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Chapter 1: Introduction

1.1- Introduction

This chapter discusses the aims and objectives of the project. A detailed background of the study, research rationale and theoretical framework has also been discussed in this chapter. At the end of this chapter, the report structure of this thesis is mentioned.

Research Title

Islamic Bank of Britain vs. Dubai Islamic Bank (A Comparative Study)

1.2- Background of Study

Islamic banking is very different as opposed to conventional banking, as it works on the principles of Islam and Sharia which entails avoiding interest and gives more preference to invest in a business and in sharing of profit and loss.

There are several Islamic banks all over the world and all of them operate on the Sharia principles, however some progress to profit and some decline to loss and a prime example of this is the Islamic Bank of Britain.

The Islamic bank of Britain was founded in 2004 by a group of Middle East investors. This was the first Islamic Bank in the United Kingdom. The formation of this bank was based on the simple foundation of Sharia conduct with typical products and services, however the bank underperformed, more so than anticipated. Losses were evident from the initiation of its business in the United Kingdom. Moreover, according to Financial times and its 2008 income statement, a loss of <£5,910,700 > was highlighting, displaying major cause for concern.

On the other hand, the Dubai Islamic Bank which was founded in UAE by Arabic investors and also adheres to Sharia principles has reported quarterly profit of US$ 122.5 million. This then raises the questions as to why Islamic Bank of Britain has been unable to attract the customers and what are the main factors causing losses for the bank every year.

1.3- Research Aim

The aim of conducting this research is to discover the factors and causes' troubling Islamic banking in United Kingdom as one of the major Islamic bank has accumulated losses for a considerable period of time, although its entrepreneurs are from the Gulf where Islamic banking has been growing and prospering. Moreover the rules of Sharia apply whether the Islamic Bank is in the UK or in UAE.

After uncovering the underlying causes of the Islamic bankings' plight in the United Kingdom recommendations will be drawn up to rectify the situation and highlight how improvements can be made. Circumstances will further be examined in form of comparisons between the United Kingdom and the UAE Islamic banks.

1.4- Research Objectives

The objectives of this research are as follows:

  • To investigate the performance of Islamic banks in UK and UAE
  • To explore the reasons that affect the performance of Islamic Banks
  • To study the investment portfolio of Islamic Banks in UK and UAE
  • To analyse the impact of risks on the performance of Islamic Banks in UK and UAE

1.5- Research Rationale

Islamic banking is a relatively new topic in the financial sector and especially in UK where the first Islamic bank started its business only in 2004. Though Islamic banks are quite successful across the globe, the first Islamic bank established in UK has not been able to gain significant success in the past 5 years. There is currently insufficient research conducted in regards to the performance of Islamic banks in the UK. This fact compels one to investigate this issue in order to gain some strong knowledge about the topic.

1.6- Theoretical Framework

This research was designed in a structured format. Initially, a detailed study of literature was conducted. The purpose of this literature review was to gain an insight in regards to Islamic banking functioning across the globe. After reviewing the relevant literature, assessments were made as to how different Islamic banks improve their performance by designing their investment policies and how different type of risks can affect the performance of Islamic banks. This assisted in the analysis of both Dubai Islamic Bank and Islamic Bank of Britain, which further assisted in arriving at a conclusion to determine the reasons of poor performance of Islamic Bank of Britain.

1.7- Structure of Thesis

Chapter 2 provides a review from literature which has been distributed into three sections. The first section describes the origin of banking and the main purpose of starting the banking. Second section explains about Islamic banking and its main functions.

Chapter 3 discusses the current business operations of both the banks. I have given a detailed description of where both the banks invest their assets and how do they manage the risks. The purpose of this chapter is to find out how different investment and risk management techniques help the Islamic banks to give better performance.

Chapter 4 highlights the methodology used in this thesis. A detailed description of the research methods used in thesis has been given in this chapter. All the sources of data used in this thesis have been explained in details and at the end of this chapter; I have given a detailed description of different accounting ratios used in this thesis. In this chapter, I have given a detailed description about the research methods used in this thesis.

Chapter 5 comprises of different financial calculations. I have calculated various financial ratios for both the banks in order to do a side by side comparison to find out the reasons of poor performance of Islamic Bank of Britain.

Chapter 6 includes a side by side comparison of the financial ratios of both the banks calculated in chapter 5. In addition to this, regression analysis has been given between certain risk ratios and profitability ratios to find out the impact of risk levels on returns. The possible reasons of poor performance of Islamic Bank of Britain in line with literature review and results in chapter 3 have also been discussed in this chapter.

Chapter 7 discusses the conclusion of this thesis. All the research questions have been answered in an appropriate manner in line with the literature review and the results discussed in chapter 3, 5 & 6. At the end of this chapter, I have discussed any limitations of this research work.

Chapter 2: Literature Review

2.1- Introduction

This chapter provides a review from literature. It has been distributed into three sections. The first section describes about origin of banking and the main purpose of starting the banking. The second section explains Islamic banking and its main functions. Lastly the third section explains the origin of Islamic banking in Dubai and United Kingdom.

2.2- History of Banking

The origins of banking are believed to have started after coinage, in the area between river Tigris and river Euphrates. People could keep their belongings safely in royal palaces and holy places. Within same period, some laws were developed and these laws are considered to be one of the earliest forms of laws (Glyn, 2002).

2.3- Banking Business

A business that provides financial services to different customers and businesses is called as banking. A detailed definition of banking business can be a financial institution that accepts, collects, transfers, pays, safeguards or lends money for its customers (Sobczak, 1997, pp 6).

2.4- Islamic Banking

A financial institution that operates under the principles of Islamic Shari'ah and it does not accept or pay out any interest (riba) is called an Islamic bank (Sadeque, 1980). Islamic banking is based on the idea of sharing profit and losses. Both the investor and the bank share any profits and losses as agreed at the time of opening the account (Venardos, 2006, pp 1).

2.5- History of Islamic Banking

A few decades ago, conventional banks and other financial organisations were not providing the customers with any Shari'ah compliant services. This led to the necessity of starting such a financial institution that could provide the Muslim clients with the Shari'ah compliant services. The original Islamic bank initiated business in 1963. During the later years of 1970's, the Association of Islamic banks was established. Initially, Islamic banks were only operating in Islamic countries. In 1980, the first Islamic bank was open in a non-Islamic country and it further expanded into additional European and American countries. Within this short span of time, Islamic banks have progressed very well all over the world (Venardos, 2005, pp 65).

2.6- Services offered by Islamic Banks

Islamic banks offer a range of services to their customers. A detailed description of these services is explained below.

2.5.1- Deposit Accounts

Islamic banks offer three types of deposit accounts: current, savings and investment accounts. The customers are assured that they can withdraw their money on demand if agreed by both parties at the time of opening the account. In Islamic banking, demand deposits are places in a contract called Wadiah (trust). Islamic banks guarantee their customers to return their principal sum on demand. The banks cannot use this principal sum unless authorised by the customers. As the banks do not use this amount for their investments they do not pay back any profits on such accounts. Some banks offer some returns in the form of Hibah (gift). Islamic banks are using some innovative techniques for offering different products and most of the demand deposit accounts are structured within the contract of Mudharabah (Saeed, 1996, pp 101).

2.5.2- Current Accounts

Current or demand deposit accounts are the same as those of conventional banks. Islamic banks guarantee the principal amount on demand (Hassan and Lewis, 2007, pp 131).

2.5.3- Saving Accounts

Saving accounts are different from conventional banks in Islamic banking. In some Islamic banks, the depositors authorise the banks to use their deposited money, however they are guaranteed that they will be returned the full amount back from the bank. No profit is guaranteed in this sort of accounts. The banks usually use these deposits for short term projects (Al-Omar and Abdel-Haq, 1996, pp 51).

2.5.4- Investment Accounts

Islamic banks accept the investment deposits for a fixed or unlimited time period. The investors agree at the time of opening the account to share any profit and loss at an agreed proportion. The banks do not guarantee to return the principal amount. Usually, the investment deposits have an expected maturity and expected rate of returns. Such investments are places under Mudharabah contract in which both the depositor and the bank agree at a ratio to share any profits or losses. This type of investment is totally different from conventional banks as there is no risk of losing any thing in those investments (Iqbal and Llewellyn, 2002, pp 198).

2.7- Financing modes in Islamic Banking

Different banks use different modes to acquire assets and finance different projects. These modes can be distributed into three different areas namely investment, trade and lending services.

2.6.1- Investment Finance

Khan (2009) says that Islamic banks can do investment financing in three different ways. First type of investment financing is called as Musharaka. In this type of investment financing, the bank can join another organisation or entity to open a joint venture. Both the parties participate in this venture in different roles. Both the parties agree on a set ratio of sharing any loss or profit before making such a venture. This type of venture is an independent entity and the bank can withdraw from this venture after an initial period. Second type of investment financing is called as Mudarabha in which the bank finances the projects and the clients provide with their expertise, labour and management. Both the parties i.e. bank and the clients share the profit but in case of any losses, it's only the bank that will bear the losses. In third type of investment financing, the banks finance on the basis of an expected rate of return. If the profits are more than the expected rate of return, the bank shares it with the clients but if the returns are lower than the expected rate, the bank will accept the lower rates. In case of any losses, the bank will share it (Khan, 2009).

2.6.2- Trade Finance

Khan (2009) says that Islamic banks can do trade financing in different ways. The most common type of trade financing is called as Mark-up in which the bank buys an item for its client and the client agrees to pay back the bank the price and the agreed profit at later stage. In second type of trade financing, the bank buys an item for the client and then leases it to client for an agreed time period. At the end of the lease, the client pays the balance amount to the bank and becomes the owner of the item. Another type of trade financing is called as hire-purchase in which, the bank buys an item for its client and then hires it to the client for an agreed time period. At the end of this time period, the client becomes the owner automatically. Another type of trade finance in Islamic banking is called as sell-and-buy-back in which a client sells his property to the bank for an agreed time period at a condition that the client will buy back the property at an agreed rate.

2.6.3- Trade Finance

Khan (2009) says that Islamic banks have different types of lending services including loans, no-cost-loans and overdrafts. Islamic banks offer the loans by charging the service charge. The bank does not charge any interest but they apply service charges to cover their expenses. Some Islamic banks offer the loans to needy people at no costs. Some Islamic banks also offer the overdraft services to the customers subject to some limits. The banks charge a certain amount if the customer's request higher overdraft limits.

2.6.4- Miscellaneous Services

Islamic banks offer additional services such as collecting the bills on behalf of different organisations, money transfers, trading foreign currency etc. Some banks charge a commission amount if their own money is not involved in such transactions.

2.8- Risks in Islamic Banking

Khan (2003, pp 130-131) says that Islamic banking faces certain risks like conventional banking. The nature of these risks varies with the structure of the bank. As discussed earlier, Islamic banks usually operate under two different kinds of models. First type of model is known as the two tier Mudarabah model. This type of model operates under the principle of sharing both the profits and losses. The latter model is known as the single tier Mudarabah model. In this type of model, both the parties share the profit just on the liabilities side. Lewis and Hassan (2007, pp 144) say that Islamic banks have to follow certain rules based on Islamic Shari'ah. Both the authors believe that in this kind of situation, the nature of risk changes for Islamic banks and only a careful management of these risks can result in the better performance of the bank. Islamic banks face following risks:

  • Operational Risks
  • Credit Risks
  • Liquidity Risks
  • Withdrawal Risks
  • Legal Risks

2.7.1- Operational Risks

El-Hawary (2005, pp 21) says that this type of risk is caused when the people working for the bank fail to perform their duties appropriately or the systems used by the bank staff fail. Most of the time, this risk is caused due to the employees of the bank or any frauds. El-Hawary (2005, pp 21,22) has quoted the example of Dubai Islamic bank when the bank suffered huge losses due to an incompetent person during the later years of 1990's. Iqbal et al (1998) considers that the Islamic banks face more operational risk than conventional banks as a minor problem in computer systems can cost them too much.

2.7.2- Credit Risk

Sundrarajan and Errico (2002, pp 5) believe that Islamic banks administer the profit loss accounts differently from conventional banks. Islamic banks determine the profit and loss ratios of different projects before the start of any agreement. On the basis of this expectation, Islamic banks set a share ratio that sometimes can cause them losses. In addition to this, Islamic banks carry on auditing the financial projects. In such situations, it becomes very difficult for the banks to standardise their financial products. Cihak and Hesse (2008, pp 5) believe that in PLS (Profit and loss sharing) accounts, the banks suffer losses as well if the profits are lower or the project ends in a loss. They believe that this is due to the reduced level of assets in the balance sheet. Sundrarajan and Errico (2002, pp 5) believe that in Mudarabah accounts, the banks can only share the profits but if the business ends up in loss, it becomes very difficult for the bank to recover the loans back due to some legal complications as the Mudarabah accounts do not allow the Islamic banks to interfere in the business. On the other hand, in the case of Musharaka account, Islamic banks can monitor the financed projects and it reduces the risk levels significantly.

2.7.3- Legal Risk

Haiwad (2008) says that Islamic banks have different kind of legal documents. He considers that due to compulsion of Islamic accounts to be Shari'ah compliant, the banks need to prepare a complex set of legal documents. In addition to this, the banks need to consider the local laws of the country as well before making any legal documents. Sometimes, it is very complicated to develop the legal documents that comply with both the Shari'ah law and the local law of the country. It ultimately increases the legal risk levels in the Islamic banks.

2.7.4- Liquidity Risk

Aburime (2009) says that Islamic banks face the liquidity risk when the banks fail to sell their fixed assets at the desired rates. The banks usually develop the need to sell their fixed assets to meet their liabilities. This risk is increased due to the fact that Islamic banks do not accept any loans on interest so the Islamic banks are unable to come out of this situation by taking loans from other banks. Aburime (2009) considers that this risk is dependent on the economy of the country. The destabilisation of economy increases liquidity risk.

2.7.5- Withdrawal Risk

Aburime (2009) says that sometimes, Islamic banks do not provide the customers with handsome amount of profits and it can lead to the customers withdrawing their money from the bank. In such situations, withdrawal risk is increased significantly. Aburime (2009) believes that this risk is more in Islamic banks as compared to the conventional banks.

2.9- Do Risk Levels affect Performance?

Mencia (2009) says that a business can produce more money if there is greater risk at the start of the business provided the risks are managed appropriately. Kunt et al. (2009) says that those banks that generate income without any interests are at greater risks and can give better returns as compared to those that generate interest money. Haque and Mirakhor (2006) say that in Islamic banks, customers are at greater risk to lose their money and the banks are at lesser risk as Islamic banks do not guarantee any return at the time of account opening and in few accounts both profit and loss are shared. This fact can deter customers, leading them to invest their money in those banks where they do not have any risk to lose their money.

Shim et al. (2000, pp 176, 177) has suggested that the extent of financing the business through debts is a useful indicator of risk levels in the business. They believe that if a business is financed more through debts, it is at higher risk. Helfert (2001, pp 128) has also same beliefs as that of Shim et al. (2000, pp 176, 177). He considers that financing the business through debts increases risks but at the same time it increases the probability of better returns as well.

Falkenstein (2009) conducted research to explore the effects of risk levels on the returns of different businesses. His research results showed that the businesses that used more debts to finance their assets were at higher risk as compared to those that did not finance their assets through debts. The businesses that were at higher risk and that managed their risks appropriately produced better returns than those that were at lower risks.

2.10- Effective Risk Management in Islamic Banks

Management of different types of risks is very different from conventional banks and due to some restrictions of Shariah laws it is very difficult to manage these risks. Effective credit risk management is a very complex procedure in Islamic banks as there is no permission of paying or receiving any interest. In addition to this, Sharia's law does not allow to penalise the clients and this facility in Islamic banks is misused by some clients. In such situations, there are long delays in paying back the principal amount and it reduces the assets of the bank. Most of the Islamic banks use collaterals and take pledges from their clients. The best way to avoid the misuse of the facilities provides by Islamic banks, the banks can take more collateral before the start of different contracts. In addition to this, if the banks take personal guarantees before sanctioning the loans, it can help in reducing credit risk as well (Hawray et al., 2004).

Shariah law forbids dealing harshly with those people that are in bad financial crisis. This facility can be misused by the clients. This issue costs the Islamic banks and it should be taken seriously. A comprehensive system to credit score each client before offering them the loan can make a huge difference. Furthermore, the banks should ask the clients to sign on possible enforcement as within Islamic law a person can be enforced if he has signed before the start of the contract. In addition to this, Islamic banks working in United Kingdom can think about legal actions against those that were unable to pay back the loans (Wilson, 2007).

The nature of legal risks is very different in Islamic banks as compared to conventional banks as Islamic banks have to fulfil the requirements of both Shariah laws and local laws of the country they operate in. This makes the Islamic banking operations very complicated and legal risks are increased. The best way to come out of such situations is to make sure that prior to writing the contracts, requirements of local legislations are fulfilled as well. This can aid the banks in developing good knowledge about the possible ways of enforcement if a client fails to repay his loan. In Sharia law it is allowed to enforce those clients that file false claims. Bearing this fact in mind, Islamic banks should consider including this in the contracts. This will help the Islamic banks to reduce legal, liquidity and withdrawal risk as people will not attempt to misuse the lenient system (Djojosugito, 2008).

2.11- Diversification in Islamic Banks

The banks that provide diverse financial services or spreading different risks into different geographic areas are likely to achieve improved diversification. In the case of Islamic banks, geographical diversification helps in breaking the bank's concentration in limited areas and the bank usually gets good borrowers. (Greuning and Iqbal, 2008, p 264).

Islamic banks mostly deal in the real estate business and most of these banks start their business from their regions and carry on working in that region. The real estate business has suffered huge losses in the past few years due to the effects of recession and interest rate variations across the globe. Due to this fact the investments in real estate have not proved very fruitful for such organisations. In order to gain good profits, Islamic banks need to diversify into different sectors and geographic areas as it will diversify the investments and the risks can be spread across different areas where the banks can get good borrowers and good investment opportunities (Islamic Investment Banking, 2009).

There are different sectors that can prove beneficial for Islamic banks. The most important sector for diversification in Islamic banks is Insurance (Takaful). This sector is highly under developed even in big Islamic countries such as Malaysia where this sector is not developed much. Concentrating on this sector can prove very beneficial for Islamic banks (Thomas, KPMG.COM).

Expansion of Islamic banks across different countries can prove to be very beneficial for them. Currently, Islamic banks are working in a lot of countries but their business size is very small. If these banks diversify into different zones of the world, it is inevitable to attain benefits. Furthermore, Islamic banks can consider to make strategic alliances with those conventional banks that wish to start Islamic banking as it will not only increase the size of Islamic banks but will help in obtaining a diverse work force as well. Finally, Islamic banks can get diverse competent staff that can help in improving different systems and it will ultimately result in reduced operational risks (Iqbal et al., 1998).

Making of strategic alliances with other banks that wish to start Islamic banking will also help in reducing the liquidity risk. Making strategic alliances will help Islamic banks to increase their assets and the current assets level of Islamic banks will increase. This will help the Islamic banks to pay current liabilities and liquidity will be improved. Furthermore, strategic alliances will increase peoples' trust in Islamic banks and the level of investments will be increased that will ultimately increase current assets and better liquidity of the banks (Iqbal et al., 1998).

Chapter 3: Business Cases

3.1- Introduction

This chapter will provide an overview of the current business operations of both the banks. Detailed descriptions of where both the banks invest their assets and how they manage the risks will follow. The purpose of this chapter is to find out how different investment and risk management techniques help the Islamic banks to give better performance.

3.2- Islamic Bank of Britain

Islamic Bank of Britain started its business in UK in September 2004. This bank is the first Islamic Bank that started its business in UK. The bank is approved by FSA (Financial Services Authority).

3.2.1- Shareholders

The bank has 10 major shareholders holding different levels of share in the bank. The biggest shareholder of the bank is Al Amal Investment and Trading that holds 52% of the total shares of the bank. IIB European Investment Company is the second major shareholder of the bank and it holds 10% shares of the bank. BNP Paribas Bahrain holds 8% of the shares; Mr. Al Rajhi holds 7% of the shares. The remaining 23% shares are owned by 6 other shareholders.

3.2.2- Investments

The bank comprises of a board of directors and it is their responsibility to decide upon the investments. Most of the time, the bank invests its money in buying different properties, costly metals, different currencies etc. The bank mostly concentrates in buying the properties in United Kingdom. The board of directors decides all these matters in such a way that can be beneficial for its investors.

3.2.3- Services offered by the Bank

The bank offers three main types of services to its clients

  • Personal
  • Business
  • Premier

3.2.3-1. Personal Services

In personal services, the bank offers current accounts, saving accounts and home purchase plans to its customers. In addition to this, the bank also offers personal finance to its customers.

3.2.3-2. Business Services

In business services, the bank offers its clients business current, business savings, business finance, charity accounts and commercial property finance.

3.2.3-3. Premier Services

The bank offers this service to those clients that are highly paid (at least £100,000 per annum) and to those who can deposit more than £75,000 in their account with a view to purchasing property in the UK that is worth more than £250,000.

3.2.4- Risk Management in the Bank

Islamic Bank of Britain manages its risks in a systematic way. Board of directors has the responsibility of managing the risks with the help of some committees assisting them. They have some written policies to manage the risks that are reviewed on a regular basis by an audit committee that is responsible to measure the risk levels and start the risk management after a certain risk threshold. The bank faces credit risk, liquidity risk, market risk and operational risk. A brief description of risk management is given below.

3.2.4-1. Credit Risk Management

The bank has a systematic approach to manage the credit risk. To manage this risk certain producures are put into place such as the following:

  • The bank makes credit policies
  • The bank sets credit limits after assessing the profile of each borrower
  • Credit risk assessment before start of agreement
  • Collaterals for a few loans but in most accounts the bank does not ask for any collateral

3.2.4-2. Liquidity Risk Management

The treasury department of Islamic Bank of Britain is responsible to manage liquidity risk. The bank uses following steps to manage liquidity risk;

  • The treasury department maintains a portfolio of short term assets that can be liquefied. Comparison of liquid assets with asset maturity against any customer deposits
  • Submission of any mismatches in liquid assets and asset maturity to financial services authority on quarterly basis

3.2.4-3. Market Risk Management

The bank has a systematic approach to manage the market risk. To manage risks, the following procedures are adhered to:

  • Profit rates for few accounts are agreed at the time of agreement start. Maturity profiles are constantly reviewed.
  • Rates are agreed on a monthly basis for consumer finance transactions.
  • Long term home purchase plans and commercial property finance are benchmarked against market measure. Process is assessed every six months.
  • Profit rates on Mudaraba account are reviewed every month.

3.2.4-4. Operational Risk Management

The bank has a systematic approach to manage the market risk. The board of directors of the bank is responsible to manage the operational risks. There are some risk committees that manage this risk under the guideline of the board of directors. The purpose of operational risk management is to implement such a system that can support the process efficiency and meeting the customer needs. To manage this risk the following procedure is respected:

  • The bank aims to manage this risk by cutting down the costs on certain things.
  • Getting reports from risk committees over regular periods of time

3.3- Dubai Islamic Bank

Dubai Islamic Bank was formed in 1975 and is considered to be the first fully-fledged Islamic Bank in the world. The bank uses the latest innovative technology in its day-to-day operations. The bank is considered to be the undisputed leader in the field of Islamic banking and sets its examples for new starters in Islamic banking. A lot of Islamic banks in the world including Arab countries follow Dubai Islamic Bank to start and run their day-to-day operations (http://www.alislami.ae/en/index.htm).

3.3.1- Shareholders

The Government of Dubai is the major shareholder of the bank and other shares are held by additional stakeholders in Dubai.

3.3.2- Investments

The bank invests its money all over the world and is open to any businesses that require financing through the bank. The bank invests in properties, constructions, installations of industry and buys foreign currency.

3.3.3- Services offered by the Bank

The bank offers a wide range of services to its clients. A brief description is given below.

3.3.3-1- Retail Banking

The bank offers a wide range of retail services to its clients. They offer current accounts, saving accounts, investment accounts, auto finance, home finance, personal finance, lockers etc.

3.3.3-2- Wajaha Banking

The most important feature of this type of banking is Takaful (Insurance) Program. This scheme offers savings and investments to the beneficiaries (in case of an unfortunate event) or to the client himself after a certain time.

3.3.3-3- Business Banking

The bank offers a wide range of services to its business clients. This includes business accounts and small business finance.

3.3.3-4- Corporate Banking

The bank offers a wide range of services to its corporate clients. This includes corporate banking, merchant banking and treasury products. The major products it offers are letters of credit, letter of guarantee, Murabah, Sukuk etc.

3.3.3-5- Investment Banking

The bank offers investment services all over the world. The major products it offers are letters of credit, letter of guarantee, Murabah, Sukuk etc.

3.3.3-6- Real Estate Finance

The bank is a leading provider of real estate finance. The major services offered are Murabaha on land & buildings and land trading finance.

3.3.4- Risk Management in the Bank

Dubai Islamic Bank faces all the risks faced by Islamic Bank of Britain i.e. credit risk, liquidity risk, market risk and operational risk. The only difference in risks faced by Dubai Islamic bank is that market risk is subdivided into two types of risks namely trading and non-trading risks. The risk control process of the bank does not include any business risks such as environmental changes, technological and industrial changes. All these are managed by a strategic planning process. Like Islamic Bank of Britain, Board of Directors is responsible for identification and control of risks but there are independent bodies that are responsible to manage and monitor these risks. The most important body is the risk management committee that is responsible to develop risk strategy and implementing the principles with frameworks, limits and policies. This committee takes the responsibility of basic risk related issues and monitoring of all risk decisions. The bank has a risk management department that is responsible to implement and maintain risk related issues. They ensures that there is an independent control process. This department takes the responsibility to approve credit, portfolio management, credit risks, market risks and all risk control process. The treasury department of the bank is responsible to manage assets and liabilities of the bank. In addition to this they are also responsible to manage the liquidity risks. All the risk management process is audited over the regular periods of time and audit committee is responsible for all this.

The approach to manage the risks in Dubai Islamic Bank is noticeably different from Islamic Bank of Britain where just Board of directors and audit committee is responsible to manage the risk while Dubai Islamic Bank has some departments that share the overall responsibility of risk management. A brief description of risk management is given below.

3.3.4-1- Credit Risk Management

The bank has a systematic approach to manage the credit risk. The following procedures to monitored to manage this risk.

  • Monitoring the credit exposures
  • Limiting the transactions with specific counterparties
  • Continuously assessing credit worthiness of counterparties
  • Monitoring of credit limits
  • Writing collateral agreements with limitation of exposure duration

3.3.4-2- Liquidity Risk Management

The treasury department of Dubai Islamic Bank is responsible to manage liquidity risk. The bank uses following steps to manage liquidity risk;

  • Monitoring of day-to-day funding to make sure that the future requirements can be met.
  • Maintaining the portfolio of high liquidity
  • Monitoring of balance sheet liquidity ratios
  • Management of financing exposures maturities.
  • 3.3.4-3- Market Risk Management

    The bank has a systematic approach to manage the market risk. The following procedures are monitored to manage this risk.

    • Setting limits to ensure that the risk does not exceed aggregate risk levels
    • Market to market valuation independently
    • Tracking of stop losses for trading positions on timely basis
    • Complying with the guidelines of central bank of UAE

    3.3.4-4- Operational Risk Management

    The bank has a detailed operational risk framework. This defines the responsibilities of every individual in the bank in managing the operational risks. The following procedures are monitored to manage this risk.

    • The bank uses operational risk tracking system
    • The system keeps the data of two years operational losses
    • Operational risk management department manages all the risks in collaboration with business and support units
    • Day to day management of operational risks through maintenance of internal control systems that are supported by robust systems

    Chapter 4: Research Methodology

    4.1- Introduction

    This chapter explains the research methodology utilised in this thesis. Any sources of data used in this thesis including primary and secondary data sources have been explained in this thesis including any limitations of these sources of data. At the end of this chapter a detailed explanation is given of different financial ratios used to compare the performance of both the banks.

    4.2- Research Approach

    For the purpose of this research project, a quantitative approach was adopted as an extensive use of calculations was required in order to find out the reasons of poor performance of Islamic Bank of Britain.

    Carvahlo et al. (1997, pp 1) has defined quantitative approach as a research approach that involves the extensive use of numerical calculations of any business. The authors believe that this kind of approach is commonly used for the financial projects and a researcher does financial calculations through financial statements of the business.

    4.3- Data Sources

    The research topic demanded a collection of detailed data of both the banks. All the research was carried on in a structured format. First of all, a review of literature helped to develop a better understanding of the research topic. After a detailed study of the previous research work done on this topic, a few research questions were developed, and both banks were analysed to answer these research questions. Both primary and secondary data sources were utlised for this thesis.

    Any data collected by a researcher himself to conduct his research is called primary data. Interviews, focus group interviews, questionnaire surveys, observations and company reports are the main sources of primary data collection. Primary data is also called as first hand data and is very useful in answering typical questions related to research (Walliman, 2006, p 51).

    In order to collect primary data in this research, financial statements of Dubai Islamic Bank and Islamic Bank of Britain were used. In order to compare the performance of both the banks, different ratios were calculated such as profitability, efficiency, liquidity and risk level ratios.

    4.3.1- Secondary Data

    Data that was collected by different researchers in past is called as secondary data. Exisitng secondary data helps in developing a detailed understanding of the current research topic as researchers can get useful information about the same research topic conducted by different researchers. Furthermore, this type of data helps in developing some useful guidelines for the research topic. Books, online sources, journals, magazines, articles are the main source of collecting secondary data (Bressington and Pettitt, 2007, p 153).

    Secondary data collection has its limitations that need to be considered before collecting this type of data. The most important drawback is the fact that this type of data was collected by someone else for the purpose of his research and it is not necessary that this data will answer all the questions related to current research, meaning it would lack specific relevance. Age and quality of secondary data is another important issue that needs to be considered before collecting this type of data (McQuarrie, 2005, p 61). In order to overcome this drawback, data that was published recently and in reliable sources was used.

    During the process of gathering secondary data, general banking and Islamic banking was analysed extensively, with particular emphasis given to Islamic banking in a handful of countries. Detailed analysis was conducted in regards to the techniques adopted to measure the performance of financial organisations. Literature was also reviewed in regards to the effects of risks in performance. The sources that provided beneficial knowledge was the official website of the Islamic World Bank, International monetary fund (IMF) and social sciences research networks. Relevant literature was also used and was accessed via the London School of commerce.

    4.4- Hypothesis

    A detailed review of literature suggests the hypothesis of this research as below;

    “Taking lesser risks and lesser diversification are the main reasons of poor performance in Islamic Bank of Britain ”

    4.5- Research Questions

    Research questions of this project are;

    • Do the risk levels affect the business performance?
    • Has effective risk management any relationship with performance?
    • Does Islamic Bank of Britain generate more profit than Dubai Islamic Bank?
    • Does diversification improve performance?

    4.6- Performance and Risk Measuring Ratios

    In order to answer the above mentioned research questions, it was compulsory to measure the performance of Dubai Islamic Bank and Islamic Bank of Britain over a certain period of time. In line with literature review, some financial ratios were selected that represent a good indicator of performance and risk levels. A brief description of these ratios is given below.

    4.6.1- Return on Assets Ratio

    Fields (2002, pp 292) has described this ratio to be a useful tool to measure the profit levels of any business that it earns on the assets after taxes and expenses. The author says that if this ratio is high, the company is ending in profits and the management is utilising the assets in a better way. This ratio is calculated by dividing total income of a firm after paying all the taxes and expense with total assets of that firm. The mathematical form of this ratio is as below;

    Return on Assets Ratio = total income after tax and expense
          Total assets of the firm

    In order to assess the performance of both the banks in terms of profits, I have calculated this ratio in chapter 5 of this thesis.

    4.6.2- Return on Equity Ratio

    Domash (2003, pp 189) has described this ratio as a useful tool to measure how much the shareholders of a firm have earned after paying all the taxes and expenses on the invested money. The author says that this ratio is a good indicator to find out how good the management is in increasing the shareholders wealth. Higher values of this ratio indicate that the management is doing well to increase the shareholders wealth. The mathematical form of this ratio is given below.

    Return on Equity Ratio = total income after tax and expense

          Total shareholders' equity

    In order to assess the performance of both the banks in terms of benefits to shareholders, the ratio has been calculated in chapter 5 of this thesis.

    4.6.3- Income to Expense Ratio

    Godin (2001, pp 68) has called this ratio as a useful tool to measure the business efficiency. It gives a detailed idea about the balance between a company's income and its expenses. A higher value of this ratio shows that the company has generated more profits and the lower values indicate that the company is spending too much on its operational costs. The companies with lower values are considered to be poorly managing the operational costs. This ratio is calculated by dividing total income of a business with its expenses. The mathematical form of this ratio is given as below;

    Income to Expense Ratio = Total Income

         Total Expenses

    In order to find how well both the banks have managed their operational costs, this ratio has been calculated and can be seen in chapter 5 of this thesis.

    4.6.4- Capital Adequacy Ratio

    IMF (2006) considers capital adequacy ratio as a handy tool to measure the risk levels faced by any organisation. The higher values of this ratio show that the company is at lesser risk. This ratio is calculated by adding both tier 1 and tier 2 capital and dividing the sum with total risk weighted assets. Every business calculates the risk weighted assets according to certain standards. The mathematical form of this ratio is given below;

    Capital Adequacy Ratio = Tier 1 + Tier 2 Capital

         Total Risk Weighted Assets

    In order to find the risk levels of both the banks, this ratio is calculated in chapter 5 of this thesis.

    4.6.5- Debt to Assets Ratio

    Groppelli and Nikbakht (2006, pp 464) have called this ratio as a useful tool to measure the risk levels in a firm. Both the authors believe that this ratio is a good indicator to find out how much debts a company is using to finance its assets. Furthermore, the authors consider that higher value of this ratio shows that the company is using higher proportions of debts to finance its assets and due to this fact the levels of risk increase for that company. This ratio is calculated by dividing total assets of the company with its total debts. The mathematical form of this ratio is as below;

    Debt to Assets Ratio = Total assets

         Total debts

    In order to find the risk levels of both the banks, this ratio has been calculated in chapter 5 of this thesis.

    4.6.6- Debt to Equity Ratio

    Davis (2003, pp 107) have called this ratio as a useful tool to measure the financial leverage of a business and its risk levels. The author considers that lower value of this ratio shows that the business is at lower risk. This ratio can be calculated by dividing total debts with total shareholders' equity. The mathematical form of this ratio is as below.

    Debt to Equity Ratio = Total Debts

       Total shareholders' equity

    In order to find the risk levels of both the banks, this ratio is calculated in chapter 5 of this thesis.

    4.6.7- Equity Multiplier Ratio

    Adair (2005, pp 43-44) has described this ratio as a useful tool to measure the risk levels of any business. The author says that higher value of this ratio shows that the business is using more debts to finance the assets and due to this fact the risk levels for the business increase. This ratio is calculated by dividing total assets of a business with its total of shareholders equity. The mathematical form of this ratio is as below;

    Equity Multiplier Ratio = Total Assets

        Total shareholders' equity

    In order to find the risk levels of both the banks, this ratio is calculated in chapter 5 of this thesis.

    4.7- Limitations of Research

    The purpose of this research was to discover the reasons for the poor performance of the Islamic Bank of Britain. As the bank is relatively new, limited research was available, hence limiting the ability to research performance extensively as financial reports for this bank have only been obtainable for the past five years. Time constraints also proved to act as a limitation in the sense that further research was prevented e.g. being able to compare the Islamic bank of Britain to Islamic banks in alternative countries.

    Chapter 5: Ratio Analysis

    5.1- Introduction

    In this chapter, different financial ratios have been calculated of both the banks. The purpose of calculating all these ratios is to do a side by side comparison of both the banks in order to compare their performance and explore the reasons of poor performance of Islamic Bank of Britain.

    5.2- Financial Ratios Calculations

    As discussed in Chapter 4, a wide range of financial ratios have been used in this chapter in order to calculate some key financial figures of Dubai Islamic Bank and Islamic Bank of Britain. In the coming sections, detailed calculation tables have been given. In addition to this, a brief summary of financial ratios has been shown in the form of charts.

    In order to calculate these financial ratios, financial statements of Dubai Islamic Bank and Islamic Bank of Britain have been used. The data collected is between the years 2004 and 2008. The reason of limited data is due to the fact that the Islamic Bank of Britain started trade in 2004 and no reports have been published so far for 2009. The ratios calculated for both the banks are as below;

    • Return on Assets Ratio
    • Return on Equity Ratio
    • Income to Expense Ratio
    • Capital Adequacy Ratio
    • Debt to Assets Ratio
    • Debt to Equity Ratio
    • Equity Multiplier Ratio

    5.3- Return on Assets Ratio

    5.3.1- Dubai Islamic Bank

    The chart indicates that the bank has been gaining returns on its assets from 2004 to 2008. The returns decreased from 2004 to 2006 but then increased in 2007 and went up to the maximum figure of 5.06%. The return on assets went down in 2008 when it was recorded at 4.24%.

    5.3.2- Islamic Bank of Britain

    The chart indicates that the bank has never gained any returns on its assets from 2004 to 2008. They have constantly been suffering losses though the losses have decreased in the last 2 years.

    5.4- Return on Equity Ratio

    5.4.1- Dubai Islamic Bank

    The chart indicates that the bank has been gaining returns on its equity from 2004 to 2008. The returns decreased from at the end of 2006 as compared to the 2005 but after that the return on equity has increased constantly.

    5.4.2- Islamic Bank of Britain

    The chart indicates that the bank has been gaining returns on its equity from 2004 to 2008. The returns on equity have constantly increased for the bank from 2004 to 2008 and the bank has succeeded in increasing shareholders wealth.

    5.5- Income to Expense Ratio

    5.5.1- Dubai Islamic Bank

    The chart indicates that the bank had more operating income than its operating expenses from 2004 to 2008. This ratio has constantly fallen from 2005 from its maximum value to the lowest value during the analysed period.

    5.5.2- Islamic Bank of Britain

    The chart indicates that the bank had more operating income than its operating expenses from 2004 to 2008. Though this ratio is smaller as compared to Dubai Islamic Bank but the figures have constantly increased from 2006 onwards.

    5.6- Capital Adequacy Ratio

    5.6.1- Dubai Islamic Bank

    The chart indicates that the bank has maintained low capital adequacy ratio from 2004 to 2008. This shows that the bank has been taking more risks as stated by IMF (2006) on page 30 in Chapter 4.

    5.6.2- Islamic Bank of Britain

    The chart indicates that the bank had very high capital adequacy ratio in 2004 and this ratio has constantly dropped till the end of 2008. This shows that the bank was taking lower risks in 2004 and the risk levels are increasing after that as stated by IMF (2006) on page 30 in Chapter 4.

    5.7- Debt to Assets Ratio

    5.7.1- Dubai Islamic Bank

    The chart indicates that the bank has been mostly financing itsassets through debts and it is taking more risks as stated by Groppelli and Nikbakht (2006, pp 464) on page 30 in Chapter 4.

    5.7.2- Islamic Bank of Britain

    The chart indicates that the bank was not using much amount of loans in 2004 and after this they have increased the use of loans to finance the assets and the risk levels have increased constantly as well as stated by Groppelli and Nikbakht (2006, pp 464) on page 30 in Chapter 4.

    5.8- Debt to Equity Ratio

    5.8.1- Dubai Islamic Bank

    The chart indicates that the bank has used more amounts of loans as compared to shareholders equity throughout the analysed period. This has been taking more risks by financing the assets through debts as stated by Davis (2003, pp 107) on page 31 in Chapter 4.

    5.8.2- Islamic Bank of Britain

    The chart indicates that the bank was not using more debts to finance its assets in 2004. After that, it has started using more debts to finance its assets as compared to shareholders equity. It means that the risk levels have been increased as well due to financing the assets through debts as stated by Davis (2003, pp 107) on page 31 in Chapter 4.

    The chart indicates that the bank has used more loans as compared to shareholders equity throughout the analysed period. They have been taking more risks by financing the assets through debts as stated by Adair (2005, pp 43-44) on page 31 in Chapter 4.

    5.9.2- Islamic Bank of Britain

    The chart indicates that the bank was not using more debts to finance its assets in 2004. After that, it has started using more debts to finance its assets as compared to shareholders equity. This means that the risk levels have been increased as well due to financing the assets through debts as stated by Davis (2003, pp 107) on page 31 in Chapter 4.

    Chapter 6: Discussion on Findings

    6.1- Introduction

    In this chapter, a side-by-side comparison of the financial ratios of both the banks calculated in chapter 5 has been included. In addition to this, regression analysis has been conducted between certain risk ratios and profitability ratios to find out the impact of risk levels on returns. The possible reasons for poor performance of Islamic Bank of Britain in line with literature review and results in chapter 3 have also been discussed in this chapter.

    6.2- Return on Assets Ratio Comparison

    The comparison indicates that the performance of Islamic Bank of Britain is very poor compared to Dubai Islamic Bank over the last 5 years. In order to compare the return on assets in statistical terms, t-test has been done below. On the basis of t-test results, a brief description has been given about the possible reasons of the t-test in line with literature review and results in Chapter 3 and 5.

    Null Hypothesis: There is great difference between return on assets for both the banks

    Alternative Hypothesis: There is no difference between return on assets of both the banks

    As t Stat is more than t critical so null hypothesis will be accepted and the results indicate that there was a significant difference between return on assets ratio for both the banks. The possible reasons of this big difference can be the fact that Islamic Bank of Britain is less diversified and does not manage the risks effectively as diversification helps in improving the performance as discussed by Iqbal et al. (1998) in section 2.10 on page 19. Similarly, lack of effective risk management is another cause of this difference as discussed by Hawray et al (2004) in section 2.9 on page 18.

    6.3- Return on Equity Ratio Comparison

    The comparison indicates that the performance of Islamic Bank of Britain is very poor as compared to Dubai Islamic Bank over the last 5 years. In order to compare the return on assets in statistical terms, t-test has been done below. On the basis of t-test results, a brief description has been given about the possible reasons of the t-test in line with literature review and results in Chapter 3 and 5.

    Null Hypothesis: There is great difference between return on equity for both the banks

    Alternative Hypothesis: There is no difference between return on equity of both the banks

    As t Stat is more than t critical so null hypothesis will be accepted and the results indicate that there was a significant difference between return on equity ratio for both the banks. The possible reasons of this big difference can be the fact that Islamic Bank of Britain is less diversified and does not manage the risks effectively as diversification helps in improving the performance as discussed by Iqbal et al. (1998) in section 2.10 on page 19. Similarly, lack of effective risk management is another cause of this difference as discussed by Hawray et al (2004) in section 2.9 on page 18.

    6.4- Income to Expense Ratio Comparison

    The comparison chart indicates that there is a big difference between incomes to expense ratio of both the banks. Dubai Islamic Bank has been earning more income than Islamic Bank of Britain. In order to compare the income to expense ratio in statistical terms, t-test has been done below. On the basis of t-test results, a brief description has been given about the possible reasons of the t-test in line with literature review and results in Chapter 3 and 5.

    Null Hypothesis: There is great difference between incomes to expense for both the banks

    Alternative Hypothesis: There is no difference between incomes to expense of both the banks

    As t Stat is more than t critical so null hypothesis will be accepted and the results indicate that there was a significant difference between incomes to expense ratio for both the banks. The possible reasons of this big difference can be the fact that Islamic Bank of Britain is less diversified and does not manage the risks effectively as diversification helps in improving the performance as discussed by Iqbal et al. (1998) in section 2.10 on page 19. Similarly, lack of effective risk management is another cause of this difference as discussed by Hawray et al (2004) in section 2.9 on page 18.

    6.5- Capital Adequacy Ratio Comparison

    The comparison chart indicates that there is a big difference between capital adequacy ratios of both the banks throughout the analysed period. In order to compare the capital adequacy Null Hypothesis: There is great difference between capital adequacy ratios for both the banks

    Alternative Hypothesis: There is no difference between capital adequacy ratios of both the banks

    As t Stat is less than t critical so null hypothesis will be rejected and the results indicate that there was no difference between capital adequacy ratios for both the banks. These results are due to the fact that capital adequacy ratio for Islamic bank of Britain has fallen down at great variance. Islamic Bank of Britain was not taking more risks in 2004 and after that it has starting taking risks and due to this Capital Adequacy Ratio has fallen down greatly.

    6.6- Debt to Assets Ratio Comparison

    The chart indicates that there was a big difference between debt to assets ratio at the end of 2004 and after this the difference has started to decrease and at the end of 2008, there was no difference between debts to assets ratio. In order to compare the debt to assets ratio in statistical terms, t-test has been done below.

    Null Hypothesis: There is great difference between debts to assets ratios for both the banks

    Alternative Hypothesis: There is no difference between debts to assets ratios of both the banks

    As t Stat is less than t critical so null hypothesis will be rejected and the results indicate that there was no difference between debts to assets ratios for both the banks. These results are due to the fact that debt to assets ratio for Islamic bank of Britain has increased at great variance. Islamic Bank of Britain was not financing its assets through debts in 2004 and after that it has started to finance its assets with more amounts of debts. Due to this fact, the ratio has increased significantly.

    6.7- Debt to Equity Ratio Comparison

    The chart indicates that there was a big difference between debt to equity ratio at the end of 2004 and after this the difference has started to decrease and at the end of 2008, there was nearly no difference between debts to equity ratio. In order to compare the debt to equity ratio in statistical terms, t-test has been done below.

    Null Hypothesis: There is great difference between debts to equity ratios for both the banks

    Alternative Hypothesis: There is no difference between debts to equity ratios of both the banks

    As t Stat is greater than t critical so null hypothesis will be rejected and the results indicate that there was no difference between debts to equity ratios for both the banks. This is due to the fact that debt to equity ratio has increased at great variance for Islamic Bank of Britain and it has eliminated the difference at the start of analysis year i.e. 2004. Islamic Bank of Britain was not financing its assets through debts in 2004 and after that it has started to finance its assets with more amounts of debts. Due to this fact, the ratio has increased significantly.

    6.8- Equity Multiplier Ratio Comparison

    The chart indicates that there was a big difference between equity multiplier ratio at the end of 2004 and after this the difference has started to decrease and at the end of 2008, there was nearly no difference between equity multiplier ratio. In order to compare the equity multiplier ratio in statistical terms, t-test has been done below.

    Null Hypothesis: There is great difference between equity multiplier ratios for both the banks

    Alternative Hypothesis: There is no difference between equity multiplier of both the banks

    As t Stat is greater than t critical so null hypothesis will be rejected and the results indicate that there was no difference between equity multiplier ratios for both the banks. This is due to the fact that equity multiplier ratio has increased at great variance for Islamic Bank of Britain and it has eliminated the difference at the start of analysis year i.e. 2004. Islamic Bank of Britain was not financing its assets through debts in 2004 and after that it has started to finance its assets with more amounts of debts. Due to this fact, the ratio has increased significantly.

    6.9- Risk Levels and Performance

    In order to find out the impact of risk levels on performance of both the banks, a few regression analyses have been done to find out the statistical relationship between risk levels and performance of both the banks.

    6.9.1- Capital Adequacy vs. Return on Assets

    6.9.1-1. Dubai Islamic Bank

    As adjusted R Square is 0.58 so 58% data is explained by the model. The coefficient of CAR is rejected as the p value is greater than 0.05. The coefficient of intercept is accepted as p value is smaller than 0.05. This means that the bank was making positive returns on assets with a decrease in CAR.

    6.9.1-2- Islamic Bank of Britain

    As adjusted R Square is 0.35 so 35% data is explained by the model. The coefficient of CAR is rejected as the p value is greater than 0.05. The coefficient of intercept is rejected as p value is greater than 0.05. This means that the bank was making negative returns on assets with an increase in CAR.

    6.9.2- Debt to Assets vs. Return on Assets

    6.9.1-2- Dubai Islamic Bank

    As adjusted R Square is -0.30 so -30% data is explained by the model. The coefficient of D/A is rejected as the p value is greater than 0.05. The coefficient of intercept is rejected as p value is greater than 0.05. This means that with an increase in debt to assets ratio, the bank was generating more returns on assets. With an increase in debt to asset ratio, risk levels were higher and the bank generated more profits.

    6.9.2-2- Islamic Bank of Britain

    As adjusted R Square is 0.17 so 17% data is explained by the model. The coefficient of D/A is accepted as the p value is smaller than 0.05. The coefficient of intercept is rejected as p value is greater than 0.05. This means that with an increase in debt to assets ratio, the bank was generating more returns on assets i.e. lesser losses in this case. With an increase in debt to asset ratio, risk levels were higher and the bank generated more profits.

    6.9.3- Debt to Equity vs. Return on Assets

    6.10.1-1- Dubai Islamic Bank

    As adjusted R Square is -0.22 so -22% data is explained by the model. The coefficient of D/E is rejected as the p value is greater than 0.05. The coefficient of intercept is rejected as p value is greater than 0.05. This means that with an increase in debt to equity ratio, the bank was generating more returns on assets. With an increase in debt to equity ratio, risk levels were higher and the bank generated more profits.

    6.10.1-2- Islamic Bank of Britain

    As adjusted R Square is 0.79 so 79% data is explained by the model. The coefficient of D/E is accepted as the p value is smaller than 0.05. The coefficient of intercept is accepted as p value is smaller than 0.05. This means that with an increase in debt to equity ratio, the bank was generating more returns on assets i.e. lesser losses in this case. With an increase in debt to equity ratio, risk levels were higher and the bank generated more profits.

    Chapter 7: Conclusion

    7.1- Introduction

    In this chapter, a detailed conclusion of this research work has been given. All the research questions have been answered on the basis of the findings in Chapter 3, 5 and 6 and the possible reasons of poor performance of Islamic Bank of Britain have been explained according to the previous research work of different researchers discussed in chapter 2. At the end of this chapter, I have given some recommendations for Islamic Bank of Britain to improve its business.

    7.2- Research Aim

    The aim of doing dissertation on that topic was to find out the factors and causes troubling Islamic banking in United Kingdom, as the biggest Islamic bank in UK Islamic Bank of Britain has shown loss for some years although its entrepreneurs are from Gulf where Islamic banking has been growing and prospering, moreover the rules of Sharia are same whether for Islamic Bank in UK or in UAE, even most of the products are very same of Islamic Bank Of Britain and Dubai Islamic Bank than where has that huge difference in progress come from?

    7.3- Hypothesis

    The hypothesis of this research was as below;

    “Taking lesser risks and lesser diversification are the main reasons of poor performance in Islamic Bank of Britain ”

    7.4- Conclusions

    Initial focus of the research was to find out the impact of risk levels on the performance of the banks. I order to answer this research question, a detailed comparison of risk levels and performance of both the banks has been done in section6.9 of chapter 6 on page 62.

    First of all, a graph was plotted between Capital Adequacy Ratio and Return on Assets of Dubai Islamic Bank. The results indicated that when Capital Adequacy Ratio was higher, Dubai Islamic Bank had lower returns. This means that with higher Capital Adequacy Ratio, risk levels were lower and it resulted in lower returns on assets for Dubai Islamic Bank. To conclude with capital adequacy ratio and return on assets had a negative relationship in the case of Dubai Islamic Bank. A similar graph was plotted between Capital Adequacy Ratio and Return on Assets of Islamic Bank of Britain. The results indicated that when Capital Adequacy Ratio was higher, Islamic Bank of Britain had lower returns i.e. higher losses. Thismeans that with higher Capital Adequacy Ratio, risk levels were lower and it resulted in more losses for Islamic Bank of Britain. To conclude with capital adequacy ratio and return on assets had a negative relationship in the case of Islamic Bank of Britain.

    Second regression analysis was done between debt to assets ratio and return on assets ratio of both the banks in section 6.9.2 of chapter 6 on page 64. The results indicated that when Debt to Assets Ratio was higher, Dubai Islamic Bank had lower returns. This means that with higher Debt to Assets Ratio, risk levels were lower and it resulted in lower returns on assets for Dubai Islamic Bank. To conclude with Debt to Assets Ratio and Return on Assets had a positive relationship in the case of Dubai Islamic Bank. A similar graph was plotted between Debt to Assets Ratio and Return on Assets of Islamic Bank of Britain. The results indicated that when Debt to Assets Ratio was lower, Islamic Bank of Britain had lower returns i.e. higher losses. It means that with higher Debt to Assets Ratio, risk levels were higher and it resulted in lower losses for Islamic Bank of Britain. To conclude with Debt to Assets ratio and Return on Assets had a positive relationship in the case of Islamic Bank of Britain.

    Third regression analysis was done between Debt to Equity ratio and Return on Assets ratio of both the banks in section 6.9.3 of chapter 6 on page 66. The results indicated that when Debt to Equity Ratio was higher, Dubai Islamic Bank had lower returns. Meaning that with higher Debt to Equity Ratio, risk levels were higher and it resulted in lower Returns on Assets for Dubai Islamic Bank. The relationship between both the variables was very weak though. To conclude with Debt to Equity Ratio and Return on Assets had a very weak relationship in the case of Dubai Islamic Bank. A similar graph was plotted between Debt to Equity Ratio and Return on Assets of Islamic Bank of Britain. The results indicated that when Debt to Equity Ratio was higher, Islamic Bank of Britain had higher returns i.e. lower losses. This means that with higher Debt to Equity Ratio, risk levels were higher and it resulted in lower losses for Islamic Bank of Britain. To conclude with Debt to Equity ratio and Return on Assets had a positive relationship in the case of Islamic Bank of Britain.

    The conclusion of first research question is as below;

    There is a strong relationship between risk levels and performance of a firm. With higher levels of risks, it is very likely that the firm will perform better.

    Second research question was aimed to answer if there is any relationship between risk management techniques and performance of a business. The results of first research question indicated that overall, Dubai Islamic Bank has taken more risks than Islamic Bank of Britain but they have ended up in better returns on assets. In order to find out the reasons of this fact, a detailed analysis of risk management techniques used by both the banks was done in chapter 4 of this project report.

    Starting from the credit risk management in both the banks, it has been noted in sections 3.2.4-1 on page 22 and 3.3.4-1 on page 24. The most important difference between credit risk management of both the banks is related with collaterals and credit worthiness of counterparties. Dubai Islamic Bank writes collateral agreements with limitations of exposure duration while Islamic Bank of Britain writes collaterals for a few loans and for most of the accounts, the bank does not demand any collateral. As discussed in section 2.9 of chapter 2 on page 18, Hawray et al (2004) believes that credit risk should be managed by taking more collateral before the start of different contracts but in the case of Islamic Bank of Britain we can notice that they are not even taking collateral on all accounts. Dubai Islamic Bank constantly monitors the credit limits while Islamic Bank of Britain sets credit limit at the start of the contract and the borrowers are not scored after that.

    In regards to liquidity risk management, both the banks have a lot of differences as we discussed in sections 3.2.4-2 on page 22 and 3.3.4-2 on page 25 in Chapter 4 of this thesis report. Islamic Bank of Britain maintains a portfolio of short term assets that can be liquefied easily. In addition to this, the bank submits the mismatches in liquid assets and asset maturity to Financial Services Authority in UK. On the other hand, Dubai Islamic Bank monitors day-to-day funding to ensure that the future requirements can be met. The bank maintains the portfolio of high liquidity. In addition to this, the bank constantly monitors the balance sheet liquidity ratio and manages the financing exposures maturities. Islamic Bank of Britain lacks the constant monitoring of liquidity levels and this risk is directly associated with credit risk management that we discussed in the last paragraph. A good credit management of credit risk can help in managing liquidity risk as discussed in last paragraph.

    While analysing the operational risk techniques of both the banks, it is noted that both the banks have a lot of differences as we discussed in sections 3.2.4-4 on page 23 and 3.3.4-4 on page 26 in Chapter 4 of this thesis report. Islamic Bank of Britain aims to manage this risk by cutting down the costs on certain things and it gets reports from risk committees over regular period of time. On the other hand, Dubai Islamic Bank uses operational risk tracking systems that enables them to keep a data of last two years operational losses. Business and support units have an important role in managing the operational risk for the bank and least technology is used to manage this risk. Iqbal et al. (1998) has pointed out that expanding the business into new geographic areas helps the banks in getting diverse work force that helps in reducing operational risks. Dubai Islamic Bank operates in a lot of countries while Islamic Bank of Britain works in UK only. This seems that the use of diverse work force has helped Dubai Islamic Bank in reducing operational risks.

    The conclusion of Second research question is as below;

    There is a strong relationship between risk management techniques and performance of a firm. Firms that manage the risks effectively get better returns.

    Third research question was aimed to answer if Islamic bank of Britain generates more profits than Dubai Islamic Bank. This question has been answered by a detailed comparison of Return on Assets & Return on Equity Ratio of both the banks (in sections 6.2 on page 48 and 6.3 on page 50 in chapter 6). Return on Assets Ratio comparison of both the banks indicates that returns on assets for Dubai Islamic Bank are much higher than Islamic Bank of Britain. The results of t-test indicate that there was a big difference in return on assets ratio of both the banks. Similarly, Return on Equity Ratio comparison of both the banks indicates that returns on equity for Dubai Islamic Bank are much higher than Islamic Bank of Britain. The results of t-test indicate that there was a big difference in return on assets ratio of both the banks.

    The conclusion of Third research question is as below;

    Islamic Bank of Britain is not generating more profits than Dubai Islamic Bank.

    Fourth research question was aimed to answer if diversification helps in improving the performance. This question has been answered by doing a detailed analysis of investment portfolio of both the banks. This analysis was done to find out if there is a relationship between diversification (as discussed in literature review) and performance levels.

    A detailed analysis of investment portfolio of Islamic Bank of Britain indicates that the bank invests its money in different properties, buying costly metals and different currencies. The bank is operating only in United Kingdom and most of the properties are purchased in United Kingdom. The bank offers traditional services to its clients such as personal, business or premier accounts. On the other hand, Dubai Islamic Bank invests its money all over the world and it is open to any business that needs financing through it. The bank invests in properties, constructions, installations of industry and buys foreign currency. Dubai Islamic Bank has diversified into a lot of geographic zones of the world. Iqbal et al. (1998) says that expansion of Islamic banks across different countries can prove to be very beneficial for them. Expansion into different geographic zones helps the banks to get good borrowers and good investment opportunities. In addition to this, the banks can get diverse staff that can help in reducing operational risks. Diversification has helped Dubai Islamic Bank significantly as the bank is gaining profits all over the world.

    In regards to the services provided by the bank, it has a diverse set of services for all the clients. The bank offers retails banking, business banking, corporate banking, investment banking, real estate finance and most importantly Wajaha banking. Wajaha banking deals with insurance services (Takaful) to its clients. This service makes the bank different from Islamic Bank of Britain. Thomas (2007, cited by KPMG.COM) says that the most important sector for diversification in Islamic banks is Insurance (Takaful). This sector is highly under developed even in big Islamic countries such as Malaysia this sector is not much developed. Concentrating on this sector can prove very beneficial for Islamic banks. Dubai Islamic Bank has taken full advantage of this type of service and has gained significant benefits out of it.

    The conclusion of Fourth research question is as below;

    Diversification helps to improve the performance

    7.4.1- Research Conclusion

    On the basis of the results of all the research questions, the hypothesis is proved correct and the conclusion of this research is as below;

    Taking lesser risks and lesser diversification is the main reason of poor performance of Islamic Bank of Britain.

    7.5- Recommendations

    On the basis of findings of the collected data and a detailed study of literature in chapter 2, some recommendations for Islamic Bank of Britain are as below;

    7.5.1- Diversify into New Geographic Zones

    Islamic Bank of Britain should diversify into new geographic zones of the world. The bank should consider investing its money in different countries. Iqbal et al. (1998) says that expansion of Islamic banks across different countries can prove to be very beneficial for them. Dubai Islamic Bank has expanded its business into a lot of geographic zones and has gained significant benefits out of it.

    7.5.2- Diversification in Services Offered

    The bank needs to revise its range of services as it is currently offering the traditional services to its clients. Thomas (2007, cited by KPMG.COM) says that the most important sector for diversification in Islamic banks is Insurance (Takaful). Good market research about the useful products, can help the bank to start offering new services to its clients. Dubai Islamic Bank offers a diverse range of services and gains profits out of it.

    7.5.3- Improve Risk Management

    The bank needs to revise its risk management process. There are some drawbacks in the risk management process that need to be sorted. The most important risk that needs to be managed properly is credit risk. Hawray et al (2004) believes that credit risk should be managed by taking more collateral before the start of different contracts but in the case of Islamic Bank of Britain we can notice that they are not even taking collateral on all accounts. The bank needs to take collaterals on all the loans. Similarly, operational risks need to be managed in a better way. Iqbal et al. (1998) has pointed out that expanding the business into new geographic areas helps the banks in getting diverse work force that helps in reducing operational risks. Dubai Islamic Bank operates in a lot of countries while Islamic Bank of Britain works in UK only. This seems that the use of diverse work force has helped Dubai Islamic Bank in reducing operational risks. Similarly, Islamic Bank of Britain can get some new ideas and systems if it expands its business.

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