Islamic banking and finance: on its way to globalization; studying why Islamic finance is successful, and why Islamic banks were less

affected by the global economic crisis

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Chapter 1

Introduction

This chapter will provide a background for the undertaken thesis and give the purpose

of the study. Also, the hypotheses identification and a brief illustration of the research

methodology and methods will be presented. Finally, there are several limitations faced

throughout this study, which will be accounted for at the end of the chapter.

1.1 Introduction

Financial rules and regulations have historically played a significant role in the economy

of various societies. The Islamic financial system, which is rapidly growing and currently

used in many banks and financial institutions around the world, can be considered as a

key contributor to the growth and changes of today’s global financial system.

Furthermore, Islamic finance involves providing financial products and services by

institutions offering Islamic financial services that comply with Shariah laws, which can

be defined as the basis of financial transactions that meets the religious requirements

and obligations of Muslims’ societies (Tajudin, 2010). The industry of Islamic banking

and finance came into existence through Egypt’s MitGhamr Saving Banks in 1963, and

then in 1975 the world first Islamic bank was formed, known as Dubai Islamic Bank,

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which is currently operative through its forty-eight branches around the world (Platt,

2008). Moreover, according to El-Qorchi (2005) more than three hundreds Islamic

financial institutions were formed since then operating in seventy-five countries around

the world with assets exceeding US$400 billion. This shows Islamic bank’s spread and

worldwide growth due to factors like ‘high and efficient bank services, cheap and less

risky advances on a participation basis, higher return to customers on their investments

and low risk in returns’ (Bashir, 2008).

The financial and economic crisis which began in July 2007 in the United States of

America and then disseminated worldwide in September 2008 as the stock markets

entered a period of high volatility came into play. This crisis impact is still going on as

the world’s economy is still suffering from its effects such as unemployment, inflation

and purchasing power decrease. According to Alasrag (2010) both developed and

developing countries are still undergoing a deep economic recession arguing, in the

meantime, that Islamic banks seem to be more flexible to the international financial and

economic crisis than the conventional banks which has increased the attention on the

Islamic banks. Additionally, the Islamic banking system is primarily based on a

partnership between banks and their customers which emphasizes a social obligation

that will lead, ultimately, to a better protection for Islamic banks from any potential

financial and economic crisis.

1.2 Context and Significance of the Study

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The use of the Islamic financial system and Islamic banks are continuously increasing

worldwide. One of the reasons behind this growth is the success that was shown by

Islamic banks in avoiding the economic crisis in 2008. This encouraged a large number

of people to transfer their savings and investments from conventional to Islamic banks.

Moreover, many studies and researches were conducted to identify the reasons behind

Islamic banks success and why they were less affected during the economic crisis. For

example, Iqbal et al (2002) tried to explore the main reasons of considering Islamic

banks as one of the fastest-growing industries by studying how different risk-sharing

characteristics can be associated with the Islamic banks performance.

The main objective of this dissertation is to study the possible reasons behind the fast

growing of the Islamic financial system application as well as the increasing popularity

of Islamic banks. Additionally, this research will study how Islamic banks were less

affected by the global financial and economic crisis which took a place in 2008.

Moreover, this research will provide an insight into how Islamic banks differ from

conventional banks in terms of operations system and activities, and also comment on

the main challenges facing Islamic banking around the world.

In particular, this research will discuss number of previous studies in regards to the

globalization of Islamic banking and finance; provide in-depth and objective analysis by

studying a sample of conventional banks and Islamic banks in both of the United

Kingdom and Jordan. Additionally, practical feedback has been added to this

dissertation after an interview has been conducted with experienced Deloitte

professional advising conventional and Islamic financial institutions in Riyadh, Saudi

Arabia.

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1.3 Research Questions and Hypotheses

As mentioned previously, after the economic crisis, the Islamic financial system and

Islamic banks have received extensive consideration and recently various researches

were conducted to study the growth of Islamic banking globally.

Accordingly, there are three research questions that can be developed in this study as

follows: first, what are the reasons behind the globalization of Islamic banking and

finance? Second, is Islamic finance system successful? Finally, can Islamic banks stay

efficient during an economic and financial crisis?

Furthermore, based on the previous research questions, three research hypotheses can

be produced which are formulated as the following:

H.1: Implication of the Islamic values and regulations of the Shariah in operations and

product designing supports the sustainability characteristics of Islamic banks.

H.2: Islamic banks are less risky than conventional banks.

H.3: There is an efficiency difference between Islamic banks and conventional banks

during an economic crisis

1.4 Research Methodology and Methods

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A research methodology for the study can be defined as ‘a guideline system for solving

a problem, with specific components such as phases, tasks, methods, techniques and

tools’ (Irny and Rose, 2005). However, according to Kothari (2009) the research

methods are the scientific techniques used by the researcher in order to conduct and

support the performance of research operations.

The representative sample of the research was made up from two conventional banks

and two Islamic banks (four banks) operating in both the United Kingdom and Jordan –

Conventional banks: Barclays Bank (the UK) and Arab Bank (Jordan), Islamic banks:

Islamic Bank of Britain (the UK) and Jordan Islamic Bank (Jordan). In addition, an

analysis for an interview conducted with the Deloitte professional located in Riyadh -

Saudi Arabia, was used as a guideline for the research in order to offer some relevant

information.

Furthermore, while writing this research; most of the relevant data were collected

throughout the literature review, publications, case studies, internet, census, and

statistical data. Internet sources were the primary source of this report, as all relevant

information for most of conventional and Islamic banks considered in this study were

gathered online (i.e. financial statements) as well as number of other literatures and

studies which are also published in internet. In fact, according to Best et al. (2004)

internet employment as a direct channel for the collection of information is continuously

in a fast growing rate as it provides access to millions of data for the potential

researchers. Moreover, the present research methodology requires collecting relevant

data from two Islamic banks operating in the United Kingdom and Jordan (i.e. Islamic

Bank of Britain “UK” and Jordan Islamic Bank “Jordan”). However, for comparison

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purposes, relevant data were also collected from two conventional banks operating in

the same countries (i.e. Barclays Bank “UK” and Arab Bank “Jordan”).

1.5 Limitations of the Study

Although the study was carefully prepared, it will still have some limitations that can

affect the reliability and validity of the research findings. First of all, in terms of sample

size, the numbers of Islamic banks which were undertaken in this research was quite

small compared with numbers in the previous studies related to Islamic banking and

also with the numbers of Islamic banks around the world. Another limitation was based

on the methodology/ methods used in this research which required traveling to Jordan

and Saudi Arabia in order to study the performance of both Islamic and conventional

banks, as well as to arrange the interview with the Deloitte professional.

Additionally, another limitation on the research results is related to the time constraints.

Only small numbers of Islamic and conventional banks were considered while doing this

research as a result of the time limitations which did not allow taking larger numbers of

both types of banks. At such, this may not give an accurate representation of Islamic

and conventional banks operating model worldwide.

1.6 Layout of the Study

This research is distributed into six chapters including introduction as the first chapter.

Particularly, the introduction chapter included a general background of the research title,

context and significance of the study, the research questions and hypotheses, research

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methodology and methods, limitations faced during the research and finally the layout of

the study, which all have been illustrated above.

The second chapter of this research provides a discussion of the literature review and

analytical framework of the study. Chapter two offers an overview in addition to theory

consideration of the dissertation’s subject. Furthermore, this chapter highlights number

of published and unpublished researches (e.g. journals, books and web documents)

that were conducted in the past by different researchers which are related to

conventional and Islamic banks' globalization, performance and their effectiveness

during the global economic and financial crisis in 2008 with an explanation of how each

research is similar and how it differ from each other. At the end of the second chapter,

there will be a summary with a conclusion that includes a contribution to the

understanding and improvement of the research subject.

After that, chapter three discusses in more details and explanations the research

methodologies and methods, sample selection and data collection process which are

assigned to answer the research question that have been illustrated briefly above in the

first chapter. Additionally, this chapter provides an overview of the research design that

was used in order to reach the objectives of this study and also it will show how

research questions were developed.

Furthermore, the fourth chapter of the dissertation presents the analysis and

interpretation part of the qualitative data that were collected during the interview with

Islamic finance’s manager in Riyadh - Saudi Arabia in order to provide appropriate

answers for the research questions and hypothesis which were raised in chapter three.

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Then, chapter five will provide the quantitative data analysis which has been done by a

comparison between the representative sample of both of the Islamic banks and

conventional banks using their financial ratios to prove that one of them was more

successful during standard economic cycles and during the meltdown. This quantitative

analysis part had required using certain software and statistical data analysis methods.

Finally, chapter six concludes the undertaken thesis with summary and brief discussion

for the major findings of the research. In addition, this chapter draws conclusions and

suggests some recommendations which could be useful for future researches related to

the Islamic banking and finance.

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Chapter 2

Literature Review and Analytical Framework

2.1 Introduction

The primary aim of doing this research is to study the possible reasons behind the

globalization and success of Islamic banking system, as well as comparing the

performance and effectiveness of some conventional and Islamic banks during and after

the global economic and financial crisis. This chapter provides a literature related to the

research’s subject while illustrating the concept and principles of Islamic banking and

finance and providing readers with some previous studies and opinions related to the

efficiency and effectiveness of the Islamic financial system with extra explanations.

Furthermore, at the end of this chapter, there will be a summary and conclusion with a

contribution to the understanding and improvement of the research subject.

2.2 Literature Review

The starting of the Islamic banking and financial system was in 1975 in United Arab

Emirates when a bank named Dubai Islamic Bank was opened. Furthermore, Islamic

banking and financial systems are currently considered as one of the most growing

financial systems around the world operating in different countries in Asia, Africa,

Europe and North America (Khan et al., 2008). The Islamic financial system is a source

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of Islamic principles based on Islamic law, Shariah, functions which are characterized

by the nonappearance of interest-based financial transactions, doubtful transactions

and unethical transactions such as market manipulations (Loqman, 1999). Moreover,

according to Chong et al. (2009, p.3) ‘Islamic banking is different from conventional

banking because interest (Riba) is prohibited in Islam, i.e., banks are not allowed to

offer a fixed rate of return on deposits and are not allowed to charge interest on loans’.

According to the above statements, it can be illustrated that Islamic banking is not only

related to specific banks’ functions, but it is also a system that offers ethical concepts

which contributes for a peaceful creation and better society. Moreover, interest-based

financial transactions are forbidden in Islamic laws, Shariah, as it has negative impact

on overall economies and societies. In this respect, the absence of interest-based (riba)

transactions is considered as one of the main differences between the Islamic and

conventional banks.

However, there are some similarities in the practices of Islamic and conventional banks.

According to Dar and Presley (2000, p.4) ‘convergent evolution has meant that many of

the most common conventional financial instruments have a functionally similar

counterpart in Islamic finance’. This statement argues that Islamic banks are not totally

different from conventional banks. Islamic and conventional banks do identical practices

such as saving deposits and legal modalities, but there are still significant differences

between their objectives. Islamic banks main objective concentrates on applying Islamic

laws towards their operations which lead to equivalent sharing of wealth (Hanif, 2010).

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Moreover, the recent economic and financial crisis gave Islamic banks significant

consideration in addition to high market share price in results of their success and great

performance during that period (Hasan and Dridi, 2010). In contrast, according to

Bashir (2008), the absence of interest-based transactions, well-organized services of

banks, higher return on investments and low risk in returns are the main keys behind

this large attention and success of Islamic banking and Islamic financial systems.

2.3 Principles of Islamic banking and finance

The principles governing Islamic banks and Islamic financial system overall are

controlled by the Islamic law and Shariah, which is the legal framework of Islam

connected to its Quranic explanation, accompanied by understanding of the Sunnah.

The Sunnah can be illustrated as a law of behaviours, teachings and practices (either

physical or mental actions) which has been done by Prophet Mohammed (peace be

upon him “PBUH”) as a teacher of Islamic laws and Shariah (Peace be upon him

(PBUH) is a prayer phrase used by Muslims after mentioning or hearing the name of

any Islamic Prophets as a mark of respect and appreciation). Additionally, according to

Iqbal and Llewellyn (2002, p. 19) “the Sunnah is the most important source of the

Islamic faith after the Quran and refers to the Prophet's (PBUH) example as indicated

by his practice of the faith”. This framework of Islamic law and Shariah is established in

order to provide guidelines to Muslims to be consistent with the principles of the Holy

Quran (God’s words as revealed to the Prophet Mohammed “PBUH”) and the

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Sunnah(the living traditions of the Prophet Mohammed “PBUH”) in their decision making

related to all aspects of their life.

These principles were previously studied by numbers of Muslim and non-Muslim

researchers (e.g. Wilson in 2006; Metwally in 2006; Akacem and Gilliam in 2002; Zaher

and Hassan in 2001). Accordingly, the five general principles of the Islamic banking and

finance that will be undertaken in this study are as follows: (i) the prohibition of interest-

based financial transactions (Riba); (ii) the prohibition of risk and uncertainty (Gharar);

(iii) prohibition of gambling and other games of chance (Maysir) ;(iv) paying and

collecting of payments to the poor (Zakah); (v) ethical standards and prohibition of

dealing with forbidden commodities.

2.3.1 The prohibition of interest-based financial transactions (Riba or usury)

The prohibition of interest-based financial transactions (Riba or usury) is considered by

many Muslim and non-Muslim scholars as the most significant principle under Islamic

law and the key behind the successful of the Islamic banking and finance system. The

concept of Riba has been introduced by number of financial experts such as Al-

JarhiandIqbal (2001) who mentioned that Riba is translated literally from Arabic word

which means the increase or addition of a loan that must be paid to the lender by the

debtor, regardless of whether the amount of this increase or growth is a small or large

amount. In contrast, Metwally (2006, p. 17) explained the concept in relation with usury

by arguing that “usury is translated to mean Riba which literally means an excess or

addition above the principle lent. Since interest, however small, is an excess over the

capital lent”.

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Furthermore, the Holy Quran and the Sunnah have totally prohibited any type of interest

or usury payment (large or small amounts) which is higher or lower than the actual

amount. According to Krom (2013, p.57) ‘Riba is the payment of charges for the use of

money, including interest and usury, and is forbidden in the Qur'an in a number of

places’. In contrast, Metwally (2006, p.16-17) translates the sign for the prohibition of

Riba and usury from the Holy Quran and the Sunnah as follows:

“Those who devour usury will not stand except as stands one whom The Evil one by his

touch hath driven to madness. That is because they say: Trade is like usury. But Allah

hath permitted trade and forbidden usury (2:275)”.

“O Ye who believe! Fear Allah and give up what remains of your demand for usury, if Ye

are indeed believers. If Ye do it not, take notice of war from Allah and His Apostle. But if

ye turn back, ye shall have your capital sums: Deal not unjustly and ye shall not be dealt

with unjustly (2:278-279)”.

In addition, El-Gamal (2000, p.3) translates message from the Sunnah which also

shows an evidence for the prohibition of Riba and usury as follow:

“Muslim narrated on the authority of Abou Said Al-Khudriy: Bilal visited the Messenger

of Allah with some high quality dates and the prophet inquired about their source. Bilal

explained that he traded two volumes of lower quality dates for one volume of higher

quality. The Messenger of Allah said: “this is precisely Riba! Do not do this. Instead, sell

the first type of dates, and use the proceeds to buy the other”.

In addition, according to Oridedi (2010, p.4) an exploitation in addition to an injustice

can be created from payment and receipt of interests which lead to an inconsistency

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with the fairness and justice of Islamic laws and concepts, and in regards to this Riba

was strictly forbidden in the Islamic laws. This statement supports the view that interest

is prohibited in Islamic laws and Shariah due to the economic efficiency considerations

as it leads to unfairness produced by increasing the wealth of individuals without taking

in mind the whole culture and society.

2.3.2 The prohibition of risk and uncertainty (Gharar)

Gharar is an Arabic concept that refers to risk, fairness or uncertainty related to an

agreement which is made to sell goods which their existence or characteristics are not

certain or to sell items that have already been lost (Hourani, 2004). Furthermore,

according to Iqbal and Molyneux (2005, p.14), “Gharar refers to acts and conditions in

exchange contracts, the full implications of which are not clearly known to the parties.

This is something very similar to asymmetric information”.

Gharar is forbidden in Islamic law and measured to be the second significant prohibition

after Riba. Moreover, the main reason behind the prohibition of Gharar transactions is

that it raises injustice as there is usually a lack of satisfaction between the parties in a

Gharar’s contracts and also to protect both of sellers and buyers of risky goods or items

from fraud and cheating that derived from uncertain dealings (Ayub, 2009).

2.3.3 The prohibition of gambling and other games of chance (Maysir)

Maysir is defined by most of financial specialists as gambling, speculation or any games

of chance that make easy money and high returns by chance without consuming an

equivalent effort and time in earning this money. Some examples of Maysir (gambling)

are casino-type games, betting on outcome of football matches and sweepstakes.

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Maysir is strictly forbidden in Islamic laws and concepts. As a sign for this prohibition,

Metwally (2006, p. 15) translates evidence from the Holy Quran as follows:

“The Qur’an states (Chapter 5, verse 93): O ye who believe alcoholic drinks and games

of chance and idols and divining arrows are only an infamy of Satan’s handiwork, leave

it aside in order that ye may succeed”.

Furthermore, according to Sultan (2007, p. 29), Maysir and all types of chance games

are forbidden in Islamic laws due to the fact of inequality treatment that results from

gaining some individuals large amount of money while others will be suffering a loss

which may lead to their bankruptcy. Moreover, Maysir is usually the main reason behind

a lot of financial and social problems.

2.3.4 Paying and collecting of payments to the poor (Zakah)

Şentürk (2007, p.3-4) defines Zakah as “the process where a certain amount of property

or money is collected from those who are sufficiently endowed and then given to needy

group of people”. Zakah is mentioned in the Holy Quran and the Sunnah as one of the

five pillars of Islam as it encourages building an equitable and impartial society by

making it compulsory to support the poor and needy people. Furthermore, as specified

in the Islamic laws and identified by Prophet Mohammad (PBUH), any Muslim who has

an excess of his/her wealth over 85 grams of gold or its equivalent is required to pay the

fixed rate for Zakah on all types of the money including cash; gold, silver, idle deposits

with banks and goods for trade is equals to 2.5 per cent, 5 per cent on irrigated lands’

products, 10 per cent on the return on investments and agricultural (no-irrigated lands)

products as well and 25 per cent on fortune treasures (ibid, p.310).

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Moreover, Zakah’s main objectives are to increase the justice and solidarity and reduce

the crimes and hatreds between the people in their societies. However, in order to

achieve these objectives efficiently, several distinctive administration approaches

should be followed in the process of collection and distribution for payments of Zakah.

According to Samad and Glenn (2009, p.303), a collaborator society and theocratic

contribution level play significant roles in the efficient and effectiveness of the process

for collection and distribution of Zakah.

2.3.5 Ethical standards and prohibition of dealing with forbidden commodities

The Islamic financial principles motivate people to invest in vehicles that comply with the

rules and instructions of Islamic law and Shariah. Moreover, transactions and dealings

that include products and activities which have been strictly prohibited by the Holy

Quran and the Sunnah, such as drugs, alcoholic drinks, pork and all kinds of tobacco

cannot be made when dealing with Islamic laws’ contracts with the reason of promoting

an ethical investments and developing friendly societies as well as to prevent the great

damage which is caused by these stuffs to the human body (Imeson, 2007, p.5).

2.4 Relative risks in Islamic banks

Greuning and Iqbal (2008), mention that Islamic financial institutions have their own

distinguishing risk management and sharing strategies, especially designed on the

Shariah principles. Islamic banking products and services are designed on Islamic

values; however they are also sceptical to market risks and propositions. A speedy

growth of the conventional banking practices has impacted the practices in the Islamic

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banks operational in the areas, which have sizeable Muslim populations. Islamic banks

and other financial institutions have understood the importance of synchronisation of

modern banking practices with the core unavoidable Islamic practices. Islamic banks

have been working on the development of different risk management frameworks in

accordance to the Islamic values and practices (Greuning and Iqbal, 2008). Thus, the

risk management system in the Islamic banks and other financial institutions work on

the core Islamic values.

Salem (2013) discusses that in the light of different financial assets on the banks annual

balance sheets, these banks have an unconventional set of risks, which needs to be

managed under the Islamic values and regulations. Under these very conditions, the

risk management in Islamic banks remains a complex proposition. In Islamic banks, the

financers share the risk involved in the business to gain a part of the profit. Thus, the

agencies that supply funds to the financial institutions are regarded as investors instead

of creditors (Salem, 2013). The financial intermediaries share the risk with investors in

the regular functioning of the Islamic banks.

2.5 Efficiency of Islamic banks

An important factor that allows a bank to survive in the competitive environment is the

efficiency of the bank. From the discussion of Hassan and Lewis (2007), it is evident

that Islamic banks are interested in posting a great deal of efficiency to have a

competitive edge over the conventional banks. Islamic banks are less efficient when

compared to conventional banks, so Islamic banks are trying maintaining their presence

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in the international markets through more focused international banking regulations. The

efficiency of the Islamic banks can be improved by the use of better management

practices and technologies. Expansion of the banking business helps the Islamic banks

to post a more efficient stature against the conventional banks (Hassan and Lewis,

2007). A larger bank posts more profit and are generally efficient in their practices.

2.6 Islamic financing fundamentals and techniques

As illustrated in the section above, Islamic banking and Islamic financial systems are

designed in order to comply with the fundamental principles of the Islamic laws, and the

prohibition of interest-based transactions (Riba) is considered as the most significant

Islamic principle specified in Shariah. Additionally, this section studies financial Islamic

methods and techniques that can be used as alternatives to Riba transactions. These

techniques include cost-plus financing (Murabaha), partnership finance (Musharakah),

trust financing (Mudarabah) and leasing finance (Ijarah) which are explained as follows.

2.6.1 Cost-plus financing (Murabaha)

Murabaha (mark-ups on sales) is considered as the most commonly used form of the

Islamic financing fundamentals and techniques. In contrast, according to Hourani (2004,

p.46) “Within a Murabaha contract, the bank agrees to buy an asset or good from a third

party at the request of its client, and then re-sells the goods to its client with a mark-up

profit”. This statement describes Murabaha as a profitable transaction which considers

the Islamic banks and Islamic institutions as brokers that buys raw materials,

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equipment, properties and other types of goods that are requested from the client from

a third party and re-sellthem to the client with a profit margin and it is usually two parties

contract. Moreover, Murabaha transactions are used by the Islamic banks as the main

alternative to conventional banks’ interest-based transactions and it is widely used in

the Islamic institutions to promote dealing without Riba (Hassan and Lewis, 2007).

2.6.2 Partnership finance (Musharakah)

Musharakah (fully partnership) can be defined as a financial contract in which “an

arrangement where two or more parties establish a joint commercial enterprise and all

contribute capital as well as labour and management as a general rule” (Iqbal and

Molyneux 2005, p. 20). From this definition, it can be illustrated that Musharakah is

generally based on a jointly contract between two or more partners toward capital

investments. Moreover, according to Qadri (2009, p.10) the distribution of profits and

losses in Musharakah transactions must be pre-agreed in the contract. This encourages

the investors to invest in a wisely way in order to achieve their objectives.

2.6.3 Trust financing (Mudarabah)

Mudarabah (capital trust) is a contract whereas a partnership exists between two parties

in which one of the parties is capital provider (rabb al-mal) who provides the second

party with capital financial resources required for a certain project specified by customer

(Mudarib) who is usually expert to manage the investments (Qadri, 2009, p.10). In

addition, according to (Ayub, 2009) profits in Mudarabah contracts are shared between

the two parties based on pre-agreed ratio, but in the case of losses the investor suffers

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the financial losses while the entrepreneur bears the operating losses. This encourages

the individuals to involve themselves in financial activities in an effective way.

2.6.4 Leasing finance (Ijarah)

Ijarah (leasing or renting) is classified under the rental contracts in which the owner of a

certain good or asset gives the right to another party to use and get benefits from it for a

specific period of time and with periodic pre-agreed payment amounts. Furthermore, the

ownership of the rented goods and assets remain with the lessor during the contract

period (Bellalah and Ellouz, 2004). On the other hand, according to Islamic laws, Islamic

mortgages are based on the Ijarah’s concept and it is currently reflected as a positive

Islamic tool in achieving profits.

2.7 Compatibility between Islamic banks and Conventional banks

Referring to the previous discussions, Islamic banking which has been started early in

the 70’s usually operates for similar purposes and objectives as conventional banking

but the main difference between them lies on that fact that Islamic banking system is

based and operates in accordance to Islamic laws and regulations. Moreover, Islamic

banking and financial system attracted more attention after the demonstration of its

stability during the global economic crisis in 2008 (Hasan and Dridi, 2010). Additionally,

Laghari et al. (2011) argues that the main reason behind the fast evolution of Islamic

banking and financial system worldwide is that to achieve the objectives of Muslim

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customers and comply with Islamic principles and because conventional banks system

is based on interest (Riba) which is totally prohibited in the Holy Quran and the Sunnah.

In contrast, according to Merchant (2012, p.34) “during the global crisis Islamic banks

suffered more in terms of capital ratio, leverage and return on average equity, while

conventional banks exhibited a poor performance in return on average assets and

liquidity". This statement indicates that Islamic banks were not performing well in terms

of profitability and also that conventional banks achieved better return on investment,

but on the other hand the Islamic banks had a better capitalization rates comparing with

conventional banks during the global economic crisis.

2.8 Analytical Framework

The analytical framework of the research provides the key theories and concepts that

were used and employed in order to communicate the underlying thesis and also to

analyse the data, methods, scales, measurements and indicators that have been drown

in the literature part. The study includes a historical overview of Islamic banking and

financial system, discussing the main factors behind the growth and success of the

Islamic financial system, distinguishing between the Islamic and conventional banks and

studying the performance of both types of banks during the financial crisis in 2008.

Previous studies that were conducted by financial experts on Islamic financial systems

are undertaken in the research as some researchers studied deeply the development of

these systems worldwide as well as the reasons behind their success during the global

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economic crisis. However, the main purpose of using these previous studies is to

promote my research with more scientific opinions and information.

On the other hand, an interview was conducted with a Deloitte professional working with

conventional and Islamic financial instituions in Riyadh - Saudi Arabia in order to get

additional information about the Islamic financial system. Furthermore, certain statistical

techniques were used in the process of studying the performance and effectiveness of

both Islamic and conventional banks by analysing, comparing and looking in-depth

through their financial statements via financial ratios. In particular, these statistical

techniques include factors analysis and regression analysis that has been completed

using the Statistical Package for the Social Sciences (SPSS).

2.9 Summary

In conclusion, chapter two gives a brief introduction and overview of the Islamic banking

and Islamic financial systems through several previous studies that were conducted by

skilled financial researchers. It shows that the Islamic financial system started early in

Dubai - United Arab Emirates in 1975 and due the success that was shown by these

financial systems especially during the global economic crisis and considered nowadays

as one of the most growing financial systems around the world. The absence of

Interest-based financial transactions (Riba) is treated in the Islamic laws as the most

significant difference between Islamic and conventional banks and as one of the main

reasons behind the success of the Islamic financial system.

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Furthermore, the basic principles of Islamic financial system as well as some Islamic

financial methods and techniques were introduced in the literature review to provide the

readers with an overview about the legal framework of Islamic financial transactions,

how these transactions can be fulfilled within the Islamic laws requirements and what

possible alternatives are available in Shariah that can be used instead of the prohibited

financial transactions.

Moreover, a brief compatibility between Islamic banks and conventional banks showing

that Islamic banking’s practices and objectives are similar to those in the conventional

banks but the main difference between them lies on the prohibition transactions which

are specified in the Islamic laws and regulations such as Riba. Finally, an analytical

framework was introduced with description of the main theories and concepts that were

employed in the research paper in order to investigate the relevant data in addition to

appropriate measurements methods.

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Chapter 3

Research Methodology and Research Methods

3.1 Introduction

Research methodology is a guideline which deals with several models, procedures,

tasks and techniques employed with a main goal of finding the results of a research

problem based on the study findings (Panneerselvam, 2004, p. 2). This shows that

answering and solving the research problem is the main purpose behind introducing

research methodology in the studies. On the other hand, according to Kothari (2009)

research method is a tool of scientific investigation and technique employed in the study

in order to collect the relevant data and support the research operations’ performance.

Furthermore, the research methodology that was adopted in this research is based on

exploratory and deductive approach. This approach includes certain investigations and

examinations of both Islamic and conventional banking systems in terms of evolution,

globalization, financial treatment and successfulness during the global financial crisis.

The study is constructed on both of qualitative and quantitative research approach, as

the relevant data were collected mostly from previous studies and an interview as well

as Islamic and conventional banks’ annual financial statements. Moreover, certain

statistical software (e.g. factor analysis and regression analysis using SPSS) were

employed in this study in order to attain reliable estimates and possible approximations

for the quantitative data.

25

This chapter provides the research methodologies that were implemented in order to

answer the research question, research methods (scientific tools) that were mainly used

to collect the relevant data, employed strategies for data collection process and finally at

the end of this chapter there will be a summary for the previous studied sections.

3.2 Research Methodology and Research Methods

3.2.1 Research Questions and Hypothesis

Recently, extensive considerations were received and certain studies were conducted

by scientific researchers on how the Islamic banking and financial system operates and

what are the main aspects that differentiate this system from the conventional system in

terms of attitude, operations, financial treatments, activities and global growth. However,

this study is focusing mainly on the globalization of the Islamic and financial system and

the main reasons behind the success of this system as it was less affected during the

global economic crisis.

Accordingly, it is essential to raise research questions that clearly focused on the area

of this investigation in order to gain an understanding of the main objectives as well as

the goal of the study in which the research is conducted. In particular, the research

questions are divided into three different areas; globalization, success and efficiency

during the global economic crisis of Islamic banking and financial system. The three

research questions of this study can be designed as follows:

26

R.Q. 1: What are the reasons behind the globalization of Islamic banking and finance?

R.Q. 2: Is Islamic finance system successful?

R.Q. 3: Are Islamic banks efficient during an economic and financial crisis?

Additionally, the previous research questions are the guideline to formulate research

hypotheses which help to test predictions and provide explanations for the undertaken

facts in this investigation by testing two or more variables. Moreover, three research

hypotheses are formulated as follows:

H. 1: Implication of the Islamic values and regulations of the Shariah in operations and

product designing supports the sustainability characteristics of Islamic banks.

H. 2: Islamic banks are less risky than conventional banks.

H. 3: There is an efficiency difference between Islamic banks and conventional banks

during an economic crisis.

3.2.2 Sample Selection

For this dissertation, in order to analyse the quantitative data and compare between the

Islamic banks and conventional banks, a sample of four banks operating in both of the

United Kingdom and Jordan has been considered – Arab Bank (Jordan), Barclays Bank

(the UK), Islamic Bank of Britain (the UK) and Jordan Islamic Bank (Jordan). Analysing

of the financial ratios that were generated throughout the financial statements of all

these four banks was used for conducting this study.

27

Furthermore, as mentioned previously in this paper, an interview with a Deloitte

professional, working with the subsidiary for a one of the big four auditing companies

worldwide and located in the capital of Saudi Arabia (Riyadh), was used as a guideline

for my undertaken research. In fact, this was done by arranging a meeting to interview

the manager, in order to acutely investigate the Islamic financial system operations. In

fact, Deloitte feedback was chosen to address the needs of the undertaken hypothesis.

Relevant information from the Deloitte professional would support the idea of

investigating why Islamic banks are less risky than the conventional banks. Moreover,

as Deloitte works as an auditing organisation, the information from them can be helpful

in comparing the working pattern of these organisations.

3.2.3 Qualitative and Quantitative Research Approaches

Designing a research is usually based on two different scientific approaches; qualitative

and quantitative research approaches. According to Stejskal (2008, p.4) he argues that

studying social rations, investigating on market research and understanding the

behaviours and opinions of people as well as understanding different theories are the

reasons behind conducting a qualitative research. He also mentions that the relevant

data that should be collected in the qualitative approach is usually presented in a form

of words, schedules and pictures without statistics analysis (ibid). However, quantitative

research approach can be defined as studying and measuring the relevant numerical

data, variables and hypothesis of the undertaken research collected from representative

sample of interest by using several statistical data analysis methods (e.g. discriminate

analysis & SPSS), and it is an overview of the qualitative approach (Ernst, 2003).

28

Both of the qualitative and quantitative research approaches were used in conducting

this study as it requires a statistical and non-statistical data analysis. In particular, the

study is mainly based on the quantitative research approach as most of the relevant

data were collected from different variables such as numerical data (financial ratios)

which were gathered from the annual financial statements from the selected sample of

the Islamic and conventional banks in order to compare their financial performance

during and after the global economic crisis by using satirical seawares (e.g. factor

analysis and regression analysis using SPSS) and Microsoft Excel.

Additionally, old and recent scientific studies, some financial researchers’ opinions and

an interview with Deloitte professional in Riyadh were used in this dissertation as the

data for the qualitative research approach in order to link my research with the previous

studies, understand clearly the meaning of Islamic financial system and to study the

main differences between the Islamic and conventional banking systems in terms of

their techniques and performances. The information that was collected from the

interview was used in this study in order to understand the banking principles and

procedures employed in the Islamic banks. Deloitte professional can provide immense

knowledge about Islamic banking practices, as his company had been engaged in

auditing both types of banks for their different practices and procedures. The person

who is involved in the auditing process usually understands the practices used by

Islamic banks and the impact of various services and products on customer behaviour

and experiences.

29

3.3 Data Sources and Data Collection

In order to answer the research questions mentioned above, several methods and

techniques were used for the data collection process. Particularly, the data that is used

for this research and the required information is collected from the historical period

involving different factors like profitability, total assets, employed capital and other used

funds for the purposes. Different secondary sources were also used for the purpose of

research study. Thus, the main data sources include literature review, publications,

case study, internet, census, interview and statistical data.

In particular, in order to compare the performance and effectiveness of both Islamic and

conventional financial systems during and after the global economic crisis of 2008, the

use and analysis of financial statements of both systems were essential in this study.

The comparisons were intended to study financial ratios of both systems, look into how

Islamic banks were successful as they were less affected by the economic crisis of

2008. The comparison would also investigate why recently many of the conventional

banks are moving to use similar operations and activities for those which are used in the

Islamic banks.

For this purpose, Factor Analysis and Regression Analysis are used in this study in

order to come up with certain recommendations to be discussed further. Moreover,

SPSS is used for the quantitative analysis which provides a powerful statistical analysis

and data management system. It is able to derive the required output in the form of

statistical data to support the framed hypothesis statement.

30

The interview with the Deloitte professional was intended to gather relevant information

required for my study. The interview was focussed on gathering information from a

manager in one of the four biggest auditing companies around the world operating in an

Islamic country complying with Shariah while dealing with Islamic financial transactions.

The qualitative analysis of this conducted interview can be helpful in determining

various factors that can be used to investigate the efficiency and effectiveness of the

Islamic banking organisations. Moreover, the experience of the managers can be

supportive in analysing the factors that make the Islamic Banks less risky in comparison

to the conventional banks. Moreover, as Deloitte company has been involved in auditing

Islamic Banking organisations, the managers and the employees working there have

great deal of knowledge about the adherence to Shariah in the development of services

and products.

3.4 Summary

As outlined above, this chapter has basically concentrated firstly in the introduction part

on the theoretical discussion for the research methodologies, research methods and an

analysis of how this study was conducted. In the second part, an illustration for both of

the research methodologies and methods that were employed in order to study the

Islamic and conventional banking financial systems were represented. Finally, there

was an illustration of data sources and collection methods used to build the research.

31

In particular, research questions and hypotheses were presented in order to provide the

readers with the main objectives and goals of conducting this study which concentrates

on the globalization, differences and success of the Islamic and conventional banking

systems. Moreover, conventional banks - Barclays Bank (UK) and Arab Bank (Jordan)

and Islamic banks - Islamic bank: Islamic Bank of Britain (UK) and Jordan Islamic Bank

(Jordan) are the selected sample used to conduct the study. Mixed research approach

(qualitative and quantitative) was employed in order to achieve possible reliable results

for statistical and non-statistical analysis.

Finally, data sources and data collection methods were represented which shows that

most of data were collected from scientific published materials via internet, interview

and more important financial statements for the selected sample which were mainly

used for comparing purposes between Islamic and conventional financial systems.

32

Chapter 4

Data Analysis: Qualitative Data

4.1 Introduction: General Information of the Interviewee

4.2 Analysis of Data Collected Through Interview Method

4.3 Summary

33

Chapter 5

Data Analysis: Quantitative Data

34

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