Report Draft Final

8/7/2019 Report Draft Final

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SWINBURNE UNIVERSITY OF TECHNOLOGY

Islamic banking in the

Middle EastHBI552 Business in Asia, Americas and

Europe

Ali Ramtoola (6932584), Srinivasa Maddula (6917542), Arcris Galang(2226219)

Prepared for Dr J Mohammad


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Executive Summary


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Contents

Executive Summary ................................................................................................ i

Contents ................................................................................................................ 2

1.Introduction ........................................................................................................ 1

The limitations to this report .............................................................................. 1

Scope .................................................................................................................. 1

2.The Middle East .................................................................................................. 2

Gulf Cooperation Council (GCC) .......................................................................... 5

Banking in the Middle East .................................................................................... 7

The history of Islamic banking ............................................................................ 7

Islamic banking in the Middle East ..................................................................... 8

Islamic banking versus conventional banking .................................................. 10

The impact of Islamic banking on the Middle East ...........................................12

Conclusion ........................................................................................................... 14

4.References ........................................................................................................ 15

Appendix A .......................................................................................................... 17


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HBI552 Business in Asia, Americas and Europe (Saturday)

Group report and presentation

1.Introduction

This report on Islamic banking has been commissioned by Dr Jawed Mohammed

as part of a study of the Middle East in the HBI552 Business in Asia, Americas

and Europe unit at Swinburne University of Technology.

The limitations to this report

While Islamic banks has been in existence for over three decades, their

separation from national central banking systems creates a lack of publicly

available literature on financial performance and its impact on the Middle

Eastern region made it difficult to make comparisons to conventional models.

Scope

The report is broken up into three significant sections the first defines the Middle

East region; the second explores the concept of Islamic banking, its history andhow it differs from conventional banking; and lastly what impact Islamic banking

has had on the Middle East region. The final two sections will be explored

through academic literature and with examples to provide a comprehensive view

of the subject.

Ramtoola, Subramanynam, Galang (2226219) 1


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2.The Middle East

The Middle East is the region originally included in the Ottoman Empire,

spanning South-Western Asia and North-Eastern Africa and currently extending

from Libya to Afghanistan. Before first World War the British had ruled over thePalestine including all the Israel occupied countries. In 1917, a deal was struck

between the British and the Arab province Ottoman Empire to make a separate

Jewish national home in Palestine. After the World War I, the Ottoman Empire

established Israel as a separate nation with the help of central powers, with the

US playing a key role in the formation of Israeli.

The Middle East is a geopolitical and cultural term that refers to the countries

nestled between Africa and Asia. Historically, the boundaries are debated but

typically the western half of countries in the South-Eastern Mediterranean along

the Nile delta and extending through Iran. According to the International

Monetary Fund, the Middle East includes the countries of:

Afghanistan

Algeria

Bahrain

Djibouti

Egypt

The Islamic Republic of Iran

Iraq

Jordan

Kuwait

Lebanon



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Libya

Mauritania

Morocco

Oman

Pakistan

Qatar

Saudi Arabia

Somalia

Sudan

The Syrian Arab Republic

Tunisia

The United Arab Emirates (UAE)

West Bank and Gaza

Yemen



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Figure 1 - Map of Middle Eastern countrieshttp://www.globalresearch.ca/articlePictures/The%20Project%20for

%20the%20New%20Middle%20East.jpg

Despite comprising of small and numerous nation-states, there is a prevailing

collective pride in its long history as the origin of some of the worlds most

influential empires; the birthplace of monotheism; and fundamental contributions

to civilisation.

While a predominantly Muslim region, not all Middle Eastern countries have are

Islamic nations or have Islamic systems or governments. The majority of these

nation-states have Islamic Law woven in varying degrees into their legal

frameworks, showing that Islamic principles are persist in the present social state

in most of the regions nations.

Part of their culture also stems from a European influence. From the sixteenth

century through the nineteenth centuries while the Ottomans ruled most of the

Middle East, the region extensively traded goods, exchanged ideas and travellers

from Europe. This influenced the region, integrating European ideals into Islamic

legal systems. This coexistence was due in part to Europes desire to enhance

their position, but it also filled the need in Islamic trade and financial law.

The region is well situated globally to offer many dynamic trade and investment

opportunities. Primarily known as one of the largest oil and gas exporters, the

Middle East holds two thirds of the worlds oil reserves. Their governments are

attempting to reduce their dependence on oil by instituting policies attractive for

foreign investment. Middle Eastern leaders recognise the need to diversify by

http://www.globalresearch.ca/articlePictures/The%20Project%20for%20the%20New%20Middle%20East.jpghttp://www.globalresearch.ca/articlePictures/The%20Project%20for%20the%20New%20Middle%20East.jpghttp://www.globalresearch.ca/articlePictures/The%20Project%20for%20the%20New%20Middle%20East.jpghttp://www.globalresearch.ca/articlePictures/The%20Project%20for%20the%20New%20Middle%20East.jpghttp://www.globalresearch.ca/articlePictures/The%20Project%20for%20the%20New%20Middle%20East.jpg


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privatising traditionally state-owned assets and attract the annual $3.1 billion in

projects to realise privatisation efforts and infrastructure projects in the Middle

East (Donboli & Kashefi 2005), while coping with population growth which is

increasing faster than its economic development.

The Middle East is mostly a hot and arid climate. Agriculture is one of the keyresources for the economy as well as the dairy, textiles, leather and defence

industries. Tourism is also increasing with the provision of improved facilities

and amenities.

It is also a melting pot of various ethnic groups and uses a diverse number of

languages, the most popular being Arabic, Persian and Turkish. The region has

also been plagued by conflict with the US occupation of Iraq, the Israeli-

Palestinian conflict and the spreading fear of terrorism.

Gulf Cooperation Council (GCC)

Recognising the need to enhance regional cooperation, the GCC was established

in the early 1980s to facilitate and enhance foreign investment among the six

member states of:

Saudi Arabia

Kuwait

Bahrain

Qatar

Oman

United Arab Emirates (UAB)

Figure 2 Map of the GCC countries, http://cominganarchy.com/wordpress/wp-

content/uploads/2009/12/GCC-ap.jpg

http://cominganarchy.com/wordpress/wp-content/uploads/2009/12/GCC-ap.jpghttp://cominganarchy.com/wordpress/wp-content/uploads/2009/12/GCC-ap.jpghttp://cominganarchy.com/wordpress/wp-content/uploads/2009/12/GCC-ap.jpghttp://cominganarchy.com/wordpress/wp-content/uploads/2009/12/GCC-ap.jpg


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In banking terms, the majority of the GCC countries represent the bulk of Islamic

bank assets in the Middle East (Hasan & Dridi 2010). The banks in the GCC have

developed to be more diverse, with a mixed financial system to set them up as

mainstream financial intermediaries of the Middle East.



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Banking in the Middle East

In the 1960s and 1970s, banking in the Middle East comprised mainly of small-

sized banks serving the requirements of a limited domestic market at a time

when no local commercial banks had globalised their operation to any significantextent.

Today, the financial scene has been transformed with an increase in the size and

number of local banks, a quick expansion of banking networks and a widening of

available financial services.

Banking in the rich oil exporting countries is tightly linked to oil. While economic

policy is being used to enhance competition and raise efficiency, the sector is

relatively restricted in terms of competition. Non-oil countries are characterised

by financial institutions that rely on more diverse domestic and regional

resources. Financial liberalisation started early in these countries than the Gulfstates, with regulators introducing financial deregulation.

Banks in the Arab Middle East region earn revenues as if under conditions of

monopolistic competition. There are still heavy regulations and protective

measures imposed restricting banking in some countries. Economists and

businesses are calling for an easing on these restrictions to increase efficiency of

the system and economy while protecting domestic banks.

The history of Islamic banking

Islamic banking was a new political alliance that emerged between the rich andwealthy and Islamic law (Shariah) scholars. The relationship invigorates Shariah

scholars, influential in forming public opinion in most Muslim countries (Kahf

2004). The scholars and religious leaders have continuously spoken of the

prohibition of usury or riba, and the fact that conventional foreign banks were

based on such activity.

It was in the early 1950s to the late 1960s when Muslim economists, bankers,

Shariah scholars and political Islamists focused on the possibility of running

financial institutions without riba. They highlighted the merits of Islamic banks

to the Muslim public, but the actual establishment of these banks came from two

areas of the Muslim world, Asia and the Middle East. Conceptually, they both

involved collecting small amounts of savings from a large number of people to

invest in infrastructure or agricultural projects, or to microfinance small local

entrepreneurs.

In Asia, Malaysia was being preparing for independence in the early 1950s. The

newly emerging government supported the idea of establishing an investment

institution addressing the needs of Malays. In 1956 the Pilgrims Administration

Fund (Tabung Hajji) took shape as a financial institution that collects savings for

and invests them in accordance with Shariah. The fund was supported by

legislation requiring all Malays use the Tabung Hajji. The fund has anindependent decision-making authority, with government appointed



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management and an honorary subordination to the Prime Ministers Office. The

fund increased shares in real estate, industrial and agricultural sectors and had

initiated improvements to ideas and procedures of Islamic financing.

In the Middle East, a series of savings and investment houses known as Mit

Ghamr, were established in rural northern Egypt in 1963. This was done in atime where the current government and ruling class were sensitive to Islamic

political activity. The banks did not last long, with the houses being liquidated in

1967. The success of Mit Ghamr was in its ability to spread from small town to

small town to encourage savings from the poor of Egyptian society; which

pressured the government to fill the void when they closed. In 1971 the

Egyptian government created the first Islamic bank, the Nasser Social Bank and

was based on interest-free financing and the distribution of donation orzakat.

The bank was again supported by legislation, requiring public sector companies

to donate 2.5% of profit to the bank, as well as the administration ofzakat (El-

Gamal 2005).

Islamic banking in the Middle East

Currently, Islamic finance is one of the fastest growing segments of the global

financial services industry with assets growing over 10% per annum over the last

10 years. In 2009 the global Islamic finance industry is estimated at US$822b

(Austrade 2010).

CountryNumber/Type ofLicensed Banks Islamic banks

Offshore banks

Bahrain

21 commercial banks, 2specialised banks, 47 offshorebanks, 32 investment banks,

27 foreign bank offices

4 commercial, 14investment, 2offshore banks

47

Egypt

81 banks, 28 commercialbanks, 32 investment and

business banks, 21specialised banks

Yes None

Iran10 state-owned banks, 3

private banks

All banks mustconform to Islamic

principlesNone

Jordan

9 local commercial banks, 2Islamic banks, 5 investment

banks, 5 foreign banks, 5specialised credit institutions

2 commercial

banks None

Kuwait7 commercial banks, 2

specialised banks, no foreignbanks

One None

Lebanon68 banks (48 domestic), 14foreign banks, 8 specialised

banksNone None

Libya6 commercial banks, 18 localbanks, 3 specialised banks

Two

Oman

15 commercial banks, 3specialised banks. The

largest three banks are localcontrolling 60-70%

None None



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Qatar

15 commercial banks (7foreign). Domestic banks andQatar Industrial Bank control

88.7% bank assets

Two Yes

Saudi Arabia

11 commercial banks (3 Saudi

owned), 5 governmentspecialised credit institutions

One bank and allcommercial banks

have Islamicwindow

None

Syria1 commercial bank, 4

specialised banks all stateowned

None None

United ArabEmirates (UAE)

47 commercial banks (20locally incorporated), 1

restricted license commercialbank, 1 specialised bank, 2

investment banks

Three,conventional

banks with Islamicwindows

None

Table 1 - Creane, et al 2004, Financial sector development in the Middle East and North Africa,

International Monetary Fund, pp 27 28

As one of the most developed Islamic banking markets, the Middle East holds

almost 60% of the industrys assets. While development of the industry is

different between countries, Saudi Arabia and Kuwait are reaching maturity while

others are still experiencing some growth.

Figure 3 Size of Islamic Banking market and assets in the Middle East,

http://reports.celent.com/PressReleases/200811253/IslamicBanking.asp

http://reports.celent.com/PressReleases/200811253/IslamicBanking.asphttp://reports.celent.com/PressReleases/200811253/IslamicBanking.asp


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Islamic banking versus conventional banking

Exploration of the differences between conventional banking and Islamic banking

requires an understanding of where conventional banking from a capitalist

system and Islamic banking based on Shariah stand.

1. Conventional banks operate on the basis of return on investment and

profit, whereas an Islamic bank is bound to operate within the limits of the

Shariah fiqh al-Muamulaat; and abide by the laws of the holy Quran and

Hadiths.

2. Conventional banking mainly focuses on the economic and financial

features of a transaction. The Islamic system lays the same importance

on the ethical, social, religious, economic, and financial market dimensions

(Ahmed 2010).

For example a conventional bank will lend money to finance a casino, butan Islamic bank will not do so as gambling is not permissible under Islamic

law (Quran and Sunnah) and a form of uncertainty (gharar) (Ahmed 2010).

3. Conventional banks mobilise resources from deposits and passes it on to

other productive players in the economy using a rate of interest

mechanism and liquidity ratios. Depositors who have a bank account are

clients and not partners in the banks profit or loss. The relationship is of

creditor to debtor.

Islamic banks operate differently for resource mobilisation in the sense

they offer asset backed finance. They are organised as or in similarfashion to a joint stock company with the shareholders providing initial

capital, managed by shareholder representatives. Individual holders of

bank savings or investment accounts are partners in the success or loss of

the bank and as such share the realised profits with the bank in

accordance to ratios agreed upon at the time of contracting. Deposits

from clients are treated as loans to the bank, who then invest them in

Shariah compliant ventures.

Islamic banking promotes risk sharing between the investing party and the

borrower, whereby both the bank as an investor and the borrower as the

entrepreneur share the results (profit or loss) in a predetermined way .

Wherein conventional banking the risk factor is removed and normal bank

operate on the basis of credit worthiness of a client and based on his

credit rating lend him money in an equation such that the borrower or

entrepreneur is solely responsible for the risk of the venture and the bank

is assured of a fixed predetermined return.

4. Conventional banks lend money and consider it to have an intrinsic value

and expect a return on it in the form of interest and reward in the form of

private enterprise and profits. This money is traded as a commodity and



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banks lend money based on a rate of return payable as interest which

benefits the shareholders of the bank.

In Islamic banking riba is prohibited and as such all types of financial

contracts and transactions are exempt from interest, as per jurists who

base this banning or arguments of social justice, equality and propertyrights.

5. Conventional banks take into account the credit history and credit

worthiness of a client first and foremost to evaluate the suitability of a

loan, as they are more concerned that the loan (capital) and accrued

interest should be repayable on time.

Islamic banks on the other hand encourage the concept of profit and loss

sharing, wherein the bank only receives a return only in cases the project

they have financed makes a profit, thus the Islamic bank will be more

focused on the soundness and business expertise or experience of theproposed entrepreneur before deciding to invest (Iqbal & Molyneux 2005).



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The impact of Islamic banking on the Middle East

Some countries in the Middle East like Iran have moved to a full Islamisation of

their banking and financial system; while others like Bahrain has moved to a

mixed financial system; others still like Lebanon have not embraced Islamic

banking. Obviously, those countries with a predominantly Muslim population will

have a greater tendency toward Islamisation.

Bahrains mixed financial system provides a competitive advantage in

establishing it as a well-diversified international financial hub appealing to all

types of investors. Established during the Lebanese civil war, Bahrain approved

the entry of foreign banks.

The governments commitment to attracting leading financial institutions and

initiatives resulting from a merging of the two systems has meant that Bahrain is

home to important Islamic organisations like the Accounting and AuditingOrganization for Islamic Financial Institutions (AAOIFI), the International Islamic

Rating Agency (IIRA), the International Islamic Financial Market (IIFM) and the

Islamic Liquidity Management Center (ILMC). The ILMC was created to help

Bahrain Islamic banks meet short-term liquidity issues, which is common for all

Islamic banks not part of a national central banking system. This freed Bahrain

from having to hold significant cash reserves and increased growth potential.

Full Islamisation of financial systems is being held back by the smaller number of

Islamic financial instruments in comparison to conventional banks (Creane, et al

2004). This has led to the creation of non-profit & loss sharing instruments,

which bear a striking resemblance to those in conventional banking (Chong & Liu

2007). Some of these instruments include:

Murabaha is based on mark-ups, where the bank buys goods and sells

them to the customer for cost price plus a negotiated profit margin.

Ijarah is based on rents, where the bank purchases an asset for a

customer and then leases it for a fixed charge.

Bai salam is based on the idea of forward sale, where an entrepreneur

sells specific goods to a bank at a price determined at the time but with

the delivery of goods in the future.

It is because of these similarities that those who avail the services of Islamic

banks are similarly comfortable using conventional banks (Zaman 2002).



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Figure 3 Islamic and conventional banking profitability,

http://www.imf.org/external/pubs/ft/survey/so/2010/res100410a.htm

During the current economic crisis, the Islamic banks outperformed their

conventional counterparts. This was due in part to having smaller investment

portfolios, lower leverage and adherence to Shariah principles which includes the

prohibition of selling what is not owned (short-selling and like derivatives). It isbecause of this risk and profit sharing principle and gharar, that Islamic banks

are more conservative avoiding speculative investments (Austrade 2010).

http://www.imf.org/external/pubs/ft/survey/so/2010/res100410a.htmhttp://www.imf.org/external/pubs/ft/survey/so/2010/res100410a.htm


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Figure 4 Islamic and conventional bank profitability, credit and assets,

http://www.imf.org/external/pubs/ft/survey/so/2010/res100410a.htm

However, Islamic banks were not completely insulated from the crisis due to

their Shariah based model requiring transactions to be backed by tangible

assets. Most of the tangible assets were real estate based, the prices of which

were affected in the downturn (Austrade 2010). It is also attributable to

concentrated exposure to a sector or borrower (Hasan & Dridi 2010)

Conclusion

While Islamic banking is enjoying double digit growth, its spread across the world

is limited with the major markets being Middle East, Malaysia and UK. The

challenges facing Islamic banking in the Middle East are:

Adopting one institutional framework and regulatory body so that it can

find greater coexistence with conventional banking (Iqbal et al 1998)

Liquidity and having access to enough a Shariah compliant secondary

market (Iqbal et al 1998)

Improving the offer of financial instruments to maximise given input usage

while complying Shariah principles (Abdul-Majid, Saal & Battisti 2009)

Adopted and universal accounting standards to meet existing business

conditions

Supportive legal and government policy to provide Islamic banks theflexibility to remain non-secular (Iqbal et al 1998)

Full Islamisation of some banking industries has effectively stifled

economic development for those countries (Chong & Liu 2009)

http://www.imf.org/external/pubs/ft/survey/so/2010/res100410a.htmhttp://www.imf.org/external/pubs/ft/survey/so/2010/res100410a.htm


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Murjan, W. & Ruza, C., 2002, The competitive nature of the Arab Middle Eastern

banking markets, International Advances in Economic Research, vol 8, no 4, pp

267 273

Zaman, M.R., 2002, Assessing the nature and impact of Islamic banking and

finance, paper submitted to the 2nd

International Conference on Banking andFinance



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Appendix A

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 operatingmodes of conventional banks arebased on fully manmadeprinciples.

1. The functions and operatingmodes of Islamic banks are based onthe principles of Islamic Shariah.

2. The investor is assured of apredetermined rate of interest.

2. In contrast, it promotes risksharing between provider of capital(investor) and the user of funds(entrepreneur).

3. It aims at maximizing profitwithout any restriction.

3. It also aims at maximizing profitbut subject to Shariah restrictions.

4. It does not deal withZakat. 4. In the modern Islamic bankingsystem, it has become one of theservice-oriented functions of theIslamic banks to be aZakatCollection Centre and they also pay

out theirZakat.

5. Lending money and getting itback with compounding interest isthe fundamental function of theconventional banks.

5. Participation in partnershipbusiness is the fundamental functionof the Islamic banks. So we have tounderstand our customers businessvery well.

6. It can charge additional money(penalty and compoundedinterest) in case of defaulters.

6. The Islamic banks have noprovision to charge any extra moneyfrom the defaulters. Only small

amount of compensation and theseproceeds is given to charity. Rebatesare give for early settlement at theBanks discretion.

7. Very often it results in thebanks own interest becomingprominent. It makes no effort toensure growth with equity.

7. It gives due importance to thepublic interest. Its ultimate aim is toensure growth with equity.

8. For interest-based commercialbanks, borrowing from the money 8. For the Islamic banks, it must bebased on a Shariah approved



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market is relatively easier. underlying transaction.

9. Since income from theadvances is fixed, it gives little

importance to developingexpertise in project appraisal andevaluations.

9. Since it shares profit and loss, theIslamic banks pay greater attention

to developing project appraisal andevaluations.

10. The conventional banks givegreater emphasis on credit-worthiness of the clients.

10. The Islamic banks, on the otherhand, give greater emphasis on theviability of the projects.

11. The status of a conventionalbank, in relation to its clients, isthat of creditor and debtors.

11. The status of Islamic bank inrelation to its clients is that ofpartners, investors and trader, buyer

and seller.

12. A conventional bank has toguarantee all its deposits.

12. Islamic bank can only guaranteedeposits for deposit account, whichis based on the principle ofal-wadiah, thus the depositors areguaranteed repayment of theirfunds, however if the account isbased on the mudarabah concept,client have to share in a lossposition..

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