A CJBS study raises some interesting food for thought for Islamic bankers globally

by HABHAJAN SINGH

A NEW study has attempted to see how Islamic banks react to the adoption of a practice that challenges traditional Islamic banking codes.

The study by academics at Cambridge Judge Business School (CJBS), the business school of the University of Cambridge, raised some interesting food for thought for Islamic bankers globally.

In a nutshell, it concluded that the reaction of traditional Islamic banks depend on whether they possess an “identity buffer” — or relative identity advantage — as being seen more authentic.

The buffer translates into a greater likelihood of violating traditional codes if an “outside” bank introduces the code violation, whereas traditional banks will more likely adhere to the codes if the violator is one of their insider competitors born as an Islamic bank, the authors wrote in an article.

The study, recently published in the Academy of Management Journal, was co-authored by doctorate candidate (picture, from left) Maima Aulia Syakhroza, lecturer Dr Lionel Paolella and reader Dr Kamal Ahmed Munir. They are all based at CJBS.

Entitled “Holier than thou? Identity buffers and adoption of controversial practices in the Islamic banking category”, the study was based on data from 108 Islamic banks, both full-fledged Islamic banks and conventional-owned, in 12 countries between 2003 and 2014.

Full-fledged Islamic banks born as an Islamic bank were deemed as “insider” or incumbent banks. Conventional bank-owned Islamic banks were denoted as “outsiders” or challengers. The 61-page paper does not list the names of the banks studied in the report.

Insider Versus Outsider

In the paper, the authors said they generated insights to see when “insider” Islamic banks were likely to adopt derivatives, and whether it became more or less likely when the practice was first adopted by an “outsider” bank versus a peer “insider”.

They also examined whether insiders were more or less likely to adopt outsider-introduced derivatives when outsiders attempt to appear more like insiders through imitation of other practices.

“In all, our findings support our conjecture that insiders are more cautious to deviate when outsiders exhibit both code-violating and code-preserving behaviours,” according to the authors.

In the Islamic banking category, the authors noted that few practices were as controversial as the adoption of financial derivatives.

“Given the potential of derivatives to make risky, but more profitable bets through speculation, they appeal to category members. However, because of their speculative nature, derivatives are considered to be inherently incompatible with the Shariah law and understood to violate the principles of Islamic banking,” they said in the paper.

Looking at Data

The data collected in the study was used to explore how different identities shape dynamics of change and competition within categories.

In a case where category boundaries and codes are clearly laid out, and intra-category identities easily discernable, the authors first tested what response a category code violation elicits.

“We find that a focal insider would be less likely to adopt a code violation when the category is homogenous and the code violator is a peer insider.

“We argue that this happens because expectations of loyalty to the category code are higher for insiders, leading them to desist from following a deviant. It also implies that radical innovation rates should drop when categories are homogeneous,” the authors said.

The study found the opposite effect when the code violator was an “outsider” member of the category.

“In this case, insiders are more willing to adopt a code violation. We argue that the identity buffer that insiders possess relative to outsiders allows them some leeway to adopt controversial practices, while retaining their insider identity. This implies that the entry of outsiders is beneficial for radical innovation in any industry, though for incumbents it means dealing with identity challenges,” they said in the paper.

In another hypothesis, the authors examined what happens when the outsider code violator adopts some code-preserving practices.

“This hypothesis was posed to test how the outcome changes as the identity buffer narrows. Consistent with our overall argument, we find that as soon as the identity buffer narrows, the insiders’ propensity to adopt the code violation ushered in by outsiders also weakens,” they stated.

The authors believe that the findings hold “significant implications” for existing understandings of market categories, as well as organisational and social identities.

Kamal, who completed his doctorate from Canada-based McGill University, has been a reader in strategy and policy at CJBS since 2000. On his part, Paolella, who was formerly a visiting scholar at Columbia University’s Graduate School of Business, is a university lecturer at CJBS and an affiliated faculty at Harvard Law School (Centre on Legal Profession).