Dessertation Islamic Banking in Uk

8/12/2019 Dessertation Islamic Banking in Uk

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Chapter 1

1.0 Introduction

In the mid-1940s the model of Islamic banking gained drive which was relatively very old.

Over the years for the evolution of the Islamic banking model many Islamic scholars such as

Qureshi in 194 ! "hmad in 19#$! %&air in 19##! 'aududi in 19 1! "l-"rabi in 19 ! (iddi)i

in 19 * and "l-(adr in 19*4 +layed a very vital role. In the late 19*0s the staggering amount

of oil money +rovided a strong urge for the develo+ment of several Islamic banks in the

'iddle ,ast. hen other Islamic countries did likewise and sha+ed their own Islamic

financial institutions with the course of time. ut the real +ositivity and +rogress aboutIslamic banking has been seen over recent decades. /ithin last decade it has +roved to be the

fastest-growing division of global finance due to fre)uently high oil +rices in international

markets and other encouraging social and +olitical effects. It is booming in "frica! "sia!

,uro+e and orth "merica. In *0 countries! there are nearly 00 Islamic financial institutions

which are holding the ca+ital investments worth of %(2#00-300bn! with the average growth

of 1# +er cent +er annum "rekat! $00 5. It is accumulated that by $010 the Islamic banking

will have a market worth of %(24 trillion 6ader! $00*5. It is likely to secure about 40-#0a+iece cent of the total savings of 1. billion 'uslims globally within the ne7t 3 to 10 years

"lam! $00 5. here has been an astonishing escalation and dee+ening of Islamic banking

+roducts 8takaful or Islamic insurance services! e)uity funds! hedge funds! assets and wealth

management! risk and li)uidity management! sukuks or Islamic bonds! real estate and

cor+orate finance han and hatti! $0035. 'alaysia is the +rime releaser of sukuks! worth

more than %(2 $bn "lvi! $00 5. (ukuks consist of about 3# +er cent of the 'iddle ,astern

ca+ital market 8 %(21 bn of them have been released there with an average increase rate ofover 4# +er cent through $00$-0* Islamic :inance ews! $00 b5. he 'iddle ,ast and

"sian regions will largely de+end on sukuks! to meet u+ with their %(21.# trillion infra-

structure re)uirements over the ne7t five years he halee; imes! $00*5. here are more

than $#0 takaful com+anies globally. In $00# they gained +remiums which are worth of

%(2$bn. hey are likely to raise %(2*.#bn by $01# he ones (' Islamic :und I'" ?5! handle

assets in e7cess of %(24bn with a yearly growth rate of nearly about 1#-$0 +ercent Islamic


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:inance raining! $00*5. here has been convincing growth in the Islamic banking infra-

structure with last few years.

In recent decades the su++ort of Islamic banking has increased considerably s+ecially in the

'iddle ,ast and ahrain has a++eared as the largest focus of Islamic anking /orldwide.

It is e7+ected that the current boom in 'iddle ,astern economies will deliver %(213 trillion

or more in su++lementary revenues in ne7t five years! and at least more or less 0 +ercent of

this su++lementary income will find its way into (hariah-com+liant banking and investments


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give Islamic financing in +ro+erty and real estate to "ustralian 'uslims. In addition to the

mentioned banks and services! to su++ort Islamic banking in ,uro+ean and /estern markets

a considerable number of /estern financial institutions such as " "'CO! 6itibank and


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Islamic banking is booming at +resent des+ite conce+t of interest free business. he % is a

multicultural society which consists of many communities including 'uslim community.

'uslims from all over the world visit the % for em+loyment! business and studies. "s

interest is forbidden in Islam and 'uslims avoid entering into any business deal that involves

interest. :urther there is a need of an alternate banking system to other non-'uslim that is

based on variable rate of return Brofit and loss sharing5. "lso conventional banking is fragile

based on interest. "ll the risks involve to borrower and bank have no intension. In this way

the bank allocate it funds inefficiently. On the other hand the main theme of Islamic bank is

develo+ment and social welfare. hey monitor their fund so as the borrower manage and

utili&e them conveniently. :oregone in view! the researcher interest develo+ed in the to+ic

and has chosen the sub;ect to+ic for dissertation.

1. !ethodo"o#y

he researcher will use secondary data that will be gathering from different sources such as

>ournals! re+orts! books! maga&ines and news +a+ers etc. he secondary information is very

hel+ful as will be used to com+are findings from different +revious associated studies and it

will be used in the literature review. 6orres+ondingly )uestionnaires and documented review

will be used as data collection methods for this study. :irstly the )uestionnaires will intend to

attain the study goals. " total 1*0 )uestionnaires will be distributed to 'uslims across the

% . he )uestionnaires will either randomly given to 'uslims in the streets! mos)ues and

Islamic community centres in irmingham! Dondon and 6ardiff. (econdly documented

review of various recent and +ast +ublished documents5 literature will be analysed and

discussed

1.$ %imitations o& the study

he limitations related to given research +ro;ect wereF

1.$.1 'enera"i(ation

he researcher has used convenience sam+ling for collection of data. 6onse)uently! the

research findingsGclaims of the research cannot be generalisable :ogelman! $00$! +.1015. In

addition! the researcher has limited his research to 1*0 customers across due to timeconstraints as well as feasibility that rendered the findingsGclaims non-generalisable.

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1.$.2 Accessibi"ity to Samp"in# )rame

he researcher had avoided convenience sam+ling method with a view to giving his research

findings generalisability. Aowever! due to limitation of his accessibility to obtaining the list

of all the following Islamic anking is im+ossible due to =ata Brotection "ct of the % and

certain ethical issues.

1.$. *ime !ana#ement

" fi7ed time +eriod is allocated to the researcher to finish the research +ro;ect. ut the

research will mainly be de+endent on the data collected from the customers of the banks.

Bossibility of delay in collecting data is always being there.

1.$.$ )inancia" Resources

,very +ro;ect re)uired some financial resource in terms of money etc because to get some

literature re)uired money. Aence there is a chance that the researcher may not get a++roach to

high )uality data. he +ro;ect is conducted on individual basis! no financial benefits is

involved in the research +ro;ect.

1.$.+. %an#ua#e ,arrier

'ost 'uslim across the % came from different origins and backgrounds therefore their

native language is not ,nglish. ,nglish being a second language for most of the res+ondents!

made it difficult for some to understand the vocabulary and contents and many of them

refused to do the )uestionnaire due to this reason! es+ecially old +eo+le. he )uestionnaire is

written in ,nglish because it is the most common language between 'uslims and because

'uslims s+eak different languages according to their origins! the )uestionnaire was not

translated to another language.

Chapter 2%iterature Revie-

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2.0 Introduction

Islamic banking has shown incredible growth over the last 0 years. he +ractise of Islamic

banking now s+reads all over the world from the ,ast to the /est! all the way from 'alaysia!

ahrain to ,uro+e and the %( 'okhtar! "bdullah and "lhabshi! $0035. he si&e of the

banking industry assets is hundreds of billions of dollars as com+ared to hundreds of

thousands of dollars in the 19*0s. "ccording to ahrain 'onetary "gency $00 5 cited by

athan and CibieHre $00*5 twenty-five years ago Islamic banking was virtually unknown.

oday the market si&e is estimated! by some commentators! to be growing at a double digit

rate +er annum. Islamic banks currently o+erate in a++roaching *# countries and the industry

has a market estimated at %( 2$#0- 00 billionJ.

he given cha+ter will discuss the evolution of Islamic banking. he markets and

diversification of Islamic banking and the regions where they o+erate are highlighted.

'oreover the e7isted Islamic banks and banks offering Islamic windows in the % are

e7amined.

he Organi&ation of Islamic 6onference OI65 defined an Islamic bank as a financial

institution whose statutes! rules and +rocedures e7+ressly state its commitment to the

+rinci+les of Islamic (hariah and to the banning of the recei+t and +ayment of interest on any

of its o+erations.J

2.1 vo"ution o& Is"amic ,an/in#

he world is ra+idly moving towards globalisation! so the concentration of +ower among few

multinationals 6arlos! $00#5. :urther! it creates ine)ualities among societies. he socio-

economic idea of Islam is change from others that believe on eradicating of interest and all

other une)ual elements from the economic s+here han and hatti! $0035. 'oreover! the

Islamic financial system e)ui++ed with elements of lending! borrowing and investment

functions on a risk-sharing basis. In this way it facilitate market forces to establish the

+roductivity of ca+ital instead of fi7ing it in +riori as an KKinterest rate@@ to sabotage the free

market mechanism and encourage s+eculative use and hoarding of ca+ital. he Islamic

financial system ensures the o+timal rate of ca+ital formulation and its efficient utili&ationleading to a sustainable economic growth and fair o++ortunities for all. (iddi)i $0005 cited

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a)vi! 193$5 Lar)a! 193 5 and "hmed 19945 that it is a value-based system which

fundamental ob;ectives is to make sure the moral and material welfare of the individual and

society as a whole.

'eanwhile! Islamic banking system also introduce new Islamic financing schemes according

to the Islamic (haria Daw5 that is +laying a uni)ue role in rendering financial services to

rural-based small and cottage industries (6Is5 in many develo+ing and least develo+ed

countries of the world. "ccording to a "lam $00$5 that among other factors the lender-

borrower relationshi+s between Islamic banks and the rural-based small industry owners are

influenced by different societal sector institutions. (imilarly >ansson $00$5 argues that these

ty+es of institutions like country culture! familyGclan! legal! and +olitical system and the

government influence the economic and social life of a nation.

he conce+t of Islamic anking and :inance is very old but it has taken boom from last few

decades. "ccording to han and hatti $00#5! the conce+tual develo+ments of Islamic

banking got fame in late 1940s and in the ne7t two decades! they got to a +oint of yielding a

model which was ado+ted in the 'iddle ,astern countries to fulfil their as+iration of having

their own banks. he result became many re+utable Islamic banks in 19*0s such as asser

(ocial ank 6airo 19*$5! Islamic =evelo+ment ank I= 5 19*#5! =ubai Islamic ank

19*#5! uwait :inance Aouse :A5 19**5! :aisal Islamic ank of (udan 19**5 and =ar

"l-'aal "l-Islami 19305. =uring 1930s three 'uslim countries! Bakistan! Iran and (udan

decided to renovate their economies and financial sector on Islamic lines. o attract

+etrodollars@ de+osits from the 'iddle ,ast and 'uslims clientele in local markets some

/estern financial market +layers like 6itibank! " "'CO! A( 6 and others launched

their own Islamic windows or subsidiaries. he Islamic banking and finance system is

e7+anded by seeking innovation and diversity of +roducts! clientele and markets. It has been

develo+ing different areas like (ukuk! akaful! hedging funds! 'utual :unds! +rivate e)uity

and assets management! wealth management! real estate! cor+orate finance! li)uidity

management! treasury! derivatives! swa+s! future and forward market! Islamic (tock

,7change and =ow >ones Islamic Inde7.

he main hub of Islamic banking and finance activities are basically three +arts of the world!

'iddle ,ast! (outh "sia and (outheast "sia. he 'iddle ,ast is 'uslim dominated area andis a motherland of Islamic banking and finance. Islamic banks receive strong su++ort from

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rich individuals! governments and other state institutions in the 'iddle ,ast. 'ost of

regulatory and other su++orting bodies of the Islamic banking and finance industry would be

find there. he


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re)uired changes were brought to the % a7 Daw! thereby eradicating obstacles to +ractice

murabahah and I;arah mortgages and to reduce musharakah. he % @s reasury and the :("

have some more regulatory and ta7 changes in the channel to introduce (ukuk in the %

local market "min! $00*5. 'ore than $ million +eo+le have been living in the % . "s a

conse)uence! the 'iddle ,astern Islamic banks chose to e7+loit the % market as an entry

and bottom to o+erate into the ,uro+ean :inancial 'arkets in which 'uslim clients or

consumers also +lay an im+ortant role for the economic growth. On the other hand!

regulations in the % attem+t to avoid risk and uncertainties! as they are reluctant to allow an

Islamic bank on the basis of risk sharing and murabaha in the financial market.

:(" authori&es numerous a++liance of Islamic banking such as Islamic hedge :und! Islamic

insurance firm akaful5! (ukuk issues Islamic bonds5 etc! as it@s ultimate target is to

generate finance for Islamic bank in the global financial market. he +recise si&e of this

market is not identified! e7ce+t several estimates guess it a++ro7imately $#0bn. :("

re+orted an estimate on the annual growth rate which has been a++ro7imately 10-1#P in the

region and some observers imagine it to continue over several years. he % is well s+ot to

obtain benefit of this tendency! because it has been a key financial centre for centuries! and

has always been +re+ared to introduce fle7ibly changes and new ideas. % has a yawning

li)uid market and eventually! the Dondon e7changes are among the most fre)uently a++lied

for recording financial mechanism internationally. esides! the % :inancial (ervices

industry has a demonstrated list of develo+ing and delivering new +roducts and the ideal

;urisdiction has been taken by the ,nglish law for various Islamic transactions. Oil +rices

have risen shar+ly! thereby resulting in huge li)uidity sur+luses in the


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firms. hey include the Qatar Islamic ank QI 5! with its Dondon-based ,uro+ean :inance

Aouse in erkeley ()uare! and the Islamic ank of ritain! which has head)uarters in

irminghamJ /ade! $0095.

Dikewise! a re+ort suggested by an International :inancial (ervices Dondon I:(5 that at

+resent! ritain@s Islamic banking sector is relatively bigger than Bakistan@s Islamic banking

sector. "ccording to 6roft $00*5! Islamic mortgages are likely to accelerate on average of 4*

+er cent annually to arrive at %(2$.3 billion by the year of $009. It is very significant for

Islamic financial organi&ations to +resent (hariah obedient! +ioneering! economical +roducts

and services to their 'uslim clients or customers in order to gain their moral and material

su++ort. han and hatti! $0035.

Aead of 'arketing of I (teven "mos saidM Our core business will always be 'uslims but

the numbers of non-'uslims are really +icking u+.

"s a result! it will offer advantage to customers! encourage com+etition! im+rovement and

large )uantity in % markets! thus boosting the % financial market :("! $0035.

"ctive Islamic anks and Islamic windows in %nited ingdom

1 "lbaraka International Dtd! Dondon$ "lbaraka Investment 6o. Dtd! Dondon

"l Ca;hi Investment 6or+oration! Dondon4 "l (afa Investment :und# ank (e+ah! Iran

Islamic ank of ritain* =allah "l araka % 5 Dtd.! Dondon3 akaful % 5 Dtd! Dondon9 arclays 6a+ital10 A( 6 "manah :inance

11 " 6I Islamic "sset 'anagement! "rab anking 6or+1$ " 6 International ank! Dondon1 ,uro+e "rab ank Blc! Dondon14 Ciyadh ank ! Dondon1# 6itibank International Blc! Dondon1 6edel International! Dondon1* =awnay =ay


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$4 >. "ron 6o.


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'alaysian Islamic banks efficiency declined in year $00$ to recover slightly in years $00

and $004. :urther argued that although marginally the domestic Islamic banks were more

efficient com+ared to the foreign Islamic banks.

Cecently! han and hatti $0035 +resented in Islamic banking on the way to


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borrowers@ creditworthiness and strong collateral. "ccording to "hmed and ,l-


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+racticed by +etty money lenders and not to interest charged by modern banks and that no

riba is involved when interest is im+osed on +roductive loansJ but these arguments are

unclear and doubtful. ut the 'uslim scholars are agreed that there is no difference between

riba and interest.

'ainly religions throughout the world are against the interest on any form of loan. Interest is

absolutely +rohibited in Islam. his criticism is clearly obvious from religious literature. he

Aoly Quran 'uslims Aoly ook5! in verse $*3 of surah "l- a)arah! statesM

O ye who believeS :ear "llah and give u+ what remains of your demand of riba! if ye are

indeed believersJ and vs. $M $*9 says. If you do it not! take notice of war from "llah and Ais

'essenger but if ye turn back! ye shall have your ca+ital sums. =eal not un;ustly and you

shall not be dealt with un;ustly.J

Interest also brings in;ustice into the society and Islam is against all forms of ine)uality and

abuse and im+lements an economic system based at securing! e7tensive socio-economic

;ustice.

he term %sury!J used in the Aoly ible ing >ames Eersion5 mean interest is also

forbidden by udaism had also +rohibited interest. In the Old estament it is stated thatM

If ye lend money to any of my +eo+le with you who is +oor! you shall not be to him as a

creditorF neither shall you re)uire interest from himJ.

2.+ Is"amic and Conventiona" ,an/in#

he traditional or conventional banking system is based on interest as o++osed to Islamic

banking system. "ccording to Islamic law! Islamic banking is based on various +rinci+les.

"mong them the fundamental feature is the +rohibition of interest. Islamic finance has the

conce+t of e)uitable +rofit and risk-sharing between the +rovider of ca+ital and the

entre+reneur since Islamic law is re;ecting the conce+t of interest and +ermit an uncertain rate

of return based on +rofit. Islamic banking systems have been set u+ in many 'uslim recently.

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he ma;or distinction between Islamic banks and the traditional banks is that Islamic banks

follow the +rinci+le of +rofit and loss sharing BD(5 the latter is based on the +rinci+le of

interest when doing their business as intermediaries "riff! 19335. In addition! the association

between borrower! lender and intermediary are rooted in financial trust and +artnershi+ under

the word of Islamic BD(. he significance of the interest-free financing in Islamic anking

develo+s an innovative environment between e7+erts in which the substitute of interest is

antici+ated. =ar $00 5 +resented four ty+es of finance working as alternatives of interest

which are investment-based! sale-based! rent-based and service-based.

In Iran! the develo+ment of banking system from an interest based to a non-interest based

banking system went through three different +eriods. :irst was the nationalisation of the

banking system that brings the o+erations of the banking system according to Islamic law and

some necessary measures were taken by the 6entral ank to remove interest from banking

o+erations. (imultaneously the scholars arranged develo+ed the first draft of a law to bring

banking systems functions according to (hariah. Dater to assume and establish an evidently

conce+tualised model of Islamic banking! legislation was introduced. he Barliament +assed

the law on interest-free banking that +rovided a time frame limit of one year to the banks for

changing their de+osits according to Islamic +rinci+les. (imilarly a three year time were

given to the banks to transfer the asset side of their o+erations or loans according to Islamic

+rinci+les. he law also showed the categories of contracts that must com+rise the basis for

the asset and liability sides of banking. Earious modes of financing for the asset side and

different ty+es of de+osits for the liability side have been offered to assist the needs of

economic activities. In the same way the banking system was thought as an essential +art of

the Islamic government and a tool for restructuring the economy.

he laws associated to modern Islamic banking are only as old as the first Islamic banking

which was formed in 19*# Ce&a! $0035. :urther he argues that the laws related to the Islamic

banking are not mature! searching for it form and need to develo+. 'any research work has

been conducted but mostly discussed the religious features or on the historical research

regarding traditional financial mechanisms used during early Islam +eriod. =ifferent as+ects

like o+erational as+ects of Islamic banking are not e7+lained +ro+erly because they function

within the conventional legal environments. "s a result! the Islamic banking faces legal risk.

here is no considerable difference between the Islamic and the conventional banking because the legal risk +rofiles of both transactions are same.

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2.8 *he concept o& sharin# 6ro&it and %oss

Islamic scholars consider BD( instruments 'udarabah and 'usharakah5 as a central stake of

the Islamic banking model han and hatti! $0035. :rom the literature it is evident that in

mid-1990s the use of the BD( system has fallen by an average of 11 +ercent in the Islamic

banking industry. he im+lementation of BD( instruments has always been limited due to

o+erational difficulties and business ethics constraints. 'ost of the +ro;ects submitted to

Islamic banks by the clients for BD( are bad! risky and with over-o+timistic +rofit forecasts.

here is no standard +rocedure! frameworks! e7+ertise and tools to measure the ca+ability of

BD( investment +ro+osals. he monitoring cost of BD( +ro;ects is unbearable. "dditionally!

the inefficient ta7 system! high rate of illiteracy! low accounting standards and the +ractice of

kee+ing a double set of accounts on the +art of the ma;ority of business +eo+le have +roved to

be formidable obstacles to the +ractical im+lementation of the BD( system in 'uslim

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+rofits. I:Is are also radically different from their conventional counter+arts in ma;or as+ects

such as foundation! management! and +roducts.

On the management side! I:Is o+erate under a different structure of cor+orate governance

than the one used in conventional banking. I:Is are obliged to a++oint a board of Islamic

scholars called (hari@a (u+ervisory oardJ (( 5. Islamic banking is governed by the

(hari@a Islamic law! also referred as Islamic >uris+rudence5. Islamic (hari@a laws +rovide

rules to encom+ass the allocation of resources! management! +roduction! consum+tion!

ca+ital market activity and the distribution of income and wealth ahrain 'onetary "gency!

$00 5. his board is a++ointed by the general assembly of shareholders and recommended by

the oard of =irectors o=5.

he (( is not only autonomous from the o=! but it is also endorsed to take +art in the o=

meetings to discuss the religious views of their ;udgements "bu


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he +resence of the (( is vital for +roving the reliability and sincerity of I:Is I:( ! $00#!

+. 105. esides being acting as investor to +rotect their rights and ensure com+lete

trans+arency between the two +arties and the management (( also works as su+ervisor on

behalf e)uity holders arim! 1990! +. 4F Aassan! $001! +. 9F "bdulla! $001! +. $ 5.

o ensure the right enforcement of (hari@a rulings the (( actively im+ly internal and

e7ternal auditing +rocesses. (o its very im+ortant role that (( +lays in creating and kee+ing

trust in I:IHs and their stakeholders! disseminating timely and sufficient information

financial and non-financial5 which will address their o+erations and +erformance ""OI:I!

$00 a! b! +. 5.

2.; *he concept o& Centra" ,an/

he conce+t of central bank is very com+licated in Islamic anking. 'ostly certain issues

related arise between the relationshi+s of commercial banks with the central banks (iddi)ui!

$0035. Ais first suggested issue is that commercial banks get interest from the central banks

on the reserves ke+t with them central bank5. (imilarly! central banks are lenders act as a last

resort to the banking sector but the lending entails an interest +enalty for running out of

reserves. Islamic banking +rohibits interest on their reserves that they +ut with the central

bank so cannot get advantage from the li)uidity service offered by the central bank. Aence

Islamic banks lose earnings and +rofitability by not being able to receive a return on their

de+osits with the central bank. "t the same time the banks e7+ose themselves to higher +riced

money market funds or running short on li)uidity in critical times by not being able to +ay

interest for li)uidity reserves ac)uired from the central bank. I)bal and 'olyneu7! $00#5

argued that this +roblem can be solved if the central bank introduce an Islamic de+osit service

that +ays a rate of +rofit to commercial banks on their de+osits and the commercial banks

similarly develo+ an Islamic loans instrument based on +rofit and loss. (imilarly commercial

banks should +ool funds to assist li)uidity constrained banks 6ha+ra! 193#5.

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(addi)ui $0035 highlighted another +roblem associated with commercial and central banks

are the issue of o+en market o+erations through sales and +urchases of government interest

bearing securities. =ue to lake of Islamic structured government bonds countries in

'iddle ,ast and Bakistan have legitimated their banks to work in a hybrid environment based

on traditional interest based savings and investment instruments and Islamic windows so as to

limiting given factor. =ue to interest charge! Islamic banks cannot borrow from money

markets or from the central bank that@s why they carry on higher non-earning li)uidity

reserves and therefore loose +rofitability.

6entral bank@s regulatory standards for managing the risks of Islamic banks are another issue

o++osed to traditional banks. "lready 6entral bank has many +rudential to monitor the risk

e7+osure of financial sector that relate to ca+ital! assets! management! earnings and li)uidity

6"',D5. he +rimary mode of financing of Islamic banks is BD( which has much higher

risks and should have higher ca+ital ade)uacy ratios ,rrico and :arahbaksh! 19935. /hilst!

Islamic banking does not assured the +rinci+al of various financing contracts as a result of

such ca+ital obligation would to give greater solvency and defend the +rinci+al liabilities of

de+ositors and investors.

he business environment in which Islamic banking function is another common factor

contributed to Islamic bank@s risk e7+osure. 6ountries of south and west "sia and 'iddle

,ast are noticeable by underdevelo+ed financial markets having +olitical insecurity and weak

+ro+erty rights and legal system. ake e7am+le of Bakistan where due to weak legal structure

it is evident from the fact that the (u+reme 6ourt ruling on +rohibition of interest has been

challenged and )uashed and has still wait for solution from the (hariat Islamic5 6ourt.

2.4 Sources o& )unds

"ll the Islamic finance o+erates under the +rinci+les of the (hariah or Islamic Daw taken the

Aoly QurRan and from the (unnah e7am+le5 of Bro+het 'uhammad Beace e %+on Aim5

and it is old as the religion of Islam itself I ! $0095. "ccording to Islamic finance

+hiloso+hy! money itself has no intrinsic valueJ. he faith of 'uslim is that he cannot lend

money to or receive money from someone and e7+ect some benefit like interest riba5 whichis not allowed. Islam forbids making money from money. It is believed money must be used

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in a +roductive way and wealth can only be made through lawful trade and investment in

assets. here always involved risk in any trading activity and any gains relating to the trading

are shared between the +erson +roviding the ca+ital and the +erson +roviding the e7+ertise.

I $0095 argue that they manage all their o+erations in com+liance with Islamic law! that

we invest our funds ethically and that we do not mi7 them with interest bearing funds. "

committee of schlors +eo+le known as (hariah oardJ analyse the o+eration of banks in the

light of Quran! (unnah. (imilarly I;ma@a consensus5 is also a source of guidance that

involves the inter+retation and analysis of newly arising issues by eminent )ualified scholars

of :i)h who will arrive at a consensus or ruling about the issue in )uestion. "nother source is

Qiyas analogy5! the +rocess of analogical reasoning from a known in;unction to a new

in;unction. In the +rocess! the ruling of the Qur@an and (unnah may be e7tended to a new

+roblem +rovided that the +recedent and the new +roblem share the same o+erative or

effective cause. he last source is I;tihad! which is! the effort of a )ualified Islamic ;urist to

inter+ret or reinter+ret sources of Islamic law in cases where no clear directives e7ist.

he main conce+t of all Islamic banks are same interest free banking5! the main difference

mostly come in the a++lication they +rovide. =ifferent demogra+hic factors such as laws!

environment! bank ob;ectives! the need to interact with other interest-based banks II I!

$00*5 are res+onsible for such differences. 6urrent! saving and investment accounts are the

most common forms of accounts +rovide by every Islamic bank and Islamic windows.

2.4.1 Current Account

he Islamic banks facilitate the customer with current accounts based on trust between

customer the bank. he banks +rovide a safe custody of their funds and allow the users to use

their funds while available in the bank. he customer can take out a +art or the entire money

from their accounts and the bank is res+onsible to fulfil their re)uirement :uad! 199 5. In

this! the +rofits generated by the bank from the de+osit of the clients will go to the bank. "t

the same time banks +rovide the facilities of che)ue books! debit card and the other services

linked with current account.

2.4.2 Savin#s Accounts

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23/94

KKbithaman a;il@@5! leasing I;arah5! +artnershi+s 'odaraba and 'usharakah5 and some

forward contracts (alam and Istisna5. (imilarly! Qard-e-Aasna benevolent loan5 which is a

&ero interest loans offered to +oor farmers and needy students.

2.10.1 !urabaha trade -ith mar/ up or cost p"us sa"e5

'urabaha a ty+e of (hariah com+liant contract is the most e7tensively financing mode of

Islamic anks (addi)ui! $0035. his kind of instrument involved financing of consumer

durable! real estate and for +urchasing raw materials! machinery or e)ui+ment. 'oreover! it

is also suggested for short-term trade financing such as the financing of letters of credit. In

other words 'urabaha is similar to the consumer loans! lines of credit and working ca+ital

facilities +rovided by conventional banks.

he 'urabaha contract is signed between the bank and the +urchaser but it usually involved

three +arties involvedM the seller of the good to the bank! the buyer bank@s debtor5 who could

be an ordinaryF consumer! trader and the bank. he role of the bank is like an intermediary

KKtrader@@ and facilitator between the buyer and the seller. he contract sale of 'urabaha

between the bank and the customer debtor5 is de+endent on the contract signed initially

between the same two +arties. In the +rocess of the 'urabaha sale transaction the bank buys

the desired goods for customer from the seller resale to the customer at a +rice which contains

the cost of the +urchase +lus a +re-agreed +rofit! hence it is a cost +lus sale contract. 'ost

im+ortant is that 'urabaha contracts have fle7ible re+ayment +eriods! com+etitive +ricing!

including minimum limits on 'urabaha finance and variable tenors of loan financing for

such loans.

'ost of the financial transactions of Islamic banks deal mark u+ or cost +lus sale contract.

One o+inion is that this mark u+ sale contract to be an interest based contract as it in fact

charges interest but calls it +re-agreed +rofit. In given case it is e7-ante +rofit and not reali&ed

+rofit as was initially +redetermined under Islamic law. Islamic scholars argue that while

Islam allows trading and its related +rofits and loss and does not su++ort the conce+t of fi7ed

return loan contracts.

han and hatti $0035 argued that the +ractice of 'urabaha financing grossly violates(hariah +rinci+les. Islamic banks insure 'urabaha goods against the risks of damage!

23


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destruction and theft! and im+ose all such costs on their clients ashir! 1999F /arde! $0005.

:urther Islamic banks em+loy interest rates to fi7 returns and assign higher returns on

'urabaha contracts for longer time ;ust like conventional banks. "lso introduce the rule of

+ay now! +ay less. (imilarly! they charge clients in case of delay +ayments. "lso illegal

recovery methods are use to recover loss from clients who violate their +romises to buy

'urabaha goods. hus! Islamic banks earn almost risk-free returns on their 'urabaha

investments Aomoud! 1994F


25/94

mechanism is +redefined where as the losses are based on e)uity +artici+ation. 'usharaka

financing is commonly used by banks for financing trade! im+orts and to issue letters of

credit! agriculture and industry.

2.10.$ !odaraba

'odaraba is also similar to +revious modesF the main difference is that there is no e)uity

+artnershi+ but only +rofit and loss sharing in this ty+e of contract. Its com+arable case in

conventional business is in the form of limited +artnershi+. 'odaraba is a contract between

the bank and the customer in which the bank lends the entire ca+ital to the investorGcustomer

debtor5 and the financial losses of the debtor entre+reneur are belong wholly to the bank.

he customer held liable for the losses in case of mismanagement or neglect.

On the balance sheet it is +resented on both the asset and the liability side. On the liability

side it is an unrestricted 'odaraba in which the de+ositors agree that the bank is free to

choose the investments that it will make with their de+osit money and agree to share the

+rofits earned by the bank. On the asset side it is a restricted 'odaraba contract because the

bank agrees to finance a +articular restricted5 investment need of the customer and to share a

+ercentage of the +ro;ect@s associated +rofits.

In modern finance! the 'odaraba contract is e)uivalent to a +artici+ating +referred stock with

no contractually +romised interest ,brahim! 19995. he 'odaraba contracts are +rofit-

sharing agreements. acha 199#5 analy&ed the 'oderaba facility as a hybrid contract in

conventional financial terms. It recombines the characteristics of both e)uity and Islamically

allowed credit and debt contracts. he entire ca+ital re)uirements are +rovided by a bank

modarib5 for investment in a +ro;ect while e7+ertise! management and labours are +rovided

by the customer or investor Cabbul-mal5. On +re-agreed basis! the +rofits are shared by both

+arties from the +ro;ect! but in the case of loss! the total loss is bear by the bank 6hong and

Dui! $0035. In such agreements! as regards to debt investors the Cabbul-mal5 has a ;unior

+osition but has a +referred +osition over an e)uity investor musharik5.

he com+osition of an Islamic bank is conventionally based on two hy+othetical modelsF

.4.4.1 he two-tier 'oderabaJ model

.4.4.$ he two-windowsJ model I)bal and 'irakhor! $00*5.

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2.10.$.1 *he >t-o=tier !oderaba mode"

he two-tier 'oderaba model relies on the idea of +rofit-sharing. It integrates the +roblems

and assets sides of banks! balance sheets based on the +rinci+le of two-tier 'oderabaJ. On

the basis of 'oderaba (iddi)i 1930! 193$F 6ha+ra 193#5 this model re)uires that both

resources mobilisation and consum+tion. he first tier of 'oderaba bond is between the

investor or saver and the bank mudarib5. he saver act as the funds +rovider and the banks

invest the money on their behalf. he investors share not only in the +rofits but also in the

losses that are earned by the bank@s business related to the investors@ investments. In this ty+e

of bond the +rofit-sharing investment de+osits are not liabilities of the bank but they are a

form of limited term-non-voting e)uity I)bal and 'irakhor! $00*5. In it! funds are +laced

with the bank in an investment account and there are no guarantees on either the +rinci+al or

the return ,lhiraika! $00$5. In addition to the investment de+osits! the banks also acce+t

demand de+osits which are the liabilities of the bank as they are re+ayable on demand at +arF

therefore they yield no returns to the bank. :urther! the second tier of 'oderaba agreement is

between the bank and the entre+reneurs looking for funds5. "ccording to a certain

+redetermined +ercentage as +er the contract the entre+reneurs agree to share the +rofits with

the bank or in other words! an Islamic financial institution can act a vital role as an

intermediary between investors and entre+reneurs.

Aence uni)ue feature of thee two-tierJ model is that the assets and liabilities of the banks are

integrated. ow if the bank@s assets decline due to some shock then due to the +rofit sharing

nature 'oderaba5 of the de+osit contracts! the liabilities of the bank also decline

corres+ondinglyF therefore! +reserving the net-value of the bank. herefore! the crisis of

asset-liability dis+arity does not occur which reduces the need for active assetGliability

management and in turn! adds to the solidity of individual banks against economic shocks.

:urther! as a whole! it will also +rovide stability to the financial system by avoiding a domino

effect "li! $004F I)bal and 'irakhor! $00*5. 'oreover! stability achievements and avoid

bank runs can be attained linking the returns on liabilities to the return


27/94

Islamic +rofit-sharing model! the de+ositors see that the overall rate of return in the financial

system has declined when there is a recession in the economy and as a result of which the

+robability of withdrawals and bank runs will be undersi&ed. Aence! it can be inter+reted that

the use of 'oderaba contracts will have +enali&ing effect on the banks as un+rofessional

conduct and incom+etence are +unished by de+ositors.

2.10.$.2 *he >t-o=-indo-s mode" I@ba" and !ira/hor3 20095.

he two-windowJ model also features demand and investment accounts but takes a diverse

view from the first model on reserve re)uirements. 'ainly! funds de+osited as demand

de+osits re)uire 100P reserve whereas investment accounts re)uire no reserve re)uirements

han! 193 5. Aence! both the two-tier 'oderabaJ and two-windowsJ model of Islamic

banking demonstrate that the losses incurred are treated as a result of investment activities by

the banks so it reflects as reduction in the value of the de+ositor@s wealth but in both models

the chance of losses reduces through a diversification of bank@s investment +ortfolios and

cautious assortment. 'oderaba contracts are well again balanced in the vicinity of risk

management as the +ayment is reduced in the +eriods of economic recessionF the

entre+reneur has to make to the Islamic bank. /hile in the interest-based system lenders may

re;ect further credit overreacting to the shocking news when the entre+reneur faces

momentary hitches in debt-servicing for instance owing to a short-term adverse demand

shock. "s a fact that interest +ayments are due to irres+ective of the +roductivity of the

+hysical investment and any debt-servicing +roblems on +art of the borrowers may modify its

fortunes. In fact (tiglit& 19335 argues that interest rate is not like a conventional +rice like

+rice of credit which ad;usts to clear the market and it is assure to +ay amount in the future.

6onventional banks@ lending is carried out on the basis of the credit value of the borrowers

which is influenced by interest rates.

anks may credit ration its borrowers if!

:irstly! before +roviding loans! the banks cannot differentiate between borrowers with

different credit risks!

"nd secondly! the credit contracts were sub;ect to restricted liability the borrowers

bear no res+onsibility for making the +ayments if +ro;ect returns were less than the

debt obligation5


28/94

ow adverse selection may be caused if interest rate increases which would leave a more

risky +ool of borrowers in the market for funds. (o then only the risky borrowers with higher

returns would be ready to take u+ the banks contract again causing ethical risk (tiglit& and

"ndrew /eiss! 19315. (o increasing the interest rate adds to the +ro+ortion of the risky

borrowers in the develo+ment and reduces the overall +rofitability of conventional bank.

/hile in Islamic 'oderaba model of banking! lenders generally receive all the information

relating to the +erformance of the client@s +roduction fre)uently in order to know about

income so that the current information as well as the +ayment from the borrower to the lender

is more or fewer on an on-going basis and it is good in order to avoid tem+orary shocks so

that functioning of Islamic banks is not distressed.

'oderaba contract under Islamic banking is +rimarily footed on the influence of "llen 19315

in his e7traordinary study on the Brevention of defaultJ. Ae showed that in order to avoid

evasion! in order for lenders to be confident about receiving +ayments! de+osit on loans will

be re)uired. Aowever! it may be +ossible to create +rofitable contracts which avoid default if

the rule of only lending to those borrowers who have not defaulted is ado+ted by lenders

hence it allows +eo+le to borrow without security so in this case the lenderRs +rofit

ma7imi&ing contract is a share contract with a lower bound on out+ut and it almost

com+arable to 'oderaba contracts. "llen 19315 has argued that if borrower defaults so then

the total cost of +ayments from a share contract may be reduced for low levels of out+ut! and

then ca+ital is rented out in successive +eriods to collateral with an interest riba5. hus! share

contracts take out as much as +ossible from every borrower without +reci+itating default

which a++ears to be like a two-tier 'oderabaJ contract. "lso! "llen 19315 showed that a

varied debt e)uity loan is most favourable with the debt-e)uity ratio increasing with the

wealth of the borrower in the event of a borrower owning a small amount of collateral and

which a++ears like the two-windowJ 'oderaba. hus! we conclude that 'oderaba contracts

can be resourceful contracts which can reduces defaults in a banking system where borrowers

and lenders are involved.

"dditionally! a study by ,brahim 19995 concluded that securiti&ation of the 'oderaba

facility avoids the disagreement of ai@al-dayn bi al-dayn sale of one set of debt security

with another5. Aence Islamic banks could have turn away the recent %.(. sub+rime creditcrisis which involved the investment banks securiti&ing the credits into bonds that were

28


29/94

+urchased from the lenders and then they were sold forward to investors through

collaterali&ed debt obligations 6=Os5.

:urthermore! Aa)ue and 'irakhor 193 5 modelled the a++lication of agency theory to

'oderaba contracts by firstly +ainted that the owner of the financial ca+ital is the +rinci+al

and the entre+reneur is the agent which showed that managerial effort +lays a vital role in

strategy of the contract. ,7+licit ma++ing is created under the standard incentive-com+atible

interest based ribawi5 contract between the +ayment and in+ut of ca+ital! wherein the

manager is o+en-minded to chose the individual most favourable level of effort in each state

grou+ on the s+ecified level of investment. On the other hand! e7+licit ma++ing is created

under a 'oderaba contract between the remuneration and the +erformance or +roduct of the

+ro;ect which will give banks undeviating control on the behaviour of the agent-entre+reneur

I)bal and 'irakhor! $00*5. "dditionally! Bresley and (essions@ 19945 model! showed that

the use of 'oderaba contracts show the way to su+erior level of ca+ital investment I-e

increase in average investment while incom+etently huge fluctuations around this level are

reduced! as 'oderaba contracts have the ability to act as an efficient e7+osure device as it

may +ermit the well-organi&ed revelation of any informational benefit which the manager

may have over the owners of ca+ital investors5.

"s a++ro7imate movement of ca+ital which is one of the main causes of instability in

e7change rate! is disheartened under an Islamic financial system that is decrease in movement

of short-term ca+ital for s+eculative +ur+oses will minimi&e the demand and deliver shocks in

the currency market and eventually lead to more constancy in the e7change rate. Aence the

fle7ibility will be smaller then that of conventional economics which is because of short-term

ca+ital in an Islamic contract that is sensitive to rate of return. "s a fact that as Islamic

financing is cou+led to real transactions so it cannot be li)uidated as soon as the rate of return

changes. "n im+ortant +oint is that variability in the e7change rate will be reduced in the

absence of +rofitable interest bearing de+t and it is because as Islamic banking system interest

rate riba5 does not +ersevere and debt cannot be e7changed in markets which reduces the

mobility of ca+ital and making the e7change rate less unstable "hmed! $0015.

It can also be argued that Islamic banks +erformance on 'oderaba contracts creates a lesser

amount or relatively no ins+iration for market asset +rice bubbles to surface. (o both theIslamic bank and entre+reneurs have chance in the +roductivity of savings and none of them

29


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have definite returns. Aence we can say that sharing of losses would make sure better

financial market@s constancy and diminish the financial and social costs of banking crisis.

:inally! the 'oderaba model would also smart down the costs involved in initial structures

and institutions so as to deal with the negative effects of financial liberali&ation! e7cessive

volatility! and information +roblems related with international financial markets. Brinci+ally!

+ro;ect funding and foreign direct savings will be encouraged by eliminating +erce+tions of

risk free investment and the +rofit-loss sharing mechanism which are considered as the most

suitable forms of ca+ital flows into develo+ing countries ,lhiraika! $00$5.

2.10.+ Sa"am sa"es contract5

It is future date commodity in which +rice is +aid in advanced in cash to the seller who abides

to deliver a commodity of determined s+ecification on a definite due date (addi)ui! $0035.

he deferred is the commodity sold and described on liability5 and the immediate is the

+rice. =uring the +rocess of (alam! the bankM +ays the +rice in the contract to the seller so

that to have a )uick use of funds to cover the financial needs. he seller is res+onsible

through the contract to deliver the commodity on the s+ecific due date. he bank has many

o+tions to choose at delivery timeF for e7am+le! the bank receives the commodity on due date

and sells it either for cash or on credit! or it can authori&e the seller to sell the commodity on

its behalf against fees or without fees! or it can direct the seller to deliver the commodity to a

third +arty the buyer5 according to a +revious +romise of +urchase! where the +romise is that

the buyer will +urchase from the bank. he commodity is sold through a sale contract

between the bank and the buyer when the delivery has been arranged by any of the above

stated o+tions. he bank agrees to sell the commodity for cash or a deferred +rice higher than

the (alam +urchase +rice +aid by the bank to the seller in such contracts. "ccording to the

agreement the buyer also agrees to +urchase and to +ay the +rice. he (alam sale can be used

to meet the ca+ital re)uirements as well as cost of o+erations of farmers! industrialists!

contractors or traders as well as craftsmen and small +roducers.

(hariah s+ecifies that the terms and conditions of bai salam contracts! such as +rice! )uantity

and )uality of goods! should be clearly determined without involving any features of interest!

gharar s+eculation5 or dubious sale I)bal! 19935. 'aking the (alam contract by the banks

with a seller is beneficial because generally a (alam +urchase by the bank is chea+er than acash +urchase. "s a result the bank is secured against +rice fluctuations! barring those

30


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e7treme circumstances of a +rice deflation or a market crash when +ost (alam +rices could

immerse lower than currently contracted (alam sale +rices (addi)ui! $0035.

2.10.8 Ijara "easin# contract5

I;ara is commonly designed for sale of vehicles! e)ui+ment or +ro+erty for conducting

business. he conce+t of leasing in traditional banking is that it allows the customer buyer5

to lease goods at fi7ed interest rates while Islamic banking leasing facility has two sub

contracts. Initially! the bank signs a +urchasing contract with the seller for the commodity

that the buyer wishes to lease. he bank +ays the seller and then gets the commodity

delivered to the buyer from the seller. Dater! the bank signs a lease contract with the buyer in

which commodity is leased to the customer allowing him the ownershi+ or sim+ly the use of

the asset after +ayment of lease instalments and residual charges. his mode of finance is

commonly used for transactions in real estate! cars! com+uters! machinery and e)ui+ment.

'oreover the leasing en;oys strong su++ort from (hariah scholars and bears a close

resemblance to conventional leasing I)bal! 1993F /arde! $0005.

2.10.9 ard=e=Basna benevo"ent "oan or interest &ree "oan5

Islamic banks also offer a limited scale of loan facilities to +oorer sections of society such as

needy students or small rural farmers. hese kinds of loans would have negative BEs for

the banks (addi)ui! $0035. his kind of loan structure is e7cluded in traditional banking

system. "ny benevolence is only manifested through charities and grants or scholarshi+s! but

not through non-returnable &ero interest loans.

2.10.; *a/a&u"

:rom many years Islamic insurance +roducts e7isted. In 1930s with the contribution of =ar

"l-'all "l-Islami! one of the biggest Islamic financial institutions in the world such +roducts

came into e7istence in /estern ,uro+e. he business environments welcome it and akafol

+roducts were well received by the ethnic 'uslim community living in /estern ,uro+ean

countries. he early ty+es of akafol +roducts were unit-linked savings +lans where the

benefits of the +olicy were notionally linked to the value of the underlying assets in theinternal funds of the akafol 6om+any. hose +roducts were! in general! com+lying with

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Islamic shariah +rinci+les regarding the ty+e of investment and risk. he main +rinci+le on

which akaful +roduct design are riba-free investments! no dece+tion! no +rofit to the

akaful 6om+any from favour able mortality e7+erience and worked on solidarity +rinci+les

rather than +robabilities (hakir! $0035. In the light of above rules! the akaful +olicyholdersR

funds were invested in short term assets without any fi7ed interest or guarantee of ca+ital and

the mortality risk was shared on a solidarity basis so that any loss or +rofit due to mortality

was shared between the +olicyholders. Aowever! the akaful savings +roducts only offered a

small death cover! which limited their demand to +otential customers. (imilarly to satisfy the

insurance needs of 'uslim community a wide range of +roducts such as term assurance!

mortgage +rotection or old age annuities are introduce but the +rocedure of launching new

akaful +roducts has been very slow.

here are around more than 40 akaful o+erator@s worldwide mainly giving general business

II I! $0035. he total assets and contributions of these o+erators are around 21 billion and

2#00 million res+ectively which are very low as com+ared to the 'uslims +o+ulation.

"ccording to 6ar+enter owring Dondon which o+erates under the 'arsh 'c Dennon


33/94

here are some similarities between conventional bond and (ukuk such as marketability!

rateability! enhanceability and versatility. (everal ste+s are involved while issuing (ukuk

such as +re+aring a detailed feasibility study! creating a general framework and

organisational structure to su++ort the issuance +rocess! develo+ing suitable (hariah structure

to achieve the set ob;ectives in com+liance with (hariah. It also re)uired legal documentation

from both issuer@s and arranger@s +ers+ective and assigning the (BE to re+resent the

investors and +lacing the (ukuk into circulation.

(hariah "dvisors oard role is very significant in (ukuk because they are the advisors who

suggest (ukuk structure and +resent a (hariah structure to achieve economic ob;ectives.

hrough +arliamentary legislation % is going to create a new framework that becomes

hel+ful to (ukuk issuance. reasury minister! ,d alls! has been )uoted in mediaM /e are

looking to +lace domestic (ukuk on the same footing as conventional +roductsJ. his is a

very encouraging ste+ by the % but there is a need that industry +ractitioners with

e7+erience in (ukuk issues must be involved while develo+ing such a framework. It seems to

a++ear that future of Islamic finance is very feasible in the % and ,uro+e.

2.11 6rob"ems and cha""en#es &or Is"amic ban/in# ban/s5

In com+arison to conventional banking Islamic anking is still highly nascent. "s it is

com+aratively very new! it has been facing many +roblems and challenges. he constant

+roblem of sur+lus li)uidity is always su++osed as a biggest +roblem. "s they bear about 40

+ercent more li)uidity than their traditional rivals because there is a serious deficiency of

long-term (hariah-com+liant investment tools and avenues Aakim! $00$5. hey commit 9#

+ercent of their funds to short-term i;arah! murababah and musharakah instruments Islamic

:inance ews! $00 a5. :our ma;or Islamic banks established the Di)uidity 'anagement

6entre D'65 in $00$! which has been busy in making a secondary li)uid market for Islamic

bonds! government securities! e)uities! mutual funds ,tc. where as the other institutions for

e7am+le ank of 'alaysia! the Islamic 6hamber of 6ommerce and Industry I66I5! the

International Islamic :inancial 'arket II:'5 and the =ubai International :inance 6entre

=I:65 have been searching +ermanent answers to the li)uidity +roblem.

33


34/94

"ccounting standards and +ractices that Islamic banks +ractice and a++ly are many and

varied. " few of these banks a++ly International "ccounting (tandards I"(5! others stick to

standards a++lied by "ccounting "uditing Organi&ation for Islamic :inancial Institutions

""OI:I5! and some take on accounting standards common in their local markets. he

heterogeneity in accounting +ractice and disclosure in Islamic banks left every one in

confusion including researchers and financial managers.

In reality! the Islamic anks should sim+ly give relevant and authentic information to the

stakeholders about their res+onsibilities towards the financial! social! environmental and

religious areas (ultan! $00 5. Aowever it is significant to mention that ""OI:I and Islamic

:inancial (ervices oard I:( 5 have been working over the years to invent universal

accounting and auditing +ractices which are best for Islamic banks. (o far ""OI:I has

develo+ed more than accounting standards for the guidance! and ado+ted by 1 0 member

institutions! re+resenting in 0 countries worldwide.

here is a considerable lack of knowledgeable (hariah e7+erts in the Islamic banking

industry. Only some small (hariah e7+erts are serving on several (hariah boards of Islamic

banks globally. On (hariah com+liance a consultant names 'a;id =awood! who based in

Dondon has notified that (hariah e7+erts earn as much as %(233!#00 +er year +er bank

'atthews! $00#5. In some case it raise u+ to %(2#00!000 for advice on large ca+ital market

transactions ett! $00 5. In small Islamic banks (hariah scholars have little in-de+th into the

com+lication of +resent-day financial markets. o have strong (hariah scholars Islamic banks

should make a strong base of research and training to develo+ teems of (hariah scholars.

hose should be of high moral and +rofessional integrity. hey should also set u+ a central

(hariah board and an e7ternal audit committee to +rovide an accurately self-governing

ins+ection of the Islamicity of their o+erations.

Cisk management strategies and cor+orate governance are other big hurdles that Islamic

banks are facing. "s been relatively new they are e7+osed to all sorts of risks for e7am+le

those risks which are related to interest rates! li)uidity and non-+ayment. (ukuk issues lead to

risks! relating interest rates! foreign e7change! credit and (hariah com+liance Aobson! $00 5.

hey cannot use traditional risk management techni)ues and tools because they are based on

interest! gambling and s+eculation! as they are strictly barred by (hariah. "t this +oint onlygood governance can significantly hel+ to moderni&e the organi&ational structure of Islamic

34


35/94

banks on a more efficient and inde+endent basis. In addressing the issues which are related to

risk management! ca+ital ade)uacy and cor+orate governance! ank egara 'alaysia!

International Islamic Cating "gency IIC"5! I:( and other su++orting bodies have been

a++roaching very fast for the develo+ment of +rudential regulations and systems.

Cealistically the Cesearch! =evelo+ment and Innovation are very slow and unsatisfactory.

he reason behind this is the si&es if Islamic anks are small and cannot afford to develo+

their own or ;oint C and = facilities. >ust only big Islamic banks are engaged in some kind of

serious C and = actions. ecause of this! there has been a huge flight of native oil wealth

from the


36/94

legal! regulatory and financial frameworks for Islamic banking o+erations. " number of

su++orting bodies! including the =ubai :inancial (ervices "uthority! I:( and 'alaysia@s

(ecurities! have been working with traditional banking authorities to determine regulatory

issues linked to Islamic finance +ractice. hese develo+ments should take Islamic banking

towards greater financial and (hariah disci+lines! su+eriority and incor+oration with

international financial markets.

Dastly! Islamic banking +ersonnel are largely drawn from conventional banking because there

has been a delicate shortage of human ca+ital resources in the Islamic banking industry.

,ither they are +ro+erly trained or maybe not loyal to the learning or +ractising (hariah

entertains banking. hey are +aying attention only in removing interest from Islamic banking

o+erations without realising the true +ur+ose behind this e7ercise. 'a;or Islamic banking

training institutions such as the Institute of Islamic anking and Insurance! Islamic :inance

raining! and the International 6entre for ,ducation in Islamic :inance I 6,I:5 arrange

re+eated and numerous training sessions! conferences! collo)uiums and worksho+s! but this is

not hel+ing to develo+ Islamic banking +ersonnel with financial-cum-(hariah know-how. It is

good time that the Islamic banks should made substantial investments in human resources

develo+ment and training and research faculties. Internally groomed human resources can

only add real time value and solutions to the current issues and challenges which currently

the Islamic banking system is facing.

2.12 ,an/in# Sector crises and ro"e o& Is"amic ,an/s

he world is swiftly heading towards inter-nationalisation! so the attentiveness of +ower is

surrounded by few com+anies which are intercontinental. 'ore over! that gives birth to lack

of e)uality among societies and divided them in to se+arate classes. he socio-economic

conce+t of Islam is relatively different from others that believe on e7tir+ate of interest and all

other dis+arate elements from the economic globe. 'oreover! the Islamic financial system

ca+able of elements for lending! borrowing and investment functions on a risk-sharing basis.

(o it entertain market forces to set u+ the out+ut of ca+ital other then fi7ing it in higher in

im+ortance as an KKinterest rate@@ to damage the free market system and su++ort tentative use

and advertisement of investment.

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usiness in "sia +lagued with bankru+tcies whose incomes declined lower than that of its

fi7ed interest debt res+onsibilities in the +eriod of 1990s ,brahim! $0005. he e7+ected

condition took +lace in 1930s in some Datin "merica countries when they became defaulted

on its debt and the huge debts! left the banking system nearly irresolvable heberge! 19995.

Cecently large ritish and %.( ank such as Dehman rothers! orthern Cock! ear (tearns

and recently have been declared bankru+t as they massively defaulted on their mortgage

+ayments while oscillations in interest and mortgage rates +layed a decisive role in bringing

about the financial crisis and homeowners! cor+orations +roblems and in +articular has create

%.(. sub+rime mortgage crisis.

orrowing for banking is mostly from financial institutions! businesses! individuals! and

governments with e7cess funds savings5. hen banks use those de+osits and borrowed funds

liabilities of the bank5 to make loans or to +urchase securities assets of the bank5. :or

borrowers! lenders! and banks interest rates +rovide the +rice signals. /hen the value of their

liabilities e7ceeds with res+ect to the value of their assets! banks are bankru+t. he value of a

bank@s assets may turn down owing to the inca+acity or unwillingness of the borrowers to

service their debtGloans credit risk of default5. 6redit risk can be minimi&ed in a number of

ways! for e7am+le! by scrutini&ing loan a++licants! e7+anding the loan +ortfolios! striking

severe +enalties or fines! or asking for guarantee on loans in order for lenders to be sure of

receiving +ayment "llen! 19315.

=efault is foremost +roblems which cannot entirely be getting rid of. his is because if severe

+enalties are forced! it may +ut off +eo+le from taking loans and there may be no s+ur to take

risks "llen! 19315. "lso! asking for guarantee as a way of avoiding default become visible to

be e7ce+tionally e7tensive! however! it is e7+ensive to create and monitor! and its value is

naturally sub;ect to variations "llen! 19315. :urthermore! credit risk also a++lies to on and

off-balance sheet e7+osures! such as receiving! guarantees and investments in securities and

derivatives. ankers are fully aware that lending is a volatile business! and thus! they set a+art

of reserve for likely losses. y+ically 1 to $ +ercent of total loans and leases enton ,.


38/94

and rescue the banks either by lowering interest rates or raising them to +rotect the e7change

rate. his can ultimately guide to a currency crisis or enormous ca+ital esca+e


39/94

Ce+ort! 193$5. (ubse)uently! there is a shar+ rise in highly influenced short-term debt! which

makes the banking system susce+tible to internal and e7ternal shocks and thus! vulnerable to

financial crises.

he Kreal estate connection@ to bank failures is a common +henomenon. :or real estate

+ro;ects mortgages are a common source of finance. Ceal estate mortgage worth@s rise and

fall with interest rates. Interest rates! in turn! are affected by government monetary +olicy.

herefore! in the real estate markets! an e7+ansion of credit will reduce the interest rate at

which investors can borrow and this will eventually bid u+ the +rices they are willing to +ay.

he bubble may eventually burst and asset +rices colla+se if there is further e7+ansion in the

volume of credit cou+led with uncertainty about the future +ath of credit e7+ansion. /hen

this volcano eru+ts! the banks come under severe strain and the government will be forced to

ste+ in and rescue the banks or may be forced to li)uidate. his +henomenon can also

eventually direct to a currency crisis where the government may be forced to choose between

raise them to defending the currency or lowering interest rates to save the banking system.

,ven if the interest rates are raised there may still be ca+ital flight! as +ointed out earlier

"llen and


40/94

develo+ment as if +eo+le were not matterJ. "lso it is not wide-ranging and many negative

outcomes like shortages of demand! weakness of individual interest to achieve +ublic needs!

and the discre+ancy between +rivate and social costs and benefits is linked. It seems to a++ear

that such kind of develo+ment is usually associated with negative macroeconomic and

environmental outcomes such as stagnation! inflation! e7ternal deficits! and environmental

degradation. he main ob;ective of such system is only in increase of ca+ital accumulation so

as to get ma7imi&ation of +rofit without +aying any attention to the religious and s+iritual

dimensions that tending to social and environmental damages.

Islamic develo+ment theory is based on s+reading of develo+ment benefits between massive

rural develo+ment and e)uitable distribution of income. It contains social! financial! and

s+iritual dimensions. he general idea and conce+ts related to Islamic bank were discussed in

the light of literature. 'oreover! the difference between Islamic and conventional banking

and an overview of different +roduct offered by Islamic banks were e7amined.

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42/94

data. Aaving many methodological a++roaches to research! the most suitable to undertaken

research will be ado+ted.

he way of thinking or +oint of view of +eo+le may vary for same thing! situation or

scenario. In views of researcher@s! it is very im+ortant to look the world as having +eo+le or

+rocesses or effectiveness or guiding +rinci+les or actions or language communications or

rules and belief systems or motives and constraints but it cannot be all of these >ankowic&!

$00#5. "ccording to (aunders et al. $00*5 all the decisive events faced by the researcher to

acce+t or re;ect while collecting data de+ends on researchers ontological +osition. :urther he

considers ontology to the things that are very im+ortant and can have their influence on the

methodology and data collection techni)ues.

Limond $00 5 describe different as+ect of ontology. he first is ob;ectivism which de+icts

the stance that social entities e7ist in reality e7ternal to social actors concerned with their

e7istence. he second view is sub;ectivist view reveals that social +henomena are formed

from the observations and subse)uent actions of social actors. It is a constant +rocess in

which these social +henomena are in a constant state of revision through the +rocess of social

interaction. he researcher will launch given research by ado+ting an ob;ectivist a++roach

along with a +ositivist +osition.

(imilarly another research +hiloso+hy is e+istemology that deals the researcher@s +ersonal

theory of knowing. It suggests what to count as knowledge! evidence and +roof and what

does not. 'oreover! the researcher will em+loy the best methods to achieve the re)uired

knowledge evidence5. It is obvious that e+istemology is related to the researcher +ersonal

theory of understanding that has im+act on the ado+ted methodology and techni)ues.

" researcher could take his own! +rivate ontological +osition if the researcher only concerned

about to understand something +rivately but to create a sense of the knowledge it is im+ortant

that researcher follow certain rules so +eo+le can agree or disagree >ankowic& $00#5. he

truth e7ists se+arately of the +eo+le who search for it and can be establish through the logical

deduction or through the set of data as a result in incontestable facts. (imilarly +ersonal

beliefs! hunches! feeling intuitions! and emotions do not count as evidence (aunders et al.!

$00*5. "ccording to >ankowic& $00#5! +ositivism is among two a++roaches to +ublic

knowledge formation that contains different beliefs about how a researcher can make sense toothers. Dikely (under et.al $00*5 suggests that +ositivists advocate working with an evident

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social reality. 'oreover! the im+ortance is on well structured methodology to assist

re+lication and the result will be law similarly in natural sciences.

"s the main +ur+ose of given research +ro;ect is to analy&e Islamic anking and its

feasibility in % . he researcher will study the causal relationshi+ between variables and will

therefore the research will be +ositivist or )uantitative in design and data will be +rocessed

and analysed deductively.

. Research approaches7

. .1 eductive and Inductive !ethod

he deductive a++roach usually em+hasi&es on scientific +rinci+les. "ccording to (unders et.

al $00*5 it moves from theory to data! It involves the im+ortance to e7+lain causal

relationshi+s between variables! gathering of )uantitative data! the a++lication of controls to

ensure validity of data! the o+erational conce+ts to ensure clarity of definition! a highly

+rearranged a++roach! researcher inde+endence of what is being researched and the

re)uirement to select sam+les of sufficient si&e in order to generali&e conclusions.

:urthermore he argues that on the other hand the inductive a++roach stress on getting an

understanding of the meanings humans attach to events. It includes a close understanding of

the research conte7t! the collection of )ualitative data! the more fle7ible structure to allow

changes of research em+hasis as the research +rogresses! a reali&ation that the researcher is

+art of the research +rocess and less concern with the need to generali&e.

In view of (aunders et al $00*5 deductive research can be finished in a short +eriod of time.

ut there is a need to setting u+ the study +rior to data collection and analysis while inductive

research can be more +rolonged. (imilarly! the risk involved to the research to ado+t

deductive a++roach is less as com+ared to inductive research. "lso inductive a++roach has

greater risk that no valuable data +atterns and theory may a++ear.

"s the main +ur+ose of given research +ro;ect is to analy&e Islamic anking and its

feasibility in % . he researcher will study the causal relationshi+ between variables and will

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therefore the research will be +ositivist or )uantitative in design and data will be +rocessed

and analysed deductively.

. .2 ua"itative or uantitative *echni@ue

"ccording to (under et al $00*5 the two ma;or research a++roaches are )uantitative and

)ualitative. It is very im+ortant to use the right a++roach in order to ma7imi&e the +otential of

the research e7ercise. Nin 199 ! +. *5 stated thatFJQuantitative and )ualitative data are both

considered +otentially im+ortant and relevantJ. :urther suggesting that )ualitative research a

soft social science interested in mushy +rocess and dealing with inade)uate evidence. On the

other hand consider )uantitative research is hardnosed! data driven! outcome oriented and

truly scientific. (imilarly 6ormack $0005 argues that )ualitative research mainly em+hasis

on words that may be in written form or s+eech whilst )uantitative is based mostly on

numbers and s+astics.

he )uantitative data is considered to all such data that can be a +roduct of all research

strategies. he rage varies from sim+le counts to more com+le7 data such as test scores!

+rices etc. he data collected is analy&ed and inter+reted to make it understandable. (under et

al $00*5 suggest that )uantitative analysis techni)ues are hel+ful in such situation. It

involves in creating sim+le tables or diagrams that elaborate the fre)uency of occurrence

through evolving statistical relationshi+s connecting variables to com+le7 statistical modeling

(aunders et al.! $00*5. he )uantitative techni)ue develo+s from the idea of +ositivism tends

to e7+lain conce+ts and research results in calculable and sufficient )uantitative term dealing

with numbers and anything that is measurable Aussey and Aussey! 199*5. 'oreover! it has

structured )uestions where the res+onse o+tions have been +rearranged and a large number of

res+ondents or sam+les are concerned (aunders et al.! $00*5.

Common i&&erences bet-een uantitative and ua"itative Research Strate#ies

uantitative ua"itative

=ata e7+ressed in numbers =ata e7+ressed in words

=eductive Inductive

6ontrolled research situations aturally occurring and conte7tual

44


45/94

Isolation of o+erationally defined

variables

Aolistic view of +henomena

(eeks ob;ectively Interested in sub;ectively

,m+hasis on +rediction and e7+lanation ,m+hasis on descri+tion! e7+loration

Cesearcher directs! mani+ulates! controls Cesearchers +artici+ates and collaborates

(tatistical analysis e7t analysis

(ourceM Cudestam and ewton! $00*5

.$ Research strate#ies7

"ccording to (under et al. $00*5 research strategy will be a general +lan of how researcher

will go about answering the research )uestion. Cesearch strategies are systematic and orderly

a++roach use to collect and analyse data so as to relevant information >ankowic&! $00#5.

here are different strategies usually used in business and management +ro;ect work. he

selection of strategy de+end on the nature and sco+e of the study! the sources of data being

used! the +ur+ose in gathering data! the amount of control a researcher is e)ui++ed to use inattaining these data and the assum+tions he makes when analy&ing that data.

=ifferent strategies such as e7+licatory! case-study! survey! grounded theory ethnogra+hy!

cross sectional and longitudinal studies and e7+erimental method are +ro+osed by different

writers such as >ankowic& $00#5 (aunders et. al $00*5 Likmund $00 5. "s the research is

associated to deductive a++roach the researcher will em+loy survey as a strategy to achieve

ob;ectives of the study.

.$.1 Survey

" systematic a++roach towards getting! mani+ulating and analysing the data to e7tract

information is known as research method Likmund! $00 5. here are many methods which

are used in business and management +ro;ect work. he selection of method de+ends u+on

the nature and sco+e of the to+ic! the sources of data being used! the +ur+ose in gathering

data! the amount of control a researcher is +re+ared to e7ert in obtaining these data and the

assum+tions he makes when analy&ing that data Likmund! $00 5. 'any methods for

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researcher are available such as e7+licatory method! case-study method! survey method and

e7+erimental method (aunders et. al! $00*F >ankowic&! $00#F Likmund! $00 5.

(urvey is a method of +roducing +rimary data and is used as a research techni)ue in which

information is gathered from a sam+le of +eo+le using a )uestionnaire >ankowic&! $00#F

Likmund $00 5. In view of (aunders et al. $00*5 surveys are generally associated with

deductive a++roach and are a common strategy in business and management research.

>ankowic& $00#5 further says that in surveys! you direct your )uestions at relatively larger

grou+s of +eo+le who re+resent some larger +o+ulation such that to e7+lore issues largely in

the +resent.

he +resent study involves collection of data through )uestionnaire so as to address the

research )uestions highlighted above. Aence the researcher will use survey as a method of

research.

.+ ata Co""ection !ethod

.+.1 uestionnaire

In business and management research! )uestionnaire is used in the +resence of survey

strategy because in survey using )uestionnaire the res+ondent is asked to res+ond to the same

set of )uestions. It hel+s the researcher to collect data in an efficient manner from a large

sam+le +rior to )uantitative analysis Likmund $00 5.

Cobson $00$5 says that )uestionnaires work best with standardi&ed )uestions such that the

researcher is confident that it will be understandable the same way by all res+ondents thus is

for descri+tive or e7+lanatory research.

(aunders et al. $00*5 categories )uestionnaire variables into three ty+es namely o+inion!

behavior and attribute. O+inion variables +resent how res+ondents feel about something or

believe is correct or wrong (aunders et al.! $00*5. ee+ing this in view the underline

research is more associated to o+inion based variables.

/hen the res+ondent has time he agrees to fill the self administrated )uestionnaire so there is

greater +robability that res+ondents will take time to think regarding re+lies >ankowic&

$00#5. ut the collected res+onses are highly standardised so )uestionnaires are more

ob;ective focus. his is also su++orted by (aunders et al. $00*5 that )uestionnaires are verystandardi&ed and the )uestions are )uite +lanned that can hel+ in collecting valuable data

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from the res+ondents. It seems to a++ear that the )uestions and instructions in )uestionnaire

should be clear and sim+le because if )uestions or instructions are e7+ressed difficult then

there are more chances wrong inter+retations that lead to wrong result and will affect the

outcome of the data analysis negatively. Other characteristics are that it is easy to analy&e!

data entry and tabulation for nearly all surveys can be easily done with many com+uter

software +ackages. 'ost of the +eo+le have e7+erienced about )uestionnaires >ankowic&!

$00#5.

he main defect in written )uestionnaires is the +ossibility of slow and low res+onse rates.

he low res+onse effects the statistical analysis +rocess that can raise )uestions about the

reliability of the results generated from that analysis >ankowic&! $00 5. he researcher will

overcome from this +roblem by introducing sam+ling techni)ues which can hel+ in achieving

high res+onse rates during data collection stage.

he main ob;ective of the research +ro;ect is to analy&e Islamic anking and its feasibility in

% which is more close to the o+inion variables! so in this way the o+inion of the customers

of the about Islamic banking can be known. he researcher has taken )uantitative a++roach

so )uestionnaire will be a++ro+riate for this +ur+ose.

.8 Samp"in# and 6opu"ation

(aunders et al. $00*5 define +o+ulation as an entire set of cases or grou+ members and

sam+le is a +ortion or +art of that grou+. (am+ling involves any +rocedure that uses a small

number of items or a +ortion of +o+ulation to make a conclusion regarding the whole

+o+ulationJ Likmund! $00 5. It is im+ossible for a researcher to survey the whole +o+ulation

because some constraints such as time +revent him from surveying the whole +o+ulation

that@s why heGshe select a +ortion of it as a sam+le >ankowic&! $00#5. In fact now Islamic

ank and their windows in conventional banks are o+erating across the country! so it will be

im+ossible to analy&e the whole +o+ulation. herefore! the researcher will use sam+ling

techni)ue to re+resent the whole +o+ulation. 'uslim community +o+ulated areas in % will

be the +o+ulation in this research study as their feedback will be used to analy&e the Islamic

anking and its feasibility in % .

"ccording to Likmund $00 5! there are two techni)ues of sam+lingF +robability sam+ling

and non +robability. he +robability sam+les de+end u+on the availability and accessibility ofsam+ling frame which is a list of all the individual members of +o+ulation. "s accessibility to

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obtaining the list of all the customer having Islamic account and finance is im+ossible due to

=ata Brotection "ct of the % and certain ethical issues! therefore! the researcher will use

non +robability convenience5 sam+ling wherein the researcher will a++roach those

customers which will be most easily available to the researcher. (imilarly! another issues

related to sam+ling is to selecting an a++ro+riate sam+le si&e Likmund! $00 5. " sam+le of

1*0 customers including students following or like to follow Islamic anking in

irmingham! 'anchester! Dondon! 6ardiff and refforest areas will be selected using

convenience sam+ling

.9 ata Ana"ysis

=uring researches )uantitative5 data is in raw form. o make it meaningful! this data needs

to be +rocessed (aunders et al.! $00*5. :urther! the writers suggest that )uantitative analysis

techni)ues such as gra+hs! charts! tables and statistics should be used to e7+lore and e7+lain

trends in the collected data. =ifferent software@s are used to analyse )uantitative data such as

(B(( (tatistical Backage for the (ocial (ciences5! ,7cel! Eisio etc. he one which is taken

for the underlying research is (B(( stand for (tatistical Backage for the (ocial (ciences.

(B(( is sim+le to use! easily available and used com+rehensive statistical com+uter +ackage.

Eariety of data analysis and +resentation functions such as statistical analyses and gra+hical

+resentation of data can be +erformed through (B(( and ,7cel. he researcher will +roduce

different kind of gra+hs during data analysis. he outcome of each )uestion in a

)uestionnaire will be +resented through gra+h. (B(( and ,7cel software will be used for all

this. It will be a hel+ful +rocedure to analy&e Islamic anking and its feasibility in % .

48

Research 6hi"osophy

6ositivisim5 Rea"ism5 Interpretiv

Documents

Dessertation Islamic Banking in Uk