The Principles Of The Islamic Banking System
At the branch level, there is no delineation over Islamic and conventional transactions. Each branch officer is expected to deal with both systems. Islamic and conventional transactions share the share computers and automated teller machines (ATMs) facilities. To some extent, overhead expenses on wages/salaries, office equipment and furniture etc. can be accounted for at the bank's headquarter, but not at the branch level. The same applies to security systems, land and office premises as these cannot be divided into the Islamic and conventional individual components (Rosley, 2003).
The thrust of the Islamic financial policy in 2004 will continue to be directed at further strengthening the fundamental essence for progressive Islamic banking industry. The Central Bank is focusing on strengthening the institutional infrastructure, enhancing the regulatory framework, strengthening the Shariah and legal infrastructure as well as enhancing intellectual capital development and consumer education. In 2003, the Central Bank of Malaysia brought forward liberalization in Islamic banking to allow three full-fledged foreign Islamic banks to be set-up in Malaysia.
The principles of Islamic banking system:
The definition of GEHRAR, MAYSAR AND RIBA
Islamic financing approaches were formulated primary according to basic regulations that meet the sharia principles.
The focus here was on the most popular Islamic financing approaches implemented by the financial institutions and the Islamic banks.
The basic means take the following forms:
Mudarabah (Brokerage): funds will be in the provision of partial equity.
Musharkah: which means the full equity through partnership.
Murabaha: A method used for providing money to buy goods or services.
Bai Muajjall (Postponed sale) - Postponed payments for the products or the services.
Bai Salam (Peace Sale) - Takes the form contracts for sale that made in advance.
Tasnee-Istisna-or Industrialization contracts.
Ijarah-Financing the lease of building, offices or other locations.
Qard Hasson (Good Loan) – which means a system of good loans.
Mudaraba can be defined as a contract between the investor and the bank in order to introduce the needed fund to the business owner and provide him with the resources that he needs to go ahead with his project, and the potential profits and losses will be shared between the two parties according to a specific percentage that they agreed upon from the beginning of the process. Whereby, the investor will take the responsibility of all the financial losses and the other party takes the responsibility of the operating losses, which inpricipel means the cost of the opportunity and the efforts being made.
Musharaka (Full partnership):
In this method all the earnings and the losses that appear as a result from this full partnership are distributed among the two involved parties on a percentage that they previously agreed upon it. In general, Musharaka is most relevant for the purpose financing the public or private firms.
In the field of Islamic banking, Musharaka is seen as cooperation or a joint process between the Islamic bank and the client or the business company for conducting certain transactions. It is possible that the Islamic bank can perform as the money provider to finance different kinds of industries.
Murabaha (Growth on Sales):
Murabaha is considered one of the Islamic tools for purchasing or reselling the merchants or importing goods through the financial institutions, including the banks and companies.
According to the Murabaha agreement or contract, the client submits to the bank the details and the goods prices that he needs to buy or to import.
It is obvious that the Murabaha contract is only between two parties to buy or sell, namely between the bank and the client, engaging no financial intermediaries. On the words, the bank has the role to provide this service to the clients that have the duty to pay for the costs of the products, the goods, or for the services, in addition to a profit margin ratio the bank following receipt.
But the client can pay the costs of the product and the profit margin ratio to the bank by agreed upon payment or lump sum with no increase in the profit margin ratio.
This type of contracts called (Bai Muajjall-Murabha, Or Bai Bethaman (Sale for a cost). (Obaiedullah, 2005)
Tasneé (Manufacturing contracts):
Tasneé or Istisna is a new mean in Islamic banking transactions, and has the definition as the industrialization contract that permits one party to acquire the needed industrial materials with an advanced cash payment or by deferred possible payments and dates of delivery.
Ijarah (Rent Financing):
Ijarah is a pre-payment for a rent contract between the two involved parties, where the owner of the building or the offices leases the assets to the lessee, to the person who uses the location.
Literally speaking, Ijarah means… provide something on the form a rent (Lewis & Alguad, 2001).
Quard Hassan (Good Loan):
The process of lending money is acceptable in the Islamic Sahria, but the form of lending that gives the sign of Riba is not allowed in Islamic rules and even prohibited in this process of transactions.
Quard Hassan is a process that does not include interest on the loan to help those who need the money, and to decrease their hard working situation. As a result, firms and individuals can lend money on the basis of zero-interest to any one of the society for different aims including money for expenditures in relation with education or marriage.
The money offered to the first party by the lender considered a loan with no interest from the time of receiving the loan to the time of paying back to loan. Lewis & Algaud, (2001), Metwally (2006), made the addition, that it is possible for the lender to demand assets as collateral, and sit a share for administrative expenditures on the loan.
Types and Examples of Islamic Banks:
Islamic banks are classifying to their ownership frames-whether state owned, privately owned, or partnership owned, also available the classification based on the banks goals and purposes, this includes the presence of Islamic social banks, commercial banks, development banks and holding banks.
Islamic social banks:
The emphasis of the Islamic social banks is objectives that consider the movements of saving between the clients.
Generally, this is more important for the Islamic banks than the increase in their earnings. The Islamic social bank also offers different social services such as the process of collecting and distributing the Zakah funds, and the terms Zero-rate of interest on loans. Examples of such banks include Mit Ghamer Saving banks in Egypt.
Islamic development banks
This kinds of banks usually have the aim to improve social and economic development and also these banks have the goals to finance the development of social projects.
This concept firstly was accepted in Saudi Arabia, since the Islamic development Bank was established in 1975 by several governments, including the following countries, "Saudi Arabia, United Arab Emirates, Kuwait, Egypt, Libya, Turkey and Iran.”
These institutions have the purpose to enhance the economic development, economic relations and social progress between those countries.
Islamic commercial Banks
The Islamic commercial Banks were defined as financial institution that receive saving from the depositors and provide these funds to projects and to contractors through the methods of sharing the losses or in earning.
Usually, these banks involve in several types of commercial endeavours and activities, and may invest directly in many sectors, and most modern Islamic banks after the financing tools derived from the Islamic Sharia. Examples include Bank Muamalat (Indonesia).
Islamic Banking Transactions:
Islamic banking transactions have witnessed developments through the time to be relevant for the transactions of the conventional banks in order to comply with the needs of the firms and the individuals according to the Islamic sharia.
Generally, Islamic banks greatly depend on shareholders money, as well as on deposits from the clients, and also on money that investors interested to invest in the bank.
Islamic banks sources and their usages of this money were and still subject to inquiry and investigation in several studies. Particularly Abdul-Gafoor (2003), Alam (2000) and Haron (1995).
The three basic methods of Islamic deposit accounts are the following:
Islamic money accounts considered as a service provided to depositors for the banks transfers transactions and for the pay cheques through transfer systems.
These accounts could be paid on demand without any interest paid to the depositors, and it is also possible to keep these accounts in the form of foreign currency in order to make it easier to conduct international trade.
Islamic saving accounts are like comparable products provided by the conventional banks, they offer the flexible deposit and withdrawal according to the demand from the client, and with a guarantee for the capital.
But differing from conventional banks saving accounts, for the Islamic banks interest is prohibited on the account balance. At the same time, depositors can receive benefits in the form of rewards that depend on the amount of the deposited money, and on the banks earning. Often these services offered free to the depositors.
For the Islamic banks, investment deposit accounts were formulated for the clients who wish to make investment by using their money according to the principle share in profit or in loss.
Practically, there are available two basic forms of investment accounts:
Specified investment accounts.
In this method, the depositor promotes the bank to conduct the investing process of his money in specific investments, or in unconditional investment, in specific projects or specific sectors.
Unspecified investment accounts.
In this method the depositor grants the bank the full authority for the investment, with regard to the banks’ ability and wish to invest in any relevant transaction.
Apart from retail services, Islamic banks are able to provide several services similar to the services provided by the conventional banks such as letters of guarantee, performance bonds, travellers' cheques, foreign exchange transactions, letters of credit, safe deposits and money transfer.
Islamic banks are able to collect some kinds of fees, such as administrative or service fees according to the expenditures generated on the service and provided in correspondence with the Islamic sharia.
Also, the Islamic banks are in the position to change a commission ratio when the financial transactions are for the purpose of selling and buying metals such as the gold on behalf of the client because the banks responsibility is to act as an agent. This is acceptable in the Islamic sharia.
Literature Review\ last studies
In his work, (Ariss, 2010) tested the competitive situations and compared between the Islamic and the conventional banks, his goal was to evaluate these banks, profitability during the period (2000-2006).
He selected a sample consisted of (58) Islamic banks and (192) conventional banks working in (13) Asian and Middle East countries.
(Ariss) used four financial ratios and H-statistics to evaluate and to compare the competitive situation in those banks.
The results of his work regarding profitability levels, revealed that the Islamic banks designate greater part of their assets to provide loans to finance their clients comparing with the commercial banks.
Also, his work showed that Islamic banks are less prone and exposure to financial risks than the commercial banks, and the competitive situation of the commercial banks shows less concentration, while the conventional banks are in a better competitive advantage than the Islamic banking sector.
(Samad, 2004) tested in his work the Bahrain's interest free Islamic banks comparative performance, and compared it with the conventional commercial banks that based on interest after Gulf war period regarding the following indexes.
To make these indexes, he used nine financial ratios.
By applying students t-tests for these banks financial ratios, (Samad) concluded that during the period (1991-2001) the absence of basic difference in performance between the two types of the banks regarding profitability and liquidity, but the presence of great difference in credit performance.
(Ali, 2010) conducted recently a study with the purpose to estimate and evaluate the financial performance of the conventional and the Islamic banks during the last global financial crisis period (2006-2009).
He compared the total equity, total assets, market capitalization, net profit, and financial indicators; of top 10 commercial banks with 10 ten top Islamic banks.
The results of (Ali's) comparison revealed that during the Year from (2006 to 2009), Islamic banks encountered a decline by 8.5% while the commercial banks went through losses by 42.8% in the market capitalization.
The growth in the Islamic banks equity reached 36%, while for the commercial banks; growth in equity was 24% for the conventional banks.
The accumulated net profit decreased from net profit (116bill. D) to net loss (42 bill. D), during the years from (2006-2008).
While the accumulated net profit of the Islamic banks increased by (9%).
As a result of the strong impact of the global financing crisis on the conventional banks, five of the largest 10 commercial banks in the world received assistance from the governments, (163 bill. D), at the same period, one Islamic banks demanded assistance from the government to restructure it position and its shares in the market.
The total return of Islamic Down Jones declined during the years from (2007 to 2008) by 24.7%.
While the total return of MSCI world index declined by 34.7%.
In 2009, the world economic and financial survey indicated that the financial performance of the Islamic banks and the profitability slightly decreased in the Gulf cooperation council states, and he analyzed 50 conventional banks and 18 Islamic banks in the region during the financial crisis.
The survey's results revealed that commercial banks profitability fell greatly in 2008, and the Islamic banks were less prone to credit risk comparing with the commercial banks.
(Mahmud, 2009) examined the impact of the global financial crisis on the performance of 54 conventional banks and 22 Islamic Banks in the Gulf Region during the period (200-2008), through t-testing nine financial percentages with the goal to compare the following indexes (credit risk, liquidity, efficiency and profitability of each financial system), Mahmoud reached the conclusion that during normal economic conditions, commercial banks are more profitable and efficient, higher liquidity risk comparing with the Islamic banks.
The global financial crisis decreased the variance in profitability and efficiency between the two systems as a result of the strong impact of credit pressure on the conventional banks and the good financial performance of the Islamic banks.
At the same time, Islamic banks were less prone to credit risk in comparison with the conventional banks.
The purpose of (Cihak & Hesse, 2008) work was to test the financial stability of the conventional and Islamic banks in Asia and In the Middle East.
To do so, they used the Z score financial analysis tool which indicates to several forms of financial ratios such as return on assets an on equity.
It is a useful instrument for measuring banks, solvency risk that operate out of capital and reserve.
They analyzed and observed 397 conventional banks and 77 Islamic banks, from south East Asia and the Middle East from the year 1993 to the year 2004.
The conducted a comparison between conventional and Islamic banks working in small and large capitals in order to analyze the financial stability of each system.
The result was that the financial situation of small Islamic banks was stronger and more stable compared with the small conventional banks and large Islamic banks, the reason was because of concentrating on investments with low risks.
While the large conventional banks were stronger than the large Islamic banks, because of the of difficulty to monitor the credits.
(Mohammad, Hassan and Bader, 2007) have examined the cost efficiency and the profit of the commercial and the Islamic banks in North Asia and in the Middle East, this was done from the year 1990 to 2005, using stochastic frontier approach.
They used a sample consisted of 37 commercial banks and 43 Islamic banks, the comparison between the two types of banks was based on the size and the region.
The results showed that the cost efficiency of the Islamic banks was 31.8%, while this percentage for the conventional banks was 29.3% profit efficiency for the commercial banks was 75.4%, and 75.1% for the Islamic banks. Also, the findings show that the Islamic and the conventional bans are good in creating profit, and poor in controlling the costs.
The final result that the study reached is the fact the absence of big variance between profit and cost efficiency for the two banks' system.
In his work (Wilson, 2007) mentioned that the first Islamic banks was found in 1963, and the Islamic banks began to expand in many Islamic and non-Islamic countries around the world.
The united kingdom considered by several financial specialists as the exit for the Islamic banks to enter Europe, when one of its banks provided Islamic services in the year 1980, while the first Islamic financial institution founded in Geneva in 1981.
And some commercial banks began in 1990 in France and Germany offering and providing Islamic niches in their banks.
The bank of Britain was the first Islamic retail bank established in Europe in the year (2004).
While the European Islamic investment bank founded in (2006) in the united Kingdom.
In the Gulf cooperation council states (Johns & Pappas, 2009) evaluated the effectiveness of 50 commercial banks and 19 Islamic banks during the period (2004-2009) by using the (DEA), data Envelopment Analysis in order to measure the technical efficiency.
Also, the applied 6 financial ratios analysis in order to evaluate the two systems.
This analysis showed that the Islamic banking system has higher return on investment compared with the commercial banking system.
Also, regardless of the fact that the total assets of the Islamic banks are smaller than the conventional total assets, still they are more effective in using and employing their resource to create revenues and profit.
(Shahid & Rehman, 2010) tested the comparison between the conventional and Islamic banks effectiveness in Pakistan, they used a sample consisted of 5 conventional and 5 Islamic banks from the year (2005-2009).
They applied the DEA model in order to measure the effectiveness of the two systems according to CRS & VRS approach.
Their findings showed that the TE of the conventional bans is better, but in CE and AE the two sectors revealed good competition.
And the t-statistics shows the absence of notable difference in mean effectiveness scores between the two systems expect in 2008.
(Hamim & Mohktar, 2006) tested the effectiveness of 20 Islamic and conventional banks in Malaysia they found that the Islamic banking industry in Malaysia in terms of deposits, financing base, and assets grown rapidly during the period (1997-2003).
Then they measured the technical and cost efficiency of these banks by using (SFA) approach – stochastic frontier approach.
The results of their study revealed that the efficiency of the Islamic banking industry has increased, while the same parameter for the conventional banks remained stable over the study period, also the study revealed that the Islamic banks are more effective than Islamic niches, at the same time the Islamic niches of the foreign banks seemed more effective than the niches of the local banks.
Yudistir (2004) paper to tackle the evidence on performance of a sample consisted of 18 Islamic banks during the period (1997-2009), his paper was founded on efficiency measurement in which (DEA) was utilized to address the technical effectiveness of the Islamic banking industry.
And in determining input-output variables for the Islamic banks, intermediation approach was selected, because it is in accordance with the principle of the Islamic financial system.
Yudistir results including the following:
The total efficiency results suggest that the 18 Islamic banks is small only nearly 10% a low ratio when compared with many conventional banks.
In the Islamic banks sample, it is noticed that they impacted by the financial crisis, but their performance was good after the hard period, which indicates to the need to encourage the process merging with other financial institution.
When (Hassan, 2006) cost and profit efficiency of a selected sample from 43 Islamic banks with commercial bands during the period (1995-2001), in the Arab Gulf States, Jordan, Lebanon and some African and other Asian countries, and the united Kingdom he calculated five data envelopment analysis measures including cost efficiency, pure technical, scale technical efficiency and a locative with the purpose to measure the efficiency.
Cost efficiency during the study period revealed that the Islamic banks were good in using their available resources to create 91.7% in 2001.
The reason for this was due to inefficiency in using the resources. Also, the Islamic banks made growth by 21.4% in 1997, 6& period 1998-1990, and 12% during the period (200-2001).
The same banks encountered productivity loss by (4.6%) during the years 1995-1996, and (10%) loss during the years 1999-2000, the reason for that loss in productivity was the miss use of their resources.
While the Islamic banks in Iran and Sudan were more efficient than the conventional banks because they work according to "Sahriha', (The Islamic law), but inspit of the fact that the Islamic banks were able to achieve (84% profit, still they locked the competency in using their resources and controlling their costs.
In 2008, Majd tested the efficiency of 37 Islamic banks during the period (2001-2006) in 16 Asian and Middle East countries, the largest Islamic financial markets.
He used the Data Envelopment Analysis tool and he found out that their performance was good, but were inefficient in managing the usage of their resources which might affect their financial performance in the following years.
The Islamic banks in the Middle east scored 66.7% in technical and pure technical efficiency, while this percentage for the Asian banks was 61.4%, which indicates that the Islamic banks in the Middle East were more efficient than the banks in Asia, and they perform better.
In Iran, the Islamic banks scored the highest percentage in efficiency (85.4%) than the other Islamic banks in Asia and the Middle East.
Khan and Bhatli (2008) conducted a study that tackled the growth of the Islamic banking system in the western countries.
They noticed that the Islamic services offered in the commercial banks in U.S.A since 1987, and today many conventional banks delivering Islamic services through windows to their clients, including the banks of Michigan, and Devon Bank in 1989, in Australia some banks began to provide Islamic investment transactions.
Mean is the average of absolute difference between each value in a set of values, and the average of all values of that set.
Standard deviation: is the investment measure of the variability of a security, it is derived from the securities historical returns, and used to determine the extent of possible future return.
They higher the standard deviation the greater the like hood for volatility.
lack of adequate standard: because ratios explained by people in different ways, so they understand the ratios according to their perceptions.
Limited use of single ratios: using only single ratio will be an obstacle to make clear interpretation, so to avoid any misinterpretation or confusion in analyzing data should calculate more ratios to reach the right results.
Limitations of the financial statements: personal role has great impact on judgment, and on pointing to the figures for the financial statement. Also the accounting principles and conventions has the impact on the financial statement.
Problems of price level changes: for different periods of time, validity of the ratios has the impact on the change in price level.
So, companies' profitability cannot be Cleary found out only through the process ratio analysis.
There is no cut definition of "financial crisis" but the common feature I s the disruption in the financial markets rise to the crisis level when the credit to businesses and to households is constrained, and the economy of the services and the goods negatively impacted.
The reasons for the financial crisis:
Or other reference in Arabic: http://www.alaswaq.net/views/2008/10/12/18895.html
The recent financial crisis started in the USA in September 2007, which was creating from the rising inordinate in property prices without fit for a real supply and demand in USA. This resulting from the easy acquires to loans without verification about the financial capacity for the borrowers allowance (mqabl) collect very high interest. Accordingly, when the borrowers were unable to repayment their loans, they replace their houses to the banks which did not find anyone to purchase it. The problem worsened when the banks unable to marketing and reselling this property due to the increase the houses prices exaggerated (more than the actual price for these houses). Which lead to retraction purchasing power to the buyer of property. (Market crises, the financial system and the real economy: Analysis and implications for the global financial services industry 2010:213)
This mortgage crisis moved to the stock market by the securitization. The securitization is issue the new securities by the guarantee of portfolio of mortgages, accordingly any problems appear in this mortgage will be affecting directly to the stock market.
The global financial crisis that took place in July 2007, that began to appear in the united states resulted in marvellous and terrifying impact on the financial markets and stock markets all over the world, including different sectors, because the impact was not exclusively on the banking and monetary institution, rather it touched all aspects of human life.
The causes of the global financial crisis as explained by (Bruce & Yanadle (2010) were due to many reasons some of them including the collapse that occurred in the real estate business, and the collapse in the banking and monetary systems, including bankruptcy of many banks, firms, industries, and huge companies.
When we talk about the banks, it worth mentioning the collapse and the bankruptcy of Lehman brothers banks that brought the huge negative impacts on the different sectors of the human life. (Deep explanation about the bank)Check idea
Another example that clearly illustrates the great negative impact of the global financial crisis can be seen in the cases of the collapse of many auto firms in America and Europe, where many thousands of workers lost their jobs and their monthly payments, the only source to pay for their families expenses, for rent, food, education, and health care.
So life became very hard for people all over the world, but in varying degrees according to the financial system that the country adopts.
And most of banks depositors were in a position to withdraw their money from the banks, which resulted in the lack of liquidity in the markets.
The global financial crisis took many shapes, including a great decline in sets prices, harmful effects on the production process, increased unemployment, decline in purchasing power and many huge firms, families, countries, and governments found themselves unable to achieve their plans and objectives, and it became very difficult to meet their financial duties and commitments.