Impacts of Endogenous Sunk-Cost Investment on the Islamic Banking Industry: A Historical Analysis
Abstract
:1. Introduction
2. Modelling Endogenous Sunk-Cost Investment for the Islamic Banking Industry
2.1. Endogenous Sunk-Cost Investment and Imperfect Appropriability
2.2. Detection of the Sunk-Cost Investment
2.3. Efficiency Frontiers to Measure Profitability: The Cost Function Approach to Islamic Banks
+ ½ ∑k∑l δkl ln(Ykt) ln(Ylt) + ∑j∑k ρik ln(wjt) ln(Ykt) + ηit + vit
- Cit—the total costs of bank i in year t;
- Yijt—the vector of the outputs of bank i at date t; output (labelled j) are (i) the total loan, (ii) investment, and (iii) other earning assets at date t;
- Wijt—the vector of input prices facing bank i; j is input types which are (i) the price of labour, (ii) price of physical capital, and (iii) price of financial capital inputs computed as
Price of physical capital = wiA = (non-interest and non-personal expenses)/(fixed assets)
Price of financial capital = wiF = (total interest costs)/(total deposits)
2.4. Efficiency Frontiers to Measure Profitability: The Profit Function Approach
+ Σn Σm βnmw lnYn Pm + ηit + μit
- Yn is the vector of the outputs of bank in year , which are (i) total loans, (ii) investment and (iii) other earning assets;
- Xmt is the vector of input uses (labour, capital, and financial capital) as a function of input prices and output;
- Pm is the price of inputs (PL: price of labour (wage), PK: price of capital, PF: price of financial capital);
- nit is the measure of inefficiency in terms of forfeited profits;
- μit is the error term.
2.5. Historical Dataset (1993–2010) and Relevant Variables
2.6. Implications of Competition for the Banking Industry
[T]here is clearly some tension between financial stability goals and the tenets of competition policy, which hold that oligopolies are inefficient and serve consumers badly … many policymakers seem to think that some curbs on competition may be a price worth paying to improve stability.
3. Determinants of Profitability and Endogenous Sunk-Cost Investment of Islamic Banks of Jordon: The ARDL Approach
3.1. Stationarity (Unit Root) Tests
3.2. Postulated Models to Unravel the Effects of IT Capital as Sunk-Cost Capital on Efficiency Scores of Islamic Banks
4. Findings
5. Conclusions
Author Contributions
Funding
Conflicts of Interest
Appendix A
Bank Name | Jarque–Bera Test | ||
---|---|---|---|
Normality | |||
CES | PES | lnITK | |
AB | 12.82 *** | 2.52 | 6.38 *** |
AEB | 1.57 | 1.79 | 7.38 *** |
CAB | 1.63 | 3.47 | 0.03 |
HB | 4.39 | 1.75 | 0.45 |
JB | 9.80 *** | 4.27 | 3.92 |
JCB | 2.24 | 7.35 *** | 11.41 *** |
JIB | 0.71 | 0.45 | 7.50 *** |
JKB | 1.49 | 0.45 | 4.51 |
UB | 1.49 | 0.31 | 0.12 |
Bank Name | Breusch–Godfrey | |
---|---|---|
Serial Correlation | ||
CES & lnITK | PES & lnITK | |
AB | 0.08 | 3.43 * |
AEB | 7.85 *** | 0.29 |
CAB | 3.28 * | 0.1 * |
HB | 13.00 *** | 0 |
JB | 3.07 * | 2.07 |
JCB | 6.67 *** | 0.06 |
JIB | 6.88 *** | 0.09 |
JKB | 0.04 | 0.18 |
UB | 0.511 | 2.04 |
Bank Name | Breusch–Pagan | |
---|---|---|
Heteroskedasticity | ||
CES & lnITK | PES & lnITK | |
AB | 0.64 | 0.07 |
AEB | 0.001 | 0.08 |
CAB | 2.17 | 1.21 |
HB | 1.63 | 0.01 |
JB | 1.78 | 0.72 |
JCB | 0.16 | 1.1 |
JIB | 0.43 | 0.63 |
JKB | 1.04 | 0.03 |
UB | 1.93 | 0.01 |
Bank | CES | PES |
---|---|---|
AB | ||
AEB | ||
CAB | ||
HB | ||
JB | ||
JCB | ||
JIB | ||
JKB | ||
UB |
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1 | At the outset, the selection of the country and its industry begs the question of whether it is justified to consider Jordon’s Islamic banking industry for a detailed analysis like this. In the Middle East, Jordon’s banking industry has consistently posted an excellent record since the early 1990s, as policy makers launched a series of banking liberalization measures to fight financial repression in Jordan. Such measures were meant to intensify competition among banks for delivering efficiency gains. As a result, the banking sector became one of the largest economic sectors in Jordon; by 2019, the banking industry contributed 18.8% of Jordon’s GDP. As another indicator of its relevance, in 2017, the total assets of Jordon’s banks stood at 114% of its GDP, while the global average stood at 64%. Despite mounting economic challenges in the region, Jordon’s banks have maintained excellent profit figures with adequate stocks of liquid assets and healthy capital adequacy ratios (17.2% in 2019). The banking sector has enforced a strong compliance system to contain the NPL ratio under 6%. Hence, Jordon fulfils all Basel III requirements. Jordon thus stands out as a prime example of how competition can promote efficiency in banking without risking financial instability. Additionally, in Section 2, we will also highlight that the Islamic banks have become a major player in Jordon. There are two important sources of growth in Islamic banking in Jordon. First, investors came to hold a shared perception that Islamic banks adopt more responsible business practices (see Alam and Seifzadeh 2020). Second, it is widely held that Islamic banks’ better financing quality lowers their credit risks (see Misman and Bhatti 2020). We hence choose Jordon as a prime example of successful banking reforms, with the strong presence of Islamic banks, for understanding if endogenous sunk-cost investments can propel efficiencies, which will, in turn, create stability for Islamic banking. |
2 | |
3 | The other type of sunk-cost investment is comprised of a firm’s expenses to grab market shares from its rivals, like advertisement, without any impact on its relative efficiency. |
4 | At the textbook level, appropriability is defined by Kay (1995) as the capacity of a business entity to capture the value added—through its rivalry with its competitors in the market—that it creates for its own profits. The value added is created and captured either by innovating better products or better processes than their rivals. The appropriability critically depends on the structure of the market in which it operates (see Cohen et al. 2000). |
5 | There will be little effects on their profits if a bank improves its product quality or technology of production, which is easily imitable or reproducible by others. The appropriability regime is defined as weak. On the other hand, some quality improvements involve sticky knowledge, which are intimately ingrained in a particular organization, so that they cannot be easily imitated and replanted elsewhere in a meaningful way. The market/system has strong appropriability (see Teece 2000). |
1. Arab Bank | 2. Arab Egyptian Bank | 3. Cairo Amman Bank |
4. Housing Bank | 5. Jordan Bank | 6. Jordon Commercial Bank |
7. Jordon Islamic Bank | 8. Jordan | 9. Kuwait Bank |
Yn: Vector of Output (Y1: Loans, Y2: Investment, Y3: Other Earning Assets) |
Pn: Prices of Output |
Xm: Vector of Inputs (X1: Labour input, X2: Capital Input, X3: Financial Capital Input) |
Pm: Price of Inputs (PL: Price of Labour (Wage) |
PK: Price of Capital, PF: Price of Financial Capital) |
Cit: Cost of production of bank i at date t |
ITK: IT Budget Allocated to Acquiring only IT Capital (in $) |
Πit: Profit of Bank i at date t |
ηit: Measures inefficiency in terms of profits/costs |
CES: Cost Efficiency Scores |
PES: Profit Efficiency Scores |
Variable | Mean | Std. Dev. | Min | Max | Observations | |
---|---|---|---|---|---|---|
CES | overall | 0.800 | 0.096 | 0.600 | 1.000 | N = 162 |
between | 0.083 | 0.726 | 0.983 | n = 9 | ||
within | 0.056 | 0.659 | 1.009 | T = 18 | ||
PES | overall | 0.860 | 0.091 | 0.540 | 1.000 | N = 162 |
between | 0.028 | 0.825 | 0.910 | n = 9 | ||
within | 0.087 | 0.539 | 1.023 | T = 18 | ||
ITK(Million) | overall | 7.307 | 10.782 | 0.530 | 65.118 | N = 162 |
between | 9.518 | 2.137 | 32.335 | n = 9 | ||
within | 5.934 | −20.170 | 40.090 | T = 18 |
Bank Name | Variables | ADF (AIC) | PP | ||||||
---|---|---|---|---|---|---|---|---|---|
Level | 1st Difference | Level | 1st Difference | ||||||
Intercept | Intercept & Trend | Intercept | Intercept & Trend | Intercept | Intercept & Trend | Intercept | Intercept & Trend | ||
Arab Bank | CES | −3.53 ** | −3.46 * | −3.17 *** | −3.03 | −3.57 ** | −3.54 * | −9.94 *** | −10.11 *** |
PES | −3.42 ** | −3.49 * | −3.81 ** | −3.68 * | −2.44 | −2.35 | −4.53 *** | −4.82 *** | |
ITK | −2.18 | 0.16 | −0.88 | −1.64 | −4.41 *** | −4.91 *** | −5.36 *** | −5.03 *** | |
Arab Egyptian Bank | CES | −1.79 | −1.63 | −3.70 ** | −3.61 * | −1.86 | −1.76 | −3.70 ** | −3.61 * |
PES | −1.65 | −5.62 *** | −3.99 ** | −3.87 ** | −3.58 ** | −5.64 *** | −7.47 *** | −7.34 *** | |
ITK | −3.92 *** | −1.27 | −9.54 *** | −8.53 *** | −3.39 ** | −5.87 *** | −9.54 *** | −8.28 *** | |
Cairo Amman Bank | CES | −1.35 | −1.93 | 3.11 ** | −4.65 ** | −1.32 | −2.25 | −4.62 *** | −4.91 *** |
PES | −3.82 ** | −3.46 ** | −5.32 *** | −5.13 *** | −2.77 * | −2.80 | −5.32 *** | −5.13 *** | |
ITK | −1.58 | −2.15 | −1.84 | −1.91 | −2.31 | −2.68 | −3.75 ** | −3.57 * | |
Housing Bank | CES | −1.64 | −1.90 | −1.96 | −2.09 | −1.43 | −0.88 | −2.02 | −2.09 |
PES | −2.73 * | −3.62 * | −5.67 *** | −4.06 ** | −2.69 * | −3.58 * | −10.80 *** | −12.87 *** | |
ITK | −0.22 | −2.81 | −4.56 *** | −4.34 ** | −1.66 | −2.70 | −4.28 *** | −4.17 ** | |
Jordan Bank | CES | −1.55 | −2.12 | −4.28 *** | −6.86 *** | −2.19 | −2.22 | −5.50 *** | −5.24 *** |
PES | −1.96 | −1.86 | −4.60 *** | −4.77 *** | −1.88 | −1.89 | −4.74 *** | −5.19 *** | |
ITK | −2.62 | −4.17 ** | −1.60 | −1.05 | −3.40 ** | −8.54 *** | −7.01 *** | −7.26 *** | |
Jordan Commercial Bank | CES | −2.80 * | −3.17 | −3.16 ** | −3.05 | −1.88 | −1.83 | −3.18 ** | −3.08 |
PES | −4.09 *** | −3.98 ** | −5.53 *** | −5.29 *** | −4.19 *** | −4.05 ** | −11.73 *** | −11.62 *** | |
ITK | −2.11 | −0.35 | −2.26 | −2.81 | −4.37 *** | −4.15 ** | −6.48 *** | −6.22 *** | |
Jordan Islamic Bank | CES | −2.91 * | −2.97 | −3.56 ** | −3.63 * | −1.97 | −1.97 | −2.48 | −2.44 |
PES | −3.57 ** | −4.53 ** | −5.10 *** | −5.09 *** | −3.62 ** | −4.52 ** | −16.58 *** | −18.96 *** | |
ITK | −3.99 *** | −1.38 | −9.37 *** | −8.38 *** | −3.46 ** | −5.97 *** | −9.37 | −8.22 | |
Jordan Kuwait Bank | CES | −4.09 *** | −4.05 ** | −4.67 *** | −3.55 * | −4.14 *** | −4.07 ** | −14.14 *** | −15.78 *** |
PES | −3.45 ** | −3.15 | −6.35 *** | −6.13 *** | −3.45 ** | −3.35 * | −6.35 *** | −6.13 *** | |
ITK | −1.67 | −1.83 | −2.51 | −2.42 | −3.18 ** | −3.17 | −4.73 *** | −4.21 ** | |
Union Bank | CES | −4.50 *** | −4.43 ** | −6.15 *** | −6.07 *** | −3.38 ** | −3.27 | −6.19 *** | −6.15 *** |
PES | −5.09 *** | −5.46 *** | −6.00 *** | −5.75 *** | −5.09 *** | −5.50 *** | −18.74 *** | −18.04 *** | |
ITK | −1.38 | −1.67 | −2.02 | −1.71 | −1.91 | −2.75 | −3.34 ** | −3.22 |
Banks | Variables | Order of Integration |
---|---|---|
Arab Bank | CES | I(0) |
PES | I(1) | |
ITK | I(1) | |
Arab Egyptian Bank | CES | I(1) |
PES | I(0) | |
ITK | I(0) | |
Cairo Amman Bank | CES | I(1) |
PES | I(0) | |
ITK | I(1) | |
Housing Bank | CES | I(2) * |
PES | I(1) | |
ITK | I(1) | |
Jordan Bank | CES | I(1) |
PES | I(1) | |
ITK | I(1) | |
Jordan Commercial Bank | CES | I(1) |
PES | I(0) | |
ITK | I(1) | |
Jordan Islamic Bank | CES | I(1) |
PES | I(0) | |
ITK | I(0) | |
Jordan Kuwait Bank | CES | I(0) |
PES | I(0) | |
ITK | I(1) | |
Union Bank | CES | I(0) |
PES | I(0) | |
ITK | I(1) |
AB | AEB | CAB | HB | JB | JCB | JIB | JKB | UB | |
---|---|---|---|---|---|---|---|---|---|
Adjustment | |||||||||
CESL1 | −1.90 ** | −1.04 ** | 0.91 | 2.21 | −2.40 ** | −0.50 | −0.79 *** | −1.23 *** | −1.67 |
LONG-RUN | |||||||||
lnITK | −0.02 | 0.07 | −0.39 | 0.60 ** | −0.20 | 0.06 | 0.24 *** | 0.02 | −0.06 |
SHORT-RUN | |||||||||
ΔCESLD | 0.84 | −0.56 | −1.25 | −3.84 | 1.17 * | 0.38 | − | − | 0.19 |
ΔCESL2D | 0.53 | −0.20 | −1.23 | −5.50 | − | 0.49 | − | − | 0.54 |
ΔCESL3D | − | −0.17 | −1.27 | −5.46 | − | −0.60 | − | − | 0.45 |
ΔlnITKD1 | 0.15 | 0.28 | −0.43 | 2.90 | 0.90 * | −0.22 | 0.72 *** | − | 0.33 |
ΔlnITKLD | −0.06 | 0.75 | −0.51 | 4.77 | 0.23 | 0.31 | − | − | 0.11 |
ΔlnITKL2D | 0.38 ** | 0.36 ** | −0.25 | 4.16 | 0.14 | −0.60 * | − | − | 0.17 |
ΔlnITKL3D | −0.08 | 0.07 | −0.09 | −0.20 | 0.18 | 0.17 | − | − | −0.11 |
CONSTANT | 2.42 ** | −0.42 ** | −5.95 | 17.36 | 2.36 * | −0.08 | −2.16 ** | 0.71 | 2.86 |
Adj R squared | 0.73 | 0.96 | 0.01 | 0.64 | 0.39 | 0.89 | 0.80 | 0.53 | 0.94 |
F statistic for no cointegration | 8.52 | 5.82 | 0.68 | 3.83 | 4.85 | 11.09 | 16.42 | 7.26 | 6.99 |
Cointegration | Yes ** | Yes ** | No | No | Yes * | Yes *** | Yes *** | Yes ** | Yes ** |
AB | AEB | CAB | HB | JB | JCB | JIB | JKB | UB | |
---|---|---|---|---|---|---|---|---|---|
Adjustment | |||||||||
PESL1 | 9.681 | −1.067 | −1.577 *** | −2.929 ** | 2.143 | −1.09 *** | −2.127 *** | −2.493 *** | −1.425 *** |
LONG-RUN | |||||||||
lnITK | 0.442 *** | 0.288 | 0.0153 | −0.02 | 0.381 ** | 0.095 | 0.009 | 0.035 * | 0.262 ** |
SHORT-RUN | |||||||||
ΔPESLD | −10.389 | −0.699 | 0.448 | 1.175 * | −2.271 | − | 0.412 | 1.607 ** | − |
ΔPESL2D | −6.806 | −0.746 | 0.554 | 0.802 | −1.717 | − | − | 1.319 ** | − |
ΔPESL3D | 4.927 ** | −0.308 | 0.519 * | − | −0.525 | − | − | 0.634 ** | − |
ΔlnITKD1 | 35.84 * | −1.214 ** | − | −0.853 * | 1.299 | − | − | 0.276 ** | −0.998 ** |
ΔlnITKLD | 5.549 | −0.642 | − | − | −1.312 | − | − | −0.124 | −0.423 |
ΔlnITKL2D | −0.623 | 0.505 | − | − | 2.236 | − | − | 0.419 *** | −0.791 ** |
ΔlnITKL3D | −4.516 * | 0.295 * | − | − | −0.479 * | − | − | − | − |
CONSTANT | 62.569 * | −3.596 | 0.907 | 3.479 * | 10.76 | −0.578 | 1.395 | 0.931 | −4.183 ** |
Adj R squared | 0.886 | 0.954 | 0.575 | 0.582 | 0.741 | 0.442 | 0.751 | 0.912 | 0.798 |
F statistic for no cointegration | 31.576 | 21.512 | 7.694 | 5.791 | 7.72 | 5.349 | 9.469 | 27.303 | 20.569 |
Cointegration | Yes *** | Yes *** | Yes ** | Yes ** | Yes ** | Yes * | Yes *** | Yes *** | Yes *** |
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Jain, S.; Gangopadhyay, P. Impacts of Endogenous Sunk-Cost Investment on the Islamic Banking Industry: A Historical Analysis. J. Risk Financial Manag. 2020, 13, 108. https://doi.org/10.3390/jrfm13060108
Jain S, Gangopadhyay P. Impacts of Endogenous Sunk-Cost Investment on the Islamic Banking Industry: A Historical Analysis. Journal of Risk and Financial Management. 2020; 13(6):108. https://doi.org/10.3390/jrfm13060108
Chicago/Turabian StyleJain, Siddharth, and Partha Gangopadhyay. 2020. "Impacts of Endogenous Sunk-Cost Investment on the Islamic Banking Industry: A Historical Analysis" Journal of Risk and Financial Management 13, no. 6: 108. https://doi.org/10.3390/jrfm13060108