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Islamic banking and finance: on its way to globalization; studying why Islamic finance is successful, and why Islamic banks were less
affected by the global economic crisis
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Chapter 1
Introduction
This chapter will provide a background for the undertaken thesis and give the purpose
of the study. Also, the hypotheses identification and a brief illustration of the research
methodology and methods will be presented. Finally, there are several limitations faced
throughout this study, which will be accounted for at the end of the chapter.
1.1 Introduction
Financial rules and regulations have historically played a significant role in the economy
of various societies. The Islamic financial system, which is rapidly growing and currently
used in many banks and financial institutions around the world, can be considered as a
key contributor to the growth and changes of today’s global financial system.
Furthermore, Islamic finance involves providing financial products and services by
institutions offering Islamic financial services that comply with Shariah laws, which can
be defined as the basis of financial transactions that meets the religious requirements
and obligations of Muslims’ societies (Tajudin, 2010). The industry of Islamic banking
and finance came into existence through Egypt’s MitGhamr Saving Banks in 1963, and
then in 1975 the world first Islamic bank was formed, known as Dubai Islamic Bank,
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which is currently operative through its forty-eight branches around the world (Platt,
2008). Moreover, according to El-Qorchi (2005) more than three hundreds Islamic
financial institutions were formed since then operating in seventy-five countries around
the world with assets exceeding US$400 billion. This shows Islamic bank’s spread and
worldwide growth due to factors like ‘high and efficient bank services, cheap and less
risky advances on a participation basis, higher return to customers on their investments
and low risk in returns’ (Bashir, 2008).
The financial and economic crisis which began in July 2007 in the United States of
America and then disseminated worldwide in September 2008 as the stock markets
entered a period of high volatility came into play. This crisis impact is still going on as
the world’s economy is still suffering from its effects such as unemployment, inflation
and purchasing power decrease. According to Alasrag (2010) both developed and
developing countries are still undergoing a deep economic recession arguing, in the
meantime, that Islamic banks seem to be more flexible to the international financial and
economic crisis than the conventional banks which has increased the attention on the
Islamic banks. Additionally, the Islamic banking system is primarily based on a
partnership between banks and their customers which emphasizes a social obligation
that will lead, ultimately, to a better protection for Islamic banks from any potential
financial and economic crisis.
1.2 Context and Significance of the Study
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The use of the Islamic financial system and Islamic banks are continuously increasing
worldwide. One of the reasons behind this growth is the success that was shown by
Islamic banks in avoiding the economic crisis in 2008. This encouraged a large number
of people to transfer their savings and investments from conventional to Islamic banks.
Moreover, many studies and researches were conducted to identify the reasons behind
Islamic banks success and why they were less affected during the economic crisis. For
example, Iqbal et al (2002) tried to explore the main reasons of considering Islamic
banks as one of the fastest-growing industries by studying how different risk-sharing
characteristics can be associated with the Islamic banks performance.
The main objective of this dissertation is to study the possible reasons behind the fast
growing of the Islamic financial system application as well as the increasing popularity
of Islamic banks. Additionally, this research will study how Islamic banks were less
affected by the global financial and economic crisis which took a place in 2008.
Moreover, this research will provide an insight into how Islamic banks differ from
conventional banks in terms of operations system and activities, and also comment on
the main challenges facing Islamic banking around the world.
In particular, this research will discuss number of previous studies in regards to the
globalization of Islamic banking and finance; provide in-depth and objective analysis by
studying a sample of conventional banks and Islamic banks in both of the United
Kingdom and Jordan. Additionally, practical feedback has been added to this
dissertation after an interview has been conducted with experienced Deloitte
professional advising conventional and Islamic financial institutions in Riyadh, Saudi
Arabia.
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1.3 Research Questions and Hypotheses
As mentioned previously, after the economic crisis, the Islamic financial system and
Islamic banks have received extensive consideration and recently various researches
were conducted to study the growth of Islamic banking globally.
Accordingly, there are three research questions that can be developed in this study as
follows: first, what are the reasons behind the globalization of Islamic banking and
finance? Second, is Islamic finance system successful? Finally, can Islamic banks stay
efficient during an economic and financial crisis?
Furthermore, based on the previous research questions, three research hypotheses can
be produced which are formulated as the following:
H.1: Implication of the Islamic values and regulations of the Shariah in operations and
product designing supports the sustainability characteristics of Islamic banks.
H.2: Islamic banks are less risky than conventional banks.
H.3: There is an efficiency difference between Islamic banks and conventional banks
during an economic crisis
1.4 Research Methodology and Methods
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A research methodology for the study can be defined as ‘a guideline system for solving
a problem, with specific components such as phases, tasks, methods, techniques and
tools’ (Irny and Rose, 2005). However, according to Kothari (2009) the research
methods are the scientific techniques used by the researcher in order to conduct and
support the performance of research operations.
The representative sample of the research was made up from two conventional banks
and two Islamic banks (four banks) operating in both the United Kingdom and Jordan –
Conventional banks: Barclays Bank (the UK) and Arab Bank (Jordan), Islamic banks:
Islamic Bank of Britain (the UK) and Jordan Islamic Bank (Jordan). In addition, an
analysis for an interview conducted with the Deloitte professional located in Riyadh -
Saudi Arabia, was used as a guideline for the research in order to offer some relevant
information.
Furthermore, while writing this research; most of the relevant data were collected
throughout the literature review, publications, case studies, internet, census, and
statistical data. Internet sources were the primary source of this report, as all relevant
information for most of conventional and Islamic banks considered in this study were
gathered online (i.e. financial statements) as well as number of other literatures and
studies which are also published in internet. In fact, according to Best et al. (2004)
internet employment as a direct channel for the collection of information is continuously
in a fast growing rate as it provides access to millions of data for the potential
researchers. Moreover, the present research methodology requires collecting relevant
data from two Islamic banks operating in the United Kingdom and Jordan (i.e. Islamic
Bank of Britain “UK” and Jordan Islamic Bank “Jordan”). However, for comparison
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purposes, relevant data were also collected from two conventional banks operating in
the same countries (i.e. Barclays Bank “UK” and Arab Bank “Jordan”).
1.5 Limitations of the Study
Although the study was carefully prepared, it will still have some limitations that can
affect the reliability and validity of the research findings. First of all, in terms of sample
size, the numbers of Islamic banks which were undertaken in this research was quite
small compared with numbers in the previous studies related to Islamic banking and
also with the numbers of Islamic banks around the world. Another limitation was based
on the methodology/ methods used in this research which required traveling to Jordan
and Saudi Arabia in order to study the performance of both Islamic and conventional
banks, as well as to arrange the interview with the Deloitte professional.
Additionally, another limitation on the research results is related to the time constraints.
Only small numbers of Islamic and conventional banks were considered while doing this
research as a result of the time limitations which did not allow taking larger numbers of
both types of banks. At such, this may not give an accurate representation of Islamic
and conventional banks operating model worldwide.
1.6 Layout of the Study
This research is distributed into six chapters including introduction as the first chapter.
Particularly, the introduction chapter included a general background of the research title,
context and significance of the study, the research questions and hypotheses, research
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methodology and methods, limitations faced during the research and finally the layout of
the study, which all have been illustrated above.
The second chapter of this research provides a discussion of the literature review and
analytical framework of the study. Chapter two offers an overview in addition to theory
consideration of the dissertation’s subject. Furthermore, this chapter highlights number
of published and unpublished researches (e.g. journals, books and web documents)
that were conducted in the past by different researchers which are related to
conventional and Islamic banks' globalization, performance and their effectiveness
during the global economic and financial crisis in 2008 with an explanation of how each
research is similar and how it differ from each other. At the end of the second chapter,
there will be a summary with a conclusion that includes a contribution to the
understanding and improvement of the research subject.
After that, chapter three discusses in more details and explanations the research
methodologies and methods, sample selection and data collection process which are
assigned to answer the research question that have been illustrated briefly above in the
first chapter. Additionally, this chapter provides an overview of the research design that
was used in order to reach the objectives of this study and also it will show how
research questions were developed.
Furthermore, the fourth chapter of the dissertation presents the analysis and
interpretation part of the qualitative data that were collected during the interview with
Islamic finance’s manager in Riyadh - Saudi Arabia in order to provide appropriate
answers for the research questions and hypothesis which were raised in chapter three.
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Then, chapter five will provide the quantitative data analysis which has been done by a
comparison between the representative sample of both of the Islamic banks and
conventional banks using their financial ratios to prove that one of them was more
successful during standard economic cycles and during the meltdown. This quantitative
analysis part had required using certain software and statistical data analysis methods.
Finally, chapter six concludes the undertaken thesis with summary and brief discussion
for the major findings of the research. In addition, this chapter draws conclusions and
suggests some recommendations which could be useful for future researches related to
the Islamic banking and finance.
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Chapter 2
Literature Review and Analytical Framework
2.1 Introduction
The primary aim of doing this research is to study the possible reasons behind the
globalization and success of Islamic banking system, as well as comparing the
performance and effectiveness of some conventional and Islamic banks during and after
the global economic and financial crisis. This chapter provides a literature related to the
research’s subject while illustrating the concept and principles of Islamic banking and
finance and providing readers with some previous studies and opinions related to the
efficiency and effectiveness of the Islamic financial system with extra explanations.
Furthermore, at the end of this chapter, there will be a summary and conclusion with a
contribution to the understanding and improvement of the research subject.
2.2 Literature Review
The starting of the Islamic banking and financial system was in 1975 in United Arab
Emirates when a bank named Dubai Islamic Bank was opened. Furthermore, Islamic
banking and financial systems are currently considered as one of the most growing
financial systems around the world operating in different countries in Asia, Africa,
Europe and North America (Khan et al., 2008). The Islamic financial system is a source
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of Islamic principles based on Islamic law, Shariah, functions which are characterized
by the nonappearance of interest-based financial transactions, doubtful transactions
and unethical transactions such as market manipulations (Loqman, 1999). Moreover,
according to Chong et al. (2009, p.3) ‘Islamic banking is different from conventional
banking because interest (Riba) is prohibited in Islam, i.e., banks are not allowed to
offer a fixed rate of return on deposits and are not allowed to charge interest on loans’.
According to the above statements, it can be illustrated that Islamic banking is not only
related to specific banks’ functions, but it is also a system that offers ethical concepts
which contributes for a peaceful creation and better society. Moreover, interest-based
financial transactions are forbidden in Islamic laws, Shariah, as it has negative impact
on overall economies and societies. In this respect, the absence of interest-based (riba)
transactions is considered as one of the main differences between the Islamic and
conventional banks.
However, there are some similarities in the practices of Islamic and conventional banks.
According to Dar and Presley (2000, p.4) ‘convergent evolution has meant that many of
the most common conventional financial instruments have a functionally similar
counterpart in Islamic finance’. This statement argues that Islamic banks are not totally
different from conventional banks. Islamic and conventional banks do identical practices
such as saving deposits and legal modalities, but there are still significant differences
between their objectives. Islamic banks main objective concentrates on applying Islamic
laws towards their operations which lead to equivalent sharing of wealth (Hanif, 2010).
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Moreover, the recent economic and financial crisis gave Islamic banks significant
consideration in addition to high market share price in results of their success and great
performance during that period (Hasan and Dridi, 2010). In contrast, according to
Bashir (2008), the absence of interest-based transactions, well-organized services of
banks, higher return on investments and low risk in returns are the main keys behind
this large attention and success of Islamic banking and Islamic financial systems.
2.3 Principles of Islamic banking and finance
The principles governing Islamic banks and Islamic financial system overall are
controlled by the Islamic law and Shariah, which is the legal framework of Islam
connected to its Quranic explanation, accompanied by understanding of the Sunnah.
The Sunnah can be illustrated as a law of behaviours, teachings and practices (either
physical or mental actions) which has been done by Prophet Mohammed (peace be
upon him “PBUH”) as a teacher of Islamic laws and Shariah (Peace be upon him
(PBUH) is a prayer phrase used by Muslims after mentioning or hearing the name of
any Islamic Prophets as a mark of respect and appreciation). Additionally, according to
Iqbal and Llewellyn (2002, p. 19) “the Sunnah is the most important source of the
Islamic faith after the Quran and refers to the Prophet's (PBUH) example as indicated
by his practice of the faith”. This framework of Islamic law and Shariah is established in
order to provide guidelines to Muslims to be consistent with the principles of the Holy
Quran (God’s words as revealed to the Prophet Mohammed “PBUH”) and the
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Sunnah(the living traditions of the Prophet Mohammed “PBUH”) in their decision making
related to all aspects of their life.
These principles were previously studied by numbers of Muslim and non-Muslim
researchers (e.g. Wilson in 2006; Metwally in 2006; Akacem and Gilliam in 2002; Zaher
and Hassan in 2001). Accordingly, the five general principles of the Islamic banking and
finance that will be undertaken in this study are as follows: (i) the prohibition of interest-
based financial transactions (Riba); (ii) the prohibition of risk and uncertainty (Gharar);
(iii) prohibition of gambling and other games of chance (Maysir) ;(iv) paying and
collecting of payments to the poor (Zakah); (v) ethical standards and prohibition of
dealing with forbidden commodities.
2.3.1 The prohibition of interest-based financial transactions (Riba or usury)
The prohibition of interest-based financial transactions (Riba or usury) is considered by
many Muslim and non-Muslim scholars as the most significant principle under Islamic
law and the key behind the successful of the Islamic banking and finance system. The
concept of Riba has been introduced by number of financial experts such as Al-
JarhiandIqbal (2001) who mentioned that Riba is translated literally from Arabic word
which means the increase or addition of a loan that must be paid to the lender by the
debtor, regardless of whether the amount of this increase or growth is a small or large
amount. In contrast, Metwally (2006, p. 17) explained the concept in relation with usury
by arguing that “usury is translated to mean Riba which literally means an excess or
addition above the principle lent. Since interest, however small, is an excess over the
capital lent”.
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Furthermore, the Holy Quran and the Sunnah have totally prohibited any type of interest
or usury payment (large or small amounts) which is higher or lower than the actual
amount. According to Krom (2013, p.57) ‘Riba is the payment of charges for the use of
money, including interest and usury, and is forbidden in the Qur'an in a number of
places’. In contrast, Metwally (2006, p.16-17) translates the sign for the prohibition of
Riba and usury from the Holy Quran and the Sunnah as follows:
“Those who devour usury will not stand except as stands one whom The Evil one by his
touch hath driven to madness. That is because they say: Trade is like usury. But Allah
hath permitted trade and forbidden usury (2:275)”.
“O Ye who believe! Fear Allah and give up what remains of your demand for usury, if Ye
are indeed believers. If Ye do it not, take notice of war from Allah and His Apostle. But if
ye turn back, ye shall have your capital sums: Deal not unjustly and ye shall not be dealt
with unjustly (2:278-279)”.
In addition, El-Gamal (2000, p.3) translates message from the Sunnah which also
shows an evidence for the prohibition of Riba and usury as follow:
“Muslim narrated on the authority of Abou Said Al-Khudriy: Bilal visited the Messenger
of Allah with some high quality dates and the prophet inquired about their source. Bilal
explained that he traded two volumes of lower quality dates for one volume of higher
quality. The Messenger of Allah said: “this is precisely Riba! Do not do this. Instead, sell
the first type of dates, and use the proceeds to buy the other”.
In addition, according to Oridedi (2010, p.4) an exploitation in addition to an injustice
can be created from payment and receipt of interests which lead to an inconsistency
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with the fairness and justice of Islamic laws and concepts, and in regards to this Riba
was strictly forbidden in the Islamic laws. This statement supports the view that interest
is prohibited in Islamic laws and Shariah due to the economic efficiency considerations
as it leads to unfairness produced by increasing the wealth of individuals without taking
in mind the whole culture and society.
2.3.2 The prohibition of risk and uncertainty (Gharar)
Gharar is an Arabic concept that refers to risk, fairness or uncertainty related to an
agreement which is made to sell goods which their existence or characteristics are not
certain or to sell items that have already been lost (Hourani, 2004). Furthermore,
according to Iqbal and Molyneux (2005, p.14), “Gharar refers to acts and conditions in
exchange contracts, the full implications of which are not clearly known to the parties.
This is something very similar to asymmetric information”.
Gharar is forbidden in Islamic law and measured to be the second significant prohibition
after Riba. Moreover, the main reason behind the prohibition of Gharar transactions is
that it raises injustice as there is usually a lack of satisfaction between the parties in a
Gharar’s contracts and also to protect both of sellers and buyers of risky goods or items
from fraud and cheating that derived from uncertain dealings (Ayub, 2009).
2.3.3 The prohibition of gambling and other games of chance (Maysir)
Maysir is defined by most of financial specialists as gambling, speculation or any games
of chance that make easy money and high returns by chance without consuming an
equivalent effort and time in earning this money. Some examples of Maysir (gambling)
are casino-type games, betting on outcome of football matches and sweepstakes.
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Maysir is strictly forbidden in Islamic laws and concepts. As a sign for this prohibition,
Metwally (2006, p. 15) translates evidence from the Holy Quran as follows:
“The Qur’an states (Chapter 5, verse 93): O ye who believe alcoholic drinks and games
of chance and idols and divining arrows are only an infamy of Satan’s handiwork, leave
it aside in order that ye may succeed”.
Furthermore, according to Sultan (2007, p. 29), Maysir and all types of chance games
are forbidden in Islamic laws due to the fact of inequality treatment that results from
gaining some individuals large amount of money while others will be suffering a loss
which may lead to their bankruptcy. Moreover, Maysir is usually the main reason behind
a lot of financial and social problems.
2.3.4 Paying and collecting of payments to the poor (Zakah)
Şentürk (2007, p.3-4) defines Zakah as “the process where a certain amount of property
or money is collected from those who are sufficiently endowed and then given to needy
group of people”. Zakah is mentioned in the Holy Quran and the Sunnah as one of the
five pillars of Islam as it encourages building an equitable and impartial society by
making it compulsory to support the poor and needy people. Furthermore, as specified
in the Islamic laws and identified by Prophet Mohammad (PBUH), any Muslim who has
an excess of his/her wealth over 85 grams of gold or its equivalent is required to pay the
fixed rate for Zakah on all types of the money including cash; gold, silver, idle deposits
with banks and goods for trade is equals to 2.5 per cent, 5 per cent on irrigated lands’
products, 10 per cent on the return on investments and agricultural (no-irrigated lands)
products as well and 25 per cent on fortune treasures (ibid, p.310).
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Moreover, Zakah’s main objectives are to increase the justice and solidarity and reduce
the crimes and hatreds between the people in their societies. However, in order to
achieve these objectives efficiently, several distinctive administration approaches
should be followed in the process of collection and distribution for payments of Zakah.
According to Samad and Glenn (2009, p.303), a collaborator society and theocratic
contribution level play significant roles in the efficient and effectiveness of the process
for collection and distribution of Zakah.
2.3.5 Ethical standards and prohibition of dealing with forbidden commodities
The Islamic financial principles motivate people to invest in vehicles that comply with the
rules and instructions of Islamic law and Shariah. Moreover, transactions and dealings
that include products and activities which have been strictly prohibited by the Holy
Quran and the Sunnah, such as drugs, alcoholic drinks, pork and all kinds of tobacco
cannot be made when dealing with Islamic laws’ contracts with the reason of promoting
an ethical investments and developing friendly societies as well as to prevent the great
damage which is caused by these stuffs to the human body (Imeson, 2007, p.5).
2.4 Relative risks in Islamic banks
Greuning and Iqbal (2008), mention that Islamic financial institutions have their own
distinguishing risk management and sharing strategies, especially designed on the
Shariah principles. Islamic banking products and services are designed on Islamic
values; however they are also sceptical to market risks and propositions. A speedy
growth of the conventional banking practices has impacted the practices in the Islamic
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banks operational in the areas, which have sizeable Muslim populations. Islamic banks
and other financial institutions have understood the importance of synchronisation of
modern banking practices with the core unavoidable Islamic practices. Islamic banks
have been working on the development of different risk management frameworks in
accordance to the Islamic values and practices (Greuning and Iqbal, 2008). Thus, the
risk management system in the Islamic banks and other financial institutions work on
the core Islamic values.
Salem (2013) discusses that in the light of different financial assets on the banks annual
balance sheets, these banks have an unconventional set of risks, which needs to be
managed under the Islamic values and regulations. Under these very conditions, the
risk management in Islamic banks remains a complex proposition. In Islamic banks, the
financers share the risk involved in the business to gain a part of the profit. Thus, the
agencies that supply funds to the financial institutions are regarded as investors instead
of creditors (Salem, 2013). The financial intermediaries share the risk with investors in
the regular functioning of the Islamic banks.
2.5 Efficiency of Islamic banks
An important factor that allows a bank to survive in the competitive environment is the
efficiency of the bank. From the discussion of Hassan and Lewis (2007), it is evident
that Islamic banks are interested in posting a great deal of efficiency to have a
competitive edge over the conventional banks. Islamic banks are less efficient when
compared to conventional banks, so Islamic banks are trying maintaining their presence
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in the international markets through more focused international banking regulations. The
efficiency of the Islamic banks can be improved by the use of better management
practices and technologies. Expansion of the banking business helps the Islamic banks
to post a more efficient stature against the conventional banks (Hassan and Lewis,
2007). A larger bank posts more profit and are generally efficient in their practices.
2.6 Islamic financing fundamentals and techniques
As illustrated in the section above, Islamic banking and Islamic financial systems are
designed in order to comply with the fundamental principles of the Islamic laws, and the
prohibition of interest-based transactions (Riba) is considered as the most significant
Islamic principle specified in Shariah. Additionally, this section studies financial Islamic
methods and techniques that can be used as alternatives to Riba transactions. These
techniques include cost-plus financing (Murabaha), partnership finance (Musharakah),
trust financing (Mudarabah) and leasing finance (Ijarah) which are explained as follows.
2.6.1 Cost-plus financing (Murabaha)
Murabaha (mark-ups on sales) is considered as the most commonly used form of the
Islamic financing fundamentals and techniques. In contrast, according to Hourani (2004,
p.46) “Within a Murabaha contract, the bank agrees to buy an asset or good from a third
party at the request of its client, and then re-sells the goods to its client with a mark-up
profit”. This statement describes Murabaha as a profitable transaction which considers
the Islamic banks and Islamic institutions as brokers that buys raw materials,
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equipment, properties and other types of goods that are requested from the client from
a third party and re-sellthem to the client with a profit margin and it is usually two parties
contract. Moreover, Murabaha transactions are used by the Islamic banks as the main
alternative to conventional banks’ interest-based transactions and it is widely used in
the Islamic institutions to promote dealing without Riba (Hassan and Lewis, 2007).
2.6.2 Partnership finance (Musharakah)
Musharakah (fully partnership) can be defined as a financial contract in which “an
arrangement where two or more parties establish a joint commercial enterprise and all
contribute capital as well as labour and management as a general rule” (Iqbal and
Molyneux 2005, p. 20). From this definition, it can be illustrated that Musharakah is
generally based on a jointly contract between two or more partners toward capital
investments. Moreover, according to Qadri (2009, p.10) the distribution of profits and
losses in Musharakah transactions must be pre-agreed in the contract. This encourages
the investors to invest in a wisely way in order to achieve their objectives.
2.6.3 Trust financing (Mudarabah)
Mudarabah (capital trust) is a contract whereas a partnership exists between two parties
in which one of the parties is capital provider (rabb al-mal) who provides the second
party with capital financial resources required for a certain project specified by customer
(Mudarib) who is usually expert to manage the investments (Qadri, 2009, p.10). In
addition, according to (Ayub, 2009) profits in Mudarabah contracts are shared between
the two parties based on pre-agreed ratio, but in the case of losses the investor suffers
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the financial losses while the entrepreneur bears the operating losses. This encourages
the individuals to involve themselves in financial activities in an effective way.
2.6.4 Leasing finance (Ijarah)
Ijarah (leasing or renting) is classified under the rental contracts in which the owner of a
certain good or asset gives the right to another party to use and get benefits from it for a
specific period of time and with periodic pre-agreed payment amounts. Furthermore, the
ownership of the rented goods and assets remain with the lessor during the contract
period (Bellalah and Ellouz, 2004). On the other hand, according to Islamic laws, Islamic
mortgages are based on the Ijarah’s concept and it is currently reflected as a positive
Islamic tool in achieving profits.
2.7 Compatibility between Islamic banks and Conventional banks
Referring to the previous discussions, Islamic banking which has been started early in
the 70’s usually operates for similar purposes and objectives as conventional banking
but the main difference between them lies on that fact that Islamic banking system is
based and operates in accordance to Islamic laws and regulations. Moreover, Islamic
banking and financial system attracted more attention after the demonstration of its
stability during the global economic crisis in 2008 (Hasan and Dridi, 2010). Additionally,
Laghari et al. (2011) argues that the main reason behind the fast evolution of Islamic
banking and financial system worldwide is that to achieve the objectives of Muslim
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customers and comply with Islamic principles and because conventional banks system
is based on interest (Riba) which is totally prohibited in the Holy Quran and the Sunnah.
In contrast, according to Merchant (2012, p.34) “during the global crisis Islamic banks
suffered more in terms of capital ratio, leverage and return on average equity, while
conventional banks exhibited a poor performance in return on average assets and
liquidity". This statement indicates that Islamic banks were not performing well in terms
of profitability and also that conventional banks achieved better return on investment,
but on the other hand the Islamic banks had a better capitalization rates comparing with
conventional banks during the global economic crisis.
2.8 Analytical Framework
The analytical framework of the research provides the key theories and concepts that
were used and employed in order to communicate the underlying thesis and also to
analyse the data, methods, scales, measurements and indicators that have been drown
in the literature part. The study includes a historical overview of Islamic banking and
financial system, discussing the main factors behind the growth and success of the
Islamic financial system, distinguishing between the Islamic and conventional banks and
studying the performance of both types of banks during the financial crisis in 2008.
Previous studies that were conducted by financial experts on Islamic financial systems
are undertaken in the research as some researchers studied deeply the development of
these systems worldwide as well as the reasons behind their success during the global
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economic crisis. However, the main purpose of using these previous studies is to
promote my research with more scientific opinions and information.
On the other hand, an interview was conducted with a Deloitte professional working with
conventional and Islamic financial instituions in Riyadh - Saudi Arabia in order to get
additional information about the Islamic financial system. Furthermore, certain statistical
techniques were used in the process of studying the performance and effectiveness of
both Islamic and conventional banks by analysing, comparing and looking in-depth
through their financial statements via financial ratios. In particular, these statistical
techniques include factors analysis and regression analysis that has been completed
using the Statistical Package for the Social Sciences (SPSS).
2.9 Summary
In conclusion, chapter two gives a brief introduction and overview of the Islamic banking
and Islamic financial systems through several previous studies that were conducted by
skilled financial researchers. It shows that the Islamic financial system started early in
Dubai - United Arab Emirates in 1975 and due the success that was shown by these
financial systems especially during the global economic crisis and considered nowadays
as one of the most growing financial systems around the world. The absence of
Interest-based financial transactions (Riba) is treated in the Islamic laws as the most
significant difference between Islamic and conventional banks and as one of the main
reasons behind the success of the Islamic financial system.
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Furthermore, the basic principles of Islamic financial system as well as some Islamic
financial methods and techniques were introduced in the literature review to provide the
readers with an overview about the legal framework of Islamic financial transactions,
how these transactions can be fulfilled within the Islamic laws requirements and what
possible alternatives are available in Shariah that can be used instead of the prohibited
financial transactions.
Moreover, a brief compatibility between Islamic banks and conventional banks showing
that Islamic banking’s practices and objectives are similar to those in the conventional
banks but the main difference between them lies on the prohibition transactions which
are specified in the Islamic laws and regulations such as Riba. Finally, an analytical
framework was introduced with description of the main theories and concepts that were
employed in the research paper in order to investigate the relevant data in addition to
appropriate measurements methods.
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Chapter 3
Research Methodology and Research Methods
3.1 Introduction
Research methodology is a guideline which deals with several models, procedures,
tasks and techniques employed with a main goal of finding the results of a research
problem based on the study findings (Panneerselvam, 2004, p. 2). This shows that
answering and solving the research problem is the main purpose behind introducing
research methodology in the studies. On the other hand, according to Kothari (2009)
research method is a tool of scientific investigation and technique employed in the study
in order to collect the relevant data and support the research operations’ performance.
Furthermore, the research methodology that was adopted in this research is based on
exploratory and deductive approach. This approach includes certain investigations and
examinations of both Islamic and conventional banking systems in terms of evolution,
globalization, financial treatment and successfulness during the global financial crisis.
The study is constructed on both of qualitative and quantitative research approach, as
the relevant data were collected mostly from previous studies and an interview as well
as Islamic and conventional banks’ annual financial statements. Moreover, certain
statistical software (e.g. factor analysis and regression analysis using SPSS) were
employed in this study in order to attain reliable estimates and possible approximations
for the quantitative data.
25
This chapter provides the research methodologies that were implemented in order to
answer the research question, research methods (scientific tools) that were mainly used
to collect the relevant data, employed strategies for data collection process and finally at
the end of this chapter there will be a summary for the previous studied sections.
3.2 Research Methodology and Research Methods
3.2.1 Research Questions and Hypothesis
Recently, extensive considerations were received and certain studies were conducted
by scientific researchers on how the Islamic banking and financial system operates and
what are the main aspects that differentiate this system from the conventional system in
terms of attitude, operations, financial treatments, activities and global growth. However,
this study is focusing mainly on the globalization of the Islamic and financial system and
the main reasons behind the success of this system as it was less affected during the
global economic crisis.
Accordingly, it is essential to raise research questions that clearly focused on the area
of this investigation in order to gain an understanding of the main objectives as well as
the goal of the study in which the research is conducted. In particular, the research
questions are divided into three different areas; globalization, success and efficiency
during the global economic crisis of Islamic banking and financial system. The three
research questions of this study can be designed as follows:
26
R.Q. 1: What are the reasons behind the globalization of Islamic banking and finance?
R.Q. 2: Is Islamic finance system successful?
R.Q. 3: Are Islamic banks efficient during an economic and financial crisis?
Additionally, the previous research questions are the guideline to formulate research
hypotheses which help to test predictions and provide explanations for the undertaken
facts in this investigation by testing two or more variables. Moreover, three research
hypotheses are formulated as follows:
H. 1: Implication of the Islamic values and regulations of the Shariah in operations and
product designing supports the sustainability characteristics of Islamic banks.
H. 2: Islamic banks are less risky than conventional banks.
H. 3: There is an efficiency difference between Islamic banks and conventional banks
during an economic crisis.
3.2.2 Sample Selection
For this dissertation, in order to analyse the quantitative data and compare between the
Islamic banks and conventional banks, a sample of four banks operating in both of the
United Kingdom and Jordan has been considered – Arab Bank (Jordan), Barclays Bank
(the UK), Islamic Bank of Britain (the UK) and Jordan Islamic Bank (Jordan). Analysing
of the financial ratios that were generated throughout the financial statements of all
these four banks was used for conducting this study.
27
Furthermore, as mentioned previously in this paper, an interview with a Deloitte
professional, working with the subsidiary for a one of the big four auditing companies
worldwide and located in the capital of Saudi Arabia (Riyadh), was used as a guideline
for my undertaken research. In fact, this was done by arranging a meeting to interview
the manager, in order to acutely investigate the Islamic financial system operations. In
fact, Deloitte feedback was chosen to address the needs of the undertaken hypothesis.
Relevant information from the Deloitte professional would support the idea of
investigating why Islamic banks are less risky than the conventional banks. Moreover,
as Deloitte works as an auditing organisation, the information from them can be helpful
in comparing the working pattern of these organisations.
3.2.3 Qualitative and Quantitative Research Approaches
Designing a research is usually based on two different scientific approaches; qualitative
and quantitative research approaches. According to Stejskal (2008, p.4) he argues that
studying social rations, investigating on market research and understanding the
behaviours and opinions of people as well as understanding different theories are the
reasons behind conducting a qualitative research. He also mentions that the relevant
data that should be collected in the qualitative approach is usually presented in a form
of words, schedules and pictures without statistics analysis (ibid). However, quantitative
research approach can be defined as studying and measuring the relevant numerical
data, variables and hypothesis of the undertaken research collected from representative
sample of interest by using several statistical data analysis methods (e.g. discriminate
analysis & SPSS), and it is an overview of the qualitative approach (Ernst, 2003).
28
Both of the qualitative and quantitative research approaches were used in conducting
this study as it requires a statistical and non-statistical data analysis. In particular, the
study is mainly based on the quantitative research approach as most of the relevant
data were collected from different variables such as numerical data (financial ratios)
which were gathered from the annual financial statements from the selected sample of
the Islamic and conventional banks in order to compare their financial performance
during and after the global economic crisis by using satirical seawares (e.g. factor
analysis and regression analysis using SPSS) and Microsoft Excel.
Additionally, old and recent scientific studies, some financial researchers’ opinions and
an interview with Deloitte professional in Riyadh were used in this dissertation as the
data for the qualitative research approach in order to link my research with the previous
studies, understand clearly the meaning of Islamic financial system and to study the
main differences between the Islamic and conventional banking systems in terms of
their techniques and performances. The information that was collected from the
interview was used in this study in order to understand the banking principles and
procedures employed in the Islamic banks. Deloitte professional can provide immense
knowledge about Islamic banking practices, as his company had been engaged in
auditing both types of banks for their different practices and procedures. The person
who is involved in the auditing process usually understands the practices used by
Islamic banks and the impact of various services and products on customer behaviour
and experiences.
29
3.3 Data Sources and Data Collection
In order to answer the research questions mentioned above, several methods and
techniques were used for the data collection process. Particularly, the data that is used
for this research and the required information is collected from the historical period
involving different factors like profitability, total assets, employed capital and other used
funds for the purposes. Different secondary sources were also used for the purpose of
research study. Thus, the main data sources include literature review, publications,
case study, internet, census, interview and statistical data.
In particular, in order to compare the performance and effectiveness of both Islamic and
conventional financial systems during and after the global economic crisis of 2008, the
use and analysis of financial statements of both systems were essential in this study.
The comparisons were intended to study financial ratios of both systems, look into how
Islamic banks were successful as they were less affected by the economic crisis of
2008. The comparison would also investigate why recently many of the conventional
banks are moving to use similar operations and activities for those which are used in the
Islamic banks.
For this purpose, Factor Analysis and Regression Analysis are used in this study in
order to come up with certain recommendations to be discussed further. Moreover,
SPSS is used for the quantitative analysis which provides a powerful statistical analysis
and data management system. It is able to derive the required output in the form of
statistical data to support the framed hypothesis statement.
30
The interview with the Deloitte professional was intended to gather relevant information
required for my study. The interview was focussed on gathering information from a
manager in one of the four biggest auditing companies around the world operating in an
Islamic country complying with Shariah while dealing with Islamic financial transactions.
The qualitative analysis of this conducted interview can be helpful in determining
various factors that can be used to investigate the efficiency and effectiveness of the
Islamic banking organisations. Moreover, the experience of the managers can be
supportive in analysing the factors that make the Islamic Banks less risky in comparison
to the conventional banks. Moreover, as Deloitte company has been involved in auditing
Islamic Banking organisations, the managers and the employees working there have
great deal of knowledge about the adherence to Shariah in the development of services
and products.
3.4 Summary
As outlined above, this chapter has basically concentrated firstly in the introduction part
on the theoretical discussion for the research methodologies, research methods and an
analysis of how this study was conducted. In the second part, an illustration for both of
the research methodologies and methods that were employed in order to study the
Islamic and conventional banking financial systems were represented. Finally, there
was an illustration of data sources and collection methods used to build the research.
31
In particular, research questions and hypotheses were presented in order to provide the
readers with the main objectives and goals of conducting this study which concentrates
on the globalization, differences and success of the Islamic and conventional banking
systems. Moreover, conventional banks - Barclays Bank (UK) and Arab Bank (Jordan)
and Islamic banks - Islamic bank: Islamic Bank of Britain (UK) and Jordan Islamic Bank
(Jordan) are the selected sample used to conduct the study. Mixed research approach
(qualitative and quantitative) was employed in order to achieve possible reliable results
for statistical and non-statistical analysis.
Finally, data sources and data collection methods were represented which shows that
most of data were collected from scientific published materials via internet, interview
and more important financial statements for the selected sample which were mainly
used for comparing purposes between Islamic and conventional financial systems.
32
Chapter 4
Data Analysis: Qualitative Data
4.1 Introduction: General Information of the Interviewee
4.2 Analysis of Data Collected Through Interview Method
4.3 Summary
33
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