Essay Sample about the Difference Between the Islamic Conventional Banking Systems

Conclusion

The purpose of this research was to analyze the difference between the Islamic conventional banking systems. To get a comprehensive analysis, the research focused on Bahrain and other offshore states such as Jordan, Kuwait, Malaysia, Qatar, Saudi Arabia, Turkey, and the UAE. These countries have the banking systems equally distributed to the population and, that is why we chose them (Haron, 2000). The paper developed strata and chose 16 banks for analysis. The 16 banks included 11 conventional banks and 5 Islamic banks. A comparative study of the banking systems was analyzed and findings noted.

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From the Literature review, there were four hypotheses formed regarding the differences between the conventional Islamic banks. The research has tested all the hypotheses and came out with findings explained in the methodology. The paper, therefore, makes a conclusion based on the findings explained below.

The first hypothesis which held that there was the difference in profitability between the conventional banks and the Islamic banks has been not supported (Ansari & Rehman, 2011). Assessing both Return on Assets and Return on Equity, there is no significant difference between the conventional banks and the Islamic ones. Both banks showed a profitability margin that was very slim. The conventional banks are profitable by a very small margin compared to the Islamic (Erol et. al., 2014). This can conclude that, although the Islamic banks do not charge interests on the loans they give to their clients, they have other modes of raising capital to not only run their operations but also to grow financially. Both banks are therefore considered to have the profitability rate relatively equal. The margin between the two banking systems is so slim that it can be neglected.

Considering the ratios of the total equities/ total assets, we can say that the shareholders of conventional banks have a say in their banks compared to the Islamic banks. This ratio is very high for the conventional banks and relatively low for the banks practicing Islamic banking systems. The ratio also indicates that the conventional banks benefit much from the services they give to their clients. This benefiting is accrued from the high interests that these banks charge their clients on loans.

Total loans/ Total assets should give us the level of liquidity of the bank since the loans and the assets are compared directly. Although it can be deduced that the Islamic banks do not possess a lot of loans compared to the conventional banks, we can see that the bank face liquidity challenges. The Islamic banks have high liquidity compared to the conventional banks (Esam, 2013). This high liquidity of the Islamic banks even though they have very little loans associated with their low asset levels. The conventional banks have very large asset volumes compared to the Islamic banks. The large asset volume of the conventional banks is gained by the interest rates charged on the loans offered. The interests gained by these banks are further cultivated as investments and hence, the banks grow in volumes (Hubert & Van Driessen, 2004). The convention banks, therefore, have a better performance rate compared to the Islamic banks.

The ratio of total deposits/total assets for the Islamic banks is lower than that of conventional banks. The Islamic banks are characterized by low deposits since most of their liquid money is given to the clients in terms of loans (Kakakhel, Raheem, & Tariq, 2013). The conventional banks have this ratio higher since they have more cash floating. They will then deposit them in other banks or the central bank. People will always want to borrow loans from the Islamic banks since they charge no interest rates. They will be left with very little to deposit to the other banks and central bank. The ratio then shows that the conventional banks have a better performance space compared to the Islamic banks. The high ratio of the total deposits/ total assets also gives the reason as to why the conventional banks have more liquid cash than the Islamic banks. Due to low deposits of the Islamic banks to other banks and the central bank, they have a very limited source of income. They cannot borrow from other banks since the banks will charge interests which their systems do not support. The conventional banks will have the money deposited to other banks making them able to borrow from these banks.

Assessing from all the angles, the conventional banks are seen to be having high profitability, liquidity and less solvency. On the contrary, the ratios show that the Islamic banks are less risky and have a higher chance of being dissolved. The risks are brought about by the restriction of the bank to borrow from other banks and hence have low debts (Alrawashdeh, Sabri, & Ismail, 2012). Due to less operational liquid assets, the Islamic banks face a threat of being faced with bad debts and hence declared bankruptcy. The banks also make fewer profits compared to the conventional banks. The fewer profits will scare away investors in Islamic banks. The banks are also seen to be giving loans to selected groups of people and hence, scares away other people. This gives the reason as to why the bank has limited regions to cover.

Inflation will affect both banking systems negatively. Both the banks will feel almost the same weight when the inflation hits the country since the people will want more advances and loans straining the capabilities of the loans. Although the conventional banks will gain more since the customers will want the loans and the period when the currency is of low value and repay when the currency has stabilized, the profit gained is not much. The available funds for lending out will be strained so much (Farhan, Ali, & Sadaqat, 2011). Also, the Gross Domestic Product (GDP) growth rate affects both banking systems almost in the same quantity. When the GDP of a nation grows at a high pace, the Islamic banks will benefit more since the nation will have enough resources and the people will borrow fewer loans. The margin that the Islamic banks benefit compared to the conventional banks is so minimal and can be neglected (Samad, 2004).

On the verge of interest rates, the Islamic banks are affected more negatively than the conventional banks. The conventional banks will have the stress brought by the increasing interest rates transferred to their clients and will have less adverse effects. On the contrary, the Islamic banks will have to suffer silently due to increase in interest rates since it will cause more restrictions on borrowing. When the interest rates drop the Islamic banks benefit more as their clients will still pay what they had borrowed, unlike the conventional banks which will need to reduce the rates for their clients (Zulkarnain & Jalil, 2009).

References

Alrawashdeh, M., Sabri, S. and Ismail, M. T. (2012). Robust linear discriminant analysis with financial ratios in special interval. Appl. Math. Sci., 6(121): 6021-6034.

Ansari, S. and Rehman, A. (2011). Financial performance of Islamic and conventional banks in Pakistan. A comparative study International Conference on Islamic Economics and Finance, p. 1-19.

Farhan, M. A., Ali, K., Sadaqat, S. (2011), Liquidity risk management: A comparative study between Conventional and Islamic banks of Pakistan. Interdisciplinary Journal of Research in Business Vol. 1, Issue. 1, p. 35-44

Haron, S., 2000. A comparative study of Islamic banking practices. Islamic Economic, 10 (1), January: pp. 1-31.

Erol. C., Hasan, F., Baklaci, Aydogan, B. and Gokce Tunc, (2014). Performance comparison of Islamic (participation) banks and commercial banks in Turkish banking sector. EuroMed Journal of Business, Vol. 9 Iss 2 pp. 114 128.

Hubert, M. and Van-Driessen, K. (2004). Fast and robust discriminant analysis. Comput. Stat. Data Anal., 45(2): 301-320.

Kakakhel, S. J., Raheem, F. and Tariq, M. (2013) .A study of performance comparison Conventional and Islamic banking in Pakistan. Abasyn University Journal of Social Sciences, vol.6 (2),p.91-105.

Esam F. M. (2013). Comparative performance study of Conventional and Islamic banking in Egypt. Journal of Applied Finance & Banking, vol. 3, no. 2, 2013, 1-14 ISSN: 1792- 6580 (print version), 1792-6599 (online) Scienpress Ltd, 2013

Samad, A., (2004) Performance of interest free Islamic banks vis-a-vis interest-based conventional banks of Bahrain. IIUM J. Econ. Manage., 12(2): 155-170.

Zulkarnain, M.S., and H.A. Jalil, (2009). Financial Ratios. Discriminant Analysis and the Prediction of Corporate Distress.