Abdus Samad & M. Kabir Hassan

The study evaluates intertemporal and interbank performance of Islamic bank (Bank Islam Malaysia Berhad (BIMB) inprofitability, liquidity, risk and solvency; and community involvement for the period 1984-1997. Financial ratios areapplied in measuring these performances. T-test and F-test are used in determining their significance. The study found thatBIMB is relatively more liquid and less risky compared to a group of 8 conventional banks. Our analysis of the primary dataidentified reasons why the supply of loans under profit sharing and joint venture profit sharing is not popular in Malaysia.40% to 70% bankers surveyed indicated that lack of knowledgeable bankers in selecting, evaluating and managingprofitable project is a significant cause.I. Introduction

Evaluation of bank performance is important for all parties: depositors, bank managers and regulators. In a com-

petitive financial market bank performance provides signal to depositor-investors whether to invest or withdraw

funds from the bank. Similarly, it flashes direction to bank managers whether to improve its deposit service or loan

service or both to improve its finance. Regulator is also interested to know for its regulation purposes.

Bank Islam Malaysia Bhd (BIMB) is a single full-fledged Islamic bank in Malaysia. The important underlying force

that led to the establishment of this Islamic bank in Malaysia was the elimination of riba that is used for interest.

Tabung Haji took the initiative to do business without using interest considered as being predetermined rate of

return to a deposit. Tabung Haji is an organization for the Muslim for taking care of pilgrims to Mecca. It is

basically act as a privately to facilitate the Muslims to perform their Hajj with the feeling of minimum financial

burden. Its objective is to implement Muslim code of life (shariah) in Hajj and all business transactions. All trans-

actions in the conventional banks are based on interest or “riba” which is prohibited by Islam. Tabung Hajj wanted

to get rid of “riba” (interest). Islamic bank is sought as a solution to it. With the increase in Muslim populations and

awareness of Islamic values, there was a greater demand for Islamic bank and interest-free finance by Muslim

consumers, traders, investors, and businessmen.

Bank Islam Malaysia was established in July 1983 to meet these demands and challenges. Since then BIMB

introduced and marketed various interest free products such as Wadiah ad Dhamana account, Mudarabah,

Musharakah and others. Bank’s business has expanded over the years. Its assets and deposits have increased

from RM 325 mil to RM 4,440 mil in 1997. The financing of loans and services increased to RM 991 mil in 1997.

The number of branches increased to 75 in 1998.

However, 15 years have passed since BIMB was established. There has been no study as to how the bank

performed in liquidity, profitability, risk and solvency, as well as its commitment to economy and Muslim community

during 1984-1997. The previous studies on profitability and other measures, Samad (1998), Ariff (1989), Dirrar

(1996), Mohiuddin (1991) Sum (1995) and Hassan (1999) are far from satisfactory. These studies used neither

statistical technique nor made inter-temporal and inter-bank comparisons with three sets of conventional banks.

However, such issues of profitability, liquidity, risk and solvency; and community involvement of the bank during

1984-1997 are very important to depositors and investors. So, the present study intends to evaluate the perfor-

mance of Islamic banks using the above mentioned criteria. This study is different from the earlier studies with

respect to contents, coverage of years and methodology. In evaluating BIMB’s performances, this study also

wants to test two hypotheses. The first hypothesis states that the liquidity ratios of Islamic banks are expected to

be higher in earlier years of operation than later years due to a learning curve. The second hypothesis states that as

Islamic banking makes its inroad in the society, the volume of two truly islamic financial modes of lending

(Mudharabah and Musharakah) are expected to grow larger in later years of its operation.

Hassan (1999) examines the Islamic banking principles in theory and its application with a case study of Bangladesh.

The abundance of short-term funds compared to long-term funds available for lending is a rational response on

behalf of banks to solve informational asymmetries prevalent in credit market. In traditional finance literature, it is

shown that debt contract (murabaha) is superior to equity contract. However, equity contract can be superior to

debt contract in an economy where informational asymmetries resulting from adverse selection and moral hazard

are smaller. In Islam, business is an Ibadah (worship) and is recommended whereas riba (interest) is prohibited.

From business point of view Islamic bank is not only a firm but also a moral trustee of the depositors where deposits

are trust given to banking firm. It is naturally expected that as a custodian of trust for the depositors’ deposits,

Islamic bank is likely to be more liquid and become more solvent compared to its counterpart conventional banks.

Islamic bank management, according to Islamic ethics, is accountable to the depositors in this world and the world

hereafter for their failure to keep the trust entrusted upon them. It is, therefore, expected that the liquidity and

solvency ratio of the Islamic bank will be higher than conventional banks.

However, it is also expected that the liquidity ratio of the Islamic bank may decline during the later periods com-

pared to its early eras. As the bank grows, it acquires more skill and the art of banking business, it will keep less

liquidity and thus the liquidity ratio may decline. This paper wants to test the hypothesis that the liquidity ratio and

solvency for Islamic banks in the early periods are higher than those of later periods are.

Instead of interest based contract, Islamic bank is founded on different philosophy; and it delivers a set of distin-

guished products in the financial market. Unlike conventional banks where interest is an integral part of bank

business, Islamic bank was established to avoid interest in all bank transactions. It does not deal with interest.

Interest is avoided because “riba” is prohibited in Islam. As a business firm BIMB delivers special financial prod-

ucts that are different from the conventional banks. It delivers interest-free products. For example, trust profit

sharing (called Mudarabah) and joint venture profit sharing (called Musharakah) are two distinguished and unique

products of an Islamic bank. The important feature of this loan (Mudarabah and Musharakh) is that they are

interest-free. There are no elements of interest involved in this transaction. For the Muslims there is a great

demand for them. BIMB was established to meet these demands. With the increase in Muslim population, business

firms and entrepreneurs in Malaysia, the supply of Mudarabah and Musharakah loan was a long waited product. In

these transaction Muslims can serve religious obligation and at the same time can earn profits. With the economic

development of Malaysia and the increase in Muslim population, Islamic values, Muslim business and firms, it is

expected that demand for these products (Mudarabah and Musharakah) are likely to increase gradually over the

years. It is also expected that the information gap between bank and the bank borrowers to be minimum because

both party jointly working to maximize profit and minimize losses. Projects undertaken under the Mudarabah and

Musharaka are constantly supervised and monitored by the Islamic bank. So the chances of failures are minimized.

Based on the expectation of minimum failure it is expected that the supply of these loans will increase over the

years. This paper will test the hypothesis that the supply for this loan (Mudarabah and Musherakah) of the Islamic

bank increases over years.

The paper is organized as follows. Following introduction and rational of this study in section I, Section II describes

methodology, data and the tools for measuring bank performance. Section III provides empirical evidence and

analysis. Summary and Conclusion are provided in Section IV.


Please refer for reference and appendix International Journal of Islamic Financial Services Vol. 1 No.3

Financing the Islamic way

A Michigan bank turns a profit on loan without chargning interest

DETROIT – Big financial institutions have been battered by mortgages gone bad.

But a tiny Michigan bank is getting attention in the industry by turning a profit on loans without even charging interest.

Its specialty: financial products that comply with Islamic law. That means no collecting interest, no short selling and no contracts that are considered exceedingly risky.

also rules out some of the activity that got Western finance in trouble — subprime mortgages, credit default swaps and the like.

“When you look at the economic crisis we’re in, if you were to follow Islamic or Sharia financing, you couldn’t have this crisis,” said John Sickler, corporate director for the bank, University Islamic Financial Corp. in Ann Arbor.

Islamic finance operations aren’t prohibited from making a profit. Far from it. Instead, banks that comply with Islamic law, or Sharia, earn money from fees that are part of the cost of the loan, some paid up front and some over time.

University Islamic Financial has two types of financing, one called a marked-up installment sale and the other a lease-to-purchase sale. Fees in both cases are comparable to interest payments in traditional loans, bank officials say.

For example: A seller who bought a house for $100,000 could sell it for $120,000 or even $300,000, provided the buyer agrees it’s a fair deal. The home could be sold on an installment plan negotiated by buyer and seller.

The bank is a subsidiary of Michigan-based University Bank, and its leaders say they have talked recently with executives from two national banks hoping to learn more about the business.

What is acceptable

Islamic law says money cannot grow by itself, the way it does with compounding interest. Trade is acceptable as long as the equal amounts of money are traded or two different things are swapped with a fairly negotiated price.

So a dime for an apple would be considered “halal,” or religiously acceptable, while one apple for two apples would be “haram,” or unacceptable.

Even at University, not everyone is on board. Some customers have closed their accounts when they learned it was engaging in Islamic finance. Some employees who objected to the move quit. The bank also stopped having a Christmas party and no longer serves alcohol at after-hours events.

The Michigan bank focuses on contracts that clearly spell out the risk and reward between lender and borrower. University Islamic Financial says it’s the nation’s first to offer Sharia-compliant, federally insured deposits.

Growth potential

Islamic banking is more common overseas, but some U.S. banks and credit card companies are exploring the idea of branching out into Sharia products to reach out to the growing Muslim population.

Islamic banking is only expected to increase in coming years. Already, Citigroup offers Sharia products and services to clients overseas, and Visa says it has worked with banks around the world to offer Islamic-compliant products.

The conventional banking system could learn a lot from the idea, said Jawad Ali, a finance lawyer based in Dubai and London who specializes in structuring Sharia-compliant deals.

“We haven’t made as much money as the conventional banks because we can’t, for example, sell what we don’t own,” he said. “We have to own it before we sell it. We may have missed out on gains in good times … but we haven’t suffered any losses.”

No guarantee

Of course, there’s no guarantee that banks will find immunity in Islamic finance from a severe global downturn.

“I am not doing banking on Mars,” said Afaq Khan, the head of Saadiq, the Islamic banking arm of Standard Chartered Bank, based in London. “If real economic activity slows down significantly, the Islamic banking industry will also be affected.”

A Sharia-compliant mortgage is like rent-to-own: There is no note, or mortgage, but typically part of each month’s payment is held toward the ultimate purchase. The property is titled to an individual trust, or limited liability corporation.

Deutsche Bank estimates total assets in the Islamic finance market at $1 trillion — a tiny fraction of global financial assets, but the bank said in a recent report that the sector has been growing at a clip of 15 to 20 percent per year.

source : Press E

Is Islamic finance answer to crisis?

Robert E. Michael


THE HOTTEST TOPIC in the Islamic intellectual world in the West is whether the financial meltdown and Wall Street collapse of the last year would not have happened if we had an Islamic system of finance instead of 20th Century capitalism. The answer is clearly yes, but for two mutually exclusive reasons. On the one hand, it is clear that, properly employed, Quranic restrictions would have prevented the excesses of leverage and gambling on derivatives that led to the current collapse; on the other hand, however, those same restrictions would have prevented our Western economies from reaching anywhere near the levels of size and complexity we enjoy that make it possible for such enormous problems to occur.

As a threshold matter, it is important to remember that Islamic law is at once ancient and modern. From its origins in the Quran and the words and acts of the Prophet Mohammed in the early 7th century, up until around the end of the 1st Millennium, it was unquestionably the most advanced body of law, as well as civilization in general, west of China (other than, perhaps, Byzantium). However, for theological reasons, it then entered a nearly 1,000-year-long period of constricted growth that only really ended for the Shi’a in the 19th Century and for the Sunni much more recently.

During that period, the Dark Ages ended in the West and the Renaissance and the Enlightenment ushered in not only nation-state democracy, but also modern capitalism. The real economic evolution started when Western merchant banking developed in Italy, in the 13th Century. In fact, our word “bank” comes from the benches (bancas) that the Medicis and others set up starting in the 14th Century. As Western financing vehicles advanced from these early compagnias to unincorporated associations, the evolution of the entity theory of partnership law and then incorporated entities, and finally, in the 20th Century, limited-liability structures, in Islam there was very little movement from the traditional forms developed in the 8th and 9th centuries.

Islamic finance is therefore still imbued with the principles of the 7th Century Quran. The most important is (whether or not honored in the breach) the concept of “social justice” or “social responsibility.” This means that relationships in the economic sphere must be based on the same ideals of fairness, honesty and charity that govern a person’s religious obligations as well as his relationships with other people. The most famous post-Enlightenment Western expression of this might be Marx’s “from each according to his ability, to each according to his need.” But unlike Marx and Engels, Mohammed and his disciples had nothing against profit being retained by enterprise owners. What they did forbid was (and therefore is) riba and gharar — interest and excess or unquantifiable risk.

For 1,000 years, Muslim scholars virtually unanimously interpreted that the prohibition on riba means that both charging and paying interest is a forbidden activity (haram). And since unlike the Jewish and Christian Bibles, every word of the Quran is the literal word of God, it is a divine edict, not a statutory or constitutional one. Therefore, finding safe ways around an express prohibition like riba is not a simple matter. Gharar is less precisely defined, and therefore more flexible. But some of the major aspects of modern finance that are covered by gharar’s prohibitions are gambling, promises to make loans or investments in the future based on conditions that are not certain to occur, pledges of currently non-existent collateral and property, casualty and life insurance.

One result of these prohibitions is that Islamic banking has developed very differently from Western models. First of all, they cannot finance in any way enterprises engaged in prohibited activities, such as alcohol, gambling and pork production, or any business predicated on the paying or charging of interest. Nevertheless, as today’s Islamic societies discovered that capital formation is needed to expand their economies, they had to confront the issues successfully navigated by Western capitalism 700 years before: the difference between “usury” and “interest.”

The capitalist solution was based on the realization that there are two aspects of interest: the risk value of money (the risk that the borrower will not repay it in full or at all) and the time value of money (ability to generate profits using the money over the time it is in the hands of the borrower). While the former, arguably, can be associated with social justice in that it involves an important aspect of trusting one’s borrower’s promises, the latter clearly does not.

In 1980, when I drafted the model loan documents for Saudi American Bank, basically all I had to do was change the word “interest” to “commission” throughout the documents. That would not work today. The level and scope of Islamic finance and banking has exploded exponentially. Yet, while there has been tremendous creative efforts made to find ways to use the traditional, 1,000-year-old vehicles (basically different forms of partnership, including mutual insurance pools [takaful]), the basic limitations of riba and gharar remain major obstacles to the development of Islamic finance within the current international finance system. And despite those efforts, including the hermeneutical investigations of ancient Arabic to re-translate those terms, there is nothing approaching a consensus on the horizon to change the traditional rules.

Legislating greed out of profit-seeking would certainly be a major blow to Wall Street. However, it would also be a major blow to entrepreneurship, as well as require a tectonic shift in human nature. And even then, there is still the issue of the failure to take into account the mathematical imperatives of the time value of loaned and invested capital. Without that, you can have equity investments, which derive profit from taking the speculative risk that the investment itself will increase in value, but you cannot have secured or unsecured lending.

So Islamic finance and banking remove one of the essential underpinnings of wide-scale capital formation — risk-averse capital. Their adoption would therefore end not only over-leveraged markets that lead to bursting bubbles but most of the rest of those markets as well.

Robert E. Michael is an international insolvency and finance lawyer who has created and led the Islamic law program at the New York City Bar Association.

source : pro jour

ONE ON ONE: ‘Pent-up demand’ for Islamic finance in Egypt, says expert

Amid the gloom of the global economic crisis, many are hopeful that investors will turn to Islamic finance as the less risky option. Meanwhile, the relatively nascent market needs to play catch up with rising demand.

Ibrahim Warde, adjunct professor of international business at the Fletcher School of law and diplomacy at Tufts University, works on the Islamic Finance Project at Harvard University. He has authored three books — including “The Price of Fear: the Truth behind the Financial War on Terror” — numerous articles for Le Monde diplomatique and lectures at institutions worldwide on the topics of banking and finance.

The TREND Training Center, along with the Egypt Stock Forum, invited Warde to instruct the “Islamic Banking and Finance” training program held recently in Cairo. Warde sat down with Daily News Egypt to discuss the development of and challenges facing Islamic financial institutions.

Daily News Egypt: In 2000, when your book “Islamic Finance in the Global Economy” was published, how was Islamic finance being approached and how has it developed?

Ibrahim Warde: Much of what was being written about Islamic finance back then was either saying it was a perfect system or a deeply flawed system. What I tried to do is look at both sides.

It was more about trying to explain a paradox that was right in the middle of globalization. You have this very old system that reappeared, and so the core of what [the book] looked at was how a system of medieval tradition could rise in the midst of globalization. How in the 1970s, because of the oil boom and the rising role of Saudi Arabia, Islamic finance appeared on the scene and then how it has evolved towards more pragmatism.

I did anticipate that Islamic finance would grow very rapidly and continue to grow in the double digits. I didn’t quite foresee the huge growth that has happened… The September 11th attacks had a number of indirect consequences, including the strengthening of Islamic finance.

The other interesting thing about the development of Islamic finance that was hard to predict was the impact of the current financial crisis. In Islamic finance you have many prohibitions — on short-selling, on selling debt; there’s a dislike for excessive debt — which has led many promoters of Islamic finance to say that under this system normally you couldn’t have the sub-prime crisis. This is because the sub-prime crisis was all based on excessive leveraging, on the selling of debt etc.

So people all over the world have been paying attention to Islamic finance, not necessarily because it would have solutions to all these problems; but because it is institutionalized and has embraced conservative principles.

Certainly, one of the consequences of the last couple of years is a sense that conservatism is something that was ignored and forgotten.

Is it because of the nature of the current crisis or just the development of Islamic finance that has caused demand for conservative finance?

It is a difficult question because on the one hand, Islamic finance was limited in what it offered, mostly because it was just a very young industry when it came into existence in the 1970s. It didn’t exactly have time to go through what conventional finance has gone through.

The fact that the big financial crisis happened has led people in Islamic finance to say we should not simply mimic conventional finance, as the trend seemed to be towards trying to see what conventional finance does and to do the same thing.

Right now I think that Islamic banking, as a form of conservative banking, is regarded as maybe something to be looked at. In the world of finance, everybody assumed that there was a single model of finance and [they] were copying the Wall Street model especially.

The fact that the Wall Street model that was based on open-ended innovation and leverage had more or less collapsed made people look at alternatives. And it so happens that Islamic finance is one of the very few alternatives that are available today.

I think conventional systems have pretty much forgotten about ethics. There was an implicit assumption in conventional finance that the market place will take care of issues of ethics.

The fact that Islamic banks are always asking questions before innovating is really what is interesting about the Islamic finance model. When you think of a product, in conventional finance the only questions you ask are ‘is there a market for that?’ ‘are we going to make money from that?’

Also, Islamic finance has an anti-speculation bent to it, in that you cannot bet on certain outcomes. Whereas in conventional finance, for example, the credit default swaps were a giant system of side-bets and an incentive system that encouraged very risky behavior. Islamic finance has a more negative attitude towards speculation that is quite unique.

What about Islamic financial systems in the Egyptian economy?

Well in the Islamic world it would make sense to take a serious look at Islamic finance. I know that Egypt is in a special position within the Islamic world in that there is a history in terms of some bad experiences, not with Islamic banks but with Islamic money management companies, around the 1980s, and I think it had a traumatic effect on Egyptian society.

So now could be a good time for sober reflection on all those questions and to understand, for example, how to set up the system that learns from past mistakes and, at the same time, does not forget the big issues of ethics and all those rules of conservative finance.

I think that there is a lot of pent-up demand for Islamic finance in Egypt. If you look at the population at large, there is a lot of interest in Islamic finance. As the Central Bank starts loosening restrictions, I think there is potential for a big boom. My understanding is that the potential is there for the Egyptian economy and high demand exists.

Paradoxically, one of the challenges is the very burst of interest in Islamic finance which is always a bit worrisome. With any sudden demand, the risk of a bubble forming and bursting becomes apparent. The main risk of Islamic finance is in fact in its popularity. Probably Egypt, because of the memory of what happened in the 1980s, would be very cautious of something that catches fire.

So that’s the kind of thing that financial regulators are very keen on making sure they can control: the growth, so that it doesn’t get out of hand. I would say this regulatory function is probably the main challenge.

Describe the environment in the US for Islamic finance.

Ironically, in late November, the US Treasury Department organized a day of information on Islamic finance which they called “Islamic Finance 101;” and the goal was to educate the regulators. Of course, there is a great deal of Islamophobia there so on the day this happened, there was a press campaign saying that “the US government supports terrorism.” I think that all things having to do with Islam in the US are likely to elicit this kind of reaction.

The example of the UK is a useful one. The government, since the time when Gordon Brown was Chancellor of the Exchequer, had a policy of encouraging Islamic finance and turning London into a hub for Islamic finance. I don’t think this will happen in the US because there is a big current of Islamophobia that is not as significant in the UK.

My recent book, “The Price of Fear: The Truth Behind the Financial War on Terror,” is mostly about the financial aspects of the war on terror, a critical assessment of, first of all, a lot of the beliefs that drove the financial war on terror that were based on mythology.

There were many ideas about the location and centrality of money, so going back and looking at all the elements of this mythology we discovered that it was mostly rooted in fiction.

The other thing is that there were many political reasons that explain why there was this focus on finance. Finally, there are bureaucratic reasons why things evolved the way they did.

So the bottom line is that the first front of the war on terror was a financial front. On September 24, President Bush announced a war on the financial foundations of terrorists and he said that money is the oxygen of terrorists.

Now, of course, terror has continued worldwide despite all those measures, so obviously the belief that money is the oxygen to terror has to be revised.

I notice a lot of curiosity at Cairo sessions, a lot of discussions and almost not enough time to answer so many questions. So just from the intellectual standpoint, it is an interesting subject and certainly in light of the current financial crisis, there is a great deal of interest.

source : dailynews