The composite risk‐sharing finance index: Implications for Islamic finance

Abstract

In policy-making, assessment of where a country stands relative to other countries is important to achieve desired goals, to understand how much the current policy implementation diverts from the target, and to understand main obstacles on reaching at the ends in the light of the comparators and the benchmark. This study evaluates relative standing of countries with respect to their financial system's friendliness for risk-sharing finance, the concept which forms the core foundation of Islamic finance. A composite risk-sharing finance friendliness index is developed to compare and rank the countries with regard to their level of their support and adoption of risk-sharing finance. Although, there have been attempts to develop such index, this study is novel in the Islamic finance literature in the sense that it brings the factor analysis and non-linear weights into the picture to come up with an objective and convincing composite index with objective weights. The composite index also allows us to look into the relative contribution of components, namely, Institutional Scaffolding, Governance and Legal Environment, Financial Sector Development and Inclusion. The results and ranking of the countries reveal important information about the potential of developing risk-sharing finance and financial products in different countries. The results also reveal that the OIC countries are far away from meeting the basic requirements of setting-up risk-sharing finance and thus a framework for comprehensive development of Islamic finance. ABSTRACTIn policy-making, assessment of where a country stands relative to other countries is important to achieve desired goals, to understand how much the current policy implementation diverts from the target, and to understand main obstacles on reaching at the ends in the light of the comparators and the benchmark. This study evaluates relative standing of countries with respect to their financial system's friendliness for risk-sharing finance, the concept which forms the core foundation of Islamic finance. A composite risk-sharing finance friendliness index is developed to compare and rank the countries with regard to their level of their support and adoption of risk-sharing finance. Although, there have been attempts to develop such index, this study is novel in the Islamic finance literature in the sense that it brings the factor analysis and non-linear weights into the picture to come up with an objective and convincing composite index with objective weights. The composite index also allows us to look into the relative contribution of components, namely, Institutional Scaffolding, Governance and Legal Environment, Financial Sector Development and Inclusion. The results and ranking of the countries reveal important information about the potential of developing risk-sharing finance and financial products in different countries. The results also reveal that the OIC countries are far away from meeting the basic requirements of setting-up risk-sharing finance and thus a framework for comprehe...

CAMELS, risk-sharing financing, institutional quality and stability of Islamic banks: evidence from 6 OIC countries

“…The quality of institutions encourages IBs to offer more musharakah , yet it increases their risk-taking. Akin et al (2016) found that OIC countries lack the basic requirements for an effective environment that would promote risk-sharing finance.…”

“…The success or otherwise of risk-sharing financing might depend on a country's institutional quality. Akin et al (2016) developed a "risk-sharing friendliness index" to assess whether the institutional quality of a country is favorable for mudarabah and musharakah financing. They concluded that an enabling environment with institutional quality was a challenge for OIC countries to support risk-sharing finance in their jurisdictions.…”

“…The quality of institutions might affect the financing activities of IBs in their domicile environments. Akin et al (2016) show that the quality of institutions is essential for risk-sharing financing.…”

Risk-sharing finance governance: Islamic vs conventional indexes option pricing

“…Majdoub and Mansour, 2014; Mansour et al , 2015; Majdoub et al , 2016). In fact, Akin et al (2016) showed that the Islamic composite index provides more information about institutional scaffolding, risk governance and risk-sharing finance in order to optimize risk-sharing finance based on Islamic finance. Also, Hayat and Hassan (2017) investigated the effect of Islamic label on corporate governance by controlling governance determinants based on Islamic and conventional S&P 500 index and found that Islamic label adds about two percentage points of governance quality, as measured by the Bloomberg Governance Disclosure score.…”

Muḍārabah and mushārakah as micro-equity finance: perception of Selangor’s disadvantaged women entrepreneurs

“…It is worth mentioning that the Malaysian microfinance industry is practising Islamic microfinance solely by offering qar Á d Á hasan (interest-free loan) by charging a certain administrative fee on top of the loan (Abdullah et al, 2019). Several studies pointed out that Islamic financial institutions (IFIs) are reluctant to offer these instruments because of the issues of credit risks, moral hazard, agency problems and the discretionary power of clients (Akin et al, 2016;Mili and Abid, 2017;Fianto et al, 2018;Bello et al, 2020).…”