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Name: Ismail Ali Ahmed Student ID: 185768 University of Atlanta Doctorate of Business Administration Course: Business Research

Methods II Tutor: Dr. B. Erastus

Assignment #1: Analysis based research paper: Islamic Banking System Word count: 1,953 (excluding bibliography and table of contents)

Version 1.3 Date: Feb. 1, 2011

Electronic copy available at: http://ssrn.com/abstract=1759273

Business Research Methods II

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Table of Contents

INTRODUCTION .................................................................................................................................. 3 ISLAMIC AND CONVENTIONAL BANKING: THE DIFFERENCES AND GROWTH ............ 6 ISLAMIC BANKING: EMERGING BANKING ALTERNATIVE ................................................ 10 CONCLUSION ..................................................................................................................................... 12 REFERENCES ..................................................................................................................................... 13

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Electronic copy available at: http://ssrn.com/abstract=1759273

Business Research Methods II

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Introduction
Over the past decade the Islamic banking sector has grown steadily and rapidly globally, the multinational banks paid attention while the Islamic banking expanding out of Middle East and Asia Pacific into European and African markets.

The difference between Islamic and conventional banking system is much more related to the product / service offering that based on philosophy of dealing with the money as an economical tool rather than a commodity and using the tool in the conscience of religion values.

Being considering money as an economical tool and not as a commodity for trading, Islamic banking does not allow trading money, accordingly interest based deals are not allowed (Cash loans).

The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service," the Vatican's official newspaper Osservatore Romano said in an article in its latest issue on March 6, 2009.

Since the institution of the first trial of offering banking system; based on Islamic principles in Egypt more than four decades ago, the Islamic banking has been growing across the Muslim communities. The number of financial institutions that offers banking practices based on the Islamic
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principle increased tremendously comparing to conventional banks; In the Middle East and Malaysia; more than twenty new Islamic banks introduced while the major global banks like HSBC, Citibank, Standard Chartered bank offered Islamic products. . As the model getting matured, the government regulated the Islamic banking practices, as of today almost all of the Middle East countries, has a regulations and policies to monitor and control the Islamic banking practices as well the conventional banking practices, some countries like Sudan and Pakistan allows only Islamic banking practices. Gartner report issued July 2010 about the competitive landscape of Islamic banking solutions, indicated that the Middle East and North Africa countries has developed regulation to control the Islamic banking offering, however the Islamic banking practice is expanding to other countries with no clear regulations. According to most estimates, Islamic banking growth rate surpassed an average 15 per cent in the last decade and assets under management of Islamic financial institutions are worth close to a trillion dollars. The number of operating Islamic financial institutions is well above 300 in more than 75 countries (El Qorchi, 2005).

The Islamic banking system is built on the premise that money should not be borrowed instead the financial institutions must be sharing risks with their clients, Islamic financial institutions approach their Banking activities from a partner perspective.. The customer and the bank share the risk of any

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investment on agreed terms, and divide any profits or losses between them. In addition, investments should only support practices that are not forbidden trades in alcohol, betting and pornography are not allowed. Moreover, an Islamic banking institution is not permitted to lend to other banks at interest.

For example; the famous Islamic banking product, Murabaha - A form of credit that enables customers to make purchases without taking an interest bearing loan. The bank buys the goods for the customer and re-sells them to the customer on a deferred basis, adding an agreed profit margin. The customer then pays the sale price for the goods over installments, effectively obtaining credit without paying interest.

While the Islamic banks share the risk of conducting economic activity by buying, owning and re-selling the commodity to the client, the conventional banks exposed to a less risky attitude of a lender by considering the interest as a function of time only without including economic activity.

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Islamic and Conventional Banking: The Differences and growth

The Islamic banking deals with the customer as an investor or partner and that reduces the risk of the Islamic banking by passing through the loss to the depositor/investor as well reduces the operational risk comparing to the conventional banks, Conventional banks deals with customers deposits as a liabilities; such liabilities which getting insured - deposit insurance to protect bank depositors, in full or in part, from losses caused by a bank's inability to pay its debts when due

The Islamic banking offering is based on several banking business models including finance, leasing, investment, trading and reverse finance. All these models are based on Sharia compliant mechanisms. For example Istisnaa product: The Arabic word "Istisnaa" means "asking someone to manufacture". It may be further defined and elaborated as a sale contract between the seller and the buyer for the sale of an asset described in the sale contract and transacted before it comes into existence. To fulfil its obligation, the seller can either manufacture/construct it by itself or can get it manufactured/constructed by someone else to deliver it to the buyer on the date described in the sale contract. The buyer can pay the sale price in lump sum at the time of signing the contract or later in different stages as the manufacturing/construction process proceeds.

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Although the Islamic banking system is incorporated into the global financial system, but the Islamic banks are not directly affected by the current global financial crisis. Islamic banks are not involved in trading of debt securities due to prohibition of interest in Islam. Islamic banking is prohibited from dealing with derivative products which is not based on asset trading or it does include high uncertainty, so buying debt securities under Islamic Sharia'a law is not allowed; therefore, Islamic banks are safer from the direct effect of the global financial crisis.

However the global crisis has affected the Islamic financial institutions, the Islamic banks in the Arabian Gulf had negative effect with a certain degree. As the Islamic banking system is part of the global economy, and the Islamic banks get to invest into the real estate and stock shares as an asset. During the global crisis, the value of the real estate assets depreciated by more than 40% in some geographical areas like Dubai, as well as the stock shares value decreased globally; accordingly the Islamic banks affected by the depreciation in the real estate and the stock shares.

The Islamic financial system does not allow the creation of debt through direct lending and borrowing. It rather requires the creation of debt through an economic event like the sale or lease of real assets by means of its sales- and lease-based modes of Banking (murabaha, ijara, salam, istisna, and sukuk). The purpose is to enable an individual or firm to buy now the urgently needed real goods and services in conformity with his/her ability to

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make the payment later. The leasing product has several options including but not limited to: Ijarah: Under this mode of financing, the client approaches the bank specifying what asset he wishes to purchase. The bank purchases the asset and allows the client to take benefit of the asset for a specified period of time by means of a lease or rental contract, in return for a periodic lease payment.

Operating Lease Contract: In this case, the bank assumes the risks related to the asset such as defects, breakdowns, periodic major maintenance, and complete destruction of the asset. The bank signs a lease contract with the client for a specified period of time, after which the bank retains possession of the assets and may rent said asset to another client at a different lease rate. The lessee assumes daily operating expenses and maintenance of the leased asset. Furthermore, any misusage of the assets that is concluded with damages to the assets is the responsibility of the client. Financial Lease (Lease and Own): In this case, the lease contract shall incorporate the clients interest in buying the asset after a specific period of time. The bank purchases the asset based on the clients request and leases the assets to the client for a longer period of time. As soon as the lease contract is terminated the asset may be sold to the client at an agreed price to be paid as agreed.

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The injection of a greater discipline into the financial system may tend to deprive the subprime borrowers from access to credit. Therefore, justice demands that some suitable innovation be introduced in the system to ensure that even small borrowers are also able to get adequate credit. (Cihak, 2008)

Islamic banking system is capable of minimising the severity and frequency of financial crises by getting rid of the major weaknesses of the conventional system. It introduces greater discipline into the financial system by requiring the financier to share in the risk. It links credit expansion to the growth of the real economy by allowing credit primarily for the purchase of real goods and services which the seller owns and possesses, and the buyer wishes to take delivery. It also requires the creditor to bear the risk of default by prohibiting the sale of debt, thereby ensuring that he evaluates the risk more carefully. (Iqbal, 2009)

Another fundamental principle of Islamic Banking is the risk and profitsharing feature of Islamic Banking transactions that requires a level of transparency to be communicated to the investor and the market.

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Islamic Banking: Emerging Banking Alternative


Its rapid evolution is particularly evident in four dimensions of its development. First, today Islamic Banking is viewed as a competitive form of financial intermediation, drawing significant participation by non-Muslims. The total assets of the Islamic financial system have surpassed $1 trillion, a fivefold increase over their magnitude just five years ago. Islamic Banking is now among the fastest growing financial segments in the world, with an estimated annual growth of 20 per cent. (Iqbal, 2009), With the emergence of more diverse Islamic Banking institutions and the development of Islamic Banking markets, the scope of Islamic Banking business has been expanded to include private equity, project Banking, the origination and issuance of sukuk (bonds), and fund, asset, and wealth management activities. (Khan, 2008)

The Islamic banking system is not as mature as the conventional banking system in terms of product standardization, regulatory and policies, almost each Islamic banking organization has its own Sharia board whom approving the offered products, services and the operational workflow. There has been significant evolution in the regulatory, policies and legal framework of Islamic Banking, The central banks across the Middle East, Asia Pacific, Africa and some European countries has established central rules, regulation to monitor and control the Islamic banking practices from accounting point of view. Some other countries centralized the Shariaa standards through the central banks like Sudan and Pakistan, where the banks does follow the approved Shariaa products or services from the central banks.
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Conclusion
In recent years, Islamic Banking has developed into a universal business and has extended to international financial markets across the world. Analysts predict Islamic Banking will further grow across Asia, the Middle East, Africa, South America and the Western World to ultimately increase overall share of the global financial market.

Islamic Banking is still in its growing stage and shares a very small proportion of international Banking. The Islamic banking system is, equipped with offers and business models requested and demanded, however the standardization of the offering and positioning it as a complementary model to the current existing banking system, will help to increase the growth rate.

The Islamic banking growth rate in the Western World will not be as high as the Middle East due to social reasons. The naming convention of Islamic Banking might be a reason to hinder the growth rate due to positioning the model as an a religion model rather than a banking model, however the introduction of the Islamic banking system to the Western world as an ethical banking model might help to speed up the introduction phase on the individuals level.

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References
Yahia Abdul-Rahaman, (2010), The Art of Islamic banking and Finance, Wiley Finance. Al-Hamzani, M. (2008), "Islamic banks unaffected by global financial crisis", available at: www.asharq-e.com, accessed January 03, 2011. Bashir, A. (1999), "Risk and profitability measures in Islamic banks: the case of two Sudanese banks", Islamic Economic Studies, Vol. 6 No.2, pp.124. Chapra, U. (2009), "The global financial crisis: can Islamic Banking help?", available at: www.newhorizonislamicbanking.com/index.cfm?section=academicarticles&action=view &id=10733 , accessed January 03, 2011.. Cihak, M., Hesse, H. (2008), "Islamic banks and financial stability: an empirical analysis", International Monetary Fund, Washington, DC, working paper, . El Qorchi, M. (2005), "Islamic Banking gears up", Banking & Development, International Monetary Fund, Washington, DC, . Khan, M., Bhatti, M. (2008), "Islamic banking and Banking: on its way to globalization", Managerial Banking, Vol. 34 No.10, pp.708-25.

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