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Corporate Governance, Risk-taking and Firm Performance of Islamic Banks During Global Financial Crisis

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Title: Corporate Governance, Risk-taking and Firm Performance of Islamic Banks During Global Financial Crisis


1
Corporate Governance, Risk-taking and Firm
Performance of Islamic Banks During Global
Financial Crisis
M. Kabir Hassan University of New Orleans Sabur
Mollah Stockholm University
2
In This Study
  • The distinctions between CBs and IBs are utilized
    in this study to examine
  • Firstly, whether the multi-layer governance
    provided via the SSB acts as an independent
    control mechanism in restraining the board of
    directors or other governance agents from
    engaging in excessive risk taking.
  • Secondly, the distinction between the two-types
    of banking systems is utilized to test whether
    IBs supposed adherence to ethical conduct
    resulted in shielding them from the devastating
    effects of the financial crisis and create
    shareholder value and hence, perform better
    during crisis.
  • We conclude that the corporate governance index
    (CGI) and financial disclosure and transparency
    index (FDTI) emerged as the key driving force for
    risk-taking behavior of IBs during financial
    turbulence.

3
Background
  • Akhigbe and Martin (2008) and Pathan (2009)
    Highlight disclosure and governance practices and
    risk-taking behavior of US Banks around
    Sarbanes-Oxley Act 2002, but nothing is done on
    the IBs governance and risk-taking.
  • Sierra et al. (2006), Adams and Mehran (2012),
    Anders and Valledado (2008), Wintoki et al.
    (2012), Francis et al. (2012) and Pathan and Faff
    (2013) Investigate governance mechanism and firm
    performance/value, but nothing on the IBs.
  • This study adds value in the existing literature
    by producing empirical evidence between
    governance and firm performance/value for the IBs
    during financial crisis.

4
Hypothesis
  • Hypothesis 1 There is no relationship between
    governance structure of IBs and risk-taking.
  • Hypothesis 2 There is no relationship between
    governance structure of IBs and firm performance.
  • Hypothesis 3 There is no relation between
    Shariah Supervisoty Board (SSB) and the
    risk-taking of IBs.
  • Hypothesis 4 There is no relation between
    Shariah Supervisoty Board (SSB) and the firm
    performance of IBs.

5
Data and Methodology
  • BankScope database 147 Islamic Banks listed in
    the BankScope database, but a large number of IBs
    do not fully involve into the Shariah compliant
    products.
  • Hand collected data from the Islamic Banks, which
    fully provide Shariah compliant products. We
    include 59 Islamic Banks in the sample.
  • In addition, we collected the corporate
    governance data from the annual reports of these
    banks.
  • The data consists of 84 banks (59 Islamic and 25
    Conventional) from Bangladesh, Bahrain, Malaysia,
    Pakistan, Saudi Arabia, The United Arab Emirates,
    and The United Kingdom over the period of
    2006-2009.
  • In addition, we have conducted an extended
    questionnaire survey over the Shariah board
    members from the sample Islamic banks.
  • We sent 47 questionnaires to the Shariah
    scholars during April-July, 2012 to Bangladesh,
    Bahrain, Malaysia, Pakistan and the UK. The
    Shariah governance data from the survey has been
    included in the analysis to test hypotheses 3 and
    4.

6
Measures of Dependent Variables
  • Risk-taking variable is defined as investment in
    risky assets and securities to total loans.
  • Firm performance is measured using return on
    equity (ROE) and return on assets (ROA).
  • The ROE is calculated as net income divided by
    total equity and ROA is calculated as net income
    divided by total assets.
  • The similar proxies are implemented by Hutchinson
    and Gul (2004) and Gani and Jermias (2006).
  • The paper uses Tobins Q as a market-based
    measure of firm value. Tobins Q is calculated as
    the Market-to-Book-Value of the equity ratio.
  • The similar proxy for firm value is also
    implemented by Yermack (1996), Weir et al.
    (2002), and Haat et al. (2008).

7
Measures of Explanatory Variables
  • To capture the corporate governance structure, we
    construct four indices
  • Board structure index (BSI), financial disclosure
    and transparency index (FDTI), risk disclosure
    index (RDI) and corporate governance index (CGI).
  • BSI, FDTI, and RDI are the sub-indices
    therefore, CGI constitutes all the three indices.
  • BSI constitutes sixteen different aspects of
    board and CEO structure.
  • FDTI contents eleven components of the audit
    firm/committee, risk committee, and Shariah
    committee.
  • In addition, the RDI contents the disclosure of
    the five key risk parameters.
  • Furthermore, the CGI consists of all thirty-two
    characteristics, which contents the BSI, FDTI,
    and RDI. Finally, the SSB (Shariah Supervisory
    Board) is introduced as a dummy variable in the
    model.

8
Results for Risk-Taking and Corporate Governance
  • The results of the model for both Islamic and
    conventional banks are presented in Table 4.
  • The F-statistics for all models are highly
    significant, which indicate the OLS pooled
    regression is the right choice.
  • The results show that the CGI and FDTI are highly
    significant, which indicate that the corporate
    governance mechanism as a whole and financial
    disclosure and transparency in particular emerged
    as the key driving force for risk taking for
    Islamic banks.
  • Similarly, the full-sample finds positive
    (significant) results for CGI and FDTI.
  • However, board size influences risk-taking for
    the full-sample.
  • In addition, size and financial leverage play
    significant roles in protecting Islamic banks
    from high, but none of them matter for
    Conventional banks.
  • Nevertheless, the SSB appear as a significant
    parameter for the risk-taking for the IBs.

9
Results for Shareholders Value, Firm Performance
and Corporate Governance
  • In Panel A, we find that board structure
    variables (board size and independence) are
    positively significant with ROA, which indicate
    that these variables are the key driving forces
    for the Islamic banking profitability.
  • Conversely, the coefficients of FDTI and CGI
    indices are negatively significant with
    performance variables, which indicate that these
    indices destruct Islamic banks profitability.
  • The similar results are reported in the
    full-sample (Panel C).
  • However, risk-taking behaviour, religion and
    financial leverage help Islamic banks making
    short-term profits (ROA and ROE).
  • On the other hand, the risk disclosure index
    (RDI) and FDTI play key roles in conventional
    banks profit and value destruction (Panel B).
  • Nevertheless, financial leverage positively
    influences conventional banks profitability.
  • Nevertheless, religion and SSB played a leading
    role in profit making mechanism for the
    full-sample (Panel C).
  • These results indicate that governance mechanisms
    provide a weak explanation to changes in
    shareholders value measured by Tobins Q for
    Islamic banks.

10
Analysis of Survey Responses
  • The average size of the Shariah board is 3 and
    all members are male.
  • The Shariah boards consist of Shariah scholars
    and economists, but no lawyers.
  • Shariah board members do not work for the bank
    as employees.
  • 55 of the respondents have said that they are
    accountable to the Board, but 45 said, they are
    accountable to the shareholders.
  • However, 91 of the respondents have agreed that
    the shareholders have the power to appoint and
    dismiss the Shariah Board and the Shariah board
    reports to the board of directors.

11
Analysis of Survey Responses
  • Despite the fact that all the respondents have
    agreed that banks review the qualifications and
    expertise of Shariah members, the responses are
    mixed when asked about Shariah members training
    and their understanding for the internal control
    and risk management process.
  • All respondents, however, have agreed that the
    bank never evaluated their performance.
  • However, 63 has said that they meet quarterly,
    and 34 said, they meet monthly and they never
    experienced quorum problems. The decisions are
    made based on consensus.
  • Moreover, 45 has said that the internal Shariah
    officer, who are bank employees, are responsible
    for Shariah board meeting, but 55 said that the
    company secretary is responsible for it.
  • Interestingly, all Shariah scholars serve the
    bank on a part-time basis, and Shariah scholars
    sit in different boards but, in some cases, the
    Central bank permits one to sit in max 2 boards.

12
Analysis of Survey Responses
  • There are a few issues raised in this section
    regarding disclosure and transparency.
  • The Shariah governance system is monitored
    either by national Shariah council or Shariah
    authority of the central bank.
  • 82 of respondents have agreed that the bank has
    an independent Shariah board.
  • The internal Shariah review is conducted by
    internal Shariah committee (73)7. Fourth, the
    Shariah resolutions are publicly available
    (82).
  • There are questions about role of Shariah board
    and Shariah ruling, 55of the respondents
    believe that Shariah board plays an advisory
    role, and they validate the documentation, but
    45 of the respondents noted that the Shariah
    board plays a supervisory role, and the board
    members perform Shariah audit.
  • However, 73 of the respondents believe that the
    banks consider Shariah board ruling as the
    binding but 27 thinks that it is simply
    advisory.

13
Analysis of Survey Responses
  • Finally, the survey results cast doubt on the
    independent role of Shariah board, which was
    considered as the key driving force for the IBs
    governance system in restraining IBs in excessive
    risk-taking and hence, perform better during
    crisis.
  • The results fail to reject H3-H4, which help
    identify SSB as the weak parameter in IBs
    governance system.
  • In addition, the regression results identify
    corporate governance index (CGI) and financial
    disclosure and transparency index (FDTI) as the
    major variables for risk taking in IBs, but board
    structure of the IBs has profit motive.
  • In our opinion, the monitoring ability of the
    Shariah board is minimum.
  • The SSB performs Shariah audits and validate the
    products and services.
  • The Shariah board members, however, perform the
    advisory role, and they work as an additional
    checkpoint, which adds some value to the bank,
    but Shariah board cannot play any supervisory
    role.

14
Conclusion
  • CGI and FDTI emerged as the key driving force for
    risk taking for Islamic banks, but board
    structure of the Islamic banks are driven by
    short-term profitability.
  • However, governance mechanisms provide a weak
    explanation for the changes in shareholders
    value measured by Tobins Q for Islamic banks.
  • Our findings cast doubt on the independence of
    Shariah Boards.
  • In addition, Shariah board member tend not to
    undertake a monitoring role, limiting their role
    to giving opinions on Shariah compliance of the
    products and services offered by IBs.
  • The findings of this research will be a valuable
    source of knowledge for policy makers and
    regulators, particularly in the financial
    services sectors, in devising strategies to deal
    with future financial crises.

15
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