Scope of Islamic Banking - Coursework Example

Islamic banking system in the UAE Introduction Under circumstances when the conventional banking system fails to provide any solutions Islamic banking system can provide business solutions. In normal parlance the conventional banks are mainly financial intermediaries between the investors and entrepreneurs. The profits of such banks are earned by borrowing at one rate of interest from the surplus holders and then lending it at a high rate to the ones who are able to use it profitably (Lawai, 1994). Whereas Islamic Banking is partaking in the fruits of economic activity yielded through intermediation of savers and investors. The rationale behind the elimination of interest in banking dealings is its forbiddance in Islam. The rulings against interest, substitutable to riba, are clear and the word, under a variety of intensions of forbiddance, emerge numerous times in the Holy Quran. It covers financing for trade and industry tangled in banned goods and services (Lawai, 1994) The market for Islamic banking has developed speedily over the past few years, and this strong development is anticipated to prolong for the predictable future. In many markets, Islamic banking has developed from being a niche offering into being part of the normal financial services background. Simultaneously, the aggressive setting is being redrawn, with more Islamic financial services associations in the market than ever before. Present banks and new market fledglings are confronting immensely different market circumstances and need to formulate new beginnings of distinction beyond conformity with sharia (Islamic law) to vie or stay successful in the future (Peter, et al, 2008). Scope of Islamic banking Since its setting up in the mid-1970s, Islamic banking has come out from a niche to financial service providers in the mainstream markets. Even though there are a small number of official figures on the extent of the market and figures deviate extensively the entire volume of Islamic assets is alleged to be about US$500 billion. Dubai Islamic Bank is normally accepted to be the first full-grown Islamic bank. This bank was instituted in 1975. Since then the number of institutions functioning in line with sharia has mushroomed. At present there are more than 500 Islamic financial services institutions all over the world. In only during the past 2-3 years, more than 50 Islamic financial services institutions have been established (as shown in the figure below) (Peter, et al, 2008). The Middle East particularly, has seen an outburst in the number of these establishments, both banks and non-banks. For instance, Boubyan Bank was established in Kuwait, Bank Al Bilad was launched in Saudi Arabia. Noor Islamic Bank and Al Hilal Bank are of recent origin and were established in the United Arab Emirates. At the same time Bank Al Inma is launched in Saudi Arabia. The total capital of all the banks mentioned above is about $15 billion (Peter, et al, 2008). Examples of New Islamic banks: Conversion of conventional banks to Islamic banks Source: Central Banks; The Banker, Islamic Business and Finance Network, Islamic Development Bank Booz $ Company. The banking sector in the UAE During 2005, the banking sector in the UAE was served by 21 domestic and 25 foreign banks. Thus the UAE banking sector is quite disconnected. Banks which are instituted in Abu Dhabi and Dubai contain more than 90% of the total domestic assets. This total asset is actually fractioned almost evenly between Abu Dhabi and Dubai banks (Anaam, 2007). During the years 1980 to 2003 the access for financial services markets for foreign banks was rather fixed because they were not permitted to unfold more than 8 branches all through the modern banking process. In 2003, nevertheless, laws were altered, and now banks are permitted to have more than 8 branches but exceptional authorisation is needed. Foreign banks faced no obstructions in case they wanted to open a representative office (Anaam, 2007). At the end of 2004, there were 36 representative offices all over the emirates. Thus, UAE is well constituted by a range of foreign banks. Appendix 1 contains a list of all domestic and foreign banks operating in the UAE and appendix 2 is a list of representative offices of foreign banks (Central Bank of the UAE, 2006), (Anaam, 2007). The UAE Federal Law 10 of 1980 which was ordained in 1980 is the spine of the established banking sector and does not include the Islamic banks. The UAE Federal Law 6 of 1980 was proclaimed in 1985 to authorise Islamic banking in the UAE. Islamic banking is even now a minor portion of the UAE banking sector. The reason is that the Islamic law states that banks are banned from charging fixed interest on deposits or loans (Anaam, 2007). The Islamic Banking is based on a variable interest rates based on a profit / loss sharing model. According to the UAE Federal Law 10 of 1980, the Central Bank of the UAE was also founded, and the responsibilities of the Currency Board came under its governance. The bank advises the government on issues related to monetary and finance, currency issuing, maintenance of gold and foreign currency reserves and also credit policy formulation. The Central Bank directs with regard to the regulation and administrative duties (Anaam, 2007). The currency of the UAE is nailed to the US dollar, and this is the reason for the limited role of the central bank in fixing fiscal guidelines and ascertaining interest rates. But some of the monetary and credit controls are conducted by way of sale and leverage of certificates of deposits (Anaam, 2007). The central bank’s role is to formulate and monitor credit policy, and in supervise the monetary sector as well. All commercial banks instituted in the UAE are certified by the central bank, and hence are subject to the central bank’s requisites and rules (Anaam, 2007). In 1998, the central bank passed a mandatory rule stating that all banks must use International Accounting Standards (IAS), and in the beginning of 1999, local banks were appraised to set up clear corporate structures. Moreover, the UAE central bank calls for banks to hold a capital to risk-weighted assets proportion of at least 10% at all times. The Central Bank of UAE regulates and instructs that all banks must have UAE nationals as their majority owners and also to register themselves as “Shareholding Company” under the UAE Companies Law. Apart from this they must be registered with the Federal Ministry of Economy and Trade (Central Bank of the UAE, 2005). It is crucial to note that investments in Islamic Banks are segregated into two types that is profit and loss sharing investments and this includes Mudarabah that is trust partnership and mark-up base investments which includes the Murabahah which is sale contract with mark up. Number of Banks in the UAE as at 2008 47 commercial banks are located in the UAE out of which 22 are national banks and the remaining 25 are foreign banks. 5 Islamic banks can be found amount the national banks as at the end of 2008. The entire assets of the national banks have increased from AED 123 billion in 1996 to AED 1,041.7 billion in 2008. The total assets of Islamic banks have augmented from AED 7.1 billion in 1996 to AED 182.6 billion in 2008. The percentage of UAE Islamic banks’ assets has augmented from 4.1% of the total assets of the UAE banking sector and 5.5% of the UAE national banks’ assets in 1996 to 10.6% and 14.9% in 2008 respectively (Emirates Banks Association and Orisis database). On the other hand, the UAE Islamic banks’ market share is even now comparatively little, even though the UAE is a Muslim country. Research conducted by different researchers on UAE Banks Rao (2002) examined 35 domestic and foreign banks functioning in UAE for 1998 and 2000. He studied cost ratio, scale and range criterion, and cost efficiency development rate. Finally after his research, Rao (2002) concluded that considerable cost inefficiencies and range economies existed in UAE banks. Apart from this he detected that only small banks bettered their scale economies while large banks observed status quo. This encountering discloses that the management teams of small banks were competent of dealing with their portfolio more expeditiously than larger banks. Duncan and Elliott (2002) by trial and error studied the relationship between service quality and financial operation among agent cross-section of Australian banks and credit unions. They established that all financial operation measures are completely concurrent with service quality measures. Al-Tamimi and Al-Amiri (2003) examined two major Islamic banks in UAE (Dubai Islamic Bank and Abu Dhabi Islamic Bank). Actually these 2 banks dictate the Islamic banking sector having 21 branches throughout UAE (only 5 percent of conservative banks). They equated the service quality of these banks with deep-rooted SERVQUAL standards. The research established that these two chief banks have statistically noteworthy apparent service quality. This discovery is opposing to the trust that most of the domestic conservative and Islamic banks may have a service quality concern with customers. Thus UAE banks must concentrate on their quality of service if they want to compete with foreign banks, mainly when the banking segment opens up. Troubles and Handicaps for Islamic Banking According to Lawai (1994) even though Islamic banking has been acknowledged as an alternative, autonomous organisation of banking free from riba, all the same it is still going through a host of problems and handicaps. They are: (i) Financial frauds in the pretext of Islamic banking have been detected during the last two decades. These frauds actually were committed on the small savers under the pretence of profitable and usual financial profits in the name of Islamic systems of financing Lawai (1994). (ii) Certain instruments which are used by the Islamic bankers have raised some doubts in the minds of the Islamic jurists and they are even now under criticism. Doubts in particular pertain to selling and acquiring of currencies and Murahaba and financial rental Lawai (1994). (iii) Most of the Islamic banking is not in a position to develop due to inadequate economic, financial and legal substructure. The most common areas of distress are due to their economic policies and dictatorial policy which are unstable and does not have a uniform regulative framework. The economic and financial areas are also lacking. Apart from this the structure of tax and their legal frameworks are normally unproductive and not favourable to Islamic banking Lawai (1994). Islamic Banks and their responsibilities Deposits are not assured in the Islamic banks in UAE. But on certain occasions the government has interfered to guarantee that investors do not suffer a loss. The legal and regulatory restrictions applies to transactions between banks and their affiliates are that some prescribed percentages of maximum vulnerability that a bank can acquire to its parent company or subsidiaries or other subsidiaries of its parent company. A minimum of 40% of share capital or that percentage which influences the controlling of the subsidiary can be held by a bank. Also, Circular No. 16/93 published by the UAE Central Bank regularises huge exposures obtained by banks. Large exposures are in reality funded disclosures which means they will have less provisions, cash collaterals and deposits under lien. Banks are limited from overstepping the maximum disclosure per client or group (Afridi et. all, 2009) Islamic banking is more multifaceted than conventional banking as the products must match not only the material laws of a country but also to interpreting of the holy Quran by local Islamic scholars. A vital principle of Shari'ah is riba, the ban of interest. Furthermore, Islamic law does not allow usage of funds for investments or leverages linked to actions it views as forbidden (haram), for example alcohol ingestion or gambling. In common, everything not set as haram is conceived allowable (halal) under Shari'ah. On the other hand, Shari'ah versions can differ by region and country since they are determined by local Islamic scholars. Banks striving to offer Islamic banking characteristically enroll local scholars to serve the bank Shari'ah board or committee to help in planning Shari'ah-amenable bank products and operations. Many bigger established banks also have a specified function to train employees and check continuing observance to Islamic principles (Hunt, 2007). Al Rahji bank, for instance, has a Shari'ah Group whose main obligations are to study the transaction and activities of banks and send reports to the Shari'ah Committee so that suitable policies can be prepared. The group has to check the execution of policies determined by the Shari'ah Committee and its Executive Committee with regard to both internal and external activities of all the Banks. The group also has the duty to build up formats, contracts and creations giving weight to Islamic regulations. The group also has to augment consciousness of Islamic finance in the Bank and away from it and also build up essential information and communication ways to enforce the Group's responsibilities (Hunt, 2007). Synopsis of Islamic Banking Products Above and beyond following the inhibitions against interest and the financing of prohibited actions, Islamic banking products are established on the conception of property swap, profit and risk allocation, and firmness. Uncertainty (gharar) is not permitted, and agreements relating to banking services must undoubtedly describe the obligations and privileges of the customer and bank as to the possession of property, fees, and risk sharing (Hunt, 2007). Islamic Banks and their Deposit Products Shari'ah-amenable banks can extend customers non-interest-paying current accounts but cannot render usual interest-paying savings or time deposit accounts. On the other hand, banks can offer wadiah accounts, which operate much like formal savings accounts. These accounts are established on safe custody contracts whereby the bank assures to accommodate the deposit account for the customer. Islamic banks normally present a hibah credit to the client as an incentive for holding the deposit account. This incentive relates to a share of the bank's profits, and it is the exclusive prudence of the bank. But banks which do not provide hibah will naturally not be able to capture a significant market share with competitors (Hunt, 2007). Mudaraba investment account is another account which is similar to deposits but which awards clients who hand over their funds to the bank. The funds deposited in mudaraba accounts can be made a part of a common coming led investment fund or, with the request of the customer and conformity of the bank; these funds can be used to finance a precise project. Even though there is no assurance of return, any successive profit from the funds deposited so can be circulated to both the bank and the depositors. Since any losses are assumed exclusively by the capitalists, many Islamic banks have founded reserves and they endow the funds conventionally to defend the clients' principal (Hunt, 2007). An attractive characteristic of the deposit productions is the calculation of zakat, a benevolent payment founded on the yearly wealth or income of the client. If the wealth or income surpasses a limited amount which is known as nisab, the bank computes the zakat amount for the client. The zakat finances are then spanned into an exceptional government-patronised fund for following charitable dispersion. Even though the zakat computation is mostly based on deposits and investment funds, banks in numerous countries also let in the amount credited by the customer in the zakat computation (Hunt, 2007). Islamic Funding Products The 3 key kinds of Shari'ah-compliant retail funding products use dissimilar agreements between the bank and customer. The agreements vary with regard to the ownership of the goods, quality of payments, and dealing of profit and loss. As an alternative to interest, the banks charge managerial and board fees that meet their costs and render them a profit margin. All the three kinds of contracts can be utilized for home financing. The most generally used contracts are the ijara which is leasing and musharaka which relates to partnership or profit-sharing (Hunt, 2007). Murabaha contract financing: Under this the client specifies the goods to be bought and talks terms with the bank with regard to the down payment and full amount of determined payments the customer is eager to pay. This amount constitutes the purchase value and a rational fee over a decided period of time. The bank then buys the goods and sells them to the client, authorising the title to the client during the purchase. This cost-plus kind of contribution of finance is normally protected to the level that the consumer cannot sell the goods exclusive of permission from the bank (Hunt, 2007). Ijara financing contracts These are similar to rent-to-own systems. The consumer keys out the goods and bargains with the bank the full amount of payments which also includes an administrative or management fee which the consumer may have to pay to the bank. The bank then buys the commodities and holds back the ownership till the payments have been finished (Hunt, 2007). Musharaka contract This type of contract, calls for sharing of rights of a property among the bank and customer. The consumer names the property and bargains with the bank for the full purchase cost of the goods and the proportion of ownership. The property is then rented to the consumer. Defrayals include a sum to be enforced to the bank's fraction of ownership in addition to the managerial and maintenance costs. The ownership proportion is corrected occasionally thereby reducing musharaka to replicate the consumer’s collective payments. Most Islamic banks also extend two exclusive profit-free funding types to individuals. Hajj financing is extended to Muslims who wish to partake in the Hajj which is an annual spiritual pilgrimage to Mecca. Hajj funding is normally unlocked and may need only proof of the customer's journey plans(Hunt, 2007). A second exclusive product to Islamic banking is qard alhasan or qard hasan. This is a profit-free funding which is financed by the bank and is established on the applier’s adversity or benevolent need. Hajj and qard hasan funding ponder the principled role of Islamic banks (Hunt, 2007). The notion of future release of goods has vagueness as to the date of deliverance and possibly the price as it depends on the contract terms and thus seems prohibited under Islamic law. Two Shari'ah-amenable products have been formulated to convene the requirements for funding the future release of property or goods. These funding products are established on either Istisna or Salam contracts. Istisna contracts are used to manufacture goods or for construction projects and need the purchaser and vendor to accord on a determined price and elaborated stipulations. The bank behaves as the third party, undertaking with the purchaser to render the goods and with the vendor to create the goods. Upon achievement of the seller's obligation, the bank pays off the vendor and the buyer afterwards pays up the bank either in full or in pre-determined installments (Hunt, 2007). Salam contracts vary from istisna contracts. In such contracts the bank compensates the vendor before hand for the future deliverance of goods. Salam contracts are normally applied to meet the funding requirements of small farmers and dealers, and they call for goods that can be depicted in detail with regard to the quantity and quality. The bank undertakes with the consumer for the release of the goods at a precise future date and works up a profit margin into the cost agreed. The bank accepts ownership of the completed goods and sells them to get cash defrayal and record any profit (Hunt, 2007). Conclusion The business of Islamic banking and finance arranges its business and financial dealings harmonising to a belief structure that considers community, partnerships and corporate trusts as its main precedence. Islamic moneymen reward business patterns and financial social systems that underline the reciprocal gains of sharing both gains and losses with consumers, instead of concentrating on profit only (http://works.bepress.com/ cgi/viewcontent.cgi?article=1001&context= karen_ hunt_ahmed retrieved on 19th April, 2010). References 1. Afridi, Angell; Bashir, Ahmed; Jayanthi, Guru. 2009. Retrieved from www.gettingthedealthrough.com on 19th April 2010 2. Al-Tamimi, Hussain and Abdulla Al-Ameri, (2003) Analyzing Service Quality in UAE Islamic Banks, Journal of Financial Services Marketing, Vol.8, 2, PP: 119-132. 3. Central Bank of the United Arab Emirates, January 2006, http://www.cbuae.gov.ae/ Retrieved on 18th April, 2010. 4. Duncan, E. and Elliott, G. (2002) Customer Service Quality and Financial Performance Among Australian Retail Financial Institutions, Journal of Financial Services Marketing, 7 (1): pp. 25-41. 5. Emirates Banks Association, “Financial Position of Commercial Banks in the UAE”. Different issues, Abu Dhabi. 6. Hashmi, Anaam, M. (2007). “An Analysis of the United Arab Emirates Banking Sector.” International Business & Economics Research Journal, 6(1): pp.77-85. 7. Hussain, Lawai. 1994. “Key Features of Islamic Banking.” Journal of Islamic Banking and Finance, 11 (4): pg 7-13 8. http://works.bepress.com/ cgi/viewcontent.cgi?article=1001&context= karen_ hunt_ahmed retrieved on 19th April, 2010 9. ORISIS database, University of Sharjah Library. 10. Rao, Ananth (2002) Estimation of Efficiency, Scale & Scope and Productivity Measures of UAE Banks. 11. Robert. Hunt, 2007 “Islamic Banking: Core Vendors Fill Growing Demand for Shari'ah-Compliant Banking”. Published in The Tower Group, Inc. 12. UAE Federal Law of 1980 13. Vayanos, Peter, Wackerbeck, Philipp. Golder, Peter and Haimari, George. 2008. “Competing Successfully In Islamic Banking. Booz & Company Inc. APPENDIX 1 Domestic Banks Operating in UAE Foreign Banks Operating in UAE 1. Abu Dhabi Islamic Bank (ADIB) 1. Al Ahli Bank of Kuwait K.S.C. 2. Abu Dhabi Commercial Bank (ADCB) 2. ABN-Amro Bank N.V. 3. Arab Bank for Invest. & Foreign Trade 3. Arab African International Bank 4. Bank of Sharjah (BOS) 4. Arab Bank plc. 5. Commercial Bank International (CBI) 5. Bank of Baroda 6. Commercial Bank of Dubai (CBD) 6. Bank Saderat Iran 7. Dubai Bank 7. Bank Melli Iran 8. Dubai Islamic Bank (DIB) 8. Banque Banorabe 9. Emirates Bank International (EBI) 9. Barclays Bank Plc. 10. First Gulf Bank (FGB) 10. Banque du Caire 11. Invest Bank 11. Credit Agricole Indosuez 12. Mashreq Bank (MASHREQ) 12. BLC (France) S.A. 13. Middle East Bank 13. BNP Paribas 14. National Bank of Abu Dhabi (NBAD) 14. HSBC Bank Middle East (HSBC) 15. National Bank of Dubai (NBD) 15. Citibank N.A. 16. National Bank of Fujairah 16. El-Nilein Bank 17. National Bank of Ras Al Khaimah 17. Habib Bank A.G.Zurich 18. National Bank of Sharjah (NBOS) 18. Habib Bank Limited 19. National Bank of Umm Al Qaiwain 19. Janata Bank 20. Union National Bank (UNB) 20. Lloyds TSB Bank Plc 21. United Arab Bank 21. National Bank of Bahrain 22. National Bank of Oman S.A.O.G. 23. Rafidain Bank 24. Standard Chartered Bank (Stan Chart) 25. United Bank Limited APPENDIX 2 Representative Offices Of The Foreign Banks 1. American Express Bank Ltd. 19. Kotak Mahindra International Ltd. 2. Bank Brussels Lambert 20. Kuwait Interests for Financial Investments (KSC) 3. Bank Muscat (S.A.O.G) 21. Man Investment Ltd. 4. Bank of America - National Association 22. Merrill Lynch Bank (Suisse) S.A 5. Bank of Bahrain and Kuwait (B.S.C) 23. Natexis Banque – Pupulaires 6. Bank of Beirut SAL 24. Nationwide International Ltd. 7. ICICI Bank Ltd. 25. Philippine National Bank 8. Citi Group Global Markets 26. Royal Bank of Canada 9. Clearstream Banking S.A. 27. Societe Generale Bank 10. Coutts & Co. 28. Standard Bank London Ltd 11. Credit Suisse 29. State Street Bank and Trust Company 12. Deutsche Bank AG 30. Towry Law (Asia) HK Ltd 13. Dresdner Bank A.G. 31. UBS A.G. 14. Fidelity Investments International 32. Union Bancaire Privee (CBI-TDB) 15. HDFC Bank Ltd. 33. Union de Banques Arabes et Francaises (UBAF) 16. HSBC Bank International Ltd. 34. Unit Trust Of India 17. Indusin Bank Ltd. 35. Wachovia Bank National Association 18. Korea Exchange Bank 36. West LB A.G. Read More