ISLAMIC BANKING V/S CONVENTIONAL BANKING A COMPARATIVE ANALYSIS

SUMMER INTERNSHIP PROGRAM- 2012

ISLAMIC BANKING DEPARTMENT

STATE BANK OF PAKISTAN

Report prepared by: Mubarak Nasir- ACCA Muhammad Asad Shaikh-M.Com Muhammad Jahangir Jawaid-MBA -College of Accounting & Management Sciences (CAMS) -University Of Sindh Jamshoro -Mohammad Ali Jinnah University August 03, 2012

Table of Contents
CHAPTER 1 ............................................................................................................................ 3 Scope .................................................................................................................................... 3 Introduction .......................................................................................................................... 3 Overview of Conventional banking ..................................................................................... 3 Overview of Islamic banking............................................................................................... 4 Comparative Analysis ......................................................................................................... 6 Key differences between conventional banking and Islamic banking ................................... 7 CHAPTER 2 ............................................................................................................................ 9 Islamic Banking as a preferable banking system over Conventional Banking ........................... 9 Islamic banking- Strong resilience during global financial crises ............................................ 12 The Ultimate Cause of the Crises ......................................................................................... 12 Islamic Financial System ...................................................................................................... 14 Islamic Financial Stability ..................................................................................................... 16 CHAPTER 3 .......................................................................................................................... 17 Islamic Banking Emergence.................................................................................................. 17 Local Perspective ............................................................................................................. 17 International Perspective ................................................................................................. 18 UK ................................................................................................................................ 18 Gulf countries ............................................................................................................... 18 Malaysia ....................................................................................................................... 18 Challenges Facing Islamic banking ........................................................................................ 19 Conclusion........................................................................................................................... 22 Recommendations .............................................................................................................. 22

ISLAMIC BANKING V/S CONVENTIONAL BANKING (COMPARATIVE ANALYSIS)

ISLAMIC BANKING V/S CONVENTIONAL BANKING A COMPARATIVE ANALYSIS CHAPTER 1 Scope

The study examines the main characteristics of Islamic banking vis-a-vis conventional banking and aims at identifying their role towards the overall economic stability. The study also makes an attempt to find out that which paradigm plays comparatively a better role towards economic development. Study also endeavors to find out the financial system which fared better during the recent global financial crisis. Finally, the study intends to delineate the role of Islamic economic system in achieving financial stability the world needs.

Introduction Overview of Conventional banking

Conventional banks are based on the capitalistic model of economics charging interest for the man made factor of production i.e. capital, through dealing in money (taking deposits and granting loans) during its normal operating activities. Interest - defined The standard dictionary definition for interest is as follows:
1

A charge made for a loan or credit facility

Interest is a fee paid on borrowed assets. It is the price paid for the use of borrowed money or, money earned by deposited funds. Assets that are sometimes lent with interest include money, shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in finance lease arrangements. The interest is calculated upon the value of the assets in the same manner as upon money. Interest can be thought of as "rent of money". Banks

(Ismail, 2009)According to Wikipedia encyclopedia

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usually employs various products or instruments in order to perform its basic banking function or the modern expanded activities.

Traditional banking operating activities are;

Exchange of currency, Commercial notes and loans, Offering saving deposits, Safekeeping of valuables, Supporting government activities with credit, Fund transfer services, Trust services.

Modern banks activities;

Consumer Loans, Financial advices, Cash management, Equipment leasing, Venture capital loans, Securities underwriting and brokerage services, Merchant bank services.2

Overview of Islamic banking

The first modern experiment with Islamic banking was undertaken in Egypt. The pioneering effort, led by Ahmad El Najjar, took the form of a savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in 1963. This experiment lasted until 1967, by which time there were nine such banks in the country, and over the next three decades a diverse number of Islamic Banks, Islamic Investment Banks, and Islamic Development Banks emerged, and eventually received government backing in some Muslim countries, e.g. Pakistan, Malaysia, and The Gulf States and across the world. They have largely focused on trying to become major players in international banking and developing instruments akin to those used by other banks
2

Dilley, 2008

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whilst finding technical legal explanations to accommodate those developments with the stipulations of Islamic Law. The basic principle of Islamic banking is that interest is forbidden whereas trade is encouraged. Muslim scholars have developed a completely different model of banking that does not use interest but rather relies on trade and profit-loss sharing for purposes of financial intermediation. Under Islamic banking, all partners involved in financial transactions share the risk and profit or loss of a venture and no one gets a predetermined return.

Following are the modes of finance which are of three categories: 1) Participatory modes of Finance
a) Mudaraba b) Musharaka

2) Non Participatory modes of Finance

a) Murabaha b) Musawamah c) Salam d) Istisna e) Ijarah f) Ijarah wa Iqtina (Ijarah Muntahiyyah Bittamleek)

3) Sub contracts
a) Wakalah b) Kafalah c) Rahn

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ISLAMIC BANKING V/S CONVENTIONAL BANKING (COMPARATIVE ANALYSIS) Comparative Analysis

Characteristics of Conventional banking I. The basic function and operating modes are based on self developed principles. II. III. They provide fixed return on investment. Their main focus is on to generate profit without restriction. IV. They mainly deal with the tax matter not with the collection and distribution of zakat. V. VI. They generate interest on lending. The defaulter of the bank pays extra charges as penalty. VII. The bank has no concern with clients equity growth. VIII. They can easily borrow money from money market. IX. Conventional banks did not provide VIII. VII. VI. V. IV. III. II. I. Characteristics of Islamic banking The basic function and operating modes are based on Islamic Shariah principles. The Islamic banking based on trade and profit and loss sharing principles. Their focus is to generate profit by adhering to Islamic Shariah principles. Islamic banks are used to provide services of collection and distribution of Zakat. Islamic business. Islamic banks are multipurpose institution because of this their scope is wider. Islamic banks highly appreciate equity growth for public interest. Islamic Shariah principle of profit and loss sharing provides equal opportunity to the both parties. IX. Attention to developing projects appraisal and evaluation process is better due to profit and loss sharing principle. X. Islamic bank create a relation with client as a partner investor and trader.
XI.

banking

promotes

partnership

attention to develop expertise in project appraisal and evaluations. X. They build relation with clients of creditor and debtors. XI. They provide guarantee to clients for their deposits.
XII.

Conventional bank greatly emphasis on the client creditworthiness.

Islamic

bank

do

not

guarantee

the

repayment of the principle amount, In case of any loss principle amount may also get affected.

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ISLAMIC BANKING V/S CONVENTIONAL BANKING (COMPARATIVE ANALYSIS) Key differences between conventional banking and Islamic banking
Characteristics Business Framework Islamic Banking System Based on Shariah laws. Shariah scholars ensure adherence to Islamic laws and provide Guidance. Equity financing with risk to capital Available. Enables several parties, Not generally through commercial including the Islamic bank to banks , but through venture capital provide equity capital to a project Companies and investment banks or venture. Losses are shared which typically take equity stakes venture. Losses are shared on the and take equity stakes of and an Conventional Banking System (interest based system) Not based on religious laws or guidelines-only secular banking laws

basis of equity Participation while management

control

profits are shared on a pre-agreed enterprise for providing start-up ratio. Management of the finance.

enterprise can be in one of several forms depending on whether the financing is through Mudarabah, Musharaks , etc. Prohibition of Gharar Transactions deemed Gharar are Trading and dealing in derivatives of prohibited. Gharar demotes varying various forms is allowed. degrees of deception pertaining to the price and quality of goods received by a party at the expense of the other. Derivatives trading e.g. options are considered as having elements of Gharar Profit and Loss Sharing Majority of transactions are based This principle is not applied. Returns on this principle. Returns are to depositors are irrespective of bank variable, dependent on bank Performance and profitability. The
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performance and not guaranteed. customer as depositor is like a lender But the risks are managed to and does not share in the success of ensure better returns than deposit the enterprise beyond receiving a accounts. Consumers can fixed rate of predetermined interest. the Islamic system the

participate in the profit upside i.e. Unlike

in a more equitable way than depositor cannot theoretically gain receiving a predetermined return. subject to improved bank

performance.

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CHAPTER 2 Islamic Banking as a preferable banking system over Conventional Banking

There is always an underlying theoretical framework on the base of which the foundation of a financial system is built. Like conventional bank, Islamic bank is an intermediary and trustee of money of other people but the difference is that it shares profit and loss with its depositors. This difference that introduces the element of mutuality in Islamic banking makes its depositors as customers with some ownership of right in it3. Islamic banking and conventional banking differs in that while the conventional banking follows conventional interest-based principle, the Islamic banking is based on interest-free principle and principle of Profit-and-Loss (PLS) sharing in performing their businesses as intermediaries4. While Islamic banks perform mostly the same functions as conventional banks, they do this in distinctly different ways. Some of the distinguishing features of Islamic banking are given below.

Asset-backed Financing
One of the most important characteristics of Islamic financing is that it is an asset-backed financing. The conventional / capitalist concept of financing is that the banks and financial institutions deal in money and monetary papers only. That is why they are forbidden, in most countries, from trading in goods and making inventories. Islam, on the other hand, does not recognize money as a subject-matter of trade, except in case of inter currency exchange. Money has no intrinsic utility; it is only a medium of exchange; Each unit of money is 100% equal to another unit of the same denomination, therefore, there is no room for making profit through the exchange of these units inter se. Profit is generated when something having intrinsic utility is sold for money or when different currencies are exchanged, one for another. The profit earned through dealing in money (of the same currency) or the papers representing them is interest, hence prohibited. Therefore, unlike conventional financial institutions,
3 4

Presley & Dar, 2000/2001 Mohamed Arif, 1988

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financing in Islam is always based on illiquid assets which create real assets and inventories. The instruments of financing in Shariah are:

Musharaka Mudaraba Salam Istisna Murabaha Ijarah Qard-e-Hasan

Profit/loss based system

PROFIT AND LOSS SHARING (PLS) is the mechanism used in Islamic banking to comply with the prohibition of interest. The Islamic solution, commonly referred to as Profit & Loss Sharing (PLS), suggests an equitable sharing of risks and profits between the parties involved in a financial transaction. The Islamic profit sharing concept helps to foster economic development by encouraging equal income distribution and which results in greater benefits for social justice and long term growth. The mode of sharing profit and loss in Islamic banking is different from conventional banking. In terms of: In Musharaka based contract the sharing of profit and loss is on the basis of investment ratio. The loss ratio is decided on the basis of investment contributed but the profit ratio may be determined by the mutual concern of parties as per defined in the agreement. In Mudaraba contract the investor (rab.ul.mal) is actual hiring the services of bank/financial institution and in return the bank/ financial institution charge the service. In case of loss, the investor had to bare the total loss and the service provider also bares the loss of his charges in terms of service provided. In case of profit, both parties are to be agreed on a certain formula of sharing the actual profit right at the beginning of the contract through mutual consensus.
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Lending/borrowing not an earning base

Under conventional banking the main earning base is interest charged on lending and borrowings of money whereas Islamic banking does not treat money as a commodity. Islamic banks do trade or enters into participatory modes to finance the business needs of the entrepreneur. To put it in simple terms, an Islamic bank takes/carries risk earning profit.

Risk sharing
The most important feature of Islamic banking is that it promotes risk sharing between the provider of funds (investor) and the user of funds (entrepreneur). By contrast, under conventional banking, the investor is assured of a predetermined rate of interest. Since the nature of this world is uncertain, the results of any project are not known with certainty extant, and so there is always some risk involved. In conventional banking, all this risk is borne by the entrepreneur. Whether the project succeeds and produces a profit or fails and produces a loss, the owner of capital gets away with a predetermined return. In Islam, this kind of unjust distribution is not allowed. In Islamic banking both the investor and the entrepreneur share the results of the project in an equitable way. In the case of profit, both share this in pre-agreed proportions. In the case of loss, all financial loss is borne by the capitalist and the entrepreneur loses his service charges

Execution of Agreement
The basic principle in Islamic law is that exploitative contracts or unfair contracts that may provoke exploitation by either of the parties are impermissible. Under Islamic banking, all partners involved in financial transactions share the risk and profit or loss of a venture and no one gets a predetermined return. Under Islamic banking all terms and conditions are predetermined by mutual consensus of both the parties.

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Islamic banking- Strong resilience during global financial crises The Ultimate Cause of the Crises
The global financial crisis of 2007 has cast its long shadow on the economic fortunes of many countries, resulting in what has often been called the Great Recession.5 What started as seemingly isolated turbulence in the sub-prime segment of the US housing market mutated into a full blown recession by the end of 2007. The old proverbial truth that the rest of the world sneezes when the US catches a cold appeared to be vindicated as systemically important economies in the European Union and Japan went collectively into recession by mid-2008. Overall, 2009 was the first year since World War II that the world was in recession, a calamitous turn around on the boom years of 2002-2007. This has led to a call for comprehensive reform of the international financial system to help prevent the outbreak and spread of financial crises or, at least, minimize their frequency and severity. It may not, however, be possible to formulate a comprehensive reform progamme until the primary cause of the crises is determined. A number of economists have made an effort to determine the causes of crises. However, no consensus seems to have developed so far about the ultimate cause or the cause of all causes. The primary cause in our view is Imprudent Mortgage Lending against a backdrop of abundant credit, low interest rates, and rising house prices, lending standards were relaxed to the point that many people were able to buy houses they couldnt afford. When prices began to fall and loans started going bad, there was a severe shock to the financial system. With its easy money policies, the Federal Reserve allowed housing prices to rise to unsustainable levels. The crisis was triggered by the bubble bursting, as it was bound to do. Other reason for this is many participants contributed to the creation of bad mortgages and the selling of bad securities, apparently feeling secure that they would not be held accountable for their actions. A lender could sell exotic mortgages to home-owners, apparently without fear of
5

Rampell (2009)

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repercussions if those mortgages failed. Similarly, a trader could sell toxic securities to investors, apparently without fear of personal responsibility if those contracts failed. And so it was for brokers, realtors, individuals in rating agencies, and other market participants, each maximizing his or her own gain and passing problems on down the line until the system itself collapsed. Because of the lack of participant accountability, the originate-to distribute model of mortgage finance, with its once great promise of managing risk, became itself a massive generator of risk. Another reason is that the credit rating agencies gave AAA ratings to numerous issues of subprime mortgage-backed securities, many of which were subsequently downgraded to junk status. Critics cite poor economic models, conflicts of interest, and lack of effective regulation as reasons for the rating agencies failure. Another factor is the markets excessive reliance on ratings, which has been reinforced by numerous laws and regulations that use ratings as a criterion for permissible investments or as a factor in required capital levels.6 Another main reason is that many banks established off-the-books special purpose entities (including structured investment vehicles, or SIVs) to engage in risky speculative investments. This allowed banks to make more loans during the expansion, but also created contingent liabilities that, with the onset of the crisis, reduced market confidence in the banks creditworthiness. At the same time, they had allowed banks to hold less capital against potential losses. Investors had little ability to understand banks true financial positions.7 Another cause in our view is the inadequate market discipline in the conventional financial system. Instead of making the depositors and the bankers share in the risks of business, it assures them of the repayment of their deposits or loans with interest. This makes the depositors complacent. They, therefore, take little interest in the affairs of their financial institution. It also makes the banks rely on the crutches of the collateral to extend financing for practically any purpose, including speculation. The collateral cannot, however, be a substitute for a more careful evaluation of the project financed. This is because the value of the collateral
6

Securities and Exchange Commission, SEC Approves Measures to Strengthen Oversight of Credit Rating Agencies, press release 2008-284, Dec. 3, 2008. 7 Adrian Blundell-Wignall, Structured Products: Implications for Financial Markets, Financial Market Trends, Nov. 2007, p. 27.

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can itself be impaired by the same factors that diminish the ability of the borrower to repay the loan. This shows that the absence of risk/reward sharing reduces market discipline and, thereby, introduces a fault line in the international financial system. It is this fault line that makes it possible for the financier to lend excessively and also to move funds rapidly from place to place at the slightest Change in the economic environment. A high degree of volatility thus gets injected into interest rates and asset prices. Consequently, there is a steep rise in highly leveraged short-term debt, which has accentuated economic and financial instability. 8The IMF acknowledged this fact in its May 1998 World Economic Outlook by stating that countries with high levels of short-term debt are "likely to be particularly vulnerable to internal and external shocks and thus susceptible to financial crises" One of the major reasons for this is the close link between easy availability of credit, macroeconomic imbalances, and financial instability. The easy availability of credit makes it possible for the public sector to have a high debt profile and for the private-sector to live beyond its means and to have a high leverage. If the debt is not used productively, the ability to service the debt does not rise in proportion to the debt and leads to financial fragility and debt crises.

Islamic Financial System

This brings us to Islamic banking, which tries to introduce the principle of risk-reward sharing in financial intermediation instead of interest. Since demand deposits do not participate in the risks of financing by the financial institutions, they do not earn any return and must, therefore, be guaranteed. This is because one of the basic principles of Islamic finance is: No risk, no gain. However, since investment deposits do participate in the risks, they must share in the profits or losses in agreed proportions. What this will do is to turn investment depositors into temporary shareholders. Placing investment deposits in financial institutions will be like purchasing their shares, and withdrawing them will be like redeeming these shares. The same would be the case when these institutions lend to, and get repaid by, businesses. They will be
8

IMF working paper- May 1998 World Economic Outlook

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sharing in the risks of businesses they finance. This will raise substantially the share of equity in total financing and reduce that of debt. Equity will take the form of either shares in joint stock companies or other businesses or of profit-and-loss sharing (PLS) in projects and ventures through the Mudaraba and Musharaka modes of financing. Greater reliance on equity does not necessarily mean that debt financing is totally ruled out. This is because all financial needs of individuals, firms, or governments cannot be made amenable to PLS. Debt is, therefore, indispensable. Debt, however, gets created in the Islamic financial system through the sale or lease of real goods and services via the sales- and leased-based modes of financing (Murabaha, Ijarah, Salam, and Istisna). In this case, the rate of return gets stipulated in advance and becomes a part of the deferred payment price. Since the rate of return is fixed in advance and the debt is associated with real goods or services, it is less risky as compared with equity or PLS financing. The predetermined rate of return on sales- and lease-based modes of financing may make them appear like interest-based instruments. They are, however, not so because of significant differences between the two for a number of reasons. First, the sales- and lease-based modes do not involve direct lending and borrowing. They are rather purchase and sale or lease transactions involving real goods and services. The Shariah has imposed a number of conditions for the validity of these transactions. One of these conditions is that the seller (or lessor) must also share a part of the risk to be able to get a share in the return. He cannot avoid doing this because of the second condition that requires that the seller (financier) or lessor must own and possess the goods being sold. The Shariah does not allow a person to sell or lease what he does not own and possess. Once the seller (financier) acquires ownership and possession of the goods for sale or lease, he/she bears the risk. All speculative short sales, therefore, get ruled out automatically. Financing extended through the Islamic modes can thus expand only in step with the rise of the real economy and thereby help curb excessive credit expansion, which is one of the major causes of instability in the international financial markets. Second, it is the price of the good or service sold, and not the rate of interest, that is stipulated in the case of sales- or lease-based modes of finance. Once the price has been set, it cannot be altered, even if there is a delay in payment due to unforeseen circumstances. This helps protect
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the interest of the buyer in strained circumstances. However, it may also lead to a liquidity problem for the bank if the buyer willfully delays payment. This is a major unresolved problem in Islamic finance and discussions are in progress among the jurists to find a solution that is Shariah-compliant.

Islamic Financial Stability

Islamic banks enjoy a built-in stabilizer to help them cope with economic downturns, as instead of paying interest to depositors, those with investment Mudaraba accounts share in the banks profits. Thus, if profitability declines in an economic downturn, depositors receive lower returns, but if profits rise they enjoy higher returns. This profit sharing reduces risk for the banks and means they are less likely to become insolvent. However as the banks build up a profit equalization reserve, which can be used to finance pay-outs during difficult years, depositors benefit from some protection of their returns during economic downturns.

Investors in equities screened for Shariah compliance have also suffered, but less than their conventional counterparts, because they have not invested in the shares of interest-based banks which have fared especially badly during the global financial turmoil. Investors seeking Shariah compliance have portfolios which are more heavily weighted in sectors such as healthcare or utilities where revenue streams are maintained even during cyclical down-turns.

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CHAPTER 3 Islamic Banking Emergence

Local Perspective
The Islamic banking industry (IBI) in Pakistan which started in 2002 has the assets worth Rs. 644 billion constituting 7.7 percent share of the overall banking industry. Islamic banking industry were Rs 530 billion whereas financing and investment remained at Rs. 487 billion.

IBI Network Expansion: By the end of first quarter CY12 IBI network comprised of 905 branches in 76 cities indicating addition of 19 new branches (see Table above); the industry has plans to open total 172 fully fledged branches and 26 sub branches in the ongoing year.

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ISLAMIC BANKING V/S CONVENTIONAL BANKING (COMPARATIVE ANALYSIS) International Perspective UK

Islamic banks are no longer only a feature of traditional Muslim regions: there are more than 300 Islamic financial institutions spread across 70 countries of the world. Indeed, there are now 5 Islamic banks in the UK (the only EU country to have Islamic banks), and 19 Islamic financial institutions in the USA9. Recent figures suggest that during 2009, Shariah-compliant assets grew by 29%10, making Islamic finance amongst the fastest growing financial sectors11. Shariahcompliant assets are valued at just over US$800 billion12, and these could rise to US$4 trillion by 2015 (Arthur D Little 2009).

Gulf countries
Islamic banks in the Gulf region currently control a market share of around 15% of the regional banking systems assets. Saudi Arabia, Kuwait and the UAE are considered to be three of the big 4 countries (along with Malaysia) in global Islamic finance. Saudi Arabia has a large concentration of Islamic finance assets (compared to total assets) at 40%, compared to Kuwait and the UAE which have 21% and 20% respectively. The remaining three countries of the GCC are considered to be credible challengers to these 4 countries. Bahrain has a 15% concentration of Islamic finance assets compared to Qatar with only 5%.13

Malaysia
Islamic banking assets in Malaysia, the worlds biggest market for Shariah-compliant debt, rose 16 percent last year after the government approved new licenses and eased restrictions on foreign ownership. 14Assets that comply with Islams ban on interest increased to 350.8 billion

Hamdan 2009 The Economist 2009b 11 Arthur D Little 2009 12 The Economist 2009b 13 http://www.lums.lancs.ac.uk/files/Efficiency.pdf 14 http://www.bloomberg.com/news/2011-03-23/malaysia-islamic-banking-assets-rise-16-percent-to-116billion.html
10

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ringgit ($116 billion) and accounted for 21 percent of the total banking system, according to Bank Negara Malaysias 2010 annual report published in Kuala Lumpur today. Malaysias position as the global hub for Islamic finance will continue to be reinforced, supported by a diverse set of institutions, deep, liquid and efficient financial markets, the central bank said. Bank Negara will focus on developing the players, infrastructure and expertise required to meet the needs of the growing economy.

Challenges Facing Islamic banking

The Islamic banking and finance industry is still in its infancy stage, and it certainly faces many challenges due to the fact that Islamic banks operate in an economy that is driven and manipulated by interest. In a financial economy, the banking sector is supported and regulated by the central bank. The central banks regulation and policies are created for conventional commercial banks and it acts as lender of last resort (LOLR). Unfortunately, most Islamic banks do not enjoy such privileges. Another challenge facing Islamic banks is that they work under operational procedures that are different from those of the conventional banks; the resulting no compatibility prevents the central banks from controlling or giving support to Islamic banks if a liquidity gap arises. Since the Islamic finance industry is working under the secular system, it may suffer from the same systemic problems that contemporary conventional financial institutions are facing. For example, due to lack of proper regulation, Islamic banks do not genuinely engage in risk sharing, which means defaulting clients of Islamic banks suffer the same consequences as clients of interest-based banks. If Islamic banks engage in money creation, they also will suffer the same inflation and boom-bust cycle that is evident in Western economies. Other key challenges faced by Islamic banking are as follows

Lack of Harmonization in Shariah Practices

Interpretations of Islamic Shariah principles are left to Muslim scholars affiliated with different schools of thoughts. Hence the Shariah Committees at the Islamic financial institutions

approves the products on the premise of the fiqh it follows. Given that there are five major
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fiqh, therefore, standardization of Shariah practices remains missing when compared at global level. Lack of standardization leads to confusion about what Islamic banking really encompasses and, therefore, hinders its widespread acceptance. Thus, standardization of Shariah practices would remove the confusions about the practices of Islamic banking and would enhance its appeal in terms of globalization of the industry.

Lack of Product Innovation

All Islamic financial institutions offer the same basic products, 90 per cent Murabaha and Ijarah, but on the other side conventional banks are offering more variety of innovative products to their users. Thus in order to compete with conventional banks, Islamic banks has to offer a more range of innovative products to attract new users and increase their market share.

Lack of Shariah compliant liquidity management structures

Many Islamic banks lack liquidity instruments such as treasury bills and other marketable securities, which could be utilized either to cover liquidity shortages or to manage excess liquidity. This problem is aggravated since many Islamic banks work under operational procedures different from those of the central banks; the resulting non-compatibility prevents the central banks from controlling or giving support to Islamic banks if a liquidity gap should occur. So the issue of liquidity management must come under active discussion and scrutiny by the authorities involved is Islamic banking.

Lacking enabling legal framework

In the absence of Islamic banking laws, the enforcement of agreements in courts may require extra efforts and costs. Therefore, banking and companies laws in several countries require suitable modifications to provide a level playing field for Islamic banks. Furthermore, international acceptance of Islamic financial contracts requires them to be Shariah compatible as well as acceptable under the major legal regimes such as Common law and Civil law systems.

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ISLAMIC BANKING V/S CONVENTIONAL BANKING (COMPARATIVE ANALYSIS) Mirroring conventional banking products
The current products offered by Islamic banks are mainly similar to conventional banks with certain amendments made to those in accordance with Shariah principles to make it Shariah compliant. This refers that the base of Islamic products stands on conventional banking products which is a rising argument created by the general peoples which make them reluctant to work with Islamic banks. The solution for this problem would be to introduce a totally different range of products that facilitates achieving the maqasid (objectives) of Shariah.

Slow-paced Research and development

As Islamic banking is emerging with a fast pace of growth thus it also require a significant attention towards its research and development activities. Currently the pace of research and development is very slow which is therefore not adequately facilitating Islamic banking industry to proceed to higher levels. Thus in order to overcome this problem there must be adequate allocation of desired resources towards research and development activities.

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Conclusion
In conclusion it could be said that Islamic banking financial system is emerging not only in Islamic countries but also in Non Islamic countries due to its various qualities discussed above and the implication of Islamic Banking Financial system can be concluded as more economic stable as compared to the traditional conventional banking financial system. As Islamic Banking is a new sector thus it needs further time to be adequately implemented as an independent financial system.

Recommendations
It was a big challenge for the Islamic banking system to come up with such a system in a short period of time, which might be compatible with the demands of the modern financial system. This would not have been possible without the hard work and continuous effort of Islamic scholars and financial experts to design this system. Although the present system of Islamic banking has fulfilled the generic demands of the financial industry but still it lags behind in certain areas. Islamic jurists and experts need to design their own new products to cope up with increasingly innovative new products emerging in the financial industry of the world. Islamic banks should penetrate in all major markets of the world and should open up their branches in all those countries where they have their client base. Muslims constitute one fifth of the worlds population and are very rich. Hence Islamic banks can target them and take maximum benefits out of them. In this way they can also attract customers from other religions of the society. Their smooth operations and good returns will benefit the society in large. In order to implement the Islamic financial system in Pakistan, a whole-hearted effort is required at government and people level. Government can take steps to facilitate the smooth sail of this system and can provide incentives to people to use Islamic system but it can never force someone to use this system. Now at this stage, people come in and they should fully utilize the Islamic financial system, to make it a success.

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