Islamic Banking System and the World Credit Crunch - Essay Example

Write of this and work on Islamic banking system and the world credit crunch, its mean that what solution Islamic bank has for credit crunch Table of Contents 1. Introduction 3 2. Reasons 8 3. Aims 8 4. Objectives 9 5. Research methods 9 6. Method of Data collection and analysis 12 7. Sampling 13 8. Limitation 14 9. References 15 10. Appendix 16 1. Introduction The appearance of the financial crisis in 2008 has been characterized as an expected event; in fact, the policies used by financial institutions the last decade have been doubted as of their credibility and their risk. The fact that the crisis started in West indicates another issue: the effectiveness of Western financial institutions is rather lower from that of the Islamic bank institutions; the rapid deterioration of financial markets in the West since 2008 can lead to the assumption that these markets did not have the necessary mechanisms to face such crises; moreover, the fact that the effects of recession on markets that are based on Islamic banking has been limited proves the effectiveness of Islamic banking scheme towards its western rival. Current study focuses on the examination of the solutions that Islamic banking can offer regarding the limitation of losses caused because of the credit crunch. In order to understand the potential solutions of Islamic banking against the credit crunch it would be necessary to refer primarily to the characteristics and the framework of Islamic banking as an alternative scheme of banking compared to the traditional (western) banking system. In accordance with Iqbal et al. (1987, p.29) ‘the central requirement of an Islamic financial system is the replacement of the rate of interest with the rate of return on real activities as a mechanism for allocating financial resources’. On the other hand, Saeed (1996) notes that ‘the investment activities of the Islamic bank would be based on the two legal concepts of Mudaraba and Musharaka, alternatively known as profit and loss sharing (PLS)’ (Saeed, 1996, p.51); in other words, the existing principles and mechanisms of Islamic banking can be used in order to control the pressure of the global market – which is based on the western banking system; in this case, an appropriate customization of the rules of Islamic banking system would be required in order to suit to the needs and the potentials of customers worldwide (Scharf, 1983, p.18).On the other hand, Islamic banking system has an important weakness: the lack of an appropriate regulatory framework; this means that in case of failure the allocation of risk among the persons that participated in a specific investment initiative may not easy; furthermore, the recovery of damages would also face difficulties (Ledgerwood, 1999, p.56). The above problem is examined in the study of Venardos (2005); in the specific study it is noted that ‘an appropriate regulatory framework for an Islamic financial system should aim at reinforcing the operational environment at banks, as well as their internal governance and market discipline’ (Venardos, 2005, p.106). In accordance with Venardos (2005) the above issue can be addressed by using the ‘standards and practices established by the Basle Committee on Banking Supervision’ (Venardos, 2005, p.106). The issue highlighted by Venardos (2005) is important; however, it seems that a critical fact is not taken into consideration: Islamic banking system has its own rules and principles; these rules are applied on all activities developed by Islamic banks and they guarantee – up to a certain point – the limitation of risk in investment. In this context, the lack of general accepted framework on the Islamic banking system can be considered as a weakness but also as a strength (Mullineux et al., 2003, p.15); Islamic banking system is effective against the recession – at least compared to the Western banking system – and for this reason it should be used (as possible) in order to develop methods and mechanisms for the control of credit crunch. Of course, it would be necessary that specific changes would be made on the Islamic system’s current practices and regulatory framework. The benefits of Islamic banking towards the western banking system are highlighted in the study of El-Gamal (2006); particular emphasis is given on the account available to the customers of banks based on the Islamic banking system. More specifically, El-Gamal (2006) notes that ‘the replacement of conventional bank saving accounts with investment accounts based on profit and loss sharing continues to be the main distinctive feature of Islamic banks’ (El-Gamal, 2006, p.166); the above policy can be used in order to understand the hierarchy of priorities in Islamic banking system; the profit is not the top priority of the banks based on the specific banking system; the safety of financial transactions is the most important characteristic of Islamic banking system. However, the development of investment accounts may involve in risk for these accounts-holders; the holders of accounts in the banks based on the western banking system are protected against their bank’s bankruptcy – they are likely to be paid first from the bank’s assets; however, the holders of investment accounts are not offered such protection. El-Gamal (2006) suggests that the banks based on the Islamic banking system should ‘adopt a mutual corporate structure’ (El-Gamal, 2006, 166). It is made clear that the policies of Islamic banking system need to be appropriately customized in order for the interests of their customers to be better protected. The above facts do not influence the assumptions made on the effectiveness of Islamic banking system which remains a safer banking system compared to its Western rival. However, there are certain aspects of the Islamic banking system that needs to be carefully reviewed; the fact that this system was primarily developed in order to meet the cultural and social needs of specific populations can lead to the assumption that Islamic banking system can be used in the context of Western societies but it should be appropriately adapted – as possible – at their ethics. The development of the Islamic banking system can be explained by referring to the need of Western countries to develop their commercial activities in countries using the Islamic banking system; an example is Britain; when money had to be sent from Muslims living in Britain to their relatives in Middle East, a bank based on the Islamic banking system had to be involved in the transaction; the development of transactions between Western and Islamic banks had become a political issue that led to the establishment of the first Islamic bank in Britain (Henry et al., 2004, p.83). In accordance with Thomas the development of the Islamic banking system can be explained by referring to the following facts/ conditions: ‘a) the understanding and application of Sharia principles by Muslims jurisprudents, b) the facility developed by the Sharia boards with the nominate contracts and c) the growing discourse on Islamic finance in the English language’ (Thomas, 2006, p.5). In other words, the increase of power of Islamic finance has been related with the globalization; the development of financial activities between countries using the Western banking system and those using the Islamic banking system led to the radical development of the latter – a fact that indicates the superiority of the Islamic banking system towards the Western banking system. Another fact showing the increase of power of the Islamic banking system is mentioned in the study of von Pock (2007); in accordance with the above researcher ‘the ever-increasing importance of Islamic finance is also mirrored by the introduction of Islamic stock market indices, i.e. of the Dow Jones Islamic Market Index and the FTSE Global Islamic Index’ (von Pock, 2007, p. 1); it is expected that the development of Islamic finance – as highlighted above - will help to the further growth of the Islamic banking system. The fact that Islamic banking system prohibits the interest cannot lead to the assumption that in the specific system there is no profit; in fact, van Tulder et al. (2006) noted that ‘Islamic banking requires a form of participatory financing that differs fundamentally from the practice of commercial banks’ (van Tulder et al., 2006, p.19); this means that profit exists in Islamic banking but it has different form than in Western banking system. Mullineux et al. (2003) described the structure of Islamic banking system as follows: ‘Islamic banking is based on the idea of profit and loss sharing (PLS) between bank and depositors; Islamic PLS is based on trust financing and financial partnership’ (Mullineux et al., 2003, p.194). In other words, the cooperation between the bank and its customers is considered as a key strategic policy in the context of Islamic banking system; in Western banking this relationship exists but not at satisfactory level; customers are not always informed on the investment schemes chosen by their banks. Hassan et al. (2007) state that ‘Islamic banking operations have been appreciated widely in Muslim and in non-Muslim countries for giving a different perspective to banking and financial practices’ (Hassan et al., 2007, p.401); in accordance with this view the use of Islamic banking practices in order to control the credit crunch would be accepted by the customers of Western banks – of course under the terms that appropriate justification would be offered for the specific decision; in any case, the effectiveness of these practices in reducing the effects of the global crisis would be an important criterion for the elimination of doubts regarding this system’s prospects in the global financial services industry. 2. Reasons The development of the recession worldwide has led to the need for the identification of policies and schemes that could help to its control; measures have been developed by governments and financial institutions worldwide but it seems that the relevant effort was delayed; since its appearance, the crisis has been expanded rapidly proving that the failures of existing risk management strategies. This study is expected to help towards the identification of the potentials of Islamic banking in regard to the global recession; Islamic banking is already known and used in financial markets internationally; however, its role in the limitation of the financial crisis has not been adequately explored. Its performance up to now proves that the specific banking system can serve the needs of customers of different background and financial status (Iqbal et al., 2002, 47); on the other hand, its principles offer an increased protection against the risky investments – this fact is quite important in modern market where the lack of effective risk management in the financial services has become a major problem. Furthermore, Islamic banking has not been tested as a recession-prevention framework even if its policies have been characterized as guaranteeing the safety of investment – at the highest possible level taking into consideration the current structure of financial markets. 3. Aims Current study focuses on the methods that Islamic banking has developed against the credit crunch. Under these terms, the aims of this study could be described as follows: a) to show the value of islamic banking in modern market and b) to highlight the mechanisms that Islamic banking has developed in order to protect the financial markets against the recession. A series of additional issues will be examined in the context of the study’s main issues as described above. 4.Objectives As noted above this study focuses on the identification and the critical analysis of the methods developed by the Islamic banking against the credit crunch. In order for this issue to be effectively and adequately examined it is necessary that the following problems are answered: a) which is the current position of Islamic banking in the global financial industry, b) has Islamic banking developed a mechanism that can help to face the recession and which are the main characteristics of this mechanism, c) has the above mechanism specific requirements, i.e. which are the terms of its activation, d) is this mechanism accessible to all people, e) can this mechanism affect the global market or it can only serve local needs, f) how this mechanism operates and controlled – monitored and g) which is the response of the market to this mechanism, i.e. has the global financial industry make use of this mechanism – at international or national level – in order to face the recession and which could be the reason for the delays in this cooperation (referring to the potential incorporation of Islamic banking policies in western strategies of banking n order to face the global financial crisis). 5. Research Methods Current study will be based on two different research methods: the literature review (secondary research) and the survey (primary research); the simultaneous use of two research methods is expected to offer the following benefits: a) increase the credibility of findings; the results of the survey will be analyzed using the views of the literature; in this way, any risk for wrong interpretation of the findings is limited, b) highlight points that need further analysis; it is possible that through the examination of the study’s issues using the literature not all critical points are revealed; in this context, the survey will be used to identify all key aspects of the issues under examination, c) offer well-supported arguments on the study’s problems; the limitation of the research in the literature could lead to the development of assumptions that would not be well-justified; in this case, these assumptions could be doubted as of their reasoning. The benefits described above can be acquired by developing an accurate research plan using a Gantt chart – see the Appendix section; at the next level, specific criteria and principles should be set in regard to each particular method of research. Furthermore, the use of the chosen research methods should be justified using the literature. Many theorists that have worked on the specific field have highlighted the value of literature review as an effective research tool. More specifically, literature review has been considered as an effective research tool when the examination of issues that have been extensively studied in the academic field is required (Denzin et al., 2005, p.34); moreover, the literature review is related with the acquisition of material that has been appropriately tested and evaluated (Guari, 2005, p.12). The criteria for choosing the manuscripts used in the literature review are highlighted in the study of Shamoo et al. (2009); in the above study it is noted that the manuscripts chosen for the literature reviewed in the context of academic research meet a series of criteria, including: ‘a) originality or significance of the research, b) strength of the conclusions, results or interpretations and c) the validity of the research methods and the research design’ (Shamoo et al., 2009, p. 116); it is also expected that the manuscripts included in the literature of a specific study have been published recently – as possibly; at this point the demands of the study will be examined; also, the criteria set for the literature review in a specific study need to be met; otherwise, the credibility of the literature may be doubted. The literature review developed in this study will be based on specific criteria that could be summarized as follows: a) recent studies are preferred, i.e. studies published the years 2006 onwards; however, older studies may also be included at the level that they can help to the identification of points that are not adequately explained in studies that have been published recently, b) only academic resources will be used in the research; these resources may be books or journals or academic periodicals; non-academic resources will be rejected, c) material retrieved through the websites of governmental and non-governmental organizations will be included in the literature review section of the study; this material will be used only if it is considered as necessary and valuable for the development of the study; however, its credibility needs to be tested carefully – only websites of organizations operating in the public or the private sector will be employed in the study. Apart from the literature review the empirical research has been also employed in this study in order to examine all aspects of the issue under discussion. The empirical research is based on a survey, which will be conducted within the framework described in the following sections. The findings of the survey will be critically discussed using the literature published on the issue under examination. The cross-examination of findings and views will help to develop credible assumptions on the issues discussed in this study. 6. Methods of data collection and analysis The choice of the appropriate methods of data collection and analysis need to be taken on specific criteria; these criteria have been examined in the literature and the following issues are highlighted: a) ‘familiarity with the expectations related to methodology as well as clarity and precision in the research question can lead to logical and practical research methods’ (O’Leary, 2009, p.95), b) the depth of the literature review is related with its quality; the more studies are reviewed the more chances exist for the literature review part of the study to be appropriately supported (Brew et al., 2009, p.64). Other criteria for choosing the literature employed in a specific study can be set; however, these criteria are not likely to have a standard form. Because the literature – as also in the empirical research – used in a specific study needs to be aligned with this study’s principles and ethics, it is necessary that the literature chosen for a specific study is chosen carefully. The empirical research of this study is based on a survey; the survey will be conducted using a questionnaire – see Appendix section – that is divided in three parts: the first part involves in the personal details of the participants; the second part includes the questions of the survey followed by suggested answers; participants are free to choose among the suggested answers or to avoid answer in one or more questions – as noted in the ethics section of the questionnaire; the third part of the questionnaire refers to the ethical framework of the survey. The questionnaire will be distributed in the beginning of the study – in order to save time. A period of 2 weeks is given to the participants to return it – see the Gantt chart in the Appendix section; the participants are explained their rights and are informed on the ethical framework of the survey – also on the scope of the survey as a research tool for the development of this study. There will be no statistical analysis of results; rather, the findings of the survey will be critically discussed using the views of the literature – including the data retrieved from governmental and non-governmental organizations. Furthermore, graphs produced through the Microsoft Office Word will be used for the graphical representation of the survey’s findings. 7. Sampling The success of the research conducted in the context of this study is depended on the use of the appropriate research techniques and concepts; sampling is an important part of empirical research; in accordance with Ember et al. (2009, 89) ‘a satisfactory sample should represent a larger universe of cases (population) in a fair or representative way so that we can generalize the sample results to the larger universe from which the sample was drawn’; in other words, the population used in the empirical research need to be chosen using specific criteria; the aims and objectives of the study, the time limit and the available resources of the research are usually the factors that affect the structure of studies based on empirical research. As explained above, the survey is based on the views of employees of Islamic banks in UK; about 200 employees will be contacted and will be asked to participate in the survey; this sample is considered to be quite satisfactory taking into consideration the fact that gaps have been identified in the literature in regard to the certain issues discussed in this study – especially in regard to the specific measures suggested by Islamic banks for the limitation of losses caused because of the credit crunch. No limitations have been set regarding the demographic characteristics of participants; participants of different ages, gender and background will be asked to state their view on the study’s issues. 8. Limitation Current study focuses on a quite important issue; the potentials of Islamic banking to offer solutions against current credit crunch. However, as already explained above the specific is not particularly examined in the literature; in fact the studies addressing the above problem are quite limited. In this context one of the major problems that this study has to face is the lack of adequate literature on the issue under examination. This problem has been addressed by using two different research methods, the literature review and the survey. In this way, the risk for limitation of the credibility of the assumptions made is reduced; more specifically, the findings of the empirical research are critically discussed using the views stated on the issues under examination; at the same time, data published by governmental and non-governmental organizations are also used to support the study – in the context described above. At this point, the following problem can appear: the examination of certain critical issues of the study is based solely on the views of participants – which are also employees of Islamic banks – referring to the case that there are gaps in the literature in regard to the study’s issues. This problem has been resolved by expanding the sampling of the survey; as noted above, about 200 employees in the Islamic banking industry will be asked to participate in the survey; this fact set limits to any potential doubt in regard to the study’s credibility. 9. References Bashir, B., 1983. Portfolio management of islamic banks : ‘Certainty model’. Journal of Banking & Finance, Volume 7, Issue 3, September 1983, Pages 339-354 Boje, D., 2001. Narrative methods for organizational and communication research. SAGE Brew, A., Lucas, L., 2009. Academic Research. McGraw-Hill International Cassell, C., Symon, G., 2004. Essential guide to qualitative methods in organizational research. SAGE Chong, B., Liu, M., 2009. Islamic banking: Interest-free or interest-based? Pacific-Basin Finance Journal, Volume 17, Issue 1, January 2009, pp. 125-144 Denzin, N., Lincoln, Y., 2005. The SAGE handbook of qualitative research. SAGE El-Gamal, M., 2006. Islamic finance: law, economics, and practice. Cambridge University Press Ember, C., Ember, M., 2009. Cross-Cultural Research Methods. Rowman Altamira Ghauri, P., 2005. Research methods in business studies: a practical guide. Pearson Education Hassan, K., Lewis, M., 2007. Handbook of Islamic banking. Edward Elgar Publishing Henry, C., Wilson, R., 2004. The politics of Islamic finance. Edinburgh University Press Iqbal, Z., Mirakhor, A., 1987. Islamic banking. International Monetary Fund Iqbal, M., Llewellyn, D., 2002. Islamic banking and finance: new perspectives on profit sharing and risk. Edward Elgar Publishing Ledgerwood, J., 1999. Microfinance handbook: an institutional and financial perspective. World Bank Publications Mullineux, A., Murinde, V., 2003. Handbook of international banking. Edward Elgar Publishing O’Leary, Z., 2009. The Essential Guide to Doing Your Research Project. SAGE Publications Olson, D., Zoubi, T., 2008. Using accounting ratios to distinguish between Islamic and conventional banks in the GCC region. The International Journal of Accounting, Volume 43, Issue 1, pp. 45-65 Saeed, A., 1996. Islamic banking and interest: a study of the prohibition of riba and its contemporary interpretation. BRILL Scharf, W., 1983. Arab and Islamic banks: new business partners for developing countries, Volume 1. OECD Publishing Shamoo, A., Resnik, D., 2009. Responsible Conduct of Research. Oxford University Press Thomas, A., 2006. Interest in Islamic economics: understanding riba. Routledge van Greuning, H., Izbal, Z., 2008. Risk analysis for Islamic banks. World Bank Venardos, A., 2005. ISLAMIC BANKING AND FINANCE IN SOUTH-EAST ASIA: ITS DEVELOPMENT AND FUTURE. World Scientific von Pock, A., 2007. Strategic Management in Islamic Finance. DUV van Tulder, R., der Zwart, A., 2006. International business-society management: linking corporate responsibility and globalization. Routledge 10. Appendix 10a. Gantt chart – Analysis of the phases of research Weeks/ Tasks 1 2 3 4 5 6 7 Literature Review Questionnaires are sent to recipients Questionnaires are received and analyzed Development of critical discussion – literature – findings of research Conclusion section/ overview of study 10b. Questionnaire First Part Personal Details Name Surname Gender Age Education Marital Status Job description Years of professional experience Second Part Questions 1. How many years do you work in the specific organization? a. Less than 1 year b. Less than 5 years c. More than 5 years d. More than 10 years 2. Has the performance of your bank affected by the crisis? a. Yes b. No 3. Has your bank taken specific measures for handling the recession? a. Yes b. No 4. Which are the mechanisms that your bank has developed in order to face the credit crunch? a. Close monitoring of all transactions b. Strict application of Islamic banking rules c. Use of investment products of low risk 5. Have these mechanisms proved effective? a. Yes b. No 6. Which are the advantages of these mechanisms? a. Low cost b. Effectiveness c. Existence of tools/ resources for their development 7. Which are the disadvantages of these mechanisms? a. Lack of flexibility b. Not tested under extreme market conditions 8. Which was the response of the public to these mechanisms? a. Many customers were interested b. Moderate c. Not satisfactory 9. Have the mechanisms led to the increase of the firm’s customer basis? a. Yes b. No 10. Are these mechanisms accessible to all customers of the bank? a. Yes b. No 11. Which are the requirements of these mechanisms? a. The existence of customer-bank relationship b. It depends on each bank’s rules 12. Can these mechanisms be used globally or within a specific market? a. Yes b. No 13. Are these mechanisms closely monitored? a. Yes b. No 14. Which is the potential of Islamic banking to fight the credit crunch? a. High b. Moderate c. Rather limited Third Part Ethics of research 1. No-one has access to the questionnaires completed for this study apart from the researcher 2. The personal details will be kept safe – no-one can have access to the participants’ personal details apart from the researcher 3. Each participant can have access to his/her questionnaire anytime but he/ she cannot change her choices on answers after the delivery of the questionnaire to the researcher 4. The participant is not obliged to return the questionnaire completed to the researcher; however, if the questionnaire is returned completed this means that the participant accepts the terms of the research 5. The participant can choose not to answer in one or more questions without explaining the reasons 6. The scope of the research has been explained to all the participants 7. The participants can be informed on the results of the survey after the completion of the study 8. The questionnaires cannot use in any other way but only as for parts/tools of the survey conducted for this study 9. The ethics and standards of academic research are applied on the research conducted for this study Read More