The effect of economic sanctions on the performance of Islamic banks
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Background of the Study
Economic sanctions represent a critical external factor that can profoundly affect the performance of financial institutions, including Islamic banks. In an increasingly interconnected global economy, sanctions imposed by governments or international bodies have far‐reaching consequences on trade, capital flow, and market stability. For Islamic banks, which operate within a framework that emphasizes ethical finance and risk-sharing, the impact of sanctions is multifaceted (Shakir & Ali, 2023). This study investigates how economic sanctions affect the operational and financial performance of Islamic banks, focusing on both direct and indirect repercussions.
Sanctions can disrupt access to international financial markets, restrict cross-border transactions, and impair the ability of banks to secure external funding. For Islamic banks, these disruptions are particularly challenging because they rely heavily on international collaboration and asset-backed financing structures that are sensitive to external economic shocks. The study explores how these institutions adapt their strategies in response to sanctions, including diversifying funding sources, enhancing internal risk management, and modifying product portfolios to mitigate adverse effects (Khan, 2024). Furthermore, sanctions may lead to increased operational costs and liquidity challenges, thereby impacting profitability and market competitiveness.
In addition to direct financial implications, economic sanctions also influence investor sentiment and customer confidence. A decline in trust can trigger a reduction in deposits and hinder the banks’ ability to finance long-term projects, which is crucial for maintaining Shariah compliance. Recent empirical studies have indicated that Islamic banks exposed to sanctions often experience slower growth and reduced profitability compared to their counterparts in less restricted environments (Ibrahim & Suleiman, 2024). The background of this research reviews these dynamics, drawing on case studies from regions frequently affected by economic sanctions.
Moreover, the study situates the impact of sanctions within a broader geopolitical context, analyzing how international policy shifts and diplomatic negotiations influence the operational landscape of Islamic banking. By doing so, it aims to provide a comprehensive analysis of the risks associated with economic sanctions and to offer insights into potential strategic responses that can safeguard the performance and resilience of Islamic banks.
Statement of the Problem
Economic sanctions pose significant challenges for Islamic banks by disrupting traditional funding channels, increasing operational costs, and impairing liquidity. One key issue is the difficulty in accessing international capital markets when sanctions are in place, which limits the banks’ ability to engage in asset-backed financing and cross-border transactions (Shakir & Ali, 2023). This limitation forces many IFIs to rely on domestic sources of funding, which may not be sufficient to meet their growth and operational needs. Furthermore, sanctions create an environment of uncertainty, negatively impacting investor confidence and leading to a contraction in deposits and capital inflows.
Another problem arises from the increased costs associated with compliance and risk management during periods of sanctions. Islamic banks must invest significantly in monitoring and mitigating risks associated with restricted markets, which can divert resources from core business activities and innovation. These operational inefficiencies can lead to a decline in profitability and may compromise the banks’ competitive positioning in both local and international markets (Khan, 2024). Moreover, the reputational risks linked to sanctions can further erode customer trust, which is crucial for sustaining long-term growth and adherence to Shariah principles.
This study seeks to identify the specific mechanisms through which economic sanctions affect the performance of Islamic banks. It examines both macroeconomic impacts and institution-level responses to provide a detailed understanding of the challenges posed by sanctions. Ultimately, the research aims to propose strategies that can help Islamic banks mitigate these adverse effects, ensuring operational continuity and financial stability even under adverse external pressures (Ibrahim & Suleiman, 2024).
Objectives of the Study
- To assess the impact of economic sanctions on the funding and liquidity of Islamic banks.
- To analyze the operational challenges and cost implications of sanctions on IFIs.
- To recommend strategic responses to mitigate the adverse effects of sanctions on Islamic banking performance.
Research Questions
- How do economic sanctions affect the liquidity and funding sources of Islamic banks?
- What operational challenges do IFIs face as a result of sanctions?
- What strategies can Islamic banks adopt to mitigate the negative impacts of economic sanctions?
Research Hypotheses
- H1: Economic sanctions significantly reduce the access of IFIs to international capital markets.
- H2: Increased compliance costs during sanctions periods negatively affect the profitability of Islamic banks.
- H3: Strategic diversification of funding sources can mitigate the adverse effects of sanctions on IFIs.
Scope and Limitations of the Study
This study focuses on Islamic banks operating in regions subject to international sanctions, with data drawn from affected countries. Limitations include the variability in sanction regimes and the challenge of isolating sanctions effects from other macroeconomic variables.
Definitions of Terms
- Economic Sanctions: Restrictions imposed by governments or international bodies to limit trade or financial transactions with target countries.
- Islamic Banks: Financial institutions that operate in accordance with Shariah principles.
- Liquidity: The ability of an institution to meet its short-term financial obligations.
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