Academic journal article Journal of Financial Management & Analysis

Financial Management Analysis of Islamic and Conventional Banking in Selected Countries

Academic journal article Journal of Financial Management & Analysis

Financial Management Analysis of Islamic and Conventional Banking in Selected Countries

Article excerpt

Introduction

Islamic banking is a paradigm that provides a structure for transactions involving exchange of capital in accordance with Sharia Law. Without the provision of charging interest1, i,t is a setting in which the lending institute makes money through the sharing of profits and losses with the borrowing party2*3. The assets of Islamic banks are expected to reach the $6.1 trillion level by 2020 (all limits in U.S. dollars), up from $1.6 trillion in 20 1 24; this growth approximates a fourfold ihcrease in assets in less than a decade; thereby demonstrating the potential of Islamic banking as an engine for economic growth throughout the world.

Assets held by Islamic institutions, during the aftermath of the 2008 financial crisis (2009-2013), exhibited an annual compounded growth rate of 17 per cent5. This sector has witnessed avast expansion in the majority of their segments compared to its conventional counterpart6 7, but, Islamic banking is still a nascent paradigm, which only emerged in the 1970s, when some Islamic financial institutes started providing enhanced services within the arena of lending money8.

The explosive growth of Islamic banking has been very successful to this point and still has significant upside potential. It has not yet been able to capture substantial market share, even in the Gulf market. Islamic banking has not captured more than half of any market that it services5. As it has proved to be such a profitable domain, some of the largest conventional banks (e.g., Citibank9, HSBC10) have begun to provide Islamic banking in certain selected markets, HSBC offers Islamic banking in Malaysia and Saudi Arabia10 while CitiBank provides Islamic banking services in the UAE9.

The conventional banking system has been relatively unsuccessful in preserving the monetary interest of its various stakeholders, including those involved in national economies. The 2008 financial crisis accentuated that loopholes do indeed still exist and that regulatory failures were more prevalent in the conventional system. Islamic banking is not only poised to grow faster than conventional banking, but can also safeguard customers from various forms of financial exploitations in the future11. This study compares Islamic banking to conventional banking during the aftermath of the widespread 2008 financial crisis. Islamic banks were chosen from countries in the Organization of Islamic Cooperation (OIC) countries which consists of 57 predominantly Islamic countries, with India and Russia often invited to attend meetings as observers, (see Exhibit).

This study analyses the performance of Islamic and conventional banks from six different OIC countries encompassing distinct and disparate economic, ideological, and political characteristics. The study finds evidence that Islamic banks in developed countries, as well as those in constitutionally Islamic countries (CICs), performed much better than conventional banks during the height of the financial crisis. This study provides robust results that the conservative nature of Islamic banking was instrumental in protecting them from the downturn that the conventional banks experienced.

Principles of Islamic Banking

Islam is the religious faith of Muslims as founded by the prophet Muhammad and taught through the Holy Quran. The basic principle is submission to a unique and personal god, Allah. It is the world's second largest religion that is also the world's fastest growing, which has 1.7 billion followers or 23 per cent of the world's population. There are two major denominations in Islam, Shia and Sunni. Their division traces back to a Sunni-Shia schism following the death of Muhammad in 632, which arose over the succession to Muhammad as caliph of the Islamic community. The present demographic breakdown between the two denominations is difficult to fully assess and varies according to the source employed, but an accepted approximation is that 85 to 90 per cent of the world's Muslims are Sunni and the rest being Shia. …

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