Economists typically divide the overall macro economy into two sectors, the real sector and financial sector. The real sector represents the productive capacity of the economy and produces the goods and services that accounts for a nation's GDP (Gross Domestic Product). The financial sector on the other hand serves to provide the financing needed by the real sector to produce the goods and services. Islamic economics requires that all financial returns be anchored in real sector returns. For an economy to function optimally, both the real and financial sectors need to function optimally.

Efficiency of financial institution has become an important part of insurance literature. This study aims to evaluate the performance in term of cost efficiency for takaful and insurance firms in Malaysia. A sample of 18 firms consisting of 7 takaful operators and 11 conventional insurers are chosen from the period 2004 to 2009. The cost efficiency score for each firm are obtained using input oriented DEA model. A Kruskal Wallis and Mann Whitney test are employed to examine any significant difference in cost efficiency between Takaful industry and insurance industry. The main findings indicate a significant difference in cost efficiency between takaful and insurance industries. The average cost efficiency for takaful industry is 49.20% which implies they could reduce the cost of production by 50% without affecting the level of output. A lower market share exist in takaful industry has resulted to cost inefficiency. Essentially, this study has supported the market power theory.

The role of regulation extends beyond ensuring stability and confidence in the financial system, as it is also behavioral shaper of market players. The laws, standards, and guidelines issued are instrumental in creating an incentive structure for market players to behave in certain ways. Using incentive audit approach, this paper attempts to examine the efficacy of the evolving Malaysian regulatory and supervisory framework for Islamic banking, in preserving financial stability as well as supporting the growth of the financial system and real economy. The findings suggest that the present framework unintentionally misaligns incentives and discourages Islamic banks from fully embracing risk sharing as the underlying principle for their financial instruments.

This article undertakes an empirical examination of pure rights issues in Malaysia. Though pricing efficiency is the main focus, we also examine related issues. We study a total of 38 pure rights issues that occurred over the 8-year period January 1998 to December 2005. Using two alternative valuation models, the adjusted Black–Scholes Call Option Model (BSOPM) and the traditional Implied Rights Valuation Model (IRVM), we find the Malaysian market to be inefficient in pricing the rights. Mispricing is quite extensive with a predominance of overpricing. Significantly, both pricing models, despite their different theoretical underpinnings produce similar results. These results are further validated by the returns to our two arbitrage strategies. The trading strategy, which establishes a net short position in the rights produces substantial positive returns, whereas the strategy which effectively goes long the rights, produced marginally negative returns. We found underlying stock price volatility, liquidity and moneyness of the rights to be the key determinants of the extent of mispricing. Finally, we find that underlying stock price volatility was significantly lower post rights issue.

What a month March had been. Over a three-week period, four mid-size US banks had to be rescued and one large Swiss bank had to be folded into another. Meanwhile, a German bank had to suffer serious erosion of its equity value. It started with Silicon Valley Bank (SVB) needing to be rescued following a run by its depositors, on news of its loss of some US$2 billion (RM8.8 billion) from the sale of US government bonds it had been holding. It appears that SVB was holding a huge portfolio of long-dated government bonds - a clear case of a serious duration mismatch. Surprisingly, no one, not even the banking regulators, seemed to have been watching interest rate risks, even as the US Federal Reserve had been raising rates rapidly. Rising rates affect the value of items on a bank's balance sheet. Both assets and liabilities are affected, with the impact being determined by the duration of each item. Given the intermediation function of banks, the duration of assets is invariably longer than that of liabilities, a large part of which would be deposits. Thus, a bank holding large amounts of long-dated bonds would have a disproportionately large asset side duration and. accordingly, a large duration gap, making it highly susceptible to even small interest rate rises.

The impact of leverage on financial market stability and the relationship with the real economy is a key concern among researchers. This paper makes an initial attempt to investigate the relationship between a firm's leverage, return and share price volatility from an Islamic finance perspective and capital structure theory. A multicountry dynamic panel framework and the mean-variance efficient frontier are applied to 320 sample firms from eight European countries, divided into portfolios of low and high debt using the shari'ah screening threshold of 33%. We find that the firm's return and volatility change with changes in the capital structure. Islamic compliant stocks show, in most cases, less volatility than non-compliant stocks but are no different in terms of return. Finally, our results tend to imply a case for limiting debt beyond certain levels.

The risk sharing principles of Islamic finance as embodied in mudarabah and musharakah contracts have been extensively used throughout history. For example, the maritime trades of 14th century Italian city-states with Middle East and Asia were financed by ‘sea loans' and ‘commenda’. Historians have traced the development of commenda to borrowing from the concept of mudarabah used by Muslims (Udovitch, 1962; 1967; 1970; Mirakhor, 2003). They have also recorded how crucially important these contracts were to the growth of not only the maritime trade but also to the economic, social and political progress of European city-states.

The issue of liquidity and underdevelopment of the Organisation of Islamic Cooperation (OIC) stock markets has caused problems to companies in those countries that seek higher equity capital. One way out of this problem is to employ international markets more intensively by seeking cheaper cost of capital through Depositary Receipts (DRs). Many studies on DRs focused on emerging and developed countries, leaving many OIC countries behind. Thus, this study investigates the financial implication by examining the integration of returns of local and foreign stock markets via American Depositary Receipts (ADRs) and Global Depositary Receipts (GDRs) of OIC countries. Techniques employed in this study are cointegration and the speed of adjustments to examine the existence of integration between the local and foreign stock markets. The study covers a sample of 146 firms from 17 OIC countries that are cross-listed as ADRs or GDRs from 1992 to 2011. The findings show mixed results when some markets provide evidence of integration while others show evidence of segmentation. The study on the integration between DR and home equity markets has practical implications for both the international as well as domestic investors especially on portfolio selection, asset pricing and risk management

This chapter examines risk management issues in Islamic banking and finance (IBF). It describes the current state of affairs, the available risk management tools and prescribes possible solutions where there are no risk management tools currently. It focuses on four key areas within IBF. These are: (1) net worth/profit rate risk of Islamic banks; (2) risks associated with sukuk portfolios; (3) equity risks of Islamic mutual funds; and (4) exchange rate risks of Shari'ah-compliant business entities.

This study is an empirical investigation of the pricing efficiency of Malaysia’s interest rate futures contract, the 3-month Kuala Lumpur Interbank Offered Rates (KLIBOR) futures contract. This article also examines several issues related to pricing efficiency. The study spans the contract’s entire 10-year history, June 1996 to June 2006. In line with findings in other markets, we find a pre-ponderance of overpricing. Almost 80% of the mispricing constituted overpricing of the futures contract. Mean overpricing was 8 basis points. Our results lend support to the hypothesis that there may be a ‘Futures Habitat Premium’. Underpricing, though less frequent was of a larger magnitude and had higher volatility. Even after adjusting for brokerage costs, most of the price deviations were arbitrageable. We find the extent of mispricing to be dependent on the trend and volatility of the underlying rate. Analysis of the impact of switch in Central Bank target policy rate, away from the underlying asset of the futures contract, showed higher pricing deviation post switch. Our examination of the interest rate announcement effect showed the spot market to be more responsive and faster in reaction than the futures market. The magnitude of reaction to rate cuts appears to be different at different interest rate levels.

Capital markets play a very important role in modern economies. Being a part of the financial sector, which they share with the banking system, capital markets have become the focus of many a governments' development plans. Most developing countries' financial sector tends to be dominated by the banking system. As countries develop, capital markets begin to take on a bigger role...