ISLAMIC BANKING VERSUS
COMMERCIAL BANKING:
PROSPECTS & OPPORTUNITIES
A PRESENTATION BY:
Dr. Fouad Shaker
Senior Advisor & Partner: First East Invest
Former Secretary General: Union of Arab Banks
OUTLINE
Principals and development of Islamic finance
Theory and practice of Islamic financial intermediation
Theoretical & practical differences between Islamic & conventional banking
Comparison of financial ratios of Islamic and conventional banks
Future challenges
Areas for improvement and steps forward
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Principals and development of Islamic finance
I.
Principals of Islamic financial system
1) Prohibition of Interest (RIBA)
 “An excess” Any unjustifiable increase of capital whether are
loans or sales in the central tenant of the system.
 Islamic regulations encourage the earning of profit but forbid
the charging of interest.
2) Money as a potential capital
 It joins hands with other resources to undertake a productive
activity.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Principals and development of Islamic finance
3) Risk sharing
 When interest is prohibited, suppliers of fund become investors instead
of creditors.
 Investors & financial intermediary relationship is based on profit & loss
sharing principals.
4) Prohibition of speculative behavior
 Discouraging hoarding & prohibits transacting featuring extreme
uncertainties.
5) Sanctity of contracts
 Upholding contractual obligations & the disclosure as a sacred duty to
reduce the risk of asymmetric information & moral hazard.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Principals and development of Islamic finance
6) Sharing-approved activities
 Only activities that don’t violate the rules of shariah qualify for
investment.
 Any business Dealing with alcohol, gambling or casinos is
prohibited.
7) Social justice
 In Principle , any transaction leads to injustice & exploitation is
prohibited.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Principals and development of Islamic finance
II. Development & growth of Islamic finance
1) Development of Islamic finance
 A rapidly growth part of the financial sector in the world ( >15% annual
growth rate).
 Not only Islamic countries, more than 300 financial institutions in over 50
countries practice some form of Islamic finance.
 The market current turnover is estimated to be $350 Billion compared
with $5 Million in 1985.
 Islamic finance industry has reached $1.4 Trillion by the end of 2011,
expected to be $4 Trillion over medium term.
 Global conventional banks (HSBC, Citibank…etc.) have setups separate
windows to offer Islamic banking services.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Principals and development of Islamic finance
2) Emergence & evolution of Islamic institutions in recent history
 In Muslim countries:
o 1963, local saving banks was established in Egypt to practice their work on a noneinterest bases to enhance the banking habit.
o After 1974, many Islamic banks were established in different Muslim countries due to
the sharp increase of the oil prices.
o Sudan, Iran, Pakistan started the Islamization of banking system during 1980s.
 In the western world:
o In 1983 Islamic finance house started in Luxemburg.
o recently, besides establishing Islamic banks, Islamic windows in leading banks
pursuing this market very aggressively.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theory & practice of Islamic financial intermediation
I.
Basic contracts & instruments
1) Financing instruments
Used to finance obligations arising from the trade and sale of
commodities or property and collateralized by the product being
financed, such as:
a)Murabahah
 A bank purchases a product for a customer who doesn’t have a capital. Both
agree on a profit margin added to the cost, the customer should pay the bank
later the whole amount.
b)Bay Al-Muajjil
 A sale transaction with deferred payment allows the sale of a product on the
bases of deferred payment.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theory & practice of Islamic financial intermediation
c)
Bay Al-Salam
 The buyers pays the seller the full price of a product which the seller promises to
deliver at a specific future date.
d) Ijarah
 A medium term financial instrument gives something in return for rent,
resembles the leasing contract.
e) Istisnah
 To facilitate the manufacture of an asset at the request of the buyer. Once the
manufacturer undertakes to manufacture the asset for the buyer, the transaction
of Istisnah comes into existence.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theory & practice of Islamic financial intermediation
2) Investing instruments
Vehicles for capital instrument in the form of a partnership.
a)Mudarabah
 A fund management instrument , could be short, medium or long term,
whereby an investor entrust capital to an agent to undertake a project.
b)Musharakah
 An equity partnership instrument which could be either medium or long
term partnership, where two or more persons combine either their
capital or their labor to share the profit & losses.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theory & practice of Islamic financial intermediation
II.
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Structure & components of financial
statements for Islamic banks
ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theory & practice of Islamic financial intermediation
Theoretical Balance Sheet of an Islamic bank based on maturity profile
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theory & practice of Islamic financial intermediation
Theoretical Balance Sheet of an Islamic bank based on functionality
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theory & practice of Islamic financial intermediation
Composition of an Islamic bank Balance Sheet
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theory & practice of Islamic financial intermediation
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theory & practice of Islamic financial intermediation
III. Islamic financial institutions in practice
Early forms of Islamic financial institutions were concentrated in commercial
banking activities, todays’ Islamic financial institutions can be divided into
the following broad categories
1) Islamic banks
 Could be public or private sector.
 A hybrid of conventional commercial banks & investment banks, it
resembles universal banks.
2) Islamic windows
 A setup in a conventional bank that offer Shariah-compliant product.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theory & practice of Islamic financial intermediation
3) Islamic investment banks & funds
 Aiming to capitalize on large investment syndications, market-making
and under writing opportunities.
 Succeeded in developing innovative large-scale transactions in
infrastructure finance.
4) Islamic mortgage companies
 Targeted at the housing market for Muslim communities in western
countries.
 Four models:
1.
2.
3.
4.
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Ijarah.
Equity partnership (diminishing Musharaka).
Murabahah. (sales transaction).
Along the lines of corporative societies.
ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theory & practice of Islamic financial intermediation
5) Islamic insurance companies (Takaful)
 Takaful means mutual or joint guarantee. The participants agree to share
their losses by contributing periodic premiums in the form of investment.
They have to redeem the residual value of profits after fulfilling the claims
and premiums, which is a critical difference between contemporary
insurance and Takaful. Takaful is a given solidarity.
6) Mudaraba companies
 Similar to that of closed-end fund managed by specialized professional
management companies. Unlike the Islamic bank, they are not allowed to
accept deposits. Funded by equity capital.
 Two types; Multipurpose (more than one investment purpose) and
Specific purpose.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theoretical & practical differences between Islamic &
conventional banking
I.
Different concepts of borrowing, financing &
investment
1) Different modes of borrowing
 According to the state bank’s of Pakistan 2008, conventional banks
average for deposits ranged from 2.09% - 2.30% per annum while
borrowing rate average ranged from 11.20% - 11.56%. The difference is
7.82%. Islamic banks average rate on PLS deposits ranged from 3.5% to
3.79%. Profit & loss sharing deposits earn more than 1% higher.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theoretical & practical differences between Islamic &
conventional banking
2) Different modes of financing
 Conventional banks high rates of interest on all types of loans. Which may
be the cause of the business failure & the default of the loan. Islamic bank
provides loans on profit & loss (PLS) bases, and only for production
purposes.
3) Different modes of investment
 Conventional banks; 50% in government treasury bills, bonds, term
finance certificates for security, they suffer badly in case of stock market
crash.
 Islamic banks; can not invest in government bonds. Nevertheless, the
Sukuk issued by Islamic government would act as a practical solution for
(IB) liquidity.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theoretical & practical differences between Islamic &
conventional banking
II. Different visualization of the role of money
1) Conventional banks
 Uses interest to make money out of money. They use money as a
commodity which is bought & sold.
2) Islamic banks
 Use money as a medium of exchange to facilitate trade transactions. They
supply money to traders to purchase real assets or industrialists to
produce value-added products. If finance takers generate profit they will
share it with the Islamic bank. If they suffer losses the bank will share the
loss.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theoretical & practical differences between Islamic &
conventional banking
III. Different attitude of risk sharing & income distribution
1) Different concepts of risk sharing
 Conventional banks; being interest rates based, their depositors do not
share the risk with the bank in case of economic shock. Also banks
receive fixed rates from borrowers regardless their losses in case of
business failure.
 Islamic banks; their deposits and investors are ready to share risk with
the bank in case of financial shocks. The bank as well, is responsible to
take risk in case of business failure.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Theoretical & practical differences between Islamic &
conventional banking
2) Different approaches of income distributions
 The interest-based financial system is pro-rich and anti poor, unlike
Islamic financial system which play a vital role in eradication of poverty
through Zakat and profit & loss sharing principle.
3) Having different objectives and goals
 Islamic bank works for all benefit of the overall society and for equitable
allocation of resources through credit distribution. While the
conventional bank works for a specific class that is rich.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Comparison of financial ratios of Islamic and
conventional banks
Based on the findings of a recent research in Pakistan on two similar groups of
conventional & Islamic banks (Average of 6 banks each group).
1) Earning ratios
Islamic Banks
Conventional
Banks
(ROA) Return on Assets
0.079
-0.75
(ROD) Return on Deposits
0.07
-0.93
(ROE) Return on Equity
1.297
-2.27
(EPS) Earning per Share
0.38
-0.34
Ratios
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Comparison of financial ratios of Islamic and
conventional banks
3) Debt management ratios
Islamic Banks
Conventional
Banks
Debt / equity
2.3
8.0
Deposit times capital
3.78
5.71
Debt / assets
0.78
0.85
Equity / equity + debt
31.3
17.17
Ratios
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Comparison of financial ratios of Islamic and
conventional banks
2) Asset quality management
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Ratios
Islamic Banks
Conventional
Banks
NPLs / advances
Non-performing loans / advances
1.06
5.88
Provisions / NPLs
Provision / non-performing loans
47.09
40.89
NPL / deposits
Non-performing loans / deposits
1.22
6.24
ISLAMIC BANKING VERSES COMMERCIAL BANKING
Comparison of financial ratios of Islamic and
conventional banks
4) Liquidity ratios
Islamic Banks
Conventional
Banks
Earning assets / total assets
95%
93%
Advances / deposits
83%
70%
Yield on earning assets
2.7%
1.83%
Ratios
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Comparison of financial ratios of Islamic and
conventional banks
5) Solvency ratios
Islamic Banks
Conventional
Banks
Equity / total assets
Capital adequacy ratio (CAR)
21.78%
14.59%
Equity / deposits
36.2%
20.09%
The earning assets / deposits
143.79
115.98
Ratios
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
6) Cash to deposit ratio
Ratios
Islamic Banks
Conventional
Banks
Cash & balance / total deposits
11.55%
12.55%
Islamic Banks
Conventional
Banks
Investments / deposits
15.39%
23.85%
Investments / total assets
4.37%
9.25%
Islamic Banks
Conventional
Banks
Borrowing / total assets
4.37%
4.25%
Borrowing / total deposits
5.86%
11.92%
Borrowing / total advances
12.93%
16.05%
7) Investment to deposit ratios
Ratios
8) Borrowing ratios
Ratios
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Future Challenges
1) Liquidity
 Liquidity- enhancing financial instruments & the development of capital
market.
2) Limited scope
 Can benefit from economies of scale &enhancement of scope. Both
approaches offer diversification benefits.
3) Concentrated banking
 Diversifying their base of depositors, reduce their exposure, introduction
of Internet banking, geographical diversity on the liabilities side.
4) Concentrated banking
 Risk management framework can be enhanced by improving the
transparency in current financial disclosure.
 Measurement & management of risk need to be supplemented with
analytical method.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Areas of improvement & steps forward
 To enhance Financial Engineering that includes the design, development &
implementation of innovative financial instruments, new securities or new
process of creative solution to corporate finance problems, provided to be
Shariah complaint.
 There is need to establish supporting institutions to act as a Lender of Last
Resort .
 There is need to achieve Uniformity in, & Harmonization of, Shariah Standards
across markets & borders.
 To develop Fee -Based Services like, Joalah, Wakalah & Kifalah to exploit the
full capabilities of Islamic banks by diversifying the scope of non bank financial
services.
 Developing benchmarks based on the rate of return reflecting Islamic modes
of financing instead of using interest base benchmarks such as the London
interbank offered rate (LIBOR) which has been accepted on an adhoc based.
 Creating a secondary market to enhance the liquidity, & standardizing
contracts, to reduce the risk of asset backed securities.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
Areas of improvement & steps forward
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Standardizing the operations & instruments will pave the way for pooling
assets, much needed for enhancing liquidity in the market.
By expanding the scope of services, Islamic bank could spread the fixed
costs since they are similar to universal banking in a form of hybrid between
commercial & investment banking.
Having a Shariah board for every institution is not efficient. A Shariah board
for the system as a whole is needed to ensure that rules are defined &
enforced in compliance with the contractual obligations to all stockholders.
Well developed Islamic capital market will benefit borrowers, institutional
investors, together with enhancing the stability of Islamic banks.
A well developed Islamic microfinance industry will promote economic
development in underdeveloped Islamic countries, also it will economically
empowered the poor segments of society since they will be able to move
from being non-bankable to bankable, this will expand the base of the
depositors & investors.
ISLAMIC BANKING VERSES COMMERCIAL BANKING
A FEW WORDS ABOUT …
FIRST EAST INVEST
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
FIRST EAST INVEST …. What we do:
1 - INTERMEDIATE,
We intermediate in “trade” and “investment banking” deals and transactions between the
Arab countries and Eastern and Central, East Europe & CIS businesses
2 - SUPPORT
We support Middle Central, East Europe & CIS businesses trade with the Arab World. We
also support Arab Gulf investors identify & explore investment opportunities in Central,
East Europe & CIS markets as well as raise capital for financing existing or new business
ventures.
3 - PROMOTE
We promote Middle Eastern and Central, East Europe & CIS businesses’ market
expansions. We promote their business ideas, business ventures, and existing & new
projects. We also promote inward and outward direct investments & portfolio
investment between the Arab World and Central, East Europe & CIS businesses.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
FIRST EAST INVEST …. What we do:
BUSINESS DEVELOPMENT SOLUTIONS
INVESTMENT BANKING SOLUTIONS
 Exploring the initiative, assessing products &
 Private placements,
capabilities, and preparing the Company’s for the
 Debt structuring,
initiative,
 Raising funds,
 Targeting by identifying the market & clients base,
 Privatization,
 Planning the initiative, and producing an Action Plan,
 Mergers & acquisitions,
 Networking to establish the client’s own contacts in
 Corporate restructuring,
local market,
 Spin-offs,
 Visiting the market & testing the initiative,
 Leveraged buyouts, and
 Cooperating by identifying agents, representatives,
 Initial Public Offering (IPOs).
and/or Joint Venture partners in the local market, and
 Selling the Company’s products & services to the
clients already identified in the Arab World.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
FIRST EAST INVEST …. Our contact:
Cairo, Egypt – Head Quarters
First-East Invest Company
Flat # 12, Block 21
District 3, 6th of October, Giza ,Egypt
Tel
: + 20 (2) 3835 7677
Email : info@firsteastinvest.eu
Web : www.firsteastinvest.eu
Vilnius, Lithuania – Rep. Office
First-East Invest Company
16 – 4, Rudninku g.
Vilnius, Lithuania
Tel
: + (370) 646 54 795
Email : info@firsteastinvest.eu
Web : www.firsteastinvest.eu
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ISLAMIC BANKING VERSES COMMERCIAL BANKING
THANK YOU
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ISLAMIC BANKING VERSES COMMERCIAL BANKING