Islamic Mortgage System as a Solution to Prevent Future Current Credit Crises - Research Proposal Example

Table of Contents Introduction 2 Problem Statement 2 Research Question 2 Significance of the Study 3 Definition of Terms 4 Limitation 4 Organization of the Study 5 Literature Review 6 Methodology 13 Research Method 13 Population & Sample 13 Instrumentation 14 Data Collection 15 Data Analysis 15 References 17 Introduction This chapter will look at presenting the reason for carrying out the research and will identify the research background, the research question, the significance of the study, the limitation of the study and the structure which the research will follow. This will thereby lay the foundation based on which research will be carried out. Problem Statement The financial system has been continuously been impacted by financial crisis which has impacted economic growth (Chapra, 2008). Banks whether Islamic or conventional bank is central for economic growth and identifying the different reasons which has led towards financial crisis and having appropriate strategies which will help to reduce such crisis is the need of the hour. There are different literature and researches available for the reason for financial crisis but very little information is available regarding the reason which Islamic banks were affected to such an extent as conventional bank during the financial crisis. This thereby presents a good reason for analyzing and finding out the different reasons which traditional banks can adopt from Islamic banks as Islamic mortgage system provides a solution which can help to reduce credit crisis in the future. Understanding the manner in which Islamic banks works and following their model for mortgage system conventional banks can reduce the level of risk and ensure that their banks are able to reduce the chances of a financial crisis in the future Research Question The research study will focus towards answering the following mentioned research questions Identify the manner in which Islamic mortgage system works as it helps to reduce tje impact of financial crisis? What are the challenges which Islamic banking system is facing and the areas they need to work to reduce such challenges? Determining the manner in which interest free banking system (Sharia principle based) has helped the Islamic mortgage banking system to withstand financial crisis? Identifying the manner in which Islamic banking system works in comparison to conventional banking system? Identify the manner in which conventional banks can work according to the Islamic mortgage system so that the overall chance of a financial crisis in the future is reduced? Identifying the different reasons which helped Islamic banks to avert financial crisis to a large extent? Finding out the different areas which conventional banks can adopt from Islamic banking system so that financial crisis can be averted in the future? Developing and identification of policies and strategies which will help both conventional and Islamic banks to reduce the impact of financial crisis? Significance of the Study The importance of the study lies in the fact that it will help to identify the manner in which Islamic mortgage bank work and is a solution to prevent future financial crisis. This will increase the opportunity of averting financial crisis in the future and will provide an opportunity for conventional banks to learn and work on the same model which Islamic banks follow. Since, financial crisis have become a part of business and it impacts economic development so identifying the different areas which when worked on will help to reduce the impact of such a crisis is imperative. This study will look to focus on those areas and bring forward the manner in which Islamic mortgage banking system works which has helped them to reduce the chances of a financial crisis and acts as an example for other banks to follow. Definition of Terms The term “banco” which arose in the middle ages means table which refers to the table which a banker has and displays the entire records of a banker (Sineldin, 1990). This theory helps to bring forwards the reason which led towards the existence of banks and the manner in which different functions were performed by the banks. Investment bank is a financial institutions which helps government and corporations in raising finance through the issuance of securities, mergers and acquisitions. Islamic banks is a conventional bank which works on the principles of Sharia and is governed by the Islamic economic law. The basic principle which governs Islamic Banking law is that no interest is paid or collected and an arrangement of profit and loss sharing in entered into. Limitation The limitation of the study is that it will not go into details regarding the concept of Sharia law as the research doesn’t goes into details regarding the conventional banking system. In addition to it paucity of time and data is another hindrance to the research. Since limited data is available with regard to Islamic banking institutions and the manner in which it was able to deal with financial crisis so that research gets restricted. Organization of the Study Chapter 1 will look to present the introduction by highlighting the research problem, research question, significance of the study, limitations and definition. This will set the tone for the research which is being carried out Chapter 2 will present the literature review and will focus on using past published research and sources so that the manner in which Islamic bank and conventional banks work can be understood and will help to lay the foundation which led towards the financial crisis Chapter 3 will present the methodology which will state the research method, the research question, the sample size, the research strategy and other areas related to which the research will be carried out. Chapter 4 will present the findings and analyze the data to present the different results which the study reveals. This will lay foundation for future research and will determine the path based on which future research will be carried out. Chapter 5 will provide the recommendation and conclusion and will present the entire thesis in a framework. This will also lay down the research question for further research and will help the user by guiding them in future research. Literature Review This chapter will look to present the literature study based on past published research and publication. This chapter will look to provide information pertaining to both conventional banks and Islamic banks and will help to understand the working and the manner in which Islamic banks differ from conventional banks Justification for the existence of Banks Zineldin (1990) has stated that the main purpose of banks is to act an intermediary between the depositors and the lenders. Banks carry out the purpose of gathering the funds from those scattered individuals, who earn more and spend less and provide the same to different government bodies, institutions and people who earn less and spend more (Casu, Girdardone & Molyneux, 2006). Five different theories which highlights the manner in which banks work have been identified and are as First theory is delegated monitoring which states that the lender looks to pass on the burned of monitoring the risk of the borrowers to agents who have specialized knowledge so that they can be more secure about their funds. Since banks have an economy of scale and can gather vast information about the borrower so it provides an opportunity through which better monitoring becomes possible and it helps to reduce the level of risk (Casu, Girdardone & Molyneux, 2006). Second theory is the information production theory which states that there is a cost associated with gathering of information. Since it is not possible for the lender to gather all information about the borrower due to increased cost associated with it so banks carry out the necessary function and carry out the search work based on which whether providing loan to the borrower or not is decided. Third theory is the liquidity transformation theory which states that the lenders who have sufficient funds are provided with an opportunity to invest the extra money into financial institutions and don’t have to invest in equity or bonds (Casu, Girdardone & Molyneux, 2006). This financials are more liquid and can be converted as and when the lender wants thereby providing the liquidity option which lenders look forward The fourth theory is the theory of consumption smoothing which states that some section of the society look to create a balance between their spending and saving pattern so that they can support their future. Banks help those people in this function as people park their excess savings on which banks provide certain incentives so that their long term future gets protected. This acts as a measure through which banks help to smoothen their consumption function and helps to multiply opportunities for the future The last theory is the commitment mechanism which states that banks have to abide with the different commitment which they have made. This requires that banks have the required liquid and illiquid assets which provide them an opportunity to pay bank the depositors. The mechanism of having money from the depositors provides them the opportunity ti have liquid assets and helps to maintain the required balance between liquid assets and capital reserves so that banks are able to carry out their commitment mechanism and justify their roles within the society. This makes it important that the different roles which banks perform are properly understood. Banks carry out three main functions which is size, maturity and risk transformation (Casu, Girdardone & Molyneux, 2006). The size transformation refers to the manner in which small investors are willing to lend money to others but the large borrowers require large sum of money which the banks provide by converting the small size of deposits into big sizes. The banks also look to carry out the size transformation function here as they bring about a change in the size of loans. The second function is maturity transformation where they look to provide short term loan in compared to medium and long term loan so that the money can be again passed on to the depositors in case they need the same. This has helped to work on the maturity transformation function and will help to identify the manner in which maturity function works. This also provides an opportunity for banks to maintain a match between assets and liabilities so that the liquidity risk is reduced and proper management of funds becomes possible. The third function is the risk transformation function as banks look to deal with the risk associated with lending the money of depositors and the depositors don’t have to take the risk associated with lending. This helps to protect the interest of the depositors and ensures that the depositors are safe and protected from the risk associated with lending the money. Banks thereby look to work as follows Conventional banks look to borrow the money from the depositors and provide interest on the deposited money. The banks then provides this deposited money to borrowers at a slightly higher rate for a higher risk involved and looks to compensate the depositors from the interest they earn on borrowed money. The banks thereby perform as an intermediary and help to carry out the different functions in a most effective manner. Islamic Banking Islamic banks works in a similar manner as conventional banks and carry out all the activities that conventional banks carry bike taking deposits from people and lending money to people but don’t either charge an interest rate or provide interest rate. Instead they agree on a profit and loss sharing agreement which takes place between the banks, lender and depositor. Islamic banking through the process are able to act as a major contributor towards the information function and helps to reduce the asymmetry information issues which would otherwise be present. Islamic banks like conventional banks also look to reduce the transaction cost and ensure diversification for small savers so that the risk is reduced. The liability side of the balance sheet under Islamic banking system mobilizes the funds on the basis of Mudarabaha (Trustee financing) or Wakalah (agent) contract. The bank also accepts deposits from people as interest free loans and work according to the principle of Sharia which lays the manner in which profit-loss sharing agreement will be entered at. Bank deposits are further divided into time deposit and demand deposits. In case of demand deposit no interest is provided as the banks act as a safe guardian and promises to pay a certain sum after an expiry of a certain period. In case of time deposits banks works on the basis of Mudarabaha (Trustee financing) or Wakalah (agent) contract and enter into a profit-loss sharing agreement with the depositor. Islamic banks thereby work as investment managers and searches for potential investors so that their savings and funds can be mobilized in other areas to so that gains based on it can be ensured. This thereby makes the Islamic banking institutions work in the following manner Shariah Concept Sharia refers to the set of rules, teachings, values and ideals which governs the way Muslims live. The Sharia consist of five elements which are as: First is Quran which Muslims believe as a word of God and they need to follow. Second is Hadith or records of actions and sayings of the Prophet Muhammad by reliable witnesses. Third element is “Sunna” or the ideal of human conducts such as tacit approvals of the Prophet. The fourth element is called “Ijm’a “, meaning the consensus of Muslim scholars on a point of view of the Islamic law. The final element of the Sharia element is called “Ijtihad” which is based on the science and adapting and interpreting existing doctrine to changing the economic or social circumstances by some method such analogy and derivation of meaning from other than revealed text such as reasoning (Zineldin1990). The most important element is Koran & Hadith which is followed by Sunna and Ijtim’a. The manner in which Islamic law is different has helped to bring forward the different which is present between Islamic economic system and Western economic system. The Islamic law provides the person to sell, but or inherit the wealth but no unlawful ways should be undertaken. The unlawful ways refers to ways which are not provided in the Sharia law. The Islamic law allows the right to keep or invest the wealth but needs to be carried out without any interest. Islamic law allows wealth to grow through work and efforts but doesn’t allow the increase in wealth without any efforts which has thereby prohibited interest to be provided on money which is provided to others. This makes the Islamic law to be different from other law as it doesn’t provide the opportunity to amass wealth through unlawful ways and is thereby different from the manner in which conventional banks work. Interest (Riba) & major religions views Interest means towards getting some incentive because of parting with the money and proving the money to others. It is the return which a person gets due to involvement of high risk which is present while looking to provide money to people. The Canon law states that it is a promise where the principal sum along with the interest will be paid after a certain period of time (Mehboob, 2005). Interest in prohibited in different religion like Islam, Christianity and Judaism as the law prohibits earning something without any efforts. However, Islam is the only religion which still prohibits interest (Mehboob, 2005). Jews on the other hand looked towards charging interest from people who were non Jews but prohibited the same from people among their own culture. Slowly with the passage of time interest was allowed to be charged by Jews and Christian while Islam still looks to work on the same model and prohibits people from charging interest on the money. Methodology This chapter will look to present the methodology which has been used for the research and will highlight the research method which is used, the sample size for the study, the research instrument which is used, the manner in which data has been collected and manner in which analysis of data will take place. Research Method The research method which has been used is qualitative in nature and investigates the reasons for having certain things instead of stating the manner in which it should be. Shank (2002) has defined qualitative research as a planned inquiry into different issues so that the purpose can be identified and the underlying reasons which have led towards it can be understood. Denzin & Lincoln (2000) states that qualitative analysis looks at studying things in natural setting so that important meaning based on it can be interpreted. The research can further be described at descriptive and exploratory as it will describe the manner in which Islamic banks performed during the financial crisis. This will be presented from two angles where one will look to present different literature views and secondly will look at view points from different managers point of view. Population & Sample The research was being carried out over Sharia complaint banks and conventional banks with Islamic windows so that different information about the financial crisis and strategies which they had in place could be discussed. The population consisted of entire Sharia complaint banks and conventional banks with Islamic windows who could be contacted directly so that different inputs from them could be gathered. The population also looked towards ensuring that there was proper participation from different type of banks so that the results which would be achieved could provide useful impetus for the future. The sample out of the total population was four Sharia complaint banks and two conventional banks with Islamic windows. In addition to it 8 managers were contacted out of which 6 responded. Three of the interviewee were managers from fully Sharia compliant bank whereas the other three were conventional banks with Islamic window. Five of the six managers who were interviewed were corporate level managers and one was middle level manager. The sample size thereby looked towards ensuring that entire population was represented in it and provided useful information pertaining to the manner in which Islamic banks performed during the financial crisis. Instrumentation The data was collected through a process of open ended questionnaire and semi structured interview process. In addition to it the banks financial statement was also used. The research was firstly carried out by sending questionnaire to bank managers and then semi-structured interviews were carried out so that different perception and the manner in which bank managers felt could be analyzed. This was then substantiated using financial statements so that the manner and process through which different information was gathered could be substantiated. The process of interviews was carried out both through telephonic conversation and visiting the different respondents personally. This helped to work on the different aspect and gather the information which was required and helped to provide different inputs regarding the manner in which Islamic banks performed during the financial crisis and were able to avert the crisis. Data Collection The research was carried out over four Sharia complaint banks and two conventional banks with Islamic windows. The data was collected through a process of open ended questionnaire and semi structured interview process. In addition to it the banks financial statement was also used. The research was firstly carried out by sending questionnaire to bank managers and then semi-structured interviews were carried out so that different perception and the manner in which bank managers felt could be analyzed. This was then substantiated using financial statements so that the manner and process through which different information was gathered could be substantiated. Since bank managers were not allowed to give recorded interviews it was not recorded. The process of interview also looked at gathering information from different level of managers like senior, middle and low level managers along with managers. The process of interviews was carried out both through telephonic conversation and visiting the different respondents personally. In a total 8 managers were contacted out of which 6 responded. Three of the interviewee were managers from fully Sharia compliant bank whereas the other three were conventional banks with Islamic window. Five of the six managers who were interviewed were corporate level managers and one was middle level manager. Since, banks have a policy where information is provided from the corporate manager so I was directed towards the headquarters to gather all the information which I needed for the study. Data Analysis The different inputs which were provided by the respondents were analyzed through a process of triangulation so that important imperatives and areas which have an impact on the working of conventional and Islamic banks can be understood. Using a process of triangulation the different areas were identified and helped to understand the manner in which different aspects were ignored by conventional banks as compared to Islamic banks. The different results were then substantiated against financial statement so that the manner in which financial crisis had an impact on conventional banks and Islamic banks can be analyzed. References Chapra, M. (2008). The Global Financial Crisis: Can Islamic Finance help? (http://www.isdbforum.org/presentation Papers/5-M_Umer_Chapra.pdf) Casu, Girardone & Moluneux (2006). Introduction to banking: Prentice Hall Financial Times, Harlow , England Denzin & Lincoln, Y. (2000). Handbook of Qualitative Research, London: Sage Publication Inc. Mehboob, H. (2005). An Explanation of Rationale behind Prohibition of Riba in the Doctrine of three Relagions; with special reference to Islam (http://www.econ.nagoyacu.ac.jp/~oikono/oikono/vol47_34/pdf/vol42_2/mehboob.pdf) Shaikh, S. Jalbani (2008). Amanat Risk Management in Islamic and Conventional Banks: A Differential Analysis, Journal of Independent Studies & Research, Szabist, Karachi, Zineldin, M. (1990). 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