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How the Islamic religious beliefs affect their financial institutions

Islamic financial institutions are based on the Islamic religious beliefs and Islamic Shariah, trust. This is very different approach than the commercial banks where profitability and maximization of shareholders’ value is the primary focus. The concept of Islamic banking goes beyond profitability and growth. There are many institutions across the world following Islamic banking concepts. However it is interesting to understand how Islamic banking concepts are applied in the banking format that makes it very different from the traditional or commercial banking.

According to Karasik, Wehrey & Strom (2007) in the year 1963 the first Islamic Financial Institution was formed in Mit Ghamar, Egypt as a mutual savings bank. The concept of Islamic finance have adapted with international financial practices and regulations and functioning within Muslim religious context. There are various positive aspects of the Islamic finance listed by Karasik et al (2007) such as social responsibility, risk sharing, religious harmonization and a blend of traditionalism and modernism in the globalized banking context. Different studies in the explored various aspects of Islamic bank concepts within the social and business environment (Amim, Las, Hamid and Tankijal, 2006; Bianchi, 2007).

“According to the International Monetary Fund, there are over 300 Islamic financial institutions in more than 75 countries with total assets worldwide exceeding $250 billion and growth rates exceeding 15 percent a year.1 As of June 2006, Moody's estimated that there are over 250 Islamic mutual funds, with a total of $300 billion in assets.” (Karasik, Wehrey & Strom, 2007)

There have been various movements at the grassroots levels. These movements were based on the implementation of Islamic socio-economic values for example “Najjar’s Mit Ghamr Bank” of Egypt that allowed access to finance to the rural population of the location and “Malaysian Tabung Haji Mutual fund” (Hegazy, 2007). Mit Ghamr Bank was successful in meeting various socio-economic objectives for the population it was serving. According to Hegazy (2007) The Mit Ghamr Bank in Egypt was successful in meeting several objectives in terms of promoting entrepreneurship and building a strong financial market based on “mutual trust’ and ‘cooperation’.

Islamic banking focuses on the profit and risk concept than the interest alone as it is in the traditional banking for the calculation of returns (Saeed, 1999, p. 51). In the Islamic the risk of the individual sharing the financial resources is similar to banking borrower’s risk. The returns are also calculated in the similar manner. It is based on Shariah laws where in honesty and trust is the basic foundation of such approach (Hoq, Sultan & Amin, 2010). It is assumed that everyone from investor to borrower would be honest regarding their work and financial aspects. However it is borrower’s challenge to run the business and making it profitable. Hoq et al (2010) explain that the level of trust in the context of Malaysian Banks were determined by the basic belief of Muslim and non-Muslim customers on the bank for fulfilling its promises and obligations. “In this sense, when Islamic banks are operated on the basis of Islamic Shariah, trust becomes even more important dimension in gaining the customers than trust in the conventional banks.” (Hoq, Sultana & Amin, 2010)

Nevertheless, ‘Reba’ or Interest is forbidden under Islamic laws” (Cocheo, 2007). This changes the overall banking process very different from the conventional banking.

Looking from the conventional banking approaches, Islamic banking and its product may sound complex. The overall development of products, designing, training manpower for the product management, business compliances, human resource and overall administration is much different from the conventional banking. Even though Islamic banking is being implemented in various parts of world and not just Muslims even non-Muslims are also involving in the banking operations of the Islamic bank. Cocheo (2007) gives account of Islamic Banking in America and quotes the study of Ranzini; “Ranzini learned that serving the Islamic market hinges on finding the answer to the interest question, and more, and has built his search into a significant new line of business for his bank. Islamic banking products, including deposits and mortgage alternatives, represent a market of potentially $2 billion in the U.S. and $500 billion worldwide.”

Karasik et al (2007) identified different gaps in understanding various aspects of Islamic finance and theoretical and practical levels. The challenges of Islamic Banking are multifold as it needs to have ideological integration with all the changes it is adapting to deal with the challenges of globalization process. There is a need for understanding the concept of Islamic finance within the Muslim population as well as the non Muslim populations who are participating in Islamic Banking process. Islamic finance is not based on traditional returns on investment rules as interest is forbidden. The other interesting aspect of the Islamic finance is security issues. There are two main movements identified by Karasik et al (2007) stress on the need of understanding different movements in the development of Islamic banking and finance in order to understand the challenges of Muslim financial instruments and law.

Organizational Background

In the Saudi Arabia, Islamic Development Bank is one of the strongest financial institutions based on the Islamic Law or Shari’ah. “The purpose of the Bank is to foster the economic development and social progress of member countries and Muslim communities individually as well as jointly in accordance with the principles of Shari'ah i.e., Islamic Law” (para. 2). There are 56 countries which are member to this bank and have accepted terms and conditions of IDB Board of Governors. (para. 4) The funding to any project is based on the principles of Shari’ah and focuses on the “Sahira’ah compatible investment opportunities”. These projects can be private sector, public sector or trade and other projects. The fund’s portfolio consists of the short to long term investment products. However the most common are the medium and long term investment opportunities. Short term investment opportunities are used for yield maximization of the cash balances of those areas where medium and long term investments are not available at the given point of time.

The profit distribution is fixed for all kinds of investments where 5% of the total income from the Fund (Before Mudarib’s Share) is transferred to the Capital Preservation Account and the remaining is distributed as 15% of the total is considered Mudarib (Management) Fees and 85% is the Distributable Dividends . There is clarity of the profitability, income stability, exit mechanism and the security of fund for the investors. Islamic auditing is conducted quarterly and yearly and annual financial statements are prepared.

Proposed Research Methodology

The proposed Research method is case study approach that will include qualitative and quantitative data collection and analysis. The financial statements of the Islamic Development Bank and World Bank, financial instruments and nature of projects of investments will be studied thoroughly. Officials from these two organizations will be approached through telephone or e-mails to collect their view points in the qualitative interview form. All the data will be analyzed and compared using appropriate data analysis tools. Thematic analysis will allow analyzing qualitative research whereas comparative analysis using statistical tools, descriptive analysis will be used for the quantitative data.

Research Limitations

The primary limitation of the research approach is the availability of time. The magnitude of the research is high and it may require much time and financial resources to explore every aspect of the investments, returns and profitability of these two organizations. However within the specified time and within the scope researcher will try to meet all the research aims and objectives.

Tentative Schedule

Task

Start

End

Literature research

Jan 1, 2011

Jan 15, 2011

Developing Research design

Jan 16, 2011

Jan 30th2011

Developing research instruments, questionnaire

Feb 1, 2011

Feb 7, 2011

Data collection, compilation and analysis

Feb 8, 2011

March 7, 2011

Development of the first draft discussion, analysis and conclusion

March 8th, 2011

March 30th, 2011

Final project

April

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