Haider Thises 3

Islamic Bank Vr Conventional Bank

CHAPTER 1:

1.1 An Overview of Bank

1.1.1 Bank Definition

The definition of a bank varies from country to country.

Under English common law, a banker is defined as a person who carries on the

business of banking, which is specified as:

conducting current accounts for his customers

paying cheques drawn on him, and

collecting cheques for his customers.

Bank is a financial intermediary and appears in several related basic forms:

A central bank issues money on behalf of a government, and regulates the

money supply

A commercial bank accepts deposits and channels those deposits into

lending activities, either directly or through capital markets. A bank

connects customers with capital deficits to customers with capital surpluses

on the world's open financial markets.

A savings bank, is only allowed to borrow and save from members of a

financial cooperative.

1.1.2 Islamic Banks and Conventional Banks.

Islamic banking and conventional banking are extremely different in many

ways. The key difference is that Islamic Banking is based on Shariah foundation.

Thus, all dealing, transaction, business approach, product feature, investment

focus, responsibility are derived from the Shariah law, which lead to the significant

difference in many part of the operations with as of the conventional

The foundation of Islamic bank is based on the Islamic faith and must stay

within the limits of Islamic Law or the Shariah in all of its actions and deeds. The 1

http://en.wikipedia.org/wiki/Cooperative

http://en.wikipedia.org/wiki/Savings_bank

http://en.wikipedia.org/wiki/Financial_market

http://en.wikipedia.org/wiki/Capital_surplus

http://en.wikipedia.org/wiki/Capital_market

http://en.wikipedia.org/wiki/Loan

http://en.wikipedia.org/wiki/Deposit_account

http://en.wikipedia.org/wiki/Commercial_bank

http://en.wikipedia.org/wiki/Money_supply

http://en.wikipedia.org/wiki/Central_bank

http://en.wikipedia.org/wiki/Financial_intermediary

http://en.wikipedia.org/wiki/English_common_law


original meaning of the Arabic word Shariah is 'the way to the source of life' and is

now used to refer to legal system in keeping with the code of behaviour called for

by the Holly Qur'an (Koran). Amongst the governing principles of an Islamic bank

are :

* The absence of interest-based (riba) transactions;

* The avoidance of economic activities involving oppression (zulm)

* The avoidance of economic activities involving speculation (gharar);

* The introduction of an Islamic tax, zakat;

* The discouragement of the production of goods and services which contradict

the Islamic value (haram)

On the other hand, conventional banking is essentially based on the debtor-

creditor relationship between the depositors and the bank on one hand, and

between the borrowers and the bank on the other. Interest is considered to be the

price of credit, reflecting the opportunity cost of money.

1.2 Financial Markets & Financial Industry.

Financial markets and financial industry are seeing the fast growth of

Islamic finance in last year’s. Some experts in the financial industry have

estimated this growth in some countries is very fast. This growth is reducing

the market share of traditional banks, and seems attractive to some of

them to convert their operations to Islamic banking.

Islamic banking forbids dealing in interest and the traditional

financing tools which are used by conventional banking, and they created

some other financing tools which are compatible with Islamic Sharei'a; as

the advocates of this industry say and as we will discuss in details in chapter

two.

In association with the growth of Islamic banking it was subjected

2


to many criticisms, one of these criticisms is that the operating Islamic

banks don't use all the Islamic financing instruments, they are using only

some instruments which fulfill the benefits and the profitability to the bank

and its share holders, and they neglect or avoid some other financing

instruments which are more beneficial to the bank customers and more

related to main principles of Islamic finance theory. By avoiding such

instruments, the real activities and services of Islamic banks became strongly

close to those provided by conventional banks.

The main objective of this study is to assess the performance of

Islamic banks in U.A.E compared to the conventional or commercial banks.

We will apply an analysis using the financial ratios indicating the liquidity,

structure and profitability as a measure of the performance of both types of

banks.

1.3 PROBLEM DEFINITION

The basic framework for an Islamic financial system is a set of rules

and laws collectively referred to as Sharei’a, governing economic, social,

political, and cultural aspects of Islamic societies. Since the emergence of

the term "Islamic financial system", the system was built on some basic

principles like: prohibition of interest, risk sharing, prohibition of speculative

behavior, and sanctity of contracts. The Islamic financial system is

founded on the absolute prohibition of the payment or receipt of any

predetermined, guaranteed rate of return. This closes the door to the

concept of interest and precludes the use of debt-based instruments. The

system encourages risk-sharing, promotes entrepreneurship, discourage

speculative behavior, and emphasizes the sanctity of contracts.

The Islamic financial system has developed some basic instruments

which stick to the basics of the system. Basic instruments include cost-plus

financing (Murabaha), profit-sharing (Mudaraba), leasing (Ijara), partnership

(Musharaka) and forward sale (Bay' Salam). These instruments serve as the

basic building blocks for developing a wide variety of more complex financial

instruments. ( Zamir Iqbal, 1997).3


Based on the above bases and instruments, the Islamic finance are

suppose to play a great role in economic development through

promoting and encouraging entrepreneurs and business firms to expand

their activities. The actuality of this situation may be compatible with the

above theoretical bases or not, and the Islamic financing institutions may

play its aimed role or not. But based on our literature review, we see a big

gap between the theoretical bases and the actuality and applied services by

Islamic banks in many countries which are subjected to researches. And

many writers see that there is not any significant difference between the

actual operations and services provided by Islamic banks and the conventional

banks.

As a matter of fact, the Islamic banks and companies provide

significant contributions to the economic development process in U.A.E;

its popularity has increased during the past 20 years and a lot of Islamic

companies and funds have been established. It is clear also how much this

industry become attractive for the conventional banks to convert part of its

activities to Islamic finance.

For all the above, we think it is necessary to investigate the performance

of these Islamic banks, compared to the conventional ones. This assessment

of the performance should consider the profitability and structural issues.

Many studies has conducted such.

Type of assessment in many countries, we will try to conduct such assessment

on Abu Dhabi Islamic Bank

Zamir Iqbal (a national of Pakistan, is an Information Officer in the World Bank’s Treasury Information Services Department)

1.4 Objectives of the Study

This study aims to investigate the performance of the Islamic banks vs. conventional banks

4


in U.A.E. The main objectives of this study are as follows:

1. To evaluate and analyze the financial performance of Islamic banks and the

conventional banks in U.A.E. my study object here to compare Abu Dhabi Islamic

Bank (ADIB) Verses Abu Dhabi Commercial Bank (ADCB)

2. To compare the financial performance of Islamic banks and conventional banks in U.A.E.

3. To investigate the relationship between financial performance of Islamic and

conventional banks in U.A.E.

1.5 Hypothesis

In fact, this study aims to answer the following questions:

1. Is there any significant difference between the performances of Islamic and

conventional banks in U.A.E?

2. What is the relationship between financial performance of Islamic and

conventional banks in U.A.E.

1.6 Scope and Limitations.

Following the introduction, chapter two reviews the literature concerning issues

related to this research. This chapter will include an overview of the concepts of Islamic

banking and finance, discovering the main principles and instruments of Islamic banking and

finance, and try to review the researches on the actual situation of Islamic banking

practices. Chapter three provides the research design and methodology and the data

description. In chapter four data analysis is achieved and its findings are obtained.

Finally, chapter five will present the conclusion, recommendations and also will include

suggestions for further research.

1.7 RELEVANCE OF THIS THESIS TO THE COUNTRY OF U.A.E

In U.A.E the Islamic banking services are in the way of continuous development and a

5


very fast growth during the recent years. Obvious among this development is the

number of Islamic financial institutions and banks working in the U.A.E market.

The first private interest-free bank, the Dubai Islamic Bank, was also set up in 1975 by a

group of Muslim businessmen from several countries. Two more private banks were founded in

1977 under the name of Faisal Islamic Bank in Egypt and the Sudan. In the same year the U.A.E

government set up the U.A.E Finance House.

In the ten years since the establishment of the first private commercial bank in Dubai, more

than 50 interest-free banks have come into being. Though nearly all of them are in Muslim

countries, there are some in Western Europe as well: in Denmark, Luxembourg, Switzerland and

the UK. Many banks were established in 1983 (11) and 1984 (13). The numbers have declined

considerably in the following years.

In most countries the establishment of interest-free banking had been by private initiative and was

confined to that bank.

Current practices

Generally speaking, all interest-free banks agree on the basic principles. However,

individual banks differ in their application. These differences are due to several reasons including

the laws of the country, objectives of the different banks, individual bank’s circumstances and

experiences, the need to interact with other interest-based banks, etc.

1.8 Defination of Terms.

1. Al-Wadiah Yad Dhamanah (guaranteed custody) and investment .

2. Al-Mudharabah (profit-sharing). The bank grants financing facilities such as working capital financing .

3. Al-Murabahah (cost-plus), house financing .

4. Bai' Bithaman Ajil (deferred payment sale), leasing.

5. Al-Ijarah (leasing) and project financing .

6. Al-Musyarakah (profit and loss sharing).

CHAPTER 2:

LITERATURE REVIEW

6


INTRODUCTION

Due to the observed significant growth in Islamic finance industry, this industry was

a subject of many studies and papers in last decade. In this chapter we tried to review some

of these literatures about Islamic finance and Islamic banking. We tried to indicate both

views about Islamic banking; the advocators and the critics. We tried also to review the

views about the actual situation of Islamic banking compared to the theoretical

principles of this industry. And at the end of chapter we added a review about the Islamic

banking in U.A.E.

2.1 HISTORY OF ISLAMIC FINANCE AND ISLAMIC BANKING:

According to Institute of Banking Studies of U.A.E the first Islamic bank start operation

in U.A.E in 1975, an early experiment with Islamic banking took place in Malaysia around

1940 and in Pakistan in 1950's. Countries like Egypt followed suit. Most banks in those

countries had rural orientation then. In the Arab world, the first experience with Islamic bank

goes to Egypt in 1963. The bank was formed under cover, without projecting an Islamic

image, for fear of mistaking as Islamic fundamentalism. However, the bank closed on 1967.

During this period, other banks came into being catering to trade and industry without

charging interest. Various countries in the Middle East did not support the formation of

Islamic banks for fear of subversive actives, creating support to the opposition parties in

creating political turmoil. The only Islamic institution to survive this period was Nasser

Social Bank of Egypt and Tabung Haji of Malaysia. These banks created an

atmosphere conducive for the Islamic banks in future to set up and improve the concept of

Islamic institutions: the concept of providing full range of commercial banking services,

in Islamic manner i.e. Interest f ree and b a l a n c i n g soc io -economic respons ib i l i t y

wi th commercial interests.

Institute of banking studies of U.A.E divided the development of modern

Islamic banks into three phases:

1. Emergence: 1972 through 1975: this period was marked by a surge in

oil revenues and great liquidity. Parallel events included a

resurgence of fundamentalist Muslim movements.

2. Expansion: 1976 to the early 1980's: Islamic banking spread from

the Arabian Gulf eastward to Malaysia, and westward to England.

Islamic banks spread across, including international and

intercontinental institutions. Islamic banking associations and

7


consultancy bodies' broadened their operations.

3. Maturity: 1983 to the present: Arab banks opened branches in the

United States and Islamic banking practices were implemented in both

Pakistan and Iran, U.A.E. This gave an impetus to the growth of Islamic

banking internationally. Many conventional banks in the Middle East

have started the concept of Islamic banking into its portfolio. Many

western conventional banks followed suit and have exclusive Islamic

banking division. Islamic financial institutions now operate in over 75

countries.

Zamir Iqbal (1997) argued that the term "Islamic financial system" is

relatively new, appearing only in the mid-1980s. In fact, all the earlier references to

commercial or mercantile activities conforming to Islamic principles were made

under the umbrella of either "interest free" or "Islamic banking" (Zamir Iqbal, 1997)

A.L.M Abdul Gafoor (1995) wrote a more detailed explanation of the

history of Islamic finance. He divided the history of Islamic finance or (interest free

banking) into two parts. First, when it still remained an idea; second, when it

became a reality - by private initiative in some countries and by law in others.

The earliest references to the reorganization of banking on the basis of profit

sharing rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi

(1948) and Mahmud Ahmad (1952) in the late forties, followed by a more

elaborate exposition by Mawdudi in (1950 ,1961). Muhammad Hamidullah’s

1944, 1955, 1957 and 1962 writings too should be included in this category. They

have all recognized the need for commercial banks and the evil of interest in that

enterprise, and have proposed a banking system based on the concept of

Mudaraba - profit and loss sharing.

In the next two decades interest-free banking attracted more attention,

partly because of the political interest it created in Pakistan and partly because of

the emergence of young Muslim economists. Works specifically devoted to this

subject began to appear in this period. The first such work is that of Muhammad

Uzair (1955). Another set of works emerged in the late sixties and early

seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar

(1971) and Baqir al-Sadr (1961, 1974) were the main contributors.8


Early seventies saw the institutional involvement. Conference of the Finance

Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian

study in 1972, First International Conference on Islamic Economics in

Mecca in 1976, International Economic Conference in London in 1977

were the result of such involvement. The involvement of institutions and

governments led to the application of theory to practice and resulted in the

establishment of the first interest-free banks. The Islamic Development

Bank, an inter-governmental bank established in 1975, was born of this

process.

The first private interest-free bank, the Dubai Islamic Bank, was also set up

in 1975 by a group of Muslim businessmen from several countries. Two more

private banks were founded in 1977 under the name of Faisal Islamic Bank in

Egypt and the Sudan.

2.2 PRINCIPLES OF ISLAMIC FINANCIAL SYSTEM

“The basic framework for an Islamic financial system is a set of rules

and laws, collectively referred to as Sharei’a, governing economics, social,

political, and cultural aspects of Islamic societies.” ( Zamir Iqbal, 1997).

The basic principles of Islamic financial system can be summarized as follows:

2.2.1 PROHIBITION OF INTEREST:

The Islamic financial system is founded on the absolute prohibition of

the payment or receipt of any predetermined, guaranteed rate of return.

Most of the literatures of Islamic finance agree with the Mr. Iqbal about the

prohibition of interest in Islamic finance. They used the expression

"Reba" as the equivalent to interest. And all the Muslims know that Islam is

prohibiting "Reba"

That Prohibition of "Reba", a term literally meaning "an excess" and

interpreted as "any unjustifiable increase of capital whether in loans or sales"

9


is the central tenet of the system. More precisely, any p o s i t i v e ,

fixed, predetermined rate tied to the maturity and the amount of principal

(i.e., guaranteed regardless of the performance of the investment) is

considered "Reba" and prohibited. The general consensus among Islamic

scholars is that “Reba” covers not only usury but also the charging of

"interest" as widely practiced. ( Zamir Iqbal, 1997)

Aggarwal & Yousef (2000) also indicated that the most important

principle in Islamic finance is the prohibition of Reba, any predetermined or

fixed return in financial transactions. As stated in the Quran: " Allah forbids

Reba and permits trade" while there is much debate about the exact

nature of this prohibition on "Reba', there exists a widespread perception

that the ban on Reba implies a ban on interest

2.2.1.1 DOUBTS ABOUT PROHIBITION OF INTEREST

Recently, Islamic finance industry faced voices of some writers and

specialists who scruple about the prohibition of interest by Islam.

Rasul Shams (2004) is one of those writers who have doubts about this

ban of interest in Islamic finance. He said that, in many English translation of

Quran the word "usury" is used for the Quranic word "Reba" and not for the

word "interest". According to Collins English dictionary (sixth edition 2003) the

word "interest" means "a charge for use of credit or borrowed money", while

"usury" is "an exorbitant or unlawfully high amount or rate of interest". If the

Quranic word "Reba" means usury, usury is forbidden but not necessarily

interest. Interest is a simple expression for a charge which under

competition in the credit market would be reduced to the conventional

interest rate in trading and commerce. Everything above this rate is

forbidden but not this conventional interest rate. (Shams, 2004)

2.2.2 RISK SHARING (OR PROFIT AND LOSS SHARING):

10


Aggarwal & Yousef (2000) argued that the profit-and-loss sharing

principle is unanimously accepted in the Islamic legal and economic

literatures as the cornerstone of financial transactions. According to profit-and-

loss sharing principle, the bank may earn a return on invested funds provided

that the bank shares in the risk of the investment and bears a loss if the

project fails. (Aggarwal & Yousef, 2000).

Zamir Iqbal (1997) explained that, because interest is prohibited,

suppliers of funds become investors instead of creditors, the provider of

financial capital and the entrepreneur share risks in return for shares of the

profits. (Zamir Iqbal, 1997)

2.2.3 MONEY AS "POTENTIAL CAPITAL:

Zamir Iqbal (1997) argued that Money is treated as "potential" capital-

that is, it becomes actual capital only when it joins hands with other

resources to undertake a productive activity. Islam recognizes the time value

of money, but only when it acts as

capital, not when it is "potential" capital. (Zamir Iqbal, 1997)

2.2.4 PROHIBITION OF SPECULATIVE BEHAVIOR

"An Islamic financial system discourages holding and prohibits

transactions featuring extreme uncertainties, gambling, and risks" . We think

this is a logic principle for a system originated from a religion; the system

should respect all issues, ethics and laws related to same religion.

2.2.5 SANCTITY OF CONTRACTS

"Islam upholds contractual obligations and disclosure of information as

a sacred duty. This feature is intended to reduce the risk of asymmetric

information and moral hazard". ( Zamir Iqbal, 1997)

2.2.6 SHAREI’A-APPROVED ACTIVITIES

"Only those business activities that do not violate the rules of Sharei’a

11


qualify for investment. For example; any investment in business dealing with

alcohol, gambling, and casinos would be prohibited" (Zamir Iqbal, 1997). As

indicated above, we think this type of principles is logic for a religious

financial system, all principles and applications of such system suppose to be

approved by the source religion.

2.3 Islamic Financial Instuments

There are many contracts and instruments used within the industry

collectively known as Islamic finance. These instruments are widely varying

in the degree of their acceptance by Islamic finance specialists. In this

overview we will focus on the most popular and known financing instruments.

According to Aggarwal & Yousef (2000) , Alternative "interest-free"

financing technique have been developed by Islamic banks and the monetary

authorities of different countries. The instruments of commercial financing

have been based on two principles:

the profit-and-loss sharing (PLS) principle and markup principle.

2.3.1 PROFIT-AND-LOSS SHARING (PLS) INSTRUMENTS

The PLS principle is unanimously accepted in the Islamic legal and

economic literatures as the cornerstone of financial transactions.

According to profit-and-loss sharing principle, the bank may earn a return

on invested funds provided that the bank shares in the risk of the

investment and bears a loss if the project fails. (Aggarwal & Yousef, 2000).

The main PLC instruments are Mudaraba and Musharaka

2.3.1.1 PROFIT-SHARING AGREEMENT (MUDARABA)“This is identical to an investment fund in which managers handle a

12


pool of funds. The agent-manager has relatively limited liability while

having sufficient incentives to perform. The capital is invested in broadly

defined activities, and the terms of profit and risk sharing are customizes

for each investment. The maturity structure ranges from short to medium

terms and is more suitable for trade activities.” (Zamir Iqbal, 1997)

“Mudaraba where the bank contributes the finance and the client

provides the expertise, management and labor. Profits are shared by

both the partners in a pre- arranged proportion, but when a loss occurs the

total loss is borne by the bank.” (Abdul Gafoor, 1995)

Aggarwal & Yousef (2000) explained the Mudaraba financing, as where

the bank provides capital and the entrepreneur contributes effort and

exercises complete control over the business venture. In case of a loss, the

bank earns no return or a negative return on its investments and the

entrepreneur receives no compensation for her effort. In case of a gain,

returns are split according to a negotiated equity percentage. (Aggarwal &

Yousef, 2000).

2.3.1.2 EQUITY PARTICIPATION (MUSHARAKA)

“This is analogous to a classical joint venture. Both entrepreneur and

investor contribute to the capital (assets, technical and managerial expertise,

working capital, etc. ) of the operation in varying degrees and agree to share

the returns ( as well as the risks) in proportions agreed to in advance.

Traditionally, this form of transaction has been used for financing fixed assets

and working capital of medium-and long-term duration.” (Zamir Iqbal, 1997)

“Musharaka where a bank may join another entity to set up a joint

venture, both parties participating in the various aspects of the project in

varying degrees. Profit and loss are shared in a pre-arranged fashion. This is

not very different from the joint venture concept. The venture is an

independent legal entity and the bank may withdraw gradually after an initial

period.” (Abdul Gafoor, 1995)

13


Aggarwal & Yousef (2000) explained the Musharaka financing, as

where the entrepreneur and the bank jointly supply the capital and manage

the project. Losses are born in proportion to the contribution of capital while

profit proportions are negotiated freely. (Aggarwal & Yousef, 2000).

2.3.2 MARK-UP INSTRUMENTS

The markup principle has its historical roots in commercial trade

activities. The bank finances the purchase of assets in exchange for a

negotiated profit margin.

Although markup instruments are widely used, their acceptability under

Islamic law is disputed because they can imply a fixed return on investment

for the bank. Many Islamic scholars have taken the position that markup

technique, while permissible, should still be avoided or restricted. (Aggarwal &

Yousef, 2000).

Beng Soon Chong and Ming-Hua Liu (2007) announced that The

acceptability of the non-PLS modes of financing, however, has been widely

debated and disputed because of their close resemblance to conventional

methods of interest-based financing. Many Islamic scholars, including

Pakistan's Council of Islamic Ideology, have warned that, although

permissible, such non-PLS modes of financing should be restricted or avoided

to prevent them from being misused as a “back door” for interest-based financing.

Mahmoud El-Gamal (2006) explained the reasons for the markup

principle. He said: the juristic-based understanding of forbidden Reba/usury

suggested that the Islamic finance has to be "asset-based", in the sense

that one cannot collect or pay interest on

Rented money, as one does in conventional banking. Therefore, the easiest transactions to

Islamize were secured lending operations, e.g., to finance the purchase

of real estate, vehicles, business equipment, etc. (El-Gamal, 2006)

14


The most famous and mostly used markup instruments are Murabaha and

Ijara.

2.3.2.1 TRADE WITH MARKUP OR COST-PLUS SALE (MURABAHA)

“One of the most widely used instruments for short-term financing is

based on the traditional notion of purchase finance. The investor

undertakes to supply specific goods or commodities, incorporating a mutually

agreed contact for resale to the client and the mutually negotiated margin.”

(Zamir Iqbal, 1997)

Zamir Iqbal (1997) reported that around 75% of Islamic financial

transactions are cost-plus sales. Some other researchers reported that it

reached more than 90% of financing activities in some Islamic banks.

(Maali, Casson and Napier , 2006)

“Mark-up where the bank buys an item for a client and the client

agrees to repay the bank the price and an agreed profit later on.” (Abdul

Gafoor, 1995)

Aggarwal & Yousef (2000) explained the Murabaha financing as where

the bank purchases an asset on behalf of an entrepreneur. The bank

resells the asset to the entrepreneur at a predetermined price that

covers the original cost and an added, negotiated profit margin. Payment

is made in the future in lump sum or in installments. Ownership resides with

the bank until all payments are made. (Aggarwal & Yousef,

2000).

The definition by Mahmoud El-Gamal (2006) is matching with

the above definitions, but in addition he indicates that these are analogous to

the Federal Reserve’s use of "matched-sale purchase". And the mark-up in

Murabaha financing is benchmarked (i.e., made to track ) conventional interest

rate. (El-Gamal, 2006)

2.3.2.2 LEASING (IJARA)

15


"Another popular instrument, accounting for about 10% of Islamic

financial transactions, is leasing." ( Zamir Iqbal, 1997)

Leasing is designed for financing vehicles, machinery, equipment,

and aircraft. Different forms of leasing are permissible, including leases

where a portion of the installment payment goes toward the final purchase

(with the transfer of ownership to the leasee). ( Zamir Iqbal, 1997)

“Leasing where the bank buys an item for a client and leases it to

him for an agreed period and at the end of that period the lessee pays the

balance on the price agreed at the beginning an becomes the owner of the

item.” (Abdul Gafoor, 1995)

Aggarwal & Yousef (2000) explained the Ijara financing, as where

the bank purchases the asset and allows the entrepreneur to use it for

a fixed charge. The ownership of the asset either remains with the bank

or is gradually transferred to the entrepreneur in a rent-to-own contract. Ijara

financing is the traditional contract for what is known as leasing today.

(Aggarwal & Yousef, 2000).

According the explanation by Mahmoud El-Gamal (2006), Ijara is

a typical structure requires the bank to create a special purpose vehicle (SPV)

to purchase and hold title to the financed property. The SPV then leases the

property to the customer, who makes monthly payments that are part-rent

and part-principal. Rents are calculated based on market interest rate,

allowing monthly payments to follow a conventional amortization table. The

juristic justification of the practice is that principal parts of monthly payments

increase the customer's ownership in the property, and allow him to pay less

rent (on the part ostensibly owned by the bank through the SPV) over

time, thus replicating the conventional amortization table. (El-Gamal, 2006)

2.3.2.3 ISTISNA'AU.A.E finance house (KFH) explained this type of financing as

follow “Istisna’a is a special financing facility that could be used for

financing construction projects, industrial equipment and various capital

goods. Istisna’a financing is arranged through a mechanism whereby, bank

contracts with a purchaser to deliver the contracted items on a future date 16


assuming responsibility for project completion (Istisna’a), and then appoints

sub-contractors to complete the project under its supervision through a

separate contract (parallel Istisna’a). On completion of the project, the

contracted items are delivered to the original purchaser who has the

responsibility for paying the purchase

price as agreed upon in advance. The mode of payment could be flexible

depending on the advance agreement between the bank and the

customer. The Bank’s return for financing this transaction comprises of a

profit margin included in the selling price, and is usually benchmarked to

LIBOR."(KFH, 2008)

2.4 Actual Islamic Banking Situation: Practice

Recent years have brought an increasing flow of empirical studies of

Islamic banking. The earliest systematic empirical work was undertaken by

Khan (l983). His observations covered Islamic banks operating in Sudan,

United Arab Emirates, U.A.E, Bahrain, Jordan, and Egypt. Khan's study

showed that these banks had little difficulty in devising practices in

conformity with Sharei’a. He identified two types of investment accounts:

one where the depositor authorized the banks to invest the money in any

project and the other where the depositor had a say in the choice of project to

be financed. On the asset side, the banks under investigation had been

resorting to Mudaraba, Musharaka and Murabaha modes. Khan's study

reported profit rates ranging from 9 to 20 per cent which were competitive

with conventional banks in the corresponding areas. The rates of return to

depositors varied between 8 and l5 per cent, which were quite comparable

with the rates of return offered by conventional banks.

Khan's study revealed that Islamic banks had a preference for trade

finance and real estate investments. The study also revealed a strong

preference for quick returns, which is understandable in view of the fact that

these newly established institutions were anxious to report positive results

even in the early years of operation.

Nienhaus (1988) suggests that the relative profitability of Islamic 17


banks, especially in the Middle East in recent years, was to a large extent

due to the property (real estate) boom. He has cited cases of heavy losses

which came with the crash of the property sector.

Aggarwal & Yousef (2000) argued that Islamic banks are

supposed to offer instruments consistent with the religious beliefs and

cultural characteristics of Muslim societies. According to prevailing

interpretations of Islamic law, financial instruments should emphasize profit-

and-loss sharing (equity). Interest is prohibited, which seems to

exclude debt contracts. But their research indicates that most of the financing

provided by Islamic banks do not conform to the principle of profit-and-loss

sharing. Instead, much of the financing provided by Islamic banks takes the

form of debt-like instruments.

Aggarwal & Yousef study also, contrary to the expectations of Islamic

banking's advocates; they found that Islamic banks rarely offer

long-term financing to entrepreneurs seeking capital. In addition, the

majority of Islamic banks' financial transactions at least initially were

directed away from agriculture and industry and toward retail or trade

financing.

The study by Iqbal and Mirakhor (l987) contains extremely interesting

empirical observations, although these are confined to the experience of Iran

and Pakistan, both of which have attempted to Islamize the entire banking

system on a comprehensive basis. Iran switched to Islamic banking in

August l983 with a three-year transition period. The Iranian system allows

banks to accept current and savings deposits without having to pay any

return, but it permits the banks to offer incentives such as variable prizes or

bonuses in cash or kind on these deposits. Term deposits (both short-term

and long-term) earn a rate of return based on the bank's profits and on the

deposit maturity. No empirical evidence is as yet available on the interesting

question as to whether interest or a profit- share provides the more effective

incentive to depositors for the mobilization of private saving. Where Islamic

18


and conventional banks exist side by side, central bank control of bank

interest rates is liable to be circumvented by shifts of funds to the Islamic

banks.

Iqbal noted that the conversion to Islamic modes has been much

slower on the asset than on the deposit side. It appears that the Islamic

banking system in Iran was able to use less than half of its resources for

credit to the private sector, mostly in the form of short-term facilities, i.e.,

commercial and trade transactions. The slower pace of conversion on the

asset side was attributed by the authors to the inadequate supply of

personnel trained in long-term financing. The authors, however, found no

evidence to show that the effectiveness of monetary policy in Iran, broadly

speaking, was altered by the conversion.

The Pakistani experience differs from the Iranian one in that Pakistan

had adopted for a gradual Islamic process which began in l979. In the first

phase, which ended on 1st January, l985, domestic banks operated both

interest- free and interest-based 'windows'.

In the second phase of the transformation process, the banking

system was geared to operate all transactions on the basis of no interest,

the only exceptions being foreign currency deposits, foreign loans and

government debts. The Pakistani model took care to ensure that the new

modes of financing did not upset the basic functioning and structure of the

banking system. This and the gradual pace of transition, according to the

authors, made it easier for the Pakistani banks to adapt to the new system.

The rate of return on profit-and-loss sharing (PLS) deposits appears not only

to have been in general higher than the interest rate before Islamization

but also to have varied between banks, the differential indicating the

degree of competition in the banking industry. The authors noted that the

PLS system and the new modes of financing had accorded considerable

flexibility t o b a n k s a n d their c l i e n t s . Once a g a i n t h e s t u d y

c o n c l u d e d t h a t t h e effectiveness of monetary policy in Pakistan was not

impaired by the changeover.

19


Iqbal and Mirakhor study, however, expressed considerable

uneasiness about the concentration of bank assets on short-term trade

credits rather than on long-term financing. This the authors found

undesirable, not only because it is inconsistent with the intentions of the new

system, but also because the heavy concentration on a few assets might

increase risks and destabilize the asset portfolios.

Beng Soon Chong and Ming-Hua Liu in their study about the

Islamic banks (2007), they found that a unique feature that suppose to

differentiates Islamic banking from Conventional banking is the PLS

paradigm. In practice, however, they found that Islamic banking is not very

different from conventional banking from the perspective of the PLS

paradigm. On the asset side of Islamic banking, they found that only a

negligible portion of financing is based on the PLS principle. Consistent

with Islamic banking experiences elsewhere; a large majority of Islamic bank

financing in Malaysia is still based on non-PLS modes that are permissible

under the Sharei’a law, but ignore the spirit of the usury prohibition. On the

liability side, the PLS principle is more widely adopted in structuring Islamic

deposits. Their study, however, provides new evidence, which shows that,

in practice, Islamic deposits are not interest-free.

2.5 Synthesis

The Islamic financial system has developed some basic instruments

which stick to the basics of the system. Basic instruments include cost-plus

financing (Murabaha), profit-sharing (Mudaraba), leasing (Ijara), partnership

(Musharaka) and forward sale (Bay' Salam). These instruments serve as the

basic building blocks for developing a wide variety of more complex financial

instruments. ( Zamir Iqbal, 1997). Based on the above bases and

instruments, the Islamic finance are suppose to play a great role in

economic development through promoting and encouraging entrepreneurs

and business firms to expand their activities.

The actuality of this situation may be compatible with the above

20


theoretical bases or not, and the Islamic financing institutions may play its

aimed role or not. But based on our literature review, we see a big gap

between the theoretical bases and the actuality and applied services by

Islamic banks in many countries which are subjected to researches. And

many writers see that there is not a significant difference between the

actual situation of Islamic banks and the conventional banks.

So, based on the above, our null hypothesis for this research will be

the equality of performances of both Islamic and conventional banks in U.A.E.

The data analysis will show if this hypothesis is accepted or not.

21


CHAPTER 3.

RESEARCH METHODOLOGY

3.1 Research Design

3.1.1 Descriptive Design

1. Case Study

2. Correlation Study

3. Development Study

4. Survey Study

3.1.2 Empirical Design

1. Financial Rations

2. Graphs

3. Financial Statements

3.2 Population

The Population is defined as all members that are described by the

characteristic select by the experimenter.

Major Islamic Bank (IB) in U.A.E.

Major Conventional Banks (CB) In U.A.E.

Trends of Islamic Banks in International Market.

Trends of Conventional Bank sin International Market.

3.3 Tools

22


Categorized as primary and secondary tools

1. Primary Tools : Internet, Online Urls. Internal case study

2. Seconday Tools : Accounting and financial rations,

Financial Statements

3.4 Limitations

There are more than fifty two (52) banks operating in U.A.E. Out of

these 42 is conventional banks and ten is Islamic banks. The conventional

banks are assessed performance of this bank may be not enough indication

to the performance of industry of Islamic banking.

23


CHAPTER 4:

4.1 BANKS TAKEN INTO STUDY

In this chapter we will discuss our empirical tests and their findings, a descriptive

statistics of performance financial ratios will be represented. We would like to mention that,

all financial ratios used in this analysis are obtained from financial Statements of banks. First

of all I will introduce my selected banks which I selected to complete my research.

4.1.1 ABU DHABI COMMERCIAL BANK

Abu Dhabi Commercial Bank is 65 percent owned by the state-controlled Abu Dhabi

Investment Council, and is the United Arab Emirates' third-biggest bank by assets.

The bank changed its name from Khalij Commercial Bank to Abu Dhabi Commercial Bank

after merging with Emirates Commercial Bank and Federal Commercial Bank on 1 July 1985. The

bank is a public shareholding company with limited liability, and was incorporated in Abu Dhabi in

1975, to carry on retail, commercial, investment and merchant banking through a 33-branch

network spread across the UAE, in addition to two branches in India and an offshore banking unit

in the Cayman Islands.

More about the company

Address: Al Salam Street P.O.Box 939, Abu Dhabi, UAE

Previous Name: Khalij Commercial Bank

Alternate Name: ADCB

Type: Joint stock

Established Date: 1st July 1985

Ownership: Public

24


Abu Dhabi Commercial Bank (“ADCB”), headquartered in Abu Dhabi in the UAE, is a

diversified full service Bank active in all banking services that span corporate, retail and

commercial banking as well as in the areas of treasury derivatives, infrastructure finance, private

banking and wealth management. ADCB’s strong franchise is supported by a network of 172

ATMs across the UAE and 45 branches in the UAE as well as 2 branches in India.

ADCB considers its principal competitive strengths in the retail area include its strong market

share and franchise reflecting its large and loyal customer base. In addition, ADCB is indirectly

majority owned by the Government of Abu Dhabi.

In relation to investment banking, ADCB competes with local, regional and major

international financial institutions. ADCB believes that its deep knowledge and understanding of

what customers really want and need, will enable it to reach its goal of becoming one of the UAE’s

most modern and service orientated Banks in the UAE.

During May 2008, ADCB acquired a 25 per cent, interest in RHBC, a leading Malaysian Bank

in a step that will pave the way for a strategic partnership between the two financial institutions

enabling them to leverage on the growing cross border banking activities between Asia and Gulf

Corporation Council.

ADCB’s recently launched campaign ‘Long Live Ambition’ is more than just a catchy slogan.

It’s a celebration of the UAE and its people, and of the ways in which the Bank is different. The

campaign neatly captures the essence of the country, but the trick is in ensuring that it is reflected

not just in the Bank’s branding, but in its day-to-day operations too. ADCB reflects ‘Long Live

Ambition’ in the way that it deals with its customers. The Bank is putting this into practice in the

products and services it offers too

ADCB - Accounts

Active saver account.

Current account

Fixed deposit account

Millionaire destiny saving accounts

Business choice current account

25


Fast tract account

Debit card account

Ethihad guest account

Loans

Personal loans –

1. Personal loans for UAE nationals

2. Personal loans for Expartriates.

ADCB education loans

End use loans

Mortgage services

1. Mortgage refinance services

2. Mortgage overdraft

Excellency mortage services

1. For UAE Nationals

2. For Expartriates.

Car loans – for new and used cars

New Products

ADIB has partnered with Etihad Airways to bring you the most rewarding Shari’a compliant

airline card in the UAE, the customer will be awarded up to 50,000 Etihad Guest Miles when they

apply, and earn more miles every time when they use their card.

They are the first UAE bank to bring you a new mobile banking service *161# Banking.

Covered and Debit Cards now come with chip technology for enhanced security and peace of

mind. In addition, our Covered Cards feature Paywave technology, which enables contactless

payments - just wave your card over the scanner in participating outlets. The new cards will also

feature a special instant finance option that will revolutionize the purchases ADCB is also

upgrading women’s banking with the launch of Dana, a new package of products, services and 26


special life style benefits designed to give our female customers the attention they deserve. From

uniquely designed women-only areas and branches to highly skilled female relationship managers

Dana Women’s Banking gives the ladies customers special attention by people who truly

understand their needs.

4.1.2 ABDU DHABI ISLAMIC BANK.

Abu Dhabi Islamic Bank was established on 20th May 1997 as a Public Joint Stock

Company through the Amiri Decree No. 9 of 1997. The Bank commenced commercial operations

on 11th November 1998, and was formally inaugurated by His Highness Sheikh Abdullah Bin

Zayed Al Nahyan, UAE Minister of Information and Culture on 18th April 1999. All contracts,

operations and transactions are carried out in accordance with Islamic Shari'a principles.

The Capital

ADIB commenced its operations with a paid-up capital of One Billion Dirhams divided into

hundred million shares, the value of each share being ten dirhams. The shares are quoted on the

Abu Dhabi Securities Market.

Mission

Islamic financial solutions for the global community.

Vision

To be the top tier Islamic financial services group.

SUBSIDIARIES – ABUDHABI ISLAMIC FINANCIAL SERVICES

ASSOCIATES: NATIONAL BANK FOR DEVELOPMENT, ABUDHABI NATIONAL TAKAFUL,

BOSNA BANK INTERNATIONAL

REAL ESTATE - AL BUROOJ PROPERTIES

Burooj Properties LLC is a solely owned subsidiary of Abu Dhabi Islamic Bank. The company

which was established in October 2005 with a working capital of AED 500 million was created from

the bank's former Real Estate department.

27


ADIB Securities

Kawader Services

Kawader is a premier recruitment Consultancy based in UAE that offers a hands-on quality

service that allows us to source and work with candidates from a wide range of countries. Kawader

provides Executive Search, Overseas Recruitment and Contract Staffing Services for

contingencies as well as for turnkey projects and covers the following sectors: Aviation, Banking,

Call Center, Construction, Engineering, Hospitality, Healthcare, IT, Media, Office Support also

Facilities Management Services.

National Bank for Development (NBD) - Egypt

ADIB OWNERSHIP STRUCTURE

Emirates International Investment co.

UAE Nationals

H.H Sheikh Hammad Bin Zayed Bin Sultan Al Nahyyan

H.H Sheikh Khalid Bin Zayed Bin Sutlan Al Nahyyan

U.A.E General Pension and Social security authority

Jawaan Awaida Suhail Al Khaili

The estate of HH Sheikh Nasser bIn Zayed Al Nahyan

National Bank of Abudhabi.

Sheikh Suroor Bin Muhammed bin Khalifa Al Nahyan

Tasamim Real Estate Co. (LLC)

28

http://www.nbdegypt.com/

http://www.kawader.ae/

http://adibsecurities.ae/


4.2 Islamic Banking and Conventional Banking

Islamic banking and conventional banking are extremely different in many ways. The key

difference is that Islamic Banking is based on Shariah foundation. Thus, all dealing, transaction,

business approach, product feature, investment focus, responsibility are derived from the Shariah

law, which lead to the significant difference in many part of the operations with as of the

conventional

The foundation of Islamic bank is based on the Islamic faith and must stay within the limits of

Islamic Law or the Shariah in all of its actions and deeds. The original meaning of the Arabic word

Shariah is 'the way to the source of life' and is now used to refer to legal system in keeping with

the code of behaviour called for by the Holly Qur'an (Koran). Amongst the governing principles of

an Islamic bank are :

* The absence of interest-based (riba) transactions;

* The avoidance of economic activities involving oppression (zulm)

* The avoidance of economic activities involving speculation (gharar);

* The introduction of an Islamic tax, zakat;

* The discouragement of the production of goods and services which contradict the Islamic value

(haram)

On the other hand, conventional banking is essentially based on the debtor-creditor relationship

between the depositors and the bank on one hand, and between the borrowers and the bank on

the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money.

Islamic law considers a loan to be given or taken, free of charge, to meet any contingency. Thus

in Islamic Banking, the creditor should not take advantage of the borrower. When money is lent out

on the basis of interest, more often that it leads to some kind of injustice. The first Islamic principle

underlying for such kind of transactions is "deal not unjustly, and ye shall not be dealt with unjustly"

29


[2:279] which explain why commercial banking in an Islamic framework is not based on the debtor-

creditor relationship.

The other principle pertaining to financial transactions in Islam is that there should not be any

reward without taking a risk. This principle is applicable to both labor and capital. As no payment is

allowed for labor, unless it is applied to work, there is no reward for capital unless it is exposed to

business risk.

Thus, financial intermediation in an Islamic framework has been developed on the basis of the

above-mentioned principles. Consequently financial relationships in Islam have been participatory

in nature.

Lastly, for the interest of the readers, the unique features of the conventional banking and Islamic

banking are shown in terms of a box diagram as shown below:-

Conventional Banks Islamic Banks

1. The functions and operating modes

of conventional banks are based on fully

manmade principles.

1. The functions and operating modes of

Islamic banks are based on the

principles of Islamic Shariah.

2. The investor is assured of a

predetermined rate of interest.

2. In contrast, it promotes risk sharing

between provider of capital (investor)

and the user of funds (entrepreneur).

3. It aims at maximizing profit without

any restriction.

3. It also aims at maximizing profit but

subject to Shariah restrictions.

30


4. It does not deal with Zakat. 4. In the modern Islamic banking

system, it has become one of the

service-oriented functions of the Islamic

banks to be a Zakat Collection Centre

and they also pay out their Zakat.

5. Lending money and getting it back

with compounding interest is the

fundamental function of the

conventional banks.

5. Participation in partnership business

is the fundamental function of the

Islamic banks. So we have to

understand our customer's business

very well.

6. It can charge additional money

(penalty and compounded interest) in

case of defaulters.

6. The Islamic banks have no provision

to charge any extra money from the

defaulters. Only small amount of

compensation and these proceeds is

given to charity. Rebates are give for

early settlement at the Bank's discretion.

7. Very often it results in the bank's own

interest becoming prominent. It makes

no effort to ensure growth with equity.

7. It gives due importance to the public

interest. Its ultimate aim is to ensure

growth with equity.

8. For interest-based commercial banks,

borrowing from the money market is

relatively easier.

8. For the Islamic banks, it must be

based on a Shariah approved underlying

transaction.

9. Since income from the advances is

fixed, it gives little importance to

developing expertise in project appraisal

and evaluations.

9. Since it shares profit and loss, the

Islamic banks pay greater attention to

developing project appraisal and

evaluations.

31


10. The conventional banks give greater

emphasis on credit-worthiness of the

clients.

10. The Islamic banks, on the other

hand, give greater emphasis on the

viability of the projects.

11. The status of a conventional bank,

in relation to its clients, is that of creditor

and debtors.

11. The status of Islamic bank in relation

to its clients is that of partners, investors

and trader, buyer and seller.

12. A conventional bank has to

guarantee all its deposits.

12. Islamic bank can only guarantee

deposits for deposit account, which is

based on the principle of al-wadiah, thus

the depositors are guaranteed

repayment of their funds, however if the

account is based on the mudarabah

concept, client have to share in a loss

position.

FINANCIAL STATEMENTS

OF

Abdu Dhabi Commercial Bank

&32


Abdu Dhbai Islamic Bank

I. Balance Sheet of ADCB

II. Profit & Loss Account of ADCB

III. Balance Sheet of ADIB

IV. Profit & Loss Account of ADIB


Balance Sheet

At December 2010

2010

AED '000

Assets

Cash and Balance with the Central Bank 5,88,630

Deposits and balance due from banks 18,397,534

Loans and advances, net 122,771,870

33


Derivative financial instruments 3,588,973

Investment security’s 8,263,138

Investment in associates 5,358,199

Investment in Properties 289,192

Other assets 12,489,157

Property and equipment, net 1,070,321

Intangible assets 155,180

Total Assets 175,271,194

Liabilities

Due to banks 4,841,865

Deposits from customers 106,134,185

Mandatory convertible security- liability component 29,131

Sort and medium term borrowings l 21,019,694

Deactivate financial instruments 3,487,764

Long term borrowings 8,906,109

Other liabilities 14,279,098

Total liabilities 158,697,846

Equity 19,573,348

178,271,194

31,285,722Commitment and contingent liabilities

34


35



Income Statement

At December 2010

For the year ended December 31,2010

2010

AED '000

Interest income 7,158,894

Income for Islamic financing 217,541

Interest expenses (3,507,961)

Net interest expense 3,868,474

Distribution to depositors (186,269)

Net interest income net of distribution to depositors 3,682,205

Net fees and commission income 956,253

Net gain on dealing in derivatives 169,766

Net gains from dealing in foreign currencies 142,962

Decrease in fair value of investment properties (116,412)

Share of profit of associates 336,294

Net(loss)/gain from trading and investment security (4,444)

Other operating income 160,868

Loss on disposal of subsidiary (992)

Dividend income 9,400

Operating income 5,335,900

36


Staff expenses (829,541)

Depreciation and amortization (108,795)

Other operating expenses (710,646)

Impairment allowance (3,287,071)

Operating Expenses (4,936,053)

Profit/(loss) from operations before taxation 399,847

Overseas income tax expenses

Net profit /(loss) for the year

Attributed to

Equity holders of the parent

Non-controlling interest

399,847

390,615

381,001

9,614

Net profit/ (loss ) for the year

Basic earnings/(loss) per share

Net profit /(loss) for the year

Exchange difference arising on transaction of foreign operations

Fair value charge on net investment in foreign operation hedges

Fair value charges on available for sales investments

Fair value charges reserved on disposal of available for sales

390,615

0.04

390,615

508,442

)430,544(

176,744

37


investments

Board of directors remuneration

Share in comprehensive income statement items of associate

Total comprehensive income /(loss) for the year

Attributed to :

Equity holders of the parent

Non-controlling interest

Total comprehensive income/(loss) for the year

111,474

)5,250(

68,460

819,941

810,327

9,614

819,941

Abu Dhabi Islamic bank

Balance Sheet

At December 2010

2010

38


Asset

Cash and Balance with the UAE Central Bank 5,400,335

Balance and wakala deposit with Islamic bank and other financial institution 2,906,382

Murabaha and murabaha with financial institution 12,823,542

Murabaha and other Islamic financing 22,682,521

Ijara financing 25,270,071

Investments 1,639,414

Investment in associates 837,195

Investment in Properties 191,654

Development properties 1,050,445

Other assets

Property and equipment 585,887

Total Assets 75,257,518

Liabilities

Due to financial institutions 891,390

Depositors accounts 56,517,045

Other liabilities 2,091,500

Tier 2 wakala capital 2,207,408

Sukuk financing instrument 5,439,523

Total Liabilities 67,146,866

Equity

Share Capital 2,364,706

Legal reserve 1,754,899

39


General reserve 443,182

Retained earnings 984,069

Proposed dividends 511,783

Proposed dividends to charity 6,816

Other reserves 42,122

6,107,577

Equity attribution to the equity holders of the bank 6,107,577

Tier 1 sukuk 2,000,000

Non-controlling interest 3,075

Total equity 8,110,652

TOTAL LIBILITIES AND EQUITY 75,257,518

CONTINGENT LIABILITY AND COMMITMENTS 12,156,042

40


Abu Dhabi Islamic bank

Income Statement

At December 2010

Operating Income

2010

AED '000

Income from murabaha, murabaha wakala with financial institution 187,719

Income from murabaha, murabaha, ijara and other Islamic financing 3,453,005

Investment income 75,699

Share of result of associate 14,798

Fees and commission income net 343,325

Foreign exchange income 29,071

Income from investment properties 5,265

Income from development properties (4,300)

Other income 14,441

4,119,023

Other expenses

Employees cost (792,815)

General and administrative expenses (431,210)

Depreciation (77,215)

Provision for impairment, net (749,212)

(2,050,452)

41


Profit From Operation, Before Distribution To Depositors And Sukuk Holders 2,068,571

Distribution to depositors and sukuk holders (1,045,006)

PROFIT FOR THE YEAR 1,023,565

Attributable to:

Equity holder of the bank 1,023,565

Non-controlling interest 220

1,023,565

Basic and diluted earnings per share attributable to ordinary share (AED) 0.382

42


4.2 DATA ANALYSIS (Ratios analysis )

Financial statement analysis is based on accounting ratios. The following ratios are

calculated to measure the performance of a commercial bank and Islamic bank.

Profit margin ratio.

Assets utilization ratio.

Equity Multiplier Ratio.

Return on assets ratio.

Return of equity ratio.

4.2.1 PROFIT MARGIN RATIO

FORMULA:

Profit margin Ratio = Net Income

TOTAL Operating Income

COMPONENTS: ADIB ADCB

Net Income 1,078,144 818,941

TOTAL Operating Income 1,023,565 5,335,900

SIGNIFICANCE:

A measure of how well a bank controls its costs. It is calculated by dividing a bank's profit by its

revenues and expressing the result as a percentage. The higher the profit margin is, the better the

company is thought to control costs. Investors use the profit margin to compare companies in the

same industry and well as between industries to determine which are the most profitable.

S. No

RATIO DESCRIPTION CALCULATION

ADIB

1. Profit margin

Net Income TOTAL Operating Income

1,078,144 1,023,565

1.062

S. No


ADCB

43

Ratio

Ana

lysi

s

http://financial-dictionary.thefreedictionary.com/Investors

http://financial-dictionary.thefreedictionary.com/Revenues

http://financial-dictionary.thefreedictionary.com/Profit

http://financial-dictionary.thefreedictionary.com/Costs


1. Profit margin

Net Income TOTAL Operating Income

818,941 5,335,900

0.1537

GRAPH NO.1

INTERPRETATION

The Abu Dhabi Islamic Bank is in good position as compare to Abdu Dhabi

Commercial bank. In ratio analysis we find great difference in profit margin

ration the ration as ADIB is 1.062 and ADCB is .1537 only. Its means the ADIB is in great position

to control its operating cost. A higher profit margin ratio can also mean sales are increasing faster

than cost and defiantly ADIB is in a relatively liquid position as Compare to ADCB.

4.2.2 ASSET UTILIZATION

FORMULA:

44

Ratio

Ana

lysi

sRa

tio A

naly

sis

RATIO ADIB ADCB

Profit margin 1.062 0.1537


ASSET UTILIZATION = TOTAL OPERATING INCOME

TOTAL ASSETS

COMPONENTS:

ADIB ADCB

TOTAL OPERATING INCOME 1,023,565 5,335,900

TOTAL ASSETS 75,357,518 178,271,194

SIGNIFICANCE:

A ratio that is used to determine how well a firm is managing its assets is called an activity

ratio or asset utilization ratio. These ratios compare a company's sales to different asset

categories. Three of the most common activity ratios compare sales to a company's

accounts receivable, inventory and to its fixed assets (i.e., plants and equipment). These

activity ratios are especially useful when used to compare a particular company to its

industry bellwether, or to another company.

The asset utilization ratio measures the extent to which the bank`s assets to generate

revenue. The breakdown of asset utilization ratio separates the total revenue generated into

interest income and noninterest income.

GRAPH

NO .2

45

Ratio

Ana

lysi

s

S. No


ADIB

2Assets utilization

Total operating income Total asset

1,023,565 75,357,518

1.36%

S. No


ADCB

2 Assets Utilization

Total operating income Total asset

5,335,900 178,271,194

2.10%

RATIO ADIB ADCB

ASSETS UTILIZATION 1.36% 2.10%


INTERPRETATION

Asset Utilization ratio seems to like that ADCB is in good position as compare to ADIB the asset

utilization ratio of ADCB is almost higher than ADIB is 54%. Theoretically ADCB is in better

position than ADIB.

4.2.3 EQUITY MULTIPLIER

FORMULA:

EQUITY MULTIPLIER = TOTAL ASSETS

TOTAL EQUITY CAPITAL


Total Assets of the year 75,257,518 178,271,194

Total Equity Capital 8,110,652 19,573,348

SIGNIFICANCE:

Equity Multiplier measures the dollar value of assets funded with each dollar of equity

capital (the higher this ratio, the more leverage or debt the bank is using to fund its assets.)

It can be defined as,

Amount or percentage of assets owned by each dollar of the equity invested in a business.

S. No RATIO DESCRIPTION CALCULATIO

NADIB

3

EQUITY MULTIPLIER

TOTAL ASSETS TOTAL EQUITY CAPITAL

75,257,518 8,110,652

9.28 times

46

Ratio

Ana

lysi

s



NADIB

3

EQUITY MULTIPLIER


178,271,194 19,573,348

9.10 times

GRAPH NO. 3

INTERPRETATION

47

RATIO ADIB ADCB

EQUITY MULTIPLIER 9.28 times 9.10 times


Equity Multiplier Ratio shows very minor difference as ADIB is 9.28 Times and ADCB is

9.10Times. As the graph showing almost equilibrium. The Abdu Dhabi Commercial bank is .18

Times better than Abu Dhabi Islamic Bank.

4.2.4 RETURN ON ASSETS (ROA)

FORMULA:

RETURN ON ASSET (ROA) =

NET INCOME x TOTAL OPERATING INCOME

TOTAL OPERATING INCOME TOTAL ASSETS

OR = NET INCOME

TOTAL ASSETS


Total Net Income 1,086,924 819,941

Total Assets 75,257,518 178,271,194

A further breakdown of a bank`s profitability is that of dividing ROA into its profit margin PM

and Assets Utilization AU ratio components.

SIGNIFICANCE:

Return on assets is an indicator of how profitable a company is before leverage, and

is compared with companies in the same industry. Since the figure for total assets of the

company depends on the carrying value of the assets, some caution is required for

companies whose carrying value may not correspond to the actual market value. Return on

assets is a common figure used for comparing performance of financial institutions (such as

banks), because the majority of their assets will have a carrying value that is close to their

48

Ratio

Ana

lysi

s

http://en.wikipedia.org/wiki/Bank

http://en.wikipedia.org/wiki/Financial_institution

http://en.wikipedia.org/wiki/Market_value

http://en.wikipedia.org/wiki/Book_value

http://en.wikipedia.org/wiki/Gearing


actual market value. Return on assets is not useful for comparisons between industries

because of factors of scale and peculiar capital requirements (such as reserve requirements

in the insurance and banking industries).


NADIB

4

RETURN ON ASSETS

NET INCOME TOTAL ASSETS

1,086,924 75,257,518

1.445%


NADIB

4

RETURN ON ASSETS

NET INCOME TOTAL ASSETS

819,941

178,271,194

0.46%

49

RATIO ADIB ADCB

RETURN ON ASSETS 1.445% 0.46%


GRAPH NO. 4

INTERPRETATION

The only common rule is that the higher return on assets is, the better, because the company is

earning more money on its assets. A low return on assets compared with the industry average

indicates inefficient use of company's assets

So according to the rule ADIB ratio is 98.5% better than ADCB.

4.2.5 RETURN ON EQUITY (ROE)

FORMULA:

RETURN ON EQUITY (ROI) =

NET INCOME X TOTAL ASSETS


OR = NET INCOME

TOTAL EQUITY CAPITAL


Net Income = 1,086,924 819,941

50 Ratio

Ana

lysi

s


Total Equity Capital = 8,110,652 19,573,348

SIGNIFICANCE:

Return on Equity (ROE, Return on average common equity, and return on net worth)

measures the rate of return on the ownership interest (shareholders' equity) of the common

stock owners. ROE is viewed by investors as one of the most important financial ratios. It

measures a firm's efficiency at generating profits from every dollar of shareholders' equity

(also known as net assets or assets minus liabilities). It shows how well a company uses

investment dollars to generate earnings growth. ROE is equal to a fiscal year's net income

(after preferred stock dividends but before common stock dividends) divided by total equity

(excluding preferred shares), expressed as a percentage.


NADIB

5 RETURN ON EQUITY

NET INCOME TOTAL EQUITY CAPITAL

1,086,924 8,110,652

13.406%


NADIB

5RETURN ON

EQUITY

NET INCOME TOTAL EQUITY CAPITAL

819,941 19,573,348

4.19%

51

RATIO ADIB ADCB

RETURN ON EQUITY (ROE) 13.406% 4.19%

http://en.wikipedia.org/wiki/Net_income

http://en.wikipedia.org/wiki/Fiscal_year

http://en.wikipedia.org/wiki/Financial_ratio

http://en.wikipedia.org/wiki/Shareholders'_equity


GRAPH NO. 5

INTERPRETATION

.

From the analysis of ADIB and ADCB we find Return on Equity of ADIB is 13.406% as

compare to ADCB 4.19%. So The ADIB is in better position over ADCB. So the ADIB

overall performance in return on equity is very good. ADIB is in position of provide

dividends to owners and have funds for future growth of the company.

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4.3 DISCUSSION AND FINDINGS

In This Chapter we determine whether it is possible to distinguish between conventional and

Islamic banks in the Gulf Cooperation Council (GCC) region on the basis of financial

characteristics alone. Islamic banks operate under different principles, such as risk sharing and the

prohibition of interest, yet both types of banks face similar competitive conditions. The combination

of effects makes it unclear whether financial ratios will differ significantly between the two

categories of banks. We input 5 financial ratios in measurement of ADIB and ADCB to determine

whether researchers or regulators could use these ratios to distinguish between the two types of

banks. Although the means of several ratios are similar between the two categories of banks, so,

we find that the main distinction between Islamic and convention banks are the difference in

Principles.

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CHAPTER 5:

SUMMEARY OF FINDINGS, CONCLUSIONS,RECOMMENDATION

5.1. SUMMARY OF FINDINGS.

As a matter of fact, the Islamic banks and companies provide

significant contributions to the economic development process in U.A.E.

And because of this reason the Islamic finance industry need to be in

focus for more researches and developments. We think that our study itself

needs to be repeated after some years to assess the performance of U.A.E

Islamic banks after more maturity of this industry in U.A.E. Also the

differences between the services provided by Islamic and conventional

banks need to be subjected to more investigations and analysis.

We think also, there should be a more studies about the real practices of

Islamic finance industry, and the differences between the theoretical bases of this

industry and the actual practice. As we see many of the advocators of this

industry writing about the benefits and the social role of Islamic finance, but we

think they are focusing more on the theory and neglecting the actual practice

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5.2 CONCLUSIONS

1- The evaluation of the performance of Islamic banks through a number of

key ratios yields fairly satisfactory results. In general, Islamic banks are well

Capitalized, profitable and stable. They also seem to be making an effective use of

the resources at their disposal. However, they do not appear to be cost-effective in

their operations

2- While their profitability ratios compare favorably with international

Standards, it should be noted that conventional banks’ depositors are guaranteed

their principal amounts, and hence bear less risk than Islamic banks’ depositors.

Therefore, the depositors of Islamic banks would genuinely expect a higher rate of

Return to compensate for the extra risk. The current rates of profits on assets of

the

Islamic banks may not be enough to meet that expectation.

4) The study does not lend any support to the general belief that Islamic

Banks are suffering from excess liquidity.

5) When compared with conventional banks, Islamic banks as a group

outperformed the former in almost all areas and in almost all years. However,

there are considerable variations among Islamic banks in terms of growth as well

as performance. Such variations are quite natural. As a matter of fact, one

objective of this study was to study the comparative performance of various

Islamic banks, something that has never been done before in such detail. Similar

variations are there even in the case of conventional banks.

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5.3 RECOMMENDATIONS

Islamic banking and finance activities are expected to grow even more

rapidly in the foreseeable future providing sophisticated products and financial

services. Based on our research, we think that it is very important to Islamic

banks in U.A.E to pursue diversification by giving more focus to profit-loss-

sharing financing instruments like Mudaraba and Musharaka. This will support

the ethical and social expected role of Islamic finance industry. The Islamic

banks also should decrease their dependence on debt-like financing instruments

like Murabaha and Ijara, which form more than 90% of Islamic banks

operations, as mentioned in some studies.

We think also the rapid growth of Islamic banking is supported by

religious Emotions of Muslim people; it is not based on a real competition in

performance between Islamic and conventional banks. We think that Islamic

banks should focus more in improving their efficiency for benefits of both owners

and customers.

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Reference list:

1) www.adib.ae

2) www.adcb.ae

3) From Wikipedia, the form encyclopedia

4) Notes on Financial Institutions prepared by Mr.Imran Hasnain, Lecturer

Accounting and Finance, Preston University, Ajman.

5) Notes on Banking Operations prepared by Mr.Hakim Shabir, Lecturer

Banking Operations, Preston University, Ajman.

6) Code of Ethics & Business Conduct for ADCB Staff.

7) Banking law and practice by Dr. Israr Ahmad.

8) Dr. Zamir Iqbal Articals.

57

http://www.adcb.ae/

http://www.nationalbankofdubai.com/

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