiency in comparable unrestricted and Islamic portfolios. The study also investigates the existence of Autoregressive Conditional Heteroscedasticity (ARCH) effects in the returns series of unrestricted and Islamic portfolios in developed and emerging markets. Finally, we also investigate the existence of bi-directional causality between portfolios. From the runs test, we find that the returns of most indices are random, except for a few. Finally, we also find strong evidence for co-integration and causality in both directions between Islamic and unrestricted market portfolios.

Revisiting the Design of Interest Free House Finance

In this paper, we present an alternate proposal for house finance. In our proposal, the Islamic bank buys the house paying the house owner the full amount of the house and becomes the owner. Then, the bank gives the house on rent to the client and the Islamic bank also enters into an options contract as the call option writer. If the call buyer does not exercise the option, the options contract expires and the Islamic bank is in a position to give the house on rent again. We present numerical examples of computing rents in two separate structures. In structure I, call option is used with the lease contract. In structure II, house is resold at market price with stated price floor. We show that the proposal is robust in different scenarios. Furthermore, it is substantially and meaningfully different from conventional finance in form and substance.In this paper, we revisit the design of interest free house finance. First, we discuss the current practice in conventional banking and Islamic banking. Then, we discuss an alternate design for interest free house finance. The proposal we present attempts to analyze the implication of using market based rent setting in place of using an interest rate benchmark. In the alternate design, the Islamic bank buys the house by paying the house owner full amount of the house upfront. Then, the bank gives the house on rent to the client and the Islamic bank also enters into an options contract as the call option writer. If the call buyer does not exercise the call option, the options contract expires and the Islamic bank is in a position to give the house on rent again. We present numerical examples of computing rents in two separate structures. In structure I, call option is used with the lease contract. In structure II, house is resold at market price with stated price floor.

Islam and Human Development

The paper aims to present the Islamic appraisal of established theories in academic literature of development economics, both in classical and neo-classical economics. The paper also explains the Islamic concept of human development and shows it to be more welfare maximizing to humans in their entire life span which includes afterlife. The paper extensively reviews the development literature in mainstream economics and Islamic economics. The paper also uses basic mathematical formulation to explain the concepts. The paper explains the Islamic concept of human development and shows it to be more welfare maximizing to humans and to society. It discusses how Islam is not the source of underdevelopment in Muslim countries and cites the external factors responsible for underdevelopment besides weak internal administration, commitment and management. The paper is one of the few attempts to cite and critically appraise specific development theories from Islamic perspective.

Economic Analysis of Islamic Banking in Pakistan

Islamic banking has achieved substantial growth in Pakistan and all over the world in the last two decades or so. Despite the financial and economic crisis of 2007 and afterwards, the Islamic banking industry has witnessed exemplary and uninterrupted growth. In Pakistan, it has achieved market share of almost 9% in the banking industry. There is vast literature available on explaining the features and mechanics of Islamic banking; however, limited attention has been paid on the thorough analysis of Islamic banking architecture from finance, economics, and development and distribution point of view. Though, there exists substantial body of literature explaining the negative effects of interest based institutions in Capitalism. But, little has been written on conducting a meaningful and objective economic analysis of Islamic banking practices. In this paper, we attempt to touch upon an overlooked area which is a thorough and objective analysis of Islamic banking with its economic merits and shortcomings. The paper is structured as follows. Section 2 explains the problem with interest based financial intermediation. Section 3 describes the essential features of commonly used Islamic contracts and modes of financing. Section 4 presents the economic analysis of Islamic banking and modes of financing by explaining the merits. Section 5 presents the economic analysis of Islamic banking and modes of financing by outlining the shortcomings.