Islamic Bank Performance and Commercial Banks Example for Free

CHAPTER 1

1.1 ABSTRACT

1.2 INTRODUCTIONS and BACKGROUND

Banks are a one of vital institution in the development of an economy (Jairus 2007), since they are the key drivers of the economy in terms of ensuring that the financial system is running and there is money in circulation (Ayub 2007). From the primitive set-up, that was banks in the past, to the present set up of the same, banks have continued to demonstrate their pivotal role in ensuring that businesses are conducted through the provision of credits, savings facilities, safe holdings, intermediary in local and international transactions and even advisory roles (Mahlknecht, 2009). Some of the best known banks in the world like Barclays and HSBC have been in operations for many years (Rahman 2010) and are hence shaping the way in which business is conducted, by shown the best practices in the banking sector. Unlike the other sectors of the economy, banks operate on two fundamental different rules, first, banks hold money and monetary instruments and they trade on these as opposed to the other businesses which operate on other forms of goods and services against money, secondly, banks mainly operate in liabilities and not assets and their strength is indirectly gauged by this (Jairus 2007), for instance, banks take up deposits from investors and account holders (this is a liability that the banks undertake to keep other people's money) and using this money, the banks lend to borrowers and other banks and charge interest on the same therefore, they create a financial system that is developed on the basis of liabilities (Akgunduz 2009). This mode of trading is what separates the banks from the other financial institutions and as such make the banks to be increasingly relied upon by other stakeholders in the business environment (Rahman 2010). The increased usage of money as opposed to the old aged barter system has also made the banks to be imported in all major activities of selling and buying of goods and services and in reality, riches and success are measured in terms of money (Iqbal , Llewellyn 2002, Timur 2005). As stated earlier, the normal or conventional banking system is based on the premise of interest charges that the banks have to levy in order to remain in trade, and therefore, different banks have in the recent past, made significant effort to 'tailor' their products in such a way that the interests and other charges will be accumulated and contribute to their profits (Mahlknecht, 2009). This is not to say that interests alone make their profits, since, according to Ayub (2007), profits can also in increased by identifying the business units that require 'cuts' and implementing these cuts. Now, the conventional way of trading as given above, is mainly based on the Western worlds model of banking which to some extent is hinged on Capitalism and has been called by (Akgunduz 2009) as a simple way to 'rip other off'. This does not really fell well with certain ideological leanings and certainly not with the Islamic ideology, which mainly advocates welfare and support to the 'have nots' by the 'haves [1] ', and on this premise, the banks have a duty to provide to those who are lacking (Jaffer 2005). According to Islamic teachings the 'Riba and usury' or interest is not to be levied and is prohibited in certain terms hence it is 'Haraam - unfair or prohibited' (Timur 2005). However, this concept seem to have started just in the near past, since according to Lewis , Algaoud (2001) , a look at the works of Qureshi Annwar (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) show a tendency to profit sharing and not interest charges, so the company is expected not to charge interest as a way of sharing its profits (Schoon 2009). The first Islamic bank was later on formed in Egypt, but this was held secret for fear of being seen as an Islamic fundamental group and this was in 1975 (Rahman 2010). At present Islamic banking institution are worth about $400 billion and Saudi Arabia has world known banks like the Al Rajhi, and the bank Mellat. Being an Islamic nation as most of the MENA region (Middle East and North Africa) , it could only follow that it is a good idea to ensure that this banking concept develops in this region to serve those clients in a way that responds to their religious needs (Hassan, Lewis, 2007). This is not to say that Islamic banks can run in isolation, especially in the wake of international business and with the recent accession of KSA to the World Trade Organisation (WTO), thereby making business between KSA and the world to increase (Rosly, 2006), besides, KSA is the largest producer of crude oil (Timur 2005), which is a product in demand all over the world and in this inter-national trade, banks must act as underwriters or even agents to the buyers and sellers (Hassan , Lewis 2007). Also, according to (Jaffer 2005), and as seen earlier, Islamic banks have been developed along the principles of conventional banks with a few but important differences. From an investors point of view, the choice of investing in an Islamic bank or a conventional commercial bank in KSA is therefore an issue that requires careful thought (Timur 2005), this is because, while an assumption can be made that being an Islamic bank in an Islamic nation, there are obvious advantages to the investor (Pock 2007), this assumption may be disputed, since, in the same environment, the conventional commercial banks may ensure that they counter the advantages of Islamic banks with tailor made products that respond to the clients' needs and therefore, they may be more beneficial to the clients (Lewis , Algaoud 2001). It also depends on what the investor is looking for, because, individual investors like the corporate investors have varied investment objectives, and while it can be said that in general, corporate investors may be patient and hence looking for long-term investment, individual investors may need quick benefits (Mahlknecht, 2009). Again, suppose the investors are considering monetary benefits, which is often the case for many (Khan 2010), what banking concept are they likely to invest in and at what investing limit (threshold or minimum investment) must they commit in order to achieve their objectives? (Iqbal , Llewellyn 2002).

THE PROBLEM

These are important questions that have driven the interest in conducting this study. The researcher wishes to find out what bank or banking concept is more likely to benefit investors. In this context, investors will be viewed as individual investors who have the power to save their money in the hope of achieving certain benefits in due time. According to (Akgunduz 2009), and also (Rosly, 2006), there is a need to find out what might motivate investors to consider investing in Islamic banks, even though, the concept of interest is forbidden and hence they are unlikely to earn any, or what might motivate them to invest in conventional commercial banks although there are charges and minimum amounts to be invested to realise some benefits. It is therefore important to ensure that a comparative analysis is conducted between Islamic and Conventional Commercial banks is undertaken with a view to fully establish the major differences in various operational aspects of these banks and also to evaluate what banking concept of the two would be most beneficial to the investors. Hypothesis: In this study, the research is based on the premise that conventional banks still provide the best option to investors compared with Islamic banks and that as time goes by and competition in the banking sector increases, there appears to be more differences between the operations of these banks as each bank seeks to provide more diverse products and services to their clients. The research sought to evaluate the following research questions; Are there fundamental differences between Conventional commercial and Islamic banks? What are they? What are the differences in operations of Islamic and Conventional commercial banks, in KSA? What are the monetary benefits to the investors in the Islamic and Conventional banks in KSA? What banking concept would you consider for the investor in KSA in terms the general benefits? The following objectives have been evaluated: Identifying the operational differences between Islamic and conventional banks in KSA. This involves an investigation into the functional areas of these banks as they seek to get and keep their clients including other functions that support business both locally and internationally. Discuss the performance between the Islamic and commercial banks in KSA: In this section, the financial ratios will be evaluated including liquidity, gearing and profitability ratios. Assessing the monetary benefits to the investors in investing in either Conventional or Islamic banks in the KSA. Assessing and recommending the best banking concept to the investor in terms of the long term, and short term benefits: In this section the research considered the issues of interest, duration, benefits of tailor made banking to the investors, other collateral benefits that say and account holder would be given, that non account holder would not have. The Scope: This research will mainly consider investment benefits while comparing the banking sector in KSA with relations to the banking conventions in the KSA. The focus will be on KSA, which has strong Islamic and Conventional banking sectors.

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