Islamic Financial System

In a changing economics and political environment

ECO 6226

Summer 04

Mohammed Dasser

MS/MIS

Introduction

Latest political and economic events: 9/11 US PATRIOT ACT Afghanistan Iraq

Islamic Economics: 1400 years old concept, newly introduced in 70’s “Terrorist Money Laundering” Misunderstanding of Islamic Finance Impact of political and economic events

Islamic Financial System

Islamic Financial Institutions: Banks Non-Bank Institutions

Islamic Financial Instruments: Equity-Like Instruments Financing Working Capital Leasing

Islamic Financial Market

Islamic Financial Institution

Governed by the Islamic laws (Shariaa & Hadith) , and must bond to the same widely accepted rules[1]:

The absence of interest-based transactions (riba). The avoidance of economic activities involving

speculation (ghirar). The introduction of an Islamic tax (zakat). The discouragement of the production of goods and

services which contradict the value pattern of Islam (haram).

[1] (Nasser M. Suleiman, 2000) “CORPORATE GOVERNANCE IN ISLAMIC BANKS” ARAB gateway. Retrieved from http://www.al-bab.com/arab/econ/nsbanks.htm on June 9, 2004

Islamic Financial Instruments:Equity-Like Instruments

Musharakah: is a standard partnership, like any corporation agreement, all profits and losses are to be shared by all partners and all associates having the right to co-manages their common project investments.

Mudarabah: is a silent partnership, similar to a standard financing contract between the investor (rab-ul-mal) who provides the entire funding and the entrepreneur (mudarib) who is the sole responsible of the management and receive a share of profit as agreed with the investor. But losses are endured by investor only.

Islamic Financial Instruments: Financing Working Capital

Murabaha: is what known as a sale against deferred payment for cost plus mark-up or profit margin which is negotiated preceding transaction.

Salam: Stand for future sale, where a sale in which the price is paid on the spot and the delivery is deferred, usually used to allow financing a producer before the production of the goods ( i.e. agriculture).

Istisna: The other type of sale where transaction are made before product is manufactured, with two main differences, the money doesn’t have to be paid before receiving and the contract can be canceled before the manufacturing of the goods starts.

Islamic Financial Instruments: Leasing

Leasing Ijara: It’s the lease-based financing very

similar to the conventional leasing contract with few minor differences.

Can be used with other Instruments to constitut a hybrid instrument like Diminishing Musharakah

The Islamic Financial Market

Industries and their financial instruments must consistent with Islamic Law guidelines.

Prohibiting investments involving in these activities[1]: Alcohol Tobacco Pork-related products Conventional financial services (banking, insurance, etc.) Weapons and defense Entertainment (hotels, casinos/gambling, cinema, pornography,

music, etc.) unacceptable level of debt and impure revenues from interest

rate incomes

[1] (Dow Jones,2004), “Guide to the Dow Jones Islamic Market Index”. Retrieved from http://www.dowjones.com/index_products.htm on June 9, 2004

Analysis

Goals: the IFM vs. The US market. The impact of Major events on the IFM

Methods: Historical Data : 3 years (3/2001 to Present) Indexes: S&P 500, IMUS (DJ Islamic Market) Correlation: Highly correlated Regression result: No evidence of ImpactRegression Equation: Dow Jones Islamic Index = Constant + S&P 500 + Event (0 or 1)

Historical Data: 3 years (3/2001 to Present)

0

2000

4000

6000

8000

10000

120005/

14/2

001

7/14

/200

1

9/14

/200

1

11/1

4/20

01

1/14

/200

2

3/14

/200

2

5/14

/200

2

7/14

/200

2

9/14

/200

2

11/1

4/20

02

1/14

/200

3

3/14

/200

3

5/14

/200

3

7/14

/200

3

9/14

/200

3

11/1

4/20

03

1/14

/200

4

3/14

/200

4

5/14

/200

4

DJIA

S&P 500

NASDAQ

IMUS

DJICA

DJIM

Correlation result: Highly correlated

DJIM Dow Jones Islamic Market World Index

IMUS Dow Jones Islamic Market U.S. Index

DJIA S&P 500

DJIM 0.972815905 0.99245222

IMUS 0.944738241 0.99445279

Historical Data : 9/11 events

0

500

1000

1500

2000

2500

5/14

/200

1

6/14

/200

1

7/14

/200

1

8/14

/200

1

9/14

/200

1

10/1

4/20

01

11/1

4/20

01

12/1

4/20

01

1/14

/200

2

2/14

/200

2

3/14

/200

2

4/14

/200

2

5/14

/200

2

6/14

/200

2

7/14

/200

2

8/14

/200

2

9/14

/200

2

10/1

4/20

02

11/1

4/20

02

S&P 500

9/11 events

IMUS

DJIM

Historical Data : Iraq events

0

500

1000

1500

2000

25003/

4/20

02

4/4/

2002

5/4/

2002

6/4/

2002

7/4/

2002

8/4/

2002

9/4/

2002

10/4

/200

2

11/4

/200

2

12/4

/200

2

1/4/

2003

2/4/

2003

3/4/

2003

4/4/

2003

5/4/

2003

6/4/

2003

7/4/

2003

8/4/

2003

9/4/

2003

10/4

/200

3

11/4

/200

3

12/4

/200

3

1/4/

2004

2/4/

2004

3/4/

2004

4/4/

2004

5/4/

2004

6/4/

2004

S&P 500

Iraq invasion

IMUS

DJIM

Regression Result: No evidence of Impacts

This is a two tail test: Wish to see Impacts in any direction. At the 95% confidence level 2P( T >|1.96|): These events are not

statistically significant. Islamic Financial Market’s Investors are no different from other

investors: Profit seeking.

  Coefficients Standard Error t Stat P-value

Intercept -196.6931125 25.20402352 -7.804036224 2.25E-11

9/11 related event 13.51182979 5.924714575 2.280587465 0.025303154

S&P 500 1.730402963 0.021238102 81.47634695 3.09E-77

  Coefficients Standard Error t Stat P-value

Intercept 1.675998047 12.75400658 0.131409533 0.895678992

S&P 500 1.534932473 0.013349146 114.9835664 2.27E-121

Iraq invasion 7.30572235 2.791512696 2.617119514 0.01004871

Conclusion:

The IFIs are in full rise in the US because increasing Moslem population.

High Correlation with Broad Benchmarks: The Dow Jones Islamic Market Indexes perform similarly to broader market indexes.

The events of 9/11 & Iraq created a certain distance between the US and the Moslem world, but the market of investment of the United States remained accessible.

Lack of receptive atmosphere and Scarcity of research: Need more awareness initiative from Islamic Institutions and more research funding for Moslem scholars.

Thank you for your attention.