ISLAMIC BANKING VERSUS

COMMERCIAL BANKING:
PROSPECTS & OPPORTUNITIES
A PRESENTATION BY:

Dr. Fouad Shaker

Senior Advisor & Partner: First East Invest
Former Secretary General: Union of Arab Banks

OUTLIN
E

Principals and development of Islamic finance

Theory and practice of Islamic financial intermediation
Theoretical & practical differences between Islamic &
conventional banking
Comparison of financial ratios of Islamic and conventional
banks
Future challenges
Areas for improvement and steps forward

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Principals and development of Islamic fina

I. Principals of Islamic financial
system
1) Prohibition of Interest (RIBA)
An excess Any unjustifiable increase of
capital whether are loans or sales in the
central tenant of the system.
Islamic regulations encourage the earning of
profit but forbid the charging of interest.

2) Money as a potential capital

It joins hands with other resources to
undertake a productive activity.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Principals and development of Islamic fina

3) Risk sharing
When interest is prohibited, suppliers of fund
become investors instead of creditors.
Investors & financial intermediary relationship is
based on profit & loss sharing principals.

4) Prohibition of speculative behavior

Discouraging hoarding & prohibits transacting
featuring extreme uncertainties.

5) Sanctity of contracts
Upholding contractual obligations & the disclosure
as a sacred duty to reduce the risk of asymmetric
information & moral hazard.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Principals and development of Islamic fina

6) Sharing-approved activities
Only activities that dont violate the rules of
shariah qualify for investment.
Any business Dealing with alcohol, gambling
or casinos is prohibited.

7) Social justice
In Principle , any transaction leads to injustice
& exploitation is prohibited.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Principals and development of Islamic fina

II. Development & growth of Islamic finance
1) Development of Islamic finance

A rapidly growth part of the financial sector in the

world ( >15% annual growth rate).
Not only Islamic countries, more than 300 financial
institutions in over 50 countries practice some form
of Islamic finance.
The market current turnover is estimated to be $350
Billion compared with $5 Million in 1985.
Islamic finance industry has reached $1.4 Trillion by
the end of 2011, expected to be $4 Trillion over
medium term.
Global conventional banks (HSBC, Citibanketc.)
have setups separate windows to offer Islamic
banking services.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Principals and development of Islamic fina

2) Emergence & evolution of Islamic institutions
in recent history
In Muslim countries:

o 1963, local saving banks was established in Egypt to practice

their work on a none-interest bases to enhance the banking
habit.
o After 1974, many Islamic banks were established in different
Muslim countries due to the sharp increase of the oil prices.
o Sudan, Iran, Pakistan started the Islamization of banking
system during 1980s.

In the western world:

o In 1983 Islamic finance house started in Luxemburg.

o recently, besides establishing Islamic banks, Islamic windows
in leading banks pursuing this market very aggressively.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial inte

I. Basic contracts & instruments
1) Financing instruments
Used to finance obligations arising from the trade
and sale of commodities or property and
collateralized by the product being financed, such
as:
a)Murabahah
A bank purchases a product for a customer who doesnt
have a capital. Both agree on a profit margin added to the
cost, the customer should pay the bank later the whole
amount.

b)Bay Al-Muajjil
A sale transaction with deferred payment allows the sale
of a product on the bases of deferred payment.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial inte

c) Bay Al-Salam
The buyers pays the seller the full price of a product which
the seller promises to deliver at a specific future date.

d) Ijarah
A medium term financial instrument gives something in
return for rent, resembles the leasing contract.

e) Istisnah
To facilitate the manufacture of an asset at the request of
the buyer. Once the manufacturer undertakes to
manufacture the asset for the buyer, the transaction of
Istisnah comes into existence.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial inte

2) Investing instruments
Vehicles for capital instrument in the form of a
partnership.
a)Mudarabah
A fund management instrument , could be short,
medium or long term, whereby an investor entrust
capital to an agent to undertake a project.

b)Musharakah
An equity partnership instrument which could be
either medium or long term partnership, where two
or more persons combine either their capital or their
labor to share the profit & losses.

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial inte

II. Structure & components of

financial statements for
Islamic banks
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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial inte

Theoretical Balance Sheet of an Islamic bank based
on maturity profile

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial inte

Theoretical Balance Sheet of an Islamic bank
based on functionality

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial inte

Composition of an Islamic bank
Balance Sheet

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial inte

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial inte

III. Islamic financial institutions in practice
Early forms of Islamic financial institutions were
concentrated in commercial banking activities, todays
Islamic financial institutions can be divided into the
following broad categories

1) Islamic banks
Could be public or private sector.
A hybrid of conventional commercial banks &
investment banks, it resembles universal banks.

2) Islamic windows
A setup in a conventional bank that offer Shariahcompliant product.

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial inte

3) Islamic investment banks & funds
Aiming to capitalize on large investment
syndications, market-making and under writing
opportunities.
Succeeded in developing innovative large-scale
transactions in infrastructure finance.

4) Islamic mortgage companies

Targeted at the housing market for Muslim
communities in western countries.
Four models:
1.
2.
3.
4.

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Ijarah.
Equity partnership (diminishing Musharaka).
Murabahah. (sales transaction).
Along the lines of corporative societies.

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theory & practice of Islamic financial inte

5) Islamic insurance companies (Takaful)
Takaful means mutual or joint guarantee. The
participants agree to share their losses by
contributing periodic premiums in the form of
investment. They have to redeem the residual value
of profits after fulfilling the claims and premiums,
which is a critical difference between contemporary
insurance and Takaful. Takaful is a given solidarity.

6) Mudaraba companies
Similar to that of closed-end fund managed by
specialized professional management companies.
Unlike the Islamic bank, they are not allowed to
accept deposits. Funded by equity capital.
Two types; Multipurpose (more than one investment
purpose) and Specific purpose.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theoretical & practical differences

between Islamic & conventional
banking
I.
Different concepts of borrowing,
financing & investment
1) Different modes of borrowing
According to the state banks of Pakistan 2008,
conventional banks average for deposits ranged from
2.09% - 2.30% per annum while borrowing rate
average ranged from 11.20% - 11.56%. The
difference is 7.82%. Islamic banks average rate on
PLS deposits ranged from 3.5% to 3.79%. Profit &
loss sharing deposits earn more than 1% higher.

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theoretical & practical differences

between Islamic & conventional
banking
2) Different modes of financing
Conventional banks high rates of interest on all types
of loans. Which may be the cause of the business
failure & the default of the loan. Islamic bank
provides loans on profit & loss (PLS) bases, and only
for production purposes.

3) Different modes of investment

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Conventional banks; 50% in government treasury

bills, bonds, term finance certificates for security,
they suffer badly in case of stock market crash.
Islamic banks; can not invest in government bonds.
Nevertheless, the Sukuk issued by Islamic
government would act as a practical solution for (IB)

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theoretical & practical differences

between Islamic & conventional
banking
II. Different visualization of the role of
money
1) Conventional banks
Uses interest to make money out of money. They use
money as a commodity which is bought & sold.

2) Islamic banks

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Use money as a medium of exchange to facilitate

trade transactions. They supply money to traders to
purchase real assets or industrialists to produce
value-added products. If finance takers generate
profit they will share it with the Islamic bank. If they
suffer losses the bank will share the
loss.
ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theoretical & practical differences

between Islamic & conventional
banking
III. Different attitude of risk sharing &
income distribution
1) Different concepts of risk sharing
Conventional banks; being interest rates based,
their depositors do not share the risk with the bank
in case of economic shock. Also banks receive fixed
rates from borrowers regardless their losses in case
of business failure.
Islamic banks; their deposits and investors are
ready to share risk with the bank in case of financial
shocks. The bank as well, is responsible to take risk
in case of business failure.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Theoretical & practical differences

between Islamic & conventional
banking
2) Different approaches of income distributions
The interest-based financial system is pro-rich and
anti poor, unlike Islamic financial system which play a
vital role in eradication of poverty through Zakat and
profit & loss sharing principle.

3) Having different objectives and goals

Islamic bank works for all benefit of the overall
society and for equitable allocation of resources
through credit distribution. While the conventional
bank works for a specific class that is rich.

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Comparison of financial ratios of

Islamic and conventional banks
Based on the findings of a recent research in Pakistan on two
similar groups of conventional & Islamic banks (Average of 6
banks each group).

1) Earning ratios
Ratios

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Islamic Banks

Conventional
Banks

(ROA) Return on Assets

0.079

-0.75

(ROD) Return on Deposits

0.07

-0.93

(ROE) Return on Equity

1.297

-2.27

(EPS) Earning per Share

0.38

-0.34

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Comparison of financial ratios of

Islamic and conventional banks
3) Debt management ratios
Islamic Banks

Conventional
Banks

Debt / equity

2.3

8.0

Deposit times capital

3.78

5.71

Debt / assets

0.78

0.85

Equity / equity + debt

31.3

17.17

Ratios

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Comparison of financial ratios of

Islamic and conventional banks
2) Asset quality management

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Ratios

Islamic Banks

Conventional
Banks

NPLs / advances
Non-performing loans / advances

1.06

5.88

Provisions / NPLs
Provision / non-performing loans

47.09

40.89

NPL / deposits
Non-performing loans / deposits

1.22

6.24

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Comparison of financial ratios of

Islamic and conventional banks
4) Liquidity ratios
Islamic Banks

Conventional
Banks

Earning assets / total assets

95%

93%

Advances / deposits

83%

70%

Yield on earning assets

2.7%

1.83%

Ratios

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

Comparison of financial ratios of

Islamic and conventional banks
5) Solvency ratios
Islamic Banks

Conventional
Banks

Equity / total assets

Capital adequacy ratio (CAR)

21.78%

14.59%

Equity / deposits

36.2%

20.09%

The earning assets / deposits

143.79

115.98

Ratios

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

6) Cash to deposit ratio

Ratios
Cash & balance / total deposits

Islamic Banks

Conventional
Banks

11.55%

12.55%

7) Investment to deposit ratios

Islamic Banks
Ratios
Investments / deposits

15.39%

23.85%

Investments / total assets

4.37%

9.25%

Islamic Banks

Conventional
Banks

Borrowing / total assets

4.37%

4.25%

Borrowing / total deposits

5.86%

11.92%

Borrowing / total advances

12.93%

16.05%

8) Borrowing ratios
Ratios

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Conventional
Banks

ISLAMIC BANKING VERSES COMMERCIAL BANKING

Future Challenges
1) Liquidity
Liquidity- enhancing financial instruments & the
development of capital market.

2) Limited scope
Can benefit from economies of scale &enhancement
of scope. Both approaches offer diversification
benefits.

3) Concentrated banking
Diversifying their base of depositors, reduce their
exposure, introduction of Internet banking,
geographical diversity on the liabilities side.

4) Concentrated banking

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Risk management framework can be enhanced by

improving the transparency in current financial
disclosure.
Measurement & management of risk
ISLAMIC
BANKING VERSES
COMMERCIAL BANKING
need
to be

Areas of improvement & steps forward

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To enhance Financial Engineering that includes the

design, development & implementation of innovative
financial instruments, new securities or new process of
creative solution to corporate finance problems,
provided to be Shariah complaint.
There is need to establish supporting institutions to act
as a Lender of Last Resort .
There is need to achieve Uniformity in, & Harmonization
of, Shariah Standards across markets & borders.
To develop Fee -Based Services like, Joalah, Wakalah &
Kifalah to exploit the full capabilities of Islamic banks by
diversifying the scope of non bank financial services.
Developing benchmarks based on the rate of return
reflecting Islamic modes of financing instead of using
interest base benchmarks such as the London interbank
offered rate (LIBOR) which has been accepted on an
ISLAMIC BANKING VERSES COMMERCIAL BANKING

Areas of improvement & steps forward

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Standardizing the operations & instruments will pave

the way for pooling assets, much needed for enhancing
liquidity in the market.
By expanding the scope of services, Islamic bank could
spread the fixed costs since they are similar to
universal banking in a form of hybrid between
commercial & investment banking.
Having a Shariah board for every institution is not
efficient. A Shariah board for the system as a whole is
needed to ensure that rules are defined & enforced in
compliance with the contractual obligations to all
stockholders.
Well developed Islamic capital market will benefit
borrowers, institutional investors, together with
enhancing the stability of Islamic banks.
A well developed Islamic microfinance industry will
ISLAMIC BANKING VERSES COMMERCIAL BANKING
promote economic development in underdeveloped

A FEW WORDS ABOUT

FIRST EAST INVEST

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

FIRST EAST INVEST . What we do:

1 - INTERMEDIATE,
We intermediate in trade and investment banking deals and
transactions between the Arab countries and Eastern and Central, East
Europe & CIS businesses
2 - SUPPORT
We support Middle Central, East Europe & CIS businesses trade with the
Arab World. We also support Arab Gulf investors identify & explore
investment opportunities in Central, East Europe & CIS markets as well
as raise capital for financing existing or new business ventures.
3 - PROMOTE
We promote Middle Eastern and Central, East Europe & CIS businesses
market expansions. We promote their business ideas, business
ventures, and existing & new projects. We also promote inward and
outward direct investments & portfolio investment between the Arab
World and Central, East Europe & CIS businesses.
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ISLAMIC BANKING VERSES COMMERCIAL BANKING

FIRST EAST INVEST . What we do:

35

BUSINESS DEVELOPMENT SOLUTIONS

INVESTMENT BANKING SOLUTIONS

Exploring the initiative, assessing products

& capabilities, and preparing the Companys
for the initiative,
Targeting by identifying the market & clients
base,
Planning the initiative, and producing an
Action Plan,
Networking to establish the clients own
contacts in local market,
Visiting the market & testing the initiative,
Cooperating by identifying agents,
representatives, and/or Joint Venture
partners in the local market, and
Selling the Companys products & services

Private placements,
Debt structuring,
Raising funds,
Privatization,
Mergers & acquisitions,
Corporate restructuring,
Spin-offs,
Leveraged buyouts, and
Initial Public Offering (IPOs).

ISLAMIC BANKING VERSES COMMERCIAL BANKING

FIRST EAST INVEST . Our contact:

Cairo, Egypt Head Quarters

First-East Invest Company
Flat # 12, Block 21
District 3, 6th of October, Giza ,Egypt
Tel
: + 20 (2) 3835 7677
Email : info@firsteastinvest.eu
Web : www.firsteastinvest.eu

Vilnius, Lithuania Rep. Office

First-East Invest Company
16 4, Rudninku g.
Vilnius, Lithuania
Tel
: + (370) 646 54 795
Email : info@firsteastinvest.eu
Web : www.firsteastinvest.eu

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ISLAMIC BANKING VERSES COMMERCIAL BANKING

THANK YOU

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ISLAMIC BANKING VERSES COMMERCIAL BANKING