Aurora Borealis
1 August 2014 CFA Institute Journal Review

On Sharia’a-Compliance, Positive Assortative Matching, and Return to Investment Banking (Digest Summary)

  1. Marc L. Ross, CFA

Islamic banks’ financial performance often lags that of their non-Sharia’a-compliant competitors. The authors investigate why, focusing on the practice of assortative matching in the hiring process, which tends to place less competent employees in Sharia’a-compliant financial institutions.

What’s Inside?

The authors argue that the limited opportunity set of Sharia’a-compliant investment strategies could work to an investor’s advantage in certain circumstances. But any possible disadvantages that such restrictions may impose tend to be magnified by hiring practices that historically place less skilled employees at banks that are in compliance with Sharia’a law.

How Is This Research Useful to Practitioners?

Islamic finance makes use of a limited opportunity set. Although the exclusion of certain types of investments potentially limits competitive advantage, it may also avoid certain risks. More than their Western counterparts, however, Sharia’a-compliant banks face the challenge of finding and retaining highly skilled professionals. It is this challenge that puts such institutions at a greater competitive disadvantage.

The authors illustrate how the practice of assortative matching, or nonrandom pairing (meaning the selection by employers of employees with a lower level of skill), in the hiring process tends to exacerbate the small competitive disadvantage that institutions face that are practicing Islamic finance. Attracting and keeping finance professionals who can deliver competitive results while adhering to Sharia’a law should be the goal, yet it has proven to be an elusive one. Compensation appears to be a key issue. The authors argue that Sharia’a-compliant institutions should attract Sharia’a-compliant individuals. Their discussion is nonetheless descriptive rather than prescriptive.

Students and practitioners of Islamic finance as well as policymakers and financial regulators in Islamic countries would do well to understand the challenges that the authors identify in their analysis. Although some may argue that there is lesser significance of staffing decisions in regions with little competition from Western banks, such a point of view nonetheless fails to address the fact that Sharia’a-compliant banks are as deserving of highly skilled professionals as their Western counterparts.

How Did the Authors Conduct This Research?

The authors’ research considers the relevant literature on Sharia’a-compliant investing and assortative matching in hiring practices. They use the findings as the basis of a model to demonstrate how the latter practice tends to exacerbate the performance disadvantage that Islamic banks experience. The model indicates that the assortative matching practices lead to a lack of qualified candidates because most professionals seem to be drawn to non-Sharia’a-compliant institutions, presumably because of greater opportunities and compensation.

The model uses a conventional bank, Islamic bank, highly skilled employee, and lesser skilled employee as inputs. The bank’s productivity parameter is a function of the investment opportunities that it may manage. Matching that parameter with an employee of a given level of human capital (e.g., skill) determines the organization’s output, what the authors call “production function.” Using complex algebra, they demonstrate that conventional banks draw more highly skilled employees than Sharia’a-compliant banks through positive assortative matching. Their argument identifies the consistency of the occurrence but does not necessarily offer a solution. It is possible that Islamic banks could find skilled employees by looking to those who practice Islam. Compensation and employee self-selection tend to consistently produce the result of more highly skilled practitioners choosing to work for conventional banks, where greater opportunity and remuneration are available.

Abstractor’s Viewpoint

A significant category of environmental, social, and governance investment practice, Sharia’a-compliant asset management serves a large investor base. How extensively and effectively it serves this investor base appears to be at issue. The authors’ contention that Islamic financial institutions’ staffing practices hinder their performance beyond a necessarily more constrained opportunity set of investments should be a wake-up call to such organizations with global aspirations. Their analysis seems to transcend the issue of whether markets price social responsibility. The arguments are overall clear ones, but the article could benefit from editing to allow for a smoother narrative and avoid any potential ambiguity.

We’re using cookies, but you can turn them off in Privacy Settings.  Otherwise, you are agreeing to our use of cookies.  Accepting cookies does not mean that we are collecting personal data. Learn more in our Privacy Policy.