Global Financial Crises & the Gulf Cooperation Council - Research Paper Example

? Global Financial Crises (2007-2009) & The Gulf Cooperation Council Table of Contents: Introduction to the Global Financial Crises (2007 to 2009) Main Body Determinable impacts of the crises on the financial markets of Qatar & other GCC countries Plausible reasons for the GCC financial markets reacting differently to the financial crises Performance of the GCC banking sector during the crises: comparative analysis between traditional and Islamic banks Islamic Finance: a viable option to curb financial crises? Conclusion Brief Introduction on the Global Financial Crises (2007-2009): The Global Financial Crises of the 2007 to 2009 has been regarded as one of the most severe financial downturns in the history. Following the footsteps of the Great Depression of 1923 it was termed as The Great Recession due to the magnitude of the economic disruption caused by it. Our analysis relates to the determinable impacts of the GFC on the middle-eastern financial markets with specific focus on the financial markets of Qatar and other Gulf Cooperation Council members. The widely known cause of the recession is the collapsing of the housing bubble in the US in 2006; the bubble was created as a result of lenient credit terms and easy initial availability of housing mortgages, based on the perception that property prices are always likely to appreciate. The initiation of easy credit was made by certain US based banks following the inflow of funds from the booming Asian markets. Collateralized Debt Obligations (CDOs), that were relatively recent financial instruments, promised residential properties as the security against default; this gave further incentive to the banks to lend out customized loans. The collapse, which resulted from rising interest rates leading to a multitude of defaults, caused a significant drop in the prices of securities that were collateralized with the housing market. This, in turn, resulted in several financial institutions facing the risk of solvency as speculations regarding huge liquidity shortage rose, causing a great stir in the stock markets world-wide, ending up in record-setting lows (Rashwan, 2012). However several economists debate that financial markets in the middle-east, specifically the GCC countries, were somewhat shielded from the devastative impact that certain Western economies faced. Our analysis will highlight reasons on whether it would be fair to conclude this and if so, on what grounds can we claim economies relating to the gulf cooperation council as any different. Project Objectives: To present a brief reasoning behind the Global Financial Crises 2007-2009 To assess the difference between the impact of the Global Financial Crises on the western markets and in the GCC Countries To determine reasons why the financial markets in Qatar and other GCC countries responded to the crises differently To assess whether Islamic financing investments have a contribution to the lesser risk exposure of the gulf markets To draw conclusions on whether there are possibilities for western markets to open up avenues of introducing alternative financial instruments following the impact of the GFC Literature Review: We intend on looking up related literature in order to analyze the impact of the GFC on the middle-eastern financial markets, to devise a conclusive analysis on what factors were responsible for the relevant markets to react differently than most of the West, and to formulate deductive reasoning on whether an alternative form of financial instruments might prove to be a securer investment on the macroeconomic level. To obtain supporting information we will take assistance from a combination of primary as well as secondary sources of information, focusing primarily on related articles and scholarly journals. With the GFC being one of the major contributors for financial downturns in history, we hope to obtain appropriate market information that will be sufficient enough for us to reach conclusive grounds by the end of our analysis. In our research we have come across a number of studies that have been conducted by various teams of individuals in order to assess the performance of conventional banks as opposed to Islamic banks during the recent financial crises. Our literature can be bifurcated into various dimensions. While some compare the macroeconomic factors of the GFC affecting the western economies, against those of the middle-eastern, other studies conclude elaborate reasoning on what specific Islamic financing instrument might prove to be a viable option to curb the effects of financial turmoil such as that of 2007-2009. Using different techniques and methodologies, all researches that we have observed concluded a relatively profitable performance by the Islamic banks in the GCC countries amidst the financial chaos of 2007 to 2009. Research Methodology: Our research will take form of a report, analyzing the economic indicators that lead certain experts to conclude a lesser exposure to risk being faced by the gulf cooperation council members in contrast to the western markets. Our primary highlight will be the economic reactions and the respective banking sectors of all the GCC countries, focusing specifically on the financial and economic indicators for performance in Qatar, Dubai and KSA pre and post the Global Financial Crises 2007-2009. Our methodology will constitute analysis of various studies that have been conducted in the relevant field. Important contributors in our research are the studies performed by (Ftiti, Nafti, & Sreiri, 2013) and (Rashwan, 2012). The researchers have mainly emphasized on performance measures as the basis for their study. Techniques such as variation analysis, data envelopment approach (DEA) and efficiency measurement (output efficiency and input efficiency) via ratio analysis of profitability and investors ratios (ROI & ROA) have been primarily been focused on. Output efficiency will be used as a performance measure for the banking sector that reflects the ratio of the output (profits) generated as a result of the loans that have been issued; whereas input efficiency would be responsible for computing how much loans were issued in order to reach a predetermined benchmark of profits. Information from comparative years is will be incorporated in the analysis. Our study will conclude that in terms of efficiency how well have the Islamic Banks in Qatar and other GCC countries performed during the crises era in contrast to the conventional banks operating in the region. Data Collection & Analysis: The GCC countries comprise of six major financial market players within the middle-east, comprising Oman, Kuwait, Qatar, Bahrain, Saudi Arabia and the UAE. Out of a total 300 Islamic Banks worldwide, it is important to note here that up to 85% of the total financial assets of this region constitute those of Islamic banks. GCC countries are single-handedly responsible for at least two third of the total Islamic banking market around the globe. Not only do these countries share similar cultures and languages but also contribute to a major portion of the world’s oil needs, relying on up to 70 percent of their profits from oil exports. Various studies conducted on these countries have concluded that their combined GDP by purchasing power and population density has a direct significant relationship to the Islamic Banking performance (Ftiti, Nafti, & Sreiri, 2013). 1. Comparison of the Crises on GCC and the Western Economies The impact of the GFC in the global markets is fairly well-known. Initiating from the US where the defaults on the sub-prime lending resulted in three of the largest investment banks being either sold out in emergency via government backed acquisitions or entering bankruptcy, namely Bear Stearns, Lehman Brothers and Merrill Lynch. The crises were known to rapidly spread toward a global economic shock. Both MBS and CDO were purchased by foreign corporate as well as institutional investors. CDS was responsible for large financial institutions being interconnected with each other via counter-part default risk. As credit markets were left illiquid the debt obligations could not be rolled over, which resulted in magnified liquidity crises and a spiraling downturn in international trade. The economic world witnessed a number of European bank failures, global stock indexes crashes and a significant drop in the market value of equities and commodities. Let us now compare the impact of the Global Financial Crises of 2007-2009 with that on the GCC countries. Despite the gulf being characterized with dependence on oil production and excess liquidity, the GCC countries did not appear to be entirely resilient to the financial chaos associated to the GFC; needless to say that all economies world-wide faced the effects of the GFC as a result of economic and trade ties with the US. The stock market crash in the US and solvency of several major financial institutions plummeted oil prices in the GCC and hence its production. Stock markets reacted simultaneously as the overall government spending took a downturn. The collapse of Lehman Brothers and the resulting drop in speculated investment inflows by the United Nation in the GCC economies exacerbated the crises in gulf. In order to offset the negative impact of the crises on diminished oil revenues, GCC economies increased spending levels. In 2008, monetary easing was initiated in the US to alleviate domestic credit conditions. GCC countries, with the exclusion of Qatar, followed in the footsteps to inject liquidity, reduce interest rates and minimize statutory liquidity reserve requirements with the banks (Khamis & Senhadji, 2010). The steep fall in global commodity prices took a downturn in the GCC economies as well, significantly impacting real-estate prices, specifically in the UAE. Dubai, in individuality, faced a severe financial crises post its six year construction boom (Renaud, 2012). Dubai’s government related entities had engaged in highly leveraged property development projects, which were being speculated to result in a government default if debt restructuring did not immediately take place. Most of the borrowing of the government had been via offshore banks and the post-crises credit crunch had worsened Dubai’s credit position. The total government debt in 2009 stood at USD 80 billion (Mehta, 2012). The situation was somewhat alleviated by the restructuring that took place with the assistance from Abu Dhabi. The economic spillovers from Dubai to other GCC countries were limited due to this. The Middle East has suffered significant unemployment losses by 2009 due to the multiplier effect damaging demand in the region. In 2009, banking sector losses up to USD 4 billion were recognized within the gulf resulting from the impact on oil production, diminished foreign investment and unemployment (Rashwan, 2012). The global financial crises appeared to be paving way for another financial catastrophe in the Western world (the European Debt Crises). However, despite the losses reported by the banking sector in Qatar and other GCC countries, the overall banking segments in the maintained profitability (Khamis & Senhadji, 2010). This was one reality that left many economists perplexed. The only determinable variable responsible for somewhat cushioning the gulf economies from the crises is its emphasis toward Islamic banking. 2. Introduction to Islamic Banking in the GCC The Accounting and Auditing Organization regulates Islamic banking and finance for Islamic Financial Institutions (AAOIFI) and the International Islamic Fiqh Academy (IIFA), which are GCC-based Islamic financial standard setters. Let us begin with a brief introduction of what Islamic banking and finance is. The main factor that determines the regulatory framework behind Islamic banking is the ‘Shariah’ guidelines. Being derived directly from the religious teachings in Islam, the Shariah prohibits any gain that is excess and terms it as ‘Riba’. Another core principle in Islamic finance is the tangibility of assets, which promotes all investments being ‘backed’ by actual ownership of physical assets. This can be regarded as an asset-oriented finance which establishes a general rule that the subject matter of the trade must be real, present and owned. It regulates a both profit as well as loss-sharing arrangement between the parties concerned. As physical ownership of good or service being traded is critical, the purchase and sale of debt is therefore completely prohibited under the Shariah law. It is important to highlight that this framework, by default, deems unlawful several types of derivatives and short sale transactions; which, in effect, suppresses excessive lending, as finance can only be made available against legal ownership of tangible assets under the Shariah jurisprudence. Debt issuance is curbed to the real capacity set within the economy; therefore the mortgage bubble that initiated the 2007-2009 crises is ruled out entirely from the scope of Islamic finance (El Hussein, 2013). Alternatively, the reserves are directed toward productive sectors. The conservative approach to financing, set down by the Islamic jurisprudence, limits the susceptibility to financial instability that economies face via conventional modes of financing. Another crucial principle is the disallowance of ambiguous, uncertain and speculative transactions. Any transaction that incorporates imprecision, ambiguity and unpredictability in its outcomes is outlawed under the Islamic law. Therefore, derivatives such as Credit Default Swaps (CDS) and Collateralized Debt Obligations (CDO) are ruled out of scope of Shariah complaint transactions. With our research on Islamic finance, it appears that the Shariah complaint regulations take up a less superficial approach to financing than what the global economies witnessed via conventional means. 3. The Global Financial Crises under Islamic Finance Let us now asses why Islamic finance proved to be a securer finance method in the GFC. Easy credit provision and pro-risk financial innovation primarily stem from a profit driven sentiment which is relevant to an interest-based financial system. The 2007’s financial crises followed from imprudent sub-prime lending by the banks as well as massive over-pricing of the credit default swaps. Easy credit conditions and excessive lending had led to a major shift of default risk from original lenders back to individuals who were eventually purchasing the asset as well as a large number of other market participants (Ftiti, Nafti, & Sreiri, 2013). On the contrary, a risk as well as a reward sharing discipline such as Islamic Finance enforces regulations which not only act as incentives but also deterrents in profit making. The jurisprudence, in this manner, promotes social justice and therefore eradicates the problems faced by traditional market disciplines. 4. Performance of the Banking Sector in GCC during the Crises We will derive the basis of our analysis for performance of the GCC countries’ banking sector during the global financial crises taking assistance first from the study conducted by (Ftiti, Nafti, & Sreiri, 2013). The researchers studied market sentiments in the middle-east by assessing the percentage of deposits that were made to Islamic banks in the gulf as compared to those in the conventional banks. The market behavior reflected popularity marked by a constant increase in the deposit stream specifically during the crises period. Equity has been one of the more popular forms of investment in the market. In terms of Islamic instruments the study suggested the market’s interest toward asset-backed ‘Sukuk’ bonds as well, partially because of their attributes being similar to that of equity finance (Said & Grassa, 2013). Regardless of whichever specific instrument the investors have reflected interest in, Islamic banks have shown to consistently evolved before, during, as well as after the financial crises. The graph blow reflects the issuances of debt instruments by the GCC banks during 2009 (Khamis & Senhadji, 2010). The study has also highlighted the revenue streams in the Islamic banks in the GCC. The period from 2005 to 2009 was the prospering era for Islamic banking. However, banks experienced a slight decline in profitability during the sub-prime loan crises. Post 2009, all revenues from the Islamic banking sector appeared to revive. It is important to note here that even during the crises period the sector never faced losses in contrast to the conventional banks operating within the same region. By studying the financing stream of the Islamic banks in the same period, it is observed that during 2007 the banks maintained an upward trend of the financing operations and it continued to reach USD 12,563,930 in 2009. This reflects the market’s confidence in Islamic Finance within the region. The study has also used regression analysis for performance measures, incorporating macro-economic variables such as population density and GDP alongside the micro-economic counterparts such as ROI and ROA. In terms of population density Islamic banking has reflected a higher revenue stream in the GCC region where the population is denser and countries where the GDP is higher. As per (Ftiti, Nafti, & Sreiri, 2013) the positive correlation can be justifiable as the Islamic banking sector’s efficiency is likely to increase with increasing potential customers. A slightly contrasting study carried out by Rashwan (2012) will also be used in our research, which was based on previously held studies by various experts. The study has used The Multivariate analysis of Variance and Variation Analysis to conclude the relative performance of traditional banks and Islamic banks within the GCC. The study has revealed that while the first wave of the global financial crises hit in 2007 to 2008 the traditional banks in Qatar, Bahrain and other GCC countries faced significant losses while the Islamic banks maintained profitability. However, the second wave of the crises targeted the real economy (2009), and as the fundamentals of the Islamic banking rest upon asset-back securitization, post 2009 was the period when tradition banks within the GCC outperformed the Islamic banks. The study also defines as managerial drawbacks in some of the major Islamic banks in the region as more responsible for the lost profitability in rather than the uncontrollable economic factors. However, the Shariah restrictions assisted the Islamic banks in evading the negative consequences from investing into securities in which the traditional banks did. Conclusion: We conducted a research on various studies, also taking assistance from certain primary information like the report by (Khamis & Senhadji, 2010) from the IMF, in order to meet our defined set of objectives. From the studies it is fairly evident that, as per historical information pertaining to the financial crises of 2007 onwards, the gulf remained relatively resilient in terms of economic turmoil that most of the global economies faced. Considering the magnitude of the susceptibility of various financial markets around the globe, it is remarkable to see that the banking sectors within the GCC economies reported profitability. Understanding the GCC economies as a separate institution for a moment, isolated from the banking sector, it is fairly obvious that unemployment losses within Qatar, Bahrain, UAE and KSA are enormous. The drop in the demand and production of oil had drastically impacted the gulf post 2008, nevertheless. And with oil being the major source of revenue stream for most of the Middle East the financial turmoil did prove to be evident there as well. Coming down to the banking sector, specifically Islamic Banking, an overall profitability even during the crises was observed in the GCC countries. These appear to be unusual circumstances for many observers, however, as we elaborate on the fundamentals of Islamic Finance and its conservative approach to investment and securitization, the behavior reflected by the GCC banking sector seems justifiable. Another factor contributing to the improve GDP and hence, improved efficiency of the banks can be associated with the acceptability of this type of jurisprudence, considering that most of the middle-eastern world follows Islam. The investigative analysis that we performed has highlighted a few very important points. Despite the positivity with respect to profitability and resilience that the GCC region has shown, it needs to be clarified that Islamic Finance is still a growing medium. Acceptability of Islamic means of finance in the western world still has a long way to go, despite the openness to some Islamic finance instruments that certain offshore markets have reflected, especially during the post financial crises period. Sukuk finance is a popular choice for investors in the western markets who consider Islamic finance as a safer medium for investment and securitization (Said & Grassa, 2013). A major shortcoming in the Islamic finance jurisprudence is the absence of a clear set of regulations; a certain percentage of ambiguity between the allowed and disallowed transactions still exists. Hence the regulations are not easily fathomed. A clear guideline on the disallowed transactions such as those involving Riba (Usury) or Gharar (Speculation) are available, whereas no distinction on what is allowable is clarified; therefore, by default, any transaction for which has no clear ruling on disallowance is deemed allowable. However, it is of significant importance to note that economic data reveals the post-crises sentiment in the global market to be pro-Islamic Finance. Therefore, for the foreseeable future Islamic banking and finance appears to be a securer medium for investment and securitization in contrast to traditional finance. Basing our ruling primarily on the fundamentals of the Shariah, that devises the principles of Islamic finance, it is evident that returns on investments are only allowed where there is actual, physical ownership of a tangible asset by the investor. Therefore the basis for Islamic finance rests with the real economy, as opposed to superficial or fictitious. Excessive lending and highly risky approaches are prohibited under the Shariah law, which also delegates a profit and loss sharing arrangement between the concerned parties. It is important to note here that as excessive lending and sale/purchase of debt is out of the scope, the resultant losses from investment are very limited, in contrast to the highly profit-driven traditional finance As more and more market participants have inclined toward a more risk-averse and safer mode of finance post the GFC, we can predict that the western economies are likely to open up to Islamic Finance sometime in the medium to distant future, if regulatory authorities such as the AAOIFI and IIFA devise a clearer set of regulations and remove the ambiguity within the teachings of the Shariah law. Reference List El Hussein, N. H. (2013). Islamic finance: Is it a viable option to restrain financial crisis? Business And Economics, 5(4), 576-588. Ftiti, Z., Nafti, O., & Sreiri, S. (2013). Efficiency Of Islamic Banks During Subprime Crisis: Evidence Of GCC Countries. Journal of Applied Business Research, 29(1), 285-285. Khamis, M., & Senhadji, A. (2010). Impact of the Global Financial Crisis on the Gulf Cooperation. Middle East and Central Asia Department. Washington, D.C: International Monetary Fund Publication Services. Mehta, A. (2012). Financial Performance of UAE Banking Sector- AComparison of before and during Crisis Ratios. International Journal Trade, Economics and Finance, 3(5), 381-381. Rashwan, M. H. (2012). How did listed Islamic and Traditional Banks Performed: pre and post the 2008 financial crisis? Journal of Applied Finance and Banking, 2(2), 149-175. Renaud, B. (2012). International Articles: Real Estate Bubble and Financial Crisis In Dubai: Dynamics and Policy Responses. Journal of Real Estate Literature, 20(1), 51-77. Said, A., & Grassa, R. (2013). The Determinants of Sukuk Market Development: Does Macroeconomic Factors Influence the Construction of Certain Structure of Sukuk? Journal of Applied Finance and Banking, 3(5), 251-267. Soufan, T., Abdul-Khaliq, S., & Shihab, R. A. (2012). Causes of the Global Financial Crisis and Its Effectes on the Arab Countries. Canadian Social Science, 8(6), 153-159. Read More