Islamic Banking can be defined as a financial institution that operates with the aim of implementing and materializing the economic and financial principles of Islam in the banking environment. The Organization Of Islamic Conference (OIC) defined an Islamic Bank as "a financial institution whose statutes, rules and procedures expressly state its commitment to the principles of Islamic Shariah and to the banning of the receipt and payment of interest on any of its financial activities.
Islamic Banking is considered to be the fastest rising element of the financial services industry with around 270 IB globally totalizing US$13 billion in market capitalization. Moreover, it is expanding at an average of 15% and 20 % annually. The resources and investments of these banks have gained impetus during the precedent years and are predictable to be over US $265 and US $400 billion likewise on the worldwide scale.
The IB progress has initiated in the Middle East and the Arabian countries thereby increasing all over the world like Europe, Canada, Africa, USA, Australia, Asian countries as well as the GCC countries where it has by now starts to take over normal conventional banking. This unexpected entrance of IB from the postern and which has efficiently establish a way through, in the global modern finance, makes it suggestive to study, in the view of making Mauritius a financial hub.
The objective of Islamic Banking is not only to make profits, but to do well and bring welfare to people and it is also committed to do away with the disparity and establish justice in the economy, trade, commerce and industry. Islam upholds the concept that money, income and property belongs to the Almighty Allah and this wealth is to be used for the needs of a good society.
1.1 Objectives of the study:
Islamic Banking is the fastest growing component of the financial services industry. Islamic Banking is however facing a lot of difficulties in the way of its development. Since, Mauritius is a multicultural country; this is why banking rules and financial activities are in favor of conventional banking system.
Therefore, the objectives will show:
The different behavior towards the Islamic Bank.
The willingness of Muslims and Non-Muslims to invest in the Islamic Banks
If there is a potential expansion for Islamic Banking Services in Mauritius
CHAPTER 2
LITERATURE REVIEW
2.0 Introduction:
Quran (III, 130):
"O you who believe, do not consume Riba with continued redoubling and protect yourselves from God, perchance you may be blissful". The concept of Islamic Banking is taken from the saying of the Muslim Holy Book, the Quran.
Islamic banking appeared on world forum as a prominent player over two decades ago. But actually, many principles of Islamic banking system have been accepted all over the World for centuries rather than decades. Islamic financial system existed in Muslim community in different forms according to situation of time. Actually Islamic financial system has a potential to fulfill the society requirements in respectable way.
Islamic banking is a growing sector with its diversity in different segments and spectrum. It caters for Muslims in Muslim's dominated societies as well as in countries where Muslims are in minority. In addition, it is a broad standard: non-Muslim individuals and communities that seek ethical financial solutions have also been attracted to Islamic banking. It is clear from banking practice that Islamic banking is equally popular in all
communities.
It is clear from above statements that Islamic banking is not only Islamic or specific banking but actually it is a system which provides more ethical and moral concept of financial issues as well as it is really helpful to create a peaceful, economically prosperous and welfare society.
The Organization of Islamic Conference (OIC) defined an Islamic banking as "a financial institution whose statutes, rules and procedures expressly state its commitment to the Principles of Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations" (Hassan, 1999, p.60).
According to this statement, it is evident that interest is fully prohibited in Islamic law due to its bad effects on human being and more badly effects on overall society and economy. In an interest based economy, a trend arises that rich people create the methods to increase their wealth through effecting the middle and lower classes. In interest based economy the middle class cannot contribute positively in economic system then gradually the economy travel towards financial crises such as credit crunch.
In the middle of the nineteenth century and on, Western Style banks entered the Muslim countries. Islamic objector, Shariah scholars and religious leaders came out in disagreement to these methods of financing. The latter point of view was that these dealings were being based on prohibited activity.
Therefore, there was a must to structure a sovereign technique of banking which is different to the conventional one. The earlier modest foundation of Islamic Banking was in Mit Gamr, a small town in Egypt and in Malaysia. Since then Islamic Banking has recognized an enormous expansion with the system of Islamic Development Bank in Jeddah, Saudi Arabia, which added very much in Research and Development. There are 99 Islamic Financial Institutions which are here in diverse countries and in 1996 these organizations were managing approximately 28 billion US Dollars.
One explanation for the success and growth of Islamic Financing Institution is initiated in its efficiencies.
2.1 Efficiency:
According to Molineux and Iqbal (2005), they disagreed that the operation of Islamic Banks were still in a formative phase. Simple studies which have been carried out so far were generally on analysis of descriptive statistics rather than applied statistical estimation (El Gamal and Inanoglu 2002). However, changes were expected because various authors have used advanced modeling techniques in their study. For instance, Molineux and Iqbal (2005) have used the econometric models while Berger and Humphrey (1997) classified it into parametric and non-parametric models. The benefits and drawbacks of these methods were reviewed nonetheless resulting in more or less the same outcomes when comparing bank cost and profit efficiencies of Islamic Bank and conventional bank in the GCC countries.
Empirical evidence which has been discussed by Molineux and Iqbal (2005) showed that the study of Shammari (2003) used translog stochastic cost and alternative profit frontier approaches to approximate Islamic Banks with the other conventional banks. The conclusion was that Islamic Banks were the most cost and profit efficient while investment banks were the least efficient. He also found that, with cheaper source of funds than other type of financial institutions, Islamic Banking activities were carried out.
Furthermore, this result was verified by the study of Molineux and Al Jarah (2003). They used the frontier approach along with the Fourier Flexible form to show that the average cost efficient for the investment bank in 93% -98% for Islamic Banks operating in Bahrain, Jordan, Egypt and Saudi Arabia. Also, profit efficiency score ranged from 56% for investment banks and 75% for Islamic banks.
Another study made in Malaysia by Majid (2003) using stochastic cost frontier approach showed that Islamic banks performance is better than conventional counterparts in terms of efficiency even though there was a preventive business environment. Even by using ratio analysis, Molineux and Iqbal (2005) concluded with their assessment that Islamic Bank was more efficient than conventional bank even when using ratio analysis.
Bashir (2001) studied the underlying determinants of performance of Islamic Banks. He used regression analysis to find out the book value of equity over total asset and ratio of loan to total loan asset were the main internal determinants of profitability. Therefore, high leverage and large loans to assets ratios would direct to higher profitability.
2.2 Methods of financing
2.2.1 Introduction:
Islamic commercial law is in fact supported on four elementary principles. The fundamental of primary Islamic business principle is profit and loss sharing and the next is based on fixed service fees and charges and third is based on free of cost and no charges. The other principles are changing with the circumstances of the business and its operation (Bellalah and Ellouz, 2004).
There are fundamental financing contracts which are Shariah compliant and have been developed for the practice of Islamic Banks. The Islamic modes of financing are split up into two groups, which involve both the assets and liabilities sides of the Bank's balance sheets (Zaher and Hassan, 2001) and (Siddiqui, 2008) and (Sundararajan and Errico, 2002) and (Islamic Finance, 2010):
Fundamental modes which are based on the profit-and-loss-sharing (PLS) principle and comprise: Mudaraba (trustee finance), Musharaka (equity participation).
Marginal modes which are based on mark-up principle and are (non-PLS) based, for instance, Qard Al Hasanah (beneficence loans), Bai' Mua'jjal (credit sales or deferred payments sales), Bai' Salam or Bai' Salaf (purchase with deferred delivery), Ijara and Ijara wa iqtina' (leasing and lease-purchase), Murabaha (mark-up), Istisna'a (forward contract), and Jo'alah (service charge).
2.2.2 Mudarabah:
Mudarabah is an agreement between the bank and the customer. Here, the bank is recognized as the financing partner and the customer is known as the managing partner. This is a formation of equity contribution. Here, the bank and the client talk about the business plan, and afterward the bank gives the finance to the client. The customer then set up and supervises the business. Besides, guarantee is not necessary because the recovery of the capital depends on the achievement of the business financed. If the business makes profit, the profit must be distributed between the two parties their pre-agreed ratio. The agreed profit can either be a proportion of the realized profit or at a fixed/predetermined rate. In case if the business makes a loss, it is the bank which takes up all losses unless the finance user is found in a breach of trust. Mudarbah works also in such a way where the bank is the managing partner and the client is the financing partner. In this case, it is known as investment deposit.
2.2.3 Musharaka:
It is considered as a form of equity participation contract where is usually employed to finance long-term investment projects. It is a joint venture between the financial Institution and the enterprise. This mode of financing gives the bank the chance of participating in fund management. The bank puts emphasis on the productivity and viability of the project rather than their credit worthiness. So, it is a great advantage for the fund seekers. Hence, partners contribute both capital and effort and the returns are distributed according to their capital contribution.
2.2.4 Murabaha:
Murabaha is one of the most common modes of financing in Islamic banking. Here the transaction involves two parties that are the bank and the customer. Here the customer approaches the bank, the bank identifies the commodity, collect the relevant information. The information includes the price and markup. Then the bank purchases the commodity as per requisition of the client and sells him on cost-plus profit. Under this arrangement, the bank discloses the cost and profit margin to the client. The Islamic Bank, has full control over the fund compared to PLS mode of financing.
2.4 Differences between Islamic Banking and conventional banking
Schaik (2001) differentiated 3 differences between Conventional Banking and Islamic Banking. Primary, Islamic Banking believes Islam as its backbone. Therefore, the ethical philosophy and objectives play a major role in the function of Islamic Bank than in Conventional banks. Next differentiation is in its product and the third difference is in terms of its organizational structure and corporate governance. Moreover, the authors pointed out that Islamic Banking have the characteristics of investment banks, commercial banks and development banks. In contrast, Iqbal and AL-Jarhi (2001) supports the truth that there is a differentiation between commercial banks. They disagreed that the facet of financing mode of Islamic Bank made the universal bank system more enough for their operations. The first choice was given to universal bank, it is more efficient as it is allowed to hold equity which disguised that officials of universal banks could sit on board of directors of their customers, thus enabling the bank to lower their costs by monitoring the use of funds of the customers. Also, they carried out operations like trading and insurance, which typically lied beyond the field of commercial banking. The Faisal Islamic Bank in Sudan had experienced greater performance and profitability when it is changed to the universal mode of banking according to Siddiqi (2004). Section 30 of the Banking Act 2004 limits investment operation of banking institutions in Mauritius. Therefore, if there was to be an Islamic Bank in Mauritius it would be limited in some operations.
Conventional bank use interest rate mechanism to perform their task of financial intermediation, whereas Islamic banks make use of two basic principles, that of Profit and Loss Sharing and Markup. All Islamic models which have been developed so far were based on this. The idea of PLS is derivated from the theory of Islamic economies. In addition, they are tailor- made contracts that afford them safety against the bad effect of interest rate and also against economic injustice which is a main aim in Islam. A good deal of literature concerns the effectiveness of this concept.
PLS consist of several modes of financing but it is in its very nature a form of partnership where the partners share the profits and losses depending on their initial capital invested and effort and in practice is a joint venture (Musharaka) and trust financing (Mudharaba).
2.4.1 Compatibility of Islamic banking with Conventional banking:
Islamic banking has same purposes and practice as conventional banking except that Islamic banks operate in accordance with Sha'riah laws. The basic principles of Islamic banking are the sharing of profit and loss between contracted parties and as well very strongly prohibit the Riba (interest).
Islamic and traditional banking actually are not different as mentioned above. Both banking systems have the same objectives and practice, the only difference is the implementation of interest because interest is totally prohibited in Islam. Islamic banking falls into the realms of conventional banking; Islamic banking try to ensure that all their financial matters according to Islamic financial law as well as the rules and regulations of a particular state like the Financial Services Authority (FSA) in the United Kingdom (Shanmugam, Perumal and Ridzwa, 2004). Islamic banking almost provides same services as conventional banking such as current accounts, saving accounts, insurances, mortgages and investment opportunities in the society.
According to Nienhaus (1995) Islamic banks, in compliance with the welfare principle of Islam, offer facilities more or less the same segment of the economy as the conventional banks. The practices and situations are not so different from conventional banking such as the costs of funds are closely related to interest rates and guarantees are nearly as important in Islamic banks as they are in the conventional banks (Hassan, 1999).
It has been concluded from studies that the functions of Islamic banking are matched with traditional banking system such as conventional banking charge interest against Islamic banking provides these services with charging of services fees and mortgages rate are most likely same in both banking system but the only difference is that Islamic banking follow the Ijarah rules in which the instalment is calculated on the basis of monthly rent plus services fees of the banking institution.
2.5 Risk faced by Islamic Banks:
Financial institutions are faced with risk and Islamic Banks are no exception. The environment of universal bank protects Islamic Banks from asymmetric information and adverse selection in contrast with commercial counterpart. The fact that borrowers are in a position to hold back information from banks, allows them to use the loans obtained for purposes other than specified in the contract agreement. By so doing, banks are exposed to unknown risks. Since universal banks are allowed to hold equity and carry out operations like trading and insurance, they are better equipped to deal with asymmetric information. They can finance their business customers through a combination of shareholding and lending. Hence, this permits universal bank to monitor their customer while sitting on a board of directors Iqbal and AL-Jarhi (2001).
On the other hand, Islamic Banks encounter other risks. Using the PLS modes in Islamic Banks changes the nature of the risks of these institutions face. Depositors share the business risk of banking operations with the bank. Khan and Ahmed (2001) demonstrated various risk faced by Islamic Banks as being credit risk, benchmark risk, liquidity risk, operational risk, legal risk, withdrawal risk, fiduciary risk and displaced commercial risk. They also give risk associated with different modes of financing.
In a survey carried out by these authors on the perception of risk faced by the Islamic Banking Institution, markup risk appeared as the lending and the most critical one followed by the operational and liquidity risk. While credit risk is the risk that most financial institutions deal with, they argued that Islamic Banks were able to establish better risk management, policies and procedures than measuring, mitigating and monitoring risks, with internal control somewhere in the middle. The results also showed that there was a lack of financial instrument like short term financing assets and derivatives. This risk was evoked many times by several authors in the literature. However, we must note that there is a lack of research on default risk: a situation faced by the bank when a company defaults. Special attention is brought here due to the fact that the loan granted is in the form of equity participation, thus the need to know if the bank will bear the same risk as shareholders in the case of an Islamic Bank operating as universal bank.
Banks working on Islamic principles and techniques suppress the interest rate to zero for savers but alternatively give returns on investments. To be able to attain at a higher positive returns or at least the same rate offered by conventional banking there should exist in investment opportunities. Khan (1991) argued that portfolio diversification was an important factor to reduce the overall risk on its investment to a negligible amount.
2.6 Mauritius an emerging centre for Islamic Finance:
Mauritius is an established and successful country which is well placed and determined to offer Shariah products and services as a new way of banking.
2.6.1 An emerging Islamic Finance hub:
Rasool (2011) highlighted that, Mauritius is a dynamic performer in the international Islamic finance industry. Actually because of the fusion of fiscal and non-fiscal causes, Mauritius is well capable of structuring Islamic financial product. An amount of Shariah compliant global funds has already been set up in Mauritius.
According to the Governor of the bank of Mauritius, Mr. R. Bheenick (2011), during the launching ceremony of Century Banking Corporation Ltd, the first Islamic Bank in Mauritius, he commented "for a country which is second to none in its pluralism, we could not just stay away from Islamic Banking. We need to develop our niche market and strive to become regional hub for Islamic Finance."
2.6.2 Objective for the development of Islamic Finance in Mauritius
According to Rassool (2011), in October 2005, the Government set up a Steering Committee to explore a propos the chance of setting up Islamic Financial Services in Mauritius and this board planned to have a legislative framework evaluated and modified to facilitate the introduction of Islamic Bank in Mauritius. A Malaysian expert of Islamic Finance; Ahamad Tajuddin, former CEO of Bank of Islam Malaysia seconded by Development Bank, was afterward called into the updated Islamic finance regulatory. The proposal was confirmed and the Finance Act 2007. It made banks to function either fully fledged Islamic Bank, or alternative to offer Islamic services through a window operation.
A committee was then set up to work on the guidelines for carrying out Islamic Banking Business in Mauritius. The purpose was to devise a straightforward and a regular regulatory framework, in which Islamic Banking could develop and be incorporated in a flawless way with conventional financial system. The team was generally supported and included representatives from the banking industry. These procedures were completed and issued to the industry in June 2008.
The BOM on the other hand, also wanted to be associated with the Islamic Financial Services Board (IFSB). In November 2007, the bank was drearily declared as an Associate Member of the IFSB. In May 2009, the BOM with the IFSB hosted a discussion on Islamic capital market in Mauritius in united association with the Financial Services Commission (FSC). The intention of the happening was to take Mauritius to the awareness of the global Islamic Finance community as well as the Mauritian society in general. In the same month, the BOM was declared as full associate of the ISFB at the same time as the FSC turned out to be a connect member, another foremost steps towards the achievement of a comprehensive Islamic Financial services industry in Mauritius.
On May 2009, HSBC Mauritius in cooperation with HSBC Amanah initiates its Islamic banking window to supply for the rising demand for Islamic Banking services from international business customers. In October 2010, the IFSB synchronized the founding of an International Islamic Liquidity Management Corporation and the BOM became founder member, alongside with 10 other central banks and two additional mutual organizations (the Islamic Development Bank of the Private Sector). The new conglomerate will issue investment grade instrument to smooth the progress of liquidity management for organizations offering Islamic financial services and cross border investment flows. The Government of Mauritius donated $5 million (US) to the capital of this supranational body, a clear demonstration commitment to creating an environment conductive to development of this new Shariah compliant platform in the banking landscape.
In October 2010, the BOM also entered into Memorandum of Understanding (MOU) with Bank Negara Malaysia, a leader regulator in Islamic Finance. The MOU establishes a collaborative framework for Mutual Corporation in capacity building and human capital development in the financial industry with the expectation of creating a pool of high-calibre professional in this field.
On 31 March 2011, the Century Bank Corporation, the first Islamic Bank Licensed by the BOM was launched. Born from a strategic partnership between Quatari investors through Domasol Limited and a British American Investment Group, the Century Banking Corporation will focus on wholesale banking, treasury and wealth management targeting Mauritius, Africa, Asia, and the Middle East.
To sum up, we can say that banking is a universal concept that knows no boundaries - be it geographical, ethnic or religious. With the increased reputation of the Islamic banking activities in the Asian countries and world-wide, it is necessary to discover the opportunities for the development and the growth of the Islamic banking activities in Mauritius and also if Islamic banking have its place in Mauritius. The results will be found in approximately 12 years.
CHAPTER 3
RESEARCH METHODOLOGY
3.1 Introduction
Ethridge (2004) defined research methodology as "specific techniques, tools or procedures applied to achieve a given objective" and Kumar (2008) added that it is "a way to systematically solve the research problems". The purpose of this chapter is to describe the process of how research is planned and carried out in order to obtain the necessary information related to the study objectives. It also contains a description of the research methodologies including the core research instrument used which is the questionnaire and highlights its different sections.
3.2 Research Objectives
Islamic Banking has been increasingly gaining popularity since decades in many countries of the World. As such, this research aims to assess the development of Islamic Banking in Mauritius namely, in terms of the cultural, social and economic impacts. In order to fulfill the main aim set forth, the study objectives are to assess the awareness of the Mauritian population on Islamic Banking and the different behavior towards this new way of banking. In addition, this research will try to explore on the willingness of Muslims and Non-Muslims to invest in the Islamic Banks.
3.2.1 Hypothesis of the study
Based on the above research objectives which will be analyzed throughout this study, the hypothesis has been designed as follows:
H0 : There is no relationship between the level of awareness of Islamic Banking and the development of this new way of banking in Mauritius.
H1 : There is a relationship between the level of awareness of Islamic Banking and the development of this new way of banking in Mauritius.
3.3 Research Plan
For the purpose of this study, descriptive research design was adopted. The plan consists of making decision on the sources of data, targeted population, sampling, research instrument, contact methods and data collection.
3.4 Data Collection Method
For the purpose of this study, both primary and secondary data have been collected which helped to bridge the gap between quantitative and qualitative research.
3.4.1 Primary Data
In line with the study objectives, primary data was collected through self-administered questionnaires as it is the main research instrument used for the quantitative research and this approach was most suited for this study.
3.4.2 Secondary Data
To further refine the research, secondary data comprising of Journal Articles, previous surveys, past literature reviews and other publications related to Islamic Banking were surveyed.
3.5 Research Instrument
After going through several researches, studies and journal articles, the main research instrument used in gathering primary data was the questionnaire. In that respect, the questionnaire was used as it has proved its efficiency, reliability, consistency and usefulness in the past. In addition, this technique was relatively straightforward and responses were easily quantified and analyzed. Also, it was easy for the respondents as they had predetermined answers which could reduce biasness in the results. The questionnaire used for this particular study had been adapted from various journals and studies on Islamic Banking and it was duly designed according to the research objectives and the nature of the sampling unit.
3.6 Questionnaire Design
To make an assessment of this study, a questionnaire (refer to Appendix) was designed and consisted mostly of close ended questions and a few open ended questions were also used and each of them had a specific objective. Information based from the literature review was used and modeled according to the objectives of the research so as to enable relevant data collection.
3.6.1 Instruments Used
The types of questions used were multiple choice questions, dichotomous questions, qualifying questions and Likert scale questions. The questionnaire is made up of 30 questions and divided into 3 different sections and each having a specific purpose which is obviously linked to the initial study objectives.
3.6.2 Questionnaire Organization
The questionnaire was organized into 3 different sections:
Section A: General Information of respondent.
Section B: Banking Activities of respondent.
Section C: Overview of Islamic Banking.
3.7 Pilot Testing
One of the most important steps before administering the questionnaires is pilot testing. The objective of this step was to ensure that unclear questions are detected that is the ultimate aim was to ensure consistency and reliability of the questionnaire. Ten questionnaires were distributed to some financial institutions as well as professional knowledgeable individuals at random. As a result, shortcomings or ambiguities were found and consequently, several modifications were made in the initial questionnaire and irrelevant questions were void. A few alterations in terms of the language used were reviewed. The layout of the questionnaire was also changed in order to reduce the bulkiness and make it more interesting for the respondent which resulted in more reliable responses.
3.8 Design Sample and Data Collection Method
This part of the study consists of choosing the population to be involved in the primary data process and the implementation of the survey will be examined.
3.8.1 Targeted Population
A population can be defined as including all people or items with the characteristic one wishes to understand. The targeted population for this particular study was mainly Students, Office employees, Professionals and Self-employed people. However, this particular sampling was chosen because it is representative of the different categories of people of varying age and ethnic groups in the country. In so doing, we will have a better sample with diverse views on the topic according to the person's knowledge and belief on the particular subject of study.
3.8.2 Sampling Plan
Referring to Jansson and Raman (1991), before a sample plan is developed, some fundamental aspects should be considered:
Sample Unit: Who is to be surveyed?
Sampling Pattern: Which sampling technique(s) to be used?
Number of Sampling Unit: How many respondents should be surveyed?
For the purpose of this research, a simple random sampling technique was used together with stratified sampling technique in order to get a better accuracy of results. Simple random technique minimizes bias and simplifies analysis of results, while stratified technique is where the population embraces a number of distinct categories and the main advantage of this technique is that it improves the accuracy and efficiency of estimation.
3.8.3 Survey Implementation
For the data collection, the questionnaires were distributed to the targeted population across different regions of the country in order to ensure a good representation of the sample. The questionnaires were printed and handed over to those people in hand. They were given a brief on the purpose of this study and those who required help to understand the related concepts and words were attended.
It is to be noted that most of the respondents could attempt the questions successfully and they could easily express their opinions on the subject. Even if the distribution of questionnaires and the collection of the data were really time consuming, yet it was worth the effort because it resulted in a good sample which represented different categories of people with varying views and opinions.
3.9 Data Analysis Technique
Survey reliability is important because it assesses the effectiveness of a survey. Therefore, the 103 questionnaires were compiled and then input on the Statistical Package for the Social Science (SPSS) version 20.0 to generate results for the various tests such as mean score, frequencies, Pearson's Chi-Squared test, Pearson's Correlation test, Mann Whitney U Test and Kruskal Wallis H Test. In addition to SPSS, Microsoft Office Tools namely Microsoft Excel and Microsoft Word version 2010 were used for high quality graphical presentations such as tables, bar and pie charts and writing the related reports respectively.
3.10 Limitations of the Study
During the lifespan of the research, the most difficult part was to collect data. As mentioned above, the target population was 125 people and so many questionnaires had to be distributed across different categories of people in different regions of the country so as to ensure a good sampling. In the initial stage of the questionnaire design, some questions had to be altered while others had to be removed so that it is clear to the understanding of the respondents. Even though 22 questionnaires were void, yet the 103 respondents well attempted all the questions listed and they gave their views on the development of Islamic Banking in Mauritius.
