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Fatwas & Finance: Impact of Islamic Religious Rulings on Growth of Fixed

Capital Investment

Azizjon AzimiDepartment of Economics

Advisors: Professor Kevin Thom & Professor Christopher Flinn New York University

Spring 2016

AbstractIslamic finance has recently come at the forefront of scholarly research in economics due to its rapid rates of growth globally. While most studies in the literature have focused on comparative analyses of Islamic financial institutions vis-à-vis conventional banks, much remains unknown in the domain of correlation between Islamic finance and macroeconomic conditions. A cross-national time-series analysis covering 15 countries from 1985 to 2010, this research employs OLS regressions to examine the impact of different types of fatwas (i.e. Islamic religious rulings) on growth of gross fixed capital investment. Over a thousand fatwa resolutions extracted through data mining techniques and textual analyses were classified and coded over a span of several months. As a result, robust results demonstrated that legal fatwas lead to an increase while financial fatwas lead to a decrease in gross fixed capital investment. Concurrently, significance is found for interaction terms involving the percentage of Muslim population, whereby financial fatwas have a negative effect and legal fatwas have a positive effect on investment in countries where Muslims constitute less than 70% of the population.

This paper, along with relevant data files, can be accessed at: https://wp.nyu.edu/azimi_economics_thesis

https://wp.nyu.edu/azimi_economics_thesis

TABLE OF CONTENTS

ACKNOWLEDGEMENTS 3

1. INTRODUCTION 4

2. LITERATURE REVIEW 6

3. THEORERTICAL FRAMEWORK & RESEARCH DESIGN 11

4. RESULTS 19

5. CONCLUSION 24

BIBLIOGRAPHY 25

APPENDIX A 27

APPENDIX B 28

APPENDIX C 29

APPENDIX D 30

APPENDIX E 31

APPENDIX F 32



Acknowledgements

First and foremost, I would like to express sincere gratitude to Professor Kevin Thom and Professor Christopher Flinn for their guidance, feedback, and support throughout this research project. I would like to also thank the Economics Department at New York University for providing me with the educational resources to conduct research in the field of Islamic finance. In addition, I would like to heartily acknowledge the Islamic Shariah Research Academy located in Malaysia for collection of immensely useful data that was used extensively in this research. Last but not least, I would like to thank my parents, Azimjon Gafurov and Rafoat Gafurova, for endowing me with the opportunity to pursue my research interests in the United States, and my sisters, Gulnora Gafurova and Gulsara Gafurova, for their utmost love and support throughout the past months.



Introduction

The role of institutions in shaping economic outcomes has been debated in the

scholarly economic literature for decades. Acemoglu, Johnson and Robinson had argued

that different types of institutions have varying effects on income levels, which in their

turn pave the way for a path-dependent trajectory (2001). As a matter of policy, plenitude

of research has been conducted on the issue of economic diversification and institutional

measures that promote it. Diversification has been identified as a priority on the political

agenda of the Organization of Islamic Cooperation (OIC) – global intergovernmental

political and economic union between Muslim-majority states. These states had

experienced unprecedented levels of economic growth thanks to the discovery of oil in

the Gulf Cooperation Council (GCC) region in the 1950s and tremendous rises in oil

prices during the 1970s and throughout the 2000s. Subsequently, GCC states have

emerged as some of the wealthiest countries in the world by GDP per capita as of 2015,

with Qatar leading the world in this metric.

Nevertheless, the chronic issue of systemic overdependence on the hydrocarbon

sector (oil & gas) for both GDP growth and government revenue has been endemic for all

countries in the OIC. For instance, the IMF estimated that the total share of the

hydrocarbon sector in the GCC countries was 51% in 2010 (Hassan & Dridi 2010).

Although this figured demonstrated significant improvement from 1990, when it stood at

61%, and 2000, when it was 59%, much of the non-hydrocarbon sector growth took place

in the services sector – partly reflecting greater spending on non-tradable goods made

possible by higher oil revenues. Furthermore, in the period of 2000-2009, fiscal

dependency on hydrocarbons continued increasing and constituted 90% of government



revenue and 80% of export of GCC member states by 2009. Thus, due to slow pace of

economic diversification from expansion of services sector, the GCC member states have

identified the growth of non-hydrocarbon industry – particularly, the manufacturing

sector – as a new avenue for diversification. This has led to substantial investments in

infrastructure – both public and private – in the form of land improvements, equipment

purchases and machinery renovations, construction of roads, railways and the like,

causing an increase in gross fixed capital investment.

An instrumental role in investment growth has been allocated to Islamic financial

institutions. Revolving around the principle of asset-backed finance, Islamic banks are in

theory expected to positively contribute to a country’s capital stock through provision of

loans to infrastructural projects. As such, Islamic banks are mandated to institute Shariah

Supervisory Boards (SSBs) consisting of religious experts hired to validate permissibility

of their operations and compliance with norms of Islamic law. In their turn, these Shariah

boards often base their decisions on precedents established by internationally recognized

authoritative institutions engaged in Islamic finance. One of the largest obstacles in

conducting research on the role of such institutions has been a persistent lack of reliable

data on Islamic finance at-large. The main contribution of this research is the compilation

of a comprehensive data set on two types of Islamic religious rulings – financial and legal

– over a span of 25 years. Utilizing this data set, I examine the impact that financial and

legal fatwas have on investment by segmenting fatwas from three important Islamic

finance institutions – OIC’s Islamic Fiqh Academy, Malaysia’s Central Bank and the

Auditing & Accounting Organization for Islamic Financial Institutions. Moreover, I take

into account countries with varying levels of Muslim population – from European nations



such as the United Kingdom and Switzerland with lower percentages of Muslim

population, to Muslim-majority states such as Saudi Arabia and Turkey.

Literature Review & Theoretical Framework

The literature on Islamic finance has come largely from multilateral financial

institutions such as the International Monetary Fund (IMF) and the Islamic Development

Bank (IDB). Researchers at the IMF have cited three crucial factors that have contributed

to the recent governmental promotion of investment through Islamic banking across the

GCC member states: finite income from hydrocarbons in light of limited reserves that are

due to run out over the next few decades, high volatility in price fluctuation – especially

given the 50% drop in oil prices since mid-2014, and sectorial overdependence on the

hydrocarbon industry (Callen et. al. 2014). The role of governmental incentives in the

form of tax subsidies and looser monetary regulations have been cited as major drivers of

asset growth for Islamic financial institutions across the world. At the same time, GCC

states have identified the Islamic private sector-driven growth in industrial and

construction sectors as viable options for diversification due to vast share of state-run and

state–tied institutions already present in the services sector (Kammer et. al. 2015).

Since 1990, the total volume of Islamic financial assets has steadily grown by 15-

20% annually, and now surpasses the $2 trillion mark according to the Al Huda Centre of

Islamic Banking and Economics (2014). Moreover – during the recent financial crisis, the

sector of Islamic finance had tripled and expanded more rapidly than the conventional

financial sector in all market areas ranging from insurance (i.e. takaful) to investment

banking (i.e. mudarabah) across the Islamic world. In the meantime, the limited use of

derivatives and other securitized structures by the vast majority of Islamic financial



institutions has led to substantially higher capital adequacy ratios than in most

conventional banks. Thus, minimal leverage ratios generated from risk-sharing and

speculation-free parameters have placed Islamic banks on an advantageous position in

regards to the Basel III requirements (Kara 2011).

Estimates of Global Assets in Islamic Finance

Due to emerging global support for principles of Basel III, it is not surprising that

there has been a concurrent surge in demand for Islamic financial products in the West.

Islamic sukuks – which are Sharia-compliant bonds – issued by major financial

institutions such as the IDB have been consistently ranked as AAA because of their

prudent risk management nature by credit rating agencies (Moody’s 2013). The trend has

caught the eye of the British government, which became the first non-Muslim country to

issue £200 million of five-year Islamic sukuks with marketing assistance from major



European and Middle Eastern banks in 2014 (Moore & Hale 2014). Islamic finance has

also been on the rise in Switzerland, with six Islamic banks operating in the country

according to the Global Banking & Finance Review (2010).

Several factors have been identified as pivoting Islamic banks to the role of chief

investment sources for governments across the world and safeguarding them from the ills

of the global financial crisis. On the demand side, the robust demand for industrial and

infrastructural project finance from the private sector in the GCC due to state dominance

in hydrocarbon and service sectors has placed Islamic banking at the forefront of

investment (Maierbrugger 2016). Increased funding of Islamic financial institutions by

Gulf sovereign wealth funds and state corporations that has stirred greater supply of

liquidity in the market of Islamic finance has demonstrated the growing link of this

demand-supply model, leading to a positive link between Islamic loans and growth of

investment. In addition, the rising presence of Islamic developmental institutions such as

the Islamic Developmental Bank and the Islamic Corporation for the Development of the

Private Sector in the market for medium- and long-term project finance is another vital

element that positively contributes to the growth of non-hydrocarbon sector in the OIC.

At this point, it is crucial to discuss the differentiation of Islamic finance from

conventional banking. The main distinction lies in the application of and adherence to

Islamic religious law – known as Sharia – by all Islamic financial institutions. The most

prominent feature of Sharia finance is the banning of usury in all forms and provision of

interest-free loans with permissibility of mark-up and commission charges by the

provider (El-Gamal 2001). Sharia law also imposes a strict ban on speculative and

excessively risky (i.e. gharar) operations such as securitization of subprime lending,



short-selling, and credit-default swaps, which have been among the major catalysts of

financial stress in conventional banks. For instance, AIG’s bankruptcy resulting from

incongruence in the high amount of credit-default swaps that it had undertaken and the

minimal volume of assets stands out as a prime example of such failure that Islamic

banks have largely avoided due to lesser composition of toxic portfolio investments.

Islamic financial institutions also differ in their corporate governance and

compliance structures from conventional banks. Special review boards – called Shariah

Supervisory Boards (SSBs) – that are composed of religious scholars exist to ensure

compliance of Islamic financial institutions with Shariah procedures and regulations (El-

Gamal 2006). Hence, each Islamic financial institution incorporates these boards as an

integral part of internal governance structure. These boards are expected to issue

adequate rulings on matters of bank’s operation, ranging from permission of institutional

engagement in issuance of a complex financial instrument to norms governing gender

interactions within banks. In some OIC member states, authorities have established

oversight mechanisms including state-run Shariah boards and Islamic banking divisions

within governing supervisory agencies that regulate the operation of individual bank

SSBs. As such, the Governor of the Bahrain Monetary Agency emphasized the role of

SSBs by noting that “Islamic banks have grown primarily by providing services to a

captive market, people who will only deal with a financial institution that strictly adhered

to Islamic principles” (Grais 2006).

Over the years, the general trend followed by the OIC has been toward

standardization of SSBs’ regulatory mechanisms through issuance of consensus-based

fatwas that serve as precedents for individual bank SSB decisions and rulings (Oxford



Analytica 2010). As such, the International Islamic Fiqh Academy launched under the

auspices of OIC was tasked with issuing fatwas on questions submitted by OIC’s member

states regarding economic, financial, social and legal matters. Since then, the Academy

has issued several hundred fatwas that have had a substantial impact on the work of

Islamic financial institutions. These fatwas have been also instrumental in defining the

normative aspects of regulation and legal procedures toward Islamic banks in OIC

member states.

In terms of investment allocation, Islamic banks have been found to have a

concentrated base of assets, focusing on select sectors and avoiding direct competition

with conventional financial institutions. Historically, Islamic banks have specialized in

financing the agricultural, construction, and microfinance sectors. This practice has made

Islamic banks vulnerable to cyclical shocks in particular sectors, as had been

demonstrated by sectorial and seasonal downfalls of Islamic banks in Jordan, UAE, and

Tunisia over the past decades as was found by Iqbal’s study (2008). Aggarwal & Yousef

examine investment behavior of Islamic banks worldwide and compare the share of

Islamic profit-and-loss sharing financial instruments vis-à-vis conventional markup

instruments (2000). They conclude that Islamic banks allocate less funds to long-term

productive projects as well as less investment financing in agricultural and industrial

sectors. Data collected from the International Association of Islamic Banks and annual

reports by Islamic banks that covered three GCC member states also showed that Islamic

banks prioritized short-term micro-finance loans in their portfolios due to higher markup

rates, resembling investments made by conventional financial institutions.



The effects of bank metrics such as capital-to-asset and loan-to-asset ratios, as

well as the financial environment in the form of macroeconomic performance and

governmental involvement in the economy on the performance of Islamic banks were

analyzed by Bashir (2003). Regression results showed higher profitability in Islamic

banks with substantial government shares in them, as well as positive correlation between

favorable macroeconomic conditions (i.e. higher GDP per capita and lower inflation) and

Islamic bank performance with data compiled on Saudi Arabia and the UAE. Another

IMF-sponsored study on Islamic finance in the GCC found higher profitability in Islamic

banks with substantial government shares in them, as well as positive correlation between

favorable macroeconomic conditions (higher GDP per capita and lower inflation) and

Islamic bank performance. Furthermore, a study of post-crisis performance of Islamic

banks vis-à-vis conventional banks concluded that higher capital adequacy ratios were

found to have strong positive correlation with higher asset growth, while higher

investment portfolio and leverage (assets to capital) negatively impacted profitability –

all leading to the conclusion that Islamic banks fared substantially better than

conventional banks due to their principles of operation. The panel data that covered GCC

states as well as Turkey, Jordan, and Malaysia resulted in Islamic bank dummy being

significant, reflecting the robust market demand for Islamic financial products in test

countries in the period after the financial crisis.

Theoretical Framework & Research Design

As evident, much of existing literature has focused on comparative studies of

Islamic financial institutions vis-à-vis conventional banks. This research employs



ordinary least squares (OLS) regression models to investigate the impact of fatwas on

countries’ fixed capital investment while controlling for a number of key macroeconomic

and demographic variables. Textual analysis of hundreds of financial fatwas conducted as

part of the research showed that over the years, the issued financial fatwas dealt with both

permissibility and impermissibility of various financial and economic activities without a

specific trend toward liberalization. Majority of these fatwas were concerned with

financial instruments (i.e. tawarruq, sukuk, musharaka, etc.) and other tools within the

financial sector. Based on Aggarwal & Yousef’s finding that Islamic banks allocate less

funds to long-term productive projects in the industrial sector, I contend that financial

fatwas have led to a decrease in fixed capital investment. The baseline suggestion of this

argument is that Islamic banks favor provision of loans in the services and financial

sectors over provision of loans to infrastructural or industrial projects, which decreases

the amount of available investment into fixed capital assets and infrastructure. Hence, the

following is the first hypothesis:

Hypothesis I: Issuance of financial fatwas leads to a decrease in gross fixed capital

investment.

On the other hand, analysis of legal fatwas showed a trend of liberalization of

regulatory standards in the Islamic financial industry. As legal procedures became more

defined and incrementally loosened to accommodate vitality of the industry, Islamic

financial institutions were able to increase the scope of their financial operation, both in

terms of engagement in issuance of financial instruments and direct funding of projects.



For instance, a number of legal fatwas over the years established and furthered legal

regulations of Islamic project finance through definition of standards governing the

istisnaa – ijara and wakala – ijara contracts that have been crucial in project finance

investment. Subsequently, it can be inferred that there is a positive link between the

furthering of Islamic project finance and growth of fixed capital investment in a country

as long term financing of infrastructural and industrial projects involves investment in

plant, machinery, equipment, and land, among other factors that constitute fixed capital.

Hence the following is the second hypothesis:

Hypothesis II: Issuance of legal fatwas leads to an increase in gross fixed capital

investment.

At the same time, it is crucial to distinguish the impact that financial and legal

fatwas might have on fixed capital investment based on varying percentage of Muslim

populations in different countries. This is especially pertinent in light of the rapid rise of

Islamic finance in western countries where Muslims are a minority. I put forward the

following hypotheses based on an assumption that fatwas will have the greatest impact in

countries with largest percentages of Muslim population:

Hypothesis III: Financial fatwas will have a negative impact on gross fixed

capital investment in countries with larger Muslim populations.



Hypothesis IV: Legal fatwas will have a positive impact on gross fixed capital

investment in countries with larger Muslim populations.

Given the persistent lack of data on Islamic financial metrics and rulings, I

engaged in data mining on the world’s largest database of fatwas – Islamic Shariah

Research Academy’s IFIKR database. As a result of months-long analytical research, I

was able to create a new data set covering 1,160 resolutions as part of fatwas issued by

international and governmental authorities on Islamic finance. The remaining

macroeconomic and demographic data was extracted from World Bank’s World

Development Indicators, while the data on percentage of Muslim population estimates

was taken from a comprehensive study published in the International Journal of

Environmental Science and Development. A fatwa was coded as financial if it dealt with

financial and economic matters, while legal fatwas were defined as rulings dealing with

regulatory and governmental aspects of Islamic finance. The following three international

or governmental issuers of fatwas were studied in the research through the IFIKR

database:

o Accounting and Auditing Organization for Islamic Financial Institutions

(AAOIFI) is an international autonomous non-profit corporate body

headquartered in Bahrain that was established in 1990. Supported by the

Islamic Development Bank, the organization comprises over 200 largest

Islamic financial institutions and central banks from 45 countries. Rulings

and standards issued by the organization have had a tremendous impact

on the Islamic financial industry globally, having been codified as



national banking standards in Bahrain, United Arab Emirates, Jordan,

Lebanon, Qatar, Sudan and Syria. Furthermore, AAOIFI’s rulings have

been legally applied by financial authorities in Australia, Indonesia,

Malaysia, Pakistan, Saudi Arabia and South Africa.

o Organization of Islamic Cooperation’s International Islamic Fiqh

Academy was established in Jeddah, Saudi Arabia in 1981. The Academy

is the most authoritative source of religious rulings in the Islamic world.

Its rulings are adopted based on the consensus of Shariah scholars from

across the OIC’s 57 member states and carry a non-binding status.

Despite the non-binding nature of the Academy’s rulings, they have been

vital in furthering the research on Islamic finance through authorization

and funding of studies on financial, social, cultural and economic topics.

o Central Bank of Malaysia (Bank Negara): global center for the growth

and development of Islamic finance over the past three decades, Malaysia

has been instrumental in implementation of innovative Islamic financial

instruments since the 1980s. As such, the country’s central bank

established a Sharia council that today consists of some of the most

prominent Shariah experts globally in 1998. The council is tasked with

reviewing queries from the country’s Islamic finance sector and issuing

substantive resolutions with legally enforceable status. Given Malaysia’s

pivotal role in the global sector of Islamic finance, taking into account



Bank Negara’s fatwas provides an important insight into the impact of

religious rulings on growth of investment in non-GCC countries.

The countries studied in this research include 15 countries with the largest Islamic

financial industries in the 1985-2010 period, with the exclusion of Iran. This was

intentionally done in order to avoid delving into the Sunni-Shia divide aspect as the fatwa

sources taken into account in this research operate under the Sunni interpretation of

Islamic law. Furthermore, a detailed taxonomy and descriptive statistics of all variables

and list of countries are provided in the appendix. The following is a breakdown of

dependent and independent variables:

Dependent Variable: Gross Fixed Capital Formation

o Formerly gross domestic fixed investment, this World Bank metric quantitatively

measures land improvements (fences, ditches, drains, and so on); plant,

machinery, and equipment purchases; and the construction of roads, railways, and

the like, including schools, offices, hospitals, private residential dwellings, and

commercial and industrial buildings. According to the 1993 SNA, net acquisitions

of valuables are also considered capital formation.

Independent Variable: Financial Fatwas

o Measures the number of financial fatwas issued either by OIC’s Fiqh Academy,

AAOIFI, or Central Bank of Malaysia in a given year. The variable is lagged by

one year in regression specifications in order to account for implementation of or



industry reaction to fatwas’ resolutions. Histogram of frequency distribution

follows a normal distribution and can be found in the appendix. The following is

an example of a financial fatwa containing one resolution:

The SAC, in its 4th meeting dated 14 February 1998, 95th meeting dated 28 January

2010 and 101st meeting dated 20 May 2010, has resolved that the late payment charge

imposed by an Islamic financial institution encompassing both concepts

of gharamah (fine or penalty) and ta`widh (compensation) is permissible (Source:

Central Bank of Malaysia)

Independent Variable: Legal Fatwas

o Measures the number of legal fatwas issued either by OIC’s Fiqh Academy,

AAOIFI or Central Bank of Malaysia in a given year. The variable is lagged by

one year in regression specifications in order account for implementation of or

industry reaction to fatwas’ resolutions. Histogram of frequency distribution

follows a normal distribution and can be found in the appendix The following is

an example of a legal fatwa containing one resolution:

The Council of the Islamic Fiqh Academy of the Organization of the Islamic

Conference in its Twelfth Session held in Riyadh (Kingdom of Saudi Arabia) during the

period from the 25th of Jumad Thani to 1st of Rajab 1421 H (23 — 28/9/2000), decides

the following: The Court may, if so required by one of the two parties, adjust the amount

of the compensation (as per the contract’s Penalty Provision), subject to a reasonable



justification, or when the compensation proves to be exaggerated. (Source: OIC’s Islamic

Fiqh Academy)

In order to adequately test the robustness of these hypotheses, I employed six

distinct OLS regression specifications, with and without country fixed effects and

clusters, and using a variety of control variables that have been previously employed in

the literature on investment. Four of the models involve individual specifications, while

models 5 & 6 are interaction models. The following are the regression specifications:

Model 1 (OLS):

INVESTMENTit = + 1FINANCIALit + 2LEGALit + 3POPULATIONit +

4DOMESTIC_CREDITit + 5AGRICULTUREit + 6GNIit + 7CURRENT_ACCOUNTit

+ 8CONSUMPTIONit +¿it

Model 2 (OLS):

INVESTMENTit = + 1FINANCIALit + 2LEGALit + 3INDUSTRYit +

4CURRENT_ACCOUNTit + 5AGRICULTUREit + 6GNIit + 7INVENTORYit + 8CPIit

+¿ 9FDIit+¿it

Model 3 (OLS):

INVESTMENTit = + 1FINANCIALit + 2LEGALit + 3MUSLIMit + 4GNIit +

5CONSUMPTIONit + 6CPIit + 7FDIit + 8DOMESTIC_CREDITit + 9EXPORTSit+¿

10INVENTORYit +FE (country ¿)+¿it

Model 4 (OLS):



INVESTMENTit = + 1FINANCIALit + 2LEGALit + 3MUSLIMit +

4CURRENT_ACCOUNTit + 5AGRICULTUREit + 6DOMESTIC_CREDITit +

7EXPORTSi + FE (country¿ )t+¿it

Model 5 (OLS):

INVESTMENTit = + 1FINANCIALit + 2LEGALit + 3(FINANCIAL x MUSLIM)it +

4(LEGAL x MUSLIM)it + 5CURRENT_ACCOUNTit + 6EXPORTSit +¿it

Model 6 (OLS):

INVESTMENTit = + 1FINANCIALit + 2LEGALit + 3(FINANCIAL x MUSLIM)it +

4(LEGAL x MUSLIM)it + 5POPULATIONit + 6DOMESTIC_CREDITit + 7EXPORTSit

+8GNIit + FE (country¿ )+¿it

Results:

Regression results demonstrate strong statistical significance of all of these

models. The addition of country fixed effects in models 3, 4 & 6 did not diminish their

statistical significance, which attests to the robustness of results. Analyzing the

independent variables, we observe that financial fatwa variable has a negative coefficient

and is statistically significant at 1% across all models. Thus, it can be concluded that the

first hypothesis is correct and Aggarwal & Yousef’s finding can be reinforced.

Table of Results

Variable: Model 1 Model 2 Model 3 Model 4

Model 5

(Interaction)

Model 6

(Interaction)

Financial -9.65 x 107 *** -1.85 x 108 *** -8.37 x 107 *** -1.10 x 108 *** -8.32 x 108 *** -2.69 x 108 **

Legal 5.30 x 107 * 1.02 x 108 *** 3.53 x 107 * 7.31 x 107 *** 6.26 x 108 *** 2.18 x 108 **This paper, along with relevant data files, can be accessed at:



Financial x Muslim 9.9 x 106 *** 2.6 x 106 *

Legal x Muslim -7.7 x 106 *** -2.3 x 106 *

Muslim -4.47 x 108 3.68 x 108 -1.65 x 108 *** -1.16 x 109

Population 10.58 290.6

Industry 0.16

GNI 0.6 *** 0.14 *** 0.53 *** 0.15***

Consumption -0.52 *** -0.39 ***

CPI 7.54 x 107 1.62 x 108 ***

FDI 0.087 ** 0.07

Current Account -0.51 *** 0.067 -0.26 ** -0.83 ***

Exports -0.16 * -0.019 0.61*** 0.08**

Domestic Credit 1.03 x 108 *** -2.76 x 107 -5.42 x 107 -1.03 x 108

Agriculture 0.46 *** 0.36 * 0.17

Inventory -0.027 -0.17 0.15

Observations 236 211 306 211 283 338

Countries 15 15 15 15 15 15

R2 0.99 0.99 0.99 0.99 0.95 0.99

Country FE

Country Cluster

*p ≤ 0.10 **p ≤ 0.05 ***p ≤ 0.001

This finding provides basis for the argument that Islamic banks tend to prefer

non-industrial financing that negatively impacts the growth of fixed capital investment in



a given country. As such, it can be inferred that issuance of financial fatwas has furthered

Islamic banks’ provision of loans in the services and financial sectors as opposed to

project financing, which has decreased the availability of financing for loans that would

have increased fixed capital investments. According to regression model 1, issuance of an

additional financial fatwa leads to a cumulative decrease of $96.5 million in fixed capital

investment. Results from remaining non-interaction models (1-4) provide a range of

estimates from $83.7 million to $185 million in decrease in gross fixed capital investment

from additional financial fatwas.

Examining the legal fatwa variable, we can conclude that the second hypothesis is

also correct and can be accepted. As such, we can observe that issuance of legal fatwas

leads to a substantial increase in fixed capital investment across all models. This can be

explained by the fact that the vast majority of legal fatwas dealt with substantive

liberalization of laws and regulations on Islamic finance, allowing for an increase in

variety of Islamic financial activity that incorporated industrial and infrastructural

financing. As such, this comes in contrast with financial fatwas that mostly focused on

innovation within the domain of financial instruments geared toward non-industrial

financing. The magnitude of growth in gross fixed capital investment from each

additional legal fatwa ranges from $53 million to $102 million across models 1-4.

Concurrently, we observe strong significance for financial and legal fatwa

variables, as well as the two interaction terms, in interaction models 5 & 6. This paves the

way for a conclusion that a joint effect of fatwa type and percentage of Muslim

population has a statistically significant impact on the growth of gross fixed capital



investment in countries included as part of this research. In order to properly interpret the

interaction coefficients, we ought to examine the average marginal effects graphs:

Marginal Effects Graphs from Model 5

As such, the marginal effects graphs from model 5 demonstrate that financial

fatwas (on the left) have a negative effect on investment in countries with less than 70%

Muslim population. On the other hand, legal fatwas (on the right) have a positive impact

on investment in countries with less than 70% Muslim population. The graphs also

demonstrate that results for both variables in the interaction terms are insignificant when

percentage of Muslim population is greater than 70%, which disproves hypotheses 3 and

4. To further test this conclusion, we can examine marginal effects from model 6:

Marginal Effects Graphs from Model 6



As evident, these graphs reinforce the aforementioned notion that the threshold

for significance of interaction terms is Muslim population percentage below 70%. The

three countries with such metric are Malaysia, Switzerland and the United Kingdom. In

the case of Malaysia, it can be speculated that the large statistical significance stems from

the fact that over half of analyzed fatwas were issued by the Central Bank of Malaysia

and had a disproportionate effect on macroeconomic conditions within the country in

comparison to other states. As for Switzerland and the UK, one can argue that because

the Muslim populations in these countries are minorities that constitute less than 5% of

the total population, the statistical significance of these two countries is rather an example

of correlation than causation. Nevertheless, it can be inferred that because both countries

are non-member states of the OIC, regulators and Islamic financial institutions alike have

more closely followed the rulings issued by authoritative entities included in this

research, producing a disproportionate impact on fixed capital investment.

Furthermore, we observe strong statistical significance of several macroeconomic

control variables, which is in line with findings in the literature. Model 1 postulates that a

rise in either gross national income, domestic credit-to-private sector ratio, or value-

added agriculture leads to an increase in gross fixed capital investment, while a rise in

current account balance and general government and household consumption leads to a

decrease. The latter two phenomenon can be explained by the fact that a rise in

consumption or in current account imbalances depletes availability of funds for fixed

capital investment. Models 2, 3 & 6 also stipulate that gross national income is positively

correlated with investment. Additionally, foreign direct investment is found to be

significant and positive in model 2, consumer price index is found to be significant and



positive in model 3, and consumption is found to be significant and negative in model 3.

It is worthy to note that all models have an R2 of nearly 0.99, meaning that independent

variables explain almost 99% of variation in the dependent variables across th models.

Conclusion:

This research adds a new dynamic to the discussion of Islamic finance and

macroeconomic conditions by examining the impact of financial and legal fatwas as well

as interaction terms. Having created a comprehensive data set that includes over a

thousand resolutions extracted and textually analyzed from hundreds of fatwas, strong

statistical significance for the hypotheses and control variables is found as a result. While

the first two hypotheses are fully accepted, the latter two are found to be statistically

significant in the opposite direction. Financial fatwas are found to decrease gross fixed

capital investment due to their promotion of loan provision to non-industrial sectors

which impedes the availability of capital investment funds. On the other hand, legal

fatwas are found to increase capital investment by widening the scope of Islamic banks’

operations in project financing on a regulatory basis. Concurrently, it was found that

financial fatwas have a negative impact and legal fatwas have a positive impact on capital

investment when Muslim population percentage is below 70%, which was the case in

three countries within the data set: Malaysia, Switzerland and the UK. Further research

can be conducted on these robust results, specifically in the dimension of interaction

between other economic and demographic variables including percentage of Islamic

banking sector as a total share of country’s financial industry, impact of differentiation

between Sunni and Shia doctrines within the domain of fatwas, and others.



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Appendix A: Table of Descriptive Statistics

Variable Observations Mean St. Dev. Min. Max.

Investment 361 4.68 x 1010 8.24 x 1010 7.16 x 108 5.56 x 1011

Financial 375 27.32 19.95 0 67

Muslim % 390 76.73 30.51 1.41 98.43

Legal 375 19.48 19.06 0 60

Population 387 4.84 x 107 6 x 107 3.7 x 105 2.42 x 108

GNI 365 2.22 x 1011 4.39 x 1011 2.74 x 109 3 x 1012

Consumption 362 1.72 x 1011 3.65 x 1011 1.82 x 109 2.48 x 1012

CPI 364 61.04 27.13 0.0079 107.72

FDI 390 6.94 x 109 2.59 x 1010 -4.55 x 109 2.53 x 1011

Industry 322 7.1 x 1010 1.06 x 1011 9.43 x 108 6.02 x 1011

Agriculture 322 1.2 x 1010 1.35 x 1010 4.02 x 107 1.05 x 1011

Current Account 298 2.20 x 109 2.3 x 1010 -1.01 x 1011 1.32 x 1011

Exports 362 7.47 x 1010 1.23 x 1011 1.13 x 109 7.74 x 1011

Domestic Credit % 286 54.1 42.8 6.48 200.6

Inventory 330 1.24 x 109 4.47 x 109 -1.98 x 1010 3.29 x 1010



Appendix B – Taxonomy of Variables

Variable Measure Unit

Investment Gross fixed capital formation (formerly gross domestic fixed investment) includes land improvements (fences, ditches, drains, and so on); plant, machinery, and equipment

purchases; and the construction of roads, railways, and the like, including schools, offices, hospitals, private residential dwellings, and commercial and industrial buildings.

Current US Dollars

Financial Frequency of financial fatwas. Frequency

Muslim % Percentage estimate of total population identifying themselves as followers of Islam. Percentage

Legal Frequency of legal fatwas. Frequency

Population Total population is based on the de facto definition of population, which counts all residents regardless of legal status or citizenship – except for refugees not permanently settled in the country of asylum, who are generally considered part of the population of their country of

originNumerical

GNI Total value of currently produced final goods and services produced by the domestic economy of a country, measured within a given period of time

Current US Dollars

Consumption Sum of private and general government consumption expenditures. Current US Dollars

CPI Changes in the cost to the average consumer of acquiring a basket of goods and services that may be fixed or changed at specified intervals

Laspeyres formula

FDI Sum of equity capital, reinvestment of earnings, and other capital Current US Dollars

Current Account

Sum of net exports of goods and services, net primary income, and net secondary income Current US Dollars

Exports Goods, services and primary income is the sum of goods exports, service exports and primary income receipts.

Current US Dollars

Industry Value added in mining, manufacturing, construction, electricity, water, and gas. Current US Dollars

Agriculture Value added in forestry, hunting, and fishing, as well as cultivation of crops and livestock production.

Current US Dollars

Domestic Credit %

Financial resources provided to the private sector by financial corporations, such as through loans, purchases of non-equity securities, and trade credits and other accounts receivable, that

establish a claim for repayment.

Percentage of GDP

Inventory Stocks of goods held by firms to meet temporary or unexpected fluctuations in production or Current US



sales, and work in progress. Dollars

Appendix C – List of Countries

Country: Year:

Bahrain 1985 – 2010

Bangladesh 1985 – 2010

Egypt 1985 – 2010

Indonesia 1985 – 2010

Jordan 1985 – 2010

Kuwait 1985 – 2010

Malaysia 1985 – 2010

Pakistan 1985 – 2010

Qatar 1985 – 2010

Saudi Arabia 1985 – 2010

Switzerland 1985 – 2010

Syria 1985 – 2010

Turkey 1985 – 2010

United Arab Emirates 1985 – 2010

United Kingdom 1985 – 2010



Appendix D – Histograms of Financial & Legal Fatwas



Appendix E – Average Marginal Effects (Model 5)



Appendix F – Average Marginal Effects (Model 6)



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