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WP# 1435-13
Measuring the Value of Islamic Banks
Abdul Ghafar Ismail, Sjaiful Akbar, Siti Manisah Ngalim
3 Ramadan 1435H | June 30, 2014
Islam2c Economics and Finance Research Division
IRTI Working Paper Series
IRTI Working Paper 1435-13
Title: Measuring the Value of Islamic Banks
Author(s): Abdul Ghafar Ismail, Sjaiful Akbar, Siti Manisah Ngalim
Abstract
This study tries to measure the effect of risk sharing in adding value to Islamic banks. In particular, this study is important to accurately gauging the impact of Islamic banking sector on the real economy. The adoption of risk sharing modes of contracts by Islamic bank as intermediary would leads to the fairness in serving the interest of community as a whole and is expected to promote value creation to the depositors, shareholders and eventually to the economy. In analysing the value added or wealth created by Islamic banks, we will use the Annual Reports of Islamic banks in Malaysia from 2008-2012. Our analysis will focus on main hypothesis, i.e., risk sharing create more value added and equitable distribution of wealth. Our finding shows that the adoption of risk sharing would lead to the fairness in serving the interest of community as a whole and is expected to promote value creation to the depositors, shareholders and eventually to the economy. The treatment on non-performing financing and investment risk allowance might change the distribution of wealth. Financial reporting based on contract might produce a more transparent distribution of wealth.
Keywords: risk sharing, Islamic banks; value added, wealth distribution, economic development
JEL Classification: D30, E01, G02, G21, 047,
Islamic Research and Training Institute
P.O. Box 9201, Jeddah 21413, Kingdom of Saudi Arabia
IRTI Working Paper Series has been created to quickly disseminate the findings of the work in progress and
share ideas on the issues related to theoretical and practical development of Islamic economics and finance
so as to encourage exchange of thoughts. The presentations of papers in this series may not be fully polished.
The papers carry the names of the authors and should be accordingly cited. The views expressed in these
papers are those of the authors and do not necessarily reflect the views of the Islamic Research and Training
Institute or the Islamic Development Bank or those of the members of its Board of Executive Directors or
its member countries.
Measuring the Value Added of Islamic Banks
Abdul Ghafar Ismail1
Islamic Research and Training Institute
Islamic Development Microfinance institution
P.O. Box 9201, Jeddah 21413 Kingdom of Saudi Arabia
e-mail:AgIsmail@isdb.org
Sjaiful Akbar2
Research Center for Islamic Economics and Finance
School of Accounting
Universiti Kebangsaan Malaysia
43600, Bangi, Selangor, Malaysia
sjaiful.akbar@gmail.com
Siti Manisah Ngalim3
Department of Accounting and Finance
Universiti Putra Malaysia
Serdang
Malaysia
1. Introduction
A significant development and rapid expanding trend of Islamic banking in the present
century can be witnessed in the Muslim countries as well as major western countries
such as United Kingdom, Australia, and Hong Kong. At the outset, the crux of Islamic
banking departure from conventional banking systems is the prohibition of Riba, in
which the orthodoxy equates with interest in general term while promoting risk sharing
as a viable alternative for Islamic bank to operate as intermediary. Leaving itself from
interest as its central allocation tool, Islamic bank has developed an impressive range
of modes of transactions which primarily based on risk sharing that could appeal to
different types of customers. These include two major modes of contracts, namely
mudharabah and musharakah that is desirable in an Islamic context due to the
characteristics on fair sharing of profit/loss and risk between contracting parties. By
offering these modes of contracts, as highlighted by Nik Hassan et.al. (2004) and Ismail
(2010), Islamic banking system should seek for social economic justice in order to
create an environment that promotes cooperation among society. The adoption of risk
sharing modes of contracts by Islamic bank as intermediary would leads to the fairness
1He is head of research division and Professor of Banking and Financial Economics. He is currently on
leave from School of Economics, Universiti Kebangsaan Malaysia. He is also principal research
fellow, Institut Islam Hadhari, Universiti Kebangsaan Malaysia and AmBank Group Resident Fellow
for Perdana Leadership Foundation. 2 Post-graduate student 3 Lecturer of Islamic accounting
* Paper has been presented at 1st International Conference on Islamic Banking and Finance, 17th –
19th April, 2014, Bayero University, Kano-Nigeria
in serving the interest of community as a whole and is expected to promote value
creation to the depositors, shareholders and eventually to the economy.
Unlike risk sharing, instruments that are interest-based are prone to favour the
rich people and against the interests of the common people. For example, when
entrepreneurs borrow huge amounts of money from the bank, they are utilizing
depositors share into their profitable project. However, when they earn profit, they will
pay nothing to the depositors. In the event of losses, it may lead to the bankruptcy of
the bank itself and ultimately depositors will have to bear the whole loss. This is how
interest-based systems create inequity and imbalance in the distribution of wealth to the
economy. Generally, in risk sharing, both depositors and entrepreneur would be willing
to share the results of the project in an equitable manner. In the case of profit, both will
share in pre-agreed ratios and in the case of loss, all financial loss will be borne by the
capital provider (Islamic bank) and labour losses is borne by the entrepreneur. This
would build a link between both parties that have business skills but lack of capital and
capital provider. The beauty of risk sharing attributes as modes of contract, could
facilitate the role of Islamic banks in providing or channelling funds to the skilled
entrepreneur in an effort to encourage economic growth.
According to Matthews, Tlemsani and Siddiqui (2004), the Islamic economic
principles of risk sharing as well as joint involvement in the wealth creation activity
through equity financing by investors and entrepreneurs has a potential to entice
creativity and productivity in an economy. In addition, risk sharing contracts might
drive fairness and subsequently create value for each contracting parties involved.
However, experiences (Abalkhail and Presley, 2000; Ahmed, 2002, Tohirin and Ismail
(2011)) show that there are some inherent problems (asymmetric information, moral
hazard and adverse selection) that might hinders the application of risk sharing. Despite
of that, Al-Jarhi (1999) proposes that Islamic banking needs to have an equilibrium
combination between mark-up modes and profit-sharing modes of financing.
Based on the above studies, it is understood that the adoption of risk sharing
contracts might lead to value creation to the shareholders, customers and economy as a
whole. Besides that, it drives the Islamic banking system to the different platform that
would create balance between the material and social objectives in an effort to provide
fairness and justice. Therefore, the success of the application of risk sharing modes in
Islamic banking systems will depend heavily on the resolution of the imperfections
associated with their use.
However, the studies on the effect of risk sharing in adding value to Islamic
banks are none. This study is important to accurately gauging the impact of Islamic
financial sector on the real economy essential for further work in this area.
This article is structured as follows - Section 2 provides an insight into the
relationship between finance and economy, in Section 3 the conventional measure of
value added is outlined in terms of the current international statistical framework for
the financial sector and subsectors; the general issues surrounding the appropriateness
of national statistical conventions for measuring of financial sector activity, and
specifically banks, are explored in Section 4; and Section 5 concludes.
2. An Insight into the Relationship between Finance and Economy
Analysing the earlier literature on finance and development theory, as proposed by
Schumpeter (1912) and summarised by Ebner (2000), Schumpeter said that “…the
process of economic development by combining the exploration of entrepreneurship
and innovation as internal mechanism of change with the cyclical fluctuations that
shape the contours of the development process.” In short, he analysed the association
between extra cash or capital and the process of economic development through the
exploration of entrepreneurship and innovation as the internal mechanism of change. In
this, entrepreneurs aims at generating profit, where profit is not the end in itself but a
means towards a greater end that includes creating family-dynasty or empire as well as
gaining power, authority and control. As the excess cash becomes financial institutions,
entrepreneurs become companies but the motivation remains.
Since, then, the focus has been on the direction between finance and economic
development. Development has always been portrayed as an increase in income and
wealth or GDP. Nevertheless, it is worth to mention the conclusion made by Lawrence
(2003). He surveyed research on this relationship and concluded from a total of 24
researches done between 1995 and 2003, that there is evidence for causation between
growth and finance, specifically from growth to finance and for bi-directionality. He
suggests that the data gathered from the survey suggested that financial development
thrives where real economy activity is strong.
However, some earlier literatures (see Levine (2004)) could not agree with one
direction of the relationship by looking into both theoretical and empirical work. He
first identified that the problem within the empirical works frequently sourced from
insufficient precise link between theory and measures. He then analyses researches
covering cross-country research, different type of studies (panel, time-series and case-
studies), industry and firm level, bank- or market-based system and reported evidences
of a strong positive link between the functions of the financial system and long-run
economic growth. He concluded that advancement on this area of research should from
now on be on development of a better model that could capture the dynamic of the
interaction between the evolution of financial system and economic growth. More
importantly, as if drawing the attention back to Schumpeterian theory of finance and
growth that looks into the relationship between entrepreneurs and access of capital, he
highlights a more relevant but related issue that is the role of finance in alleviating
poverty and income inequality.
Specifically Levine (2004) highlights the work of Beck, Demirguc-Kunt and
Levine (2004), who made the first attempt in examining whether financial development
exerts a large influence on the poor (rather than the relationship between financial
development and the level of income inequality or level of poverty). They analysed the
relationship between financial development and income distribution, and relationship
between financial development and alleviation of poverty, from data taken from 52
developed economies and 58 developing countries, respectively. They find income of
the poor grows faster than average GDP per capita, income inequality fall more rapidly
and poverty rates decrease at a faster rate, all induced by greater financial development.
Therefore, financial development has empirically reduces poverty by having a positive
effect on the poor.
Demirguc-Kunt and Levine (2008) find evidence that financial development
boost the income growth of the lowest income quintile. Particularly, they found that
expanding individual economic opportunity create positive incentive effects, thus
financial development boost efficiency and equity of opportunity. Demirguc-Kunt and
Levine (2009) further analyse the relationship between finance and inequality,
discussing the theory and finding evidences. They pointed out that in theory, financial
developments reduce inequality of opportunity and enhance aggregate efficiency.
Particularly, financial developments that lower fixed costs of accessing financial
services benefit low-income earners to pay for education and health care thus reduce
inequality of opportunity. In addition, financial developments that operate on a broad
margin could facilitate entrepreneurs who have little to offer as collateral thus enhances
aggregate efficiency. Further financial development provides greater access to risk
management and insurance services that directly improve welfare and allow families to
continuously educate their children. More importantly, financial development that
increases economic activity will stimulate the demand for labour; enhance earnings and
provide a richer range of economic opportunities. In this, Demirguc-Kunt and Levine
(2009) highlighted the need for additional research on finance and economic
opportunity. Although inconclusive, these theories are supported by empirical
evidences and clearly promote economic growth. Consequently, they called for
assessment of financial sector policies that affect economic opportunity and poverty.
In relation to this, another group of research looks into the access of financial
services, as it is a fact that having access to financial services, especially by having a
bank account, is the first step towards gaining financial assistance for both households
and firms (Ramji 2009). It is an important channel for finance to promote growth
through provision of credit to the most promising firms (Beck, Dmirguc-Kunt and
Honohan 2009). However, Ghalib and Hailu (2008) reported that the level of access to
financial services, especially in developing countries, is low and that for rural
population, they lack free and unconstrained access to and use of such services. The
access, again specifically in developing countries, often skewed toward those who are
not in dire needs of finance such as large enterprises and wealthier individuals while
those who are really in needs of financial assistance lack access to finance, hindering
their growth and reducing personal welfare (Beck, Demirguc-Kunt and Maksimovic
2005, Claessens 2006, Sarma and Pais 2008). At the same time evidences suggest that
in entirety, financial development or depth is both pro-growth as well as pro-poor (Beck
et al. 2009), where greater access will make both firms and households able to take
advantage of investment opportunities, smooth consumption and insure themselves
(World Bank 2008).
In a report by World Bank (2008), making financial services available to all
potential customers without discrimination spreads equal opportunity and taps the full
potential in an economy. This financial inclusion is crucial in order to avert poor
individuals and small firms from relying on their personal wealth or internal resources
as such reliance could limit their opportunities to invest in their education, become
entrepreneurs or take advantage of promising growth. It points out the fundamental
trade-off between growth and social justice. This is true since rapid growth need wealth
concentration to finance large and indivisible investment projects while it is a fact that
the rich tend to save compared to the poor. In other words, there should exist a
redistribution of wealth in the economy from the rich to the poor, a principle that is
crucial under Islamic economics.
The vast research on finance and income inequality and poverty alleviation,
demonstrate how important it is to look beyond the relationship between finance and
development as portrayed earlier. It implies that there occur a bigger objective of
financial existence and a deeper meaning of development such as alleviating poverty,
securing education, insuring health and make equal opportunity available for all
entrepreneurs without losing focus on the functions of financial intermediaries in
ensuring development of an economy. Regardless of different conclusions from
literature reviews on finance and development by Lawrence (2003) and Levine (2004),
researchers agreed on the important role that financial system plays.
Islamic banking by function is no different than the conventional banking. Kahf
(2007) and Wan-Ibrahim and Ismail (2014) make a very clear and direct comparison
between Islamic banking and conventional banking. Financial intermediaries is the
major function of the conventional banking system, where they receive funds from
depositors/savers and reallocate those funds to borrowers/entrepreneurs who need the
funds for their economic transactions and activities. Islamic banks, also as an
intermediary, are doing exactly the same. Similarly, financing in general is the
provision of factors of production, means of payments of goods and services without
requiring an immediate counterpart to be paid by the receiver. It is equal to what offered
by Islamic financing, which provides factors of production, goods and services for
which payment is deferred. Nevertheless, Islamic banking does not involve lending and
borrowing because interest, is prohibited by the guiding law, the Sharia (Algaoud and
Lewis 2007). Instead it relies on three principles that involve sharing of the actual, real-
life outcomes of production process, namely sharing, leasing and sale (Kahf 2007 and
Wan-Kamarudin and Ismail (2013)). Reliance on these contracts is what makes Islamic
banking a more active stimulant of growth in an economy as compared to conventional
banking.
Khan (1987) illustrated the economic effect of substituting interest with Islamic
financing and found that essentially the same market forces are operative and profit-
shares instead of interest equilibrate the market loanable funds. Given an adequate
supply of loanable funds, under Islamic financing two direct effects will take place.
First, investment maybe higher since entrepreneur can pass part of the uncertainty of
the production to the financiers and no competing financial assets diverting funds from
real investments. Second, the ability to pass part of risk to financier will encourage
composition of investment towards more risky and reduce cost pressure for business
efficiency which fixed interest rate imposed. At the same time it may also lower cost
of production and encourage output, whereas specification of a profit-share will not
affect the price output decision.
Hence, the risk sharing based financing musharaka is the preferred Islamic
mode of financing because it adheres most closely to the principle of profit and loss
sharing (Mirakhor and Zaidi 2007, and Ismail and Tohirin (2009)). Comparing profit-
sharing (mudaraba) with interest-taking (conventional loan) Uthman (2006) found that
workers’ share of profit has a positive impact upon the national profit rate and share.
This condition implies that profit-sharing is more conducive to investment, capital
accumulation and hence job creation than the interest-based system, which is in line
with the Islamic economics aim to redistribute wealth and social justice, maintaining a
balance with individual interests (Khan 2008). Also, financing modes that depend on
profit and loss sharing bring important advantage since they have almost same effect of
direct investment, which brings pronounce returns to economic development (Al-Jarhi
and Iqbal 2001).
3. Measuring Value Added from Islamic Bank’s Balance Sheet
Theoretically, GDP can be viewed in three different ways: The production approach
sums the “value-added” at each stage of production, where value-added is defined as
total sales less the value of intermediate inputs into the production process. For
example, flour would be an intermediate input and bread the final product; or an
architect’s services would be an intermediate input and the building the final product.
The expenditure approach adds up the value of purchases made by final users -
for example, the consumption of food, televisions, and medical services by households;
the investments in machinery by companies; and the purchases of goods and services
by the government and foreigners. Gross savings are calculated as the difference
between GNI (Gross National Income) and public and private consumption plus net
current transfers. GNI and GNI per capita are the sum of gross value added by all
resident producers plus any product taxes (less subsidies) that are not included in the
valuation of output plus net receipts of primary income (compensation of employees
and property income) from abroad. To smooth fluctuations in prices and exchange rates,
World Bank uses a special Atlas method of conversion.4 This is relatively difficult for
an individual financial firm such as Islamic bank. Hence, the income approach is much
more reliable.
The income approach sums the incomes generated by production - for example,
the compensation employees receive and the operating surplus of companies (roughly
sales less costs).
For financial firm, like Islamic bank, the approach to measuring value added
has never been touched before. Firstly, the expenditure approach does not appropriately
capture the full balance sheet composition of the Islamic banks as shown by the
example in Table 1. It only captures the liabilities of Islamic banks.
4 This applies a conversion factor that averages the exchange rate for a given year and the two preceding
years, adjusted for differences in rates of inflation between the country and the G-5 countries. Per capita
is GNI divided by the midyear population?
Table 1: Calculating Wealth from Islamic Banks’s Balance Sheet
In thousand Ringgit Malaysia
Assets 2009 2010 2011 2012
Cash
44,444,333.00
40,022,812.00
55,809,442.00
43,051,750.00
Financing
107,660,630.00
135,185,530.00
188,188,118.00
233,254,753.00
Investment
18,817,183.00
27,154,411.00
25,151,949.00
35,087,066.00
Other Assets
13,641,942.00
16,415,786.00
23,316,069.00
34,514,385.00
Total Asset
184,564,088.00
218,778,539.00
292,465,578.00
345,907,954.00
Equity and
Liabilities
Deposits
67,901,030.00
80,444,219.00
120,267,641.00
160,819,161.00
Investment
92,009,721.00
110,254,031.00
139,155,854.00
140,808,583.00
Other
Liabilities
12,481,960.00
12,345,937.00
14,827,676.00
23,159,234.00
Equity
12,171,377.00
15,734,352.00
18,214,407.00
21,120,976.00
Total Liabilities
Equity
184,564,088.00
218,778,539.00
292,465,578.00
345,907,954.00
Secondly, Islamic banks’ output omits other features such as capital gains and losses,
impaired financings, capital injections and promissory notes. Value added measures a sector’s
output based on production (or transactions) in a given time period. During each period net
income and expense flows accumulate in a profit or loss which is then carried forward to the
balance sheet. Profits in the years preceding the recession, contributed positively to value added
and the balance sheet position of the sector. The losses on Islamic banks’ assets which
materialised subsequently are not, however, treated as negative output in national accounts, as
they are not part of production. Instead, they are only reflected as a reduction in the sectorial
balance sheet. This leads to an asymmetry in the treatment of profits and of holding gains/losses
in national accounts, particularly in the measurement of value added.
As an example, let say, both Islamic banks (A and B) seek to maximise profits, and
have financing books worth RM100 on the asset side of their balance sheets. Bank A operates
a simplified balance sheet and funds its financing book mainly through its deposit base of
RM80. It charges mark-up rate 3 per cent for financing and pays a hiba rate of 1% on deposits.
Bank B raises funds mainly in the wholesale funding market and uses the proceeds onward to
entrepreneurs. It receives 3 per cent mark-up rate on financing and pays 1 per cent on both
deposits and sukuk. An interbank mudarabah rate of 2 per cent prevails.
Table 2: Calculating Value Added from Islamic Banks’s Profit and Loss
In thousand Ringgit Malaysia
2009 2010 2011 2012
Panel A:
Income derived
from investment
of depositors’
funds & others
7,529,747.00
9,837,222.00
10,222,763.0
0
14,231,437.0
0
Financing
income &
hibah
7,215,123.00 9,492,007.00 9,564,415.00 13,411,036.0
0
Other
dealing
income
75,724.00 70,644.00 78,701.00 121,311.00
Other
operating
income
44,771.00 64,278.00 388,848.00 329,081.00
Fee &
commissi
on
192,698.00 206,358.00 185,306.00 362,579.00
Other
income
1,431.00 3,935.00 5,493.00 7,430.00
(-) Allowance
for losses on
financing
(1,139,409.00)
(1,275,674.00)
(780,616.00)
(669,568.00)
(-) Provision
for commitments
& contingencies
(10,978.00) 12,795.00 (54,375.00) (17,640.00)
(-) Impairment
loss from dealing
& investment
securities
(investment risk
reserves)
(26,256.00) (75,089.00) 48,397.00 14,207.00
(-) Transfer
to/(from) profit
equalization
reserve
32,896.00
133,746.00
83,571.00 10,929.00
(-) Other
expenses directly
attributable to the
investment of the
(54,957.00) (103,401.00) (46,771.00) (122,421.00)
depositors and
shareholders’ funds
Panel B:
Total
distributable
income
6,331,043.00 8,529,599.00 9,472,969.00 13,446,944.0
0
(-) Income
attributable to the
depositors
(3,222,239.00)
(3,917,055.00)
(4,784,190.00)
(7,173,697.00)
Deposits
from
customers
Mudaraba
h Fund
Non-
Mudaraba
h Fund
2,282,209.00
2,886,315.00
3,633,550.00
5,617,253.00
Deposits
&
placement
s of banks
& other
financial
institution
s
Mudaraba
h Fund
Non-
Mudaraba
h Fund
1,667,507.00
614,702.00
940,030.00
2,106,397.00
779,918.00
1,030,740.00
2,534,424.00
1,099,126.00
1,150,640.00
3,085,169.00
2,532,084.00
1,556,444.00
Others
74,216.00
48,291.00
42,501.00
155,608.00
Panel C:
Income
attributable to the
shareholders
3,108,804.00 4,612,544.00 4,688,779.00 6,273,247.00
( + ) Income
derived from the
investment of
shareholders’/Isla
mic Banking funds
1,128,414.00
1,349,314.00
1,275,696.00
1,708,353.00
Financing
income &
hibah
693,999.00 900,707.00 834,191.00 1,073,154.00
Other
dealing
income
29,091.00 21,704.00 29,088.00 74,708.00
Other
operating
income
146,038.00 95,254.00 61,312.00 105,626.00
Fee &
commissi
on
241,093.00 318,256.00 341,176.00 436,231.00
Other
income
18,193.00 13,393.00 9,929.00 146,038.00
Panel D:
Total net income
4,237,218.00 5,961,858.00 5,964,475.00 7,981,600.00
( - ) Personnel
expenses
(625,323.00)
(947,427.00)
(862,144.00)
(1,006,381.0
0)
( - ) Other
overheads &
expenditures
(1,572,978.0
0)
(1,983,763.0
0)
(1,891,204.0
0)
(2,649,186.0
0)
( - )
Amortisation of
intangible assets
(7,309.00) (11,131.00) (2,434.00) (4,194.00)
( - )
Impairment loss
from property,
plant & equipment
and other assets
-
(18.00)
-
-
( - ) Finance
cost
(37,580.00)
(39,631.00)
(70,184.00)
(117,755.00)
Panel E:
Profit before
zakat & taxation
1,994,028.00
2,979,888.00
3,138,509.00
4,204,084.00
(-) Zakat
(22,755.00)
(27,479.00)
(28,772.00)
(36,305.00)
(-) Taxation
(503,001.00)
(703,500.00)
(770,840.00)
(1,053,530.00)
Panel F:
Profit after zakat
& taxation
1,468,272.00
2,248,909.00
2,338,897.00
3,114,249.00
(-)
Extraordinary item
-
-
-
-
Panel G:
Profit after the
extraordinary
item
1,468,272.00
2,248,909.00
2,338,897.00
3,114,249.00
(-) Minority
interest
-
(51.00)
(1,325.00)
1,732.00
Panel H: Net
profit for the
financial year
1,468,272.00
2,248,858.00
2,337,572.00
3,115,981.00
The statistical framework treats the operating surplus of these two banks differently.
Firstly, the calculation of banks’ operating surplus is confined to their financing and deposit
portfolio and is not fully representative of their entire balance sheet. Bank A’s profits of
RM1.80, comprise financing book related profits of RM1 = [RM100*(0.03 - 0.02)], and profits
from its deposit book of RM0.80 = [80*(0.02 - 0.01)]. The total profits related to Bank B’s
financing and deposits, are lower, amounting to RM1.20, comprising financing profits of RM1
= [RM100*(0.03 - 0.02)] and deposit profits of RM0.20 = [20*(0.02 - 0.01)]. The sukuk
issuance in the wholesale funding market by Bank B of RM70 is ignored as are its equity assets.
Basically, Islamic banks process payments and other transactions for customers and
nonfinancial companies, screening and monitoring projects, as well as underwriting a variety
of sukuk. The value of such services (Panel A, Table 2), net of items such as allowance for
losses on financing and provision for commitments and contingencies, gives us the Islamic
bank industry’s value added (Panel B, Table 2), which is the industry’s direct contribution to
GDP.
Although, it is difficult to measure the RM amount (let alone the inflation-adjusted real
value) of Islamic banks’ value added. This is primarily because they often do not charge
explicitly for services. Instead, they earn a spread between the mark-up received and the hibah
rates paid (income attributable to depositors), as well as fees for writing sukuk products. But
earning spread is not in and of itself a productive activity that contributes to GDP. This is
obviously sensible in the case of passive investors who buy market sukuk (in the secondary
market) and then merely receive return or dividends without producing new goods or services.
In reality, Islamic banks are not mere passive investors. They do hire workers (see
Panel C) and equipment, and also buy and sell commodities to carry out various services. When
the compensation for such services is not earned explicitly but bundled with asset returns that
arise purely because of risk differentials, the question becomes how to tease out that portion of
an Islamic bank’s overall income that is implicit revenue for services. The net income of an
Islamic bank after these adjustments is a correct measure of its contribution to economic output.
Islamic bank, functioning as the intermediaries between sources of funds and users of
funds, could offer services that would give opportunity to create employment (by spending on
personnel expenses and other overhead and expenditures (Panel D, Table 2), thus assist in
fulfilling the removal of poverty and need fulfilment and also via zakat payment (Panel E).
Finally, Islamic banks also create wealth to shareholders (Panels E, F and G). In addition,
Islamic banks could also be able to provide the freedom of the people in the sense of free from
unnecessary debt, mostly due to spending more than what earned. Banks could assist this notion
of freedom by providing the opportunity to save and invest rather than to spend beyond their
means, which could be related to the offering of credit card. Education is essential to develop
human self, either to develop their intellectuals or to prepare them for employment and self-
employment, which in turn would remove poverty. Though it is not obligated for banks to offer
educational financing, offering such financing would give the opportunity for the public to earn
higher education. Nevertheless, it is noted that banks might also spend their wealth in offering
sponsorship and donation towards education instead of offering financing.
4. Findings
In analysing the value added or wealth created by Islamic banks, we will use the Annual
Reports of Islamic banks in Malaysia from 2009-2012. Our analysis will focus on how
much of the income received by Islamic banks is compensated for actual services
provided to their customers and how much is merely for taking on risk, such as funding
risky financing with short-term deposits?
(a) Creating Wealth via Risk Sharing
As reported in Table 3, during the financial year to 31 December 2012, Islamic bank created
wealth of RM7.9 billion, an increase of 88.1% on the wealth created during the 2009 financial
year. While much of wealth generation benefits the employees, shareholders, customers,
suppliers and government treasuries, Islamic banks remain focused on contributing to the
socioeconomic development of the communities.
Islamic banks recognize and accepts the responsibility to contribute (via zakah) to the
broader socioeconomic goals of poverty relief, improved health, better education and general
social development especially in poor communities. Such bank-led initiatives encourage
economic development, strengthen civil society and promote the development and building of
a democracy.
The benefits of Islamic banks involvement include transferring technology, expanding
financial services and providing capital in the countries in which Islamic banks operate. These
benefits support growth and development.
The primary challenge for Islamic banks is to operate successfully in an increasingly
globalised environment. At the same time, business is required to go beyond narrow financial
considerations and to balance the social, environmental and economic demands of its
stakeholders. Islamic banks contribution to the economies in which it operates should be seen
in this context.
Value-added wealth is the wealth created by Islamic banks through the provision of
banking and other financial services. The Islamic banks’ returns in fee-based income has been
included in profit, commission and other revenues.
Islamic banks once again met their primary financial objectives of strong value-added
growth. This increased from RM4.2 billion in 2009 to RM7.9 billion in 2012. As a result, the
distribution of wealth to employees, government and shareholders increased from RM62503
million, RM503.0 million, and RM349.6 million in 2009 to RM1.0 billion, RM1.1 billion and
RM1.1 billion in 2012, respectively. At the same time, the retained earnings also increased from
RM1.1 billion in 2009 to RM3.2 billion in 2012. The figures above show a significant
contribution by Islamic banks to the economy during the period of 2009-2012. On the average,
as shown in Diagram 1, the employees, government, shareholders (all are economic agents) and
retentions received about 12.6%, 13.2%, 14.0% and 40.1%, respectively of the total wealth.
Table 3: Financial Summary of Islamic Banks
In thousands Ringgit Malaysia
2009 2010 2011 2012
Value added
Profit, Commissions and
Other revenues
8,658,161.00
11,186,536.00
11,498,459.00
15,939,790.00
Profit paid to depositors
and cost of other services
(4,420,943.00)
(5,224,678.00)
(5,533,984.00)
(7,958,190.00)
Wealth distribution over four years (%)
2009 2010 2011 2012
Employees
Government
Shareholders
Retentions
Zakat
Others
14.76
11.87
8.25
28.46
0.54
36.13
15.89
11.80
12.32
29.33
0.46
30.19
14.45
12.92
13.71
33.17
0.48
25.25
12.61
13.20
13.96
40.15
0.45
19.63
Wealth created
4,237,218.00
5,961,858.00
5,964,475.00
7,981,600.00
Distribution of wealth
Employees
Salaries and other
benefits
(625,323.00)
(947,427.00)
(862,144.00)
(1,006,381.00)
Governments
(503,001.00)
(703,500.00)
(770,840.00)
(1,053,530.00)
Zakat
(22,755.00)
(27,479.00)
(28,772.00)
(36,305.00)
Shareholders
Dividends paid to
shareholders
(349,561.00)
(734,267.00)
(817,721.00)
(1,114,402.00)
Earnings attributable to
outside and preference
shareholders
-
-
-
-
Retentions to support
future business growth
(1,205,816.00)
(1,700,191.00)
(1,978,984.00)
(3,204,223.00)
Retained surplus
(1,127,032.00)
(1,588,974.00)
(1,958,059.00)
(3,174,963.00)
Depreciation &
amortization
(78,784.00)
(111,217.00)
(20,925.00)
(29,260.00)
Others
(2,706,456.00)
(1,848,994.00)
(1506,014.00)
(6,414,841.00)
Wealth distributed
(4,237,218.00)
(5,961,858.00)
(5,964,475.00)
(7,981,600.00)
Graph 1(a): value added and total assets; (for 2009)
Value added in 10,000 RM
Total Asset in 100,000 RM
-
50,000
100,000
150,000
200,000
250,000
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
Value Added
Total Asset
Graph 1(b): value added and total assets; (for 2010)
Value added in 10,000 RM
Total Asset in 100,000 RM
Graph 1(c): value added and total assets; (for 2012)
Value added in 10,000 RM
Total Asset in 100,000 RM
-
50,000
100,000
150,000
200,000
250,000
300,000
- 50,000
100,000 150,000 200,000 250,000 300,000 350,000 400,000 450,000 500,000
Value Added
Total Asset
-
100,000
200,000
300,000
400,000
500,000
600,000
- 100,000 200,000 300,000 400,000 500,000 600,000 700,000 800,000 900,000
1,000,000
Value Added
Total Asset
Graph 1(d): value added and total assets (for 2009-2012)
13 Islamic Banks in Malaysia
Value added in 10,000 RM
Total Asset in 100,000 RM
Graph 2(a): y-axis: value added and total financings (for 2009)
Value added in 10,000 RM
Total Financing in 100,000 RM
-
500,000
1,000,000
1,500,000
2,000,000
2,500,000
-
500,000
1,000,000
1,500,000
2,000,000
2,500,000
3,000,000
3,500,000
4,000,000
2009 2010 2011 2012
Value Added
Total Asset
-
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
-
50,000
100,000
150,000
200,000
250,000
300,000
Value Added
Total Financing
Graph 2(b): value added and total financings (for 2010)
Value added in 10,000 RM
Total Financing in 100,000 RM
Graph 2(c): value added and total financings (for 2012)
Value added in 10,000 RM
Total Financing in 100,000 RM
-
50,000
100,000
150,000
200,000
250,000
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
Value Added
Total Financing
- 50,000 100,000 150,000 200,000 250,000 300,000 350,000 400,000 450,000
-
100,000
200,000
300,000
400,000
500,000
600,000
700,000
Value Added
Total Financing
Graph 2(d): value added and total financings (for 2009-2012)
Value added in 10,000 RM
Total Financing in 100,000 RM
Graph 3(a): value added and total deposits (for 2009)
Value added in 10,000 RM
Total Deposit in 100,000 RM
-
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000
1,600,000
1,800,000
-
500,000
1,000,000
1,500,000
2,000,000
2,500,000
2009 2010 2011 2012
Value Added
Total Financing
-
20,000
40,000
60,000
80,000
100,000
120,000
140,000
-
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
180,000
Value Added
Total Deposit
Graph 3(b): value added and total deposits (for 2010)
Value added in 10,000 RM
Total Deposit in 100,000 RM
Graph 3(c): value added and total deposits (for 2012)
Value added in 10,000 RM
Total Deposit in 100,000 RM
-
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
- 20,000 40,000 60,000 80,000
100,000 120,000 140,000 160,000 180,000 200,000
Value Added
Total Deposit
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
-
100,000
200,000
300,000
400,000
500,000
600,000
Value Added
Total Deposit
Graph 3(d): value added and total deposits (for 2009-2012)
Value added in 10,000 RM
Total Deposit in 100,000 RM
Graph 4(a): histogram: distribution of wealth by each bank (2009)
In 1,000 RM
-
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000
-
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000
1,600,000
1,800,000
2009 2010 2011 2012
Value Added
Total Deposit
0
100000
200000
300000
400000
500000
600000
700000
800000
900000
Others
Zakat
Retentions
Shareholders
Government
Employees
Graph 4(b): histogram: distribution of wealth by each bank (2010)
In 1,000 RM
Graph 4(c): histogram: distribution of wealth by each bank (2012)
In 1,000 RM
0
200000
400000
600000
800000
1000000
1200000
1400000
1600000
Others
Zakat
Retentions
Shareholders
Government
Employees
0
200000
400000
600000
800000
1000000
1200000
1400000
1600000
1800000
2000000
Others
Zakat
Retentions
Shareholders
Government
Employees
Benefiting Employees, Customers and Communities
In Islam, wealth should be circulated within and economy in order to ensure equitable
distribution of wealth and could also be the source for employment and self-
employment. Therefore, Islamic bank should redistribute its income and wealth back to
the economy. There are at least several parties that should be considered in
redistributing the wealth as shown in Table 2 and these redistribution are divided into
two, obligatory and voluntarily.
Islamic bank A, as shown in Table 3, paid the employees RM8.5 billion during
2008. The amount paid in 2007 was RM7.6 billion. A conservative economic estimate
indicates that more people directly depend on Islamic bank A for their livelihood.
Customers received an amount of RM31.2 billion during 2008. It contributed a
substantial amount to their wealth. Furthermore, Islamic bank A contribute to the economy by providing affordable,
effective banking and financial services to diverse individuals and organizations; contributing
over RM2.9 billion to the government in the form of taxes in 2008; and promoting economic
stability and convenience in local communities through extensive branch networks.
5. Conclusion
The role of Islamic banks includes: to clear and settle payments; to aggregate (pool)
and disaggregate wealth and to allow flow of funds so that both large-scale and small-
scale projects can be financed; to transfer economic resources over time, location, and
sectors; to accumulate, process and disseminate information for decision-making
purposes; to provide ways for managing uncertainty and controlling risk; and to provide
ways for dealing with risks and return issues that arise in financial contracting. These
roles can be performed by offering financial transactions, pooling savings and
channeling funds. By performing these roles, Islamic banks play a valuable and integral
part in the development of the national economy by creating wealth for individuals and
the community. Therefore, there are a number of suggestion for future research: first,
the adoption of RISK SHARING modes of financing by Islamic bank as intermediary
would leads to the fairness in serving the interest of community as a whole and is
expected to promote value creation to the depositors, share holders and eventually to
the economy. Could a higher RISK SHARING create a better distribution? Second,
regulation such regulation on non-performing financing and investment risk allowance
might change the distribution of wealth. Third, financial reporting based on contract
might produce a more transparent distribution of wealth.
Islamic banks play a valuable and integral part in the development of the national economy.
By focusing on sustainable economic wealth, Islamic banks can economically empower
employees, shareholders and business partners, and can also contribute to the sustainability of
state treasuries and a diverse spectrum of important social development projects. In essence
Islamic banks are able to generate employment and to increase the shareholder’s and
entrepreneur’s wealth. The economic contribution of Islamic banks can be seen by looking at
the following example.
It appears likely that the study states the Islamic banks’ contribution to GDP, and we
now have evidence that this is indeed the case. To the extent that risk sharing is one the
suggested model for Islamic banking, we have a method for proving the superiority of
this method and to arrive at a ‘clear’ evidence of the contribution that Islamic banks
make to GDP. In order to estimate the model’s ability to redistribute wealth, however,
we need to go further and analyse their distribution. Better measures of real financial
output may overturn the current consensus that the financial industry accounted for a
significant portion of the country productivity acceleration over the period 2009 to
2012.
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