The Islamic Finance Industry - Research Proposal Example

ISLAMIC BANK (Research Proposal) Islamic scholars and professionals claim that the Islamic Finance Industry was partially protected from the current financial crises due to its principles. Discuss Your name ……………….. Course ……………………. Date of submission ………………. TABLE OF CONTENTS Introduction …………………………………………….. 3 Background of the research ……………………………. 3 Problem statement …………………………………….. 4 Literature Review …………………………………….. 4 Methodology ………………………………………… 6 Conclusion …………………………………………… 7 References …………………………………………. 8 Bibliography ………………………………………… 9 Introduction In the recent economic situations where the interest-based conventional banks and financial institutions have been severely hit by the credit crunch, Islamic banks and its financial instruments like Mudarabah, Musharakah and Murabaha have been gaining considerable attention and significant growth in many countries during 2008. One of the very basic tenets of Islamic financing is that ‘riba is unjust and therefore it is haram’ (Hassan and Lewis,2007, p. 43). Other principles of Islamic Financing include 1) Prohibition of Gharar- dubious contracts and 2) the prohibition of Maysir- Gambling (Samad, Gardner and Cook, p. 72 and Sarker, p. 3). These three basic principles are of extreme importance in its operation as it requires considering these three basic principles in any transaction that it deals or any service that it provides. For instance, Islamic bank is forbidden to enter in to Mudarabah or Musharakah contracts with those business clients who may deal with speculative or gambling business or deal with interests. The recent financial turmoil was the outcome of subprime defaults in 2007 (Halm-Addo , 2010, p. 13), that caused some excitement in the market and the crisis gradually hit many industries including traditional banks and financial institutions. Islamic banks were less affected by the crisis due to the appropriateness of its principles and strict prohibition of interest-related transactions. This paper presents a proposal to the research about how and why Islamic banks remained less affected by the recent financial crisis, according to the claiming of scholars. Background of the research A number of studies, based on financial analysis and the performance of Islamic banks during the time, found that Islamic banks remained far positive despite the severe financial crisis that hit traditional banks (Parker, 2008). Islamic scholars and those in favor of this opinion claimed that Islamic banks strictly prohibit interest which was the main factor that played significant role in causing credit crunch and therefore Islamic bank is, theoretically and according to its strict compliance to Shariah, less likely to be affected by financial crisis (Visser, 2009, p. 91). Islamic banks in some countries and some sectors like Sukuk (Parker, 2008) have been found to be affected by the crisis and this justifies the argument that Islamic banks are not perfectly immune from the crisis, but can be indirectly affected. Problem statement The main issue being discussed in the research is ‘how far Islamic banks were protected from the recent financial crisis due to its principles, as claimed by scholars’. Even though scholars and Islamic banking authorities claim that their banks are less affected by financial crunch, it is yet to be clearly evaluated with detailed functional and qualitative analysis from the marketing perspectives of both Islamic and conventional banking systems. The main purpose of the research includes; To analyze what factors have led financial crisis, To evaluate these factors and its relation to the Islamic banks, To conclude whether Islamic banks are protected from the crisis due to its principles pertaining to the factors detailed above. Literature Review Mohammad Damak, based on Standard and Poor’s Rating Service (S&P), pointed that Islamic banks, almost like their counterparts, stand to post weaker financial performance and asset quality indicators (Business Monitor International, 2009a, p. 1). According to S&P, the value of sukuk issued in 2008 fell by 56% which shows that sukuk sector has been affected largely by the crisis (Business Monitor International, 2009b, p. 42). As Venardos (2010) noted, Islamic banks were indirectly affected by the crisis, due to the slower economic growth and reduction in global liquidity (p. 12). Islamic banks were partially affected by the crisis, but this may not justify the argument that Islamic banks are not different from conventional banks in relation to its explosion to the crisis. The crisis has hit almost all industries including Islamic banks. Even though Islamic banks in some countries have been partially affected by the crisis due to the very severe financial turmoil that has had tremendous influences on people income, their way of thinking and even their mindsets, the most interesting fact was that these banks have been found to be attracting more Muslim and non-Muslim customers in 2008, especially in UK and USA. It was reported that financial crisis has given greater opportunities to Islamic banks to help fill the liquidity gap. Islamic banking industry has been gaining robust growth in the recent years and this is continues to grow. A study by Oxford Business Group (2008) found that Islamic banks, especially in GCC countries have been outperforming their counterparts in the first quarter of 2008, showing the figure that Islamic banks generated a return on asset of 3.6% for 2007 as compared to 2.4% of its counterparts (p. 86). Dubai Islamic bank announced that its financial assets reached AED 52.7 billion in 2008 with an increase of 30% from 2007 (Al Shaibani, 2009). These are some of the few evidences that can support the argument thatIslamic banks remained far positive despite the severe squeezing of financial turmoil that hit traditional banks very badly. As Wakeford (2008) noted, risk profile of Islamic banks is generally lower than conventional banks and this cause many people to move to Islamic banks. Despite the crisis, number of customers visiting to Islamic banks in 2008 were more in number (Oakley, 2008). Scholars and experts viewed that Islamic banks should theoretically be less exposed to the asset-liability mismatches and financial crisis than their traditional counterparts. It is because Islamic banking is rooted in ‘risk sharing’ concept (Greuning and Iqbal, 2008, 145). Iqbal, Askari, Krichenne and Mirakhor (2010) argued that Islamic banks were less affected because they did not have any exposure to toxic assets (p.199). Visser (2009) argued that Islamic banks are less likely to be affected by crisis due to its principles. Islamic banks are not allowed to invest in financial instruments that are not assets-backed (p. 91). Islamic banks must have shunned collaterised debt obligations that are linked to subprime or high risk mortgages as these types of complex financial instruments are not compatible to Islamic Shareeah and law (Taylor, 2008). Flexible Subprime and high risk mortgages were the fundamental causes of credit crunch that started from US banks and gradually affected industries worldwide. Islamic banks, as evident from the current situations and as claimed by its scholars, remained less affected, or partially affected by the financial crisis primarily due to its principles that do not allow subprime and high risk mortgages. Methodology This research will be conducted based on explanatory research as the issue is already known and was studied by a number of researchers. Based on the reviewing of the relevant literatures and by analyzing the financial performance of some Islamic banks, this paper will evaluate how the financial crisis has affected these banks and how these banks remained less affected due to its principles. The hypothesis will be developed by analyzing views and by reviewing the literatures. Conclusion Despite the severe squeezing of the financial turmoil in recent years, Islamic banks remained far positive and showed growth in the beginning as well as attracted more customers. This was because, its basic principle does not allow it to handle interest-related transactions and subprime and high risk mortgages. References Al-Shaibani, M. I (Feb- 2009), Dubai Islamic Bank announces d 2008 net profits of AED 1.73 billion, Retrieved from http://www.alislami.ae/en/art_257.htm Business Monitor International (2009a), Islamic Banking-Not Immune to the crisis, Egypt Commercial Banking Report, Business Monitor International Business Monitor International (2009b), Islamic banking-Not escaping the crisis, Saudi Arabia Commercial Banking Report, Business Monitor International Greuning, H V and Iqbal, Z (2008), Risk analysis for Islamic banks, Illustrated edition, World Bank Publication Hassan, K and Lewis, M (2007), Handbook of Islamic banking, Edward Elgar Publishing Halm-Addo, A, 92010), The 2008 Financial Crisis: The Death of an Ideology, Dorrance Publishing Iqbal, Z, Askari, H, Krichenne, N and Mirakhor, A (2010), The Stability of Islamic Finance: Creating a Resilient Financial Environment for a Secure Future, John Wiley and Sons, Oxford Business Group (2008), Report: Bahrain 2008, Oxford Business Group Samad, A, Gardner, N. 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