Islamic Banking and Finance - Essay Example

Running head: Islamic Banking and Finance Islamic Banking and Finance s Islamic Banking and Finance Chapter 1 - Introduction Socio-economic justice in the eyes of Islam depends on the abolishment from the economic area of interest and similar kinds of aspects that exploit people. Through the Islamic financial system there is a facilitation of services such as lending, borrowing and investing on a risk-sharing basis. Through this the market forces are able to get a conclusion of what the yield of the capital would be instead of getting it fixed "in priori as an "interest rate" to sabotage the free market mechanism and encourage speculative use and hoarding of capital" (Khan & Bhatti, 2008: 1). Because of the Islamic financial system there is the guarantee that the formulation of capital would take place at a desirable rate and because it would be utilized efficiently there would be sustainable economic expansion along with everyone receiving equal advantages. Such a system can be called a value-based mechanism and the main target is to ensure "moral and material wellbeing" of the persons as well as the whole community (Ahmed, 1994; Siddiqi, 2000). It was about four decades back that Islamic banking and finance discipline came up. There was an awareness of the abstract expansions of Islamic banking back then during the late 1940s. By the next twenty years they increased such that there was a model developed which the Middle Eastern nations adopted in order to meet the requirements of their kinds of banks. Several of such Islamic banks came up by the 1970s and they had a good enough reputation. Such banks included "Nasser Social Bank Cairo (1972), Islamic Development Bank (IDB) (1975), Dubai Islamic Bank (1975), Kuwait Finance House (KFH) (1977), Faisal Islamic Bank of Sudan (1977) and Dar Al-Maal Al-Islami (1980)" (Khan & Bhatti, 2008: 1). By the beginning of the 1980s the Islamic banking industry was already emerging and at that time three Muslim nations (Iran, Pakistan and Sudan) made a decision of transforming their system of economics and finance to Islamic. Following this there was an establishment of individual Islamic windows and subsidiaries by the financial market players of the West. These included banks like Citibank, ABN AMRO and HSBC. This was done in order to "attract petrodollars' deposits from the Middle East and Muslims clientele in local markets" (Khan & Bhatti, 2008: 1). There was a continuous growth of the Islamic banking and finance mechanism and this happened through innovation and variety of the items, clients and the markets. Chapter 2 - Aims and Objective Credit crunch is nothing new to the modern man or anyone who has been working in the banking, mortgage and the financial systems. This is the crisis that has made many people think of the newer ways to develop better systems to make the economy and the finances flow in the better manner. As has been seen in the recent times there are many people who have been thinking since the last few years that Islamic finance and the banking systems are similar to the conventional banking systems. In many cases it has been said that the similarity in this case is being generated so as to make the Islamic rules in the banking and the economics look much more diluted. As in many cases it has been found that the term Islamic banking or the Islamic finance has been one of the misleading terms when the many similarities between the Islamic and the conventional banking is taken into account. This paper shall thereby make an attempt to remove the misleading meanings that in many cases has been blurring the true image of the Islamic banking in the world. Islamic banking has many differences as compared to the conventional banking and here the differences shall be highlighted. An important role is being played by the Shariah advisers as these are the one who have the responsibility to take the responsibilities of all the laws and the rules being followed in the Islamic banking. It has been made sure that all of the terms and the conditions are fully clarified to the customers so that the dealings can take place in peaceful manner. These are the main terms that need be clarified in these papers so as to clarify what Islamic banking is in the try manner. In addition to this an attempt to clarify the terms is to be made so that the rules and the legislations that are being followed by the banks are clear making the customers think clearly on the services being provided by the banks. This paper shall make an attempt to clear the blurry minds in case of the services being provided by the Islamic banks. The main services that are provided by the Islamic banks shall be discusses here in a detail so as the services are clear along with their terms as well as the conditions that make these services easier for the consumers. In addition to this there are many differences that need to be highlighted so as they are cleared. Chapter 3 - Literature review The banking activity that is in accordance to the Islamic laws is generally referred to as the Islamic banking. In this case all the banking and the banking setup is designed in such a way that they are in compliance with the predetermined Islamic rules and regulations. Islamic law in general terms is known as the Shariah (Greuning & Iqbal, 2007). Banking in this case is done by run by the implementation of the rules and regulations in the lines of Islamic rule so as to shape a pragmatic Islamic economical program all around the world. The general financial and the banking terms can be easily understood by the people who are in touch with the normal non Islamic banking however in the case of Islamic banking as has been seen there are many terms that need to be understood and realized in the comprehensive manner so as to make sense of all the rules and regulations being followed all around the world. The Shariah or the Islamic law, in banking makes prohibitions against renting of money in return of the payment of some fees as this has been known as Riba or Usury (Iqbal & Mirakhor, 1987). In the normal language usury means charging of interest on the loan that is being provided to the person. Riba and usury have been recognized as the same subject in Islamic banking and both are concerned with the interest prohibition on the loans. In this case there are two main types of Riba that have been discussed by the jury of the Islamic scholars. The Riba has been prohibited in holy Quran as well in Sunnah. In the holy Quran it has been prohibited by saying that the increase made in the capital when there are no special services being provided to the clients comes in the lines of being prohibited. In the case of Sunnah, the Riba has been prohibited when the commodity exchanges are made in unequal quantities. Another term that is usually used in the Islamic banking is the "haraam" or the forbidden (Venardos, 2006). This is the term which is used when the services being used by the banking systems in the Islamic states are in their functional zones in the rules that are against the Islamic rules. In the earlier times when the economy was in the flourishing state it has been known that these are the main principles that were being used as the basis so that the finance and the economy can show some development. There has been a trend for the development of the Islamic banks in the 20th century as the need has been realized that the banks in these days are the one kind of economic holders that need to follow some specific rules that can not only satisfy the customers to the banking system but can also make the system run in a better manner. In the case of the development of the banking institutions the semi private and the commercial banks are being created so that the rules can be implemented within the banking system that are being run in the Muslim states. The first modern face of the Islamic banking had been seen in Egypt (Akbarzadeh & Saeed, 2001). This bank had been an undercover bank as it had the rules and legislations of the Islamic finances and economics; however, the banks had not been opened in the officially Islamic banking image. In case of the principles that are followed by the Islamic bankers it has been seen that the conventional banking riles and the Islamic banking logics and the rational is almost the same where the only difference is that the conventional banking systems are not made in accordance to the rules of Shariah. Rules of Shariah that are being followed in case of Islamic banking are referred to as Fiqh al-Muamalat (Oxford Business Group, 2006) and these in the normal language are referred to as the rules of banking transactions. Basic rule of the Islamic banking are the ones that are more considerate towards the sharing of the profit and loss in the banking transaction systems and the second most important rule being the prohibition of Riba. There are many terms that are being used in the Islamic banking and these are the terms that need to be discussed here in brief. The first term is generally known within the Muslim community and this is the Mudharabah and this deals with the profit sharing in the banking system. The second most important term has been known as the Wadiah and this means the safekeeping rules in Islamic banking, Musharakah refers to the joint venture, Murabahah meaning cost plus and the last term being the Ijarah that refers to the leasing (Al-Suwaidi, 1994). The case of Islamic based mortgage transaction has to be described briefly. In case of the Islamic banking as has been seen instead of the money being loaned to the buyer for buying of any item, the Islamic bank makes an attempt to buy the item from the seller himself and then the item is sold to the buyer at a profit price and in the end the buyer is offered to make the payments to the banks in installments. In this case it has been seen that there are no penalties for the late payments being made. Home loans have been an innovative and a creative approach given by the Islamic banks and this is known as the Musharaka al-Mutanaqis. In this case as has been seen the consumers are offered to flat rates in rentals for the house. Islamically acceptable transactions are involved in the Islamic banking that does not involve any alcohol as well as gambling. Ethical investing has only been seen in the Islamic banking and it has been seen that the moral purchasing has been encouraged in most cases. Recently there are some Islamic banks that have started working on the micro financing and this has had its own importance in case of the globalization as has been seen in case of the credit crunch that is being faced. The Shariah Supervisory Board is to be followed by the Islamic banking institution so that they follow the advices and the recommendations that are made by the board. Islamic banking and finance in the Middle East The Middle East is the main area where Islamic banking and finance takes place. The Islamic financial institutions have been attempting a lot for the development of a variety of different, customer-oriented and competitive facilities for the customers. They aim at getting a powerful hold over the native oil-rich plus also try to decrease the wealth from going to the banks of the west. There have been rising numbers of traditional financial institutions in the markets of the Middle East which have been completely or partly changing the functions to be based on Islamic rules. This can turn out to be a major problem to the conventional legacy of the former kind of banking in that area. Islamic banking and finance in South Asia The region in the South Asia has great abilities of becoming a majorly important area for Islamic businesses and finance activities. Most of the Muslims residing in South Asia are living in five nations - those of Afghanistan, Bangladesh, India, Maldives and Pakistan. Out of these, in four nations the Muslims rule and the in India, the fifth country, the Muslims makes up the largest minority. India and Pakistan have seen a growing expansion in their economies. There are several Middle Eastern wealthy investors and Islamic financial institutions who undertake trade as well as ventures in the markets of India and Pakistan. As recorded in 2008 the Islamic banks were operating only in Bangladesh and Pakistan; however, there were good chances of such mechanisms being introduced in Afghanistan and India as well soon enough. Because of Islamic financing it is very much possible that Afghanistan would find this very lucrative since the nation would be able to obtain large amounts of donation, qard-e-hasanah and venture capital by means of Islamic business and the banks throughout the world (Khan & Bhatti, 2008). India too, can gain from Islamic banking since through the system the country would be able to access huge business and finance chances. There are several foreign banks such as the Grindlays, Standard Chartered, HSBC, ICICI Bank India and Kotak Mahindra which have been currently providing at least some features of Islamic banking to the Muslims in India. Islamic banking and finance in European and Western countries There has been an encouraging of Islamic banking and finance in the western region and this has taken place due to the local banks only. Such banks include Citibank, ABN AMRO, Goldman Sachs, and Kleinwort Benson. All such institutions have set up either Islamic entities or "Islamic windows" or holdings for attracting the oil-wealth from local customers coming from Middle Eastern regions or the Muslim background. Other than this the not-so-important and locally situated financial institutions have initiated services in Islamic banking products in markets in west. Chapter 4 - Methodology Introduction This chapter is going to provide with a discussion of the research methods that are available for conducting any research. After this is given the research method that would be employed in this case. Purpose The purpose of this report was to explain the procedure through which the required data was collected to be able to test the statements made in the literature review. Research Approach Social research can be deductive or inductive and each is applied according to the research type. Deductive approach is defined in the following terms: "Deductive reasoning is a theory testing process which commences with an established theory or generalisation, and seeks to see if the theory applies to specific instances" (Hyde, 2000, p.83). Conversely, inductive approach is said to be: "Inductive reasoning is a theory building process, starting with observations of specific instances, and seeking to establish generalisations about the phenomenon under investigation." (Hyde, 2000, p.83). The research that was conducted used a deductive approach. This is because first the existing literature about Islamic financing and banking industry were considered and delved into and the research itself followed it. There are different approaches to research and they encompass theory as well as method. Two approaches are qualitative and quantitative research. The aim of qualitative research is to look at attitudes, behaviour and experiences (Baker & Hart, 2007, p.148). This research uses criteria such as interviews and focus groups. In this kind of research the person wants personal opinions from the respondents. On the other hand, quantitative research looks into facts and statistics. It is usually a wide scale survey. In this research the person uses questionnaires, structured interviews or secondary data analysis. The research that was undertaken is a quantitative research. This can be said because the research involved obtaining opinions from respondents on a general level. The same questionnaires were given to them. There were not one-to-one interviews. Each research has its own benefits and pitfalls. In this case quantitative research is thought to be dependable and so would be appropriate enough. This is because the results that are obtained are statistically reliable. That means, quantitative research can reliably decide as to whether a particular concept is better than another. Another advantage is that the results are projectable to the proportion. This means that the proportion of participants responding a particular way is more or less the same as that when the whole population would have responded. Research Strategies Evaluation research employs many different research methods. Before starting on a study a researcher is supposed to decide on the focus and form the research question, that is, what the researcher is attempting to find out. After that the researcher is to select the kind of strategy that he would make use of for the research and also the method. That would be followed by setting the physical constraints and then gathering the required information and recording it. For this topic a primary research was conducted which allowed for gaining of information about the unprecedented growth of Islamic banking and finance in the contemporary finance world. For this research a questionnaire was prepared and sent to the intended participants. These included general users of Islamic banking institutions, finance managers, and people into this field. They were asked questions about the Islamic financial system. The people were such who knew about the banking systems, particularly the Islamic system. The questionnaire can be made up of a particular type of questions or many different kinds. For example, there are open ended and close ended questions. This questionnaire was a combination of both open ended as well as close ended questions. The former allowed for more detailed answers while the latter is more to the point. By combining the two kinds insight in the areas where the respondent feels it is required by him to write in detail was obtained. Questionnaires and interviews are more or less the same; the difference is only in the method of questioning. A questionnaire is: "similar to a survey, but often asks for opinions not facts" (Kirkby, McClure & Roe, 1924, p.152). Data Collection Methods The questionnaire can be sent to the required participants by post or e-mail or it can even be hand delivered. In this case the questionnaires were hand-delivered to the staff of the Islamic Bank of Britain. Through the survey the required information was found and the answer to the research question is discovered. In the present research the questionnaires were given to the Islamic Bank of Britain. Sixty copies of the questionnaire were made. There should have been more questionnaires filled as the more responses received, the more accurate the research is. However, for ease of analysis the number of questionnaires was limited to sixty. The questionnaires were given out randomly to the employees and customers of the bank- they were hand delivered to any person who was present at the time of visit. Thus, it was a completely random survey. Chapter 5 - Conclusion The Islamic banking and finance system gives to the world a highly principled as well as effective option in place of the interest-based traditional kind of financial mechanism. It was in the beginning of the 1970s that the Islamic banking and finance institutions came up in the markets of Middle East. Such banks were built upon the models that the Islamic economists had constructed previously. After the models had been adopted by the Middle Eastern nations the other Islamic nations also adopted this system and initiated their individual Islamic banks. There were three Muslim nations namely Iran, Pakistan and Sudan who initiated the adoption of Islamic banking. There were also certain western banks that commenced Islamic banking and such products for providing services to the Muslim clients. In the initial stage there were continuous and great expansions made in the industry of Islamic banking and finance. With time there has been unprecedented expansion which has been due to particular main elements such as the continuously rising oil prices throughout the world, expanding economies in the Middle East area, rising diversification of Islamic banking items, customers and markets, along with some other alterations having taken place (Khan & Bhatti, 2008). Islamic banking and finance has been highly successful in the Middle East and Asian regions and it has brought about great effects on the international financial markets. Now more and more financial institutions of the west are adopting Islamic banking system in order to get the Muslim customers who are rich in oil. The western market settings seem to be highly favourable for Islamic banking. Such kinds of progress seem to be highly hopeful. References Ahmed, Z. (1994). Islamic banking: state of the art. Islamic Economic Studies, 2(1): 1-34. Akbarzadeh, S., & Saeed, A.(2001). Muslim communities in Australia. UNSW Press. Al-Suwaidi, A. (1994). Finance of international trade in the Gulf. BRILL. Baker, M. J. & Hart, S. 2007. The Marketing Book. 6th ed. UK: Butterworth-Heinemann. Greuning, H., & Iqbal, Z. (2007). Risk analysis for Islamic banks. World Bank Publications Hyde, K. F. 2000. Recognising deductive processes in qualitative research. Qualitative Market Research: An International Journal, 3 (2), p.82-90. Iqbal Z., & Mirakhor, A. (1987). Islamic banking. International Monetary Fund. Khan, M. M., & Bhatti, M. I. (2008). Islamic banking and finance: on its way to globalization. Managerial Finance, 34(10): 708-725. Kirkby, D., McClure, L. & Roe, C. 1924. Maths Connect: Pupils Book Level 1. UK: Heinemann. Oxford Business Group. (2006). Emerging Malaysia 2006. Oxford Business Group. Siddiqi, M.N. (2000). Evolution of Islamic banking and insurance as system rooted in ethics. New York, NY, Proceedings of the Takaful Forum. Venardos, A. M. (2006). Islamic banking & finance in South-East Asia: its development & future. World Scientific. Read More