Wednesday, January 31, 2007

Developing an Islamic Microfinance Model

The recent awarding of the Nobel Peace Prize to Dr. Muhammad Yunus and the Grameen Bank of Bangladesh highlights a new awareness of the potential and power of microfinance programs. What's more, the Nobel committee has validated the link between poverty alleviation and peace saying, "Lasting peace can not be achieved unless large population groups find ways in which to break out of poverty."

This admission gives credence to the growing movement to promote socially responsible/ethical ventures - both large and small. But given this emphasis where is Islamic finance in the world of microfinance?

Missing the point of economic development

Most economic development projects focus on grandiose infrastructure or industrial projects. While jobs are a necessary outcome the process of empowering individual producers to become economically self sufficient is usually not a part of the equation. In the process we end up with large ventures that may provide jobs to thousands in the local population but only tangentially. In other words, an oil refinery which requires skilled labour will only hire workers that have experience or that have the capacity to be trained for work in the refinery. Or we give people their fish but don't teach them to fish themselves.

What is Microfinance?

Microfinance is usually defined as the provision of financial services and products to those whose low economic standing excludes them from conventional financial institutions or programs. These can include microcredit, small scale venture capital, savings, and some forms insurance. Access to each of these services is provided on a micro-scale allowing those with severely limited financial means to participate.

Theoretically, the main point of departure for microfinance from conventional credit/finance systems comes from the concept of joint liability. In this concept a group of individuals form an association to apply for financing. Members of these small groups are trained regarding the basic elements of the financing and the requirements they will have to fulfil in order to continue to have access to funding.

Financings are disbursed to individuals within the group after they are approved by other members in the group. Repayment of the financing (a loan in this example) is a joint responsibility on all of the group's members. In other words they share the risk. If one defaults, the entire group's members suffer. It's a rudimentary but effective credit scoring mechanism that may mean a temporary suspension from the program and therefore no access to financing for the group or other penalties. In most cases, microfinance programs are structured to give credit up to a maximum amount and require repayment within a short time period – usually a few weeks or at most a few months.

How Microfinance changed development

When the first modern microfinance experiments were being conducted in the 1960s and 1970s, the dominant development programs focused on a particular aspect toward which donor resources could be directed. For example, a farmer needing seeds to plant for produce was given seeds for cash crops or he was given loans at interest rates below market to lessen the financial burden of repayment. But what was not happening was the grass roots support of people who aspired to be self sufficient but did not have a ready business idea or skill/craft.

What Dr. Muhammad Yunus of Bangladesh started in the mid to late 1970s was to focus on people who generally did not have the means to fund a new business or craft. Inspired by the terrible Bangladesh famine of 1974, he made a loan of $27 to a group of 42 families enabling them to create small items for sale without the heavy burdens of repaying moneylenders who charged exorbitant rates of interest.

This effort gave individuals and families the financial fuel they needed to stand on their own feet without the repressive burden of repaying moneylenders beyond their means. Borrowers used loan proceeds to buy raw materials to manufacture products for sale in the market; purchase livestock to sell milk/eggs; or open small shops.

The World Bank now estimates that there are over 7000 microfinance institutions, serving some 16 million poor people in developing countries. The total cash turnover of MFIs world-wide is estimated at US$2.5 billion and the potential for new growth is outstanding. The Microcredit Summit estimates that US$21.6 billion is needed to provide microfinance to 100 million of the world's poorest families.

Other estimates tell us that worldwide, there are 13 million microcredit borrowers, with USD 7 billion in outstanding loans, and generating repayment rates of 97 percent; growing at a rate of 30 percent annual growth. Despite all this less than 18% of the world's poorest households have access to financial services (Grameen Foundation USA).

Similarities between IF and Microfinance

So we now return to where we started – where is Islamic finance in the world of microfinance? If Islamic finance is growing so rapidly all over the world why don't we hear about it more in microfinance circles? After all, both systems advocate entrepreneurship and risk taking through partnership finance. They are also forms of finance which represent unconventional solutions to financial needs, focusing on cash-poor but promising business activities. And most importantly, both Islamic finance and microfinance theoretically start from egalitarian approaches as they are open to all customers with different and sometimes coinciding needs without setting any apparent restriction to different categories of clientele.

But it's interesting to note that Islamic Finance principles are still not widely adopted by conventional microfinance and microcredit institutions. According to Dr. Abbas Mirakhor, Executive Director of the IMF:

"[An] important function of Islamic finance that is seldom noted … is the ability of Islamic finance to provide the vehicle for financial and economic empowerment … to convert dead capital into income generating assets to financially and economically empower the poor..."

Of note in this regard is a theoretical framework for a mudarabah based microfinance program which was advanced by Atif Raza in the Summer 2005 issue of Islamica Magazine. (see related links)

Why this state of affairs?

Why has Islamic finance not been seen more widely in the micro-finance field?

According to Mayadeh al-Zoghbi, a microfinance professional ??, Islamic finance principles are difficult to implement on a profit and loss sharing basis in rural settings. They require long-term involvement by the microfinance institutions (MFI) in the form of technical/business assistance which raises the cost of implementation.

In addition, there is too much uncertainty in profit/loss sharing models for MFIs to be able to understand and predict their present and future cash flows. Therefore, in microfinance too, as in the world of high finance, Islamic debt and leasing instruments dominate.

For example, the Hodeida Microfinance Programme in Yemen based its endeavours on a Murabaha model citing its ease of use. A case study of the program cited that the use of Murabaha “eliminates the need for written records, often unavailable at the micro enterprise level or if available (20 percent of HMFP clients keep books), the client may be unwilling to share them.” Other reasons to prefer Murabaha over equity based financing methods are:

• a well-defined contract exists, with pre-defined amounts

• there is no opportunity for abuse on the part of the client through inaccurate or false record-keeping… i.e. falsely claiming losses where there were profits

• a fixed contract creates a less complicated process and a lower implementation cost to the institution

According to the United Nations Human Settlements Programme (UN Habitat), “Microfinance services, including some compliant with Islamic law (Shari'ah) in the Arab region, tend to be limited to credit for enterprise... The most commonly used Islamic transaction is one in which the MFI [microfinance institution] purchases goods at the request of the 'borrower' and then sells the goods to the 'borrower' for a fee to cover administrative costs, with repayments in instalments (Murabaha).”

My conversations with Ms. Al-Zoghbi and other microfinance professionals yielded few results for MFIs using Islamic finance. In fact, in addition to the Hodeida Programme in Yemen the only other bona fide attempts at applying Islamic finance to microfinance were limited to Akhuwat in Pakistan and the Mali-North Program.

Bridging the Gaps

In many ways, the world of microfinance has followed the conventional world in its use of Islamic debt based instruments to limit risk while being able to more easily anticipate returns.

While on the surface this is understandable, the curious part of the puzzle is that microfinance is already more structurally aligned to applying Islamic equity financing structures. As mentioned previously, microfinance programs are based on group sharing of risk and personal guarantee while maintenance of trust and honesty is tied to the availability of future funds.

This model should allow for the inclusion of a Musharaka based model, or in the least, a model of collective guarantee. MFIs which look to implement Islamic finance in their programs can also develop Mudarabah based programs on the contours proposed by Atif Raza Khan in a Summer 2005 issue of Islamica Magazine. In short, MFIs can find Islamic finance a natural fit in their programs – both debt and equity based.

Any source

Sunday, January 28, 2007

Farm trade deal faces many hurdles

Talks on the resumption of the stalled Doha Round took place in the margins of the World Economic Forum at Davos, Switzerland during the past week, but many hurdles remain to be overcome before an acceptable farm trade deal can be sketched out. Such negotiations are necessarily complex, even arcane, but the essential elements are as follows:

1. Can the EU and US reach an accommodation of their mutual differences? Probably yes, with the EU willing to give some ground on market access and the US willing to concede on domestic subsidies. The notion of 'sensitive' products also gives room for fudges and compromise.
2. Can they sell such a deal to their own constituencies? Much more difficult. In the US, there is a Democratic, more protectionist Congress. Attempts have been made by the White House to square the Colin Peterson, the influential chairman of the House Agriculture Committee, but they may not work, particularly in terms of the renewal of trade protection authority. In Europe, France has presidential and parliamentary elections coming up and already thinks the EU has gone too far in its concessions. The poor state of Franco-German relations leaves Angela Merkel little scope to broker a deal.
3. Can the leading developing countries be brought along? This remains a major difficulty, although Brazil and India have been trying to broker a common position. The real problem is between the US and the emerging countries. The Americans want substantial access to their consumer markets. They are looking for any agreement on farm trade to be offset by reciprocal concessions by Brazil and India on lowering barriers to trade in industrial goods and services. This remains politically difficult.

The recent talks have sought to grapple with the core issues, but the political difficulties remain considerable and there is not much time.Any source
The Role of Stakeholders in Islamic Financial Institutions
Zamir Iqbal & Abbas Mirakhor
The paper discusses the design of an efficient and optimal corporate governance structure of a firm within the Islamic economic system. The objective of this paper is to identify factors, which will influence corporate governance within an Islamic economic system and to examine if corporate governance model will be shareholder- or stakeholder- cantered? The paper argues that the governance model in Islamic economic system is a stakeholderoriented model where governance structure and process at system and firm level protect rights of stakeholders who are exposed to any risk as a result of firms activities. Whereas conventional system is struggling with finding convincing arguments to justify stakeholders participation in governance, the foundation of a stakeholder model is found in Islams principles of property rights, commitment to explicit and implicit contractual agreements and implementation of an effective incentive system. The paper also discusses the implication of a stakeholder model on depositors, Islamic financial institutions, and regulators.
The issue of corporate governance and search for optimal governance structure has recently received considerable attention in conventional economic literature and public policy debates. This increased attention can be attributed to several factors such as (a) the growth of institutional investors, i.e. Pension funds, insurance companies, mutual funds and highly leveraged institutions, and the role institutional investors play in the financial sector especially in major industrial economies; (b) widely articulated concerns and criticism that the contemporary monitoring and control of publicly held corporations in Anglo-Saxon countries especially UK and USA are seriously defective, leading to sub-optimal economic and social development,2 (c) a shift away from traditional shareholder value cantered view of corporate governance in favour of a corporate governance structure extended to a wide circle of stakeholders; and (d) impact of increased globalization of financial markets, global trend of deregulation of financial sectors, and liberalization of institutional investors activities which have raised concerns over corporate governance.3 Although, each of the above mentioned factors provides compelling reasons to examine current corporate governance structures, the most challenging, and the one which contains the seeds of a paradigm shift in understanding of corporate governance, is the stakeholder-oriented model of governance. This paper examines the arguments for and against the stakeholder model presented in conventional literature and argues that a stakeholder-oriented theory of corporate governance finds strong roots in the Islamic economic system. Section 2 discusses the stakeholders theory in conventional system and identifies critical issues. Sections 3 and 4 examine the theoretical framework in support of stakeholders theory from Islamic economic system. Section 5 discusses the governance structure in Islamic economic system. Section 6 concludes the discussion.
The concept of corporate governance is diverse and, over the period of time, definition of the term corporate governance has oscillated between two extremes-- from a narrow concept of a mechanism of implementing investors interest to a broad concept advocating protection of all internal and external stakeholders rights. This wide spectrum of concept stems out of two divergent views: (a) how the entity of a firm should be perceived in an economic system, and (b) the form of the incentive system to protect rights and to preserve the obligations of economic agents in the environment in which the firm operates. Whether one views the firm as a bundle of assets and liabilities, a legal entity, an economic or social organization, a nexus of contracts, or as a combination of these elements, will influence the way in which the evolution of conceptualization of corporate governance is analyzed.4 The modern theory of firm dates to Coases (1937) fundamental insight that firms exist as a substitute for more costly modes of transacting. Transaction costs in negotiating, contracting, coordinating, enforcing and discharging rights and obligations under a set of contracts can be reduced by creating a firm that serves as an intermediary between the consumer and the supplier of inputs.5 Based on Coases idea of transaction costs as an explanation for the existence of a firm, Alchian and Demsetz (1972) further refined the idea and viewed the firm through agency-cost theory and focused on the cost of monitoring. They considered management of the firm to be a continuing process of negotiation of successive contracts. Jensen and Meckling (1976), developed the notion of the firm as nexus of contracts, and argued that contractual designs emerge to minimize transaction costs between specialized factors of production. Focus of early researchers was to identify ways in which managers could be made responsive to shareholders despite the dispersed nature of share ownership. This basic agency problem suggests a possible definition of corporate governance as that which constitutes an efficient monitoring structure solving both adverse selection and the moral hazard problems. Shleifer and Vishnys (1997) survey of corporate governance is focused on this view of corporate governance restricted to the ways in which the suppliers of finance to corporations assure themselves of getting a return on their investment. Corporate governance structure, focused on investor-manager contract and relation, is often referred to shareholder model of corporate governance. It can be characterized as a model where (1) shareholders ought to have control, (2) managers have a fiduciary duty to serve shareholder interests alone, and (3) the objective of the firm ought to be the maximization of the shareholders wealth. Traditional definition of corporate governance among economist and legal scholars, based on agency relationship between the investor and the manager, is concerned with the protection of shareholders or investors interests only. Business ethicists have generally considered this result to be ethically unacceptable because it unjustifiably neglects the rights of non-shareholder groups. Opponents of shareholder-value concept point out that this profit-maximization approach to the firm is too narrow a view for an economic analysis of corporate governance because of externalities imposed by profit maximization choices on other stakeholders. These include, inter alia, constraints on welfare of management and workers who have invested their human capital as well as off-work related capital (housing, spouse employment, schools, social relationships, etc.) in the employment relationship and on suppliers and customers who have also sunk investments in the relationship and foregone alternative opportunities, and on communities who suffer from the closure of business.6 The exclusion of the interests of the others involved in the firm affirms a divisiveness that could well be consequentially counter-productive.7 The neo-institutional economists8 argue that the firms claimants go beyond shareholders and bondholders to include others with whom the firm has any explicit and implicit contractual interaction. In this nexus-of-contracts view, each corporate constituency, including employees, customers, suppliers, and investors, provide some asset in return for some gain. Contracts result from bargaining by these constituencies over the terms of their compensation as well as the institutional arrangements that protect this compensation from post-contractual expropriation.9 According to this view, there is nothing unique to corporate governance, which simply becomes a more complex version of standard contractual governance.10 All stakeholders are regarded as contractors with the firm, with their rights determined through bargaining. Stakeholder theorists reject the three main propositions of the shareholder system and argue for the following: (1) all stakeholders have a right to participate in corporate decisions that affect them, (2) managers have a fiduciary duty to serve the interests of all stakeholder groups, and (3) the objective of the firm ought to be the promotion of the interests of all and not only those of shareholders. This view is commonly referred to as stakeholders model of corporate governance where stakeholders may include customers, suppliers, providers of complementary services and products, distributors, and employees. Therefore, this theory holds that corporations ought to be managed for the benefit of all who have some stake in the firm.11 A critical review of evolving literature dealing with stakeholders reveals that the concepts of stakeholder, stakeholder model, stakeholder theory, stakeholder management, and stakeholder society are explained and used by various authors in very different ways and supported (or critiqued) with diverse and often contradictory evidence and arguments.12 Tirole (1999) suggests that there is little formal analysis of the economics of stakeholder model or stakeholder society. Stakeholder model is largely normative and is still evolving to find a sound theoretical foundation in conventional economic literature. In this process, a number of issues have to be addressed. First, it is argued that nexus-of-contracts view of the firm needs to expand the concepts of contracting and agency beyond their narrow use in economics and include their legal and moral uses in order to make stakeholders theory of governance a comprehensive one.13 Distinction between explicit (or formal) and implicit (or relational or self-enforcing) contracts and claims is key concept in understanding the foundation of stakeholder model.14 When it is difficult to write complete state-contingent contracts - when, for example, certain variables are either ex-ante unspecifiable or ex-post unverifiable - people often rely on unwritten codes of conduct, that is, on implicit contracts.15 These may be self-enforcing, in the sense that each party lives up to the other partys (reasonable) expectations due to fear of retaliation and breakdown of cooperation.16 This implies that, in addition to obligation on explicit contracts, obligations arising out of implicit contracts have to be incorporated into the nexus of contracts theory with convincing arguments, and that can only be articulated by expanding the scope of analysis to include ethics, morals and social order. Hart (2001) forcefully argues that many economic transactions are sustained by self-enforcing (implicit) contracts or norms of behaviour, such as honesty or trust; concepts which so far have proved difficult to formalize in economic theory. Second issue is how to draw a line of distinction between a stakeholder and a non-stakeholder. Existence of a stakeholder entity and its rights are easy to recognize, but question still remains who really qualifies as an actual stakeholder? Third issue deals with the stakeholders right to influence management decision-making or to participate in governance of the firm. Questions arise why stakeholders should be given such right and why managers should have a fiduciary duty to protect rights of non-investor or non-owner stakeholders if such stakeholders have protected their rights through bargaining in the terms of the contracts. Whereas there appears to be a consensus on identifying the rights of non-owner stakeholders and an implicit agreement to protect these rights, there is still a debate on why such stakeholders should participate in the control and management processes of a firm. For example, the notion that property rights are embedded in human rights and that restrictions against harmful uses are intrinsic to the property rights concept clearly highlights the interests of other non-owner stakeholders but it remains unclear which uses of property should be restricted and which persons should count as stakeholders. Simply bringing non-owner stakeholders into the conception of property rights does not, provide by itself, a justification for assigning any specific groups of stakeholders, such as employees and customers, managerial responsibilities.17 So far, discussions of stakeholder model have not been able to articulate a convincing argument on either theoretical, moral, or legal grounds to recognize active role of stakeholders in management and control of a firm. In considering an Islamic view of the role of stakeholders, it is noted that two fundamental concepts of Islamic economic system pertaining to property rights and contracts govern the economic and social behaviour of individuals, society and state. These two principles also dictate objective function of economic agents, including legal entities like firms. A firm in Islamic economic system can be viewed as nexus-of-contracts whose objective is to minimize transaction cost to maximize profits and returns to investors subject to constraints that these objectives do not violate property rights of any party whether it interacts with the firm directly or indirectly. In pursuit of these goals, firm honours its obligations to explicit and implicit contracts without impinging on the social order. This definition incorporates stakeholders role in its view of the firm and supports recognition and protection of their rights. A discussion of Islams principles of property rights and contracts in Sections 3 and 4 provides a foundation for this proposition and also clarifies issues, which the conventional stakeholder theory has yet to resolve.
The design of governance system in Islam can be best understood in light of principles governing the rights of individual, society, and state, the laws governing property ownership, and the framework of contracts. Islams recognition and protection of rights is not limited to human beings only but encompasses all forms of life as well as the environment. Each element of Allah (S.W.T)s creation has been endowed with certain rights and each is obligated to respect and honour the rights of others. These rights are bundled with the responsibilities for which humans are held accountable.18 Shari[ah offers a comprehensive framework to identify, recognize, respect and protect rights of every individual in creation, community, society, and the state. Islamic scholars and fuqaha have defined and codified detailed principles identifying these rights.19 The importance of being conscious and mindful of the rights of others (including stakeholders - human or non-human) and the significance of discharging the responsibilities associated with such rights is reflected by the following saying of the Prophet (pbuh):20 So give to everyone who possesses a right, his right. The term haqq (right) denotes something that can be justly claimed, or the interests and claims that people may have been granted by Shari[ah. Majority of Shari[ah scholars and jurists hold that similar to a physical property, rights are also property (al-mal) because, like physical property which has beneficial uses and is possessable, rights have beneficial uses and are regarded as capable of being possessed.21 Rules defining the property rights in Islam deal with the rights of ownership, acquisition, usage and disposition of the property. Any violation of these rules is considered a transgression and leads to disruption in social order. The notion of ownership in Islam is two-tiered: (i) real and absolute, and (ii) delegated and restricted through time-bound possession. The former belongs to Allah (S.W.T) only because He is the ultimate creator while the latter is reserved for the man in order that he becomes materially able to perform his duties and obligations. Therefore, the first axiom of the property rights in Islam is that Allah (S.W.T)-- the real owner, creator, and benefactor - reserves the right to prescribe for man - His vicegerent, recipient and possessor-owner - rules governing the property while it is in the temporal possession of man.22 Ownership rights in Islam originate from the concept of khilafah (stewardship) as the Quran and sunnah clearly and explicitly state that Allah (S.W.T) is the sole owner of property and that man as vicegerent of Allah (S.W.T) is merely trustee and custodian.23 This relationship implies that man has the right to use and manage his private property in a manner similar to that of a custodian and trustee. Property is not an end itself, but a means to discharge effectively mans responsibilities as the vicegerent of Allah (S.W.T). The second axiom of property rights in Islam is that this right of possession is a collective right and individuals can only earn a priority in the use of these resources.24 While a part of these resources are reserved for the exclusive possession of the collectivity, the remaining part is allowed to be owned by individuals without the collectivity losing its initial right of possession to these resources. However, when an individual applies his creative labour to these resources he gains a right of priority in the use and enjoyment of the resulting product, without the rights of others being nullified. Individuals are to use these resources with the full understanding that Allah (S.W.T)s ultimate ownership and the collectivitys prior right, remain intact. This notion is the result of the permanence, constant, and invariant ownership of Allah (S.W.T) of all the resources, and by implications, that of prior right to these resources by the collectivity.25 This proposition becomes a legislative basis for requiring preservation of societys well-being and interests. Social interest and the collective dimensions of human life demands that individual freedom is kept within certain limits and a balance is created such that the individual, the society, and the state each has a claim on property rights in respect of the roles assigned to them. Property rights of these three agents should not come into conflict with one another, nor should the exercise of those rights by any one of these agents jeopardize the exercise of rights by the others.26 If as a result of the growth of the society, division of labour, or increasing complexities of markets, either the obligation to share is shirked or the rights of the society and the cohesion of the community are undermined, or a harmonious social order is at stake, the justification is created for the intervention of the legitimate authority to take corrective measures. Second axiom of the property rights implies that while individuals possession of these resources and his share in the outcome is allowed, sanctioned and protected by the Shari[ah, it is so as long as it does not come into conflict with societys interest and well being. Hence, private initiative and choice are recognized, but such recognition is not allowed to subvert the principle of sharing or lead to violation of the rights of the society and the state.27 However, once the individuals have discharged their duties to the society and the state, in accordance with prescribed manner and amount, and are not in violation of the rules of Shari[ah, their right to their possessions is held inviolate and no one has a right to force appropriation (or expropriation) of that persons property to anyone else.28 This is further endorsed by a hadith stating that Muslims blood, property and dignity are protected against each other.29 Ibn Taimiyah views property as a right granted by Shari[ah to utilize an object but a right of varying kinds and degrees. Sometimes the right is an extended one so that the proprietor can sell or give away the object, lend it or make a gift of it, bequeath it or use it for productive purposes; but sometimes the right is incomplete, and therefore the proprietors rights are limited or restricted.30 Rules concerning property acquisition, possession, usage and disposal should be looked at as regulations rather than the restrictions.31 Basic conditions to maintain lawful rights to property are that (1) property should not have been acquired by unlawful means (means repugnant to Shari[ah), (2) the acquisition and its continuity should not result in any damage or harm to others; and (3) the acquisition of property should not invalidate any valid claim nor should establish a non-valid one.32 Islam places great emphasis on acquiring and maintaining rights to property through lawful means but does not impose any limits on the amount of the property owned, i.e. Imposition of any cap on the amount of wealth an individual can accumulate as long as the individual is conforming to the obligations set by Shari[ah.33 Islam recognizes two ways in which an individual can obtain rights to property: (1) through his own creative labour and/or (2) through transfer -via exchange, contract, grants or inheritance - of property rights from another individual who has gained title to the property or asset through his own labour. Property acquired through non-permissible and unjustifiable means like gambling (maysir), bribing, stealing, cheating, forgery, coercion, or illegal trading does not qualify as al-mal as defined by Shari[ah and therefore is proscribed and forbidden. Consequently, any property, which is considered counter-productive or non-beneficial, loses its legitimacy and its associated rights. Hoarding with the intention to creating artificial scarcity and profiteering is considered unacceptable means of building wealth and property. Similarly, property acquired through breach of trust, adulteration, non-compliance with weights and measures, or unethical means does not satisfy the definition of property (al-mal) and therefore its ownership is not considered legitimate. Concomitant with property rights, the Shari[ah imposes responsibilities, among which are the obligations-- severely incumbent upon the individual--not to waste, destroy, squander, or to use the property for purposes not permitted by the Shari[ah.34 To do so would be to transgress the limits set on ones right and an encroachment on the rights of the others. The right of the collectivity to the property is further protected by the Shari[ah through the limitations imposed on the right of disposition of the property by the person who has gained priority in the use and enjoyment of that property. Hence, while the right of use and enjoyment of the property is affirmed by the Shari[ah, the exclusive and absolute right of disposition of the property is rejected.35 The prohibition of israf and tabdhir (wasting and squandering) in all areas applies to property as well. The individual may not make an alteration in his property that may harm even his neighbour. If the property owner proves his inability to use the property properly (within boundaries defined by Shari[ah), he forfeits his ownership rights. Under such conditions, the legitimate authority is fully justified in withdrawing the rights of usage of that property in order to protect it from the misuses by the owner.36 This position of the Shari[ah is in conformity with the Islamic conception of justice (al-[adl and al-ihsan) and the rights and responsibilities of the individual and the community. Islams concept of property rights differs in many aspects from the concept of property rights in other economic systems. On one extreme, proponents of market-based system argue in favour of individual-centred private property rights as fundamental right while on the other extreme a small minority believes that private property right is fundamentally immoral.37 On the contrary, Islam promotes a balance among rights of individuals, society and the state. This concept sharply contrasts with the self-centred utility maximizer economic agent idealized in neoclassical economics in an unbounded, insatiable, quest for acquisition and accumulation.38 Before the full market society came to prevail in the West, a great deal of property right in land and other assets was a right to use and enjoy the asset but not a right to dispose of it.39 The development of full market society required revision of this notion of property since it was considered that the right not to be excluded from the use or enjoyment of something that is not marketable. It was deemed impossible to reconcile this particular right with a full market economy. Hence, of the two earlier kinds of property rights—the right to exclude others and the right not to be excluded by others-the second was all but abandoned and the conception of property rights was narrowed to cover only the right to exclude others. In Islam, however, this right is preserved without in any way diminishing the role of the market as resource allocative and an impulse-transmitting mechanism. Islam does not endorse the notion of conventional system that a person does no harm to members of his group if as a result of his effort he is better off and others are no worse off than they would otherwise be. Several conclusions can be drawn from the preceding discussion. First, Islams concept of property rights is different such that the individual has a delegated right on the property whose acquisition, usage and disposal are subject to rules including the principle of sharing as dictated by Shari[ah. Second, whereas Islam strongly recognizes individuals private property rights, these rights are governed by rules designed to protect the rights of society and the state. Third, by virtue of the first and second axiom of property rights, every individual, group, community, society and the state becomes a stakeholder whose rights are granted and preserved by Shari[ah to promote social order and economic development. Fourth, whereas it is difficult to recognize or justify some rights of others in a formal economic theory in the conventional system without drawing any reference to ethics and morality, such problem does not exist in Islam where everyones rights are recognized and protected by Law (Shari[ah). Finally, inclusion (or exclusion) and recognition (or denial) of rights of stakeholders in Islamic economic system are based on foundations of rules and laws, which need no justification merely on the grounds of morality alone but are derived from principles aimed at creating a just and balance in economic and social system. Whereas Shari[ah guarantees some basic property rights to individuals by virtue of them being members of the society, rights of a firm or a legal entity like corporation are earned and acquired. It is not the firm, which accrues property rights but it is the property acquired in course of the firms economic activity that has property rights and claims. Once a property is earned or acquired by the firm, it is subject to the same rules of sharing and prohibition of wasting which apply to property of individuals. Firms property rights also come with similar claims and responsibilities as individuals. This implies that firm is expected to preserve property rights of not only local community or society but also of those who have participated in the process of acquiring or earning the firms property. No action of the firm that violates basic set of property rights of those with whom firm interacts will be acceptable. Principles of property rights in Islam clearly justify inclusion of stakeholders into decision-making and accountability of an economic agents activities. This inclusion is based on the principles that (a) collectivity (community, society, state) has sharing rights with the property acquired by either individuals or firms, (b) exercise of property rights should not lead to any harm or damage to property of others (including stakeholders), (c) rights of others are considered as property and therefore are subject to rules regarding violation of property rights, and finally (d) any property leading to the denial of any valid claim or right would not qualify to be recognized al-mal and therefore will be considered unlawful according to Shari[ah.
The significance of contractual obligations in economic and social relations cannot be over-emphasized. The whole fabric of Divine Law is contractual in its conceptualization, content, and application. Islam forcefully places all economic relations on the firm footing of contracts.40 It recognizes only one status, i.e. Moral consciousness and virtue, all other status on any basis is obliterated. The very foundation of the Shari[ah is covenant between Allah (S.W.T) and man; this imposes on man the duty of being faithful to his word. On Allahs side, the Quran often states that Allah will not fail in His promise.41 On mans side, his commitment to the contractual obligations is considered the best form of honouring his acceptance of Allah (S.W.T) as his Lord. A contract in Islam is a time-bound instrument, which stipulates the obligations that each party is expected to fulfil in order to achieve the objective(s) of the contract. Contracts are considered binding and their terms are protected by the Shari[ah, no less securely than the institution of property. The freedom to enter into contracts and the obligation to remain faithful to their stipulations has been so emphasized in Islam that a characteristic, which distinguishes a Muslim, is considered to be his faithfulness to the terms of his contracts. In the Shari[ah, the concept of justice, faithfulness (called amanah, whose antonym is khiyanah meaning betrayal, faithlessness and treachery), reward and punishment are linked with the fulfilment of obligations incurred under the stipulation of the contract. The Shari[ah judges the virtue of justice in man not only for his material fulfilment of contracts but also by the essential attribute of his forthright intention (niyyah) with which he enters into every contract. This intention consists of sincerity, truthfulness, and insistence on rigorous and loyal fulfilment of what he/she has consented to do (or not to do). This faithfulness to ones contractual obligations is so central to Islamic belief that when the Prophet was asked who is a believer? He replied that a believer is a person in whom the people can trust their person and possessions.42 In a very terse, direct and forceful verse, the Quran exhorts O you who believe, fulfil contracts.43 So basic is the notion of contracts in Islam that every public office is regarded, primarily as a contract and agreement, which defines the rights, and obligations of the parties.44 Implication of the emphasis placed on contracts in Islam is that it makes the members of the society and economic agents aware of the obligations arising from their contractual agreements-- verbal or written, explicit or implicit. In case of explicit contracts, parties to the contract clearly stipulate expected behaviour and duties with respect to the terms of the contract. This contract is to be free of information asymmetry; parties intend to comply with the terms of the contract and are fully aware of rights and obligations. Importantly, the state ensures enforceability of the contract in case of violations by either party. On the other hand, implicit contracts are not formal contracts with clearly defined terms but are claims and obligations that come with the rights to be part of a society.45 Principles of sharing and rights of collectivity to property rights are kind of implicit contracts to preserve and protect rights of others and thus establish a wide spectrum of implicit obligations.46 Within property rights framework, one has contractual obligations to others including the community and the society according to the rules of Shari[ah, and honouring of this obligation is considered a sacred duty. This sacred duty to preserve property rights of others is moral, social and legal foundation for recognizing and enforcing obligations to implicit contracts. Islams framework of contracts places equal emphasis on obligations arising from both explicit and implicit contracts. This behaviour is expected from individuals as well as from public and private entities. Therefore, just as it is incumbent upon economic agents to honour explicit contracts, it is obligatory on them to preserve sanctity of implicit contracts by recognizing and protecting property rights of stakeholders, community, society and state. Whereas conventional stakeholders theory is searching for sound arguments to incorporate implicit contracts in the theory of firm, in Islamic economic system rights of and obligations to stakeholders are taken for granted. Islams framework of property rights and contracts also establish guidelines regarding who can qualify as a stakeholder and if such stakeholder has right to influence the firms decision-making and governance. In a very broad sense, any group or individuals with whom firm has any explicit or implicit contractual obligations qualify as a stakeholder even though firm may have formal contracts with them through mutual bargaining. In Islam, a stakeholder is the one whose property rights are at stake or at risk due to voluntary or involuntary actions of the firm. In case someones rights are encroached or threatened as a result of firms operations, that individual, group, community or society becomes a stakeholder.47 This risk-based definition of stakeholder is supported by a saying of Prophet that a Muslim is the one from whose hand others are safe.48 Having established the firms responsibility to society and stakeholders, question still remains whether stakeholders have the right of participation in decision-making. Or, if they are given right to participate, is it practical and operationally efficient? These issues are discussed in detail in the following section.
Once the rights of stakeholders are recognized, one can focus on what determines the best institutional arrangements to protect the stakeholders rights to its true spirit. Or what structure of governance can yield optimal results. Within the conventional stakeholder theory, there are opposing arguments with regards to stakeholders participation in the governance. Some argue that there is greater need that a firm should internalize the externalities on the various stakeholders and this internalization should be in form of active participation in the process and structure of corporate governance.49 Others argue that each stakeholder or constituency is free to bargain with a firm and to choose the most effective means for protecting its interests. Some stakeholders may derive little benefit from the set of rights negotiated by shareholders and therefore would prefer other safeguards for their interests. Consumers, for example, instead of seeking a seat on the board of directors, or the benefit of fiduciary duties may settle for manufacturers warranties, consumer and product safety laws, and tort liability system because these protections better serve their interests.50 Islamic economic system is a rule-based incentive system; based on the rules of Shari[ah with the ultimate goal of maintaining a just and harmonious social order. Rules are restrictions on what the members may do without upsetting the social order on whose existence all members count in deciding on their individual choices and actions. Therefore, attachment to and observance of rules will guide the members of the society in their actions. The rules themselves are composed of those which deal with the individuals body and his state of consciousness, those which govern his relationships with other members of the society, those which guide his relationship with the collectivity and finally those which constitute the code of conduct necessary for the community as a whole. Rules serve to prevent conflicts, reconcile the different purposes of many individuals and facilitate cooperation among them. If as a result of growth of the society, division of labour, or increasing complexities of markets, either the obligation to contracts or property rights are shirked or the rights of the society and the cohesion of the community are undermined, justification is created for intervention of the legitimate authority to take corrective measures.51 Compliance with them promotes social integration and unity and preserves the intended social order. In Islam, expected behaviour of a firm would not be any different from the expected behaviour of any other member of the society. Since firm itself does not have a conscious, behaviour of its managers becomes the behaviour of the firm and their actions are subject to the same high standards of moral and ethical commitment expected from a Muslim. In other words, firms economic and moral behaviour is shaped by its managers acting on behalf of the owners and it becomes their fiduciary duty to manage the firm as a trust for all the stakeholders and not for the owners alone. Consequently, it will be incumbent upon managers to ensure that behaviour of the firm conforms to the principles and the rules of Shari[ah. If there is any deviation, institutional arrangement discourage such deviation. In an ideal situation where all agents are true and practicing Muslims, whose behaviour correspond fully to the requirement of the Shari[ah, the faithfulness to the terms of contracts and accountability to respect others property rights will lead to elimination of problems due to asymmetric information, moral hazard and adverse selection and thus would guarantee optimal governance. In a less perfect world where commitment to contracts may be influenced by personal interests at the cost of interests of collectivity to induce deviation from the terms of contract, design of a governance structure will be required to ensure faithfulness to agents contractual agreements and protections of everyones rights. The design of a corporate governance system in Islamic economic system entails implementation of a rule-based incentive system such that the compliance with the rules ensures an efficient governance system to preserve social justice and order among all members of society.52 This would imply the design of institutions and rules that induce or, if needed, compel managers to internalize the welfare of all stakeholders. The rights that are claimed for stakeholders are not ends in themselves-- which ought to be recognized in any form of economic organization-- but means for protecting constituency rights.53 In an Islamic system the observance of rules of behaviour guarantee internationalization of stakeholder rights (including those of the society at large). No other institutional structure would be needed if there were complete adherence to Islamic rules. However, to ensure compliance to the Islamic rules, there is need for institutional arrangements. Therefore, it would be the Islamic government that should specify appropriate corporate governance structure, incorporating all stakeholders rights into fiduciary duties of managers of the firm on behalf of non-investors or stakeholders. So no other institutional arrangement that would allow individual non-investor stakeholders to negotiate directly with the firm would be necessary. Incorporating all stakeholders right into fiduciary duties of managers would be counterproductive and would lead to sub-optimal results. The important point is that each stakeholder is given freedom of bargaining to protect its rights and there are systematic institutional arrangements in place to provide protection and to mediate where disputes and disagreements arise. Institutional arrangements can be part of system-wide infrastructure surrounding the governance structure of the firm. For example, because contracts are invariably incomplete, judicial interpretations can fill in the gaps. It is permissible to regard employment law, consumer law, tort law, as well as judicial rulings and administrative regulations, as part of the contracts that various stakeholders have with the firm.54 Similarly, the concept of Shari[ah boards is very unique to Islamic financial system. A Shari[ah board, consisting of fuqaha (scholars in Shari[ah matters) has been used to oversee the operation of a financial institution to ensure that the operations and code of conduct of Islamic bank is according to the rules of Shari[ah. A Shari[ah board for every firm, which is seen in present architecture of Islamic banking, is not efficient whereas only one set of rules is needed for appropriate corporate governance based on the Shari[ah for all firms. The same idea of Shari[ah board can be extended to a system-level board consisting of scholars from different disciplines including Shari[ah, economics, finance, and commercial law, to ensure that rules are defined and enforced so that economic agents fully comply with contractual obligations to all the stakeholders.
This paper examines the conventional stakeholder theory of corporate governance, which views a firm as a nexus-of-contracts with different stakeholders and argues that firms objective should be to maximize welfare of all stakeholders. This theory has yet to offer strong arguments with regards to who is a stakeholder and why firm has any obligation to non-owner stakeholders because of absence of theoretical foundation to incorporate morals, ethics and trust in the economic theory. This paper argues that the principles of property rights and contracts in Islam offer theoretical foundations to acknowledge the rights of all stakeholders. Islams principles of property rights, contracts, and just social order define the business environment where economic agents are morally conscious of protecting property rights and contractual obligations to each other whether acting as managers, employees, suppliers, customers, or in any other capacity. All participants in economic activities, whether individuals, firms, corporations, non-profit organization or public institutions, are subject to the same degree of commitment. Notion of sanctity of contractual obligations is not limited to explicit contracts, which are well defined, stipulated and documented, but is equally applicable to implicit contracts, which are incomplete in nature. Property rights of all contractual parties, i.e. Individuals, or local communities, or intangible legal entities, or the society are preserved and protected. Keeping in mind that voluntary behaviour of all economic agents may deviate from the expected behaviour, implementation of an incentive system according to the guidelines of Shari[ah will ensure that all economic activities adhere to Shari[ah principles of property rights and contracts so that an optimal social order is achieved. It is not necessary for each stakeholder to be a participant in the decision-making as long as their rights are protected through sound institutional arrangements.
Any source

Saturday, January 27, 2007

F-word is Indecent according to the FCC

The FCC received several complaints from organizations and individual viewers of Fox Network’s broadcast of “The 2003 Billboard Music Awards.” The indecent material complained of stemmed from remarks made by Nicole Richie to co-host Paris Hilton, where she said “f***ing.” Fox conceded to using the word but also contended that the use was not “pandering, titillating or shocking” and was not actionably indecent.

The Commission defines indecent speech as material that, in context, depicts or describes sexual or excretory activities or organs in terms patently offensive as measured by contemporary community standards for the broadcast medium.

The Commission decided that Ms. Richie’s use of the F-word, although not describing excretory activities, still fell within the scope of indecency because using the word for emphasis or as an intensifier has long been found an indecent use. The word carries with it an implied sexual connotation and therefore will always fall within the definition of “indecent.”

In the Matter of Complaints
Regarding Various Television Broadcasts
FCC 06-166 (Nov. 2006)

U.S. District Court for the Central District of California grants Plaintiffs’ motion for summary judgment against Defendant, StreamCast.

The Plaintiffs were a group of record companies, movie studios and music publishers. Defendant, StreamCast, was found liable for the infringement committed by its users on the basis of the inducement doctrine.

The Inducement Doctrine provides that one who distributes a device with the object of promoting its use to infringe copyright, as shown by clear expression or other affirmative steps taken to foster infringement, is liable for the resulting acts of infringement by third parties.

An unlawful objective to promote infringement can be shown by a variety of means. The classic instance of inducement is by advertisement or solicitation that broadcasts a message designed to stimulate others to commit violations.

The court found that evidence of Defendant’s objective of promoting infringement was overwhelming and that no reasonable fact finder could conclude that Defendant provided services and distributed a software program without the intent to induce infringement.

Metro-Goldwyn-Mayer Studios, Inx. v. Grokster, Ltd.
2006 WL 2806882Any source
Jorg Bley and Kermit Kuehn

This research investigates the relationship between university student knowledge of relevant financial concepts and terms in conventional and Islamic banking, the impact of religion and language, and other individual variables on preferences for financial services. Data from a university graduate and undergraduate business students (n = 667) from the United Arab Emirates was used to investigate the role of financial knowledge, religion, and language on self-reported attitudes and preferences for financial services. Results suggest that knowledge of conventional banking terms and concepts was higher among these students than was Islamic banking terminology. Arabic language was the primary predictor of higher Islamic banking knowledge, as well as a significant, though weaker, predictor of lower conventional banking knowledge. The more education completed tended to improve financial knowledge of both conventional and Islamic finance. Finance students tended to have higher overall knowledge of both financial systems. Further, religious sincerity, not better knowledge, was the strongest predictor of preference for Islamic banking services. Implications of the research are discussed.


The Islamic financial services sector is estimated to be growing at double digit rates, involving over 200 financial institutions with assets estimated to exceed US$200 billion (Al-Dhahiri, Al-Khamiri, and Al-Hamli, 2003). While the growth has been most noticeable in Arab Muslim markets, the potential has impact beyond these fertile markets to non-Arab Muslim and non-Muslim consumers and businesses as well. Yet, our knowledge of consumer motivations for choosing Islamic versus conventional banking services is modest and the research to date is limited and ambiguous on these key issues. The UAE is a dynamic and growing market for business, particularly in financial services. Global as well as local banks have flourished in recent years in this relatively progressive and vibrant economy.

Islamic Banking within the UAE

The United Arab Emirates (UAE) enjoys the highest economic growth rates in the Arab world, with emirate of Dubai’s 6.2 percent GDP growth in 2003 taking the first place among the seven emirates of the UAE. The average GDP growth was an impressive 4.6 percent over the last ten years. The country’s investment rating index in 2002 has surpassed even Kuwait and Bahrain.1 The index measures a country’s investment climate based on political, economic, and financial risk criteria. Overall, the UAE was rated a “very low risk” country.

The banking community in the UAE comprises 46 banks, the largest in the GCC after Saudi Arabia. The year 2003, was a record year for UAE banks, with an average net profit growth rate of about 16 percent. According to the Central Bank, aggregate net profits of the 21 national and 25 foreign banks in the UAE amounted to DH5.67 billion ($1.54 billion). Of the 21 national banks, 3 are Islamic finance institutions with combined assets totaling DH29.93 billion ($8.14 billion), which is the equivalent of about 9.5 percent of the total assets held in the UAE by all 46 banks.2 The first Islamic commercial bank was established in Dubai in 1974 and an intergovernmental Islamic bank started its functions in 1976 as the Islamic Development Bank.
Growth rates within the banking sector, however, are not homogenous. Islamic finance institutions have produced growth rates of 15-18 percent; twice the average growth rate of conventional banks.3 Not only do Islamic banks grow faster than their conventional counterparts, but their numbers seem to be increasing rapidly as well. In the past two years, two conventional financial institutions have converted to Islamic principles and another, Middle East Bank, is preparing to do so by June 2004. While the multinational Hong Kong Shanghai Banking Corporation (HSBC) is expanding its Islamic finance operations, others are contemplating joining the lucrative Islamic finance market through the offering of Islamic Finance products.
The relative success of Islamic banks is impressive and a better understanding as to the underlying factors for their popularity is important to gauging the long-term prospects of the industry. This study examines the impact of consumer knowledge and attitudes towards Islamic versus conventional banking products and services, as well as selected demographic factors, on preferences for Islamic products and services.

Literature Review

In a survey conducted in the UK, Omer (1992) found a high level of ignorance among the 300 interviewed Muslims with regard to what constitutes acceptable Islamic finance principles. He reported that the higher the religious commitment and the lower the level of general education, the stronger the preference for Islamic over conventional finance. However, Haron, Ahmad and Planisek (1994) found that the selection criteria of Muslim bank customers in Malaysia was largely based on non-religious aspects, such as service efficiency, transaction speed, and the friendliness of bank personnel. Even with these results, some 40% of the respondents indicated that religion was a prime reason for using Islamic banking services. They noted that although there was a high level of awareness of Islamic products, there was a poor understanding of the differences between Islamic and conventional banking, as well as weak knowledge regarding Islamic products and services.
Nasser, Jamal, and Al-Khatib (1999), surveying 206 bank customers on Jordan, added a bank’s reputation and perceived level of confidentiality to this list of selection criteria noted in the Haron et al (1994) study. Again, as in the earlier case, the researchers noted a high level of ignorance regarding specific Islamic products, with 70% of the respondents stating that religion was a very important reason for them to select an Islamic bank.
Similarly, Gerrard and Cunningham (1997) found no difference between Muslims and non-Muslims on bank selection criteria. They do note, however, that nearly 25% of the respondents indicated that religion was to the sole basis for choosing an Islamic bank. These primary findings are in contrast to Metawa and Almossawi (1998) who interviewed 100 Islamic bank customers in Bahrain and found that the single most

important factor for the selection of an Islamic bank is the Sharia-based principles that govern these financial institutions.
Hamid and Nordin (2001) surveyed Malaysian commercial bank customers, finding a a high awareness of Islamic banking but poor self-reported knowledge of specific Islamic products, including poor understanding of the difference between Islamic and conventional banking. In another study of Malaysian commercial customers and their views of Islamic financial services, Ahmad and Haron (2002) noted that 65% of the respondents admitted to having limited knowledge of Islamic banking, while at the same time indicating that they believed the concept had good potential in the Malaysian market.
While the literature available in this area is still developing, it does reveal that the underlying drivers of preferences in financial services are far from clear, for both individual and commercial customers. The strong growth in the Islamic financial service sector suggest that a greater understanding of the factors that influence these choices can only benefit the development of appropriate strategies to address the growing appetite for these products and services. Two things seem clear from a survey of the literature: (1) the level of knowledge of Islamic products seems weak across studies that measured such knowledge and (2) the attitudes toward Islamic financial services is at least partly influenced by religious factors and perhaps other individual characteristics of the consumer.
This study seeks to add to this literature by examining more carefully the relationship between knowledge of financial concepts (conventional and Islamic), preferences for either conventional or Islamic financial services, and certain individual characteristics of the raters. One of the driving motivations for this study was the belief that the lack of knowledge of specific Islamic products was in part attributable to the Arabic vocabulary used to identify Islamic financial products. As most of the world is not even minimally fluent in Arabic, and this is true in the Muslim world as well, the use of Arabic hinders understanding of what these Islamic products really are. Add to this the relative newness of the products offered, the market is generally ignorant of these products.


The poor knowledge of Islamic finance principles has been one area of concern in this literature for over ten years (Omer 1992). Add to this the increase in the number of Islamic banking terms has been considerable over this period. But in spite of the growing interest in the field of Islamic finance, a high level of awareness of the Islamic banks (Haron et al 1994) and the growing interest in the use of Islamic banks (Al Ahmed 1996), no general educational initiative has been launched by either government or the financial institutions (Hamid and Nordin 2001) to address this lack of basic product knowledge. Conventional banking concepts, on the other hand, are covered in the curricula of most business oriented universities and even high schools. We wanted to compare knowledge among this relatively elite population. Consequently, we hypothesize that:

H1 = Knowledge of conventional banking terms and concepts is generally higher than knowledge of Islamic banking terms and concepts.
Whether religious aspects are the deciding factor of bank patronage is still in dispute. Contrary to Omer (1992) and Metawa and Almossawi (1998), Erol and El-Bdour (1989) argue that other factors such as return expectations are more important than Islamic finance principles and that customers in Islamic countries

would not differentiate between the services offered by conventional and Islamic banks (Erol et al 1990). We believe, however, that religion is a strong driver of individual preferences of consumers. The whole Islamic financial system exists because of a religion-based interpretation of economics. This would be expected to appeal to a religious community on that basis. Consequently, we test the hypothesis that:

H2 = The preference for Islamic banking is primarily driven by religious beliefs, not financial
knowledge. That is, the stronger the religious commitment the more preference for Islamic
banking services.

Al Ahmed (1996) suggested that the level of education had an impact on bank patronage. On the other hand, Hamid and Nordin (2001) found that Islamic banks label their products “ambiguously, causing misunderstandings not only among non-Muslims. As some bank customers find these terms too difficult to learn, they simply stay away. Consequently, we hypothesize that:

H3 = The knowledge of banking terms and concepts drives students’ perception of bank products and services.

Cultural differences seem to exist that determine banking perceptions and preferences. Tan and Chua (1986) argue that, in an oriental culture, a close relationship and interaction with the bank personnel is one of the most important bank selection criteria. These bank selection criteria vary from country to country and are subject to demographic determinants such as gender, age, and educational background (Kaynak, Kucukemiroglu, and Odabasi, 1991). Specifically, prior research revealed that age, income and education play important roles in distinguishing preferences. As indicated earlier, due to the naming of Islamic products being transliterations from Arabic, we expected that Arabic language fluency would be a distinguishing characteristic, as well as religious background:

H4 = Demographic variables will affect Islamic banking knowledge and perceptions of and
preferences for financial products and services. Specifically,

(a) Those more fluent in Arabic will be more knowledgeable of Islamic financial concepts and
products than those weak in fluency, but not be a factor in conventional banking knowledge.

(b) Finance students will be more knowledgeable of both systems than non-finance students.

(c) Muslim students will be more knowledgeable of Islamic financial concepts than nonMuslim,
and show stronger preference for this system.

(d) Male and female students will be equally knowledgeable of Islamic financial concepts.

Sample and Methodology

Usable data (n = 667) was collected from of a survey of 700 graduate and undergraduate students of the School of Business and Management at the American University of Sharjah, UAE. The decision to survey university students was mainly based on three factors: First, we could gauge the knowledge of a portion of the country’s intellectual elite. As a well-recognized, regional, private university, it attracts academically a

stronger student body. We focused on business students as they should have a particular interest in and better understanding of finance related matters. Second, we could avoid some of the introduction of sample bias that tends to confound results of field studies, a particular problem in this literature. And, third, university students can easily be surveyed in a more controlled research environment, allowing for a stronger research design.
To get a representative cross-section of the business students, a set of ten courses, most with multiple class sections, were surveyed. The survey was taken in a controlled classroom environment; specifically, course instructors read a standard set of instructions to the class, informing them of the survey purpose and conditions. Students were given approximately 25 minutes to complete the survey. Each instructor of the section being surveyed was given a standard set of instructions to be read to the class. Instructors were not to answer any content related questions and prevented the students from communicating with each other while the survey was in progress. A total of 33 surveys were not completed properly and were excluded from the subsequent analysis, leaving the sample size at 667. The sample breakdown is presented in Table 1.
The sample survey consisted of three sections. The first section consisted of 24 statements pertaining to the perception of conventional and Islamic banking products and services and the underlying concepts as well as personal banking preferences. The statements had to be rated on a 1-7 scale (from 1 = “strongly disagree” to 7 = “strongly agree”). The statements were grouped into five aspects: (1) Perception of Islamic Banking Products and Services, (2) Perception of Islamic Banking Concepts, (3) Perception of Islamic Banking Terms, (4) Personal Banking Preferences, and (5) Religious aspects. The five aspects were derived using a principal components analysis with an Oblimin rotation, which explained approximately
47.9% of the total variance. For each aspect, mean scores were computed for every completed survey. The descriptive statistics for each aspect are shown in Table 2.
The second section gauges the students’ knowledge of conventional and Islamic financial. Seven financial definitions had to be matched with the corresponding conventional and Islamic terms. An additional four multiple-choice questions regarding conventional and Islamic concepts had to be answered. One point for each of the seven matching definitions and two correct conceptional answers would result in a maximum score of nine in each individual segment, the conventional (CB score) and the Islamic segment (IB score). Thus, the maximum overall score (OV score), as the sum of the individual segment results, would be eighteen. The frequency distribution of all three scores is in Table 3. The third section was comprised of several demographic variables.


It was hypothesized that students’ knowledge of conventional finance terms and concepts was more
developed than the knowledge of Islamic finance terms and concepts. H 1 was supported. The mean
CBscore (conventional finance) was 2.32 compared to a mean IBscore (Islamic finance) of 1.67. The paired samples t-test statistic determined significance at the 1%-level (see Table 3).
To shed more light on the question of what affects the level of students’ financial knowledge, the CBscore and the IBscore were separately regressed on a set of ten demographic variables (see Table 4). To identify the regression model with the highest explanatory power, a stepwise regression procedure using forward selection was applied. Forward variable selection enters the variables of the set one at a time based on

entry criteria. Stepwise variable entry and removal examines the variables of the set at each step for entry or removal. All variables must pass the tolerance criterion (0.0001) to be entered in the equation. Also, a variable is not entered if it would cause the tolerance of another variable already in the model to drop below the tolerance criterion. All independent variables selected are added to a single regression model. The minimum significance level chosen is 5 percent.

Conventional Banking Knowledge

The stepwise regression procedure yielded the following four-factor model (each of the explanatory variables was statistically significant at the 1 percent level):

(1) CBscore = a + b 1 Credits + b 2 Language + b 3 Study + b 4 GPA + e

CBscore = A student’s total score in the conventional finance segment, consisting of seven
matching definitions and two correct conceptional answers with a maximum score
of nine.

α = the intercept term

Credits = a dummy variable set equal to one if the student has completed 60 or more
credit hours, zero otherwise.

Language = a dummy variable set equal to one if the primary language is Arabic, zero

Study = a dummy variable set equal to one if the student’s area of study is finance,
zero otherwise.

GPA = a dummy variable set equal to one if the cumulative grade point average is
greater or equal to 3.0, zero otherwise.

β1 - β4 = the correlation coefficients associated with the four explanatory variables.

ε = the random error term

Number of university credits completed

Significance tests indicate that the single most important explanatory variable for the CBscore is the number of university credits completed. In other words, as the student proceeds to higher educational levels, their understanding of conventional finance terms and concepts increases. An independent samples test reveals that the mean CBscore of graduate students is 1.02 points higher than that of undergraduate students. The mean difference is significant at the 1 percent level.
The other three variables identified to have a significant impact on the CBscore are: primary language, area of study, and the cumulative grade point average.

Primary language

The negative correlation coefficient suggests that students, whose primary language is Arabic, tend to have poorer knowledge of conventional banking concepts and terms than non-Arabic language students. According to the results of an independent samples test, the mean difference in CBscores is 0.98 points (significant at the 1 percent level).

Area of study

As expected, finance majors generally display a higher level of knowledge regarding conventional finance concepts than finance majors, as indicated by the positive correlation coefficient. The mean difference in CBscores is 0.63, which is significant at the 1 percent level.

Cumulative grade point average

The more successful a student is academically, the higher his/her overall level of knowledge and, thus, the expected CBscore. The positive correlation coefficient supports this hypothesis. A cross-sectional analysis reveals that students with a GPA e” 3.0 have a mean CBscore that is 0.47 points higher than that of students with a lower GPA (significant at the 1 percent level).
Overall, the CBscore tends to be the highest for non-native Arabic speakers with a concentration in the area of finance who are fairly advanced in their program and have a high level of academic success.

Islamic Banking Knowledge

For the IBscore, the stepwise regression procedure yielded a model consisting of seven explanatory variables, with the first four variables (Arabic spoken fluency, number of university credits completed, Religion, and the cumulative grade point average) statistically significant at the 1%-level and three variables (gender, primary language, and the area of study) statistically significant at the 5%-level. The final model is shown in Table 5.
IBscore = a+ b 1 SFluency + b 2 Credits + b 3 Re ligion + b 4 GPA
+ b 5 Gender + b 6 Language + b 7 Study + e


IBscore =A student’s total score in the Islamic finance segment, consisting of seven
matching definitions and two correct conceptional answers with a maximum
score of nine.

α =the intercept term

SFluency =a dummy variable set equal to one if the level of Arabic spoken fluency is very
fluent or fluent, zero otherwise.

Credits =a dummy variable set equal to one if the student has completed 60 or more
credit hours, zero otherwise.

Religion = a dummy variable set equal to one if the student is of non-Muslim
faith, zero otherwise.

GPA = a dummy variable set equal to one if the cumulative grade point average is
greater or equal to 3.0, zero otherwise

Gender = a dummy variable set equal to one if the student is female, zero otherwise.

Language = a dummy variable set equal to one if the primary language is Arabic, zero

Study = a dummy variable set equal to one if the student’s area of study is finance,
zero otherwise.

β1 - β7 = the correlation coefficients associated with the seven explanatory variables.

ε = the random error term

Arabic spoken fluency

Significance tests indicate that the single most important explanatory variable for the IBscore is the Arabic spoken fluency level. The results suggest that the understanding of Islamic finance concepts largely depends on traditional Arabic terminology which, in turn, requires a certain level of familiarity and fluency. Theses results are supported by the findings of the subsequent independent samples test. Compared to students with limited fluency in Arabic, the IBscore means of students with fluency or reasonably fluency in spoken Arabic and in written Arabic were 1.46 points and 1.17 points higher, respectively, than their non-fluent counterparts. Both mean differences are significant at the 1 percent level. This provides specific support
for hypothesis H 4a

Number of university credits completed

The positive coefficient suggests that as students proceed through their four-year university program, they become more knowledgeable in business in general, and finance in particular, including understanding of Islamic finance terms and concepts. Supporting these findings, an independent samples test reveals that the mean IBscore of graduate students is even 0.68 points higher than that of undergraduate students. The mean difference is significant at the 1 percent level.


As Muslims would generally be expected to be more familiar with the teaching codified in the Sharia, which in turn is the basis for Islamic finance concepts, they would be expected to be more knowledgeable in the area of Islamic finance than their fellow non-Muslim students. In fact, the negative coefficient indicates that being a non-Muslim has a negative impact on a student’s IBscore. Supporting the findings of Haron et al (1994), the subsequent t-test for equality of means determined the mean difference in IBscores between Muslim and non-Muslim students to be 1.28 points. This result is statistically significant at the 1 percent
level, supporting hypothesis H 4c

Cross-sectional analysis further revealed that the interest in the field of Islamic finance is generally less in the non-Muslim community. Only 44.1% of the non-Muslim students are interested in taking a course in Islamic finance, compared to 85.2% of their fellow Muslim students. Thus, knowledge of and interest in Islamic finance differs significantly between the religious groups.

Cumulative grade point average

The more successful a student is academically, the higher his/her overall level of knowledge and, thus, the expected IBscore. The positive correlation coefficient supports this expectation. Again, top students seem to generate a premium IBscore. Students with a GPA e” 3.5 have a 0.59 point higher IBscore than students with a GPA between 3.0 - 3.49. This mean difference is significant at the 1 percent level.
The remaining three variables (gender, primary language, and the area of study) were statistically significant at the 5%-level.


The regression result suggests that male students tend to score higher on Islamic finance issues. At a 5 percent level of statistical significance, the subsequent t-test for equality of means determined the mean difference in IBscores between male and female students to be 0.24 points.

Primary language

Contrary to the CBscore, which is lower for students whose primary language is Arabic, the IBscore tends to be higher for Arabic speaking students. According to the results of an independent samples test, the mean difference in CBscores is 0.98 points (significant at the 1 percent level). This provides additional support for hypothesis H4a, where Arabic language fluency was expected to be related to knowledge of Islamic financial terms and concepts.

Area of study

Similar to the CBscore, the IBscore is positively related to the student’s area of study. Specifically, finance majors generally display a higher level of knowledge regarding Islamic finance terms and concepts than non-finance majors. However, the results are not quite as strong as they were when looking at the results for CBscore. The mean difference in IBscores is a mere 0.21 points versus the CBscore mean difference of 0.63 points. This provides support for hypothesis H4b, where finance students would tend to score higher on tests of knowledge of both systems.

Overall, the IBscore tends to be the highest for male Muslim students with a high level of Arabic fluency, who are fairly advanced in their program and have a high level of academic success, regardless of their business concentration.

Banking Preferences

Hypothesis H 2 stated that students’ preference for Islamic banking was primarily the result of religious beliefs. Table 6 shows the results of the independent samples test. The mean difference in the score Aspect4, which measures personal banking preferences, between groups of students with high (Aspect5 score e” 5.0) versus low level of religious sincerity (Aspect5 score d” 3.0), was computed to be 1.23 (significant at the 1 percent level). These results suggest that the preference for Islamic banking is largely based on religious aspects. The significance level of 1 percent suggests accepting hypothesis H 2

How students perceive conventional versus Islamic banking products and services is arguably a matter of perceived product and service characteristics. To understand whether perception of Islamic products and services (Aspect1) is influenced by religious beliefs rather than knowledge of the products themselves, we regressed Aspect1 on Aspect5, the CBscore, and the IBscore. The regression results indicate that while the degree of religious sincerity has a significant impact on the desirability of Islamic products and services (at the 1 percent level), knowledge of these products or services does not appear to influence perceptions or preferences for these products. Neither the coefficient associated with CBscore nor with IBscore was
significant (Table 7). We, therefore, fail to accept H 3

Finally, hypothesis H 4D suggested that Gender might not be a useful predictor in this study. Table 8 presents the results of corresponding independent samples tests. While male students displayed more favorable perception of Islamic banking products and services than female students, they also have a slightly higher IBscore. The mean difference in IBscore is 0.27 points, which is significant at the 5 percent level. This is surprising in light of a higher female mean GPA (mean difference is 0.44 in favor of female students, significant at the 1 percent level). Consequently, we fail to accept H4D


This research investigated the relationship between university student knowledge of relevant financial concepts and terms in conventional and Islamic banking, the impact of religion and language, and other individual variables on perceptions of and preferences for financial services. Seven hundred graduate and undergraduate students of the School of Business and Management at the American University of Sharjah were surveyed on their perceptions and preferences related to conventional and Islamic banking products and services, and their knowledge of the terms and concepts of each system. Our results suggest that personal banking preferences are largely based on students’ level of religious sincerity. In other words, Muslim students in general, and those students who reported to take their religion very seriously, perceived Islamic finance more favorably then conventional finance.

Overall, students’ knowledge of conventional and Islamic finance terms and concepts was surprisingly low. In general, conventional finance knowledge was the highest for those students with poor to no Arabic language fluency, who majored in finance and who were fairly advanced in their programs and had a high level of academic success. In contrast, the level of Islamic finance knowledge was generally the highest for male Muslim students with a high level of Arabic fluency, who are fairly advanced in their program with a high level of academic success, regardless of their business concentration.

Implications of This Research

The results of this study are based on self-reported ratings of university students and thus limit the generalizability of our findings. However, seventy-five percent of the respondents in this study did have bank accounts, over half with conventional banks. Thus, most are consumers of the financial system and have considerable credibility when it comes to communicating their perceptions of banking services and preferences. As these students come from over 40 different nationalities, they provide a snapshot of the knowledge and attitudes of this relatively diverse, young, educated consumer.

With this recognition, our findings provide a unique perspective of a population of new and potential consumers of financial services in the region and the challenges that face financial service providers in this market. From this research, we make a number of observations.

First, the use of Arabic language terminology in labeling Islamic finance products and services seems to hinder understanding for the vast number of non-Arabic language populations, which includes the majority of Muslims. The Islamic finance industry, and that includes the regulatory bodies that determine suitability of Islamic offerings, must decide what the real definition of an Islamic financial system is and then permit the packaging of the Islamic products and services to be made by the suppliers themselves and that in terms of the markets in which they compete. This approach would allow suppliers of Islamic financial services to better communicate the value of their products in the financial services market relative to conventional financial systems.

This issue leads to a second observation for Islamic finance as a market concept. This research supports other studies that found that a primary reason for choosing Islamic financial service organizations and products is religious in nature and not based on any specific understanding of the products themselves. Add to this the perception among non-Muslim students is that the concept of Islamic finance is inherently appealing only to Muslims, as Islamic financial service providers are not perceived to offer superior products or services. Finally, Kahf (2002) noted that bank personnel did not fully understand Shariah’s rulings and, in turn, had difficulty advising customers on the characteristics of different types of Islamic finance products.

From all of this, we can conclude that the ignorance is widespread. This suggests that consumers are making their decisions not on knowledge of the quality and value of the products and services offered, but simply on religious principle. This basis for consumer choice undermines the principle of an informed consumer, the very foundation of a free-market economy.

The implications of this widespread ignorance along with a propensity to religious-based preferences needs more careful analysis in future research, in order to determine the risks to consumers and the potential abuse by suppliers in these markets. As already suggested by Naser and Moutinho (1997), Islamic banks need to improve their marketing effectiveness by addressing market ignorance of, even indifference to learning about, Islamic products and services. Finally, to raise the level of awareness, understanding, and, most likely acceptance of Islamic finance among non-Arabic non-Muslim consumers, a generally accepted translation of the Islamic finance and banking terms seems necessary.

One final observation, our results revealed that students who had completed more education tended to possess more knowledge of both conventional and Islamic financial concepts. This suggests that education can assist in making people more knowledgeable consumers of the products being offered, thus the potential to make more educated decisions about the value and risks of their choices. Better consumer education was advocated previously in the literature (Hamid & Nordin, 2001).


To ensure long-term growth and prosperity of the Islamic finance sector, overcoming widespread ignorance of Islamic financial concepts seems crucial. Educating the market along with the selection of more market friendly packaging of Islamic products would aid in the competitiveness of Islamic financial products relative to conventional products. Facilitating the understanding of Islamic products being offered and making the comparability with similar conventional products easier, will help consumers make better choices. This has the added benefit of insuring that suppliers of financial products and services, whether Islamic or conventional, provide comparative value to consumers. This seems essential in an increasingly competitive financial services sector.
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