The Islamic financial system works based on group of principles, standards and ethics. The standards and ethics are essential to ensure protection, safety and steadiness such integrity, reliability, solidarity, clearness, clear fact and collaboration. All financial transactions that include interest (Riba), untruthful, gambling, unethical, monopoly, risk or uncertainty, injustice are prohibited in the Islamic financial system which based on Islamic Shari�ah.
The Islamic banks play the same roles as a trustee and liaison of moneys come from different parties with some difference in the way how the Islamic banks is handling their transactions. An Islamic bank is an intermediary and trustee of other people�s money like any conventional bank with the possible difference that the payoff to all its depositors is a share in profit and loss in one form or the other. This difference introduces an element of mutuality in Islamic banking, making its depositors as customers with some ownership rights inherent within it. However, in practice, Islamic banks hardly look different from its conventional counterpart in terms of organizational set-up (Dar and Presley, 2000).
The most important difference between the Islamic banking and the conventional banking is the interest free concept. Although it seem that the Islamic banking is charging interest in their transaction but the fact it is not an interest because of the way they do the transaction which mainly depend on buying and selling of assets which normally generate profit.
More than 30 years since the first Islamic bank start its business; the first one was in Egypt. After 20 years, Pakistan and Islamic Republics of Iran started the non interest based financial institutions. The growth of financial institutions, instruments, and transactions operating without interest has been impressive, from assets totaling a meager $5 billion in 1985 to a current level of approximately $100 billion. Today, Islamic banking is spreading and gaining acceptance in non-Muslim countries as well as Muslim ones. Equally important has been the growth of scholarly interest in the subject (Iqbal and Mirakhor, 2007).
In the past, banks depend mainly on the money comes from depositors and they use these deposits to lend borrowers and there are not other source which they can obtain money from but currently the bank have establish many sources of money such us wholesales money market where they can borrow money from other banks and then use them to lend it to it borrowers with higher profit rate.
This secondary market helps a bank to effectively insure itself against the default risk which the borrower might not be able to pay back the loan. These allowed a bank to effectively insure itself against the risk that a borrower might not pay back a loan. This gives a false impression for bank in term of buying or selling loans as they think it has low risk.
The financial crisis started when banks and financial institutions revealed that hundred of thousand of loans given to customer in the US to bought houses are not able to pay back their loans. As a result, huge number of the bank worthless assets was written down by the banks. According to the Institute of International Finance the assets value is $476 billion.
In the name of the securitization, banks started selling the bad debit to third party which will get the loan repayments and pay a charge for this privilege. Thus loan became tradable just like any assets. The capability to securitize loans gives the banks the way to spread the risks which allow them to sale more of the mortgages. The securitization rate of bad loans increased 32% since 1994 to over 77% of the total bad loan in the US and this lead to an increase in the number of financial institution involved in the sub-prime mortgage market.
As a result many financial institutions become owner of mortgage backed securities which was created of the repacking of the sub-prime loans. This package is created by banks by putting different set of loans as one investment product and sell to third party to get fees in return. The new buyer of this loan obligation will receive regular loan repayments. In most cases the package contains different level of risk attached to it because it is normally created by different type of assets and or bond. In June 2008, the mortgage backed securities was worth $6 trillion, more than US Treasury bonds.
1.2 Purpose
The purpose of this dissertation is to examine if the Islamic Investment Banks in the kingdom of Bahrain are affected by the Global Financial Crisis.
1.3 Research Questions
The research is based on the research question,, �Dose Islamic Investment Banks in the kingdom of Bahrain affected by the 2008 Global Financial Crisis?�
1.4 Limitation
The limitation of this study and its findings should be noted with a view to extending the present study.
1.4.1 Limitation of Researcher
Although it has covers almost most of the Investment Islamic Banks in the Kingdom of Bahrain, The sample size is not very large. There was a lack of explicit collaboration from some of the interviewers.
1.4.2 Limitation of Research
There is a Lack of generalization of research conclusions to Commercial Islamic banks in the Kingdom of Bahrain, since this conclusion is only related to Islamic Investment banks in the Kingdom of Bahrain. Therefore within Islamic Commercial banks of the Kingdom of Bahrain a similar research is required.
Due to the length of the questions and the limited time given by the interviewed, there was a slight difficulty in getting them all answered by the selected decision makers.
Chapter 2: Literature Review
"Islam is deeply concerned with the problem of economic development, but treats this as an important part of a wider problem, that of total human development. The primary function of Islam is to guide human development on correct lines and in the right direction. It deals with all aspects of economic development but always in the framework of total human development and never in a form divorced from this perspective" (Al-Harran, 1993).
The Shari�ah regulations cover numerous aspects in the Islamic finance starting from the sharing of the recourses to the right of the property to the manufacturing and consumption and end up with income allocation. Because of Riba, Islamic banks have had to develop financial products which are not in conflict with the Shari�ah. The task has been achieved by creating a number of special financial products (Ali and Ali, 1994).
We can get knowledge and information on Islamic economic and banking from different sources such as books written by leading academics and practitioners, published research in the form of reports and journal articles, PhD thesis and some other specialized internet web site.
2.1 History of Islamic Banking:
The Golden Age of the Islamic world took place in the 7th-10th centuries in the Middle East countries and between the 11th-14th centuries in North Africa� (Warde, 2000). Although banks did not exist, financial instruments were a part of commercial life; they were �bankers without banks. As per Warde, The available financial instruments in the Islamic world were at least until the 13th century far more advanced than in the between the Fifteenth and the twentieth century�s it was the period of stagnation and turn down and this possibly because of the effected by the dual break not only with its own past but also with the west. �The Renaissance, the Reformation, even the scientific revolution and the Enlightenment passed unnoticed in the Muslim world� (Warde, 2000, p 26).
The development of the development of the Islamic financial model delayed because of the colonization during the sixteenth and seventeenth centuries. Many conventional banks started to operate in Islamic countries at the end of the seventeenth centuries such as banks Turkey, Egypt and Iran. The colonization during the 16th and 17th centuries delayed the development of the Islamic financial models. Instead European banks were established at the end of the 17th century in Turkey, Egypt and Iran (Samuelsson, 2000; Zineldin, 1990).
If we look into the history of the Islamic Banking we will notice that there were different stages for the development of the Islamic banking since inception. First, it was just an idea and no one tried to implement it. Second, private sector in some countries begins to implement the idea of the Islamic banking and in other the idea converted to reality because of the role and regulation.
Early seventies saw the institutional involvement. Conference of the Finance Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian study in 1972, First International Conference on Islamic Economics in Mecca in 1976, International Economic Conference in London in 1977 were the result of such involvement. The involvement of institutions and governments led to the application of theory to practice and resulted in the establishment of the first interest-free banks. The Islamic Development Bank, an inter-governmental bank established in 1975, was born of this process. Group of Muslim Business man started the first private Islamic bank in Dubai it is Dubai Islamic Bank in 1975. In 1977 another two private bank were founded in Egypt and Sudan, Faisal Islamic Bank and in the same year Kuwait finance house was established by the Kuwaiti government (AbdulGafoor, 1995). In 1979 the first Islamic bank was established in Bahrain, Bahrain Islamic Bank.
In this case the Islamic banks has been establish by either the private sector or by roles and regulation forces all conventional banks to changes their operation to an Islamic complaint banks same as what happened in the Iran and Pakistan. In the other hand private sector in Sudan, Kuwait, Dubai, Bahrain and Egypt play the biggest role in establishing the Islamic bank with some support from the government. The governments in Pakistan and Iran start the process in 1981 by transferring all commercial banks in the country into an Islamic bank operation according to the Islamic principles.
In August 1983 the Usury-free Banking Law was introduced and a fourteen-month change over period began in January 1984. The whole system was converted to an interest-free one in March 1985 (Iqbal and Mirakhor, 1987).
New steps were introduced on 1 January 1985 to formally transform the banking system over the next six months to one based on no interest. From 1 July 1985 no banks could accept any interest bearing deposits, and all existing deposits became subject to PLS rules. Yet some operations were still allowed to continue on the old basis. In Iran, certain administrative steps were taken in February 1981 to eliminate interest from banking operations. Interest on all assets was replaced by a 4 percent maximum service charge and by a 4 to 8 percent �profit� rate depending on the type of economic activity. Interest on deposits was also converted into a �guaranteed minimum profit� (AbdulGafoor, 1995).
Currently, the Islamic banking is available in more than 50 countries worldwide. In some countries they permit only Islamic Banks to work by their role and regulations such as Sudan, Iran and Pakistan and no conventional banks are permitted to work in those countries. In other countries such as Islamic banks are permitted to work with the availability of the conventional banks so both types will be available in those countries such as Kuwait, UAE, Bahrain, Qatar, Egypt, Jordon, Bangladesh and Malaysia.
In 2004, the first Islamic bank in non Islamic country was established in the United Kingdom (Islamic Bank of Britain) and then Devon Bank in Chicago started to offer Islamic banking services in the United States.
2.2 Principles of Islamic Banking
Islamic Bank are guided by the Shari�ah, the precepts of which are founded upon the Qur�an, the Sunnah (the practices and sayings of Prophet Muhammad), and fiqh (jurisprudence, the opinion of Muslim legal scholars). There are a lot of books, journals and articles which have made major contributions to the Islamic banking theoretical debate such as the book by Qureshi on Islam and the Theory of Interest (Qureshi l946) argue that banking is a pure social service that to be managed and offered only by the governments. The conclusion was reached since the bank could neither pay any interest to account holders nor charge any interest on loans. He also discussed the partnerships between banks and businessmen as a possible alternative, sharing losses if any, without mentioning the profit-sharing.
Another example of the books which contribute in the development of the Islamic banking module is the Economics of Islam (Ahmad l952); Ahmed in his book believed that the founding of Islamic banks should be based on the concept of Joint Stock Company so people can customer can deposit their money based on partnership between them and the bank and the profit or loss occur will be shared between both parties. In addition to that, they can deposit their money in a normal current account so no interested should be paid.
Both Ahmed and Qurashi agreed on the possibilities of entering into a financing agreement based on partnership between businessman and banks in case the businessman need capital to for his business. However, this kind of agreement remains undefined, no clear idea about who will bear the loss.
Based on Shariah, the Islamic Banks should follow the below four major principles in term of banking and financing transactions and financing:
� No Riba - No interest must be charged in any transaction.
� No Haram - Bank should not deal in any product and services which is prohibited and considered as illegal in the Islamic Shariah.
� No Gharar � Banks should avoid any truncation that may involve speculation.
� Zakat - Banks should pay compulsory Zakat based on the Islamic role and regulations.
Let see how the above four principles govern the Islamic bank and make them different from the conventional banks:
Prohibition of Riba
The prohibition of Riba mainly comes from Quran, Quran talk about Riba in twelve different places. Below are examples of where Quran talk and describe the roles of riba in Islam:
Al-Baqarah (2:275) �� And Allah has justifies the trades and forbids the Riba�.�
Al-Baqarah (2:276)� Allah destroys usury and cultivating charity. And Allah does not love everyone who remains in unbelief, and always doing sin. �
Al-Baqarah (2:278) � �� and leave the rest of Riba (who have not collected)��
Al-�Imran (3:130) � �� do not eat Riba with the multiply� �
An-Nisaa (4:161) � �and because they eat riba, but in fact they have been banned from it, and because they eat the wealth of people with a wrong path�.�
Ar-Ruum (30:39) � �� and riba (additional) that you gave to her property only grew for human�s wealth, then the riba does not give additional value for Allah.
Qur�an 2:185 explicitly prohibits riba� and permits trade, but does not state clearly whether it is to be understood as interest or as usury.
The detail explanation on the previous section about Riba and Shari�ah compliance Sales, then we can compare between them, which will be described in the table 1.
We can explain the table 1. The first is the platform side, which the transaction could comply with the Shariah if the platform of the transaction is coming from Shariah Law, which Al-Quran, As-Sunnah, and also Ijma threated as the sources.
The ambiguity of understanding either it is interest or usury has led to disagreement among Muslim scholars in the past. However, there is a general agreement that riba� includes all forms of interest, that is, any amount charged over and above the principal.
By prohibiting interest, Islam wants to set up a just and fair society (Qur�an 2:239). According to Shariah, it is unfair that the lender pay predetermined amount of fixed income irrespective of the return of the borrower�s venture.
Table 1: Compression between Interest and Profit Margin from Trade
Interest (Riba) Profit Margin from Trade
Platform: Positive Law Platform: Shari�ah Law
Source: Capitalism Ideology Source: Al-Quran, Sunnah & Ijtihad Ulama
Money as a commodity. Bank lend the money Goods as an object. Bank use goods as a commodity
Relationships: Debtor-Creditor Relationship: Partnership
Interest may be changed unilaterally The agreed price cannot be changed
Not associated with the real sector (Monetary Real Sector is separately) Monetary and Real Sector related strong, so encourage the acceleration of the flow of goods, production and employment.
If non performing loan was getting higher, then the interest will be a compound interest Margins and selling prices unchanged
No trade transaction Fulfill buying and selling principles
Determining the interest is not considering the profit and loss Determination of the profit sharing ratio in aqad, based on the profit and loss
The percentage of interest previously determined, based on the lending amount The profit sharing is accordance with the agreed ratio
Interest payment amount is not increased
align with the increment of profits The number of profit-sharing increases align with the increment of the income
If loss happened, it is only covered by the Borrowers, based on fixed interest payment as promised in the agreement If loss happened, both parties will covered the loss
The interest paid by the borrower must be received by the bank The success of the business is going to be both parties� concern
Source: Agustianto. Riba Empiris. Indonesia. 2006
As a result, The Islamic Financial System prohibited interest in all transaction and this is including receiving of interest which is the main principle in the conventional banking module. Moreover, the Islamic financial system also prohibited any other financial product and services which include interest and illegal product.
An Islamic financial system or institution is much more than that, for it �is supported by other principles of Islamic doctrine advocating risk sharing, individuals� rights and duties, and the sanctity of contracts.� (Z. Iqbal and A. Mirakhor). The Islamic Financial System is wider than only banking transactions, it includes investment product, capital arrangement, and all types of financial services.
With the availability of Shari�ah rules, businesses transactions are not allowed if the transaction contains the prohibited content, such as riba, while trade is allowed in Islam as mentioned in Al-Quran verse Al-Baqarah (2:275). In business activities, transaction between two parties could have the relationship types. In interest based transaction, the relationship between both parties is called as debtor-creditor. While the debtor is the party who borrow the money for rich people who lend the money, and expect get the return as an interest, which is not comply with Shari�ah rules. However, the relationship between both parties in transaction which comply with Shari�ah is called partnership.
There are several types of partnership such as Shirkah Mudaraba, Shirkah Wujuh, Shirkah Mufawadhah, and Shirkah �Inan as the sample aqad which comply with Shariah rules. The main difference in the transaction done by Islamic bank and conventional bank is the Islamic bank use good and services as a commodity to trade with customer to generate profit not same as the conventional banks which using the money as a commodity and they will use the interest rate to determine the profit margin so there is no real commodity other than the money is traded between the bank and the people but in the Islamic bank transaction there is product and services included in the transaction and the money is used only as tool of exchange and this kind of transactions have big impact on the economy because it encourage the flow of goods, services, manufacturing and employment so in the Islamic banking every transaction should involve buying and selling of a commodity (Trade) and this trade should not be cash to cash.
Another difference, In Shari�ah transactions, the profit margin remain constant and can�t be changed and will remain same as what parties agreed in the contract (aqad). Where�s in the conventional banks transactions, the bank can charge the customer higher interest rate in case the customer is unable to pay any of the agreed installment on time.
In Islamic banking transaction, the profit margin / sharing is calculated based in the profit or loss which will occur because of the agreed transaction. This is not the case in the conventional banking transaction, the profit or interest will be representing the actual profit or loss and the lender will not be concern about the ability of the borrower. In the Islamic bank transaction both party will cover the losses if it�s happened not like the conventional bank transaction which the lender will receive fixed profit even of the loss has been occurred in the transaction and in this case the borrower will cover the loss individually.
When a bank provides business loans, the bank did not provide financial advice to the borrower to increase profits. What happens is where the borrower must pay the loan on time, regardless of ability to make payments to the borrower.
The main thing from the application of the riba from the economic side is the exploitation of social and economic. This has violated the core of Islamic teachings in terms of social justice.
Gharar
Islam prohibits all games of chance and gambling: They will ask about intoxicants and games of chance. Say: �In both there are great evil as well as some benefit for man, but the evil which they cause is greater than the benefit which they bring.� (Qur�an 2:219) In Qur�an 5:90, games of chance and gambling are prohibited because they cause enmity and hatred and also involve consuming property (bay` albatil), which is a kind of oppression.
The question is whether gharar, which involves uncertainty or speculation, is halal (permitted) in business. According to Ibn Taymiyyah, if the sale contains gharar and devours the property of others, it is equivalent to gambling and, as such, haram (forbidden). Pointing to the phrase devours the property of others pines that speculative risk-taking in commerce, which involves the investment of assets, skill, and labor, is not similar to gambling. In business, participants engage in transactions designed to maximize profit through trading, not through any dishonest appropriation of other people�s property. Similarly, according to El-Ashkar, speculation in business is not the result of turning over a card or throwing the dice, but rather is � the practice of (a) using available information to (b) anticipate future price movements of securities so that (c) [the] action of buying and selling securities may be taken with a view to (d) buying and selling securities in order to (e) realize capital gains and/or maximize the capitalized value of security-holdings (A. F. El-Ashkar ,1995). Islam allows risk-taking in business transactions, but prohibits gambling.
On the other hand, Islam prohibits the dealing in some product like tobacco, Alcohol, pork, gambling, illegal drugs and pornography and other harmful products. All Islamic bank should follow this role and should not enter into any agreement include the above mentioned items.
Zakat
Is the Islamic version of tax, people who owned certain amount of wealth (nisab) must pay certain amount of their wealth to poor people, this not only apply for individual but it is also applied for institution so every Islamic bank must create a Zakat fund and pay this Zakat if the profit achieved reaches to the level of nisab. In this case, the Islamic banks also have to pay any business related taxes indicated in the country rule and regulations so the Islamic banks have to pay two kinds of taxes, the Zakat and the normal income tax.
2.3 Products of Islamic Banks and Their key Elements
We can classify the Islamic financial products into two main categories: equity-type contracts and mark-up price (debt) - type contracts. All Islamic financial products come as a result of the prohibition of interest so we will notice that any contract signed by Islamic bank should not contain interest.
2.3.1 Equity-type contracts
Under the equity type contracts there are only two types of contracts: Mudarabah (trust financing) and Musharakah (partnership), based on the profit-and-loss sharing (PLS) principle, (B. Hamwi and A. Aylward, 1999).
Mudarabah
The two parties � the supplier of capital (rabb al-mal) and the entrepreneur (trustee of the venture) � share the profits according to an agreed-upon PLS ratio. It may be 70:30 or 80:20, depending upon the agreement. In Mudarabah contract, there is no fixed annual payment and lender will not guarantee any return (Samad, Gardner, and Cook). Another element in Mudarabah contract is about the losses which may occur from the business venture. Shari�ah role says the capital owner should bear the monetary losses where the mudarib will not take any responsibilities in covering the monetary losses. Last element in Mudarabah contract is that the capital owner or the financier has no right to control how the mudarib manage the business venture so the mudarib have full right to manage it.
Al-Arabi (l966) envisaged a banking system with Mudarabah as the main pivot.
He was taking about using Mudarabah contract as a saving account by the idea of the two-tier Mudarabah so the banks will act as mudarib in case of getting deposits from customer and in another time the bank will be the depositor when it comes into the deposits of the bank�s shareholders.
Irshad (l964) mentioned Mudarabah as a main principle in the Islamic banking. Although his idea about Mudarabah differs from other writer but he still indicates the Mudarabah as a saving account. The main difference between Irshad and the others is that he introduced the idea of sharing the profit comes from the Mudarabah contract between the bank and the depositor and they will share the profit or loss equally in fifty-fifty bases. His idea was against Shari�ah role regarding Mudarabah as Shari�ah says there is no profit or loss sharing in the Mudarabah contract.
Musharakah
Is a partnership agreement between two or more parties; all parties will participate in the capital. Musharakah have main three principles. First principle is about the capital contribution and profit sharing and what is the pre-agreed percentage of each party. In case of profit, every party will get his part based on the agreed percentage in the contract and not necessary its equal the percentage of their capital participation but in case of loss, parties will share the losses based on their capital contribution. The second principle, in Musharakah agreement all parties have the right to manage the investment. Last principle is that liability is unlimited joint venture individual customer.
Siddiqi (1968) come with a pioneered idea and establish a details outline for the interest free bank in the way to have a well established Islamic banking. He used Musharakah and Mudarabah contracts to build his suggested model for the Islamic banking system. He classified the operations of the Islamic banking system into three categories; services against fees, commissions, financing on the bases of Mudarabah. His model was a possible substitute for the conventional banking.
2.3.2 Mark-up price (debt)-type contracts.
The mark-up-price contract is mainly a financing contract which the bank will finance borrower to purchase certain asset for an agreed profit margin. There are five type of mark-up price contracts; Murabaha, Baimuajjal (Deferred Payment Sales), Ijarah (Lease financing), Ijara (Operating Lease) and Qard Al-Hassan. Below are some details on each type.
Murabahah (bay` bi al-thaman al-ajil)
Is the bank will buy an asset on behalf of a customer and then will resell it to him at a pre-agreed price and profit margin so the bank will charge the customer cost of the asset plus the agreed profit and the payment of this amount to the bank will be in the future either in installments or total amount in single payment.
The main distinguishing of Murabaha comparing to the conventional interest based financing product is in Murabaha the ownership of the asset purchased will remains with the banks till the customer fulfill all his obligation by paying the agreed amounts. From an economic point of view, Murabaha financing and interest-based trade financing appear quite similar, except in their contractual features. The profit margin calculated on top of the cost seems to be very similar to the interest charged by the conventional banks on top of financed amount but Islamic banks will take a real risk by purchasing the assets and keep it under its ownership till transfer the ownership to the customer. The Islamic bank will act as an intermediary between the seller and the buyer and will be responsible if anything went wrong.
Baimuajjal (Deferred Payment Sales)
The payments for this sale could be either in installments or a one-off deferred payment as per agreement between the parties at the time of the sale, and cannot include any charges for deferment. This is like as a Murabaha mode of investment with an exception that the sale under this cost-plus sale mode of investment is made on a credit basis rather than cash. It is deemed acceptable to charge higher prices for deferred payments. Such transactions are regarded as trades and not loans.
Qard Al-Hassan
This kind of loan is not available in the conventional banks; it�s a zero profit loan and banks will not get any financial return when providing this kind of loan to customers. Islamic bank normally use to give this loan to poor and needy people and the receiver of this loan have only to repay the principle with no extra profit.
Ijarah (Lease financing)
In Ijarah, the Islamic bank will buy the assets required by the customer and will keep the ownership under the name of the bank. The bank will sign an Ijarah agreement with the customer to allow him to use the asset and the customer will pay a monthly rent, the rent here is replacing the normal loan installment. The ownership of the assets will be transferred to the customer either by the end of the period and after he pay all the agreed amount or it will be partially transferred over the period of the contract.
Ijarah (Operating Lease)
Ijarah is the leasing of building, equipment, machinery, aircraft, plants and others capital assets. Same as the finance lease, the bank will buy the asset and lease it to end user under a lease agreement which the customer has to pay an agreed rent. The customer will use these assets for his operation and generating profit. The ownership of the assets will remain with the bank even after the period of the contract.
2.4 Financial Crisis 2008
Th? glob?l f?n?nc??l cr?s?s ?s on? of th? b?gg?st ?ssu?s th?t conc?rn hum?n?ty s?nc? l?st f?w y??rs. Th?s d?s?st?r h?s touch?d v?rtu?lly ?v?ry country. R?duc?d prof?ts, loss of jobs, r?s?ng pr?c?s, d?l?y?d w?g?s, st?p?nds, p?ns?ons ?nd un?mploym?nt. P?opl? ?r? just ?n ? p?n?c
The 2008 financial crisis in fact taking place to show its effects in the second half of 2007 and keen on 2008. Around the world stock market have fallen, large financial instituation have collapsed, downsized or been bought out and government in even the great nation have to come up with rescue plans to secure their financial system.
F?n?nc??l cr?s?s ?nd th? cons?qu?nc?s on to glob?l ?conomy Th? f?rst r??son for th? f?n?nc??l cr?s?s ?s th? drop of th? US r??l ?st?t? m?rk?t, wh?ch h?s r??ch?d ?t�s down po?nt ?round 2005-2006. Th? ?p?d?m?c of c?nc?l?ng mortg?g?s w?tch h?s st?rt?d ?n USA ?t th? ?nd of 2006 cont?nu?d to dr??n w??lth from th? consum?rs ?nd d?cr??s?ng f?n?nc??l pow?r of b?nk?ng ?nst?tut?ons3. Incr??s? ?n lost l??b?l?ty to p?y for d?bts ?nd los?ng opportun?ty for oth?r typ?s of lo?ns spr??d from r??l ?st?t? m?rk?t to oth?r ?conom?c s?ctors. Tot?l los?s ?r? ?st?m?t?d ?n tr?ll?on of US doll?rs glob?lly.
1.4.1. What caused the Economic Crisis of 2008?
Greed is the suitable word to describe what happened in the financial crisis in 2008. Th? r?s??rch on th? r?c?nt f?n?nc??l cr?s?s ?s ?mpl?, ?nd researcher h?v? ?d?nt?f??d ? many ?ssu?s th?t l?d to th? cr?s?s. Som? of th? ?ssu?s ?nclud? th? sub- pr?m? cr?s?s th?t w?s ?n?t??t?d ?n th? Un?t?d St?t?s of Am?r?c? ?nd th?n spr??d to th? Un?t?d K?ngdom ?nd Europ?.
Over the year before 2008, the lender was happy and aggressively lending money to people who in many cases they can�t pay their installments. They grant loans to those people against high interest rate. As this loans are backed with a mortgage so when the borrower default his payment the kinder will simply put the house back to the market and in other case they pass the risk off to mortgage insurer or put all defaulted mortgage together and sell them as mortgage backed securities.
1.4.2. Time Line of the Economic crisis
The below time line of the financial crisis was published by the telegraph.co.uk and it list down the major event happen before, during and after the financial crisis. Will use this time line just to see what is the main cause of the financial crisis and is this causes can affect the Islamic investment bank sector in Bahrain.
2007
� Late July/early August 2007: The UK stock market goes through a period of volatility. Banks begin to stop lending to each other due to market fears over exposure to potential losses on high-risk US mortgages. The credit crunch begins in earnest.
� September 13, 2007: News breaks that Northern Rock has sought emergency funding from the Bank of England in its capacity as "lender of last resort". It prompts the first run on a bank for more than a century.
2008
� February 17, 2008: The government announces that struggling Northern Rock is to be nationalized for a temporary period.
� July 14, 2008: Financial authorities step in to assist America's two largest lenders, Fannie Mae and Freddie Mac, owners or guarantors of 5 trillion worth of home loans.
� September 15, 2008: Wall Street bank Lehman Brothers files for Chapter 11 bankruptcy protection and another US bank, Merrill Lynch, is taken over by the Bank of America.
� September 17, 2008: Lloyds TSB announces a �12 billion deal to take over Britain's biggest mortgage lender HBOS after a run on HBOS shares.
� September 28, 2008: European banking and insurance giant Fortis is partly nationalized to ensure its survival.
� September 29, 2008: The government takes control of Bradford & Bingley's �50 billion of mortgages and loans. Savings operations and branches are sold to Spain's Santander.
� The Icelandic government also takes control of the country's third-largest bank, Glitnir, after the company faces short-term funding problems.
� September 30, 2008: The Irish government guarantees deposits in the country's main banks for two years.
� October 6, 2008: Trading is suspended in Icelandic banks including Kaupthing, Landsbanki, Glitnir, Straumur-Burdaras, Exista and Spron.
� October 7, 2008: The Icelandic government takes control of Landsbanki, the country's second largest bank.
� October 8, 2008: The Bank of England cuts interest rate by 0.5% to 4.5% in a surprise decision as part of a co-ordinate global attempt to ease the financial crisis. The Government unveils an unprecedented �50 billion plan to part-nationalize major UK banks and pump billions more into helping ailing money markets.
� The Bank of England also extends the existing �50 billion Special Liquidity Scheme to �200 billion, while a further �250 billion is being pumped in under a debt guarantee scheme.
� October 10, 2008: Treasury officials travel to Iceland for urgent talks after the collapse of the country's banking sector leaves councils and charities in Britain facing losses of up to �1 billion.
� October 13, 2008: The government announces a �37 billion rescue package for Royal Bank of Scotland (RBS), Lloyds TSB and HBOS.
� October 19, 2008: Chancellor Alistair Darling announces plan to pour billions of pounds into major public works in an attempt to help spend the UK out of the worst of the economic downturn.
� November 20, 2008: The International Monetary Fund (IMF) approves a 2.1 billion dollars (�1.4bn) loan for Iceland, after the country's banking system collapsed in October. It is the first IMF loan for a western European nation since 1976.
� November 29, 2008: The Government takes a 58pc in RBS for �15bn, with a further �5bn of preference shares. Sir Fred Goodwin steps down as RBS chief executive, and is replaced by Stephen Hester.
2009
� January 15, 2009: The Irish government says it is to nationalize the Anglo Irish Bank.
� January 16, 2009: The US government provides the Bank of America with another 20 billion dollars from its 700bn dollar financial rescue fund to help it with the losses incurred when it bought Merrill Lynch.
� February 11, 2009: Ireland says it will inject �7bn into Bank of Ireland and Allied Irish in return for guarantees on lending, executive pay and mortgage arrears. It gets a 25pc indirect stake in both banks.
� February 26, 2009: RBS reports a loss of �24.1bn for 2008, the biggest in British corporate history. The government asks Sir Fred to give up an annual pension worth about �700,000.
� April 16, 2010: The Securities and Exchange Commission accuses Goldman of defrauding investors of more than $1bn by willfully mis-markting toxic sub-prime mortgage-related securities.
� May 2 2010: Greece gets a �110bn (�93bn) bail-out from other countries using the euro, and the International Monetary Fund.
� November 21, 2010: Irish Finance Minister Brian Lenihan says he will recommend to the Government that the country formally request a bailout package from the EU, ECB and IMF.
� June 22, 2011: Greek PM George Papandreou tries to persuade MPs to approve 28bn Euros (�25bn) of cuts, tax rises, fiscal reforms and privatization plans. Euro zone ministers say the legislation must be passed to receive a 12bn-euro loan Greece needs to pay its debts.
Chapter 3: Research Methods and Methodology
This chapter discusses the methodology used in this study. It will also discuss how the research is approached as well as the sources of secondary data.
In order to measure the effects of 2008 financial crisis on the Islamic investment bank in the kingdom of Bahrain we will do an extensive analysis on the official figures published by the Islamic investment bank operation in Bahrain and the financial sector regulatory such us the central Bank of Bahrain. The analysis will contain data represent the financial year from 2007 to 2010.
3.1 Introduction
�Research is an activity that we all undertake to learn more about our environment and the impact we have upon it �(Ryan, Scapens & Theobold, 2002). It is about the discovery, interpretation, understanding and communication of new knowledge. Research is the process of getting the fact about an idea, problem, event, phenomena or change in the environment. The research will give clear explanation supported by a valid data and information.
The primary purpose for applied research (as opposed to basic research) is discovering, interpreting, and the development of methods and systems for the advancement of human knowledge on a wide variety of scientific matters of our world and the universe (Wikiquote.com).
This chapter discusses the method and methodology used in the present study. The largest part of this research will be depends on the official data and information published by the regulatory bodies (Central Bank of Bahrain), financial report published by the selected Islamic investment banks operating in the kingdom of Bahrain and they will be analyzed by this research and other several sources. Secondary data will be collected works and analysis of other researcher which will help in reaching to a valid and accurate finding. The researcher has approached the research in two phases:
3.1.1 Phase one:
Primary data and Secondary data will be collected from extensive data, that will only been collected through numerous different academic journals and books, publications and discussion papers from the economic sector bodies in the Kingdom of Bahrain, central bank of Bahrain, general counsel for Islamic banks and financial institutions and their related research comities, other Islamic banks. For our study purpose we will us the annual report of the banks and their financial statement to analyze their performance before and after 2008 financial crisis.
3.1.2 Phase two:
Collecting and analyzing the data which is used in indentifying and summarizing the key findings.
3.2 Research Methodology
3.2.1 Classifying Empirical Research
Empirical research is characterised by the fact that knowledge or theory that is derived from it is arrived at as a result of observations or experiments. While doing research, the researcher target is to reach to some finding and conclusion about something. This can be achieved many ways; one technique, commonly used in HCI, is empirical research. (Robson, 2002) writes that empirical research �involves a systematic investigation of an experience which should be both sceptical and ethical�. In our case we are trying to find if there are any relationship between the financial crisis happened in 2008 and the Islamic investment bank in the kingdom of Bahrain. (Cresswell, 2005) classify the split processes that comprise empirical research to be:
� Identification of a research problem
� Review of the existing literature
� Specification of a purpose
� Collection of Data
� Analysis and Interpretation of data
� Reporting on and evaluating data
Commonly a research problem is formulated in a very general way and then the researcher identifies different purposes that dictate how the subsequent data gathering will take place and how it will be analysed (Sumonhrm, 2011). In some instances, the researcher has a theory that he wishes to test out; in other cases the researcher has observed a phenomenon that he wishes to develop a theory about. These two approaches are sometimes referred to as normative and non-normative or deductive and inductive. It is common to match these approaches to two research styles, these being quantitative research and qualitative research (Cohen and Manion, 1994)
3.2.2 Research Method
The tools that are used in research have generally been developed to fit into one of the two styles of research outlined in the coming section. The following figure (adapted from (Cresswell, 2005) (Figure 1) shows the relationships between research styles and methods.
3.2.3 Quantitative Research
Quantitative research refers to the systematic empirical investigation of social phenomena via statistical mathematical or computational techniques (Given, 2008). Quantitative research is extensively used in social sciences such as: economics and information technology, sociology, psychology and political science.
3.2.4 Qualitative Research
Qualitative research is a method of inquiry employed in many different academic disciplines, traditionally in the social sciences, but also in market research and further contexts (Denzin & Lincoln, 2005). Qualitative researchers intend to draw a comprehensively understanding of behaviour related to human and the aspects that direct human behaviour in different situation. The qualitative research examines the why and how of decision making, not just what, where, when.
Figure 2 show the difference uses of the qualitative and quantitative research:
In our research we will mainly use the quantitative method to answer the research question. We can approve what was the relationship between the financial crisis in 2008 and the financial result achieved by the Islamic investment bank in the kingdom of Bahrain and this will lead us to test the damage occur in this sector because of the financial crisis.
3.3 Data Collection
As we mentioned in previous section, the researcher sources of data is the official report published by the regularity body in the kingdom of Bahrain (the Central Bank of Bahrain and the financial reported published by the Islamic investment banks in the kingdom of Bahrain. During the crisis, official try to avoid give and information about what is the effect of the financial crisis on their banks. Each bank try to prove that they are isolated from the crisis and their policy and procedure prevent them from enclose any extra information then the one available in their annual reports and financial statements. As a result the researcher will use both the figure issued by the central bank of Bahrain to analyze the performance of the Islamic investment bank sector before, during and after the crisis to understand the impact of the crisis on this sector then will use the financial statement and annual report of each bank to evaluate the performance of those bank individually.
3.4 Data Analysis
Following the data collection, the data was prepared, organized and analyzed. Data was analyzed by using descriptive statistic. Comparison table was drawn and from these data was presented bar graphs.
Awhile amazing the collected data, the researcher try to build a link between the data published by the central Bank of Bahrain which was measuring the Islamic investment bank sector and between the data published by the Islamic investment banks operates in the kingdom of Bahrain to measure the cause and effects of the financial crisis and wither the damage happened to the sector in general or just some specific banks.
Chapter 5: Discussion & Conclusion
The Islamic principles have helped shield Islamic Investment banks from the direct impact of the crisis. The Islamic investment banks which conduct their business with a lot of ethics and use the implement the risk sharing principle with the insistence of the liquidity to be available on hand before doing any transaction with strong restriction of selling debt and dealing in prohibited assets success in avoiding the first round effect of the financial crisis in 2008.
The impact of the financial crisis on The Islamic Investment Banks in the Kingdom of Bahrain was very minimum in 2008 because of factors related to the Islamic Investment Banks business model which helped contain the adverse impact on profitability in 2008 and this may approve that the Islamic Investment bank was shield by the Shari�ah principles although the profitability has been effected in 2009 due to weaknesses in risk management practices in some Islamic Investment Bank and lack of diversification.
Most of the Islamic investment bank in Bahrain record profit in 2008 which means they did not loss directly from investment in any of the product causes the crisis. As the Shari�ah principle prevent Islamic Investment Banks in the Kingdom of Bahrain from financing or investing in the instruments that was the mean reason for the global financial crisis and the banking sector was affected because of the this kind of instruments.
One reason for the weak performance in of the Islamic investment bank in the Kingdom of Bahrain is associated with concentration and lack of diversification because of the nature of the Islamic Investment Banks business model which require securitize the transaction with an assets, the lack of diversification mostly come because the Islamic investment bank in Bahrain securities their transaction with real estate and some of them they offer value those assets due to the booming in the real estate market. This may not happen in case of the availability of strict risk management and in other case clear regulation and supervision by the regulator in the Kingdom of Bahrain.
Finding of our research approve that the Islamic Investment Banks in the Kingdom of Bahrain did not adhere completely with the Islamic principles, one reason is the lack of the people works in those banks most of them have the conventional Banking and they have very limited skills and knowledge to innovate new product comply with the Islamic principle so those banks end with almost similar product with no diversification. As a result they were not immune by Islamic principle shield to the global financial crisis.
Some of the Islamic Investment Bank use a lot of leverage and have taken high risks. The risk management in those banks did not play their required roles; they allow their banks to have huge funding transaction with western corporations some of them have low credit rating and risky profiles without going throw the necessary due diligence to identifies they risks associated with those banks. Some bank was entre to these transaction motivated by the booming of the real estate which lead them to over evaluate the assets which has been securitize the transaction as per the requirements of the Islamic banking principles and some other banks had access liquidity The Islamic investment bank in Bahrain and they was eager to place those funds quickly and to maximize profits.
As a result, a lot of funds which was securitize by a real estate become junk which enforce some of the banks to sell those assets with lower value and in some case the assets was written off.
Analyzing the financial statement of the Islamic Investment Bank in the Kingdom of Bahrain approve that the Islamic Investment Bank in Bahrain have avoided the first impact of the financial crisis in 2008 but not the second round effect of the global crisis so the performance of those banks in 2008 continue to record good result. The second round effect start in 2009 when those banks start to record losses because of the falls in the real estate market and as those back use the real estate to backed their funds.
