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Halal Certification for Financial Products: A Transaction Cost Perspective

Abstract

We argue that although halal certification could potentially reduce the high transaction costs related to buying Islamic financial products, in practice these costs are just replaced by transaction costs relating to the certification itself. It takes considerable time (2–3 months) and money (USD 122.000) to obtain a halal certification. Partially, this is because the market is highly concentrated and non-contestable. About 20 individual Sharia scholars control more than half the market, with the top 3 earning an estimated USD 4.5 million in fees per year. Moreover, this market seems plagued with problems, most notably a strong incentive for excessively lenient certification, lack of consensus on what is considered halal and sub-standard governance practices. We discuss solutions to these problems and conclude that a neutral non-profit government entity should assume the role of halal certifiers.

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Fig. 1

Notes

  1. For a more detailed introduction to Islamic finance we refer to e.g. Askari et al. (2012), Visser (2009) and Shanmugam and Zahari (2009). Furthermore, the Arabic terms we use in this article are based on classical Arabic, which is conventional in research on Islamic finance.

  2. Islam can (arguably) be divided in two main groups, Sunni and Shia. Here, we describe the law schools of Sunni Islam, to which the largest part (about 85 %) of Muslims belong to and which are most widely followed. Shia Muslims mainly follow the Jafari school of thought (Visser 2009).

  3. Hadith are categorized as strong or weak based on their authenticity, which is determined by their chain of narrators. The most authorative collection of hadith are those by the Islamic scholars Muhammad ibn Ismail al-Bukhari (816–870) and Abul Husain Muslim bin al-Hajjaj al-Nisaburi (824–883), commonly known as Bukhari and Muslim.

  4. This is a contract in which the buyer makes a down payment for an asset to be bought in the future for a pre specified price. However, the buyer has the right to cancel the contract, in which case the seller keeps the down payment. Otherwise, the buyer pays the remainder of the price for the asset and gains ownership.

  5. Data taken from: http://www.zawya.com/shariahscholars/sch_results.cfm.

  6. Taken from: www.financeislamiquefrance.fr/useruploads/files/Sharia-Network_by_Funds_at_Work_AG.pdf.pdf

  7. Our search suggests that their number is limited though.

  8. Phenomena characterized by Pareto distributions are those in which approximately 80 % of the phenomenon is caused by 20 % of the cause. Mizuno et al. (2008) for example find that 80 % of revenues of a Japanese convenience store chain are attributable to only 20 % of its customers.

  9. Panel A is based on the top 20 scholars. Data is also available for the top 100 scholars but we omit it since it is very similar to the top 20.

  10. http://www.sc.com.my/main.asp?pageid=253&menuid=280&newsid=&linkid=&type=#a.

  11. We sent the same email (available on request) to all the companies. In this email we described some very basic characteristics of the fund, namely that it has an approximate size of EUR 200 million, invests in listed equities, is targeted mostly for institutional investors and has a geographical focus. For confidentiality reasons, we do not report the company names.

  12. There is no consensus on what the threshold value for the screens should be. One of the screens is a liquidity ratio with current assets in the nominator and either total assets or market capitalization in the denominator. The eligibility threshold for this ratio ranges from 33 to 80 % (Derigs and Marzban 2008).

  13. El Gamal (2006) mentions another problem with Islamic mutual funds, namely that the Islamic jurists that declared mutual fund investing halal characterized ownership in the fund as being the same as ownership of the underlying stocks. This is usually not the case for these funds.

  14. The ranges are based on overall minima and maxima. They cannot be interpreted to say that the cheapest certification is USD 32.000 (6.000 + 25.000). The cheapest overall costs for certification we found were USD 85.000.

  15. Calculated as the product of the total costs per certification (USD 185.000) and the total number of board positions of the top three scholars (241), divided by the average size per board (3.3.) and the sample size (3). This should be seen as a gross income figure, i.e. without taking into account other (fixed) costs of the Sharia advisory firm. However, we assume these to be relatively small compared to the total costs.

  16. Some typical examples of credence goods are education and medical treatment.

  17. More specifically, Islamic financial products often make use of Special Purpose Vehicles (SPVs) as an intermediate trading party to make Islamic financial products halal. See El Gamal (2006) for some detailed examples.

  18. Sellers have an extra incentive to shop around for certification when the application process is not transparent because they do not fear that prior rejections of certification become widely known.

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Acknowledgments

We thank the Netherlands Organisation for Scientific Research (NWO) for funding and two anonymous reviewers for helpful comments and suggestions.

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Correspondence to Raphie Hayat.

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The views expressed in this article are those of the authors and should not be attributed to the International Monetary Fund, its Executive Board, or its management.

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Hayat, R., Den Butter, F. & Kock, U. Halal Certification for Financial Products: A Transaction Cost Perspective. J Bus Ethics 117, 601–613 (2013). https://doi.org/10.1007/s10551-012-1534-9

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Keywords

  • Islamic finance
  • Certification
  • Transaction costs

JEL Classification

  • L14
  • L15
  • D23
  • D82