One cannot compare Islamic banks (IB) with Non-Islamic banks (NIB) because the contracts underlying the banks’ assets are different. Both IBs and NIBs suffer credit losses on non-performing loans but NIBs do not participate in the upside profits of borrowers, whereas IBs do participate in the upside. Moreover, IBs are not allowed to charge interest.
IBs are subject to Shari’ah, the Islamic law of human conduct, which regulates all matters of the lives of Muslims. Arguably, IBs are likely to adhere to higher ethical and moral standards under Shari’ah than NIBs, which respond to the standard self-interest incentives assumed under agency theory (Fama 1980; Fama and Jensen 1983). Arguably, intrinsic Shari’ah values are likely to curb (or even remove) IBs’ incentives to manage earnings. If so, IBs are likely to exhibit less earnings management compared with NIBs governed by self-interested managers and board members.
It is not clear, however, that religious values would generally trump self-interest motivations in accounting decision making: it is conceivable that NIBs utilize contracts that curb earnings management to a greater degree than the religious and social values do in IBs. Moreover, even NIBs are run by people who have different religious convictions: it is not clear that an IB would adhere to more ethical principles than, say, an IB in a religious Christian state in the US.
A challenge for researchers in this area is to position their work in the religiosity literature, which implies that religiosity is positively associated with risk aversion and negatively associated with unethical behavior (e.g. Dyreng et al. 2010, Hillary and Hui 2009). The aim would be to develop a theoretical perspective to distinguish the incentives imbued by Shari’ah from those in other religions, and to use these distinctions to support hypotheses with respect to IBs vs. NIBs (in jurisdictions with high vs. low Non-Muslim religiosity).
Barro, R. J., McCleary, R. M. 2006. Religion and Economy. Journal of Economic Perspectives 20, 49-72.
Dyreng, S. D., Mayew, W.J., Williams, C.D. 2010. Religious Social Norms and Corporate Financial Reporting. Duke University Working paper.
Guiso, L., Sapienza, P., Zingales, L. 2003. People’s Opium? Religion and Economic Attitudes. Journal of Monetary Economics 50, 225–282.
Hilary, G., Hui, K.W. 2009. Does Religion Matter in Corporate Decision Making in America? Journal of Financial Economics 93, 455-473.
My intent in answering this question is to focus only on the credit market issue. I personally think that credit markets are very productive. However, there are prohibitions of interest in shariah and, I might add, in many other cultural and religious traditions. There may have been very good reasons for this in the distant past. For example, there used to be limitations on the ability to compute with non-standard interest rates. So if a standard rate were used (say 10 percent) it might be totally inappropriate given the rate of inflation and the level of risk inherent in the deal. One or another party could be badly hurt by the transaction. So there can be reasons for these prohibitions rooted in the mists of time. But time marches on. How have other societies handled these prohibitions? Well, it is possible to lay off the credit market portion of some transactions on people who are not burdened by these prohibitions. However, it is quite awkward to develop a thriving housing market without mortgages and interest. Oh, one might call interest by some other name, but that doesn't address the problem. You can produce contracts in which the risk is shared but these contracts can disrupt incentives to maintain housing properly. So I think that there is a need to come to grips with interest. While I could go on and extoll the virtues of interest, I think that this is a good place to stop.
Oh so!
Interest or self-interest. That is the spirit of the economic gospel!
Thanks and regards.
It might not be enough because there is alot more factors to be considered
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