Development, Competitive and Product Innovation Analysis of Islamic Banking - Case Study Example

Development, Competitive and Product Innovation Analysis of Islamic Banking Name: Course: Instructor: Institution: Date of Submission Development, Competitive and Product Innovation Analysis of Islamic Banking Introduction Islamic banking is banking activity, which is consistent with principles of Islamic Shariah, and their practical application that are meant to develop the whole scope of Islamic economics. Specifically, some banking institutions call it Shariah Compliant Finance (Nzibo, 2014). Since the Shariah, principles prohibit floating or fixed payments or acceptance of any fees or interests (usury or riba) on any loanable finance, the banks participates in sharing of losses or profits with the borrower. It is important to note that although Islamic principles have been applied by various historical Islamic economies at varying degrees, it is only in the twentieth century that their usages have become widely applicable in Islamic community (Sailan & Muslim, 2009; Iqbal & Molyneux, 2006). According to the report by Ernst & Young, Islamic Banking has been rising and gaining a lot of popularity in both Muslim and non-Muslim communities. In this regard, this discussion has chosen three prominent banks in the Gulf region to analyze their development, and competitiveness and evaluate their product innovativeness. It should be noted that the GCC countries have been accounting for about 56% of the total revenues of Islamic banks. Based on McKinsey evaluation, it has been estimated that, by 2015, more than half of all business sectors in the GCC region will become Shariah compliant. Nonetheless, over 20 Islamic banks in the region have grown by 20% (Khatib, 2010) Characteristics of Islamic Bank Islamic banking is a banking system that is based on Islamic Shariah principles in the whole guidance of Islamic Economics. It is found on two basic principles: prohibition of Interest collection and sharing of loss and profits between the bank and the customer. Generally, Islamic banking espouses certain features that normally distinguish it from conventional banking. The first characteristic of Islamic baking is to avoid riba (interest) (Lewis, 2013). Riba is perceived to be an increase in money form without an increase in the assets themselves. Therefore, this increase, which represents nothing, when charged, is forbidden according to Islamic jurisprudence. Secondly, Islamic banking ensures that the bank shares profit and loss with the borrower (Bashir, 2000). This acts like partnership venture that is backed with real assets in the process of financing. By eliminating perils of uncertainties (gharar) and interest (riba), they promote the real economic activities and thus the economy may not plunge into effects of recession (Bashir, 2000). Since the banks do not charge interest to avert its risks, it ensures that there is a very careful evaluation of risks on any investment demand they undertake with the customers. The banks are normally conceived to be multi-purpose but not purely commercial. They are actually crossbreeds of investment management institutions and investment trusts, investment and commercial banks and therefore offer a variety of services to its customers. Being equity oriented institutions, they cannot permit their management to borrow for short term and lend for long term (Bashir, 2000). The banks operate primarily on the principles of Shariah unlike the conventional commercial banks, which do so on manmade basis (Beck, Demirguc & Merrouche, 2010). The Islamic banks promote risk sharing between the customer and themselves, unlike the case in commercial banks where investor is assured of the prefixed interest. Islamic banking collects zakat, which is not applicable in conventional commercial banks. Moreover, the Islamic banks functions on partnership with the borrower unlike the conventional commercial banks which are just determined to get bank full interest and principal. Although the conventional banks may charge extra money on defaulters, Islamic banks are not mandated to do so. The Islamic banks will always participate in ensuring that equity grows, which is not the case in the conventional banks. Therefore, the Shariah compliant banks pay greater attention to appraising and evaluating any development projects. As the conventional commercial bank gives a lot of emphasis on credit worthiness of the customer, Islamic banking is much concerned with the viability of the project. Therefore, the relation of a client in an Islamic bank is that of partners, which is different from that of commercial bank that is characterized with the creditor –borrower (Beck, Demirguc & Merrouche, 2010). Al Hilal Bank It is one of the fastest growing banking and financial institution in the United Arab Emirates (UAE), being owned wholly by the government. Based in Abu Dhabi, the bank is founded on Islamic Shariah laws. In this regard, it provides Islamic corporate, treasury, wholesale banking services and investment services to over 80,000 customers. By 2013, it made a net profit of 343 million from the total revenue of 1.8 billion (all based in AED). The bank operates in twenty branches across UAE and three branches in the republic of Kazakhstan. Currently, it has a customer base of 80,000. It manages Global Sukuk Fund, Al Hilal GCC Equity Fund and owns the Mall Branch (Al Hilal, 2014). The Bank was found by the Abu Dhabi Government under its investment arm of Abu Dhabi Investment Council (ADDIC), with authorized capital of AED 4 billion. By June 2008, the bank had already opened up various branches, gaining international recognitions due to its excellence in regional retail banking. In this regard, it has won several awards as distinguished by bodies such as Islamic Business & Finance Awards. Most rating agencies such as Moody’s Investors Service have found the bank being profitable, healthy in asset quality, robust in reserve coverage, espousing government support and satisfactory capitalization. Abu Dhabi Islamic Bank (ADIB) The Abu Dhabi Islamic Bank began in 1997, through the Amiri decree as a Public Joint Stock Company, though it formally began its commercial operations in 1998. Being an Islamic Bank, it is important to realize that all operations, contracts and transactions are done according to Islamic Shariah law and principle 9Al Hilal, 2014). The company which begun with I billion dirham, has had the capital divided into various shares to be enlisted on Abu Dhabi Securities Market. Among the 51 available banks in the United Arab Emirates, the bank has been particularly pushing for greater market share (Bashir, 2000). Qatar Islamic Bank (QIB) The Qatar Islamic bank was established in 1982 by an Emiri Decree as the country’s shareholding company. It was to provide banking services in the country in accordance with Sharia Law as required by the Qatar Central Bank’s regulations. Although it commenced operations in 1983 with a one branch, it has been expanded to eight. The bank has been carrying out several banking services that have included financing, banking and investment activities through Shariah compliant modes of financing. According to analysts, the country has a huge potential of becoming the biggest player of the Islamic banking sector in the region. By the end 2011, according to the Institute of Islamic Finance (IIF), the total asset value of the Qatari finance record had reached $35 billion while that of the whole GCC was $314 bn (Qatar Islamic Banking, 2014). Moreover, the country enjoy in matters such as strong regulation and compliance system of Islamic bank that ensures that the whole financial system does not become risky. Moreover, with the country having such huge surpluses in its current accounts, it can easily finance deficits of the banks. Being the country’s largest leading Islamic Bank, it has been consecutively, for three years, been named as the country’s Best Islamic Bank in Qatar, by the Islamic Finance News (IFN). The IFN awards, which were established in 2005, have gained a lot of cognizance to honor financial institutions that practice Islamic banking. Other ratings have also indicated good performances for the company. The Fitch Ratings have affirmed that the it has a rating of A while the Standard and Poors has accorded to it a rating of A-. Nonetheless, in 2009, the QIB was named the Best Islamic Financial Institution in the country by Global Finance Magazine (Qatar Islamic Banking, 2014). Competitiveness in the Three Gulf Islamic Banks General Market Scenario Generally, the three banks belong to Gulf region in which the Islamic banking has been said to be growing very first. According to analysts, the region owns 56% of the total assets of Global Islamic Banking activities. According to the 2012 report by the World Islamic Banking Competitiveness, Indonesia, Qatar, Saudi Arabia, UAE, Malaysia and Turkey are experiencing a rapid growth in Islamic Banking sector. However, all the banks face a challenge of how they can become mainstream in matters of Islamic banking in their own countries. This will also mean that the banks differentiate themselves from commercial banks to carry pure brands of Islamic banks. Market share Sales and Profits Generally, the Islamic banking sector in the Gulf region has continued to do better with a general profitability trends of 10.7%. In market share, it is important to note that the UAE banking sector is the most competitive in gulf region. This is because; a country of only 8 million people has 51 banks with 850 branches across it. With the number of ATMs increasing up to 4,000, service delivery will be high but at lower profitability than any other GCC country. For instance while the charge on loans remain at 2.9% in UAE, for Qatar, it is averagely 3.4%. For the UAE banks, although they offer mix deposits, and low customer charges, high level of non-performing assets may result in reduced profitability and therefore, low Returns on Investments, as compared to those of Qatari bank. Nonetheless, one should put in mind that UAE profitability in banks suffered a lot during the last recession (2007-9) and they have continuously been stagnating. The Global financial crisis did not affect the Qatari financial sector very much as it did on the other members of the Gulf Countries Corporation (GCC). As a number of European and American financial institutions were falling into bankruptcy, becoming unable to play their roles as creditors, the Qatari banks were enjoying good financial stability and solvency. In fact, during the year 2008, the Qatari banks recorded a 34% growth in its total assets and over 29% in net profits. Sales At ADIB, the company has had AED 3, 931,000,000, AED 3,556,600,000 and AED 3, 425, 800 for 2013, 2012 and 2011 respectively, as its revenues (Qatar Islamic Banking, 2014). At QIB revenues have been QAR 3,144, 220,000; 3,105, 070,000, and 2, 681,552,000 for the year 2013, 2012 and 2011 respectively. This is equivalent to AED 3,172,297,884.6, AED 3,132,798,275.1, and AED 2,705,498, 259.36 for 2013, 2012 and 2011 respectively. Al Hilal Bank has been enjoying revenues of AED 1,937, 951,000 and AED 1,838,848,000 and AED 1,716, 925, 000 for 2013, 2012 and 2011, respectively (Al Hilal Bank, 2014b). In this regard, the ADIB bank takes an edge over others as the largest in market share and therefore revenue. This has been enabled by its market niches as it has expanded in other countries like Susan, Egypt, Tunisia, and Iraq among others. However, it is important to note that the market for Islamic banking is expanding as it can be noted by increasing revenues for the last three years . Profits Net profit for QIB are QAR 1,325, 603,000; QAR 1,125,691,000; QAR 1,215, 863,000; for the years 2013, 2012 and 2011 respectively (QIB, 2014; QIB, 2013). This can be translated in UAE Dirham as, AED 1, 337,440,634.79, AED 1, 135,743,420.63, and AED 1, 226, 720,656.59 for the year 2013, 2012 and 2011 respectively. For Al Hilal Bank the company posted net earnings of Dh441.4 million, which marked a 42% increase over that of 2012’s Dh 310.3 million. In the year 2011, driven by sukuk and investment in Kazakhstan, the bank made a net profit of Dh 140 million (Al Hilal Bank, 2014b).AIDB, its profits jumped by 20.7 % to Dh 1.45 billion. This is a rise from the 2012 net profit of 1.20 billion. However for 2011, the company had got Dh1.425 billion, which was a rise in the 2010 revenue of Dh 1.214 by 17.3% (World Finance, 2014). Just as from revenues, the ADIB still enjoys huge revenues in the UAE and in the Gulf region. Nonetheless, profitability in the Islamic banking in the region seems to be remarkably increasing. According to its management, the significant growth in profit emanated from asset growth and improvement, and liability mix. Moreover, its deposits advanced by 13%, jumping at revenue of AED282.2 billion while financing grew by 18.3% to AED 27.1% (ADIB, 2014b). Prices of their Stocks Currently, the Qatar Islamic Bank share is trading at QAR 93.50, (equivalent to AED 94.33) with a volume of which is a 37.10% rise from that of the last year. For the ADIB share, it is being traded at AED 6.51, with a volume of 2,584,839 being a 91.95% rise in the last years volume, while for Al Hilal Bank, its share has been trading at AED 155.89, which represents an increase of 15.70% for the last three years ADIB, 2014b). In this regard, the Al Hilal current earnings per share and the expected dividend growth are pushing up its share prices. In this respect, the company is likely to be making to a lot of profit, in which higher dividends can be recouped so that the earning per share increases, leading to a higher share price (Al Hilal Bank, 2014b). Asset Base Although the UAE banks have shown having large assets, the Qatari Islamic firms may catch on them as it is growing too fast ADIB. Products Innovation, Solutions and Services Provided By Selected Companies Common Products and Services among Banks For equity structure instruments, the Islamic banking system has instituted Musharaka to refer to partnership. In this case, the borrower agrees with the lender bank to start and run the business venture but return to him the agreed share of profit/loss and the principle (Faizulayev, 2011). On the debt structure, Murabaha is a markup/ cost plus, which involves purchasing of a tangible asset from a third party and selling it to the client at an agreed price on installments where profit margins are added (Islamic Development Bank, 2014) . Qard Hassan is an interest free loan that is only acceptable in Islam. In Wadia, a customer will deposit money in the bank, earning nothing as the bank use the money as it desires. However, his funds must be secured (Faizulayev, 2011). The other important technical instrument as regards Shariah law is the sukuk. It was meant to replace the western-based bond certificate in finance. In this regard, the traditional western-based interests on bonds are not permissible. Therefore, a person wishing to sell the certificate to the bond issuer will have to make an agreement that he will return it back. In this regard, the person will rent it at a predetermined rental fee. As the interest is prohibited in this respect, the issuer of the certificate will promise to buy back his bonds at a future date, but at par value. Al Hilal Islamic Bank For deposits, the bank allows them to be made in Euro, US Dollar, Kazakhstan currencies and the United Arab Emirate dirham. The other groups of services are currency exchange money transfer, and cash management. In cash management, the bank has aimed at providing solutions in facilitating cross-border or local payments. However, it instituted electronic solutions whereby individuals, corporate and governments can access their accounts directly through Bank-client system. In this regard, since this is a purely Islamic bank, one should expect all accounts be managed according to Shariah laws. The bank also provides financing options that comply with the Shariah law. In this case, there is Ijarah Muntahiya Bi Tamlek, which is a finance option for the lease that will end up with transfer of ownership. Using Murabaha facilities, it can enable one to finance his oil and gas projects, machinery and equipment, manufacturing, transportation and communication among others. The bank also undertakes letter of credit payments to a specified beneficiary according to the instructions provided. However, the company has reiterated that in Islam, a letter, which is not covered, will be serviced under the murabaha principles. Moreover, the bank issues bank guarantee and in this case, it writes an obligation letter specifying itself as a warrantor for settling certain debts (World Finance, 2014). It has instituted the wakala services, which is one of the instruments that will make sure that the client earns high returns in his investments with the business. Therefore, the bank must ensure that the customers’ funds are invested in very promising areas to earn very attractive returns, on their assets. Nonetheless, the bank also acts as a forex, whereby currencies can be sold or bough through it. In capital markets, sukuk is available on both fixed and floating rates. The bank management provides advices to those customers who want to venture in volatiles markets to consider factors such as hedging, to enable them remain in the business for long term. The company has been offering the insurance (takaful) services to its clients on Shariah compliance. However, there are accounting policies to implement musawama, murabaha, musharaka, istisna'a, wakala, and ijarah. ADIB The Islamic banking provides, financing, banking, and investing services to medium and small businesses, corporate and institutional customers and individuals. The bank also offers personalized banking, which has included personal banking products, current or recurring investments, and personal accounts. This will also include car shares, travel, boat, education, al khair liabilities, job loss financing, cash cover, motor and takaful products. Moreover, the bank provides the wakala solutions and remittances from foreign exchange to its members. Like the Al Hilal Bank, the bank offers wholesale banking services that include many corporate finance solutions. For employers, it has been much helpful in conducting payroll managements, and procurement cards (World Finance, 2014). Taking in mind that it is much embracing IT, it has instituted e-commerce solutions and other online service to ease the client-bank transactions. Apart from trading financing, the bank provides brokerage services, treasury services, demand draft, deposit lockers, telephone banking, wire transfer services and other online banking services. For land developers, the bank acquires, leases, develops and sells it and its building. For those who want to get married, a tamweel finance program is intended to take care of them. Nonetheless, there is travel finance, especially for Hajj or Umrah. Nevertheless, there are accounting policies in place for implementation of musawama, murabaha, musharaka, istisna'a, wakala, and ijarah. Qatar Islamic Bank The company is constantly providing various treasury services, especially for those who are venturing in a volatile financial market. In this regard, there are sukuk arrangements where experts arrange to facilitate trading and pricing of sukuks. The bank also helps its clients to manage their liquidity and return on their investments. Foreign exchange is another area that the bank provides Shariah compliant solutions. In this regard, the company arranges for spot FX transactions, forward FX transactions and structure FX hedging. The company is also planning to increase investment products and make them quality. In this regard, it wants to ensure that there is an increase in income, its growth and customer’s capital preservations. On financing, it provides several options: real estate financing, project finance, contracting finance, asset finance, corporate finance, and working capital finance (Qatar Islamic Banking, 2014). For account management, there were time deposit, call/ saving account, and current account. Moreover, the company undertakes all forms of cash management that include cheque clearing and collection, cash deposits, writing cheques, SWIT transfer, salary transfer among others. The other critical part is the Internet Banking that ensures efficiency in its operations. In Trade and Finance service, the company administers various forms of both import and export. For import letters the bank has established forms such as murabaha LC, wakala LC, and mudaraba LC (World Finance, 2014). Moreover, it offers export letter credits. In this case, the bank has ensured that it gives very efficient services regarding confirmation, paying, and negotiating to the exporters. These kinds of letters are used when sellers/ exporters do not know the buyer who is abroad, or less known. Therefore when a person receives this kind of letters he will become assured that he will be paid. The company has ensured that it hires very qualified persons for verifying the documents to ensure that they are up to the required standards, so that it may not make any loss regarding them. Moreover, as a matter of safety and privacy assurance the original copies will be kept very well. Nonetheless, there are accounting policies to put into account implementation of musawama, musharaka, istisna'a, and ijarah (Qatar Islamic Banking, 2014). As realized from the discussion, although the product and service innovations in the banks can be considered somewhat equal, as each bank strives to expand its range of products, the Qatari bank seems to be setting itself apart from others. The bank in its innovation, has offered new solutions regarding hedging mechanisms. Moreover, it undertakes all forms of cash management that include cheque clearing and collection, cash deposits, writing cheques, SWIT transfer, and salary transfer among others. Foreign exchange is another area that the bank provides Shariah compliant solutions. In this regard, it arranges for spot FX transactions, forward FX transactions and structure FX hedging. References Al Hilal(2014). Al Hilal Website. Retrieved on 15 May 2014 from http://www.alhilalbank.ae/ Bashir, A. M. (2000). Determinants of Profitability and Rate of Return Margins in Islamic Banks: Some Evidence from the Middle East. ERF Seventh Annual Conference, Amman. Beck, T., Demirguc, A., & Merrouche, O. (2010). Islamic vs Conventional Banking. The World Bank Development Research Group. Faizulayev, A. (2011). Comparative Analysis between Islamic Banking and Conventional Banking Firms in terms of Profitability, 2006-2009. Eastern Mediterranean University, Gazimagusa, North Cyprus. Iqbal, M and Molyneux, P 2006, Thirty Years of Islamic Banking: History, Performance and Prospects, J.KAU: Islamic Econ, 19(1). Islamic Development Bank, 2014, Financing Instruments, viewed 16 January 2014 Khatib, A. (2010). A radically different view. Middle East Supplement. Lewis, KM 2013, In What Ways Does Islamic Banking Differ from Conventional Finance, Journal of Islamic Economics, Banking and Finance. Nzibo, Y.A. (2014). Islamic Banking: General Overview. Retrieved on 15 May 2014 from Http://www.nzibo.com/islamic.html Sailan Muslim. (2009). Origin and History of Islamic Banking. Retrieved on 15 May 2014 from http://www.sailanmuslim.com/news/origin-and-history-of-islamic-banking/ World Finance. (2014). QIB spearheads innovation in Islamic banking products. Retrieved on 15 May 2014 from http://www.worldfinance.com/markets/qib-sprearheads-innovation-in-islamic-banking-products Qatar Islamic Bank (QIB). (2014). QIB Website. Retrieved on 15 May 2014 from http://www.qib.com.qa/en/ Amazon Publications. Read More