attitude of conventional and islamic bank customers towards islamic banking practices in sri lanka
TRANSCRIPT
ATTITUDE OF CONVENTIONAL AND ISLAMIC BANK
CUSTOMERS TOWARDS ISLAMIC BANKING
PRACTICES IN SRI LANKA
MI. MOHAMED RIYATH
DEPARTMENT OF ACCOUNTANCY AND FINANCE
FACULTY OF MANAGEMENT & COMMERCE
SOUTH EASTERN UNIVERSITY OF SRI LANKA
OLUVIL
2009
i
ATTITUDE OF CONVENTIONAL AND ISLAMIC
BANK CUSTOMERS TOWARDS ISLAMIC
BANKING PRACTICES IN SRI LANKA
MI. MOHAMED RIYATH
REGISTRATION NO: SEU/IS/04/MG/021
INDEX NO: MG0385
A Dissertation Submitted to the Faculty of Management & Commerce,
South Eastern University of Sri Lanka, in partial fulfillment of the requirements
of the Bachelor of Business Administration Degree.
(Specialization in Finance)
Department of Accountancy and Finance
Faculty of Management & Commerce
South Eastern University of Sri Lanka
Oluvil
2009
ii
CERTIFICATION
This is to certify that the dissertation on “Attitude of Conventional and Islamic
Bank Customers Towards Islamic Banking Practices in Sri Lanka” submitted by
Mohamed Ismail Mohamed Riyath (SEU/IS/04/MG/021) to the Faculty of
Management & Commerce of South Eastern University of Sri Lanka in partial
fulfillment of the requirements for the award of the Degree of Bachelor of Business
Administration (BBA) is his original work based on the study carried out
independently by him during the period of study under my guidance and supervision
is approved for submission.
……………………………
Signature of the Supervisor,
Mr. A.Jamaldeen
Lecturer- in- Commerce,
Department of Accountancy and Finance,
Faculty of Management & Commerce,
South Eastern University of Sri Lanka,
Oluvil.
Sri Lanka.
Saturday, January 30, 2010
iii
DECLARATION
I do hereby declare that this work has been originally carried out by me under the
guidance and supervision of Mr. A. Jamaldeen, Lecturer in Commerce, Department
of Accountancy and Finance and this work has not been submitted elsewhere for any
other degree.
I certify that this dissertation, to the best of my knowledge, does not contain any
materials previously published or written by another author except where due
acknowledgement and reference is made in the text.
………………………….
Signature of the Candidate
MI Mohamed Riyath
The Researcher,
Faculty of Management and Commerce,
South Eastern University of Sri Lanka.
Oluvil
Saturday, January 30, 2010
iv
ACKNOWLEDGEMENT
I have great pleasure to take this opportunity to thanks ALLAH who gave me the
knowledge and ability to prepare this dissertation.
I am obliged to express my gratitude to the supervisor of this study Mr. A
Jamaldeen, Lecturer, Faculty of Management & Commerce, South Eastern
University of Sri Lanka for giving me valuable academic guidance, direction, and
dedicated encouragement extended through the research, in addition to that, his
prompt assistance and good honor should be immensely appreciated.
I am very grateful to thank our Dr.A.Jahfer, Head of the Department of Accountancy
and Finance for give confidence me to do this research effectively and also express
my sincere thanks to Dean of the faculty of Management and Commerce and the
academic staff for their corporation and guidance.
My sincere thanks go to Mr. Sarjoon Mov, Lecturer, Department Of Islamic And
Culture, Faculty of Islamic and Culture, South Eastern University of Sri Lanka. My
special thanks go to my friends those who provide support in my research work.
I would also like to thank my Brother Mr.MIM. Illyas for supporting me during my
research work and provide printing facilities.
Eventually my heartfelt gratitude goes to my parents Mr. & Mrs. MM Ismail for
their dedication to my studies and further my thanks go to my beloved brothers and
my sister for their commitment of divers with the view of my future prosperity and
life.
MI. Mohamed Riyath,
The Researcher,
Faculty of Management and Commerce,
South Eastern University of Sri Lanka,
Oluvil
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vii
ABSTRACT
Islamic banking is an investment and financing concept which expands globally.
People are becoming more aware of the Islamic banks. Islamic banking is different
from conventional banking in most aspects, since its close tie to religion is very
important. The connections to politics and history have influenced the implementation
of the Islamic banking system in the countries where the system operates.
The paper seeks to identify and clarify the controversial issues between Islamic and
conventional banks in order to help remove the misconceptions about Islamic
banking. It is due to incomplete and often distorted knowledge about Islamic banking
that the civil society remains doubtful about the viability of such a system. As the
civil society is an active and potential agent of dissemination of ideas and information
in the society, its lack of knowledge and conviction has limited the scope of Islamic
banking practices. Once the public is convinced about the utility and uniqueness of
the system, Islamic-banking practices will grow further in many Muslim countries.
The transformation of the present interest-based financial system into an interest free
Islamic system is one of the objectives espoused by many Muslims.
The paper is divided into five sections. Following this introduction, Literature review
of Islamic banking and finance has been given in section Two. The survey
methodology used in this study is presented in section Three. In section Four
Analyzes the opinions of the customers of both Islamic and conventional bank. And
finally Section Five presents the findings, conclusions and recommendations of the
study.
viii
Table of Contents Page NoTitle iCertification iiDeclaration iiiAcknowledgement ivDedication vBismillah viTable of Contents viiIndex of Table viiiTable of Figures xiAbstract xii
Chapter One INTRODUCTION 1.1. Background of the Study 11.2. Literature Review 21.2.1. Brief History Islamic Banking 21.3. Players In Islamic Finance 31.4. Problem Identification 41.5. Significant of The Study 51.6. Objective of The Study 51.6.1. Primary Objective 51.6.2. General Objective 61.7. Research Questions 61.8. Research Methodology 61.8.1. The Sample 61.9. Limitations 71.9.1. Limitation Of The Study 71.10. Organization of Chapters 8
Chapter Two LITERATURE REVIEW 2.1. Background 92.1.1. Environmental Background of Islam 92.1.2. Ownership and wealth 92.1.3. Almsgiving - Zakath 102.2. Islamic Law – Shariah 122.3. Interest Versus Profit 13
ix
2.3.1. Introduction 132.3.2. The Concept of Riba : 142.3.3. Definition of Riba or Interest 152.3.4. The Nature of Modern Banking : 162.3.5. The Feasibility of the Interest Rate Mechanism: 172.3.6. The Efficacy of the Profit Mechanism 192.4. Islamic Finance 202.4.1. Environmental Background 212.4.2. The Emergence and Spread of Islamic Finance 222.4.3. Contracts And Business Relations 222.5. The Islamic Banking System 232.5.1. Introduction 232.5.2. Environmental Background 232.5.3. The Concept of Islamic Banking 242.5.4. Aims of Islamic Banks in general 252.5.5. Activities of Islamic banks 262.6. Permissible Financing Methods 272.6.1. Cost-plus sales (Murabaha) 282.6.2. Credit sales (Bay Bithaman Ajil) 292.6.3. Leasing (Ijarah or Ijar) 312.6.4. Partnerships (Musharakah and Mudarabah) 332.6.5. Islamic forwards (Salam and Istisna) 342.7. Advantages of Islamic Finance 352.7.1. Efficiency 352.7.2. Stability 362.7.3. Moral Hazard and Adverse Selection 382.7.4. Finance And Development 392.7.5. Integrity 402.7.6. Equity 412.7.7. Sustainability 432.8. Challenges Facing Islamic Banking 442.8.1. Financial Engineering 442.8.2. Some Other Shariah Issues 452.8.3. Teaching, Training, Research and Development 472.8.4. Lack of Profit Sharing Finance 482.8.5. Defaulters and the Issue of Compensation and Penalties 502.8.6. Illiquidity of Assets 512.8.7. Short-Term Asset Structure 512.8.8. Mobilization of Deposits and Indigenizing Placement of Funds 532.8.9. Competition 542.8.10. Globalization 56
x
Chapter Three RESEARCH METHODOLOGY
3.1. Introduction 583.2. The Sample To Be Used By The Researcher 583.3. Types of Data 583.4. Methods of data collection 593.4.1. Primary Data Collection 593.4.1.1. Primary Data Collection Methods 593.4.2. Secondary data collection 63
Chapter Four DATA PRESENTATION AND ANALYSIS
4.1. Introduction 664.2. Analysis of Questionnaire 664.3. Question and Answers in the course of Interview 814.3.1. Question One 814.3.2. Question Two 834.3.3. Question Three 844.3.4. Question Four 854.3.5. Question Five 864.3.6. Question Six 87
Chapter Five FINDINGS, CONCLUSIONS AND RECOMMENDATIONS
5.1. Introduction 895.2. Finding 895.3. Conclusions 915.4. Recommendations 93
APPENDIX Glossary of Arabic Terms 95References 101Questionnaire 104
xi
Index of Table Table Page No Table: 4. 1 Question One: Type of Customer by Profession 66Table: 4. 2 Question Two; Age 67Table: 4. 3 Question Three; Sex 67Table: 4. 4 Question Four; Education Level 68Table: 4. 5 Question Five what type Account you are keeping 68Table: 4. 6 Question Six; what you are expecting from your money 69Table: 4. 7 Question Seven; Profit and Loss Sharing System is the
Essence of Islamic Finance. 69
Table: 4. 8 Question Eight; Benefits Accrued to the Society from Islamic Banking.
70
Table: 4. 9 Question nine; which is the major Basis of Development of Islamic Banking
71
Table: 4. 10 Question Ten; which is the major Causes of Continuation of Interest-based Transaction through Back Door by Islamic Banking system
72
Table: 4. 11 Question eleven; which is the major Causes of Interest Creeping into the Islamic Banking System
73
Table: 4. 12 Question twelve; Present Success of Islamic Banks is not in Conformity with Shariah
74
Table: 4. 13 Question thirteen; which is the major Cause of Not Patronizing the Islamic Banks by Rich and Prominent Muslim Businessmen and Industrialists
75
Table: 4. 14 Question fourteen; Most of Investment Financing Techniques by Islamic Banks do Not Share Risk Proportionally.
76
Table: 4. 15 Question fifteen; Many Customers are not interested in Dealing with Islamic Banks as they feel that only the Name has been changed and Interest in Real Sense has not been eliminated.
77
Table: 4. 16 Question sixteen; Possibility of Loss of Deposit is not Detrimental to Deposit Mobilization.
78
Table: 4. 17 Question Seventeen; Present Modes of investment of Islamic Banks are Compromised Modes of Financing with Interest
79
Table: 4. 18 Question Eighteen; Moral Uplifting of the Society Will Pave the Way for Islamic
80
xii
Table of Figures Figure Page NoFigure: 4.1 Question One: Type of Customer by Profession 66Figure: 4.2 Question Two; Age 67Figure: 4.3 Question Three; Sex 67Figure: 4.4 Question Four; Education Level 68Figure: 4.5 Question Five what type Account you are keeping 68Figure: 4.6 Question Six; what you are expecting from your money 69Figure: 4.7 Question Seven; Profit and Loss Sharing System is the
Essence of Islamic Finance. 70
Figure: 4.8 Question Eight; Benefits Accrued to the Society from Islamic Banking.
70
Figure: 4.9 Question nine; which is the major Basis of Development of Islamic Banking
71
Figure: 4.10 Question Ten; which is the major Causes of Continuation of Interest-based Transaction through Back Door by Islamic Banking system
72
Figure: 4.11 Question eleven; which is the major Causes of Interest Creeping into the Islamic Banking System
73
Figure: 4.12 Question twelve; Present Success of Islamic Banks is not in Conformity with Shariah
74
Figure: 4.13 Question thirteen; which is the major Cause of Not Patronizing the Islamic Banks by Rich and Prominent Muslim Businessmen and Industrialists
75
Figure: 4.14 Question fourteen; Most of Investment Financing Techniques by Islamic Banks do Not Share Risk Proportionally.
76
Figure: 4.15 Question fifteen; Many Customers are not interested in Dealing with Islamic Banks as they feel that only the Name has been changed and Interest in Real Sense has not been eliminated.
77
Figure: 4.16 Question sixteen; Possibility of Loss of Deposit is not Detrimental to Deposit Mobilization.
78
Figure: 4.17 Question Seventeen; Present Modes of investment of Islamic Banks are Compromised Modes of Financing with Interest.
79
Figure: 4.18 Question Eighteen; Moral Uplifting of the Society Will Pave the Way for Islamic
80
A
Attitude of Conventional and I
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Attitude of Conventional and Islamic Bank Customers Towards Islamic Banking Practices in Sri Lanka
MIM Riyath. SEU/IS/04/MG/021 Specialization in Finance Page | 1
Chapter One INTRODUCTION
1.1. Background of the Study Sri Lanka is one of the few non-Islamic countries to have legislated for Islamic
banking. The revised Banking Act No 30 of 1988, as amended in 2005, allows both
commercial banks and specialized banks to operate on a Shariah compliant basis,
including: “the acceptance of a sum of money in any manner or form from any person
for a fixed period of time for investment in a business venture of the bank on the basis
that profits or losses of the venture will be shared with the person from whom such
money is accepted in a manner determined at the time the money is accepted.”
Islamic Finance refers to a system of Finance that is consistent with Islamic law
(Sharia) known as Fiqh Al-Muamalat, and is guided by Islamic economics. Islamic
law prohibits usury, which is the collection and payment of interest, commonly called
‘Riba’. Islamic law also prohibits investing in businesses that are considered unlawful
or ‘Haram’ (such as alcohol, gossip columns or pornography).
Islamic Finance has a large market potential in Sri Lanka. Muslim is second largest
populated religion in Sri Lanka. It can address the long drawn issue of ‘Financial
inclusion’ and will create a feel good factor among Muslims. Sri Lankan government
can gain diplomatic advantages to make financial dealings with Muslim dominated
nations and can attract equity finance from gulf countries for infrastructure
development, thereby financing the fiscal deficit.
There exist significant challenges to materialize the objective of expansion of Islamic
Finance in Sri Lanka. Lacks of experts in this field, lead to differences in
interpretation and compliance with Shariah laws. Moreover in case of Sri Lanka,
Finance regulation & Acts are needs to be suitably modified to introduce Islamic
Finance. New Standard Accounting practices have to be developed. Islamic Finance
per say goes against the secular framework of our nation and can create financial
separation. It can also be exploited politically, so it has to be seen in the right light.
Attitude of Conventional and Islamic Bank Customers Towards Islamic Banking Practices in Sri Lanka
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There is a need to customize and advertise Islamic Finance to make it equally
attractive to Non- Muslims. The product trends are positive in Sri Lanka and given the
double digit growth of Islamic Finance in other Asian countries like Asia and
Singapore, it is definitely a possible option for Sri Lanka.
1.2. Literature Review 1.2.1. Brief History Islamic Banking During the Islamic Golden Age, early forms of proto-capitalism and free markets
were present in the Caliphate, where an early market economy and an early form of
mercantilism were developed between the 8th-12th centuries, which some refer to as
"Islamic capitalism". A vigorous monetary economy was created on the basis of the
expanding levels of circulation of a stable high-value currency (the dinar) and the
integration of monetary areas that were previously independent.
A number of innovative concepts and techniques were introduced in early Islamic
banking, including bills of exchange, the first forms of partnership (Mufawada) such
as limited partnerships (Mudaraba), and the earliest forms of capital (al-mal), capital
accumulation (Nama al-mal), cheques, promissory notes, trusts (Waqf), startup
companies, transactional accounts, loaning, ledgers and assignments. Organizational
enterprises similar to corporations independent from the state also existed in the
medieval Islamic world, while the agency institution was also introduced. Many of
these early capitalist concepts were adopted and further advanced in medieval Europe
from the 13th century onwards.
Although Islamic Finance can be traced backed to 8th Century in Muslim countries,
modern Islamic Finance started in Egypt in 1963 by Ahmad EL Najjar. In 1975, the
Islamic Development Bank was set-up with the objective to provide funding of
projects in the member countries. The first modern commercial Islamic Bank, Dubai
Islamic Bank, opened its doors in 1975.With presence in over 60 countries and a
15% CAGR, it has estimated designated assets worth $1.3 trillion in more than 400
financial institutions offering Shariah compliant products. Saudi Arabia’s Al Rajhi
is the world’s biggest Islamic Bank by assets, which stand at $28 billion.
Attitude of Conventional and Islamic Bank Customers Towards Islamic Banking Practices in Sri Lanka
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1.3. Players In Islamic Finance The market value of the Islamic banking sector in Sri Lanka is estimated at Rs 70
billion to Rs 100 billion. Islamic financial services providers currently active include
Amana Investments Ltd, Ceylinco Islamic Investment Corporation (CIIC), Muslim
Commercial Bank (MCB), National Asset Management Limited (NAMAL), First
Global Investments Group and ABC Investments.
Amana Investments, established in 1997, leads the country’s Islamic financial
services market. Its subsidiary Amana Takaful Ltd (ATL) began operations in June
1999 and is acknowledged as the market leader for Takaful services (commonly
perceived as the Islamic alternative to conventional insurance). ATL was listed on the
Colombo Stock Exchange in late 2006. CIIC made its entry in 2003 and is fully
backed by Ceylinco Insurance, one of the leading conventional insurance providers in
Sri Lanka. CIIC offers both selected Shariah compliant and Takaful products. The
new kid on the block MCB — owned by MCB Pakistan — commenced operations
early this year. It offers both Islamic and conventional financial products.
NAMAL is the first fund management company in Sri Lanka licensed to manage unit
trusts. Together with Amana Capital (a subsidiary of Amana Investments), it launched
the NAMAL Amana Equity Fund early this month. The objective of the equity fund is
to achieve significant growth over the medium to long term by primarily investing in
equity securities that are Shariah compliant.
First Global Group is a public limited finance investment company that deals with
Shariah compliant investments and financing products and services. Domestically, it
is the first institution to promote training and career development programmes related
to Islamic banking and finance.
Finally, there’s ABC Investments, a relatively new Islamic investment group that
claims to have strong funding backing from different countries. It has a memorandum
of understanding with the Central Bank of Sudan in which the latter’s experts will
provide assistance on training and development to ABC — especially in its Takaful
segment — and will be working closely with leading Islamic financial countries for
the funding in Takaful as they plan to start off with general insurance.
Attitude of Conventional and Islamic Bank Customers Towards Islamic Banking Practices in Sri Lanka
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1.4. Problem Identification How are the Attitudes of Conventional and Islamic Bank Customers towards Islamic
Banking practices in Sri Lanka? Despite the phenomenal growth of Islamic banking
practices worldwide, there is a debate among scholars about whether Islamic banking
practices are any different from the conventional banking system. This debate is not
confined to the academic circles only, but has also made its way to the banking
community and the banks’ customers. We argue that there is a lack of knowledge
about the various Islamic-banking practices among the banking community as well as
the banks’ customers. A question that generally arises is why is the Islamic banking
system growing so fast if it is not different from the conventional banking system.
Analysis of the deposit and investment mechanisms and the opinions of the
professionals and customers of both Islamic and conventional banks would be useful
to understand and identify Islamic banking with its separate unique features and its
impact on economy and society. The primary objective of this study is to examine the
reality of apparent similarities between Islamic and conventional banks, which
frequently tend to equate both systems of banking. This is done at the theoretical
plane as well as by opinion survey of the users (i.e., professionals and customers) of
the two systems.
The paper seeks to identify and clarify the controversial issues between Islamic and
conventional banks in order to help remove the misconceptions about Islamic
banking. It is due to incomplete and often distorted knowledge about Islamic banking
that the civil society remains doubtful about the viability of such a system. As the
civil society is an active and potential agent of dissemination of ideas and information
in the society, its lack of knowledge and conviction has limited the scope of Islamic
banking practices. Once the public is convinced about the utility and uniqueness of
the system, Islamic-banking practices will grow further in many Muslim countries.
The transformation of the present interest-based financial system into an interest free
Islamic system is one of the objectives espoused by many Muslims.
Attitude of Conventional and Islamic Bank Customers Towards Islamic Banking Practices in Sri Lanka
MIM Riyath. SEU/IS/04/MG/021 Specialization in Finance Page | 5
1.5. Significant of The Study The current Muslim population of the world is 1.8Bn and Muslims are about 8% of
total population of Sri Lanka approximately 2 million Muslims, Given the above
mentioned statistics, it becomes essential to introduce this form of Finance in Sri
Lanka as there exist wide difference in terms of regions, religions, languages etc. This
difference provides us with a Blue Ocean which can be exploited to make a positive
mark on the Finance landscape of our country. It would help to increase the size of the
Finance industry various and prove to be a foundation for many more innovations to
be introduced in future.
The approximately 30% Muslims are financially qualified. The long held issue of
financial inclusion can be taken care of by introducing Islamic Finance. Majority of
Sri Lankan Muslims are so poor that they are not targeted by the Commercial Banks
and whose savings lie idle at home. Muslims in Sri Lanka generally creditworthiness
primarily because they form part of business areas. It is here where the actual market
potential of Islamic Baking lies. One may argue that Sri Lankan Muslims are
satisfactorily using the existing Conventional Finance system. A one to one interview
with Bank executives of Personal Finance division of many Banks revealed that a
significant Muslim population is:
Not investing in mutual funds with a debt component.
Donating the interest on their salary savings account to charity.
Using a zero-interest current account instead of a savings account.
The above steps are diligent efforts made by many Sri Lankan Muslims to make the
current conventional Finance ‘Shariah’ compliant in their own way. This is the huge
market which can be tapped by Islamic Finance.
1.6. Objective of The Study 1.6.1. Primary Objective The purpose of this dissertation is to describe the Islamic Banking system and how it
is implemented based on whether profit or interest in Sri Lanka.
Attitude of Conventional and Islamic Bank Customers Towards Islamic Banking Practices in Sri Lanka
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1.6.2. General Objective To understand Islamic Finance
To understand system of Islamic Finance and its components
To understand implementation of Islamic Finance in Sri Lanka
To understand opportunities and challenges.
To understand how is differ from conventional bank
1.7. Research Questions How are the Attitudes of Conventional and Islamic Bank Customers towards
Islamic Banking practices in Sri Lanka? It is the main research problem. It is
analyzed that the following research questions.
The dissertation is based on following research questions:
What is Islamic Finance?
How does the system work and what are its components?
How do interest and profit and its mechanism regarding Islamic banking system?
How is it different from a conventional bank?
Is Islamic Finance practicable?
1.8. Research Methodology A purposive random sampling was used to collect data on a series of questions
regarding Islamic banking practices. Data of the study was collected from both
primary and secondary sources. The sets of approved questionnaire were used in the
survey, through interview method, among the customers as well as professionals of
selected Islamic and conventional banks in Sri Lanka.
The study includes Islamic and conventional banks. So we assume that the officers of
these banks and their customers know and understand the similarities and differences
in the banking practices of Islamic banks and conventional banks.
1.8.1. The Sample The sample consists of customers of each bank and professionals. As such,
professionals and customers were interviewed to record their opinions about some
noticeable similarities between Islamic and conventional banks. Findings of the study
Attitude of Conventional and Islamic Bank Customers Towards Islamic Banking Practices in Sri Lanka
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were consulted with the available literature and executives of the banks to confirm
their reliability and acceptability.
1.9. Limitations Limited time as well as limited scope has caused us to restraint the dissertation to
Islamic Finance in Sri Lanka.
1.9.1. Limitation of The Study The focus of the study is limited to few factors which means only work load, target
achievement, superior behavior etc. are considered to illustrate and represent the
concept of intention to leave. But when we considering broadly there is another
factors also to affect this situation.
Some time selected sample may not represent the whole population.
Lack of specialists on the area under discussion of Islamic finance in the region.
Peoples who are the passion in the Islamic Bank are hesitating to give data
regarding the bank.
Lack of articles and journals regarding Islamic finance in Sri Lankan point of
view.
There are some constraints to meet, cost, other available resource, literature
reviews.
Attitude of Conventional and Islamic Bank Customers Towards Islamic Banking Practices in Sri Lanka
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1.10. Organization of Chapters The dissertation is divided into five chapters as follows.
CHAPTER ONE: Introduction.
This chapter will present the brief introduction, history, objective, research questions,
methods used and limitations as well as the authors, upon whose works, based this
Dissertation.
CHAPTER TWO: Literature Review.
This chapter will present the environmental background of Islam, the Islamic view on
ownership, wealth and almsgiving and the Islamic Law – Shariah emergence and
spread, contracts used and business relations, different categories of Islamic banks, as
well as concept of Islamic Banking will be described.
CHAPTER THREE: Research Methodology.
This chapter will explain about data collection, sample interpretation, and way of
analyzing.
CHAPTER FOUR: Data Presentation and Analysis.
This chapter will analyze the opinions of the professionals and customers of both
Islamic and conventional banks.
CHAPTER FIVE: Findings, Conclusion and Recommendation.
This chapter will present the summary Conclusions and Recommendation of the
study.
A
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Chapter Two LITERATURE REVIEW
2.1. Background The environmental background of Islam, the Islamic view on ownership, wealth and
almsgiving and the Islamic Law – Shariah will be described.
2.1.1. Environmental Background of Islam In order to understand Islamic finance, it is necessary to have certain knowledge about
the history and the tenets of Islam. It is also important to be familiar with Islam’s
position within the society, which is different from the religious power within the
Western countries. It is not always easy for individuals used to the Western traditions
to understand the teachings of Islam. (Samuelsson, 2000)
Islam means ‘submission’ which points out that a believing Muslim should submit to
the will of Allah. It might be worth mentioning that the expression ‘the will of Allah’
has a quite different meaning to the true Muslim than to the secularized Western
citizen. The superiority of Allah in the eyes of the Muslims forms the foundation for
both Islam and Islamic banking. The Koran is the holy book of Islam and to be seen
as the true words of Allah. (Samuelsson, 2000)
There are five pillars or corner stone’s in Islamic faith; the Islamic Confession, the
daily prayers, the fast during Ramadan, the almsgiving (Zakath) and the pilgrimage to
Mecca. (Samuelsson, 2000) Since the main topic of this dissertation concerns the
financial part of Islam, the corner stone about almsgiving naturally receives most
interest. Before studying the almsgiving more closely, one should take a look at what
Islam teaches about property and wealth in general.
2.1.2. Ownership and wealth In Islam brotherhood and justice are strongly pointed out and the well being of society
is more important than the well being of the individual. Efforts made to improve or
expand production in order to raise the output are good and worth struggling for, but
justice and fair play at all levels of human interaction must take place. Wealth or
Attitude of Conventional and Islamic Bank Customers Towards Islamic Banking Practices in Sri Lanka
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income is considered as a favor from Allah and not as an evil. Heaven is open equally
to the rich and the poor.
Poverty is not necessarily associated with virtue. It is, however, still considered as
provocative if wealthy people boast with their wealth. If a rich person sees his- or
herself as being superior to other people, it is a blasphemy against Allah.
(Samuelsson, 2000) What matters is not whether a person has wealth but how it is
obtained and how it is used. Wealthy persons should use their wealth in the
community to gain society. (Al-Omar et. al., 1996)
To better understand the behavior of consumer and producer it is useful to study the
concept of property within Islam. The following three points are particularly relevant.
(Al-Omar et. al., 1996)
1. Property is unconditionally owned only by Allah
2. Property among human beings is a form of stewardship or care taking – in other
words: it is conditional. A person is answerable to Allah for the use of every property
he or she uses.
3. Conditional ownership is either collective or individual:
Collective ownership: fundamental natural resources as water air and fire
Individual ownership: things as goods, buildings, livestock and rights to lease, rent
or re-sale
According to Islam, “Allah owns all resources and man is only a trustee in their use”
(Al-Omar et. al., 1996, p 5). Therefore, the economic aspect of how to handle those
resources in real life is also not completely free. There are moral and legal constraints.
2.1.3. Almsgiving - Zakath As mentioned above, one of the five pillars or duties in Islamic faith is the
almsgiving, the Zakath, which literally means ‘purification’. Persons with resources
above an exemption limit are to pay an amount levied on their wealth in order to
purify the wealth and the person’s soul. (Al-Omar et. al., 1996) The main purpose of
the Zakath is redistribution of wealth and income. It has been regarded throughout
Islamic history as the principal welfare system – a way of taking care of the poor and
the needy in society. It can be seen as a form of religious tax, even though the
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almsgiving in theory is considered to be voluntary. The true Muslim is also strongly
encouraged to practice charity besides the Zakath. (Warde, 2000)
In the Koran it is clearly written who should pay Zakath, how much to pay and who
the receivers are. Islam requires every Muslim, having resources in excess of a certain
basic amount, to pay the Zakath as a given proportion of her or his net worth or
agricultural output. The Zakath receivers are the poor and needy people or people in
different kinds of trouble – independent of their religion. The Zakath is paid once a
year and calculated at 2.5 per cent of the total value of capital and profits minus
unrecovered debts and depreciation. In agriculture it varies from 5 per cent to 10 per
cent, according to the type of irrigation. (Al-Omar et. al., 1996; Samuelsson, 2000;
Warde, 2000)
The socio-economic function of the Zakath aims not only at satisfying the hunger of a
poor man or to help him with a few pounds. The purpose is also to enable him to
support himself by his own efforts so that he may have a fixed source of income. This
rescues the individual from the indignity of dependence on others or on the state, for a
livelihood. This way of acting runs well with the special rules for collection and
distribution of the Zakath. The rules say that the Zakath should be collected and
distributed locally. It should also be made collectively and not by each individual. The
reason for this is to avoid almsgivers from boasting with their actions and to prevent
the Zakath receivers from feeling ashamed. Many Islamic banks are involved in
Zakath – either through setting aside a percentage of their profits for charitable
activities or through administration of Zakath funds, collection or distribution of
money. In countries where the ruler takes charge of collecting alms a Zakath fund
must be established in each Islamic bank. The Islamic bank can then play a technical
assistance role in the government’s fight against poverty. (Al-Omar et. al., 1996;
Warde, 2000)
In the early days of Islam, detailed rules as to amounts, collection practices,
exemptions and the like were established for the practice of the Zakath. This system,
however, has changed through the years to fit the Islamic community’s revenue and
welfare needs of today.
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The Zakath payment has been replaced by modern tax systems in Muslim countries,
but is, nevertheless, still considered as a religious duty among true Muslims.
(Samuelsson, 2000)
There is a debate between the proponents of social solidarity, compassion and mutual
obligation and the proponents of the sanctity of private property. The first part
believes that the rich should pay to the needy, even beyond their obligation to pay
Zakath. The latter part, however, is of the idea that the only obligatory claim on the
wealth of Muslims is Zakath. This debate has apparently been going on since the
death of the Prophet Mohammed. It is obviously related to the modern debate over the
capitalist or socialist nature of the Islamic economic system. Since the Islamic
economic system is based on the Islamic Law – the Shariah – the main question is
whether the practical economic purposes should be emphasized on the strict letter of
the law or on the spirit of the law. (Nomani & Rahnema, 1994)
2.2. Islamic Law – Shariah As the Islamic ‘nation’ grew, a need for a more detailed legal system arose. The
Islamic Law is called the Shariah and is defined as the Divine Law – the Law of
Allah. It is mainly based on the Koran, the Sunnah and the Hadith. Among those
sources the Koran has a superior place. The Koran is considered to be divine and
eternal since it is the true words of Allah. (Al-Omar et. al., 1996) The Sunnah
contains the words and acts of the Prophet Muhammad and relates to the practice or
ruling deduced from them. The Sunnah transmits and explains the Koran. The Hadith
refer to a tradition or story of the Prophet. In short, the Sunnah is what was practiced
and the Hadith are the record of what was practiced. Both the Sunnah and the Hadith
refer back to the Koran. (Nomani et. al., 1994)
The Hadith are – as Warde puts it – a collection of stories about and sayings of the
Prophet Mohammad set down in writing two or three centuries later. It has become a
source of controversy between Islamic groups since there are a number of
interpretations of it. (Warde, 2000)
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Since the Shariah is the Law given from Allah, it is divine and not to be questioned by
human beings. According to Al-Omar, human reason has considerable sovereignty
within the law, but it has no sovereignty over the law. What Allah has prohibited
cannot be made unconditionally permissible. The Divine Legislator is not bound by
the limits of theoretical reason. What the law declares must be accepted and never
doubted, even when it passes or appears to contradict human reasoning. (Al-Omar et.
al., 1996)
The statement of the Shariah as a divine law is, however, denied by Amereller. He
claims that the Shariah should not be considered as a divine law like for instance the
Ten Commandments, but instead be declared as a “body of Islamic law created and
developed by jurists” (Amereller, 1995, p 25). According to Amereller, the Koran
does not serve as a code of laws. The Koran and the Sunnah do mostly not contain
clear laws and regulations, but decisions and hints that laws and regulations can be
founded on. Therefore, law advisors are recommended only to use the Koran and the
Sunnah if necessary. Much more are the interpretations of the Koran and the
analogical conclusions of known jurists to be used. Those works were completed in
the 10th century and considered as valid for coming generations. (Amereller, 1995)
The Shariah does not allow certain condition as interest (riba) and gambling or
speculation (maysir). From a Shariah point of view, business and investments made
by Muslims must be conducted in a responsible and committed way. (Archer & Abdel
Karim, 2002)
The Shariah might give the impression of being very restraining since it contains a
number of prohibitions. On the other hand, the law includes the general principle that
if nothing is specifically prohibited, it is permitted. (Al-Omar et. al., 1996)
2.3. Interest Versus Profit 2.3.1. Introduction For the past few years, particularly after the emergence of "Islamic" monetary,
financial, and economic institutions, there has been a argument as to whether bank
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interest is a legitimate, permissible (Halal) return or a forbidden Riba and as to its
feasibility as a mechanism for the management of contemporary economic activity.
2.3.2. The Concept of Riba : Rib as a term is the increment obtained over the principal in return for nothing in
commutative contracts. Riba mentioned in the Holy Qur'an is. The pre-Islamic Riba,
the clear Riba which is the Riba of a debtor loan. It is the increment given in return
for time, whether the increment is specified as a condition at the conclusion of
contract or designated at the time of repayment for extending the due date. In this
context, Riba is forbidden in all Divine Revelations as it represents the most
abominable form of illegally expropriating personal and public capital. As such, it is
considered a grave sin in Islam. Any excess over the original debt, no matter how
little it may be is considered an evil gain. On that, Allah, the Exalted says: "If you
repent, you may retain your principal, wronging none (with an increase) without being
wronged (by suffering a loss).
Riba in this sense is forbidden, irrespective of the nature of the loan whether for
consumption or production or of the nature of the parties to the loan contract
individuals, individuals-companies, governmental, or international organizations or
the circumstances of one party, or all parties, to the contract rich or poor; and, finally,
of the change of the value of the currency decrease or increase.
Riba, in this sense, is really the "AIDS" of contemporary economic activity, as it
deprives economic life of its immunity and robs it of its ability to fight economic
diseases. Consequently, a feeling of exploitation prevails, productivity decreases, the
efficient use of resources deteriorates, economic potential is wasted, and, ultimately,
economic disorders are aggravated.
Please see in Al Quran
(Surah al-Baqarah, verses 275, 276, 278,) (Surah Al 'Imran, Verses 130), (Surah Al-
Nisa', Verse 161), (Surah Al-Rum, Verse 39),
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2.3.3. Definition of Riba or Interest The word "Riba" means excess, increase or addition, which correctly interpreted
according to Shariah terminology, implies any excess compensation without due
consideration (consideration does not include time value of money). This definition of
Riba is derived from the Quran and is unanimously accepted by all Islamic scholars.
There are two types of Riba, identified to date by these scholars namely 'Riba An
Nasiyah' and 'Riba Al Fadl'. 'Riba An Nasiyah' is defined as excess, which results
from predetermined interest which a lender receives over and above the principle (Ras
ul Maal)
'Riba Al Fadl' is defined as excess compensation without any consideration resulting
from a sale of goods. During the dark ages, only the first form (Riba An Nasiyah) was
considered to be Riba. However the Holy Prophet also classified the second form
(Riba Al Fadl) as Riba.
The meaning of Riba has been clarified in the following verses of Quran:
"O those who believe, fear Allah and give up what still remains of the Riba if you are
believers. But if you do not do so, then be warned of war from Allah and His
Messenger. If you repent even now, you have the right of the return of your capital;
neither will you do wrong nor will you be wronged." Al Baqarah 2:278-9
These verses clearly indicate that the term Riba means any excess compensation over
and above the principal which is without due consideration. However, the Quran has
not altogether forbidden all types of excess; as it is present in trade as well, which is
permissible. The excess that has been rendered Haram in Quran is a special type
termed as Riba. In the dark ages, the Arabs used to accept Riba as a type of sale,
which unfortunately is also being understood at the present times. Islam has
categorically made a clear distinction between the excess in capital resulting from sale
and excess resulting from interest. The first type of excess is permissible but the
second type is forbidden and rendered Haram.
“Seized in this state they say: ‘Buying and selling is but a kind of interest’, even
though Allah has made buying and selling lawful, and interest unlawful.” Al Baqarah
2:275
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2.3.4. The Nature of Modern Banking : The work of modern banks, commercial or specialized, is to handle credits, debts, or
loans. Credits and debts are the two aspects of a loan. Credit pertains to the loan-giver
in relation, to the loan, and debt pertains to the loan-receiver in relation to the loan.
The relationship between the bank-and those dealing with it are control-led by the
loan contract. The way that the bank deals with its clients is revealed in the details of
its financial position as presented in its balance sheet. The balance sheet is divided
into two parts: resources of funds, or liabilities, and uses of funds, or assets.
Resources are basically controlled by the loan contract. The major part of these
resources comes mainly from depositors. As such, depositors are loan-givers and the
bank is a loan-receiver in return for interest which the bank pays a debit interest from
its part, except for current deposits for which the owners are not usually given any
interest. In relation to all deposits, the bank is, a guarantor, i.e., the bank guarantees
the original deposit and -offers interest" on deposits that are not current.
As to the uses, the bank loans the money it has accumulated to merchants, investors
and others. Their status as loan-receivers is that of a guarantor, i.e., guaranteeing the
original loan and paying interest a credit interest from the bank's part. The "difference
between the-total interest that the bank pays to its depositors and the total interest
which the bank receives from those making use of its financial resources represents
the bank's net return.
Therefore, in the bank's balance sheet there are fixed debts on both sides which must
be paid after a definite period of time, along with a conditional increment defined at
the start, for payment on due date, or on a new due date after maturity for extending
the period of time. Thus, the return for the use of the debt is justifiable for the debtor
as he is the guarantor, but is not justifiable to the creditor, according to the Islamic
principle which stipulates that "Al Kharaj bi Addamaan, i.e., the return is not justified
unless there is some risk involved, and, in this case, the loan-giver, in contrast to the
loan-receiver, bears no risk.
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In this basis, Islam, emphasizing real social solidarity, recognizes only Qard Hasan.
Any loan repaid with any benefit is Riba. If people wish to develop and invest their
money, then they must do so through true Islamic investment, by placing their money
in risk-taking projects and bearing the consequence, be it profit or loss. Money does
not by itself generate money; it increases or accumulates, justifiably, through actual
investment in economic activity, in accordance with different Islamic modes of
investment based on partnership and sales contracts. Thus, money grows through a
partnership system, not through a debt system in return for interest. This, in essence,
is how Islamic banks function
2.3.5. The Feasibility of the Interest Rate Mechanism: Some economists consider the interest rate as the strategic price in the contemporary
economic system. For them, it is the nervous system of modern banking; the main tool
for the management of the monetary system; the effective savings factor; and the
criterion that helps to ensure investment allocation in the most efficient projects. They
believe that the use of this mechanism will save developing countries from further
foreign indebtedness and, consequently, from dependence. Eventually, they believe, it
will guarantee the most efficient use of resources through better distribution; and as a
result, economic development will be achieved; pillars of economic power will be
perfected; and society will progress. Some economists even consider the use of the
interest rate mechanism in contemporary economic system to be a manifest destiny
and an irreversible fate.
They further believe that if any existing system attempts to free itself from the interest
rate mechanism, a great misfortune will befall the owners of wealth, most especially
creditors. They believe that this would result in the collapse of the banking system,
the paralysis of the monetary system and decreasing savings by- increasing hoardings,
and the flight of capital to the rest of the world, exposing a nonconforming economy
to escalating foreign debt in order to finance investment with interest loans. This, they
believe, is inevitable and unavoidable.
For Western economists, the contemporary economic system with its methodology
and modern institutions is inextricably bound to the interest rate mechanism. The
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elimination of this mechanism will lead to collapse and destruction. Money and banks
are among the variables of modern global economics, and the Islamic economic
system should not be 'prevented from adapting to the innovations of the present age
simply because there are no precedents (i.e. Banks) from earlier Islamic period. At the
same time, the adaptation of these innovations to the needs of Islamic society does not
presume the abandonment of one of the immutable principles of the Islamic economic
system on the pretext that contemporary economics cannot function without the
interest rate mechanism.
The situation in developing countries is, in fact, very different. In spite of the
existence of monetary and banking systems in these countries, we find that many, of
the basic conditions for the already limited efficiency and effectiveness of Monetary
and credit policy are either completely absent, or present only in a primitive form.
As a result, it is clear that this policy is even much less efficient in these countries.
Economists agree that the problem, here, is not a monetary problem; it is, rather, a
structural one. What these countries need to end their chronic stagnation is not more
monetary spending. They need a structural change in the production process through
development. The problem here is not a problem of "Demand" as much as it is a
matter of "supply". It is necessary to raise the level of the utilization of existing
productive resources. In this context, it is possible that rational monetary, financial
and commercial policies, not the interest rate mechanism, will play a beneficial role in
this process In the opinion of many economists the negative influence of the rate of
interest on the process of capital formation and its ineffectiveness in the treatment of
inflationary and deflationary disorders are considered the most important causes of
instability in. contemporary economies. In the early 1980s, M. Friedman asked what
caused the unprecedented irrational performance of the American economy. He
concluded that the main cause was the equally irrational behavior of interest rates.
Finally, R. Turvey has confirmed that the rate of interest does not control the
economy that the interest rate mechanism is, in fact, unfit for investment decisions
and that it should be replaced by the rate of the price of real assets or by the general
level of prices of shares. From this understanding, a general theory may be proposed
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in which the price of real assets and not paper assets is central to the economy and in
which profit and not interest is it’s real and effective mechanism. This brings us to a
discussion of the efficacy of the profit mechanism.
2.3.6. The Efficacy of the Profit Mechanism There are four factors of production: land, labor, capital and entrepreneurship. Each
one of these factors generates an income corresponding to the: actual part it plays in
economic activity. Income generated from land is rent; Income generated from labor
is wages. Income generated from capital is interest and income generated from
entrepreneurship is profit. The fourfold division of the factors of production and their
corresponding incomes, particularly capital and interest, are basic to economic theory
and fundamental to the theory of capital.
The analysis of the theory of capital rests upon an unrealistic over-simplification,
which assumes the existence of certainty or perfect foresight. In this strange certainty-
based setting, strange things are put forward,, as for example contending that the
equilibrium rate of interest always equals exactly the marginal productivity of capital,
or as P. Samuel-son and D. Patinkin say, the rate of interest is equivalent to the rate of
profit anticipated to be certainly realized.
According to Western economic literalism, investible capital without interest, i.e.,
"free" capital, would create "unlimited" demand. The result will be an absence of a
supply and demand mechanism (through interest), hence no capital equilibrium can be
achieved. The end result will be wastage of capital as a consequence of this irrational
utilization which leads inevitably to economic spoil.
The real participation of capital in the production process, Islamic or otherwise,
definitely yields a return. From an Islamic perspective, this return is not a pre-
determined rate of interest but a common and proportional share in the actual or
estimated realization of profits. Simply because it exists, no one should be dogmatic
on this concept of the fourfold division of return on the ground that such ideas of
conventional economics cannot be challenged.
According to Islamic economic principle, this share in profits is the cost of capital. In
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consequence, profit becomes the criterion which controls the allocation of financial
resources. It is a mechanism which balances the demand for and the supply of these
resources. When the anticipated profit rate from a new investment exceeds the
achieved prevailing rate of the actual profit in the economic activity where investment
is to be under-taken, under uncertainty conditions, and on the basis of developmental
priorities of the society and the goal of achieving sufficiency, the supply of investible
funds for the project increases and the project is actually implemented. The opposite
is also absolutely correct.
Therefore, the actual profit generated is considered in Islamic economics as a decisive
factor in determining the success of a new project, and its ability to attract investible
capital. Capital in an Islamic economy is quite naturally invested where profit is
greater, rather than where interest is higher. So profit and not interest is the true
indicator of the real scarcity in the supply of capital and guarantees the efficient and
productive utilization of available financial resources in all economic activities.
Islamic states cannot, therefore, face the economic and cultural challenges presented
by the modern world without the comprehensive application of Islam. The aim of the
Islamic system is realized through the worship of Allah the Almighty which, in the
broadest sense, involves the constant struggle to improve real human progress through
learning, economic development and the realization of a decent and righteous life for
everyone living under this system.
If this can be achieved, the objectives of Shariah, i.e., the protection of faith; life,
intellect, property and progeny for present and future generations of Muslims, will be
realized. The above discussion has touched briefly upon one aspect of the fourth
objective, which is the protection of property or wealth, manifest in the efficacy of the
mechanism of profit in the utilization of resources.
2.4. Islamic Finance This includes a discussion about Islamic Finance, its environmental background,
emergence and spread as well as contracts used and business relations.
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2.4.1. Environmental Background Warde summarizes the situation in the Islamic world in a comparison with the
situation in Europe. “At a time when Europe was still in the Dark Ages”, he claims,
“Culture and knowledge thrived in the Islamic world. Later, as the West went through
its ‘great transformation’, the Islamic world remained stagnant”. (Warde, 2000, p 25)
The so-called Golden Age of the Islamic world took place in the 7th-10th centuries in
the Middle East countries and between the 11th-14th centuries in North Africa. The
available financial instruments in the Islamic world were, Warde claims, at least until
the 13th century far more advanced than in the West. Although banks did not exist,
innovative financial instruments were a part of commercial life. A frequently used
expression is that they were ‘bankers without banks’. After the Golden Age a period –
between the 15th and the 20th centuries – followed, which is on the contrary
remembered as a period of stagnation and decline. The reasons for this might be that
the Islamic world suffered a double break – not only with its own past but also with
the West. “The Renaissance, the Reformation, even the scientific revolution and the
Enlightenment passed unnoticed in the Muslim world.” (Warde, 2000, p 26)The
colonization during the 16th and 17th centuries delayed the development of the
Islamic financial models. Instead European banks were established at the end of the
17th century in Turkey, Egypt and Iran (Samuelsson, 2000; Zineldin, 1990). By the
19th century, most of the Islamic world was brought into a Western imposed
economic order for which it was ill prepared. Between the Golden Age of Islam and
this encounter, the world of ideas and institutions had changed dramatically. Most
institutions with relevance to finance that exist today – capital markets, corporations,
etc – did not exist in the early days of Islam. (Warde, 2000) In some areas the
classical Islam anticipates modern finance:
Private property
Emphasis on written contracts
Favorable view of business endeavors
Some Islamic business forms such as commend a partnership; have found their way in
European legal codes. Along with economic and political transformations came new
perspectives on debt and indebtedness. Debt was no longer seen as something
negative. With the rise of capitalism and the industrial revolution, it became logical
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that a nation needed not only skills and knowledge but also capital in order to
succeed. In those countries where there was only little money to lend, the
entrepreneurship was held back, which had a negative impact on the country. (Warde,
2000)
2.4.2. The Emergence and Spread of Islamic Finance Today, Islamic banking is estimated to be managing funds of US$ 200 billion. Its
clientele is not confined to Muslim countries but are also spread over Northern Africa,
the Far East, Europe and the United States. Islamic banking continues to grow.
Islamic bankers, keeping pace with sophisticated techniques and latest developments
have evolved investment instruments that are both profitable and ethically motivated.
Today, more than 250 Islamic financial institutions are operating worldwide.
(www.islamic-banking.com)
2.4.3. Contracts And Business Relations As mentioned before, Islamic finance is strongly based on the principles and rules of
the Islamic Law – the Shariah. The Shariah contains rules about contracts, which are
the main instrument in Islamic finance. A branch of the Shariah points out which
contracts are permissible or valid, which ones to be used and which are not to be. It
also gives instructions on how to form those contracts to avoid any form of confusion
or disputes. The clear rules about contracts have made the contracts an optimal
instrument in the Islamic finance. They have existed ever since the early days of
Islamic finance, when there were no Islamic Financial Institutions. At the beginning
of Islam, businesses through partnerships were quite frequent. Business was based on
‘credit instruments’ and it was the good name that ruled the credit abilities. People
with good reputation – normally through high social status – bought goods on credit
and resold them later on. The business relations were as good as always based on
already existing personal relations, but the social position of the business partners was
also of great importance. The risk sharing is very important within Islamic finance.
The Shariah manages this risk sharing by insisting on the use of well-defined
contracts when financial transactions take place. The contracts are to be clear and well
formulated to avoid all kinds of misunderstanding and confusion. It also fulfils its
purpose to stabilize future happenings by connecting the unknown future to the
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known past. In this way the uncertainty is lowered and the desire to minimize the risk
is met. (Al- Omar et. al., 1996) According to Al-Omar, there should in Islam not be a
winner and a loser when doing business, but a partnership that will gain both parts.
2.5. The Islamic Banking System The environmental background and different categories of Islamic banks are
described. The concept of Islamic Banking is presented as well as the aims and
activities of Islamic banks in general.
2.5.1. Introduction It is hard to pinpoint the start of Islamic banking. Although financial transactions had
existed for a long time, there was, until the 14th century, no institution exclusively
devoted to banking. As mentioned above, one explanation for the late development of
Islamic financial institution could have been the powerful role of the existing
contracts. Another interpretation of the reasons why Islamic banks did not develop in
the Islamic world is that it had to do with the structure of economic life. For one
thing, Warde argues, finance was never an autonomous activity; it was always a
subset of commerce. Financial relationships were to a much greater extent embedded
in personal and communal ties in the Islamic world compared to the European
economies of the late middle Ages.
2.5.2. Environmental Background Western banking arose as a combination of two factors: the generation of capital by
means of deposits of the many on the one hand, and money lending and the provision
of credit for the few on the other. In the Islamic world, there was a disconnection
between deposit and credit, and the conversion of deposits into loans was therefore
not necessary. Credit and financing operations were conducted through transactions,
usually involving profit-and-loss sharing and, therefore, unrelated to safekeeping.
(Warde, 2000) Al-Omar claims that theoretical discussions and articles on Islamic
economics and banking led to the pioneering experiment in Egypt in 1963 (Al-Omar
et. al., 1996).
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The experiment was based on the Mudarabah principle and lasted until 1967 – by that
time there were nine banks involved. The non-interest banks invested mostly in the
trade and industry sectors. The banks were not called Islamic banks for political
reasons; since the regime in Egypt feared it might be associated with fundamental
currents within the country. The banks were established to win the confidence of
farmers and workers in Egypt. Those people were more religious and traditionally
minded and shared no confidence in the secularized banks, which were run according
to Western laws. In Cairo and Alexandria, though, the Islamic banks had less success
when competing with the secularized banks. However, in 1967 the Islamic banks were
shut down for political reasons. (Samuelsson, 2000; Zineldin, 1990)
2.5.3. The Concept of Islamic Banking The Islamic bank is a mix of commercial bank and investment bank. The banking
operations must be compatible with Islamic norms. Furthermore they must be viable
and profitable overall because the system must protect the depositors and give them
an adequate rate of return. Islamic banks general objective is to develop the economy
within and according to Islamic principles. The banks can therefore under no
circumstances engage in the payment and receipt of interest, in alcoholic beverage
trade, in the gambling industry or in the pork meat trade, or any other activities
explicitly prohibited by the Shariah. (Al-Omar et. al., 1996)
Islamic banks operate on the basis of profit and not on paying and receiving interest.
The banks can earn profit from three areas: trading, leasing and by direct financing in
Profit-and-Loss-Sharing contracts. Different instruments are devised to earn profit in
any of these ways. The structure and conditions of these transactions must conform to the
Shariah and fulfill its desired objectives. This means that Islamic banks can extend
loans only if interest or return is not earned on it. The only way to finance
consumption activities, if at all, is through cost plus the capital, since there is no profit
to be earned or shared. The banks advance money for commercially productive
activities on the basis of profit-sharing principles. (Al-Omar et. al., 1996)
There are four principles of special importance for Islamic banking (Al-Omar et. al.,
1996, p 24)
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There must be some risk, whether funds are used in commercial or productive
venture.
All funds should preferably finance socially productive activity:
Financial risk must lie solely with the lender of the capital and not with the manager
or agent who works with the capital;
Interest is prohibited in that it is a predetermined, fixed sum owed to the lender
irrespective of the outcome of the business venture in which the fund is used.” The
Islamic banking system aims at developing new financial instruments to deal with the
problems of the Muslim communities. This can be done by mobilizing internal
resources into a banking system conforming to Islamic teaching and principles. The
main objective is to make the financial system an efficient medium for intermediation
between savings and investments. (Zineldin, 1990)
The relationship between the bank and its clients is not the same for Islamic banks as
for conventional banks. In the former it is one of direct trading or equity participation
while in the latter it is that of lender/borrower. Islamic banks do not trade in debts as
conventional banks do. Suggestions have been made by some Muslim writers that the
financial intermediation sector should be nationalized. However, very few share this
opinion. Nationalization in general is not an authentic Islamic policy. It is considered
to violate the basic Islamic philosophy of free will and respect for private property.
(Al-Omar et. al., 1996)
2.5.4. Aims of Islamic Banks in general Prince Muhammed al-Faisal al-Sa´ud from Saudi-Arabia has said the following about
the aims of the bank Dar al-Mal al-Islami/Faisal Group (DMI). The following list can
be seen as rather representative of what Islamic banks state as their goals.
1. “To undertake all financial operations required by Muslims today in the
framework of the principles and precepts of the Shariah.
2. To implement its (DMI’s) various activities through subsidiaries to be established
in Islamic and other countries.
3. To invest, within an Islamic context, the funds of Muslims to generate licit profits.
4. To promote and consolidate co operations among Muslims.” (Ray, 1995, p16)
Ray suggests two additions to the list. The first is to promote economic and social
development in Muslim countries. The social aspect has been implemented through
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the aims giving Zakath and creation of funds which Islamic banks employ (on a
limited scale) in charitable works. On the whole, Islamic banks have achieved
significant success in economic development by using participatory financing
methods such as Mudarabah, Musharakah and (rarely) interest-free loans. The other
aim must be the main motivating principle behind Islamic banking; to mobilize the
capital of the hundreds of millions of Muslim farmers, artisans, shop owners, and
other relatively poor people who have never put their savings in banks. (Ray, 1995)
The norm for an Islamic bank is to assess the profitability of a project and back those
projects which promise the highest rate of profit, are the safest and the most socially
beneficial. The primary basis on which the projects for PLS funding are selected is
their anticipated profitability rather than the credit-worthiness of the borrower. (Al-
Omar et. al., 1996)
The profits made by the bank are shared in two steps. First the profit is shared
between the bank and the business partner and then the bank’s profit is shared
between the bank and the holders of investment deposits. Let us say that the profit in
the business venture is $ 20.000 and the profit-sharing ratio is 50 per cent each. The
bank would then get $10.000 and the business partner $10.000 as a compensation for
his successful work with the bank’s capital. Clients with investment accounts are
entitled to a share in the profits of the activities done by the bank. The profit-sharing
ratio might be 40-60, that is 40 per cent of the profit goes to the bank and 60 per cent
is given to depositors. This means that $ 4000 stays with the bank while $ 6000 is
given to the depositors. (Zineldin, 1990)
2.5.5. Activities of Islamic banks Every bank must offer various accounts to attract different customers. Not all
customers have the same needs and wishes. The range of customers varies from
personal customer, business people, official customers, organizations and clubs to
societies. (Zineldin, 1990)
Some conventional bank activities are not conducted in Islamic banking. Interest, in
all forms, is rejected by the participants in modern Islamic banking. This includes
bonds, bank deposits, and certificates of deposits and the discounting of commercial
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paper. Islamic banks can deal with commercial paper at it initial stage, or to
collect/accept it at face value. The majority of Islamic banks forbid the purchase of
stock in companies dealing with interest (including Western companies). Exceptions
do exist; for instance banks as al-Baraka accept trading of stock in Western firms.
(Ray, 1995)
Currency futures cause diversity among the Islamic banks; some forbid them while
others distinguish between two cases. The first case is where one currency is paid on a
spot basis and the other delayed; this is forbidden. The second permitted case involves
the future exchange of both currencies at the previously agreed rate. Future trading in
commodities is forbidden for gold and silver, but not for other commodities.
According to Ray currency options should be forbidden since it is necessary for
currencies to change hands without delay. Ray further argues that commodities or
shares options are acceptable in principle, but there is debate as to whether or not they
can be traded to third party. (Ray, 1995) Charges on issuing travelers cheques and
transferring money are also permitted is some banks. (Saeed, 1996)
2.6. Permissible Financing Methods Most types of trade (buying and selling) are permitted in Islam, where prohibition is
the notable exception. Yusuf ‘Ali (1991) translated the meaning of [2:275] thus:
Those who devour usury (riba) will not stand except as stands one whom the Evil One
by his touch hath driven to madness. That is because they say: ‘trade is like usury’,
but Allah hath permitted trade and forbidden usury. Thus, “Allah has permitted trade”
(bay‘) is the general rule, with Riba sales being a strictly forbidden exception.
A valid trade is concluded in Islam if the seller and buyer exchange an offer and
acceptance which specify the object of sale and the price, and they both agree. Yusuf
‘Ali (1991) translates the meaning of [4:29] thus: But let there be among you traffic
and trade by mutual good will.
Al-Bayhaqi and Ibn Majah narrated on the authority of ’Abu-Saıd Al-Khudriy that the
Messenger of Allah said (translation of the language in Ibn Majah): I shall meet Allah
before I give anyone something owned by an-other without his consent, for a trade
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requires mutual consent. Not only is trading permitted, it is encouraged. Al-Suyutı
mentioned in Al-Jami, Al-Sagıra Hadith on the authority of Rafi that:
“The Prophet (Sal) was asked: “which are the best forms of income generation?”
He (Sal) replied: “A man’s labor, and every legitimate sale”.
Therefore, any financing conducted through valid trading by mutual consent is
permissible. However, since most Muslims lack sufficient knowledge regarding the
various conditions for a sale to be valid, contemporary jurists and financial
practitioners have limited Islamic banking and finance to a few “named” contracts.
Those are contracts that have been studied extensively by jurists over the centuries,
and whose validity is well established through the Prophet’s (Sal) own actions
(Sunnah), or consensus of the early Muslim communities and jurists (’ijma‘). To
further add credibility to the industry, the Arabic names for those contracts are often
used instead of their English counterparts (e.g. the term ’ijarah is often used instead
of its English counterpart “lease”). In what follows, I shall review the most commonly
used contracts in Islamic finance, utilizing both their Arabic and English names.
2.6.1. Cost-plus sales (Murabaha) In this sale, the buyer knows the price at which the seller obtained the object to be
financed, and agrees to pay a premium over that initial price. It was narrated that ’Ibn
Masud ruled that there was no harm in declared lump sum or percentage profit
margins. Thus, one may approach an Islamic financial institution and say “purchase
this item on my behalf at this price, and I shall give you a profit (Urbihuka) margin of
$10”, or “purchase this item on my behalf at this price, and I shall give you a profit
(Urbihuka.) margin of 10%”. The fact that the latter statement may be perceived to
make explicit a percentage payment should not be of concern, since it is not Riba if
the sale satisfies the conditions of Murabaha. Notice that in this contract, the Islamic
bank or financial institution must own the item at the time the customer buys it from
them with the specified profit margin.
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2.6.2. Credit sales (Bay Bithaman Ajil) Very rarely is Murabaha used by Islamic banks with the price paid immediately by
the customer. In such cases, there would be no financing included, and the Islamic
bank would simply be a middle-man or broker-agent (Simsar). When a customer
approaches an Islamic bank to finance a purchase through Murabaha the payment of
the price is usually deferred, and most commonly paid in installments.
In such cases, it is easy to look at the end result and assume that this is simply a
juristic “trick” to circumvent the prohibition of Riba. However, this is certainly not
the case. Indeed, the Murabaha component determines a profit margin (even as a
percentage of the original price), and the deferment ensures that this profit is collected
over a period of time. The rate of return is thus guaranteed (up to the risk of default on
payments by the buyer) over a fixed period of time. Twenty-some year-old
misconceptions in the literature on Islamic banking would argue that this makes the
banks’ profits a form of Riba. However, it is curious to note that some of the
proponents of this view in the 1970s were themselves the pioneers of the field of
Islamic banking in the Arab Islamic countries and elsewhere. Those banks dealt
almost exclusively in the early years in instruments such as the one considered here
(and leases to which we shall turn shortly). It was only a matter of time for
sophisticated observers to note that those banks’ rhetoric contradicted their actions.
This early confusion about Islamic banking and finance continues to plague the
immigrant Muslim community in North America to this day.
Perhaps the source of the confusion is precipitated by the conjunction of the
deferment of the price payment and the profit rate. A seventh grader can calculate the
implicit annual interest rate in such a contract. However, traditional Islamic jurists
over the centuries have indeed permitted such a conjunction of increase with
deferment. In fact, they have explicitly justified the increase by the deferment. Al-
Misri (1997, pp.39-44) lists a number of quotes by traditional jurists of various
schools, illustrating the permissibility of increasing the price based on deferment.
Some jurists qualified this permissibility with conditions to ensure that other reasons
for prohibition (e.g. two sales in one, a sale and a condition in one contract, etc.) were
not present.
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I shall only list a few of the quotations included in the above text to illustrate that
increasing the price due to deferment is without a doubt permissible:
Al-Kasanıin Badai Al-Sanai‘ (Hanafı masterpiece) said: “the price may be
increased based on deferment”
Hin (compendium of Hanafı jurisprudence): “a price. is increased if it is deferred”
Ibn Rush d (Malikı) in Bidayat Al-Mujtahid wa Nih¯ayat Al-Muqtas.id: “He has
given time a share in the price”
In Al-Majmam Al-Nawaw in Al-Subk¯I (Shıu‘by Al-’Imıand Taqiyud Al-Subki
(safi masterpiece): “deferment earns a portion of the price”, also in Hiyatash El-
Gamal ‘al¯aSh arh. Al-Manhaj (Shafiı), and Fatawa’ Ibn Taymiya (Hanbalı),
The contemporary confusion is hardly new. In ’Ibn Al-‘Arab ıs ’Aham Al-Quran, he
reports a specific argument given by the Arabs during the time of Prophet
Muhammad (Sal) to support their statement that “trade is like Riba” [2:275]. They
argued as follows: Consider a credit sale, with a price of 10 payable in a month. After
a month, the buyer and seller agree to postpone for one more month, and increase the
price to 11. The latter is forbidden Riba. They then argued: is this not the same as an
initial sale with the price of 11 deferred for two months? The answer in [2:275] was a
decisive “but Allah has permitted trade and forbidden Riba”.
The legal difference between the two is very clear: one is a sale in which price is
increased for deferment, and the other is an increase in the amount of a debt for
deferment. The first is permitted, and meets almost all the financing needs which can
be met through forbidden Riba-based lending. The second, however, is strictly
forbidden. The permissibility of the first and the prohibition of the second are both
quite clear and unequivocal. Therefore, we may use credit sales as a form of finance,
and we must categorically avoid interest-bearing loans. Why one is permitted while
the other is forbidden can only be fully known by Allah and whomsoever he gave
such knowledge. As a practical matter, we should know what is permitted and use it
to our advantage and what is forbidden and avoid it.
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2.6.3. Leasing (Ijarah or Ijar) Legally, the lease contract is not a sale of the object, but rather a sale of the usufruct
(the right to use the object) for a specified period of time. The sale of usufruct is
permissible in Islam, as evidenced by the verses (translation of meaning by Yusuf Ali
(1991)):
And if they suckle your offspring, give them their recompense. [65:6] Said
one of them: ‘O father, hire him on wages, for truly the best to employ is a
strong and trustworthy man’. He said: ‘I intend to wed one of my daughters
to you, on condition that you work for me for eight years, and if you
complete ten full years, that will be a grace from you’. [28:26-27]
It is also established by the following Hadith narrated by ’Ahmad, ’Abu Dawud, and
Al-Nasaı on the authority of Sad (Rali):
The farmers during the time of the Prophet (Sal) used to pay rent for the
land in water and seeds. He (Sal) forbade them from doing that, and
ordered them to use gold and silver (money) to pay the rent.
Also, ’Ah.mad, Al-Bukharı and Muslim narrated on the authority of ’Ibn Abbas (Rali)
that the Prophet (Sal) hired a man to cup [water] for him, and paid him his wages.
There are a number of conditions for lease-financing to be valid (the in-terested reader
may refer to M. Taqi Usmani (1998, pp. 157-174) for a partial list). The most
important financial difference between Islamically permitted leasing and conventional
financial leasing is that the leasing agency must own the leased object for the duration
of the lease. Therefore, while leasing an automobile from a car manufacturer or
dealership may in principle be permitted (if the contract satisfies the other conditions),
Muslims should be careful. In many cases, the dealership will in-fact use a bank or
other financial intermediary to provide a loan for the present value of lease payments,
and charge the customer an interest on this loan. This would constitute the forbidden
Riba. Careful Islamic financial institutions ensure that the contract abides by all the
restrictions set in the Shariah (e.g. sub-leasing requires the permission of the lessor,
late payment penalties must be handled very carefully to avoid the forbidden Riba,
etc.).
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Recently, Muslim jurists have also provided an Islamic alternative to conventional
lease-purchase agreements (called in Arabic ijarah waiqtina’). In this contract, a lease
is written as discussed above, with an additional promise by the lessor that he will
agree to sell the leased object at the end of the lease at a predetermined residual value.
This promise is binding on the lessor only, and the lessee has the option of purchasing
the item at the end of the lease, or returning it to the owner-lessor (c.f. ibid. (pp.175).
A common model for equipment, auto and home financing in North America is based
on leasing or lease-purchase. The Islamic financial institution buys the financed
object, and retains the title through the life of the contract. The customer makes a
series of lease payments over a specified period of time, and may have the option at
the end to buy the item from the lessor (and owner) at a pre-specified residual value.
The period of the lease and the rent payments may be made such that the final
payment is only symbolic.
It is no secret (at least it should not be a secret) that the Islamic bank or financial
institution will take into consideration the same factors when determining the rental
payments and residual value that a regular bank would consider: the value of the
financed item, its depreciation value, inflation, the credit-worthiness of the lessee, the
opportunity-cost value of the money (as reflected by market interest rates), etc. Of
course, an implicit “interest rate” can trivially be calculated from the price, residual
value, term of the lease and the lease payment. There is no need to hide this fact, and
indeed, the intelligent Muslim customer (as Muslim customers should always be)
must be encouraged to “shop-around” and ensure that the Islamic financial institution
is not implicitly charging an interest rate which is not in line with the conventional
market. However, in the final analysis, the difference will be in the form of the
contract. If the lease is structured in accordance with the various conditions detailed in
books of jurisprudence, it will contain no Riba and will ensure that it cannot contain
such forbidden Riba in the future (e.g. in terms of late payment fees, etc.).
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2.6.4. Partnerships (Musharakah and Mudarabah) Various forms of partnership can be direct financing methods. In the early days of
Islamic banking and finance, those forms were commonly grouped under the banner
“profit and loss sharing”, to be contrasted with the above listed debt-based forms of
financing. It was assumed by some that the profit and loss sharing methods were
somehow more ideal from an Islamic point of view. The fact that most Islamic
banking practice concentrated on credit sales and leases was thus often lamented as
re-labeling of the forbidden inter-est. As we have already seen, if the Islamic banks
and financial institutions are careful to abide by the rules of Shariah, there is no
reason to think that credit sales are any “less Islamic” than a silent partnership
(Mudarabah) or full partnership (Musharakah number of rules in Musharakah
regarding the language of the various partnership contracts, the rights and obligations
of various parties, and the sharing rules for profits and losses.
Most of the users of such partnership contracts will require the services of legal
experts in any case and therefore should also consult Islamic legal experts on the
legitimacy of any specific contract. Therefore, there is no need to spend much time on
those general contracts.
However, one model of financing which has been used in North America is based on
a form of Musharakah, where the financing agency and the customer share the
ownership of real estate. This contract is known by many names; most prominent
among them is the name mushaqisah (diminishing partnership). In contrast to the
leasing model, where ownership of the financed item remains with the lessor for the
entire lease period, ownership in a diminishing partnership is explicitly shared
between the customer and the Islamic financial institution (legally, what is established
is an Islamic sharikat al-milk). The periodic payments of the customer in this model
contain two parts: (i) a rental payment for the part of the property owned by the
Islamic financial institution, and (ii) a buy-out of part of that ownership. Over time,
the portion of the asset which is owned by the customer increases, until he owns the
entire asset and needs to pay no more rent. At that time, the contract is terminated.
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Examining the periodic payments, the customer will find that they look very much
like a conventional mortgage schedule. Early-on, a large portion of the payment is
“rent” (corresponding to “interest payment” in conventional mortgage), and a small
part is “buy-out” (corresponding to the “principal payment” in a conventional
mortgage). As time progresses, the first component gets smaller, and the latter
component gets bigger, until the rent becomes zero when the customer owns 100% of
the asset. Given this one-to-one correspondence between the two components of the
payments, it is again trivial to calculate the equivalent interest rate which would make
the conventional mortgage payments identical with the diminishing partnership
payments.
Again, this should not be cause for concern, as long as the partnership contract is
written in full accordance with the rules of Shariah (for a partial list and general
discussion, see M. Taqi Usmani (1998, pp. 31-92)). For in-stance, there is a
fundamental difference between a mortgage company which holds a lien on a
financed house, and the actual joint ownership of the house between the client and the
Islamic financial institution. There are a variety of issues which such institutions need
to resolve to operate in compliance with Shariah as well as government regulations,
and the intelligent Muslim customer is again encouraged to ensure that both sets of
regulations are met. As for the correspondence of the “rental” portion of payments to
what would be an interest payment on the principal balance in a conventional
mortgage, this should afford the intelligent Muslim customer an opportunity to ensure
that he is not being charged excessively relative to the conventional market. As far as
compliance with the Islamic Shariah is concerned, the form of the contract is what
matters. To keep the Islamic financial industry from creeping excessive profits at the
expense of devout Muslims with few alternative sources of financing, this comparison
to conventional market trends is very valuable.
2.6.5. Islamic forwards (Salam and Istisna) Those forms of financing are very rarely used, and hence will be mentioned only in
passing. In general, the sale of non-existent objects is forbidden due to Gharar.
However, to facilitate certain types of business, exceptions were given through those
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two contracts. The six major books of Hadith narrate on the authority of ’Ibn ‘Abbas
(Rali):
The Messenger of Allah (Sal) came to Madınah, and found its inhabitants
entering Salam contracts (with the price paid in advance) in fruits for one,
two, and three years. He (Sal) said: “whoever enters into a Salam contract
let him specify a known volume or weight, and a known term of deferment”.
Thus, he (Sal) permitted this trade, where the price is paid in full, and the well-defined
object of the sale is delivered after a specified time. This pre-payment of the price
allowed the farmers to buy seeds, spend for their own sustenance, etc., in order to be
able to produce the fruits.
Most jurists reasoned by analogy (Qiyas) and preference (Istihsan) from the
permissibility of Salam to the permissibility of Istisna, which may be translated as
“commission to manufacture”. In the latter contract, the price is paid in installments
as the work progresses in manufacturing or building an otherwise non-existent object.
The price pre-paid in installments in this case will often be lower than the cost of
purchasing the finished product (if it were to exist), and can therefore be a useful tool
for building schools, Masjids, etc. Those two contracts are permitted as exceptions to
the general rules of sale. As such, there are many conditions which must be met for
Salam or Istisna contracts to be valid. Those considering the use of such contracts are
advised to consult an Islamic Legal expert along with their other lawyers to ensure
that they abide by Shariah as well as government regulations.
2.7. Advantages of Islamic Finance This section examines Islamic finance from several sides, including efficiency,
stability, moral hazard and adverse selection, role in economic development, integrity,
equity and sustainability.
2.7.1. Efficiency At the macroeconomic level, Islamic finance avoids the use of interest-based lending.
The rate of interest is replaced by the rate of profit on equity and profit-sharing
finance, by markups on credit-purchase finance and by rental rates on leasing finance.
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While the time-value of money is maintained, there is no need to handle the
complicated questions of how to bring the rate of interest down to zero in order to
reach the optimal allocation of resources.
Conventional finance allocates financial resources with paramount regard for
borrower’s ability to repay loan principal and interest. In modes of Islamic finance
that are based on equity and profit sharing, focus would be on the profitability and
rate of return of the concerned investment. This type of finance has the potential of
directing financial resources to the most productive investments. This would increase
the efficiency of the financing process and reinforce efficiency in the real sectors.
2.7.2. Stability A conventional bank has on the one hand liabilities that include demand, time and
saving deposits, which the bank guarantees. On the other hand, it has assets that are
mostly composed of debt instruments each of which has a quality that depends on the
ability of the corresponding debtor to repay. Default on the asset side, if it happens in
significant proportion, would imply inability to meet the bank’s obligations on the
liability side. Such default can be expected at times of crises, be it of macroeconomic
nature or caused by circumstances specific to the bank. A bank operating according to
Islamic rules of finance has liabilities of different nature. Only demand deposits are
guaranteed. Meanwhile, investment deposits are placed on profit-and-loss sharing
basis. When such bank faces macroeconomic or specific crises, investment depositors
automatically share the risk. The bank is less likely to fall and a bank run is less
probable. It can therefore be said that an Islamic banking system is relatively more
stable when compared to conventional banking (Khan, 1986).
In conventional finance, present money is traded in an integrated debt market against
future money, which takes the shape of commitments to pay specified amounts at
specified future dates, or bonds. Bonds are supposed to be easily traded financial
instruments, many of which are listed in international financial markets. Hundreds of
billions of dollars of debt are traded daily in those markets. Bonds markets provide an
easy and automatic mechanism through which short-term funds flow at will from one
country to another. Much of those flows follow factors that are only nebulously
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related to economic fundamentals. They bring an important element of instability into
national economies. They threaten the world economy with the spread of instability
that might start in one single debt market in a fashion that economists have come to
call “contagion.” The integrated debt market has grown immense in size as well as in
scale of integration that now encompasses the whole world economy. Many
experiences, as lately manifested in the Southeast Asian economies, have shown that
integrated debt markets are sources of both domestic financial instability and
contagion. Some economists have come forward with proposals to place restrictions
on capital movements in contrary with what has been considered in economics as
received doctrine.
In contrast, debt is created in Islamic finance through selling goods and services on
credit. Resulting debt instruments are not readily tradable. We can visualize the
existence of a credit market for each commodity and service in which the demand and
supply to buy it on credit determines a mark-up rate. Such credit markets would be
fully segmented, while the debt instruments themselves are traded only for nominal
values at maturity. There is no room for sudden and mass movements of funds.
Possibilities of instability and contagion through the debt market would therefore be
remote and the justifications to choke capital movements with restrictions become
unnecessary.
Examination of daily records of trading in financial markets vividly shows that
institutional participants carry out huge speculative transactions. More often than not,
such transactions are sources of instabilities. In contrast, Islamic financial institutions
are automatically prevented from carrying out such gambling activities; destabilizing
speculations would be significantly curtailed in financial markets.
We have noted above that Islamic finance never provides present money in return for
future money. All Islamic modes of finance involve money on the one end and goods
and services on the other. Monetary flows through Islamic financial modes would
have to be tied directly with commodity flows. In other words, Islamic finance
removes the dichotomy between financial and real activities. Obviously, this leaves
little room for excessive credit expansion, as the finance extended is automatically
earmarked for specific uses.
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Speculative activities related to interest rate expectations would become out of place.
Changes in spending would automatically be reflected on changes in demands and
supplies of goods and services, causing quantities of output produced to respond more
quickly to market forces. In other words, markets are more likely to operate
efficiently and smoothly. It is therefore interesting to note that Islamic finance, though
non-conventional, supports market forces and mechanisms more than does
conventional finance.
2.7.3. Moral Hazard and Adverse Selection We have mentioned above that Islamic banks hold equity and trade in goods and
services as they operate as universal rather than commercial banks. Universal banks
are defined as “large-scale banks that operate extensive networks of branches, provide
many different services, hold several claims on firms (including equity and debt), and
participate directly in the corporate governance of the firms that rely on the banks as
sources of funding or as securities underwriters“(Calomiris, 2000).
A bank can be exposed to moral hazard when the firm obtaining finance uses the
funds for purposes other than those for which finance was advanced. This could lead
to business failure and inability to repay on part of the debtor firm. The bank would
be exposed to adverse selection when it fails to choose the finance applicants who are
most likely to perform.
Obviously, adverse selection can be avoided by careful screening of finance
applicants. When a bank provides equity and debt finance simultaneously, it will have
more access to information than when only debt finance is provided. We can therefore
conclude that screening would be more effective and adverse selection less probable
with universal banking.
Reducing possibilities of moral hazard requires monitoring the firm that obtains
finance. All three kinds of ex ante, interim and ex post monitoring must be exercised
to be effective (Aoki, Masahiko, 1994). Equity finance provides the bank with access
to information necessary to practice monitoring at all intervals. It also reduces the
firm incentives to substitute riskier for safer assets. Meanwhile, debt finance would
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reduce the firm incentives to hide its profits. Furthermore, when the firm faces
problems, the bank, as an equity holder, will assist in order to protect its investment.
In summary, banking theory indicates that universal banking would be exposed to
lower levels of moral hazard and adverse selection. In addition, by sitting on the
firms’ board of directors, banks could influence corporate governance in the whole
productive sector, leading to improvements in economic performance. Empirically, it
has been found that using a combination of debt and equity finance by banks seems to
carry several advantages to both banks and firms, confirming theoretical findings.
Banking theory would indicate that banks would be relatively more exposed to
adverse selection during economic upturns and to moral hazard during downturns.
Applied research has found that universal banks face lower risk than commercial
banks during both upturns and downturns. In addition, the risk differential between
universal and commercial banks gets wider and more significant during downturns
(Dewenter and Hess, 1998).
2.7.4. Finance And Development Given the characteristics of Islamic finance mentioned above, particularly the fact that
Islamic banks operate according to the rules of universal rather than commercial
banking, we can ask which system gives better support to economic development. In
this regard, we can intuitively conclude that the practice of universal banking by
Islamic banks put their financing activities right in the center of the development
process. Bankers in this case become both partners and financiers of entrepreneurial
efforts to develop the economy. Empirical findings seem to confirm such intuition.
Calomiris (2000), through his study of pre-World-War I Germany, has found that
universal banking served to reduce the cost of financing industrialization in Germany
relative to its corresponding level in other countries where commercial banking is
prevalent. He also found that the financial sector reached a higher level of a locative
efficiency in the former than in the latter country. We can therefore rest assured that
banks operating as universal banks give better support to development efforts.
It is widely accepted that economic development requires mobilization of vast
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financial resources both internally and externally. Any financial resources left
hoarded would imply unrealized potential for economic development. As Islamic
teachings emphatically prohibit trading present for future money at a rate of interest,
many Muslims hold their funds outside the banking and financial sector, thereby
missing an opportunity to apply those funds to the development process. Islamic
finance opens the door to the effective use of much needed financial resources within
many Islamic countries that would be otherwise kept idle. In addition, it provides
Muslims with a way through which they can participate in the development process
without exceeding their religious beliefs. Muslim minorities in other countries, whose
banking systems do not provide Islamic financial products, suffer from cultural
exclusion. Some of those Muslims may have to keep their savings outside the
financial system thereby contributing to idle financial resources in their countries.
2.7.5. Integrity Conventional finance can be likened to a spectator’s game where few skilled players
stay in the playground and a big crowd is watching from outside. Islamic finance,
meanwhile, is similar to participatory sports, where everyone is playing and no one is
concerned with mere watching. In addition, there is a moral side to Islamic finance
that seems to be in the back of mind of everyone.
Risk is known to be one of the most important ingredients of making investment.
Those who finance investment share a good part of the risk involved with those who
carry out actual investment activities. Conventional finance leaves risk to be borne by
specialists. Banks and financial institutions provide investors with loans guaranteed
by collateral. In this fashion, they keep themselves apart from certain kinds of risk,
like those attached to production, marketing and distribution, and limit their exposure
to risk related to collateral only.
Islamic finance allows savers who deposit their funds to share with banks the risks
associated with choosing the right investment and how successful it would be. Banks
and financial institutions advancing funds share risk with those receiving finance,
including producers, traders, and the like. Islamic finance with proper corporate
governance allows depositors some influence on banks investment decisions and
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allows banks and financial institutions a share in the decision-making process, by
sitting on the boards of directors of firms receiving funds.
We can therefore notice that risk as well as decision-making is spread over a much
larger number and wider variety of concerned people. Risk sharing is balanced by
sharing in decision-making. This allows for wider involvement in economic activities,
so that people will eventually feel they are partners rather than spectators.
The benefit of wider involvement goes beyond the mere feeling of involvement. It
adds to the stability of banks. Holders of investment deposits with banks share in both
the profits and losses. When a bank faced the unlikely event of an overall loss over
the placement of its investment pool, its depositors shoulder their proportional share
of the loss. Individual banks as well as the banking system as a whole would therefore
be less likely to break down.
2.7.6. Equity Islamic financial institutions must be viewed as basically private profit-seeking
business enterprises that operate according to the market mechanism. By themselves,
they cannot reduce, let alone, eradicate poverty. However, if given the right tools,
they can contribute to the efforts taken by the whole society in that regard.
Islam prescribes a tax-subsidy approach to reducing poverty. A levy called Zakath is
paid out by the wealthy (those whose wealth exceeds a certain minimum level) in
proportion to their property.
Zakath proceeds are to be earmarked for several uses including income and wealth
maintenance for the poor. Income maintenance is provided within narrow limits to
those incapable of work and wealth maintenance is provided to the rest of the poor.
The latter policy entails giving the poor productive assets, which they can use to
produce goods and services and sell them for profit. This method of poverty reduction
can be closely intertwined with that of economic development, as redistribution is
mostly directed towards making the poor more productive, which in turn contributes
to economic development.
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Income maintenance would involve regular (monthly) payments to the needy. Wealth
maintenance, meanwhile, involves transferring to the poor a combination of
productive resources, which would be capable of generating sufficient income to
maintain at least one household.
Zakath collection would be expected to be carried out mostly by nongovernmental
and sometimes by governmental organizations. Islamic banks can help by acting as
custodians and in the disbursement of the proceeds. In addition, non-banking financial
institutions can also take part in collecting Zakath, using Islamic banks as
depositories, and invest the proceeds allocated to the poor in special accounts with
Islamic financial institutions, to which they would also add a proportion of Zakath due
on their shareholders equity. They can even accept direct payments of Zakath and
other donations on behalf of philanthropic institutions.
As to income maintenance, Islamic banks and financial institutions can credit the
accounts of the prescribed poor with monthly payments. Wealth maintenance can be
implemented through the establishment of micro enterprises that would be owned and
operated by the poor. While, the titles to such enterprises are transferred to the poor,
certain measures must be taken to insure that the new businesses would not be
immaturely liquidated to finance consumption outlays for their owners. The
experience of Islamic banking and financial institutions in project financing should
come in handy in eradicating poverty and increasing equity through proper use of
Zakath proceeds.
Conventional lending gives utmost attention to the ability to repay loans. To ascertain
such ability, it depends overwhelmingly on the provisions of collaterals and
guarantees. Thus those already rich would have most access to finance. In contrast,
Islamic finance providing funds on equity or profit-sharing basis would be more
concerned about profitability and rate of return and less concerned about collateral as
the primary consideration. Those who are not wealthy, but have worthy investment
projects, would have more access to finance.
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2.7.7. Sustainability Conventional debt has certain characteristics that could place debtors in difficulties if
circumstances do not allow them to repay in time. Interest is usually calculated on the
outstanding balance of debt, usually compounded annually and sometimes at shorter
intervals. Delinquent debtors are often subjected to penalty rates of interest, which are
higher than regular rates. It is not uncommon to find borrowers who end up paying
debt service that is many folds the original principal they borrowed. This is
particularly symptomatic of developing countries debt, as they continue to face debt
problems that sometimes reach crisis levels. Creditor countries and institutions have
often sought to find ways and mechanisms to provide debt relief to debtor countries.
Despite continuous efforts, the debt problems faced by developing countries seem to
be ever-present.
We can therefore conclude that interest based financing lacks a great deal of
sustainability. Creditors have to stop every few years to give debtors relief in terms of
rescheduling and forgiveness. Sometimes this also includes floating low quality debt
at lower market value and swapping it with equity. The system has demonstrated
unsustainability several times. Unconventional debt created through Islamic finance
has characteristics with which debt crises are less likely to rise. Particularly, the total
value of debt, which includes the spot value of Commodities purchased on credit as
well as an implicit mark-up, is set from the very beginning. The total value of debt
can be repaid in installments, without increase in its total value, as there is no
compounded interest to pay on outstanding balance.
When debtors face unavoidable circumstances that would make them temporarily
insolvent, they are often granted grace periods to help them bring their finances back
to order. No penalty fees can be levied in this case. In other words, debt
rescheduling, when justifiable, would be granted at no extra cost to borrowers.
Therefore, we can conclude that Islamic finance is sustainable and less liable in itself
to cause undue hardship to debtors.
Quite often, conventional debt cannot be repaid because it was not used for its
prescribed purpose. Under the rules of conventional finance, creditors assume that the
use of the loans they extend would strengthen the ability of debtors to meet their
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future obligations. However, conventional loans are usually offered without ways or
mechanisms to assure their use for certain purpose. In contrast, Islamic debt is created
through the finance of acquiring goods and services on credit. In other words, the
loan is used from the very beginning for its prescribed purpose. Default resulting
from improper use of borrowed funds would therefore be most unlikely.
As Islamic finance provided to finance investment is asset-based, i.e., it is used to
acquire real assets; it is much less likely to lead to debt crises. Such type of asset-
based finance, directly contributes to the ability of the economy to meet its internal
and external financial obligations. This is certainly a welcome effect.
2.8. Challenges Facing Islamic Banking 2.8.1. Financial Engineering “Financial engineering”, as the word indicates refers to the art of designing financial
products to meet the needs and tastes of the users with regard to risk, maturity and
yield. Financial markets are becoming more and more sophisticated, and competitive.
In order to exploit the fast changing market environment and face increasing
competition, financial engineering and innovation is imperative. Until now, the
Islamic financial tools have essentially been limited to classical modes developed
centuries ago. They were developed to meet the needs of those societies. While they
may serve as useful guidelines for contemporary Islamic contracts, there is no reason
to be restricted only to those.
In the light of the principles of Maslaha and Istihsan, a “needs approach” to financial
engineering is desirable, of course within the known principles of Islamic finance. In
this regard, the example of bai‘Salam is very important to remember. In general, it is
not allowed to sell anything, which is not in one’s possession. But in case of Salam,
the Prophet (Sal) allowed such sale because of “need” of the people, but laid down
clear rules to protect the interests of both parties. Financial needs of both individuals
and businesses have changed. Engineers in modern finance have designed several new
ways such as mortgages, options, derivatives, hedging, insurance pension plans, credit
cards etc., to meet those needs. We must examine what needs are being fulfilled by
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these instruments. If the needs are genuine (Islamically speaking), then we must either
adapt them for our purposes or invent Islamic alternatives for them.
The process of adaptation is well recognized in Islamic fiqh and has never stopped.
However, its speed needs to be greatly enhanced. Classical contracts have been
modified in a number of cases to meet current needs. One potent example is the
initiation of Islamic banking on the basis of Al-Mudarib Udarib principle, which
provides that a Mudarib (agent) may himself appoint another agent to actually run the
business. Another is the practice of Murabaha, through which the bank buys
merchandize upon the promise of another party to purchase it from the bank at a
higher price.
The principle of Al-Mudarib Udarib essentially allows for sub-contracting. If the
principle is acceptable, there is no reason to restrict it only to Mudarabah. Contracts
can also be designed on the basis of other principles, like Al-Muajjar Uajjir, Al
Mustasna’ Yastasna’, etc. In other words, the original contractee may arrange to fulfill
the obligations under the contract through third parties. That the principle is
acceptable from an Islamic point of view is not questionable.
While it is possible to modify classical contracts to suit modern conditions, a much
broader scope for financial engineering exists in developing new contracts. These
contracts could be hybrids of old contracts or may be entirely new. The scope for
financial engineering, and for that matter for innovations in other fields, is quite wide.
It is important that the task is given over to those experts who know the needs and
niceties of the trade. The final contract may be, say a, Leasalam contract (a
combination of leasing and Salam), an Ijarka contract (a combination of ijarah and
Musharakah) or even an entirely new product.
2.8.2. Some Other Shariah Issues Because of the religious dimension of Islamic banking and finance, no new product
can be adopted until it is cleared by Shariah scholars. Even after a new product is put
into use, Shariah auditing of the operations of financial institutions is very important
to ensure that the actual practice complies with the requirements of Shariah. This is
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important not only for religious reasons but also for purely business considerations
because the clients of Islamic banks will not have confidence in their operations
unless Shariah scholars clear their activities. In this background, the expertise of fiqh
scholars in understanding the pre-requisites of modern financial products and in
evaluating these products becomes very important.
Almost all Islamic banks have their own Shariah boards or Shariah advisers. A survey
of the members of these boards would reveal that hardly any of these scholars have a
formal training in modern finance. They are using a number of ways to acquire the
necessary background information before issuing a fatwa. One way is to discuss an
issue in meetings/ workshops attended by both Shariah scholars and financial experts.
Institutions working in the field of Islamic economics, banking and finance are
playing an active role in organizing such workshops. However, these workshops have
no mandate to issue a fatwa. For that purpose, the meetings of the Fiqh Academies,
the most prominent among which is the OIC Fiqh Academy in Jeddah, play an
important role. Those academies also commission a number of studies by specialized
experts on specific issues before discussing them and taking a decision. In the absence
of the required expertise in the field of finance among Shariah scholars, this approach
of group ijtehad is playing an important role in safeguarding against serious mistakes
in adopting doubtful instruments.
The situation is, however, far from being ideal. As any participant of the workshops
and meetings of the Fiqh Academies can notice that the interaction between Fiqh
scholars and the experts of modern economics and finance does not always proceed
smoothly. They have so different backgrounds and speak such different technical
languages that the communication between them requires special effort. It is,
therefore, quite understandable that the Shariah scholars are cautious in giving their
rulings. The result has been that the fatwa-giving process has become extremely slow
and tends to be over-conservative.
The past record shows that Shariah bodies have done a commendable job in
evaluating the applications of classical contracts. However, when it comes to
evaluating modern financial contracts or Islamic substitutes for them, Shariah bodies
have found it quite difficult to issue verdicts. This is basically due to an acute shortage
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of scholars with dual specialization or at least having working knowledge of modern
finance and Shariah at the same time.
Another important issue relating to the Shariah boards is to determine their exact role.
As mentioned before, questions have been raised about the autonomy and powers of
these boards. “Supervision” by definition implies autonomy and independence in
decision-making. This does not seem to be the case. Furthermore, Shariah boards of
different banks could issue different rulings on similar practices which may raise
doubts in the minds of clients. Minimum Shariah standards for each type of contract
issued by an autonomous body will go a long way to assure customers of the “Shariah
compatibility” of those contracts as well as actual operations. This need becomes
more important in the wake of the entry of several Western banks in Islamic banking.
2.8.3. Teaching, Training, Research and Development Teaching, training and research are the wherewithal for the development of any
discipline. This is more so for a discipline like Islamic banking and finance, which is
still nascent. As mentioned above, there is a serious shortage of scholars who possess
even a working knowledge of both Islamic fiqh and modern economics and finance.
Similarly, many managers of Islamic banks are not very well trained in the use of
Islamic modes of finance. Unfortunately, very little effort has been made to meet
these requirements.
In the area of teaching, some universities in some Muslim countries particularly,
Egypt, Saudi Arabia, Pakistan and Malaysia have initiated some teaching programs to
produce graduates with the dual specialization. However, a close examination of their
curricula would reveal that they are not well designed to achieve this objective. This
may also be confirmed by the fact that the Islamic banks have not been able to find a
reasonable number of suitable managers from the graduates of those universities nor
could anyone of them find a place in the Shariah board of any Islamic bank.
In the area of research, the Islamic banks, neither individually nor as a group spend
enough amount on research and development. Some Islamic banks have small units
for research but very little of this research activity is designed for product
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development. It is, therefore, not surprising that the Islamic banking industry has not
been able to produce enough new financial products. The Islamic universities and the
few research institutions working here and there have not received any substantial
financial assistance from Islamic banks. Another very important component for useful
and scientific research is the availability of authentic information. This has not
received much attention from Islamic banks. There is no consistent data series on the
activities of Islamic banks for a reasonable number of years available anywhere.
In the area of training, a small effort was made in early 1980s by establishing a
training institute in Cyprus. Due to certain reasons, this institute has been closed. The
managers of Islamic banks may have been attending some short-term courses either
on the job or elsewhere but there are not many formal training programs meant to
prepare the employees of the Islamic banks for the needs of the system. Most of the
employees of the Islamic banks, including the managers and financial experts come
from traditional sources lacking necessary expertise in Islamic banking. An institution
is what its employees make it. Therefore, it is extremely important to have the people
with the right kind of skills and commitment.
The future of Islamic banking and finance crucially depends on teaching, training and
research in the desired specialization. There is also a need to arrange short courses for
Shariah scholars in economics and finance and similar courses for economists in
Shariah. The efforts in this area need to be enhanced to several times of current levels.
2.8.4. Lack of Profit Sharing Finance Islamic financial transactions are two kinds. One is based on fixed charge on capital
and the other is based on profit sharing. Both kinds provide finance through the
purchase and sale of real commodities. Conventional financial transactions are based
on lending and borrowing of money for a fixed charge (interest).
Islamic economics specialists built up their hopes on Islamic banks to provide a significant
amount of profit-sharing finance. This would have economic effects similar to direct
investment and produce a strong economic development impact. Theoreticians have provided
some arguments in favor of profit-sharing finance over fixed return-on-capital finance.
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However, in practice, profit-sharing finance has remained negligible in the operations
of Islamic banks. Reasons for this are numerous seen from the perspective of the
Islamic banks and their clients. From the perspective of firms as fund users, it is
important to note that those financial contracts, which do not impose restrictions and
encourage re-investment of earnings in the firm’s growth, are more preferable. The
profit sharing contracts have not been properly adapted to this requirement of firms as
ongoing concerns. From the perspective of the banks, it appears that there are
significantly higher costs of placing funds on profit-sharing basis. The choice of the
right project to finance requires feasibility studies, technical and financial evaluation.
The cost of such effort usually exceeds that of fixed return placements. In addition,
profit-sharing arrangements require follow-up and provision of technical and
sometimes additional financial support to entrepreneurs. In all cases project managers
must have a good accounting system and be subjected to scrupulous auditing.
The Islamic banks can be encouraged to provide more profit-sharing finance, if
arrangements are made to reduce the costs involved by institutional appropriate
arrangements as well as financial engineering consistent with the preferences of fund
users. The benefits of direct investment in terms of economic development may not
always be fully reflected in the rate of return. However, they occur to the society as a
whole. It may, therefore, pay to support the involvement of Islamic banks into profit-
sharing finance through some of the following arrangements.
Take care of the genuine concerns of the clients with regard to their requirements
and preferences for funds,
Undertake entrepreneurial promotion activities by using appropriate incentive
compatible financial arrangements,
Giving tax incentives to companies working on project feasibility studies and their
evaluation,
Giving Islamic banks tax incentives to use the services of investment auditing
companies,
Enforcement of sound accounting practices on small and medium size enterprises,
and
Creating a special department in Central banks through which information of
project feasibility and evaluation can be exchanged in addition to provision of
technical assistance to Islamic banks when needed.
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Banks, under the present circumstances, cannot afford to increase their risk exposure
to any large extent. The emphasis should rather move to a greater reliance of
businesses on equity and smaller reliance on credit. For this purpose attempts should
be made to increase the number of equity institutions such as mutual funds, unit trusts,
etc. Nobody denies that Murabaha and leasing are permissible modes of financing.
They also have some desirable features such as simplicity, convenience and safety.
Under present circumstances, financing modes like Murabaha are indispensable. They
are serving a useful purpose, that of providing investors high liquidity with low risk.
Until proper institutional set up is built and needed products, including those for
managing risk are developed, it may not be advisable to drastically increase the use of
risky modes. However, several problems have been noted in the way Murabaha is
being used. Serious attempts should be made to “cleanse” the “quasi” Murabaha being
practiced by many banks at present of the undesirable features, to make it “genuine”
Murabaha. Islamic banks must ensure that the conditions specified by jurists for the
use of these modes are strictly observed.
However, an overwhelming use of these modes by Islamic banks in the absence of
other Islamic financial institutions has led to some undesirable results for Islamic
finance scene. These include:
2.8.5. Defaulters and the Issue of Compensation and Penalties By using fixed rate modes of financing, the Islamic banks are able to side step the
problems of moral hazard and adverse selection. But precisely because of the same
reason, i.e., use of debt as compared to equity, they land themselves into a serious
problem. Murabaha deals create debt obligations against buyers. Now, while it is
permissible to charge a higher price in credit sales as compared to cash sales, the
wherewithal of Murabaha mode of financing, once the deal has been entered, it
creates a fixed liability. If the buyer defaults on his payment, banks cannot charge
anything extra because that would mean taking riba. Thus, there is a built-in incentive
for immoral buyers to default.
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Islamic jurists have been discussing this problem. It is generally agreed that penalties,
both physical and financial, can be imposed against defaulters but the bank cannot get
any benefit out of these penalties. Many contemporary scholars have argued that the
banks can be compensated because a damage has been caused by the defaulter and
Islam permits, rather encourages compensation of damages. The issue still remains
unresolved.
2.8.6. Illiquidity of Assets Another problem caused by the predominance of debt-based modes of financing is
that it is difficult to transform these financial modes into negotiable financial
instruments. Once a debt has been created, it cannot be transferred to anyone else
except at par value. This renders the whole structure of Islamic financial market as
highly illiquid. This is one of the major obstacles in the development of secondary
markets in Islamic financial instruments. Unless equity-based modes become more
popular or other negotiable instruments are developed, the Islamic financial markets
will remain undeveloped. Some attempts are being made to develop negotiable
instruments based on Ijarah and Salam. However, these have not been used to any
significant extent so far. The major hope for developing Islamic secondary markets
lies in a wider application of equity-based financial instruments and securitization of
some of the existing modes With the exception of Ijarah.
2.8.7. Short-Term Asset Structure Banks everywhere prefer short-term investments. This is so because they work on the
basis of small reserves. They have to have the ability to liquidate their assets fairly
quickly, if the need arises. In the case of Islamic banks, the short-term structure of
their assets is even more pronounced. This also has to do with the predominance of
Murabaha among the modes of finance. Murabaha, a trading practice, by its very
nature is a short-term contract. Even though it is conceivable to design an installment
sale Murabaha contract spreading over many years, the needs for which the Murabaha
contract can “genuinely” be used are, by and large, short term. Therefore, Murabaha
deals entered into by the Islamic banks have been and are going to be largely short
term. Since Murabaha comprises a very large percentage of Islamic banks’
investments, the structure of their assets has also become short-term.
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Is it a problem? There are needs for financial resources on a long-term basis, e.g.,
venture capital. In the conventional framework, these needs are met by the other
financial institutions such as securities markets. For this purpose equities need to be a
major activity in the financial market. The problem assumes a more critical dimension
in view of the fact that in most of the Muslim countries, the major domain of Islamic
banks well developed securities markets do not exist.
It must, however, be emphasized that providing these needs is the responsibility of
the financial system as a whole. It is unfair to expect that Islamic banks should
provide an alternative for all kinds of needs. There is an urgent need to establish other
financial institutions for performing those functions.
The situation is also ripe for establishing equity-based institutions and instruments. As
mentioned in an earlier section, there is now a worldwide trend for establishing equity
institutions such as mutual funds. Savers are now increasingly recognizing the
benefits of profit-based instruments. The appeal of rate-based investment is waning.
Although stock market investments have not become any less risky over the years,
savers are beginning to accept the historical evidence that in any five year period
since World War II, with one exception, stocks have produced higher returns than
bank accounts, bonds or bullion.
There is also an historic opportunity of taking advantage of privatization programs
going on in many Muslim countries. A number of public companies, many with good
track records and bright prospects are being offered to private parties. Islamic banks
and financial institutions can take advantage of this opportunity. It must be noted,
however, that leading Shariah institutions have ruled that it is not permissible to take
equity stake in companies which deal in interest even in small proportions. While this
rightly reflects the serious concern that Muslims must garner against the use of
interest, it puts a serious constraint on placement of funds. It closes an important
market to Islamic banks and also exposes many big corporations in Muslim countries
to foreign ownership. The matter needs serious consideration with a view to find an
acceptable solution on the basis of a common need.
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2.8.8. Mobilization of Deposits and Indigenizing Placement of Funds As mentioned above, Islamic banks have shown tremendous success in mobilizing
deposits in the past. However, it will require much more strenuous efforts to maintain
even a relatively modest rate of growth in the future. It must be realized that much of
the deposits now with the Islamic banks came not due to the attraction of higher
returns but because of the religious commitment of the clients. Many of them were
keeping their savings in conventional banks without taking any interest and many
others were keeping them “under their pillows”. For all such persons, a modest return
or even no return from Islamic banks was acceptable. Now, most of this money has
already found its way into the coffers of Islamic banks.
As conventional banking and financial institutions apply their vast experience to
establishing financial instruments that conform to Islamic modes, Muslim savers will
continue to find alternatives to depositing their cash in Islamic banks at lower rates of
return. Competition from other institutions is gradually introducing new realities to
the Islamic banking industry. Therefore, it is reasonable to assume that the rate of
growth of deposits of the Islamic banks will be much lower unless they are able to
attract deposits on competitive basis and from new sources. As a matter of fact, this is
already happening. A recent study shows that the rate of growth of deposits in major
Islamic banks has slowed down in the nineties.
This has serious implications for the profitability of Islamic banks. Deposits constitute
a very important source of investible funds. The data for the Islamic banks in our
sample show that deposits are 15 times the owners’ capital.
While Islamic banks and investment funds have so far mobilized huge financial
resources, a large part of these resources have found its way into Western financial
markets. Likewise, the same thing happened with resources mobilized with
conventional banks. There is no Islamic (or for that matter, conventional indigenous)
financial institution which has been able to channel savings from Western countries
into Muslim countries in spite of the great demand for such resources in the latter
countries. This is another challenge for Islamic banks with very important
implications for Muslim countries.
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2.8.9. Competition So far, Islamic banks had a fairly large degree of ‘monopoly’ over the financial
resources of Islamically motivated clients. This situation is changing fast. Islamic
banks are now facing ever increasing competition. An important development in
Islamic banking in the last few years has been the entry of some conventional banks
in that market. Although, it is difficult to know with certainty how many conventional
banks around the globe practice Islamic banking techniques, even a randomly selected
short list may contain some of the giants of international banking business such as
Chase Manhattan, Citibank, ANZ Grind lays, Kleinwort Benson along with others
such as Union Bank of Switzerland, Girozentale of Australia, the ABC International.
In addition to these, in many Muslim countries, several commercial banks are offering
Islamic banking services. Bank Misr in Egypt and National Commercial Bank in
Saudi Arabia have opened Islamic Branches. In Malaysia, commercial banks have
been permitted to open Islamic banking windows.
While this development is recognition of the viability of Islamic banking, does it
augur well for the future of Islamic banking? The answer may not be very simple. In
general, competition is supposed to be good for the growth of any industry. It forces
inefficient firms to either shape up or ship out. It reduces the costs and improves
services to consumers. It promotes innovation and brings improvements in product
quality.
There is one exception to this rule. This is the well-known infant-industry argument
which states that small firms in their infancy may be protected from harsh, ruthless
competition until they can stand on their feet and be able to face competition from
their bigger counterparts. One may argue that Islamic banks may well deserve that
treatment. Conventional banks, particularly western banks have a large advantage
over Islamic banks in terms of their experience and long standing in the market. Their
systems, procedures, techniques of product innovations, marketing strategies,
diversification in portfolio, are much superior to those of Islamic banks. This exposes
Islamic banks to an unequal competition. On the other hand, it may be argued that
such competition may be good for Islamic banking as western banks may bring their
efficiency, market research and innovative capabilities, sophisticated banking and
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result oriented approach to Islamic banking which may lead to the development of
new products and provision of better services to consumers.
While it may be difficult to settle the point on theoretical grounds, the stark reality is
that even if one could invoke infant industry entitlements for Islamic banks, there is
no institutional arrangement to put those in operation. Infant industry benefits are
usually offered by governments in terms of tax concessions or provision of subsidies.
No such possibility exists at present. Therefore, the survival of Islamic banks
essentially depends on their own efficiency. As mentioned earlier, at present more
than 85 percent of Islamic banking in the corporate sector is concentrated in the hands
of Islamic banks of GCC origin. This is going to be at stake in the near future due to
competition from West-based multinational banks. Indigenous banks of Muslim
countries will have to increase their efficiency substantially in order to keep a
reasonable share of the market.
There are some other genuine concerns about the entry of large multinational banks
into Islamic banking market. Naturally, their motives are purely commercial. They
view it as a lucrative business opportunity. That is fair enough. However, serious
doubts have been expressed as to whether they are following the rules of the game. It
is apprehended that conventional banks may not follow correctly and faithfully the
percepts of Islamic banking. In all major Islamic banks, there is a Shariah board
which regularly reviews the operations and contracts of the bank to determine their
compliance with the requirements of the Shariah. Similar arrangements do not exist at
the conventional Western banks in most cases. It is also suspected that conventional
banks may not be able to keep fully separate accounts for their Islamic banking
operations. In the event they do mix “Islamic money” with their general pool of
investible resources or they do not keep separate accounts for Islamic banking
activities, there is a strong possibility that permissible (Halal) returns may be
‘contaminated’ by riba.
There may be a silver lining, however. Even under competitive conditions, there is
room for product differentiation. It is well known that the bulk of deposits of Islamic
banks come from individuals with strong commitment to religious principles. Serious
concerns have been expressed with respect to “Shariah compatibility” of certain
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practices of Islamic banks. The entry of Western banks in the market has increased
those concerns. Under these circumstances, Islamic banks are in a better position to
allay those fears by paying attention to criticisms of some of current practices in
Islamic banking. Practice of “genuine” risk sharing and increasing the use of more
variable return modes will “differentiate” their products and hence will enable them to
keep a niche of the market.
2.8.10. Globalization The competition from conventional banks is expected to increase further in the near
future due to globalization. Globalization refers to “growing economic
interdependence of countries worldwide through the increasing volume and variety of
cross border transactions in goods and services and of international capital flows and
also through the more rapid and widespread diffusion of technology”. Due to
liberalization, the world markets are rapidly converging into a single market place.
This poses opportunities as well as challenges for Islamic banks. On the one hand, it
will allow more portfolio diversification and hence reduce the risk in profit sharing
modes. This will open up opportunities for Islamic banks to increase the use of such
modes. It is also expected that Islamic banks may be allowed to open more and more
branches in non-Muslim countries. The possibilities of further deposit mobilization by
Islamic banks are the greatest in this area, especially in the Muslim communities of
these countries. On the other hand, they should also be prepared for more intense
competition from foreign banks. To benefit from the opportunities offered by
globalization, the Islamic banks need to improve the quality of their services and
develop suitable products. Once again, customers will be the ultimate benefactors.
Technological innovations have played a more important part in financial integration
and globalization. Electronic banking and widespread use of computers in banking
has transformed the way banking was done. It has prompted the large scale banking
corporation to step in, as the application of modern technology requires more
resources. Mergers are already producing in Western countries mega banking and
financial establishments. Globalization of financial markets has led to more and more
integration of capital markets. Liberalization of foreign exchange markets has further
reinforced this trend. The paper currency is being replaced with plastic cards and
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electronic records have replaced accounts books. The communication revolutions
through faxes, telexes, emails, have reduced the cost of international communication.
Now, the saving of one country can be invested in other countries by the click of a
mouse. Customers in many countries can now “navigate” on the internet between
competing banks, unit trusts, mutual funds and even business firms.
What is this entire means for Islamic banking? Shall it help Islamic banks or harm
them? It may be difficult to venture out a definite answer to these questions but it may
not be too adventurous to put on record some initial conjectures:
Islamic banks are too small to benefit from, or even participate effectively in the
process of globalization. They cannot play any significant role because of their
small size. This reinforces our earlier suggestion that they should consider
mergers or at least establish joint ventures.
Under the right conditions, internationalization of financial markets can benefit
Islamic banking. Most importantly, Islamic countries need to improve their
investment climate, develop their financial markets and reform their economies.
This would enable Islamic financial institutions to channel domestic as well as
foreign savings into Muslim countries to meet the great demand for such resources
in those countries.
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Chapter Three RESEARCH METHODOLOGY
3.1. Introduction
This chapter contains the methodology that is used by the researcher. Data have been
collected from various sources for this particular research. Thos chapter describes
sample of the study, method of data collection, and data analysis methods.
3.2. The Sample To Be Used By The Researcher
The study includes two Islamic and two conventional banks. The two Islamic banks
are: Amana Investment Ltd, Ceylinco Islamic Investment Corporation (CIIC) Ltd.
The two conventional banks are Haton National Bank Limited (HNB) and Peoples
Bank. These Islamic banks were established after introduction of conventional
banking and which are facing major competition in Sri Lankan banking industry as
well insurance. So we assume that the officers of these banks and their customers
know and understand the similarities and differences in the banking practices of
Islamic banks and conventional banks.
Data of this study was collected from both primary and secondary sources. Set of
questionnaire were used in the interview survey, among the customers and
professionals of selected Islamic and conventional banks in Sri Lanka. A purposive
random sampling was used in the survey. One hundred (100) customers were
interviewed to record their opinions about some apparent similarities between Islamic
and conventional banks.
3.3. Types of Data Data in lots of places in The Knowledge Base, but here I just want to make a
fundamental distinction between two types of data: qualitative and quantitative. The
way we typically define them, we call data 'quantitative' if it is in numerical form and
'qualitative' if it is not. Notice that qualitative data could be much more than just
words or text. Photographs, videos, sound recordings and so on, can be considered
qualitative data.
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The distinction between qualitative and quantitative data to have some utility, I think
most people draw too hard a distinction, and that can lead to all sorts of confusion. In
some areas of social research, the qualitative-quantitative distinction has led to
protracted arguments with the proponents of each arguing the superiority of their kind
of data over the other. The quantitative types argue that their data is 'hard', 'rigorous',
'credible', and 'scientific'. The qualitative proponents counter that their data is
'sensitive', 'nuanced', 'detailed', and 'contextual'.
For my research purpose I will use both qualitative data and quantitative data. These
data is collected as follows.
3.4. Methods of data collection The relevant and related data for this research have been collected mainly from two
sources as follows.
Primary data
Secondary data
3.4.1. Primary Data Collection Primary data collection is necessary when a researcher cannot find the data needed in
secondary sources. Market researchers are interested in primary data about
demographic/socioeconomic characteristics, attitudes/opinions/interests,
awareness/knowledge, intentions, motivation, and behavior. Three basic means of
obtaining primary data are observation, surveys, and experiments. The choice will be
influenced by the nature of the problem and by the availability of time and money.
3.4.1.1. Primary Data Collection Methods
Under this section, I am going to explain the primary data collection methods of the
study and the way of analyzing method.
In primary data collection, the data using methods such as interviews and
questionnaires. The key point here is that the data I collect is unique to my research
and, until I publish, no one else has access to it. There are many methods of collecting
primary data and the main methods include:
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Questionnaires
Interviews
Focus group interviews
Observation
Case-studies
Diaries
Critical incidents
Portfolios
A. Questionnaires
Questionnaires are a popular means of collecting data, but are difficult to design and
often require many rewrites before an acceptable questionnaire is produced.
Types of questions
a. Closed questions
A question is asked and then a number of possible answers are provided for the
respondent. The respondent selects the answer which is appropriate. Closed questions
are particularly useful in obtaining factual information:
b. Attitude questions
Frequently questions are asked to find out the respondents’ opinions or attitudes to a
given situation. A Likert scale provides a battery of attitude statements. The
respondent then says how much they agree or disagree with each one:
c. Open questions
An open question such as ‘What are the essential skills a manager should possess?’
should be used as an adjunct to the main theme of the questionnaire and could allow
the respondent to elaborate upon an earlier more specific question. Open questions
inserted at the end of major sections, or at the end of the questionnaire, can act as
safety valves, and possibly offer additional information. However, they should not be
used to introduce a section since there is a high risk of influencing later responses.
The main problem of open questions is that many different answers have to be
summarized and possibly coded.
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The primary data, which is generated by the above methods, may be qualitative in
nature (usually in the form of words) or quantitative (usually in the form of numbers
or where you can make counts of words used). I briefly outline these methods but you
should also read around the various methods.
Data of the study was collected from primary sources. A purposive random sampling
was used to collect data on a series of questions regarding Islamic banking practices
and interview. The sets of approved questionnaire were used in the survey, and
through interview method, among the customers and bankers of selected Islamic and
conventional banks in Sri Lanka.
The final sample consists of customers and professionals in Islamic and conventional
banking field. As such, 100 Muslim customers and professionals were interviewed to
record their opinions about some apparent similarities between Islamic and
conventional banks. Findings of the study were consulted with the available literature
and executives of the banks to confirm their reliability and acceptability.
B. Interviews
Interviewing is a technique that is primarily used to gain an understanding of the
underlying reasons and motivations for people’s attitudes, preferences or behaviour.
Interviews can be undertaken on a personal one-to-one basis or in a group. They can
be conducted at work, at home, in the street or in a shopping centre, or some other
agreed location.
Types of interview
a. Structured:
Based on a carefully worded interview schedule.
Frequently require short answers with the answers being ticked off.
Useful when there are a lot of questions which are not particularly contentious
or thought provoking.
Respondent may become irritated by having to give over-simplified answers.
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b. Semi-structured
The interview is focused by asking certain questions but with scope for the respondent
to express him or herself at length.
c. Unstructured
This also called an in-depth interview. The interviewer begins by asking a general
question. The interviewer then encourages the respondent to talk freely. The
interviewer uses an unstructured format, the subsequent direction of the interview
being determined by the respondent’s initial reply. The interviewer then probes for
elaboration – ‘Why do you say that?’ or, ‘That’s interesting, tell me more’ or, ‘would
you like to add anything else?’ being typical probes.
Conducting an interview:
I. Personally – Arrive on time be smart smile employ good manners
find a balance between friendliness and objectivity.
II. At the start – Introduce yourself re-confirm the purpose assure
confidentiality – if relevant specify what will happen to
the data.
III. The questions – Speak slowly in a soft, yet audible tone of voice
control your body language knows the questions and
topic ask all the questions.
IV. Responses – recorded as you go on questionnaire written verbatim,
but slow and time-consuming summarized by you
taped – agree beforehand – have alternative method if
not acceptable consider effect on respondent’s answers
proper equipment in good working order sufficient
tapes and batteries minimum of background noise.
V. At the end – Ask if the respondent would like to give further details
about anything or any questions about the research
thank them.
d. Telephone interview
This is an alternative form of interview to the personal, face-to-face interview.
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This dissertation is to the larger part based on primary data. The primary data also has
been collected through a personal interview with professionals regarding Islamic
Banking, such as Prof Dr. Mohamed Asmi Omer, International Islamic University
Malaysia. The interview took place at the Auditorium, South Eastern University of
Sri Lanka, Oluvil, on July 10th, 2009.
3.4.2. Secondary data collection All methods of data collection can supply quantitative data (numbers, statistics or
financial) or qualitative data (usually words or text). Quantitative data may often be
presented in tabular or graphical form. Secondary data is data that has already been
collected by someone else for a different purpose to yours. For example, this could
mean using:
Data collected by a hotel on its customers through its guest history system
Data supplied by a marketing organization
Annual company reports
Government statistics.
Trade associations
Trade and other journals
Private research publishers
Stock broking firms
Large company market reports
Local authorities
Professional bodies
Academic institutions.
Secondary data can be used in different ways:
You can simply report the data in its original format. If so, then it is most likely that
the place for this data will be in your main introduction or literature review as support
or evidence for your argument.
You can do something with the data. If you use it (analyze it or re-interpret it) for a
different purpose to the original then the most likely place would be in the ‘Analysis
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of findings’ section of your dissertation. In this way, data that had been collected for
quite a different purpose and used it in his own study – but to do a lot of comparisons
and statistical correlations in order to analyze the data. (See Haralambos, 1995, for
details of Durkheim’s work).
Most research requires the collection of primary data (data that you collect at first
hand), and this is what students concentrate on. Unfortunately, many dissertations do
not include secondary data in their findings section although it is perfectly acceptable
to do so, providing you have analyzed it. It is always a good idea to use data collected
by someone else if it exists – it may be on a much larger scale than you could hope to
collect and could contribute to your findings considerably.
As secondary data has been collected for a different purpose to yours, you should treat
it with care. The basic questions you should ask are:
Where has the data come from?
Does it cover the correct geographical location?
Is it current (not too out of date)?
If you are going to combine with other data are the data the same (for
example, units, time, etc.)?
If you are going to compare with other data are you comparing like with like?
Thus you should make a detailed examination of the following:
Title (for example, the time period that the data refers to and the geographical
coverage).
Units of the data.
Source (some secondary data is already secondary data).
Column and row headings, if presented in tabular form.
Definitions and abbreviations, for example, what does SIC stand for? For
example, how is ‘small’ defined in the phrase ‘small hotel’? Is ‘small’ based
on the number of rooms, value of sales, number of employees, profit, turnover,
square meters of space, etc., and do different sources use the word ‘small’ in
different ways? Even if the same unit of measurement is used, there still could
be problems.
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There are many sources of data and most people tend to underestimate the number of
sources and the amount of data within each of these sources.
Sources can be classified as:
Paper-based sources – books, journals, periodicals, abstracts, indexes,
directories, research reports, conference papers, market reports, annual reports,
internal records of organizations, newspapers and magazines
Electronic sources– CD-ROMs, on-line databases, Internet, videos and
broadcasts.
The main sources of qualitative and quantitative secondary data include the
following:
Official or government sources.
Unofficial or general business sources.
The output of all publishers of non-official sources is included in the most
comprehensive directory available:
Mort D. (1997) Sources of Unofficial UK Statistics 3rd Edition Aldershot: Gower
The guide lists 1,059 statistical titles and series published by 635 different
organizations. It excludes one-off surveys or market reports.
The arrangement is alphabetical by organization with details of titles produced and
contacts for further information.
Secondary data has been collected from several sources. Relevant literature has been
gathered from a number of libraries. Extensive data has only been collected through
various different databases, websites and articles. To receive objective information
works by different authors and organizations have been used. Since I have mainly
used secondary data, most of which is written in English, in my dissertation I have
chosen to shortly present those authors most used in my work.
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Chapter Four DATA PRESENTATION AND ANALYSIS
4.1. Introduction This chapter is dealing with presenting and analyzing the data that are collected from
both interview and questioner.
4.2. Analysis of Questionnaire This research purpose I have used closed ended question. The collected questionnaires
are analyzed using SPSS 10 Software package and presented using tables and chards.
Question One:
Table: 4. 1
It is observed from the survey that an overwhelming group of the customers are
businessmen. They total 45 per cent of the sample. The remaining groups are: service
holders (33 per cent), self-employed (10 per cent), housewives (5 per cent) and others
(7 per cent) (Table: 4.1).
These data shown in the following Pie cart
Others
Housew ife
Self Employed
Businessman
Service holder
Figure: 4.1
Composition of the Customers by Profession
13 13.058 58.015 15.07 7.07 7.0
100 100.0
Service holderBusinessman Self Employed Housewife Others Total
Frequency Percent
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Question Two;
Table: 4. 2
The 56 per cent sample consists of customers in the age group 20-29 years, 21 per
cent in the age group 30-39, 20 per cent in the age group 40-49 (Table: 4.2),
These data shown in the following Pie cart
AGE
35-60
20-35
Figure: 4.2
Question Three;
Table: 4. 3
The 89% of them are male and 11% are female (Table: 4.3).
These data shown in the following Pie cart Female
Male
Figure: 4.3
Composition of the Sex of the Customers
89 89.011 11.0
100 100.0
Male FemaleTotal
Frequency Percent
Age of customer
56 56.021 21.020 20.03 3.0
100 100.0
20-2930-3940-4950-69Total
Frequency Percent
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Question Four;
Table: 4. 4
The education level is dominated by the under graduate degree (43%) followed by the
graduates (28%) the postgraduate degree (8%), and others (21%) (Table: 4.4). It
seems that the qualities of the respondent customers are unique in the perspective of
generally understood social fabrics of Sri Lanka.
These data shown in the following Pie cart;
Figure: 4.4
Question Five;
Table: 4. 5
The 66 per cent sample consists of customers are keeping their money in saving account and 34per cent in fixed deposit. (Table: 4.5), These data shown in the following Pie cart
Figure: 4.5
Type of Account keeping by the customer
66 66.034 34.0
100 100.0
SavingFixed DepositTotal
Frequency Percent
Composition of Education Level of the Customers
43 43.028 28.08 8.0
21 21.0100 100.0
Under Graduate Graduate Post GraduateOtherTotal
Frequency Percent
Other
Post Graduate
Graduate
Under Graduate
Fixed Deposit
Saving
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Question Six;
Table: 4. 6
The 84 per cent sample consists of customers are expecting profit and 16 per cent are interest from their money. (Table: 4.6), These data shown in the following Pie cart;
Figure: 4.6 Question Seven;
Table: 4. 7
Regarding the essence of the profit and loss sharing system of Islamic finance, Table:
4.7 shows that the customers are more aware. 39 per cent of them believe that Islamic
finances aim at both profit and losses. Most customers (45%) believe that Islam
permits profit and forbids riba. The opinions vary due to the fact that the Islamic
bankers get formal training on Islamic Economics and Banking and the conventional
bankers are aware due to their professional consciousness. However, the customers
are conscious about the relation of profit, in lieu of interest, to Islamic finance. It is
the outcome of launching Islamic banking in the country. The basis of such
observation is that 08% of the customers believe that Islamic finance always mean for
investment in real assets, while 8% of them have mentioned that Islamic finance
cannot earn riba in anyway.
Profit and Loss Sharing System is the Essence of Islamic Finance
39 39.045 45.08 8.08 8.0
100 100.0
Islamic finance aims at both profit and losses.Islam permits profit and forbids riba.Islamic finance cannot earn riba in any way.Islamic finance is always meant for investment.Total
Frequency Percent
Customer Expectation
16 16.084 84.0
100 100.0
InterestProfitTotal
Frequency Percent
Profit
Interest
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These data shown in the following Pie cart;
Islamic f inance is a
Islamic f inance cann
Islam permits profit
Islamic f inance aims
Figure: 4.7 Question Eight;
Table: 4. 8
A majority (67%) of the customers (Table: 4.8) view that Zakath has been mobilized
through the Islamic banking system. 15 per cent of the respondents have mentioned
that welfare activities are organized through the Islamic banking system, Again, 10%
of respondents view the concept of Halal and Haram is introduced in the case of
investment, buying and selling, while of them (8%) mention that mobilization of
financial resources to the real sector of the economy is well introduced. This indicates
that the life and society of Sri Lanka have benefited from Islamic banking, which
further justifies a separate role of the Islamic Banking system in the economy of Sri
Lanka.
These data shown in the following Pie cart;
New products of bank
Mobilization of Fina
The concept of Halal
Welfare activities a
Zakat Fund has been
Figure: 4.8
Benefits Accrued to the Society from Islamic Banking
67 67.015 15.0
10 10.0
8 8.0
100 100.0
Zakat Fund has been mobilized through banking system.Welfare activities are organized through banking systemThe concept of Halal and Haram in case of investment/buying andselling has been introduced.Mobilization of Financial resourcesto the real sector of the economyhas been introduced Total
Frequency Percent
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Question nine;
Table: 4. 9
The next question is: what is the basis of the development of Islamic banking system
in Sri Lanka. 54% of customers (Table: 4.9) think that this is due to ‘mere faith in
Islam’ of the overwhelming Muslims (8%) of the country. In contrast, 20% of them
believe that the ‘intention to earn profit’ is the basis of development of Islamic
banking system. However, 12% of the customers have the opinion that the ‘tendency
to avoid interest’ is the basis. Such discrepancy is again observed: when 5% of the
customers said that ‘to do welfare of the economy’ is the basis. 9% of customers agree
that the basis is ‘to ensure justice in the financial transactions.
These data shown in the following Pie cart;
To contribute to the
To ensure justice in
To avoid interest;
Intention to earn pr
Mere faith in Islam;
Figure: 4.9 It follows that the item 'to avoid interest' as a basis of development of Islamic banking
system has not drawn the attention of the majority of the respondents. Why does it
happen so? Do they believe that Islamic banks have opened the back door for
continuation of transactions like interest-based banks?
Basis of Development of Islamic Banking
54 54.020 20.012 12.09 9.05 5.0
100 100.0
Mere faith in Islam;Intention to earn profit; To avoid interest; To ensure justice in the financial transactions;To contribute to the welfare of the economyTotal
Frequency Percent
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Question Ten;
Table: 4. 10
In fact, all respondents believe so (Table: 4.10). They have mentioned several causes
for opening such a back door. The major cause, according to the 73% of the
customers is that the trading and the rental modes of investments of Islamic banks do
not differ much from the transactions of interest-based banks. The agreement of
payment of installment in due time and the extra payment for excess time of
repayment of an investment under the trading and rental mode create the same
financial burden to an investment customer. Besides, other arrangements (mortgage,
security, registration etc.) for getting an investment loan from Islamic banks are the
same as those of conventional banks.
On the other hand, 7% of the respondents view that the degree of risk in the present system of
Islamic banking is not enough to justify this sort of banking. It is followed by 10% of the
respondents, who views that Islamic banks are working along with the interest-based banks.
The 10% of them believes that the products of present Islamic banks serve the purpose of
interest-based banks.
These data shown in the following Pie cart;
Islamic banks are w o
Risk-sharing in curr
Products of present
Trading and Rental b
Figure: 4.10
Causes of Continuation of Interest-based Transaction through Back Door by Islamic Banking System
73 73.0
10 10.0
7 7.0
10 10.0100 100.0
Trading and Rental based modes of investment do not differmuch from the interest-based transactions.Products of present Islamic Banking are similar to those ofinterest-based banking system.Risk-sharing in current practices of Islamic Banking is notproportional to its profiteering.Islamic banks are working along with the interest-based bankTotal
Frequency Percent
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Question eleven;
Table: 4. 11
In response to the question: what are the causes of crept of interest into the Islamic
banking system, 58% of respondents replied that exploitation is going on through
Islamic banking (Table: 4.11). Alternatively, 18% mentioned causes: the products of
Islamic banks have failed to remove the curse of interest-based banking; and 10%
mentioned causes the bankers lead the Islamic-banking system to the garb of interest.
14 per cent believe that Islamic banking is introduced in a society, which is not
reorganized on Islam. It seems that the customers are concerned about the interest
factor, which tends to make both Islamic and conventional banks similar.
These data shown in the following Pie cart;
Islamic system of Ba
Banking professional
Products of Islamic
Exploitation is goin
Figure: 4.11
Causes of Interest Creeping into the Islamic Banking System
58 58.0
18 18.0
10 10.0
14 14.0
100 100.0
Exploitation is going on through Islamic system of bankingProducts of Islamic Banking have failed to remove to removethe curse of interest from financial transactions.Banking professionals have led Islamic system of Banking tothe garb of interest based bankingIslamic system of Banking was introduced in a society, whichwas not re-organized on Islamic ideology.Total
Frequency Percent
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Question twelve;
Table: 4. 12
The question is what are the reasons for which the Islamic banks do not operate in
true spirit of Islamic Shariah? In response, the majority 49% think that the status of
the Shariah Council/Department is advisory, not supervisory in the system of Islamic
banking. While (30%) of the respondents have mentioned that only the level of profit
earning cannot be the success criterion for an Islamic bank, when Islamic banks are
registered as a schedule commercial bank with a view to earning profit., A
respondents (12%) believes that exploitation still remains in the Islamic banking
system. a minority of respondents 10% has the opinion that Islamic banks do not
ensure justice and welfare in financial transactions.
These data shown in the following Pie cart;
Exploitation still r
Justice and w elfare
Earning of profit ca
The status of Shari[
Figure: 4.12
Present Success of Islamic Banks is not in Conformity with Shariah
49 49.0
30 30.0
10 10.0
11 11.0100 100.0
The status of Shari[ah Council/Department is advisory, notsupervisory in the system Islamic BankingEarning of profit cannot be the success criterionJustice and welfare in financial transactions are not ensureIslamic BanksExploitation still remains in Islamic banking systemTotal
Frequency Percent
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Question thirteen;
Table: 4. 13
As a result, many Muslim businessmen and industrialists do not really patronize the
Islamic banks. About 75% believe that the potential patrons do not find any business
difference between Islamic and conventional banks (Table: 4.13). The other two
causes identified (21%) are: (i) lack of consciousness of the patrons, and (ii)
confusion about Islamic banking. Minorities of respondents (4%) believe that people
are not properly motivated to Islamic Banking.
These data shown in the following Pie cart;
They are not motivat
Confused about Islam
Not conscious about
They do not f ind any
Figure: 4.13
Causes of Not Patronizing the Islamic Banks by Rich and Prominent Muslim Businessmen and Industrialists
75 75.0
10 10.011 11.04 4.0
100 100.0
They do not find any real business differences between Islamand conventional banking Not conscious about Islamic banking.Confused about Islamic BankingThey are not motivated to I-BankingTotal
Frequency Percent
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Question fourteen;
Table: 4. 14
The risk factor of business came into consideration. This factor is always considered
for generating profit in any business. However, it is observed (Table: 4.14) that the
respondents opine that most of the Islamic modes of investment practiced by Islamic
banks do not practically share risk for many reasons. While a majority of them (70%)
believe that the insurance company covers risks, 16% said that Islamic banks do not
buy practically for a sale. 9 per cent observe that buying and selling arrangements of
Islamic banks are almost risk-free. Only 5% of the respondents believe that Islamic
banks do business with depositors' money. Therefore, if there is any risk, it is borne
by the depositors. It seems that the respondents are conscious about the relation of
risk factor with Islamic banking. These data shown in the following Pie cart;
Islamic banks do bus
Buying and Selling a
Islamic Banks do not
The Insurance Compan
Figure: 4.14
Proportionally
70 70.016 16.0
9 9.0
5 5.0
100 100.0
The Insurance Company covers risks of Islamic banks' loansIslamic Banks do not always buy for sale.Buying and Selling arrangements by Islamic banks are almostrisk-free. Islamic banks do business with depositors money and sharerisk Total
Frequency Percent
Most of Investment Financing Techniques by Islamic Banks do Not Share Risk
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Question fifteen;
Table: 4. 15
Further, the respondents confirm that many customers are not interested in dealing
with Islamic banks because they feel that only the title name of the banks has been
changed and interest in a real sense has not been eliminated. Table 15 shows some
causes behind these feelings. For example, many respondents (72%) feel that mark-up
profit has created a financial burden like the interest burden of conventional banks.
Other reasons are: (i) repayment of the bank’s money by installment (11%), and (ii) a
failure of payment of installment create additional liability (11%). A few of them
(6%) opine that Islamic banks, in most of the cases, do not consider business losses of
the entrepreneur for adjusting repayments. These data shown in the following Pie cart;
The Islamic Banks in
Failure of installme
Customers are requir
Mark-up profit makes
Figure: 4.15
Possibility of reduction in the value of deposits through losses suffered by bank is a
feature of Islamic banking system, but it may be harmful for deposit mobilization.
With this view in mind, the respondents were asked: do they believe that the condition
of deposit loss is not harmful for deposit mobilization? I received the response that
possibility of loss is not detrimental to deposit mobilization.
Many Customers are not interested in Dealing with Islamic Banks as they feel that only theName has been Changed and Interest in Real Sense has not been eliminated
72 72.0
11 11.0
11 11.0
6 6.0
100 100.0
Mark-up profit makes customers liable for additional paymentwhich is same as that of conventional bank’s fixedinterest-based loan. Customers are required to repay banks money on installmentbasis Failure of installment payment creates additional liabilityThe Islamic Banks in most cases do not consider businessloss Total
Frequency Percent
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Question sixteen;
Table: 4. 16
The respondents believe that the profit and loss sharing system of banking cannot
ultimately make a loss of deposit. This opinion is expressed (Table: 4.16) by 56% of
respondents. However, 16% of respondents believe that it is an actual element of
investment, which makes the profit on the Islamic bank’s deposit Halal (legitimate)
therefore acceptable. 15 per cent of respondents think that the condition of a deposit
loss is insignificant to a true Muslim, who expects a garden in the heaven in the life
hereafter. This implies that the respondents have expressed their strong feelings in
favor of Islamic banking. While others (13%) view that the condition of deposit loss
does not mean total loss of deposit.
These data shown in the following Pie cart;
It does not mean tot
A true Muslim is not
It is realized profi
PLS system of bankin
Figure: 4.16
Possibility of Loss of Deposit is not Detrimental to Deposit Mobilization
56 56.0
16 16.0
15 15.0
13 13.0100 100.0
PLS system of banking does not lead to loss of value of depositultimately. It is realized profit of investment which makes return on on bankdeposit Halal.A true Muslim is not concerned about deposit loss, because heexpects Haven in the life hereafter.It does not mean total loss of deposit.Total
Frequency Percent
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Question Seventeen;
Table: 4. 17
Regarding the present modes of investment practiced by Islamic banks both bankers
and customers believe that it is compromised with the interest factor of conventional
banks. For example, according to the respondents, bay-Murabaha and bay-muajjal
modes of investment are compromised with the Pledge and Hypothecation techniques
of interest–bearing banking. It is observed that 71% believe that finance under both
systems of banking gave the same effect on business results. The remaining 29% view
that both banks are (i) justice (adl) and welfare (ihsan)-free, (ii) working side by side,
and (iii) working in the same value loaded society (Table: 4.17).
These data shown in the following Pie cart;
Both are w orking in
Both are w orking sid
Both are justice ([a
Both gives same effe
Figure: 4.17
Present Modes of investment of Islamic Banks are Compromised Modes of Financing withInterest.
71 71.011 11.09 9.09 9.0
100 100.0
Both gives same effect on business resultsBoth are justice ([adl) and Welfare (ihsan) free.Both are working side by side.Both are working in the same value loaded society.Total
Frequency Percent
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Question Eighteen;
Table: 4. 18
Finally, a last question was asked about how to get free of that situation. They quest
for governmental reformation measures for moral building and eradication of false
values of life, which would pave the way for Islamic baking. They have also
mentioned several causes to support their opinions (Table: 4.18). A majority of them
(65%) feel that Islamic banks cannot work well in an immoral society. While 14%
have mentioned that governmental power can change social values, 11% believe that
governmental reformation measures are powerful to build a moral society. About 10%
of them have expressed that false values of life give a detrimental environment to
Islamic banking. This indicates that the bankers and customers hold a very strong
opinion in favor of governmental measures for reformation.
These data shown in the following Pie cart;
Governmental reforma
Governmental pow er c
False values of life
Islamic banks cannot
Figure: 4.18
The above analysis of the misleading similarities between Islamic and conventional
banks, along with the understandings, values and attitudes of the customers about the
Islamic banking system, indicates the degree of commitments to Islamic banks in Sri
Lanka.
Moral Uplifting of the Society Will Pave the Way for Islamic Banking
65 65.0
10 10.0
14 14.0
11 11.0
100 100.0
Islamic banks cannot work well in an immoral society.False values of life give detrimental environment to IslamicBanking.Governmental power can change the social valuesGovernmental reformation measures are powerful to build amoral society. Total
Frequency Percent
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4.3. Question and Answers in the course of Interview Before the first Islamic bank was established, the understanding of Islamic banking
relied mainly on theoretical models developed by a variety of scholars. Now,
theoretical contributions as well as real life practices of Islamic banking have clarified
the picture. The following questions bring forward the most important facts associated
with Islamic banks. They provide the reader with a taste of the mainstream thinking
among Islamic economists and bankers.
4.3.1. Question One What is an Islamic bank? How different is it from a conventional bank?
Before we define what an Islamic bank is like, it is better to give a short description of
conventional banking. Conventional banking does not follow one pattern. In Anglo-
Saxon countries, commercial banking dominates, while in Germany, Switzerland, the
Netherlands, and Japan, universal banking is the rule. Naturally, then, a comparison
between banking patterns becomes inevitable.
Commercial banking is based on a pure financial intermediation model, whereby
banks mainly borrow from savers and then lend to enterprises or individuals. They
make their profit from the margin between the borrowing and lending rates of interest.
They also provide banking services, like letters of credit and guarantees. A proportion
of their profit comes from the low-cost funds that they obtain through demand
deposits. Commercial banks are prohibited from trading and their shareholding is
severely restricted to a small proportion of their net worth.
Because of the fractional reserve system, they produce derivative deposits, which
allow them to multiply their low-cost resources. The process of bank lending is,
however, subject to some problems that can make it inefficient. Borrowers usually
know more about their own operations than lenders. Acting as lenders, banks face this
information asymmetry. Because borrowers are in a position to hold back information
from banks, they can use the loans they obtain for purposes other than those specified
in the loan agreement exposing banks to unknown risks. They can also misreport their
cash flows or declare bankruptcy fraudulently. Such problems are known as moral
hazard. The ability of banks to secure repayment depends a great deal on whether the
loan is effectively used for its purpose to produce enough returns for debt servicing.
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Even at government level, several countries have borrowed billions of dollars, used
them unproductively for other purposes and ended up with serious debt problems.
Banks can ascertain the proper use of loans through monitoring but it is either
discouraged by clients or is too costly and, hence, not commercially feasible. Hence,
why the purpose for which the loan is given plays a minimal role in commercial
banking. It is the credit rating of the borrower that plays a more important role.
By contrast, universal banks are allowed to hold equity and also carry out operations
like trading and insurance, which usually lie beyond the sphere of commercial
banking. Universal banks are better equipped to deal with information asymmetry
than their commercial counterparts. They finance their business customers through a
combination of shareholding and lending. Shareholding allows universal banks to sit
on the boards of directors of their business customers, which enables them to monitor
the use of their funds at a low cost. The reduction of the monitoring costs reduces
business failures and adds efficiency to the banking system.
Following the above logic, many economists have given their preference to universal
banking, because of its being more efficient. Commercial banks are not allowed to
trade, except within the narrow limits of their own net worth. As we have noticed,
many Islamic finance modes involve trading. The same rule cannot, therefore, be
applied to Islamic banks. It may be possible for Islamic banks to establish trading
companies that finance the credit purchase of commodities as well as assets. Those
companies would buy commodities and assets and sell them back to their customers
on the basis of deferred payment. However, this involves equity participation. We
may, therefore, say that Islamic banks are closer to the universal banking model. They
are allowed to provide finance through a multitude of modes including the taking of
equity. Islamic banks would benefit from this by using a combination of shareholding
and other Islamic modes of finance. Even when they use trade-based, debt creating
modes, the financing is closely linked to real sector activities. Credit worthiness
remains relevant but the crucial role is played by the productivity/profitability of the
project financed.
An Islamic bank is a deposit-taking banking institution whose scope of activities
includes all currently known banking activities, excluding borrowing and lending on
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the basis of interest. On the liabilities side, it mobilizes funds on the basis of a
Mudarabah or wakalah (agent) contract. It can also accept demand deposits which are
treated as interest-free loans from the clients to the bank and which are guaranteed.
On the assets side, it advances funds on a profit-and-loss sharing or a debt-creating
basis, in accordance with the principles of the Shari `
ah. It plays the role of an
investment manager for the owners of time deposits, usually called investment
deposits. In addition, equity holding as well as commodity and asset trading constitute
an integral part of Islamic banking operations. An Islamic bank shares its net earnings
with its depositors in a way that depends on the size and date-to-maturity of each
deposit. Depositors must be informed beforehand of the formula used for sharing the
net earnings with the bank.
4.3.2. Question Two The value of paper currency depreciates in inflationary situations. In order to
compensate lenders for the erosion in the value of their principal, a scheme of
"indexation" has been suggested. Is such a scheme acceptable from an Islamic
point of view?
The question of indexation is often raised in the presence of a sustained high rate of
inflation. This happens in some countries under special circumstances, when the
authorities do not follow non-inflationary monetary and fiscal policies. Within the
Islam perspective, it is required of monetary and fiscal authorities to refrain from
following inflationary policies. However, once a country is caught in the mess of
inflation, the question of a possible resort to indexation arises. The Shari `ah aspect of
indexation in such exceptional situations is still under consideration by the fuqaha,
especially the OIC Fiqh Academy. While the Academy has so far allowed indexation
in the case of wages and contracts fulfilled over a period of time, provided that this
does not harm the economy, it has not allowed it in the case of monetary debts.
Meanwhile, it allows the creditor and the debtor to agree on the day of settlement —
but not before — to settle the debt in a currency other than the one specified for the
debt, provided that the rate of exchange applied is the one that prevails on the
settlement date. Similarly, for debts in a specific currency, due in installments, the
parties may agree to settle the installments due in a different currency at the prevailing
rate of exchange on the date of settlement.
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The whole practice of Islamic finance is based on modes that do not involve interest.
As a general rule, they involve the carrying out of investment and/or the purchase of
goods, services and assets. The following questions touch upon the nature and uses of
Islamic modes of finance and their implications
4.3.3. Question Three If banking were to be based on interest-free transactions, how would it work in
practice?
An Islamic bank, like other banks, is a company whose main business is to mobilize
funds from savers and supply these funds to businessmen/entrepreneurs. It is
organized as a joint stock company with the shareholders supplying the initial capital.
It is managed by shareholders through their representatives on the Board of Directors.
While a conventional bank uses the rate of interest for both obtaining funds from
savers and supplying these funds to businessmen, an Islamic bank performs these
functions using various financial modes compatible with the Shariah.
On the resource mobilization side, it uses either the contract of Mudarabah or
wakalah with the fund owners. Under the first contract, the net income of the bank is
shared between shareholders and the investment deposit holders according to a
predetermined profit sharing formula. In the case of loss, the same is shared in
proportion to the capital contributions. As far as the nature of investment deposits are
concerned, these could be either general investment deposits that enter into a pool of
investment funds or specific investment accounts in which deposits are made for
investment in particular projects. In addition, there are current accounts that are in the
nature of an interest-free loan to the bank. The bank guarantees the principle but pays
no profit on these accounts. The bank is allowed to use these deposits at its own risk.
In the case of a wakalah contract, clients give funds to the bank that serves as their
investment manager. The bank charges a predetermined fee for its managerial
services. The profit or loss is passed on to the fund providers after deducting such a
fee. On the assets side, the bank uses a number of financial instruments, none of
which involves interest, for providing finance to businesses. A wide variety of such
modes of financing are now available.
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4.3.4. Question Four Do we really need Islamic banks?
This question can be divided into two parts. The first part relates to the necessity of
banks in general and the needs of the whole economy that they are expected to satisfy.
The second part relates to the extra value an economy would gain from banks
operating according to the Islamic principles. Both parts are taken up below one by
one.
With regard to whether we need banks, we can divide agents (natural as well as legal
entities) in an economy into two groups, one that has the ability to exploit investment
opportunities requiring more financial resources than they have. We can call this
group the investors or the entrepreneurs. The second group has more financial
resources than required by the investment opportunities that they are themselves able
to exploit. We call them savers. In every economy, there is a need to transfer funds
from savers to entrepreneurs. This function is performed through the process of
financial intermediation in the financial markets, where banks are the most important
operators.
Financial intermediation enhances the efficiency of the saving/investment process by
eliminating the mismatches inherent in the requirements and availability of financial
resources of savers and entrepreneurs in an economy. Savers are often small
households who save relatively small amounts and entrepreneurs are firms who often
need relatively large amounts of cash. Financial intermediaries remove this size
mismatch by collecting the small savings and packaging them to suit the needs of
entrepreneurs. In addition, entrepreneurs may require funds for periods relatively
longer than would suit individual savers. Intermediaries resolve this mismatch of
maturity and liquidity preferences again by pooling small funds.
Moreover, the risk preferences of savers and entrepreneurs are also different. It is
often considered that small savers are risk averse and prefer safer placements whereas
entrepreneurs deploy funds in risky projects. The role of the intermediary again
becomes crucial. They can substantially reduce their own risks through the different
techniques of proper risk management. Furthermore, small savers cannot efficiently
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gather information about opportunities to place their funds. Financial intermediaries
are in a much better position to collect such information, which is crucial for making a
successful placement of funds.
The role and functions of banks outlined above are indeed highly useful and socially
desirable. Hence, we do need banks. Unfortunately, their role is marred by dealing on
the basis of interest and limiting their activities to mostly commercial operations as
pointed out above. Islamic banks add value on both counts.
Commercial banks largely finance short-term trade, business,, and personal loans.
This cannot satisfy the financial requirements of venture capital. The impact of
commercial banking on economic development, therefore, would be below potential.
Islamic banking by contrast provides finance with greater involvement in the
production process. Its financing targets both the equity as well as the working capital
needs of enterprises. It is expected that its impact on economic development will be
more pronounced.
The avoidance of interest by Islamic banking is an additional plus. The answers to
previous questions have pointed out that allocating financial resources on a
production basis is more efficient than their allocation on a purely lending basis. It has
also been argued that the whole banking system would be more stable and less liable
to suffer from financial crises Moreover; the existence of an interest-bearing debt
market opens the domestic economy to the unexpected vicissitudes of external
sources. A monetary system based on riba is also unjust. It allows savers and banks to
get away with interest, which is a guaranteed fixed rate of return on their loans,
without bearing a fair part of the risks faced by entrepreneurs.
4.3.5. Question Five How would the role of the central bank and its relationship with the banking system
change?
The elimination of government borrowing would make it inconsistent for the central
bank to continue to issue money against treasury bills and government bonds. Such
interest-bearing instruments are used as a basis for open market operations, as they
represent secure and liquid financial assets. The central bank must therefore find a
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procedure for issuing reserve money that is not based on interest. Interestingly, any
procedure that leads to avoiding lending to the government would automatically be
useful in protecting the monetary authority from pressures to increase the money
supply without regard to the state of the economy. Such procedures would therefore
be less inflationary. The following is a suggested procedure that would enable the
monetary authority to exercise effective control, tie the issuance of money to the
needs of real economic growth, and employ the issued funds into real economic
activities.
The central bank monitors the national economy, especially real growth and
inflation rates. It also examines the state of the demand for money arising from the
production and distribution of real goods and services, and makes an estimate of
the elasticity of demand for money.
In consultation with the planning authorities, the central bank sets growth and
inflation targets for the next year.
The desired rate of monetary expansion that would be consistent with growth and
inflation targets would be equal to the target rate of growth X the elasticity of
demand for money plus the target rate of inflation.
A part of the money issued by the central bank to attain the desired rate of
monetary expansion would be placed in banks as investment
4.3.6. Question Six Is Islamic banking viable?
Islamic banking, like any other banking system, must be viewed as an evolving
system. No one disputes that there is a definite desire amongst Muslim savers to
invest their savings in ways that are permitted by the Shariah. Nevertheless, they must
be provided with Halal returns on their investments. Islamic scholars and practical
bankers took up that challenge and have made commendable progress in the last
twenty-five years in providing a number of such instruments. However, the concepts
of Islamic banking and finance are still in their early stages of development and
Islamic banking is an evolving reality for continuously testing and refining those
concepts.
Islamic banking and financial institutions have now spread across several Muslim
countries. Some non-Muslim countries and/or institutions e also keen to experiment
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with Islamic financial techniques. Various components of the Islamic financial system
are now available in different parts of the world in varying depth and quality. A
detailed and integrated system of Islamic banking and finance is gradually evolving.
Theoretical arguments and models developed by Islamic economists and the
successful practice of hundreds of institutions in heterogeneous conditions both testify
to the viability of Islamic banking. The average growth rate of deposits in Islamic
banks over the past twenty years has been over ten percent per annum. Many studies
testify to the great success of Islamic banks in mobilizing resources. According to one
of these studies", the relative growth rate of Islamic banks during the period 1980-
1986 surpassed, in most cases, that realized by other banks. Another study noted that,
"These institutions have come of age now and realized a high degree of success in
respect of market penetration. This is considered remarkable in view of the fact that
the markets in which these Islamic banks were established have had highly developed
and well-established commercial banks. Moreover, some of those markets, especially
in the Gulf region, were considered replete with banks"
Another manifestation of the success of Islamic banking is the fact that many
conventional banks have also started using Islamic banking techniques in the conduct
of their business, particularly in dealing either with Muslim clients or in
predominantly Muslim regions.
A
Attitude of Conventional and I
Chap
FindR
Islamic Bank C
apter
dings, Recom
Customers Tow
r Five
Concmmen
wards Islamic B
ve
clusiondatio
Banking Practi
ons Anions
ices in Sri Lank
And
ka
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Chapter Five FINDINGS, CONCLUSIONS AND
RECOMMENDATIONS
5.1. Introduction This is the last chapter of my research. In this chapter, researcher intended to reveal the findings, the conclusions and the recommendations.
5.2. Findings In this section is going to reveal the findings which were identified from data analysis
in preceding chapter.
The prohibition of riba (interest) makes Islamic banking different from conventional
banking. Of course, the investments of an Islamic bank must be channeled to the
Islamic Shariah approved sectors. The phenomenal growth of Islamic banks has
attracted the attention of bankers, business community and bank customers. It is also
contended that Islamic banks are not very different from conventional banks. This
argues raises a natural question that if Islamic banks are no different from
conventional banks, why they are growing so fast? A survey analysis of the deposit
and investment mechanisms and the opinions of the customers of both Islamic and
conventional banks help our understanding and identification of this debate.
Our theoretical analysis shows that Islamic bank practices are indeed different from
those of conventional banks. The central theme of this study is to examine some
apparent similarities between Islamic and conventional banks, which frequently tend
to equate the similarities, was found through a process of scientific investigation. Data
of this study was collected from both primary and secondary sources. Set of
questionnaire were used in the interview survey, among the customers and
professionals of selected Islamic and conventional banks in Sri Lanka. A purposive
random sampling was used in the survey.
The majority of (sixty six percent) sample consists of customers are keeping their
money in saving account and other (34percent) in fixed deposit. The huge part of (84
Attitude of Conventional and Islamic Bank Customers Towards Islamic Banking Practices in Sri Lanka
MIM Riyath. SEU/IS/04/MG/021 Specialization in Finance P a g e | 90
percent) sample consists of customers are expecting profit and others (16 percent) are
interest from their money.
The fundamental nature of the profit and loss sharing system of Islamic finance, the
customers are more aware. Mainly of them believe that Islamic finances aim at both
profit and losses. Most customers believe that Islam permits profit and forbids riba.
The majority of the customer view that Zakath has been mobilized through the
Islamic banking system. The minor part of the respondents has mentioned that welfare
activities are organized through the Islamic banking system. More than half of
customers think that this is due to ‘mere faith in Islam’ of the overwhelming Muslims
of the country. In contrast, smaller part of them believes that the ‘intention to earn
profit’ is the basis of development of Islamic banking system.
the majority of the customers preference is that the trading and the rental modes of
investments of Islamic banks do not differ much from the transactions of interest-
based banks, The agreement of payment of installment in due time and the extra
payment for excess time of repayment of an investment under the trading and rental
mode create the same financial burden to an investment customer. More to the point,
other arrangements (mortgage, security, registration etc.) for getting an investment
loan from Islamic banks are the same as those of conventional banks.
The causes of crept of interest into the Islamic banking system, vast of respondents
replied that exploitation is going on through Islamic banking. It seems that the
customers are concerned about the interest factor, which tends to make both Islamic
and conventional banks similar. The majority think that the status of the Shariah
Council/Department is advisory, not supervisory in the system of Islamic banking.
Many Muslim businessmen and industrialists do not really support the Islamic banks.
About 75% believe that the potential customers do not find any business difference
between Islamic and conventional banks.
The respondents discourse that most of the Islamic modes of investment practiced by
Islamic banks do not practically share risk for many reasons. While a majority of
them believe that the insurance company covers risks. The respondents confirm that
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many customers are not interested in dealing with Islamic banks because they feel that
only the title name of the banks has been changed and interest in a real sense has not
been eliminated. Many respondents feel that mark-up profit has created a financial
burden like the interest burden of conventional banks.
I received the response that possibility of loss is not detrimental to deposit
mobilization. The respondents believe that the profit and loss sharing system of
banking cannot ultimately make a loss of deposit. It is observed that majority of them
believe that finance under both systems of banking gave the same effect on business
results. They quest for governmental reformation measures for moral building and
eradication of false values of life, which would pave the way for Islamic baking. They
have also mentioned several causes to support their opinions.
5.3. Conclusions In concluding the brief discussion of this important issue, I would like to point out
that I have not dealt with the juristic aspect of the issue of bank interest, as it has been
fully discussed by Islamic jurists, past and present, individually and collectively. I
would like to record here, by way of emphasis not repetition, that bank interest,
whether credit or debit, is Riba and utterly forbidden by the Al Quran, the Sunnah and
the Consensus of jurists. I also wish to stress that the interest rate mechanism is a
wicked and corrupt means of managing modern economic activity, whereas the rate of
profit is the most practical and effective mechanism for the management of an Islamic
economy.
It is pointless to be preoccupied with issues which have already long been resolved.
Such a preoccupation is nothing but a distraction from more immediate and urgent
problems. Instead of using the juridical legacy of Islam to bring our Muslim
economies back to and within Shariah, I keep reverting to matters which have already
been settled. Only when Shariah is applied to finance investment can we take steps to
redress underdevelopment.
It almost seems as if this secondary issue has been artificially revived in an attempt to
validate a prohibited practice by justifying an indulgence in the sin of Riba. The
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function of a modern bank is to trade in interest loans. Interest on loans is clearly a
preconditioned increment and constitutes Riba, which is categorically prohibited in
Islam. The interest rate mechanism is, thus, a corrupt method for managing modern
economic activity.
The Islamic system offers an easy, effective, and practical alternative. This alternative
is the profit-loss sharing system instead of credit-debit relationship that is involved in
Riba. With this form of financing investment, conventional banks can be transformed
into Islamic banks, with profit acting as an effective and rational mechanism in the
management of con-temporary economic activity.
An analysis of these deposit mechanisms shows a confusing similarity that both
Islamic and conventional banks pay money for the deposits of the customers, which
is termed as profit in Islamic banking or interest in conventional banking respectively.
While payment of return on deposit in Islamic banking contains element of risk,
payment of interest in conventional banking does not contain the element of risk.
Only payment on deposit apparently generates misunderstanding in the minds of
bank customers whether Islamic banking is definitely different from conventional
banks. In terms of financing techniques, the prevalence of short-term financing in
Islamic banks raises the questions of efficiency, equity and justness of Islamic banks.
In addition, this also raises questions such as, whether Islamic banks pay profit or
interest in the name of profit.
I showed that the Islamic banking financing mechanisms are different from those
of conventional banks. The misleading similarities between Islamic and conventional
banking products are the result of the following observations: First, fixed charges in
percentage, which increases with time as compensation for violation of an agreement
for repayment schedule of investment taken by the entrepreneur from the bank.
Second, dated payment obligations may not synchronize with the firm’s cash
flow. Third, payment obligations are mandatory whether or not the business is
making a profit. Fourth, a security or mortgage is essential for investment.
Finally, returns are practically based on the benchmark of an interest based
bank.
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The survey analysis shows that bank customers have confusing thinking about Islamic
banking practices. I argue that this misconception is partly due to incomplete
knowledge in the fundamentals of Islamic finance and due to the over-reliance on
short-term trade financing. The investment portfolio of Islamic banks has generally
favored trade-related activities over production-related activities, short-term
profitability over long-term profitability and private profitability over social
profitability. Almost 80 to 90 per cent of investment has been made to short-term
trade-related activities. Heavy reliance on a short-term asset portfolio makes Islamic
banks vulnerable, increases its risk and threatens its stability. On the other hand, the
borrowers prefer short-term trade loans to profit-loss sharing instruments, which have
weakened the bank’s portfolio. The real rates of return of the Islamic bank’s asset
portfolio are lower than those of conventional banks.
Islamic banks have become, to an extent, successful in the field of deposit
mobilization, but socially beneficial and development oriented utilization of these
deposits did not happen. Employment generation and a flow of resources towards the
lower and middle classes, particularly in the rural areas, have not taken place. Still,
Islamic banks are involved in the heroic role of eliminating riba from financial
dealings in Muslim countries against a backdrop of regulation in the area of taxation,
legal framework, and weak moral fabric of society. In order to remove misconception
from the minds of customers, there is no alternative to publicity, research and training
of Islamic banking practices. Research should focus on the development of financial
products that conform to Islamic Shariah, and training should be given to bankers,
potential researchers and bank customers.
5.4. Recommendations
In order to operate in markets effectively, it is desirable that the size of operations of
Islamic banks be substantially increased. In this regard, serious consideration should
be given to mergers. Islamic banks have to increase their size as well as form strategic
alliances with other banks. It will also be useful to build bridges between existing
Islamic banks and those conventional banks that are interested to do banking on
Islamic principles.
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To promote teaching, training and research in Islamic banking and finance and to
produce and disseminate authentic information on their activities with a view to
develop new Islamic financial products.
With a view to broaden the equity base of the economies of Muslim countries, it is
desirable to establish institutions dealing more in equities. These include mutual
funds, unit trusts, pension plans etc. It would also be desirable to encourage
businesses through macro-economic policies to increase the use of equity finance and
decrease their reliance on debt.
Until countries do not choose for a complete Islamic banking system, it is necessary
to perform some laws to facilitate the operation of a mixed system. In this context,
one of the most serious problems being faced by Islamic banks is the lack of proper
legal framework to deal with cases of delayed payments and bad loans expeditiously.
Since Islamic banks cannot charge interest on the delayed debts, they face a bigger
risk of default as well as loss in income. These considerations, among others,
necessitate that special laws for the introduction and practice of Islamic banking be
put in place.
Another important policy issue relates to tax treatment. Under the conventional
system, interest paid by corporations is treated as a tax-deductible expense. Similar
treatment must be given to the dividends paid out by financial institutions.
It is proposed that an autonomous Board for Shariah supervision of Islamic banks
may be constituted. In addition, there is also a need for Central banks in Muslim
countries to consider the special nature of Islamic banking and devise suitable
international standards for major control variables similar to the Basle Committee for
Banking Supervision.
There is an urgent need to increase the supply of scholars with dual specialization in
Shariah and finance. In order to meet this need, it is recommended that courses may
be introduced for Shariah scholars in economics and finance. Similarly, courses in
Shariah especially designed for economists and financial experts may be initiated.
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GLOSSARY OF ARABIC TERMS
Ahadith Plural of Hadith. For meaning, see below.
Al-Maks A pre-Islamic practice whereby the tribesmen imposed
levies on caravan trade passing through their areas.
Ameer Ruler.
Amwal Plural of mal. For meaning see below.
Awqaf (also waqfs) Plural of waqf. For meaning, see below.
Bayt al-mal Public treasury, Also used for a charitable institution meant
to help the poor and needy.
Dawah Acts and deeds for propagation of religion.
Falah Literally, it means to become happy, to have success.
Technically, it means achieving success in the life
Hereafter.
Fard An obligatory duty.
Fard kifayah An obligatory duty the fulfillment of which is a joint
responsibility of all members of the community. If someone
performs it, it is considered to have been fulfilled; otherwise
all members of the community are considered defaulters.
Fay’ Properties/assets that come into the hands of Muslims
without fighting. (Compare with Ghanimah).
Fiqh Refers to the whole corpus of Islamic jurisprudence. In
contrast with conventional law, fiqh covers all aspects of
life, religious, political, social, commercial or economic.
The whole corpus of fiqh is based primarily on
interpretations of the Qur’an and the Sunnah and
secondarily on Ijma (consensus) and Ijtihad (individual
judgment). While the Qur’an and the Sunnah are
immutable, fiqhi verdicts may change due to changing
circumstances.
Fiqhi Relating to fiqh.
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Fuqaha’ Plural of faqīh meaning jurist, who gives rulings on various
juristic issues in the light of the Qur’an and the Sunnah.
Ghanimah Enemy Properties/assets that come into the hands of
Muslims after fighting.
Hadith Sayings, deeds and endorsements of the Prophet
Muhammad (peace be upon him) narrated by his
Companions.
Harbi People belonging to countries with which the Muslim state
is at
Hawalah Literally, it means transfer. Technically, it refers to an
arrangement whereby a debtor transfers the responsibility of
payment of a debt to a third party who owes the former a
debt. It is also used for cheque or draft.
Hawalah or
hawalah al-dayn
Islamic rules governing transfer (sale) of debt.
Hisbah Literally, it means reward, calculation. Technically, it refers
to an institution that existed through most of Islamic history
for implementing what is proper and preventing what is
improper. The main role of Al-Hisbah was the regulation
and supervision of markets to ensure proper market conduct
by all concerned.
Ibadah Duties of man due to God.
Idtirar Doctrine of necessity, i.e. condition of extreme necessity
which may temporarily suspend some Shariah ruling.
Ijarah Leasing. Sale of usufruct of an asset. The lessor retains the
ownership of the asset with all the rights and the
responsibilities that go with ownership.
Ijtihad In technical terms, it refers to the endeavor of a jurist to
derive a rule or reach a judgment based on evidence found
in the Islamic sources of law, predominantly, the Qur’an
and the Sunnah.
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Istisna Refers to a contract whereby a manufacturer (contractor)
agrees to produce (build) and deliver a well-described well
(or premise) at a given price on a given date in the future.
As against Salam, in Istisna the price need not be paid in
advance. It may be paid in installments in step with the
preferences of the parties or partly at the front end and the
balance later on as agreed
Jizyah A levy imposed on non-Muslims living an Islamic state in
lieu of providing protection to them without obligatory
military duty.
Kharaj A land tax (either lump sump or share in produce) imposed
on non-Muslim’s lands.
Khums Literally means one-fifth. Technically a rate of tax of 20%
imposed on certain types of wealth/assets.
Maadin Mines/natural resources such as coal, copper, gold,
petroleum.
Mal Anything in the possession of someone having value.
Maqasid al-Shariah Basic objectives of the Shariah. These are protection of
faith, life, progeny, property and reason.
Maslahah(plural
Masalih)
Literally, it means benefit. Technically, it refers to any
action taken to protect any one of the five basic objectives
of the Shariah i.e. Protection of faith, life, progeny, property
and reason.
Mudarabah A contract between two parties, capital owner(s) or
financiers (called rabb al-mal) and an investment manager
(called mudarib). Profit is distributed between the two
parties in accordance with the ratio upon which they agree
at the time of the contract. Financial loss is borne only by
the financier(s). The entrepreneur’s loss lies in not getting
any reward for his services.
Mudarib An investment manager in a mudarabah contract.
Muqaradah Same as Mudarabah.
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Murabahah Sale at a specified profit margin. The term, however, is now
used to refer to a sale agreement whereby the seller
purchases the goods desired by the buyer and sells them at
an agreed marked-up price, the payment being settled
within an agreed time frame, either in installments or in a
lump sum. The seller bears the risk for the goods until they
have been delivered to the buyer. Murabahah is also
referred to as bay mu’ajjal.
Musaqah A contract in which the owner of a garden agrees to share
its produce with someone in an agreed proportion in return
for the latter’s services in irrigating and looking after the
garden.
Musharakah Partnership. A musharakah contract is similar to a
mudarabah contract, the difference being that in the former
both the partners participate in the management and the
provision of capital, and share in the profit and loss. Profits
are distributed between the partners in accordance with the
ratios initially set, whereas loss is distributed in proportion
to each one’s share in the capital.
Muzaraah Crop-sharing contract. Two or more parties contribute land,
seed, fertilizer, water, etc., and share the crop in agreed
proportions.
Nisab In reference to Zakath, the limit of wealth that marks the
beginning of the imposition of Zakath liability. Wealth
below this limit is exempt.
Nusus Texts from Qur’an or Sunnah.
Qur’an The Holy Book of Muslims, consisting of the revelations
made by God to the Prophet Muhammad (peace be upon
him). The Qur’an lays down the fundamentals of the Islamic
faith, including beliefs and all aspects of the Islamic way of
life.
Qur’anic Reference from Qur’an.
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Riba Literally, it means increase or addition or growth.
Technically it refers to the ‘premium’ that must be paid by
the borrower to the lender along with the principal amount
as a condition for the loan or an extension in its maturity.
Interest as commonly known today is regarded by a
predominant majority of fuqaha’ to be equivalent to riba.
Sadaqah An act of charity.
Salam The short form of Bay Al Salam.
Sarf Islamic rules governing currency exchange.
Shariah Refers to the corpus of Islamic law based on Divine
guidance as given by the Qur’an and the Sunnah and
embodies all aspects of the Islamic faith, including beliefs
and practices.
Shura The Islamic principle of mutual consultation before arriving
at decision.
Sukuk Plural of ‘sakk’ which refers to a financial paper showing
entitlement of the holder to the amount of money shown on
it. The English word ‘cheque’ has been derived from it.
Technically, sukuk are financial instruments entitling their
holders to some financial claims.
Sunnah The Sunnah is the second most important source of the
Islamic faith after the Qur’an and refers to the Prophet’s
(peace be upon him) example as indicated by his practice of
the faith. The only way to know the Sunnah is through the
collection of Ahadith, which consist of reports about the
sayings, deeds and endorsements of the Prophet (peace be
upon him).
Surah A chapter of Al-Qur’an.
Takaful An alternative for the contemporary insurance contract. A
group of persons agree to share certain risk (for example,
damage by fire) by collecting a specified sum from each. In
case of loss to anyone of the group, the loss is met from the
collected funds.
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Ushr Referring to the law of Zakath, it means a rate of ten percent
leviable on certain types of wealth/output/income.
Ushur Taxes imposed on foreign trade during the period of Caliph
Omar.
Wakalah Contract of agency. In this contract, one person appoints
someone else to perform a certain task on his behalf, usually
against a fixed fee.
Wakil Agent.
Waqf Appropriation or tying up a property in perpetuity for
specific purposes. No property rights can be exercised over
the corpus. Only the usufruct is applied towards the
objectives (usually charitable) of the waqf.
Zakath The amount payable by a Muslim on his net worth as a part
of his religious obligations, mainly for the benefit of the
poor and the needy.
Zakatul ard Zakath imposed on the produce of land.
Zakatul mal Zakath imposed on assets/properties.
Zulm Unfair, unjust, unduly encroaching upon the rights of
others.
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References
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challenges. London: Zed Books Ltd. 5. Amereller, Florian. (1995) Hintergründe des ‘Islamic Banking’. Berlin: Duncker & Humblot
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growth. London: Euromoney Books. 7. Ashour, Yousif (1999), “The Importance of Murabahah in Long-Term Finance Programs in the
Banking Industry,” The American Journal of Islamic Social Sciences, 16 (4), 87-102. 8. M. Ariff (ed), Jeddah: International Centre for Research in Islamic Economics, King Abdul Aziz
University: 9. Doak, E (1988), “Islamic Interest-Free Banking and 100 Percent Money”, International Monetary
Fund Staff Papers, 35, 534-36. 10. Dr. Mabid Ali Al-Jarhi, Islamic Finance: An Efficient & Equitable Option Islamic Development
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perspectives on profit-sharing and risk. Cheltenham: Edward Elgar Publishing Ltd. 17. Iréne Björklund And Lisbeth Lundström, Islamic Banking, An Alternative System, Fec 685
Bachelor Dissertation, International Business Program, The Department Of Business Studies, Kristianstad University, December 2004
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18. Khan, M. Fahim (1987), “Concept of Time in Islamic Economics”, Mimeo, Islamabad: International Institute of Islamic Economics.
19. Khan, M. S. and Abbas Mirakhor (1987), “Theoretical Studies in Islamic Banking and Finance”,
Houston, Texas: The Institute for Research and Islamic Studies. 20. Khan, Mohsin S (1986), “Islamic Interest-Free Banking: A Theoretical Analysis”, Staff Papers,
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Prohibiting Debt Financing”, Ph.D. Dissertation: Boston University. 22. Langton, Michle J. (1995), “Impact of Islamic Banking” in The Bangladesh Observer, June 30. 23. Mabid Ali Al-Jarhi And Munawar Iqbal, Islamic Banking: Answers To Some Frequently Asked
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Occasional Paper No. 1, Islamic Development Bank, Islamic Research And Training Institute 27. Nienhaus, Volker (1994), “Conceptual and Economic Foundations of Islamic Banking”, Thoughts
on Economics, 3 and 4, 1-37. 28. Nomani, Farhad & Rahnema, Ali. (1994) Islamic economic systems. London: Zed Books Ltd. 29. Prof. Dr. Abdel Hamid El-Ghazali, Islamic Economics Translation Series, No. 2, Profit versus
Bank Interest in Economic Analysis and Islamic Law, Islamic Development Bank, Islamic Research and Training Institute.
30. Ray, Nicholas Dylan. (1995) Arab Islamic banking and the renewal of Islamic Law. London:
Graham & Trotman Ltd. 31. Siddiqi, M. Nejatullah (1983), Banking Without Interest, Leicester: The Islamic Foundation. 32. Saeed, Abdullah. (1996) Islamic banking and interest: A study of the prohibition of riba and its
contemporary interpretation. Leiden: E.J. Brill 33. Samuelsson, Jan. (2000) Islamisk ekonomi. Lund: Studentlitteratur. 34. Saunders, Mark, Lewis, Philip & Thornhill, Adrian. (2003) Research Methods for Business
Student (3rd edn). Harlow: Pearson Education Ltd. 35. Warde, Ibrahim. (2000) Islamic finance in the global economy. Edinburgh: Edinburgh University
Press. 36. Zineldin, Mosad. (1990) The economics of money and banking: A theoretical and empirical study
of Islamic interest-free banking. Stockholm: Almqvist & Wiksell International.
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Websites: http://www.isdb.org http://www.islamic-banking.com http://www.ifsb.org http://www.irti.org.sa http://www.islamicity.com Http://www.meezanbank.com http://www.en.wikipedia.org/wiki/Islamic_banking#History_of_Islamic_banking http://www.dowjones.com/corp/index products.htm http://www.ftse.com/ebox/TII.html
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Questioner Analysis This questionnaire is prepared to collect the information regarding an examination of
factors affecting to
Attitude of Conventional and Islamic Bank Customers towards Islamic
Banking Practices in Sri Lanka. to the research study for the completion of Bachelor of Business Administration
degree in South Eastern University of Sri Lanka. Therefore, I kindly request you to
indicate the correct answer to the following questions.
Please selects your most preferred an answer and put mark in the appropriate box given below.
1. Type of Customer by Profession`
Service holder Businessman Self Employed Housewife Others
2. Age
20 – 29 30 – 39 40 – 49 50 – 69 More then 70
3. Sex Male Female
4. Education Level Under Graduate Graduate Post Graduate Other
5. What type Account you are keeping?
Saving Account Fixed Deposit
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6. What you are expecting from your money? Interest Profit
7. Profit and Loss Sharing System is the Essence of Islamic Finance. Which is the major cause?
Islamic finance cannot earn riba in any way. Islam permits profit and forbids riba Islamic finance aims at both profit and losses. Islamic finance is always meant for investment.
8. Benefits Accrued to the Society from Islamic Banking.
Which is the major benefit? Zakath Fund has been mobilized through banking system Welfare activities are organized through banking system The concept of Halal and Haram in case of investment/buying and selling has been introduced Mobilization of Financial resources to the real sector of the economy has been introduced New products of banking have been introduced.
9. Which is the major Basis of Development of Islamic Banking?
Mere faith in Islam; Intention to earn profit; To avoid interest; To ensure justice in the financial transactions; To contribute to the welfare of the economy
10. Which is the major Causes of Continuation of Interest-based Transaction
through Back Door by Islamic Banking system? Trading and Rental based modes of investment do not differ much from the interest-based transactions. Products of present Islamic Banking are similar to those of interest-based banking system. Risk-sharing in current practices of Islamic Banking is not proportional to its profiteering. Islamic banks are working along with the interest-based banks.
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11. Which is the major Causes of Interest Creeping into the Islamic Banking System?
Exploitation is going on through Islamic system of banking Products of Islamic Banking have failed to remove the curse of interest from financial transactions. Banking professionals have led Islamic system of Banking to the garb of interest based banking. Islamic system of Banking was introduced in a society, which was not re-organized on Islamic ideology.
12. Present Success of Islamic Banks is not in Conformity with Shariah.
Which is the major cause? The status of Shariah Council/ Department is advisory, not supervisory in the system Islamic Banking. Earning of profit cannot be the success criterion. Justice and welfare in financial transactions are not ensured by Islamic Banks. Exploitation still remains in Islamic banking system.
13. Which is the major Cause of Not Patronizing the Islamic Banks by Rich and Prominent Muslim Businessmen and Industrialists?
They do not find any real business differences between Islamic and conventional banking Not conscious about Islamic banking. Confused about Islamic Banking. They are not motivated to I-Banking.
14. Most of Investment Financing Techniques by Islamic Banks do Not Share
Risk Proportionally Which is the major cause?
The Insurance Company covers risks of Islamic banks’ loans. Islamic Banks do not always buy for sale. Buying and selling arrangements by Islamic banks are almost risk-free. Islamic banks do business with depositors money and share risk
15. Many Customers are not interested in Dealing with Islamic Banks as they feel
that only the Name has been changed and Interest in Real Sense has not been eliminated. Which is the major cause?
Mark-up profit makes customers liable for additional payment, which is same as that of conventional bank’s fixed interest-based loan. Customers are required to repay banks money on installment basis Failure of installment payment creates additional liability The Islamic Banks in most cases do not consider business loss.
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16. Possibility of Loss of Deposit is not Detrimental to Deposit Mobilization. Which is the major cause?
PLS system of banking does not lead to loss of value of deposit ultimately. It is realized profit of investment which makes return on bank deposit Halal. A true Muslim is not concerned about deposit loss, because he expects Haven in the life hereafter. It does not mean total loss of deposit.
17. Present Modes of investment of Islamic Banks are Compromised Modes of
Financing with Interest. Which is the major cause?
Both gives same effect on business results Both are justice and Welfare free. Both are working side by side. Both are working in the same value loaded society.
18. Moral Uplifting of the Society Will Pave the Way for Islamic Banking.
Which is the major cause? Islamic banks cannot work well in an immoral society. False values of life give detrimental environment to Islamic Banking. Governmental power can change the social values. Governmental reformation measures are powerful to build a moral society.
Thank you very much for corporate with me to completing this questionnaire