The Islamic Banking System: Study into Current practices of Islamic banks in Pakistan

Introduction

Islamic banking is banking in accordance with the rules and guidelines that Islam permitted under Sharia. The term refers to the Sharia Islamic law as revealed in the Qur’an and through the example of Prophet Muhammad (Peace Be upon Him). The authority of Sharia is mainly from specific guidelines in the Qur’an. The second important source is the Sunnah, which translates into the way and refers to how the Prophet Muhammad (Peace Be upon Him) lived his life. This is based on the Hadith, a collection of everything the Prophet Muhammad (peace be upon him) said, did or approved. Another important source is Qiyas involving the interpretation and analysis of existing legislation on the basis of modern circumstances. The principles of Islamic finance are as old as Islam itself. Sharia Committee is experts in the interpretation of Islamic law and its application in modern financial institutions.

Economic interest of Islam is completely forbidden. If someone wants to make money with its idle funds to invest their money in his business. Instead of borrowing money and the capital charge to the borrower, whatever the outcome of the business person should enter into a sort of partnership with him. There are a number of partnerships and other arrangements that allow two people to do business or financial activity. Provided that economic activity is not the non-Muslim and operation would increase economic output.

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Aims

The main aim of my research work is to analyze the existing and growing trend of Islamic banking system in Pakistan and to find out the reason that why customers prefer to adopt Islamic banking system compared to the conventional banking system.

Objectives

The main objectives include

Thoroughly study the Islamic banking system according to Sharia law (Islamic law)

Thoroughly study the conventional banking system prevailing in Pakistan

Comparative study of two banking system i.e. Islamic banking system and conventional system

Background of Islamic banking in Pakistan

The first attempt to establish an Islamic banking system took place in Pakistan in late 1950 with the creation of a local Islamic bank in a rural aea. Some homeowners’ religious funds deposited without interest and then loaned to small landowners for agricultural development. The borrower pays no interest on credit advanced, but little has been collected to cover its operations. The fee was much lower than the interest rate. Although experience is encouraging, two main factors are responsible for its failure. First, depositors are the landowners considered deposits as a single event, and secondly, the bank employees did not complete autonomy over its operation.

With an Islamic financial system began in 1979-1980, when the credit needs of the specialist public sector in economic activities towards non-interest. 1 January 1981 all domestic commercial banks authorized to accept deposits, based on revenue sharing (PLS). Over the next year for three years, was taken to develop new financial instruments other than interest-bearing deposits that PLS could be placed. These are rough spheres of government and its agencies, the export invoices, investments accounted for assistance to purchase certificates of PTC, the provision of specialized credit institutions loan (which has already been transferred to non-interest bearing assets), Musharakah (PCA), mortgage purchase, hire and certified Mudarabah (Iqbal. Mirakhor, 1997).

The new measures have been formally initiated in January 1.1985 transform the banking system in the next six months for an interest-based economy, thus completing the first step to put the entire financial system according to Islamic principles. 1.1985 In January all funds provided by banks to government, public sector enterprises and public companies limited by shares must be solely on the basis of Islamic modes of financing specified. Transactions with the government, however, always based on mutual interest; on the other hand, the government obtains funding by selling bonds, whose acquisition by the private sector is facilitated by the provision of bank credit fixed rate. April 1, 1985, all funding to private sector entities, including individuals, is also limited to the methods specified. On July 1, 1985, banks cannot accept interest-bearing deposits and all deposits are subject to existing rules PLS.

Bank accounts are still accepted in the past that is the sharing of profits or losses for banks. Foreign currency deposits and foreign loans, however, continue to issue new regulations (Iqbal. Mirakhor, 1997), the SBP report, Pakistan has now become the protagonist in Muslim countries in the field of Islamic financial system.

Literature review

Review of the literature is very important for any analytical work, particularly in research that is based on an analysis of the practical test, which is processed to obtain the results and compared to other work study available in media. The data used in this work is based on practical analysis on primary data collected and analyzed and interpreted. In the literature, see the paper will examine the concept of Islamic finance, looking at the sources and think Islamic banking, Islamic principles and purpose. Research in this comparison would be made between Islamic and conventional banking systems.

The Principles of Islamic banking

The principles of Islamic finance are based on Islamic law, known as Sha’riah, which means:

Interest (Riba)

Interest cannot be paid or received for operations in all cases where money is money because the money is not really a value according to Islam, if not used in business.

Prohibition of riba (interest) Many Muslim scholars and considerations of the West and still believe, considering that bank interest free is only an Islamic bank. In fact, the interest is completely forbidden in Islam, which is set in the Quran and Sunnah “The value given to increase the wealth of the people, no more than to Allah. Zakat and you pay for win the approval of God; taxpayers actually increase their wealth “(Sura Al-Roma no. 39) (Shafi and Usmani, 1997, p. 67). It’s beautiful and powerful statement of the Koran shows that interest is forbidden by God, because it can increase the wealth of the person not the company. “The exclusion of the interests of the financial activity does not necessarily mean that the lender cannot make a profit.

Gharar and Maysir

Transactions should avoid uncertainty (Gharar), speculation (Mays) or anything that could lead to unjust enrichment or unfair exploitation of one party to a contract (Imeson, 2007). In the case of large speculative investors and industry to the economic and financial system for their own personal benefit.

Unethical businesses

The transaction cannot be made about prohibited items or activities such as alcohol, illicit drugs and tobacco, because Islam wants to develop an ethical and friendly society (Imeson, 2007).

The Fundamental of Islamic Banking and Finance

Islamic commercial law is actually based on three fundamental principles. The basic principle of Islamic Affairs first is the sharing of profits and losses and the other is based on fixed fees and taxes, and the third is based on open and free. The other principles are the developments of the company and its activities (and Bellalah Ellouz, 2004).

Musharakah (Partnership Finance)

Musharakah is a contract where the bank and jointly contribute to the industrial capital of a company or project to make a profit. Profits and losses are shared between the parties on the agreed term and conditions of the contract.

Mudarabah (Trust Financing)

Mudarabah is a contract in the contract; it is the bank provides all the capital while the partner contributes to marketing efforts, skills and experience. Finally, the bank receives a certain proportion of the profits. In the event of a loss, the bank has all the financial losses if the manufacturer goes unrewarded (Rob, 1992). We conclude that this system encourages people to participate in financial activity and evidence that the active part of society.

The third principle is free charges within the fixed part of the class:
i. Murabaha (Cost-plus financing)

Murabaha is a contract whereby the bank will inform the industry about the cost of procurement of goods and negotiate with him the profit margin. One of the most widely used mode of Islamic banking in different countries to promote interest-free transactions.

ii. Bai-mua’jjal (deferred payment sale)

Bai-mua’jjal is a contract of sale of deferred payment is exchanged at no additional cost.

iii. Ijara (Leasing)

The Ijara is a lease whereby the owner of the property leased to a third party to bleed. After that he can buy and rent is reduced until the property becomes the possession of the customer (and Bellalah Ellouz, 2004). Today, Islamic Finance and mortgages are based on the concept of Ijara and is a powerful tool in the Islamic financial system.

iv. Quard Hassan

Islamic financial system is for customers who are facing unexpected financial crises or banks offer loans for welfare without paying any commission or interest (Peter, 1992). According to Rob (1992) The Islamic bank can raise funds by selling shares to the public and continues through three main deposit accounts, savings deposits and current deposits.

Difference between Islamic and conventional banking systems

Duties and functions of conventional banks are entirely based on the principles of manThe functions and operating modes of Islamic banks are based on the principles of Sharia.
There is a predetermined rate that is guaranteed to the investor.Islamic banking promotes risk sharing between provider of capital (investors), and user of funds (entrepreneur).
Traditional banks are trying to maximize their profits without any restrictions.The Islamic banking seeks to maximize profit subject to the restrictions of Sharia.
Traditional banks do not process or pay the zakat.Islamic banks pay zakat and to play a role as a collection of zakat.
Borrowing money and to get back to increasing the interest rate is central to traditional banks.Islamic banks are involved in the partnership contract and to participate accordingly.
In case of default, the bank worth of conventional and compound interest.Islamic banks have no provision to charge extra money for non-compliance. Only a small contribution and these returns will be donated to charity. Discounts have already been given a solution of the Bank’s discretion.
Very often, this translates into the bank’s interest becomes important. He makes no effort to ensure growth with equity.To ensure growth with equity, Islamic banks give importance to the common good.
Borrowing in the money market is relatively easier in the traditional banking sector.Islamic banks should be based on Sharia committee is independent in itself.
Because of its fixed income accounts, not paying too much attention to project evaluation and assessment.Islamic banks to pay more attention in project appraisal and evaluation, as the mechanism for profit sharing.
Conventional banks focus more on the credit history of customers.Islamic banks place greater emphasis on strengthening and project feasibility.
Relationships with traditional banks and their customers that creditors and debtorsThe status of Islamic bank in relation to their customers, partners, investors and sellers, the buyer and seller.
A conventional bank must guarantee all deposits.Islamic banking can not guarantee the deposits of the deposit, depositors are guaranteed repayment of the funds, but if the account is based on the concept Mudarabah, the customer has accounted for the loss of status.

Ust Hj Zaharuddin Hj Abd Rahman

RESEARCH METHODALOGY

Difference Research philosophy:

People carrying out research to find things in a systematic way, increasing their knowledge (Jankowicz, 2000). Business and management research must engage with the world both in theory and practice worldwide (Saunders et al. Al, 2003). philosophy of research is how people think that the development of knowledge (Saunders et al. al., 2003). There are two main research philosophies: positivism and phenomenology. Positivism views that knowledge is something that develops gradually discover more and more about what exists (Jankowicz, 2000). Positivism assumes that phenomena can be analyzed in terms of variables, data can be collected by an impartial outside observer. A positivist prefer to work with observable social reality and that the final product of this research can be generalized as a law similar to those produced by the natural sciences (Remenyi et al, 1998; .. Quoted by Saunders et al .. 2003).

Phenomenology of views that knowledge is, it builds a sense of personal and social experience (Jankowicz, 2000). Phenomenology assumes that the phenomena can be analyzed in terms of things that the data collected from participants and observers, who all have different degrees of involvement and detachment. Phenomenologist believes that a social enterprise and the government is too complex incapable of theorizing is a definite ‘laws’ in the same way as in physics (Saunders et al, 2003). Contributions must be understood sufficiently to predict future results.

These two research approaches are “better” is doing things different and depends on the research questions. Research management is often a mixture of two (Saunders et al, 2003)

Research Strategy

Research strategy includes following:

Quantitative and qualitative research

“Qualitative research is an unstructured, exploratory research methodology based on small samples to understanding and understanding of problem determination. Conversably quantitative research is a method that aims to quantify the data and is generally a form of statistical analysis. “(Malhotra, 2004) in this research, I will use both qualitative and quantitative research and figure out why people their way to Islamic finance. For this reason, I will conduct the interview, ask open questions send the questionnaire.

Qualitative VS Quantitative Research

Qualitative researchQuantitative research
ObjectiveTo obtain a qualitative understanding of the causes and motivations.Quantifiable data and to generalize the results of the benefit of the population sample.
SampleA small number of representative cases.A large number of representative cases.
Data collectionUnstructuredStructured
Data analysisNon statisticalStatistical
OutcomeDevelop your understanding first.Recommend a final action plan.

(Malhotra, 2004)

Data collection (Primary & secondary data)

The data are derived from primary research to address the specific problem. The Collection of some alternative is other than the problem at hand. “(Malhotra 2004).

Comparison of primary and secondary data

Primary DataSecondary Data
Collection purposeFor the problem at handFor other problems
Collection processVery involvedRapid and easy
Collection costHighRelative low
Collection timeLongShort

(malhotra2004)

Collection of primary data

The primary data collected through questionnaires. Structured questionnaires were given and make a request. Questionnaires are questions about their interest in Islamic banking, their choices in non-interest bearing (qard loans-e-Hasanah) and loans / financing with a fixed interest rate or loan / funds on the basis of sharing profits / losses. In addition, respondents are asked to provide their experiences of Islamic banking, if they had anyTheir recommendation is to obtain information on the selection of the banking system in the economy, and that they would like the implementation of Islamic banking size of the economy or not. Problems involved in the learning experience for respondents with zero-rate financing and they were happy to traditional financing, in the endThe interviews with bank staff are made by telephone.

Structured questionnaire will be prepared to ask the bank staff for information on Islamic banking and conventional banking systems in Pakistan and the future of Islamic finance.

Collection of secondary data

Information on Islamic finance is based largely on the library. Islamic banking is still looking like a full flight of 100 per cent of Islamic banking does not work in any country. Main sources of information on Islamic finance are books, journals, information on the Internet, the shopping center and bank reports of conversion to Islamic banking. The information will be of international institutions of Islamic banking and Islamic banking financial institutions.

OUTCOMES

The outcome is focuses on the results of this research project. first and foremost objective of this study is to learn to “analyze the current and growing trend of Islamic banking in Pakistan and to find the reason why customers prefer to adopt the Islamic banking system in relation to the traditional banking system.” In response range of the semi-range structure of the questionnaires were given by respondents. As mentioned above, these data were obtained by identifying concepts and coding, the details of what can be found in the Appendices. my thesis research through this process a number of important concepts emerged some to help you find answers to the first objective of this research project concepts are identified: the full belief, prohibition, sinful better (this means that the. Islamic system is better, motivated by religion and religious beliefs commitments.

Sampling for depositors’ questionnaire

There is a sample of 100 respondents to the survey of filling. Each sample will be selected at random. Since the research aims at studying the Islamic banking system and its current practice in Pakistan. Sample of primary research will be selected from the views of Pakistan and comments from the selected sample will be analyzed to assess if the general public in Pakistan is to the Islamic banking system is and what to do. Data will be collected through self-administered questionnaires will be distributed to respondents and asked them not to fill in or have completed questionnaires could be collected for some time later depending on the ease with which the respondent. These questionnaires will be distributed through a friend of the researcher, for this reason that the researcher is not able to go to Pakistan and lead the research itself. This would not only increase the costs of research, but also need more time.

The questionnaire will contain questions to elicit information on knowledge and interest of respondents in the Islamic banking system. The questionnaire will be sent to relevant researchers in Pakistan and asked that it be occupied by the sample size 100people. After completion of these questionnaires will be returned to the researcher, so he can make a research on her record. This approach is simple which asked the respondent to answer yes or no.

Depositors’ questionnaire

A simple questionnaire is to assess knowledge and interest of respondents in the Islamic bank. The questionnaire consisted of two parts, Part I, which includes the characteristics of respondents, while Part II contains questions on Islamic finance. Part II of the questionnaire contained 10 questions in this basic information about Islamic banking will be invited to sample selection based on proximity and customers will be randomly selected from commercial banks and Central Bank (State Bank of Pakistan Islamabad). Selection of commercial banks / center as a place for sampling will be a conscious decision that customers in these locations are likely to have a good knowledge of the bank.

The city of Islamabad, covering most of the conventional and Islamic banks and commercial financial institutions that offer current accounts, investment accounts, deposits of conventional banks, investment banks and Islamic financial institutions working in specific industries, such as House Building Finance Corporation, Agricultural Development Bank.

Questionnaire Part I

1. Please mark tick on your age group.

a. less than 25 years

b. 26 years to 35years

c. 36 years to 45 years

d. 46 years to 55 years

e. 56 years and above

2. Please mark tick on your gender.

a. Male

b. Female

3. Please mark tick relevant to your job/work category.

a. Executive

b. Non executive

c. Professional

d. Student

e. Government employee

f. School Teacher

g. Others

4. Please mark tick on your religion.

a. Islam

b. Christian

c. Hindu

d. Sikh

5. Please mark tick relevant to you tendency to religion.

a. Low

b. Moderate

c. High

Questionnaire part II

Answer the questions with YES/NO

1. Do you have knowledge about Islamic banking YES/NO

2. Would you like interest based banking to be replaced by interest free banking YES/NO

3. If your answer to question above is ‘yes’, is it due to religion factor YES/NO

4. Do you have Islamic banking accounts YES/NO

5. Have you ever had consumption loan on fixed interest YES/NO

6. If your answer to question above is ‘yes’, would you like to get it again when required YES/NO

7. Have you ever had investment loan on fixed interest YES/NO

8. If your answer to question above is ‘yes’, would you like to get it again when required YES/NO

9. If you are being offered investment funds on profit/loss sharing would you accept it YES/NO

10. Beneficiary loans (Qard-al-hasanah), do you think that these are good for societyYES/NO

In order to keep the quality of data at high level, questionnaires are designed to give the logical and sequential flow of topic. Questions are asked in simple words without leaving any ambiguity and complexity so that could be understood and answered by all respondents without any prior knowledge of Islamic banking. Sample is selected with keeping in mind that it represents the whole or majority of population. City of Islamabad, capital of Pakistan having registered offices of many banks and financial institutions shows a good selection of place of intended selection of sample. Due attention is given to the respondents at the time of filling questionnaire so that if they need any help in filling the questionnaire, that could be provided to them at the same time.

References:

• Iqbal.Z and Mirakhor.A (1997), “Islamic Banking” International Monetary Fund, Washington, D.C.

• Shafi, M. Taqi Usmani, M. (1997) The Issue of Interest, Pakistan, Darul Ishaat

• Taqi Usmani, M. (2005) an Introduction to Islamic Finance, Pakistan: Maktaba Ma’Ariful Qur’an

• TraShanmugam, B. Perumal, V. Ridzwa, H.A. (2004) Islamic Banking: An International

Perspective, Serdang: University Putra Malaysia Press

• Michael, I.M.E.S.O.N. (2007) Islamic Finance In London: Room For More Sharia

• Compliance – A New Islamic Bank Has Opened For Business In London, Bringing The

Roula, K.H.A.L.A.F., 2007. Islamic banking held back by lack of scholars. Financial Times,

pp. 5.

• Bellalah, M. and Ellouz, S. (2004) Islamic Finance, Interest Rates and Islamic Banking: A

Survey of the Literature. Finance India, 18, pp. 533.

• Malhotra, N, K. (2004), Marketing research, 4th edition, Pearson education ltd, England

• Jankowicz, A. D. (2000) Business Research Projects (3rd ed.) London: Business Press.

• Saunders, M. N. K., Lewis, P. and Thornhill, A. (2003) Research Methods for Business Students (2nd ed.), London: Prentice

• Hall Ust Hj Zaharuddin Hj Abd Baily, Martin, Robert Litan, and Mathew Johnson (2008), “The Origins of the Financial Crisis: (The Initiative on Business and Public Policy at the Brookings Institution), November.

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