Omparative Analysis of Islamic Banking a viable alternative to Commercial Banking

1.1 TOPIC OF RESEARCH

My research topic is Comparative Analysis of Islamic Banking a viable alternative to Commercial Banking”. This research will look at Islamic Banking from various perspectives highlighting both its strengths and weaknesses. Starting with an introduction of Islamic Banking defining both conventional and Islamic Banks it will discuss the ethical framework and guiding principles of Islamic Banking along with its brief history to familiarize the reader with its background. It will move on to discuss the rationale of Islamic Banking and why it is a viable alternative to conventional commercial banks. The research will try to throw light on current challenges faced by Islamic Banking that are hampering its growth. The project moves on with a discussion of Shariah compliance status of the current Islamic Banking model making the reader realize that Islamic Banking, despite all its weaknesses, is still a preferred alternative to conventional banks. Sukuks an integral element of Islamic Banking and Finance will be given a cursory view and a humble effort will be put to provide recommendations as to how the current situation of Islamic banking can be improved along with some conventional instruments Islamic Banking and Finance can offer customers with little or no changes.
1.2 HYPOTHESIS

Hypotheses of this research paper are presented below:

Alternative Hypothesis 1: The current financial model followed by Islamic Banks IS Shariah compliant.
Null Hypothesis 1: The current financial model followed by Islamic Banks is NOT Shariah compliant.
Alternative Hypothesis 2: Islamic Banks are currently facing SIGNIFICANT problems that are hindering its growth.
Null Hypothesis 2: Islamic Banks are currently facing NO problems that are hindering its growth.
Alternative Hypothesis 2: Emerging trends in Islamic Banking ARE feasible for implementation and have high potential for growth.
Null Hypothesis 3: Emerging trends in Islamic Banking are NOT feasible for implementation and have high potential for growth.
1.3 OBJECTIVES OF THE STUDY
The research report aims to achieve the following objectives:

i § Identify challenges faced by Islamic Banks around the world.
i § Determine Shariah compliance of the current Islamic Banking model.
i § Assess the feasibility of emerging trends in Islamic Banking.
i § Analyze growth rate of Islamic Banking around the world and ascertain if Islamic Banks are operating at the maximum potential.
i § Ascertain loopholes in Islamic Financial Instruments used by Islamic Banks around the world.
i § Suggest new and alternative (Shariah compliant) Islamic Financial Instruments.
1.4 EXISTING LITERATURE
a?a?That is because they say, trading is only like usury and Allah has allowed trading and forbidden usuryaa Surat Al Baqara v.275
Islam is the second largest religion of the world with around 1.2 billion followers and requires Muslims to lead their lives according to the Shariah principles. Shariah is a guideline for them in all avenues of their lives and commerce is central to the Islamic tradition (Chammas G., 2006). The aspiration of Muslims all over the globe to incorporate Shariah principles in all aspects of their lives has given a significant boast to Islamic Banking and Finance in the last two decades. Islamic Finance has expanded its target market to non Muslims by venturing into non member (of the Organization of the Islamic Conference) countries such as the United Kingdom and Singapore and by following high standards of ethical investment. The clientele of Islamic Banks is now spread over Europe, the United States and the Far East. Realizing the enormous potential of this emerging market, numerous conventional banks have set up a?Islamic windowsa. Thus, Islamic Banking is growing at a rapid pace because of its value-orientated ethos, enabling it to draw finances from both Muslims and non-Muslims alike (Warde I., 2000).
1.4.1 RATIONALE OF ISLAMIC BANKING
The central theme behind the establishment of Islamic Banks is to mobilize resources to finance productive activities and consumption needs. The rationale behind this resources mobilization is Profit and Loss Sharing (PLS), instead of interest payment or time value of money. The ban on interest in an Islamic system does not imply that capital is costless. Rather, Islam recognizes it as a factor of production and does not allow it to be remunerated by interest in any form. This leads us to the search of a viable alternative of the interest based financial framework. Various Islamic scholars have suggested that PLS can be a viable alternative (Kahf, Mounzer, 1982), because Islam allows the owner of capital to legitimately share profits made by the entrepreneur. Since Islam prohibits a predetermined rate of return, interest is Haram (illegal). However, PLS is permissible:
a?It has been argued that profit-sharing can help allocate resources efficiently, as the profit sharing ratio can be influenced by market forces so that capital will flow into those sectors which offer the highest profitsharing ratio to the investor, other things being equal. One dissenting view is that the substitution of profit sharing for interest as a resource allocating mechanism is crude and imperfect and that the institution of interest should therefore be retained as a necessary evil (Naqvi l982). However, mainstream Islamic thinking on this subject clearly points to the need to replace interest with something else, although there is no clear consensus on what form the alternative to the interest rate mechanism should take. The issue is not resolved and the search for an alternative continues, but it has not detracted from efforts to experiment with Islamic banking without interest (Mohamed Ariff, 1988)a?

1.4.2 GAP FILLED BY THIS RESEARCH BY REPRESENTING ISLAMIC BANKING AS A VIABLE ALTERNATIVE TO THE CONVENTIONAL BANKING SYSTEM

The research intends to produce a direct comparison of the entire product line of an Islamic Bank with that of a conventional bank and make way for new financial Islamic instruments in the process.
Almost all scholars agree that Islamic banks can function well without interest. An International Monetary Fund study by Iqbal and Mirakhor found Islamic banking to be a viable proposition resulting in efficient resource allocation. The study implies that Islamic banks face fewer solvency and liquidity risks than their conventional counterparts. The multi-purpose and extra-commercial nature of Islamic banks leads them to participate more actively in the economy since the abolition of interest makes it imperative to look for other instruments, which renders operations outside the periphery of commercial banking unavoidable. Such operations thus, yield economies of scope.
Two basic approaches by M Chapra,Umar, & Tariqullah, Khan (2004), have been adopted all around the world to suppress and eventually eliminate interest from their financial systems:
1. Countries like Iran, Pakistan and Sudan opted for suppressing interest from all their financial operations at the same time.
2. Other countries including some non-Muslim countries allowed the creation of Islamic financial institutions along with existing conventional financial institutions.
1.4.3 WHY HAVE I CHOSEN THIS RESEARCH AREA
Islamic financial products and services are gaining popularity at a rapid pace and are being classified as a viable option performing at par with the range of financial services and products available in international markets today. The ever-increasing popularity of Islamic financial institutions and products are evident from the creation of Dow Jones Islamic Market Index and FTSE Global Islamic Index series etc. This highlights recognition of the tremendous potential of Islamic products and services by the global community. Today, more than 250 Islamic financial institutions are operating in over 50 countries with combined assets in excess of $ 250 billion and an annual growth rate of 12 to 15 percent. According to Mr. Joseph Torbey