Haider Thises 3
Transcript of Haider Thises 3
Islamic Bank Vr Conventional Bank
CHAPTER 1:
1.1 An Overview of Bank
1.1.1 Bank Definition
The definition of a bank varies from country to country.
Under English common law, a banker is defined as a person who carries on the
business of banking, which is specified as:
conducting current accounts for his customers
paying cheques drawn on him, and
collecting cheques for his customers.
Bank is a financial intermediary and appears in several related basic forms:
A central bank issues money on behalf of a government, and regulates the
money supply
A commercial bank accepts deposits and channels those deposits into
lending activities, either directly or through capital markets. A bank
connects customers with capital deficits to customers with capital surpluses
on the world's open financial markets.
A savings bank, is only allowed to borrow and save from members of a
financial cooperative.
1.1.2 Islamic Banks and Conventional Banks.
Islamic banking and conventional banking are extremely different in many
ways. The key difference is that Islamic Banking is based on Shariah foundation.
Thus, all dealing, transaction, business approach, product feature, investment
focus, responsibility are derived from the Shariah law, which lead to the significant
difference in many part of the operations with as of the conventional
The foundation of Islamic bank is based on the Islamic faith and must stay
within the limits of Islamic Law or the Shariah in all of its actions and deeds. The 1
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original meaning of the Arabic word Shariah is 'the way to the source of life' and is
now used to refer to legal system in keeping with the code of behaviour called for
by the Holly Qur'an (Koran). Amongst the governing principles of an Islamic bank
are :
* The absence of interest-based (riba) transactions;
* The avoidance of economic activities involving oppression (zulm)
* The avoidance of economic activities involving speculation (gharar);
* The introduction of an Islamic tax, zakat;
* The discouragement of the production of goods and services which contradict
the Islamic value (haram)
On the other hand, conventional banking is essentially based on the debtor-
creditor relationship between the depositors and the bank on one hand, and
between the borrowers and the bank on the other. Interest is considered to be the
price of credit, reflecting the opportunity cost of money.
1.2 Financial Markets & Financial Industry.
Financial markets and financial industry are seeing the fast growth of
Islamic finance in last year’s. Some experts in the financial industry have
estimated this growth in some countries is very fast. This growth is reducing
the market share of traditional banks, and seems attractive to some of
them to convert their operations to Islamic banking.
Islamic banking forbids dealing in interest and the traditional
financing tools which are used by conventional banking, and they created
some other financing tools which are compatible with Islamic Sharei'a; as
the advocates of this industry say and as we will discuss in details in chapter
two.
In association with the growth of Islamic banking it was subjected
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to many criticisms, one of these criticisms is that the operating Islamic
banks don't use all the Islamic financing instruments, they are using only
some instruments which fulfill the benefits and the profitability to the bank
and its share holders, and they neglect or avoid some other financing
instruments which are more beneficial to the bank customers and more
related to main principles of Islamic finance theory. By avoiding such
instruments, the real activities and services of Islamic banks became strongly
close to those provided by conventional banks.
The main objective of this study is to assess the performance of
Islamic banks in U.A.E compared to the conventional or commercial banks.
We will apply an analysis using the financial ratios indicating the liquidity,
structure and profitability as a measure of the performance of both types of
banks.
1.3 PROBLEM DEFINITION
The basic framework for an Islamic financial system is a set of rules
and laws collectively referred to as Sharei’a, governing economic, social,
political, and cultural aspects of Islamic societies. Since the emergence of
the term "Islamic financial system", the system was built on some basic
principles like: prohibition of interest, risk sharing, prohibition of speculative
behavior, and sanctity of contracts. The Islamic financial system is
founded on the absolute prohibition of the payment or receipt of any
predetermined, guaranteed rate of return. This closes the door to the
concept of interest and precludes the use of debt-based instruments. The
system encourages risk-sharing, promotes entrepreneurship, discourage
speculative behavior, and emphasizes the sanctity of contracts.
The Islamic financial system has developed some basic instruments
which stick to the basics of the system. Basic instruments include cost-plus
financing (Murabaha), profit-sharing (Mudaraba), leasing (Ijara), partnership
(Musharaka) and forward sale (Bay' Salam). These instruments serve as the
basic building blocks for developing a wide variety of more complex financial
instruments. ( Zamir Iqbal, 1997).3
Islamic Bank Vr Conventional Bank
Based on the above bases and instruments, the Islamic finance are
suppose to play a great role in economic development through
promoting and encouraging entrepreneurs and business firms to expand
their activities. The actuality of this situation may be compatible with the
above theoretical bases or not, and the Islamic financing institutions may
play its aimed role or not. But based on our literature review, we see a big
gap between the theoretical bases and the actuality and applied services by
Islamic banks in many countries which are subjected to researches. And
many writers see that there is not any significant difference between the
actual operations and services provided by Islamic banks and the conventional
banks.
As a matter of fact, the Islamic banks and companies provide
significant contributions to the economic development process in U.A.E;
its popularity has increased during the past 20 years and a lot of Islamic
companies and funds have been established. It is clear also how much this
industry become attractive for the conventional banks to convert part of its
activities to Islamic finance.
For all the above, we think it is necessary to investigate the performance
of these Islamic banks, compared to the conventional ones. This assessment
of the performance should consider the profitability and structural issues.
Many studies has conducted such.
Type of assessment in many countries, we will try to conduct such assessment
on Abu Dhabi Islamic Bank
Zamir Iqbal (a national of Pakistan, is an Information Officer in the World Bank’s Treasury Information Services Department)
1.4 Objectives of the Study
This study aims to investigate the performance of the Islamic banks vs. conventional banks
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in U.A.E. The main objectives of this study are as follows:
1. To evaluate and analyze the financial performance of Islamic banks and the
conventional banks in U.A.E. my study object here to compare Abu Dhabi Islamic
Bank (ADIB) Verses Abu Dhabi Commercial Bank (ADCB)
2. To compare the financial performance of Islamic banks and conventional banks in U.A.E.
3. To investigate the relationship between financial performance of Islamic and
conventional banks in U.A.E.
1.5 Hypothesis
In fact, this study aims to answer the following questions:
1. Is there any significant difference between the performances of Islamic and
conventional banks in U.A.E?
2. What is the relationship between financial performance of Islamic and
conventional banks in U.A.E.
1.6 Scope and Limitations.
Following the introduction, chapter two reviews the literature concerning issues
related to this research. This chapter will include an overview of the concepts of Islamic
banking and finance, discovering the main principles and instruments of Islamic banking and
finance, and try to review the researches on the actual situation of Islamic banking
practices. Chapter three provides the research design and methodology and the data
description. In chapter four data analysis is achieved and its findings are obtained.
Finally, chapter five will present the conclusion, recommendations and also will include
suggestions for further research.
1.7 RELEVANCE OF THIS THESIS TO THE COUNTRY OF U.A.E
In U.A.E the Islamic banking services are in the way of continuous development and a
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very fast growth during the recent years. Obvious among this development is the
number of Islamic financial institutions and banks working in the U.A.E market.
The first private interest-free bank, the Dubai Islamic Bank, was also set up in 1975 by a
group of Muslim businessmen from several countries. Two more private banks were founded in
1977 under the name of Faisal Islamic Bank in Egypt and the Sudan. In the same year the U.A.E
government set up the U.A.E Finance House.
In the ten years since the establishment of the first private commercial bank in Dubai, more
than 50 interest-free banks have come into being. Though nearly all of them are in Muslim
countries, there are some in Western Europe as well: in Denmark, Luxembourg, Switzerland and
the UK. Many banks were established in 1983 (11) and 1984 (13). The numbers have declined
considerably in the following years.
In most countries the establishment of interest-free banking had been by private initiative and was
confined to that bank.
Current practices
Generally speaking, all interest-free banks agree on the basic principles. However,
individual banks differ in their application. These differences are due to several reasons including
the laws of the country, objectives of the different banks, individual bank’s circumstances and
experiences, the need to interact with other interest-based banks, etc.
1.8 Defination of Terms.
1. Al-Wadiah Yad Dhamanah (guaranteed custody) and investment .
2. Al-Mudharabah (profit-sharing). The bank grants financing facilities such as working capital financing .
3. Al-Murabahah (cost-plus), house financing .
4. Bai' Bithaman Ajil (deferred payment sale), leasing.
5. Al-Ijarah (leasing) and project financing .
6. Al-Musyarakah (profit and loss sharing).
CHAPTER 2:
LITERATURE REVIEW
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INTRODUCTION
Due to the observed significant growth in Islamic finance industry, this industry was
a subject of many studies and papers in last decade. In this chapter we tried to review some
of these literatures about Islamic finance and Islamic banking. We tried to indicate both
views about Islamic banking; the advocators and the critics. We tried also to review the
views about the actual situation of Islamic banking compared to the theoretical
principles of this industry. And at the end of chapter we added a review about the Islamic
banking in U.A.E.
2.1 HISTORY OF ISLAMIC FINANCE AND ISLAMIC BANKING:
According to Institute of Banking Studies of U.A.E the first Islamic bank start operation
in U.A.E in 1975, an early experiment with Islamic banking took place in Malaysia around
1940 and in Pakistan in 1950's. Countries like Egypt followed suit. Most banks in those
countries had rural orientation then. In the Arab world, the first experience with Islamic bank
goes to Egypt in 1963. The bank was formed under cover, without projecting an Islamic
image, for fear of mistaking as Islamic fundamentalism. However, the bank closed on 1967.
During this period, other banks came into being catering to trade and industry without
charging interest. Various countries in the Middle East did not support the formation of
Islamic banks for fear of subversive actives, creating support to the opposition parties in
creating political turmoil. The only Islamic institution to survive this period was Nasser
Social Bank of Egypt and Tabung Haji of Malaysia. These banks created an
atmosphere conducive for the Islamic banks in future to set up and improve the concept of
Islamic institutions: the concept of providing full range of commercial banking services,
in Islamic manner i.e. Interest f ree and b a l a n c i n g soc io -economic respons ib i l i t y
wi th commercial interests.
Institute of banking studies of U.A.E divided the development of modern
Islamic banks into three phases:
1. Emergence: 1972 through 1975: this period was marked by a surge in
oil revenues and great liquidity. Parallel events included a
resurgence of fundamentalist Muslim movements.
2. Expansion: 1976 to the early 1980's: Islamic banking spread from
the Arabian Gulf eastward to Malaysia, and westward to England.
Islamic banks spread across, including international and
intercontinental institutions. Islamic banking associations and
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consultancy bodies' broadened their operations.
3. Maturity: 1983 to the present: Arab banks opened branches in the
United States and Islamic banking practices were implemented in both
Pakistan and Iran, U.A.E. This gave an impetus to the growth of Islamic
banking internationally. Many conventional banks in the Middle East
have started the concept of Islamic banking into its portfolio. Many
western conventional banks followed suit and have exclusive Islamic
banking division. Islamic financial institutions now operate in over 75
countries.
Zamir Iqbal (1997) argued that the term "Islamic financial system" is
relatively new, appearing only in the mid-1980s. In fact, all the earlier references to
commercial or mercantile activities conforming to Islamic principles were made
under the umbrella of either "interest free" or "Islamic banking" (Zamir Iqbal, 1997)
A.L.M Abdul Gafoor (1995) wrote a more detailed explanation of the
history of Islamic finance. He divided the history of Islamic finance or (interest free
banking) into two parts. First, when it still remained an idea; second, when it
became a reality - by private initiative in some countries and by law in others.
The earliest references to the reorganization of banking on the basis of profit
sharing rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi
(1948) and Mahmud Ahmad (1952) in the late forties, followed by a more
elaborate exposition by Mawdudi in (1950 ,1961). Muhammad Hamidullah’s
1944, 1955, 1957 and 1962 writings too should be included in this category. They
have all recognized the need for commercial banks and the evil of interest in that
enterprise, and have proposed a banking system based on the concept of
Mudaraba - profit and loss sharing.
In the next two decades interest-free banking attracted more attention,
partly because of the political interest it created in Pakistan and partly because of
the emergence of young Muslim economists. Works specifically devoted to this
subject began to appear in this period. The first such work is that of Muhammad
Uzair (1955). Another set of works emerged in the late sixties and early
seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar
(1971) and Baqir al-Sadr (1961, 1974) were the main contributors.8
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Early seventies saw the institutional involvement. Conference of the Finance
Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian
study in 1972, First International Conference on Islamic Economics in
Mecca in 1976, International Economic Conference in London in 1977
were the result of such involvement. The involvement of institutions and
governments led to the application of theory to practice and resulted in the
establishment of the first interest-free banks. The Islamic Development
Bank, an inter-governmental bank established in 1975, was born of this
process.
The first private interest-free bank, the Dubai Islamic Bank, was also set up
in 1975 by a group of Muslim businessmen from several countries. Two more
private banks were founded in 1977 under the name of Faisal Islamic Bank in
Egypt and the Sudan.
2.2 PRINCIPLES OF ISLAMIC FINANCIAL SYSTEM
“The basic framework for an Islamic financial system is a set of rules
and laws, collectively referred to as Sharei’a, governing economics, social,
political, and cultural aspects of Islamic societies.” ( Zamir Iqbal, 1997).
The basic principles of Islamic financial system can be summarized as follows:
2.2.1 PROHIBITION OF INTEREST:
The Islamic financial system is founded on the absolute prohibition of
the payment or receipt of any predetermined, guaranteed rate of return.
Most of the literatures of Islamic finance agree with the Mr. Iqbal about the
prohibition of interest in Islamic finance. They used the expression
"Reba" as the equivalent to interest. And all the Muslims know that Islam is
prohibiting "Reba"
That Prohibition of "Reba", a term literally meaning "an excess" and
interpreted as "any unjustifiable increase of capital whether in loans or sales"
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is the central tenet of the system. More precisely, any p o s i t i v e ,
fixed, predetermined rate tied to the maturity and the amount of principal
(i.e., guaranteed regardless of the performance of the investment) is
considered "Reba" and prohibited. The general consensus among Islamic
scholars is that “Reba” covers not only usury but also the charging of
"interest" as widely practiced. ( Zamir Iqbal, 1997)
Aggarwal & Yousef (2000) also indicated that the most important
principle in Islamic finance is the prohibition of Reba, any predetermined or
fixed return in financial transactions. As stated in the Quran: " Allah forbids
Reba and permits trade" while there is much debate about the exact
nature of this prohibition on "Reba', there exists a widespread perception
that the ban on Reba implies a ban on interest
2.2.1.1 DOUBTS ABOUT PROHIBITION OF INTEREST
Recently, Islamic finance industry faced voices of some writers and
specialists who scruple about the prohibition of interest by Islam.
Rasul Shams (2004) is one of those writers who have doubts about this
ban of interest in Islamic finance. He said that, in many English translation of
Quran the word "usury" is used for the Quranic word "Reba" and not for the
word "interest". According to Collins English dictionary (sixth edition 2003) the
word "interest" means "a charge for use of credit or borrowed money", while
"usury" is "an exorbitant or unlawfully high amount or rate of interest". If the
Quranic word "Reba" means usury, usury is forbidden but not necessarily
interest. Interest is a simple expression for a charge which under
competition in the credit market would be reduced to the conventional
interest rate in trading and commerce. Everything above this rate is
forbidden but not this conventional interest rate. (Shams, 2004)
2.2.2 RISK SHARING (OR PROFIT AND LOSS SHARING):
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Aggarwal & Yousef (2000) argued that the profit-and-loss sharing
principle is unanimously accepted in the Islamic legal and economic
literatures as the cornerstone of financial transactions. According to profit-and-
loss sharing principle, the bank may earn a return on invested funds provided
that the bank shares in the risk of the investment and bears a loss if the
project fails. (Aggarwal & Yousef, 2000).
Zamir Iqbal (1997) explained that, because interest is prohibited,
suppliers of funds become investors instead of creditors, the provider of
financial capital and the entrepreneur share risks in return for shares of the
profits. (Zamir Iqbal, 1997)
2.2.3 MONEY AS "POTENTIAL CAPITAL:
Zamir Iqbal (1997) argued that Money is treated as "potential" capital-
that is, it becomes actual capital only when it joins hands with other
resources to undertake a productive activity. Islam recognizes the time value
of money, but only when it acts as
capital, not when it is "potential" capital. (Zamir Iqbal, 1997)
2.2.4 PROHIBITION OF SPECULATIVE BEHAVIOR
"An Islamic financial system discourages holding and prohibits
transactions featuring extreme uncertainties, gambling, and risks" . We think
this is a logic principle for a system originated from a religion; the system
should respect all issues, ethics and laws related to same religion.
2.2.5 SANCTITY OF CONTRACTS
"Islam upholds contractual obligations and disclosure of information as
a sacred duty. This feature is intended to reduce the risk of asymmetric
information and moral hazard". ( Zamir Iqbal, 1997)
2.2.6 SHAREI’A-APPROVED ACTIVITIES
"Only those business activities that do not violate the rules of Sharei’a
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qualify for investment. For example; any investment in business dealing with
alcohol, gambling, and casinos would be prohibited" (Zamir Iqbal, 1997). As
indicated above, we think this type of principles is logic for a religious
financial system, all principles and applications of such system suppose to be
approved by the source religion.
2.3 Islamic Financial Instuments
There are many contracts and instruments used within the industry
collectively known as Islamic finance. These instruments are widely varying
in the degree of their acceptance by Islamic finance specialists. In this
overview we will focus on the most popular and known financing instruments.
According to Aggarwal & Yousef (2000) , Alternative "interest-free"
financing technique have been developed by Islamic banks and the monetary
authorities of different countries. The instruments of commercial financing
have been based on two principles:
the profit-and-loss sharing (PLS) principle and markup principle.
2.3.1 PROFIT-AND-LOSS SHARING (PLS) INSTRUMENTS
The PLS principle is unanimously accepted in the Islamic legal and
economic literatures as the cornerstone of financial transactions.
According to profit-and-loss sharing principle, the bank may earn a return
on invested funds provided that the bank shares in the risk of the
investment and bears a loss if the project fails. (Aggarwal & Yousef, 2000).
The main PLC instruments are Mudaraba and Musharaka
2.3.1.1 PROFIT-SHARING AGREEMENT (MUDARABA)“This is identical to an investment fund in which managers handle a
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pool of funds. The agent-manager has relatively limited liability while
having sufficient incentives to perform. The capital is invested in broadly
defined activities, and the terms of profit and risk sharing are customizes
for each investment. The maturity structure ranges from short to medium
terms and is more suitable for trade activities.” (Zamir Iqbal, 1997)
“Mudaraba where the bank contributes the finance and the client
provides the expertise, management and labor. Profits are shared by
both the partners in a pre- arranged proportion, but when a loss occurs the
total loss is borne by the bank.” (Abdul Gafoor, 1995)
Aggarwal & Yousef (2000) explained the Mudaraba financing, as where
the bank provides capital and the entrepreneur contributes effort and
exercises complete control over the business venture. In case of a loss, the
bank earns no return or a negative return on its investments and the
entrepreneur receives no compensation for her effort. In case of a gain,
returns are split according to a negotiated equity percentage. (Aggarwal &
Yousef, 2000).
2.3.1.2 EQUITY PARTICIPATION (MUSHARAKA)
“This is analogous to a classical joint venture. Both entrepreneur and
investor contribute to the capital (assets, technical and managerial expertise,
working capital, etc. ) of the operation in varying degrees and agree to share
the returns ( as well as the risks) in proportions agreed to in advance.
Traditionally, this form of transaction has been used for financing fixed assets
and working capital of medium-and long-term duration.” (Zamir Iqbal, 1997)
“Musharaka where a bank may join another entity to set up a joint
venture, both parties participating in the various aspects of the project in
varying degrees. Profit and loss are shared in a pre-arranged fashion. This is
not very different from the joint venture concept. The venture is an
independent legal entity and the bank may withdraw gradually after an initial
period.” (Abdul Gafoor, 1995)
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Aggarwal & Yousef (2000) explained the Musharaka financing, as
where the entrepreneur and the bank jointly supply the capital and manage
the project. Losses are born in proportion to the contribution of capital while
profit proportions are negotiated freely. (Aggarwal & Yousef, 2000).
2.3.2 MARK-UP INSTRUMENTS
The markup principle has its historical roots in commercial trade
activities. The bank finances the purchase of assets in exchange for a
negotiated profit margin.
Although markup instruments are widely used, their acceptability under
Islamic law is disputed because they can imply a fixed return on investment
for the bank. Many Islamic scholars have taken the position that markup
technique, while permissible, should still be avoided or restricted. (Aggarwal &
Yousef, 2000).
Beng Soon Chong and Ming-Hua Liu (2007) announced that The
acceptability of the non-PLS modes of financing, however, has been widely
debated and disputed because of their close resemblance to conventional
methods of interest-based financing. Many Islamic scholars, including
Pakistan's Council of Islamic Ideology, have warned that, although
permissible, such non-PLS modes of financing should be restricted or avoided
to prevent them from being misused as a “back door” for interest-based financing.
Mahmoud El-Gamal (2006) explained the reasons for the markup
principle. He said: the juristic-based understanding of forbidden Reba/usury
suggested that the Islamic finance has to be "asset-based", in the sense
that one cannot collect or pay interest on
Rented money, as one does in conventional banking. Therefore, the easiest transactions to
Islamize were secured lending operations, e.g., to finance the purchase
of real estate, vehicles, business equipment, etc. (El-Gamal, 2006)
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The most famous and mostly used markup instruments are Murabaha and
Ijara.
2.3.2.1 TRADE WITH MARKUP OR COST-PLUS SALE (MURABAHA)
“One of the most widely used instruments for short-term financing is
based on the traditional notion of purchase finance. The investor
undertakes to supply specific goods or commodities, incorporating a mutually
agreed contact for resale to the client and the mutually negotiated margin.”
(Zamir Iqbal, 1997)
Zamir Iqbal (1997) reported that around 75% of Islamic financial
transactions are cost-plus sales. Some other researchers reported that it
reached more than 90% of financing activities in some Islamic banks.
(Maali, Casson and Napier , 2006)
“Mark-up where the bank buys an item for a client and the client
agrees to repay the bank the price and an agreed profit later on.” (Abdul
Gafoor, 1995)
Aggarwal & Yousef (2000) explained the Murabaha financing as where
the bank purchases an asset on behalf of an entrepreneur. The bank
resells the asset to the entrepreneur at a predetermined price that
covers the original cost and an added, negotiated profit margin. Payment
is made in the future in lump sum or in installments. Ownership resides with
the bank until all payments are made. (Aggarwal & Yousef,
2000).
The definition by Mahmoud El-Gamal (2006) is matching with
the above definitions, but in addition he indicates that these are analogous to
the Federal Reserve’s use of "matched-sale purchase". And the mark-up in
Murabaha financing is benchmarked (i.e., made to track ) conventional interest
rate. (El-Gamal, 2006)
2.3.2.2 LEASING (IJARA)
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"Another popular instrument, accounting for about 10% of Islamic
financial transactions, is leasing." ( Zamir Iqbal, 1997)
Leasing is designed for financing vehicles, machinery, equipment,
and aircraft. Different forms of leasing are permissible, including leases
where a portion of the installment payment goes toward the final purchase
(with the transfer of ownership to the leasee). ( Zamir Iqbal, 1997)
“Leasing where the bank buys an item for a client and leases it to
him for an agreed period and at the end of that period the lessee pays the
balance on the price agreed at the beginning an becomes the owner of the
item.” (Abdul Gafoor, 1995)
Aggarwal & Yousef (2000) explained the Ijara financing, as where
the bank purchases the asset and allows the entrepreneur to use it for
a fixed charge. The ownership of the asset either remains with the bank
or is gradually transferred to the entrepreneur in a rent-to-own contract. Ijara
financing is the traditional contract for what is known as leasing today.
(Aggarwal & Yousef, 2000).
According the explanation by Mahmoud El-Gamal (2006), Ijara is
a typical structure requires the bank to create a special purpose vehicle (SPV)
to purchase and hold title to the financed property. The SPV then leases the
property to the customer, who makes monthly payments that are part-rent
and part-principal. Rents are calculated based on market interest rate,
allowing monthly payments to follow a conventional amortization table. The
juristic justification of the practice is that principal parts of monthly payments
increase the customer's ownership in the property, and allow him to pay less
rent (on the part ostensibly owned by the bank through the SPV) over
time, thus replicating the conventional amortization table. (El-Gamal, 2006)
2.3.2.3 ISTISNA'AU.A.E finance house (KFH) explained this type of financing as
follow “Istisna’a is a special financing facility that could be used for
financing construction projects, industrial equipment and various capital
goods. Istisna’a financing is arranged through a mechanism whereby, bank
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assuming responsibility for project completion (Istisna’a), and then appoints
sub-contractors to complete the project under its supervision through a
separate contract (parallel Istisna’a). On completion of the project, the
contracted items are delivered to the original purchaser who has the
responsibility for paying the purchase
price as agreed upon in advance. The mode of payment could be flexible
depending on the advance agreement between the bank and the
customer. The Bank’s return for financing this transaction comprises of a
profit margin included in the selling price, and is usually benchmarked to
LIBOR."(KFH, 2008)
2.4 Actual Islamic Banking Situation: Practice
Recent years have brought an increasing flow of empirical studies of
Islamic banking. The earliest systematic empirical work was undertaken by
Khan (l983). His observations covered Islamic banks operating in Sudan,
United Arab Emirates, U.A.E, Bahrain, Jordan, and Egypt. Khan's study
showed that these banks had little difficulty in devising practices in
conformity with Sharei’a. He identified two types of investment accounts:
one where the depositor authorized the banks to invest the money in any
project and the other where the depositor had a say in the choice of project to
be financed. On the asset side, the banks under investigation had been
resorting to Mudaraba, Musharaka and Murabaha modes. Khan's study
reported profit rates ranging from 9 to 20 per cent which were competitive
with conventional banks in the corresponding areas. The rates of return to
depositors varied between 8 and l5 per cent, which were quite comparable
with the rates of return offered by conventional banks.
Khan's study revealed that Islamic banks had a preference for trade
finance and real estate investments. The study also revealed a strong
preference for quick returns, which is understandable in view of the fact that
these newly established institutions were anxious to report positive results
even in the early years of operation.
Nienhaus (1988) suggests that the relative profitability of Islamic 17
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banks, especially in the Middle East in recent years, was to a large extent
due to the property (real estate) boom. He has cited cases of heavy losses
which came with the crash of the property sector.
Aggarwal & Yousef (2000) argued that Islamic banks are
supposed to offer instruments consistent with the religious beliefs and
cultural characteristics of Muslim societies. According to prevailing
interpretations of Islamic law, financial instruments should emphasize profit-
and-loss sharing (equity). Interest is prohibited, which seems to
exclude debt contracts. But their research indicates that most of the financing
provided by Islamic banks do not conform to the principle of profit-and-loss
sharing. Instead, much of the financing provided by Islamic banks takes the
form of debt-like instruments.
Aggarwal & Yousef study also, contrary to the expectations of Islamic
banking's advocates; they found that Islamic banks rarely offer
long-term financing to entrepreneurs seeking capital. In addition, the
majority of Islamic banks' financial transactions at least initially were
directed away from agriculture and industry and toward retail or trade
financing.
The study by Iqbal and Mirakhor (l987) contains extremely interesting
empirical observations, although these are confined to the experience of Iran
and Pakistan, both of which have attempted to Islamize the entire banking
system on a comprehensive basis. Iran switched to Islamic banking in
August l983 with a three-year transition period. The Iranian system allows
banks to accept current and savings deposits without having to pay any
return, but it permits the banks to offer incentives such as variable prizes or
bonuses in cash or kind on these deposits. Term deposits (both short-term
and long-term) earn a rate of return based on the bank's profits and on the
deposit maturity. No empirical evidence is as yet available on the interesting
question as to whether interest or a profit- share provides the more effective
incentive to depositors for the mobilization of private saving. Where Islamic
18
Islamic Bank Vr Conventional Bank
and conventional banks exist side by side, central bank control of bank
interest rates is liable to be circumvented by shifts of funds to the Islamic
banks.
Iqbal noted that the conversion to Islamic modes has been much
slower on the asset than on the deposit side. It appears that the Islamic
banking system in Iran was able to use less than half of its resources for
credit to the private sector, mostly in the form of short-term facilities, i.e.,
commercial and trade transactions. The slower pace of conversion on the
asset side was attributed by the authors to the inadequate supply of
personnel trained in long-term financing. The authors, however, found no
evidence to show that the effectiveness of monetary policy in Iran, broadly
speaking, was altered by the conversion.
The Pakistani experience differs from the Iranian one in that Pakistan
had adopted for a gradual Islamic process which began in l979. In the first
phase, which ended on 1st January, l985, domestic banks operated both
interest- free and interest-based 'windows'.
In the second phase of the transformation process, the banking
system was geared to operate all transactions on the basis of no interest,
the only exceptions being foreign currency deposits, foreign loans and
government debts. The Pakistani model took care to ensure that the new
modes of financing did not upset the basic functioning and structure of the
banking system. This and the gradual pace of transition, according to the
authors, made it easier for the Pakistani banks to adapt to the new system.
The rate of return on profit-and-loss sharing (PLS) deposits appears not only
to have been in general higher than the interest rate before Islamization
but also to have varied between banks, the differential indicating the
degree of competition in the banking industry. The authors noted that the
PLS system and the new modes of financing had accorded considerable
flexibility t o b a n k s a n d their c l i e n t s . Once a g a i n t h e s t u d y
c o n c l u d e d t h a t t h e effectiveness of monetary policy in Pakistan was not
impaired by the changeover.
19
Islamic Bank Vr Conventional Bank
Iqbal and Mirakhor study, however, expressed considerable
uneasiness about the concentration of bank assets on short-term trade
credits rather than on long-term financing. This the authors found
undesirable, not only because it is inconsistent with the intentions of the new
system, but also because the heavy concentration on a few assets might
increase risks and destabilize the asset portfolios.
Beng Soon Chong and Ming-Hua Liu in their study about the
Islamic banks (2007), they found that a unique feature that suppose to
differentiates Islamic banking from Conventional banking is the PLS
paradigm. In practice, however, they found that Islamic banking is not very
different from conventional banking from the perspective of the PLS
paradigm. On the asset side of Islamic banking, they found that only a
negligible portion of financing is based on the PLS principle. Consistent
with Islamic banking experiences elsewhere; a large majority of Islamic bank
financing in Malaysia is still based on non-PLS modes that are permissible
under the Sharei’a law, but ignore the spirit of the usury prohibition. On the
liability side, the PLS principle is more widely adopted in structuring Islamic
deposits. Their study, however, provides new evidence, which shows that,
in practice, Islamic deposits are not interest-free.
2.5 Synthesis
The Islamic financial system has developed some basic instruments
which stick to the basics of the system. Basic instruments include cost-plus
financing (Murabaha), profit-sharing (Mudaraba), leasing (Ijara), partnership
(Musharaka) and forward sale (Bay' Salam). These instruments serve as the
basic building blocks for developing a wide variety of more complex financial
instruments. ( Zamir Iqbal, 1997). Based on the above bases and
instruments, the Islamic finance are suppose to play a great role in
economic development through promoting and encouraging entrepreneurs
and business firms to expand their activities.
The actuality of this situation may be compatible with the above
20
Islamic Bank Vr Conventional Bank
theoretical bases or not, and the Islamic financing institutions may play its
aimed role or not. But based on our literature review, we see a big gap
between the theoretical bases and the actuality and applied services by
Islamic banks in many countries which are subjected to researches. And
many writers see that there is not a significant difference between the
actual situation of Islamic banks and the conventional banks.
So, based on the above, our null hypothesis for this research will be
the equality of performances of both Islamic and conventional banks in U.A.E.
The data analysis will show if this hypothesis is accepted or not.
21
Islamic Bank Vr Conventional Bank
CHAPTER 3.
RESEARCH METHODOLOGY
3.1 Research Design
3.1.1 Descriptive Design
1. Case Study
2. Correlation Study
3. Development Study
4. Survey Study
3.1.2 Empirical Design
1. Financial Rations
2. Graphs
3. Financial Statements
3.2 Population
The Population is defined as all members that are described by the
characteristic select by the experimenter.
Major Islamic Bank (IB) in U.A.E.
Major Conventional Banks (CB) In U.A.E.
Trends of Islamic Banks in International Market.
Trends of Conventional Bank sin International Market.
3.3 Tools
22
Islamic Bank Vr Conventional Bank
Categorized as primary and secondary tools
1. Primary Tools : Internet, Online Urls. Internal case study
2. Seconday Tools : Accounting and financial rations,
Financial Statements
3.4 Limitations
There are more than fifty two (52) banks operating in U.A.E. Out of
these 42 is conventional banks and ten is Islamic banks. The conventional
banks are assessed performance of this bank may be not enough indication
to the performance of industry of Islamic banking.
23
Islamic Bank Vr Conventional Bank
CHAPTER 4:
4.1 BANKS TAKEN INTO STUDY
In this chapter we will discuss our empirical tests and their findings, a descriptive
statistics of performance financial ratios will be represented. We would like to mention that,
all financial ratios used in this analysis are obtained from financial Statements of banks. First
of all I will introduce my selected banks which I selected to complete my research.
4.1.1 ABU DHABI COMMERCIAL BANK
Abu Dhabi Commercial Bank is 65 percent owned by the state-controlled Abu Dhabi
Investment Council, and is the United Arab Emirates' third-biggest bank by assets.
The bank changed its name from Khalij Commercial Bank to Abu Dhabi Commercial Bank
after merging with Emirates Commercial Bank and Federal Commercial Bank on 1 July 1985. The
bank is a public shareholding company with limited liability, and was incorporated in Abu Dhabi in
1975, to carry on retail, commercial, investment and merchant banking through a 33-branch
network spread across the UAE, in addition to two branches in India and an offshore banking unit
in the Cayman Islands.
More about the company
Address: Al Salam Street P.O.Box 939, Abu Dhabi, UAE
Previous Name: Khalij Commercial Bank
Alternate Name: ADCB
Type: Joint stock
Established Date: 1st July 1985
Ownership: Public
24
Islamic Bank Vr Conventional Bank
Abu Dhabi Commercial Bank (“ADCB”), headquartered in Abu Dhabi in the UAE, is a
diversified full service Bank active in all banking services that span corporate, retail and
commercial banking as well as in the areas of treasury derivatives, infrastructure finance, private
banking and wealth management. ADCB’s strong franchise is supported by a network of 172
ATMs across the UAE and 45 branches in the UAE as well as 2 branches in India.
ADCB considers its principal competitive strengths in the retail area include its strong market
share and franchise reflecting its large and loyal customer base. In addition, ADCB is indirectly
majority owned by the Government of Abu Dhabi.
In relation to investment banking, ADCB competes with local, regional and major
international financial institutions. ADCB believes that its deep knowledge and understanding of
what customers really want and need, will enable it to reach its goal of becoming one of the UAE’s
most modern and service orientated Banks in the UAE.
During May 2008, ADCB acquired a 25 per cent, interest in RHBC, a leading Malaysian Bank
in a step that will pave the way for a strategic partnership between the two financial institutions
enabling them to leverage on the growing cross border banking activities between Asia and Gulf
Corporation Council.
ADCB’s recently launched campaign ‘Long Live Ambition’ is more than just a catchy slogan.
It’s a celebration of the UAE and its people, and of the ways in which the Bank is different. The
campaign neatly captures the essence of the country, but the trick is in ensuring that it is reflected
not just in the Bank’s branding, but in its day-to-day operations too. ADCB reflects ‘Long Live
Ambition’ in the way that it deals with its customers. The Bank is putting this into practice in the
products and services it offers too
ADCB - Accounts
Active saver account.
Current account
Fixed deposit account
Millionaire destiny saving accounts
Business choice current account
25
Islamic Bank Vr Conventional Bank
Fast tract account
Debit card account
Ethihad guest account
Loans
Personal loans –
1. Personal loans for UAE nationals
2. Personal loans for Expartriates.
ADCB education loans
End use loans
Mortgage services
1. Mortgage refinance services
2. Mortgage overdraft
Excellency mortage services
1. For UAE Nationals
2. For Expartriates.
Car loans – for new and used cars
New Products
ADIB has partnered with Etihad Airways to bring you the most rewarding Shari’a compliant
airline card in the UAE, the customer will be awarded up to 50,000 Etihad Guest Miles when they
apply, and earn more miles every time when they use their card.
They are the first UAE bank to bring you a new mobile banking service *161# Banking.
Covered and Debit Cards now come with chip technology for enhanced security and peace of
mind. In addition, our Covered Cards feature Paywave technology, which enables contactless
payments - just wave your card over the scanner in participating outlets. The new cards will also
feature a special instant finance option that will revolutionize the purchases ADCB is also
upgrading women’s banking with the launch of Dana, a new package of products, services and 26
Islamic Bank Vr Conventional Bank
special life style benefits designed to give our female customers the attention they deserve. From
uniquely designed women-only areas and branches to highly skilled female relationship managers
Dana Women’s Banking gives the ladies customers special attention by people who truly
understand their needs.
4.1.2 ABDU DHABI ISLAMIC BANK.
Abu Dhabi Islamic Bank was established on 20th May 1997 as a Public Joint Stock
Company through the Amiri Decree No. 9 of 1997. The Bank commenced commercial operations
on 11th November 1998, and was formally inaugurated by His Highness Sheikh Abdullah Bin
Zayed Al Nahyan, UAE Minister of Information and Culture on 18th April 1999. All contracts,
operations and transactions are carried out in accordance with Islamic Shari'a principles.
The Capital
ADIB commenced its operations with a paid-up capital of One Billion Dirhams divided into
hundred million shares, the value of each share being ten dirhams. The shares are quoted on the
Abu Dhabi Securities Market.
Mission
Islamic financial solutions for the global community.
Vision
To be the top tier Islamic financial services group.
SUBSIDIARIES – ABUDHABI ISLAMIC FINANCIAL SERVICES
ASSOCIATES: NATIONAL BANK FOR DEVELOPMENT, ABUDHABI NATIONAL TAKAFUL,
BOSNA BANK INTERNATIONAL
REAL ESTATE - AL BUROOJ PROPERTIES
Burooj Properties LLC is a solely owned subsidiary of Abu Dhabi Islamic Bank. The company
which was established in October 2005 with a working capital of AED 500 million was created from
the bank's former Real Estate department.
27
Islamic Bank Vr Conventional Bank
ADIB Securities
Kawader Services
Kawader is a premier recruitment Consultancy based in UAE that offers a hands-on quality
service that allows us to source and work with candidates from a wide range of countries. Kawader
provides Executive Search, Overseas Recruitment and Contract Staffing Services for
contingencies as well as for turnkey projects and covers the following sectors: Aviation, Banking,
Call Center, Construction, Engineering, Hospitality, Healthcare, IT, Media, Office Support also
Facilities Management Services.
National Bank for Development (NBD) - Egypt
ADIB OWNERSHIP STRUCTURE
Emirates International Investment co.
UAE Nationals
H.H Sheikh Hammad Bin Zayed Bin Sultan Al Nahyyan
H.H Sheikh Khalid Bin Zayed Bin Sutlan Al Nahyyan
U.A.E General Pension and Social security authority
Jawaan Awaida Suhail Al Khaili
The estate of HH Sheikh Nasser bIn Zayed Al Nahyan
National Bank of Abudhabi.
Sheikh Suroor Bin Muhammed bin Khalifa Al Nahyan
Tasamim Real Estate Co. (LLC)
28
Islamic Bank Vr Conventional Bank
4.2 Islamic Banking and Conventional Banking
Islamic banking and conventional banking are extremely different in many ways. The key
difference is that Islamic Banking is based on Shariah foundation. Thus, all dealing, transaction,
business approach, product feature, investment focus, responsibility are derived from the Shariah
law, which lead to the significant difference in many part of the operations with as of the
conventional
The foundation of Islamic bank is based on the Islamic faith and must stay within the limits of
Islamic Law or the Shariah in all of its actions and deeds. The original meaning of the Arabic word
Shariah is 'the way to the source of life' and is now used to refer to legal system in keeping with
the code of behaviour called for by the Holly Qur'an (Koran). Amongst the governing principles of
an Islamic bank are :
* The absence of interest-based (riba) transactions;
* The avoidance of economic activities involving oppression (zulm)
* The avoidance of economic activities involving speculation (gharar);
* The introduction of an Islamic tax, zakat;
* The discouragement of the production of goods and services which contradict the Islamic value
(haram)
On the other hand, conventional banking is essentially based on the debtor-creditor relationship
between the depositors and the bank on one hand, and between the borrowers and the bank on
the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money.
Islamic law considers a loan to be given or taken, free of charge, to meet any contingency. Thus
in Islamic Banking, the creditor should not take advantage of the borrower. When money is lent out
on the basis of interest, more often that it leads to some kind of injustice. The first Islamic principle
underlying for such kind of transactions is "deal not unjustly, and ye shall not be dealt with unjustly"
29
Islamic Bank Vr Conventional Bank
[2:279] which explain why commercial banking in an Islamic framework is not based on the debtor-
creditor relationship.
The other principle pertaining to financial transactions in Islam is that there should not be any
reward without taking a risk. This principle is applicable to both labor and capital. As no payment is
allowed for labor, unless it is applied to work, there is no reward for capital unless it is exposed to
business risk.
Thus, financial intermediation in an Islamic framework has been developed on the basis of the
above-mentioned principles. Consequently financial relationships in Islam have been participatory
in nature.
Lastly, for the interest of the readers, the unique features of the conventional banking and Islamic
banking are shown in terms of a box diagram as shown below:-
Conventional Banks Islamic Banks
1. The functions and operating modes
of conventional banks are based on fully
manmade principles.
1. The functions and operating modes of
Islamic banks are based on the
principles of Islamic Shariah.
2. The investor is assured of a
predetermined rate of interest.
2. In contrast, it promotes risk sharing
between provider of capital (investor)
and the user of funds (entrepreneur).
3. It aims at maximizing profit without
any restriction.
3. It also aims at maximizing profit but
subject to Shariah restrictions.
30
Islamic Bank Vr Conventional Bank
4. It does not deal with Zakat. 4. In the modern Islamic banking
system, it has become one of the
service-oriented functions of the Islamic
banks to be a Zakat Collection Centre
and they also pay out their Zakat.
5. Lending money and getting it back
with compounding interest is the
fundamental function of the
conventional banks.
5. Participation in partnership business
is the fundamental function of the
Islamic banks. So we have to
understand our customer's business
very well.
6. It can charge additional money
(penalty and compounded interest) in
case of defaulters.
6. The Islamic banks have no provision
to charge any extra money from the
defaulters. Only small amount of
compensation and these proceeds is
given to charity. Rebates are give for
early settlement at the Bank's discretion.
7. Very often it results in the bank's own
interest becoming prominent. It makes
no effort to ensure growth with equity.
7. It gives due importance to the public
interest. Its ultimate aim is to ensure
growth with equity.
8. For interest-based commercial banks,
borrowing from the money market is
relatively easier.
8. For the Islamic banks, it must be
based on a Shariah approved underlying
transaction.
9. Since income from the advances is
fixed, it gives little importance to
developing expertise in project appraisal
and evaluations.
9. Since it shares profit and loss, the
Islamic banks pay greater attention to
developing project appraisal and
evaluations.
31
Islamic Bank Vr Conventional Bank
10. The conventional banks give greater
emphasis on credit-worthiness of the
clients.
10. The Islamic banks, on the other
hand, give greater emphasis on the
viability of the projects.
11. The status of a conventional bank,
in relation to its clients, is that of creditor
and debtors.
11. The status of Islamic bank in relation
to its clients is that of partners, investors
and trader, buyer and seller.
12. A conventional bank has to
guarantee all its deposits.
12. Islamic bank can only guarantee
deposits for deposit account, which is
based on the principle of al-wadiah, thus
the depositors are guaranteed
repayment of their funds, however if the
account is based on the mudarabah
concept, client have to share in a loss
position.
FINANCIAL STATEMENTS
OF
Abdu Dhabi Commercial Bank
&32
Islamic Bank Vr Conventional Bank
Abdu Dhbai Islamic Bank
I. Balance Sheet of ADCB
II. Profit & Loss Account of ADCB
III. Balance Sheet of ADIB
IV. Profit & Loss Account of ADIB
Abdu Dhabi Commercial Bank
Balance Sheet
At December 2010
2010
AED '000
Assets
Cash and Balance with the Central Bank 5,88,630
Deposits and balance due from banks 18,397,534
Loans and advances, net 122,771,870
33
Islamic Bank Vr Conventional Bank
Derivative financial instruments 3,588,973
Investment security’s 8,263,138
Investment in associates 5,358,199
Investment in Properties 289,192
Other assets 12,489,157
Property and equipment, net 1,070,321
Intangible assets 155,180
Total Assets 175,271,194
Liabilities
Due to banks 4,841,865
Deposits from customers 106,134,185
Mandatory convertible security- liability component 29,131
Sort and medium term borrowings l 21,019,694
Deactivate financial instruments 3,487,764
Long term borrowings 8,906,109
Other liabilities 14,279,098
Total liabilities 158,697,846
Equity 19,573,348
178,271,194
31,285,722Commitment and contingent liabilities
34
Islamic Bank Vr Conventional Bank
35
Islamic Bank Vr Conventional Bank
Abdu Dhabi Commercial Bank
Income Statement
At December 2010
For the year ended December 31,2010
2010
AED '000
Interest income 7,158,894
Income for Islamic financing 217,541
Interest expenses (3,507,961)
Net interest expense 3,868,474
Distribution to depositors (186,269)
Net interest income net of distribution to depositors 3,682,205
Net fees and commission income 956,253
Net gain on dealing in derivatives 169,766
Net gains from dealing in foreign currencies 142,962
Decrease in fair value of investment properties (116,412)
Share of profit of associates 336,294
Net(loss)/gain from trading and investment security (4,444)
Other operating income 160,868
Loss on disposal of subsidiary (992)
Dividend income 9,400
Operating income 5,335,900
36
Islamic Bank Vr Conventional Bank
Staff expenses (829,541)
Depreciation and amortization (108,795)
Other operating expenses (710,646)
Impairment allowance (3,287,071)
Operating Expenses (4,936,053)
Profit/(loss) from operations before taxation 399,847
Overseas income tax expenses
Net profit /(loss) for the year
Attributed to
Equity holders of the parent
Non-controlling interest
399,847
390,615
381,001
9,614
Net profit/ (loss ) for the year
Basic earnings/(loss) per share
Net profit /(loss) for the year
Exchange difference arising on transaction of foreign operations
Fair value charge on net investment in foreign operation hedges
Fair value charges on available for sales investments
Fair value charges reserved on disposal of available for sales
390,615
0.04
390,615
508,442
)430,544(
176,744
37
Islamic Bank Vr Conventional Bank
investments
Board of directors remuneration
Share in comprehensive income statement items of associate
Total comprehensive income /(loss) for the year
Attributed to :
Equity holders of the parent
Non-controlling interest
Total comprehensive income/(loss) for the year
111,474
)5,250(
68,460
819,941
810,327
9,614
819,941
Abu Dhabi Islamic bank
Balance Sheet
At December 2010
2010
38
Islamic Bank Vr Conventional Bank
Asset
Cash and Balance with the UAE Central Bank 5,400,335
Balance and wakala deposit with Islamic bank and other financial institution 2,906,382
Murabaha and murabaha with financial institution 12,823,542
Murabaha and other Islamic financing 22,682,521
Ijara financing 25,270,071
Investments 1,639,414
Investment in associates 837,195
Investment in Properties 191,654
Development properties 1,050,445
Other assets
Property and equipment 585,887
Total Assets 75,257,518
Liabilities
Due to financial institutions 891,390
Depositors accounts 56,517,045
Other liabilities 2,091,500
Tier 2 wakala capital 2,207,408
Sukuk financing instrument 5,439,523
Total Liabilities 67,146,866
Equity
Share Capital 2,364,706
Legal reserve 1,754,899
39
Islamic Bank Vr Conventional Bank
General reserve 443,182
Retained earnings 984,069
Proposed dividends 511,783
Proposed dividends to charity 6,816
Other reserves 42,122
6,107,577
Equity attribution to the equity holders of the bank 6,107,577
Tier 1 sukuk 2,000,000
Non-controlling interest 3,075
Total equity 8,110,652
TOTAL LIBILITIES AND EQUITY 75,257,518
CONTINGENT LIABILITY AND COMMITMENTS 12,156,042
40
Islamic Bank Vr Conventional Bank
Abu Dhabi Islamic bank
Income Statement
At December 2010
Operating Income
2010
AED '000
Income from murabaha, murabaha wakala with financial institution 187,719
Income from murabaha, murabaha, ijara and other Islamic financing 3,453,005
Investment income 75,699
Share of result of associate 14,798
Fees and commission income net 343,325
Foreign exchange income 29,071
Income from investment properties 5,265
Income from development properties (4,300)
Other income 14,441
4,119,023
Other expenses
Employees cost (792,815)
General and administrative expenses (431,210)
Depreciation (77,215)
Provision for impairment, net (749,212)
(2,050,452)
41
Islamic Bank Vr Conventional Bank
Profit From Operation, Before Distribution To Depositors And Sukuk Holders 2,068,571
Distribution to depositors and sukuk holders (1,045,006)
PROFIT FOR THE YEAR 1,023,565
Attributable to:
Equity holder of the bank 1,023,565
Non-controlling interest 220
1,023,565
Basic and diluted earnings per share attributable to ordinary share (AED) 0.382
42
Islamic Bank Vr Conventional Bank
4.2 DATA ANALYSIS (Ratios analysis )
Financial statement analysis is based on accounting ratios. The following ratios are
calculated to measure the performance of a commercial bank and Islamic bank.
Profit margin ratio.
Assets utilization ratio.
Equity Multiplier Ratio.
Return on assets ratio.
Return of equity ratio.
4.2.1 PROFIT MARGIN RATIO
FORMULA:
Profit margin Ratio = Net Income
TOTAL Operating Income
COMPONENTS: ADIB ADCB
Net Income 1,078,144 818,941
TOTAL Operating Income 1,023,565 5,335,900
SIGNIFICANCE:
A measure of how well a bank controls its costs. It is calculated by dividing a bank's profit by its
revenues and expressing the result as a percentage. The higher the profit margin is, the better the
company is thought to control costs. Investors use the profit margin to compare companies in the
same industry and well as between industries to determine which are the most profitable.
S. No
RATIO DESCRIPTION CALCULATION
ADIB
1. Profit margin
Net Income TOTAL Operating Income
1,078,144 1,023,565
1.062
S. No
RATIO DESCRIPTION CALCULATION
ADCB
43
Ratio
Ana
lysi
s
Islamic Bank Vr Conventional Bank
1. Profit margin
Net Income TOTAL Operating Income
818,941 5,335,900
0.1537
GRAPH NO.1
INTERPRETATION
The Abu Dhabi Islamic Bank is in good position as compare to Abdu Dhabi
Commercial bank. In ratio analysis we find great difference in profit margin
ration the ration as ADIB is 1.062 and ADCB is .1537 only. Its means the ADIB is in great position
to control its operating cost. A higher profit margin ratio can also mean sales are increasing faster
than cost and defiantly ADIB is in a relatively liquid position as Compare to ADCB.
4.2.2 ASSET UTILIZATION
FORMULA:
44
Ratio
Ana
lysi
sRa
tio A
naly
sis
RATIO ADIB ADCB
Profit margin 1.062 0.1537
Islamic Bank Vr Conventional Bank
ASSET UTILIZATION = TOTAL OPERATING INCOME
TOTAL ASSETS
COMPONENTS:
ADIB ADCB
TOTAL OPERATING INCOME 1,023,565 5,335,900
TOTAL ASSETS 75,357,518 178,271,194
SIGNIFICANCE:
A ratio that is used to determine how well a firm is managing its assets is called an activity
ratio or asset utilization ratio. These ratios compare a company's sales to different asset
categories. Three of the most common activity ratios compare sales to a company's
accounts receivable, inventory and to its fixed assets (i.e., plants and equipment). These
activity ratios are especially useful when used to compare a particular company to its
industry bellwether, or to another company.
The asset utilization ratio measures the extent to which the bank`s assets to generate
revenue. The breakdown of asset utilization ratio separates the total revenue generated into
interest income and noninterest income.
GRAPH
NO .2
45
Ratio
Ana
lysi
s
S. No
RATIO DESCRIPTION CALCULATION
ADIB
2Assets utilization
Total operating income Total asset
1,023,565 75,357,518
1.36%
S. No
RATIO DESCRIPTION CALCULATION
ADCB
2 Assets Utilization
Total operating income Total asset
5,335,900 178,271,194
2.10%
RATIO ADIB ADCB
ASSETS UTILIZATION 1.36% 2.10%
Islamic Bank Vr Conventional Bank
INTERPRETATION
Asset Utilization ratio seems to like that ADCB is in good position as compare to ADIB the asset
utilization ratio of ADCB is almost higher than ADIB is 54%. Theoretically ADCB is in better
position than ADIB.
4.2.3 EQUITY MULTIPLIER
FORMULA:
EQUITY MULTIPLIER = TOTAL ASSETS
TOTAL EQUITY CAPITAL
COMPONENTS: ADIB ADCB
Total Assets of the year 75,257,518 178,271,194
Total Equity Capital 8,110,652 19,573,348
SIGNIFICANCE:
Equity Multiplier measures the dollar value of assets funded with each dollar of equity
capital (the higher this ratio, the more leverage or debt the bank is using to fund its assets.)
It can be defined as,
Amount or percentage of assets owned by each dollar of the equity invested in a business.
S. No RATIO DESCRIPTION CALCULATIO
NADIB
3
EQUITY MULTIPLIER
TOTAL ASSETS TOTAL EQUITY CAPITAL
75,257,518 8,110,652
9.28 times
46
Ratio
Ana
lysi
s
Islamic Bank Vr Conventional Bank
S. No RATIO DESCRIPTION CALCULATIO
NADIB
3
EQUITY MULTIPLIER
TOTAL ASSETS TOTAL EQUITY CAPITAL
178,271,194 19,573,348
9.10 times
GRAPH NO. 3
INTERPRETATION
47
RATIO ADIB ADCB
EQUITY MULTIPLIER 9.28 times 9.10 times
Islamic Bank Vr Conventional Bank
Equity Multiplier Ratio shows very minor difference as ADIB is 9.28 Times and ADCB is
9.10Times. As the graph showing almost equilibrium. The Abdu Dhabi Commercial bank is .18
Times better than Abu Dhabi Islamic Bank.
4.2.4 RETURN ON ASSETS (ROA)
FORMULA:
RETURN ON ASSET (ROA) =
NET INCOME x TOTAL OPERATING INCOME
TOTAL OPERATING INCOME TOTAL ASSETS
OR = NET INCOME
TOTAL ASSETS
COMPONENTS: ADIB ADCB
Total Net Income 1,086,924 819,941
Total Assets 75,257,518 178,271,194
A further breakdown of a bank`s profitability is that of dividing ROA into its profit margin PM
and Assets Utilization AU ratio components.
SIGNIFICANCE:
Return on assets is an indicator of how profitable a company is before leverage, and
is compared with companies in the same industry. Since the figure for total assets of the
company depends on the carrying value of the assets, some caution is required for
companies whose carrying value may not correspond to the actual market value. Return on
assets is a common figure used for comparing performance of financial institutions (such as
banks), because the majority of their assets will have a carrying value that is close to their
48
Ratio
Ana
lysi
s
Islamic Bank Vr Conventional Bank
actual market value. Return on assets is not useful for comparisons between industries
because of factors of scale and peculiar capital requirements (such as reserve requirements
in the insurance and banking industries).
S. No RATIO DESCRIPTION CALCULATIO
NADIB
4
RETURN ON ASSETS
NET INCOME TOTAL ASSETS
1,086,924 75,257,518
1.445%
S. No RATIO DESCRIPTION CALCULATIO
NADIB
4
RETURN ON ASSETS
NET INCOME TOTAL ASSETS
819,941
178,271,194
0.46%
49
RATIO ADIB ADCB
RETURN ON ASSETS 1.445% 0.46%
Islamic Bank Vr Conventional Bank
GRAPH NO. 4
INTERPRETATION
The only common rule is that the higher return on assets is, the better, because the company is
earning more money on its assets. A low return on assets compared with the industry average
indicates inefficient use of company's assets
So according to the rule ADIB ratio is 98.5% better than ADCB.
4.2.5 RETURN ON EQUITY (ROE)
FORMULA:
RETURN ON EQUITY (ROI) =
NET INCOME X TOTAL ASSETS
TOTAL ASSETS TOTAL EQUITY CAPITAL
OR = NET INCOME
TOTAL EQUITY CAPITAL
COMPONENTS: ADIB ADCB
Net Income = 1,086,924 819,941
50 Ratio
Ana
lysi
s
Islamic Bank Vr Conventional Bank
Total Equity Capital = 8,110,652 19,573,348
SIGNIFICANCE:
Return on Equity (ROE, Return on average common equity, and return on net worth)
measures the rate of return on the ownership interest (shareholders' equity) of the common
stock owners. ROE is viewed by investors as one of the most important financial ratios. It
measures a firm's efficiency at generating profits from every dollar of shareholders' equity
(also known as net assets or assets minus liabilities). It shows how well a company uses
investment dollars to generate earnings growth. ROE is equal to a fiscal year's net income
(after preferred stock dividends but before common stock dividends) divided by total equity
(excluding preferred shares), expressed as a percentage.
S. No RATIO DESCRIPTION CALCULATIO
NADIB
5 RETURN ON EQUITY
NET INCOME TOTAL EQUITY CAPITAL
1,086,924 8,110,652
13.406%
S. No RATIO DESCRIPTION CALCULATIO
NADIB
5RETURN ON
EQUITY
NET INCOME TOTAL EQUITY CAPITAL
819,941 19,573,348
4.19%
51
RATIO ADIB ADCB
RETURN ON EQUITY (ROE) 13.406% 4.19%
Islamic Bank Vr Conventional Bank
GRAPH NO. 5
INTERPRETATION
.
From the analysis of ADIB and ADCB we find Return on Equity of ADIB is 13.406% as
compare to ADCB 4.19%. So The ADIB is in better position over ADCB. So the ADIB
overall performance in return on equity is very good. ADIB is in position of provide
dividends to owners and have funds for future growth of the company.
52
Islamic Bank Vr Conventional Bank
4.3 DISCUSSION AND FINDINGS
In This Chapter we determine whether it is possible to distinguish between conventional and
Islamic banks in the Gulf Cooperation Council (GCC) region on the basis of financial
characteristics alone. Islamic banks operate under different principles, such as risk sharing and the
prohibition of interest, yet both types of banks face similar competitive conditions. The combination
of effects makes it unclear whether financial ratios will differ significantly between the two
categories of banks. We input 5 financial ratios in measurement of ADIB and ADCB to determine
whether researchers or regulators could use these ratios to distinguish between the two types of
banks. Although the means of several ratios are similar between the two categories of banks, so,
we find that the main distinction between Islamic and convention banks are the difference in
Principles.
53
Islamic Bank Vr Conventional Bank
CHAPTER 5:
SUMMEARY OF FINDINGS, CONCLUSIONS,RECOMMENDATION
5.1. SUMMARY OF FINDINGS.
As a matter of fact, the Islamic banks and companies provide
significant contributions to the economic development process in U.A.E.
And because of this reason the Islamic finance industry need to be in
focus for more researches and developments. We think that our study itself
needs to be repeated after some years to assess the performance of U.A.E
Islamic banks after more maturity of this industry in U.A.E. Also the
differences between the services provided by Islamic and conventional
banks need to be subjected to more investigations and analysis.
We think also, there should be a more studies about the real practices of
Islamic finance industry, and the differences between the theoretical bases of this
industry and the actual practice. As we see many of the advocators of this
industry writing about the benefits and the social role of Islamic finance, but we
think they are focusing more on the theory and neglecting the actual practice
54
Islamic Bank Vr Conventional Bank
5.2 CONCLUSIONS
1- The evaluation of the performance of Islamic banks through a number of
key ratios yields fairly satisfactory results. In general, Islamic banks are well
Capitalized, profitable and stable. They also seem to be making an effective use of
the resources at their disposal. However, they do not appear to be cost-effective in
their operations
2- While their profitability ratios compare favorably with international
Standards, it should be noted that conventional banks’ depositors are guaranteed
their principal amounts, and hence bear less risk than Islamic banks’ depositors.
Therefore, the depositors of Islamic banks would genuinely expect a higher rate of
Return to compensate for the extra risk. The current rates of profits on assets of
the
Islamic banks may not be enough to meet that expectation.
4) The study does not lend any support to the general belief that Islamic
Banks are suffering from excess liquidity.
5) When compared with conventional banks, Islamic banks as a group
outperformed the former in almost all areas and in almost all years. However,
there are considerable variations among Islamic banks in terms of growth as well
as performance. Such variations are quite natural. As a matter of fact, one
objective of this study was to study the comparative performance of various
Islamic banks, something that has never been done before in such detail. Similar
variations are there even in the case of conventional banks.
55
Islamic Bank Vr Conventional Bank
5.3 RECOMMENDATIONS
Islamic banking and finance activities are expected to grow even more
rapidly in the foreseeable future providing sophisticated products and financial
services. Based on our research, we think that it is very important to Islamic
banks in U.A.E to pursue diversification by giving more focus to profit-loss-
sharing financing instruments like Mudaraba and Musharaka. This will support
the ethical and social expected role of Islamic finance industry. The Islamic
banks also should decrease their dependence on debt-like financing instruments
like Murabaha and Ijara, which form more than 90% of Islamic banks
operations, as mentioned in some studies.
We think also the rapid growth of Islamic banking is supported by
religious Emotions of Muslim people; it is not based on a real competition in
performance between Islamic and conventional banks. We think that Islamic
banks should focus more in improving their efficiency for benefits of both owners
and customers.
56
Islamic Bank Vr Conventional Bank
Reference list:
1) www.adib.ae
2) www.adcb.ae
3) From Wikipedia, the form encyclopedia
4) Notes on Financial Institutions prepared by Mr.Imran Hasnain, Lecturer
Accounting and Finance, Preston University, Ajman.
5) Notes on Banking Operations prepared by Mr.Hakim Shabir, Lecturer
Banking Operations, Preston University, Ajman.
6) Code of Ethics & Business Conduct for ADCB Staff.
7) Banking law and practice by Dr. Israr Ahmad.
8) Dr. Zamir Iqbal Articals.
57