Adoption of Islamic Banking Essay

The intention of the study is to identify the benefits which could be drawn in Adoption of Islamic banking by conventional banks and to determine the challenges they are going to face in the adoption. The 60 respondents from various conventional, non-Muslim banks have been chosen through simple random sampling. The result of the survey for the questions regarding the awareness of the local people was considered positive in Edgware Road, London. They were mostly familiar with Islamic banking since there is already established Islamic bank in the area. The first branch of The Islamic Bank of Britain was in this area. It was also found out that a good portion non-Muslims are aware about the features of Islamic banking. A number of these non-Muslim respondents were also found to be employees of Islamic banks. The fact that Islamic Bank of Britain employs the best person for the job regardless of color, creed, gender, and ethnicity, the system makes it more familiar to non-Muslims. It may be concluded that although Islamic banking is a good alternative to the conventional banking system, it should not replace the conventional system. The benefits drawn in the adoption of Islamic banking may be a very good alternative for investors who could use either or both systems to maximize the outcome of their investment plans. Chapter 1 Introduction 1. 1 Introduction What is Islamic Banking? Islamic Baking is quite a different system compared to a conventional banking system. The Islamic banking system prohibit usury and interest categorized as riba. It is governed by Shariah where Islam does not distinguish interest and usury (Haron 1995, p. 26). Currently, there are more than 150 interest-free institutions all over the world according to the International Association of Islamic Banks. Islamic banks nowadays were also serving non-Muslim countries such as Denmark, Switzerland and other Western countries. No interest is paid nor charged in an Islamic Bank. (Haron 1995, p. 26). The pioneer Mit Ghamr Local Savings Banks was established in 1963, somewhere in Nile Delta, Egypt, a provincial rural center. Although most of the banks operate in Muslim countries, it was also extended to the Western world. An example is the Islamic Banking System International Holding which was established in Luxembourg in 1978. It is considered as the first Islamic bank in the Western soil. The establishments of these banks were followed by other Islamic banks not only serving Muslim customers but also those who expanded their operations to service non-Muslims (Haron 1995, p. 27). After more than a decade since its establishment, it was estimated that over US$20 billion to US$40 billon of assets existed in the Islamic banking system worldwide. Currently, they have grown for more than US$60 billion. A study shows that the adoption of Islamic Banking in a financial system has not led to collapse as some feared to happen (Ghannadian & Goswami 2004, p. 242). Islamic banking is also playing a very important role in resource allocation, mobilization and utilization. It means Islamic banks are also providing savings to depositors and credits to the needy. Normal deposits such as savings account, current account and investment deposits are very available to customers. Islamic banks provide financial assistance in a short or long term business and individuals. They are also involved in international trade activities (Haron 1995, p. 27). 1. 2 Research Background It is difficult to pinpoint when Islamic banking started, but consensus suggests that it took place in Egypt in the 1960’s. In the mid 1970’s, Islamic banking started to take root in other Muslim countries. The changes were explained into main factors. First, the 1970s have seen oil price shocks which led to a massive transfer of wealth for the oil-consuming to oil-producing countries. Second is the fact that the oil shock coincided with the Iranian revolution which brought about the Khomeini government and the first Islamic republic (Akacem & Gilliam 2002, p. 126). By 2003, there were about 176 Islamic banks around the world, handling over US$ 147 billion and 32 banks are in an Arab state (Info Prod Research, 2003). This form of specialized banking may help to promote growth in the developing countries (Ghannadian & Goswami 2004, p. 242). As recent as 2003, there have been news about the introduction of Islamic hedge funds which could tap into the capital of Islamic families that could be worth a trillion dollars in asset management. According to banking statistics, the growth rate of Islamic banking has outpaced the growth of traditional banking in the past decade. Transformation Oriented Developing Economies (TODEs) made the transformation of society into full pledged market based economies (MBEs) a centerpiece in overall strategies. Many structural changes are required in its financial institutions, especially that the role of a financial intermediary in supplying funds to a growing new industry is crucial. Moreover, there are times when improper resource allocation may potentially result destabilization due to either faulty risk assessments. Or because of the design of its contract could be significant in examining the implementation of an Islamic banking system and how Islamic banks can provide liquidity and aid in creating money. This is through offering transactions accounts with compensation for inflation to risk-avoiding depositors (Ghannadian & Goswami 2004, p. 242). Evolution of Islamic The first modern experiment with Islamic banking was undertaken in Egypt. The pioneering effort of projecting Islamic image was led by Ahmad El Najjar who aimed to establish a savings bank based on profit-sharing in the town of Mit Ghamr in 1963. This experiment lasted until 1967, and by that time there were nine banks operating in the country. These banks neither charged nor paid interest and invested mostly in trade and industry directly or in forms of partnership and shared their profit with the depositors. This function is essentially a savings investment institution rather than a commercial bank. The Nasir Social Bank was established in 1971, IDB established in 1974 by the Organization of Islamic countries, and was the primarily inter-governmental bank aimed at providing funds for development projects in member countries (Sohrab 1996, p. 287). In considering the adoption of Islamic banking by conventional banks, what kind of benefits may be drawn from such adoption and the challenges they are going to face in undertaking such? Most benefits that may be drawn from the adoption of Islamic banking by conventional banks come from the features of its equity financing contract. With Mudaraba (trustee financing) and Musharaka (equity participation), entrepreneurs with little means and substantial collateral are able to gain access to capital (Sohrab 1996, p. 288). In addition, few businesses are able to operate strictly on cash basis without taking on debt or selling a portion of the business just to cover shortfalls or when there is a need for expansion (Bartlett & Economy 2002, p. 184). Because of this, it will be more attractive to engage into Islamic bank equity financing than that of conventional banks offering debt financing thus, making Islamic banking more competitive with regards to innovative entrepreneurial customers.