The main role of this chapter is to give a brief about both Conventional and Islamic banking segments in United Arab Emirates (UAE). It starts with the background and the outline on the growth of the banking sector in UAE and then moves on with information about Islamic Banking. The role of Islamic Banks and how its operations are different from that of the conventional banks and the basic difference between the two banking practices is also discussed. Lastly the research objective and a short summary on how this paper is organized are given.
Introduction to Banking System and Islamic Banking in UAE
In today's world the banking services acts as the major service industries of the world. It fulfills the needs of different sectors of the economy as well as it caters to the diverse population around the globe.
It was not before the 1960s, when the oil reserves were discovered in the United Arab Emirates, that the banking sector started to grow. The development of the financial system started due to the entry of various different banks in the market. Soon there was a ban for about two years which was imposed by the then ruler of United Arab Emirates on new banks entering the market. It was during 1980s, when the Federal Currency Board became the new Central Bank of UAE. It framed some new laws in order to strengthen the functioning of the Central Bank. Soon licensing started again and various different banks started to enter the market and opened up their branches for public. Many banks which had opened up in the 1980s had to shut down their operations due to the fall in global oil prices (1982-86). This also resulted in fall in real estate market as well as high unpaid loans. Central Bank took some severe measure in the late 1980s like expanding audits and inspection, setting minimum capital requirements as well as bank reporting, to strengthen the banking structure even better than before. (Beltone Enclave, 2007)
After the substantial fall due to the global credit crises in the year 2008, the financial sector of UAE has started to show some improvement since 2010. In the first quarter of 2011, the aggregate net profit of the banking sector has seen a 16% year on year increase. (Hasan and Ahmed, 2011)
The UAE financial sector mainly consists of banking institutions and non-banking institutions. The banking institutions can be further divided into Islamic Banks and Conventional Banks. The number of banks currently present in UAE is quite remarkable considering its size. It has 25 foreign banks, 21 local banks, two specialized banks and 50 representative offices of other foreign banks. On the contrary, Saudi Arabia despite having a population of about 25million has only 12 commercial banks. Considering the large stakes are owned by the government, the significance of this sector can be underlined. (El-Quqa, et al, 2007)
Table 1.1: TOP 10 BANKS IN UAE
(IN DHMS mil, YEAR END-2010)
Bank
Total assets
Deposits
Total loans
Net profit before tax
Capital ratio (%)
Emirates NBD
264,593
174,667
181,184
2,354
23.57
National Bank of Abu Dhabi
211,427
123,131
136,833
3,786
23.08
Abu Dhabi Commercial Bank
178,271
106,134
122,772
400
16.65
First Gulf Bank
140,758
98,742
95,628
3,546
22.9
HSBC Bank Middle East
96,124
71,761
50,908
1,126
12.82
Dubai Islamic Bank
90,138
63,447
57,171
816
n/a
Mashreq Bank
84,846
51,254
41,211
856
22.69
Union National Bank
81,780
57,941
56,573
1,357
20.1
Standard Chartered Bank
77,879
44,581
31,451
1,250
15.03
Abu Dhabi Islamic Bank
75,258
56,517
47,953
1,024
15.86
National totals
1,704,014
1,101,513
1,049,721
23,256
n/a
Source: Emirates Bank Association.( http://www.eiu.com/index.asp?layout=ib3Article&article_id=1788702163&country_id=1850000185&pubtypeid=1132462498&industry_id=&category_id=775133077)
According to the above table (Table 1.1) we can clearly see the major banks in UAE according to their Total Assets, Total Deposits and Total Loans. They would be Emirates National Bank of Dubai (ENBD), Emirates Islamic Bank, National Bank of Abu Dhabi (NBAD), Abu Dhabi Islamic Bank (ADIB), Abu Dhabi Commercial Bank (ADCB), Sharjah Islamic Bank, Dubai Islamic Bank and First Gulf Bank.
In a recent study done on the banking sector of UAE, it's been said that for another 18 to 24 months they will be different challenges. This will be due to the fall in the property prices as well as rentals from properties mainly in Dubai, Abu Dhabi and Sharjah. The firms which are privately owned will try to negotiate their loans for a cheaper and longer rate, which in turn will affect other factors like non-performing loans. This will further affect the bank's profitability. (Deloitte, 2011)
Islamic Banking
As defined broadly by Al Baraka (2012),
"Islamic bank is an institution that mobilizes financial resources and invests that money in an attempt to achieve pre-determined islamically - acceptable social and financial objectives. Both mobilization and investment of money should be conducted in accordance with the principles of Islamic Shari'a"
Currently it is the country of Malaysia that holds the distinct position to have a developed Islamic banking system which is operating in parallel to the conventional banking system. Nowadays the development of Islamic banking has reached such a stage that the commercial banks have created special Islamic departments to cater to this rising market. (Hameed and Ahamed, 2009)
Islamic banking is supposedly thirty years old and is considered an integral part of the banking industry. In short Islamic banking is said to be "profit and loss sharing" or "interest-free banking". (Zaher and Hassan, 2001) Islamic banking is mainly governed on the concepts of Islamic Law known as 'Sharia'. Sharia law basically stipulates that the income should be derived from the profits from the risks shared in the business rather than a guaranteed return such as interest or 'Riba'. Also since the interpretation of 'riba' is different for each bank, there are products that are unacceptable by a few but acceptable by other banks. The banks neither charge any interest nor do they pay any. Instead they generally invest in trade and industry through either partnership or directly, and share the profits with their depositors. (Zaher and Hassan, 2001)
According to Dubai Islamic Bank (2011), Islamic banks in general play almost the same role as that of the conventional banks. Investors and small savers are provided with diversification and are also helped in reduction of the transactional cost. It has been seen recently that Islamic Banking is considered as one of the fastest growing sectors of the economy. It not only involves 400 different institutions in around 51 countries but also currently has asset under management of nearly US$1 trillion (US$1,000 billion). According to the Ernst & Young's report in 2011, the assets of Islamic Bank with the Commercial banks globally will amount to US$1.1 trillion by the end of 2012. This is in fact a big jump of 33% from US$826 billion in the year 2010. It also states that the Islamic Banking assets of the Middle East and North Africa (MENA) region will grow twice the current size to US$990 billion by the year 2015.
Difference Between Conventional and Islamic Banking
Both the Conventional and the Islamic Banking have completely different operations which are followed by their respective banks in different countries across the globe. One of the most prominent or notable distinction between the two banking systems is that Islamic Banking is guided and governed under the Islamic Law also known as, 'Sharia'. (Olsen and Zoubi, 2008) The entire dealings under the system of Islamic Banking are dealt according to the Sharia Foundation, which further differentiates the operations of these banking systems. (Zaharuddin and Rahman, 2007)
Further these differences can be seen and understood by looking at the figure below (Figure 1.1) and also in the table (Table 1.2) following the figure.
FIGURE 1.1: DIFFERENCE BETWEEN CONVENTIONAL AND ISLAMIC BANKING
http://www.albaraka.com/images/difference.jpg
Source: Al Baraka Bank http://www.albaraka.com/default.asp?action=article&id=308
Figure 1.1, shows the basic difference between the two banking systems which is that Islamic Banking is more focused on investment whereas Conventional Banking relies more on lending. The Islamic banks pay more attention to the overall plan of the project whereas the conventional banks focus more on the repayment criteria. The Conventional banks look more towards the financial criteria, whereas Islamic banks apply moral criteria to investing funds.
TABLE 1.2: CONVENTIONAL BANKING VS ISLAMIC BANKING
Conventional Banks
Islamic Banks
The basic principles followed by the conventional banks are fully man-made.
The operating modes are based on the principles of Sharia.
Aims at profit maximization without any restrictions.
Also aims at profit maximizations but under the Sharia restrictions.
The most fundamental function of Conventional banks is that of lending money and obtaining the same with compounding interest.
The fundamental function of Islamic banks is that of participating in partnership business and sharing the profits and losses.
The defaulters are charged with additional money in the form of penalty and interest.
There is no provision as such to charge the defaulters. Only a small compensation which is also given to charity.
A greater emphasis is given on the credit worthiness of the clients.
A greater emphasis is given on the plan of the overall project.
All the deposits have to be guaranteed by the Conventional banks.
Deposits have to be guaranteed only on the Deposit accounts, however if the account is based on Mudarabah concept, all the losses have to be shared by the client.
Borrowing money from the market for the interest-based commercial banks is easier.
All such borrowing should be approved and be according to Sharia.
Source: Created by the Author with information from Zaharuddin and Rahman, (2007)
Research Objective
The aim objectives of this research is to find out which of the two banking systems, Conventional Banking or Islamic Banking, has performed better in terms of profitability, liquidity, risk and efficiency over the years after the recession period i.e. 2008-2011. The research is done using different tools of analysis and findings. There were several other researches done in the same area (which are explained later in chapter 2) but since Islamic Banking is of the recent existence, there hasn't been many empirical studies done between Islamic and Conventional banks of UAE.
Organization of the Paper
This chapter mainly dealt with the introduction of banking system in UAE, about the Islamic Banking and also a brief distinction between both the banking systems and their operations. The next chapter will look into the Review of Literature for the main topic of study showing which other studies were done in the same area. The Third chapter will look into the methods used into this research and the different tools which will be used in the study. The Fourth chapter will show the research findings and the analysis on the research done. Finally the Fifth chapter will provide the conclusion to the research topic, stating the limitations as well as the recommendations for further research.
