Essays on the Economics of the Gulf Cooperation Council : Islamic Banking and Financial Contagion.

Pappas, Vasileios (2013) Essays on the Economics of the Gulf Cooperation Council : Islamic Banking and Financial Contagion. PhD thesis, Lancaster University.

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Abstract

Islamic banks have performed remarkably well despite the limitations of their ethical parameters have developed significantly during their relatively short existence. The Western world's attention was particularly drawn to Islamic finance during the 2007 financial crisis when Islamic banks outperformed conventional banks in terms of profitability, asset growth, liquidity and solvency. The comparative performance between Islamic and conventional banks in the face of the financial crisis deserves special attention for two main reasons. It is the first time that an investment universe, restricted by the Islamic Law, has outperformed the conventional system. Secondly, the predominance within the Gulf states of the Islamic banking sector, has made the GCC region more resilient to the recent financial crisis. The 2007 financial crisis has been the first time that the region maintains a positive economic growth amidst falling oil prices. Economic policy measures such as the revenue diversification programme and the subsequent development of a strong financial sector have paid off. The Islamic banking sector and its contributions to the GCC's economic endurance through the recent crisis warrants interest. The thesis starts by investigating two specific topics; the technical efficiency and failure risk of Islamic banks. Building from a somewhat rudimentary basic of a few years ago, in terms of know-how, restrictions, managerial competencies, Islamic banks have managed to close the gap with conventional banks. Their significant rise in techni- cal efficiency is attributable to higher revenue and profit efficiency scores, achieved by improvements in human resources, compared to conventional banks. To the best of our knowledge this research is distinct in that it encompasses bootstrap tests for the equality of means testing in the context of financial ratio analysis and a metafrontier decomposition of the DEA efficiency scores into; a managerial component and to the modus operandi of the bank. The efficiency of the Islamic banking system together with its investment restrictions not only shows in lower failure risk but also in the composition of a unique financial product whose characteristics are radically different to products of conventional banking. In particular, different sensitivities exist between the two banking systems in regard to failure risk. In addition, Islamic banks are less likely to be affected by contagion effects found with conventional banking. The study offers the first application of survival analysis in comparing the failure risk of Islamic and conventional banks. From comparisons between the financial sector (stock markets) of the GCC against developed and developing countries, we show that the GCC were among the last countries to be affected by the 2007 financial crisis. Furthermore, they recovered much faster than financial systems of many other countries. The predominance of Islamic banking in the region with its principles on risk-sharing, investments in real assets and the shunning of conventional debt instruments, has helped the GCC to weather the crisis. The chapter contributes to the literature in a number of ways. First it allows for every country an endogenous way of detecting the timing of the crisis. Other studies have taken the route of exogenously imposing a crisis date. Secondly it introduces measures of crisis duration and intensity of the crisis on every country while it distinguishes between global and regional contagion effects.