Islamic Bank Vr Conventional Bank

CHAPTER 1:

1.1 An Overview of Bank 1.1.1 Bank Definition The definition of a bank varies from country to country. Under English common law, a banker is defined as a person who carries on the business of banking, which is specified as:

conducting current accounts for his customers paying cheques drawn on him, and collecting cheques for his customers.

Bank is a financial intermediary and appears in several related basic forms:

A central bank issues money on behalf of a government, and regulates the money supply

A commercial bank accepts deposits and channels those deposits into lending activities, either directly or through capital markets. A bank connects customers with capital deficits to customers with capital surpluses on the world's open financial markets.

A savings bank, is only allowed to borrow and save from members of a financial cooperative.

1.1.2

Islamic Banks and Conventional Banks.

Islamic banking and conventional banking are extremely different in many ways. The key difference is that Islamic Banking is based on Shariah foundation. Thus, all dealing, transaction, business approach, product feature, investment focus, responsibility are derived from the Shariah law, which lead to the significant difference in many part of the operations with as of the conventional
1

Islamic Bank Vr Conventional Bank

The foundation of Islamic bank is based on the Islamic faith and must stay within the limits of Islamic Law or the Shariah in all of its actions and deeds. The original meaning of the Arabic word Shariah is 'the way to the source of life' and is now used to refer to legal system in keeping with the code of behaviour called for by the Holly Qur'an (Koran). Amongst the governing principles of an Islamic bank are : * The absence of interest-based (riba) transactions; * The avoidance of economic activities involving oppression (zulm) * The avoidance of economic activities involving speculation (gharar); * The introduction of an Islamic tax, zakat; * The discouragement of the production of goods and services which contradict the Islamic value (haram) On the other hand, conventional banking is essentially based on the debtorcreditor relationship between the depositors and the bank on one hand, and between the borrowers and the bank on the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money. 1.2 Financial Markets & Financial Industry. Financial markets and financial industry are seeing the fast growth of Islamic finance in last years. Some experts in the financial industry have estimated this growth in some countries is very fast. This growth is reducing the market share of traditional banks, and seems attractive to some of them to convert their operations to Islamic banking.

Islamic

banking forbids dealing in

interest

and the traditional

financing tools which are used by conventional banking, and they created some other financing tools which are compatible with Islamic Sharei'a; as the advocates of this industry say and as we will discuss in details in chapter two.
2

Islamic Bank Vr Conventional Bank

In association with the growth of Islamic banking it was subjected to many criticisms, one of these criticisms is that the operating Islamic banks don't use all the Islamic financing instruments, they are using only some instruments which fulfill the benefits and the profitability to the bank and its share holders, and they neglect or avoid some other financing instruments which are more beneficial to the bank customers and more related to main principles of Islamic finance theory. By avoiding such instruments, the real activities and services of Islamic banks became strongly close to those provided by conventional banks. The main objective of this study is to assess the performance of Islamic banks in U.A.E compared to the conventional or commercial banks. We will apply an analysis using the financial ratios indicating the liquidity, structure and profitability as a measure of the performance of both types of banks.

1.3

PROBLEM DEFINITION The basic framework for an Islamic financial system is a set of rules

and laws collectively referred to as Shareia, governing economic, social, political, and cultural aspects of Islamic societies. Since the emergence of the term "Islamic financial system", the system was built on some basic principles like: prohibition of interest, risk sharing, prohibition of speculative behavior, and sanctity of contracts. The Islamic financial system is founded on the absolute prohibition of the payment or receipt of any predetermined, guaranteed rate of return. This closes the door to the concept of interest and precludes the use of debt-based instruments. The system encourages risk-sharing, promotes entrepreneurship, discourage speculative behavior, and emphasizes the sanctity of contracts. The Islamic financial system has developed some basic instruments which stick to the basics of the system. Basic instruments include cost-plus financing (Murabaha), profit-sharing (Mudaraba), leasing (Ijara), partnership (Musharaka) and forward sale (Bay' Salam). These instruments serve as the
3

Islamic Bank Vr Conventional Bank

basic building blocks for developing a wide variety of more complex financial instruments. ( Zamir Iqbal, 1997). Based on the above bases and instruments, the Islamic finance are suppose to play promoting and a great role in economic development through

encouraging entrepreneurs and business firms to expand

their activities. The actuality of this situation may be compatible with the above theoretical bases or not, and the Islamic financing institutions may play its aimed role or not. But based on our literature review, we see a big gap between the theoretical bases and the actuality and applied services by Islamic banks in many countries which are subjected to researches. And many writers see that there is not any significant difference between the actual operations and services provided by Islamic banks and the conventional banks. As a matter of fact, the Islamic banks and companies provide significant contributions to the economic development process in U.A.E; its popularity has increased during the past 20 years and a lot of Islamic companies and funds have been established. It is clear also how much this industry become attractive for the conventional banks to convert part of its activities to Islamic finance. For all the above, we think it is necessary to investigate the performance of these Islamic banks, compared to the conventional ones. This assessment of the performance should consider the profitability and structural issues. Many studies has conducted such. Type of assessment in many countries, we will try to conduct such assessment on Abu Dhabi Islamic Bank

Zamir Iqbal
(a national of Pakistan, is an Information Officer in the World Banks Treasury Information Services Department)

Islamic Bank Vr Conventional Bank

1.4

Objectives of the Study

This study aims to investigate the performance of the Islamic banks vs. conventional banks in U.A.E. The main objectives of this study are as follows: 1. To evaluate and analyze the financial performance of Islamic banks and the conventional banks in U.A.E. my study object here to compare Abu Dhabi Islamic Bank (ADIB) Verses Abu Dhabi Commercial Bank (ADCB) 2. To compare the financial performance of Islamic banks and conventional banks in U.A.E. 3. To investigate the relationship between financial performance of Islamic and conventional banks in U.A.E.

1.5

Hypothesis

In fact, this study aims to answer the following questions: 1. Is there any significant difference between the performances of Islamic and conventional banks in U.A.E? 2. What is the relationship between financial performance of Islamic and conventional banks in U.A.E.

1.6

Scope and Limitations.

Following the introduction, chapter two reviews the literature concerning issues related to this research. This chapter will include an overview of the concepts of Islamic banking and finance, discovering the main principles and instruments of Islamic banking and finance, and try to review the researches on the actual situation of Islamic banking practices. Chapter three provides the research design and methodology and the data description. In chapter four data analysis is achieved and its findings are obtained. Finally, chapter five will present the conclusion, recommendations and also will include suggestions for further research.

Islamic Bank Vr Conventional Bank

1.7

RELEVANCE OF THIS THESIS TO THE COUNTRY OF U.A.E In U.A.E the Islamic banking services are in the way of continuous development and a

very fast gr o wt h during the recent ye ars .

Obvious

among this development is the

number of Islamic financial institutions and banks working in the U.A.E market. The first private interest-free bank, the Dubai Islamic Bank, was also set up in 1975 by a group of Muslim businessmen from several countries. Two more private banks were founded in 1977 under the name of Faisal Islamic Bank in Egypt and the Sudan. In the same year the U.A.E government set up the U.A.E Finance House. In the ten years since the establishment of the first private commercial bank in Dubai, more than 50 interest-free banks have come into being. Though nearly all of them are in Muslim countries, there are some in Western Europe as well: in Denmark, Luxembourg, Switzerland and the UK. Many banks were established in 1983 (11) and 1984 (13). The numbers have declined considerably in the following years. In most countries the establishment of interest-free banking had been by private initiative and was confined to that bank. Current practices Generally speaking, all interest-free banks agree on the basic principles. However, individual banks differ in their application. These differences are due to several reasons including the laws of the country, objectives of the different banks, individual banks circumstances and experiences, the need to interact with other interest-based banks, etc.

1.8 Defination of Terms. 1. Al-Wadiah Yad Dhamanah (guaranteed custody) and investment . 2. Al-Mudharabah (profit-sharing). The bank grants financing facilities such as working capital financing . 3. Al-Murabahah (cost-plus), house financing . 4. Bai' Bithaman Ajil (deferred payment sale), leasing. 5. Al-Ijarah (leasing) and project financing . 6. Al-Musyarakah (profit and loss sharing).

Islamic Bank Vr Conventional Bank

CHAPTER 2: LITERATURE REVIEW

INTRODUCTION Due to the observed significant growth in Islamic finance industry, this industry was a subject of many studies and papers in last decade. In this chapter we tried to review some of these literatures about Islamic finance and Islamic banking. We tried to indicate both views about Islamic banking; the advocators and the critics. We tried also to review the views about the actual situation of Islamic banking compared to the theoretical principles of this industry. And at the end of chapter we added a review about the Islamic banking in U.A.E.

2.1

HISTORY OF ISLAMIC FINANCE AND ISLAMIC BANKING: According to Institute of Banking Studies of U.A.E the first Islamic bank start operation

in U.A.E in 1975, an early experiment with Islamic banking took place in Malaysia around 1940 and in Pakistan in 1950's. Countries like Egypt followed suit. Most banks in those countries had rural orientation then. In the Arab world, the first experience with Islamic bank goes to Egypt in 1963. The bank was formed under cover, without projecting an Islamic image, for fear of mistaking as Islamic fundamentalism. However, the bank closed on 1967. During this period, other banks came into being catering to trade and industry without charging interest. Various countries in the Middle East did not support the formation of Islamic banks for fear of subversive actives, creating support to the opposition parties in creating political turmoil. The only Islamic institution to survive this period was Nasser Social Bank of Egypt and Tabung Haji of Mala ysia. These banks created an

atmosphere conducive for the Islamic banks in future to set up and improve the concept of Islamic institutions: the concept of providing full range of commercial banking services, in Islamic manner i.e. Interest f r e e a n d b a l a n c i n g s o c i o -economic r e s p o n s i b i l i t y

wi t h commercial interests. Institute of banking studies of U.A.E divided the development of modern Islamic banks into three phases:

1. Emergence: 1972 through 1975: this period was marked by a surge in oil revenues and great liquidity. Parallel events included a

resurgence of fundamentalist Muslim movements. 2. Expansion: 1976 to the early 1980's: Islamic banking spread from the Arabian Gulf eastward to Malaysia, and westward to England.
7

Islamic Bank Vr Conventional Bank

Islamic

banks

spread institutions.

across, Islamic

including banking

international associations

and and

intercontinental

consultancy bodies' broadened their operations. 3. Maturity: 1983 to the present: Arab banks opened branches in the United States and Islamic banking practices were implemented in both Pakistan and Iran, U.A.E. This gave an impetus to the growth of Islamic banking internationally. Many conventional banks in the Middle East have started the concept of Islamic banking into its portfolio. Many western conventional banks followed suit and have exclusive Islamic banking division. Islamic financial institutions now operate in over 75 countries. Zamir Iqbal (1997) argued that the term "Islamic financial system" is relatively new, appearing only in the mid-1980s. In fact, all the earlier references to commercial or mercantile activities conforming to Islamic principles were made under the umbrella of either "interest free" or "Islamic banking" (Zamir Iqbal, 1997) A.L.M Abdul Gafoor (1995) wrote a more detailed explanation of the history of Islamic finance. He divided the history of Islamic finance or (interest free banking) into two parts. First, when it still remained an idea; second, when it became a reality - by private initiative in some countries and by law in others. The earliest references to the reorganization of banking on the basis of profit sharing rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, elaborate exposition by followed by a more

Mawdudi in (1950 ,1961). Muhammad Hamidullahs

1944, 1955, 1957 and 1962 writings too should be included in this category. They have all recognized the need for commercial banks and the evil of interest in that enterprise, and have proposed a banking system based on the concept of Mudaraba - profit and loss sharing. In the next two decades interest-free banking attracted more attention, partly because of the political interest it created in Pakistan and partly because of the emergence of young Muslim economists. Works specifically devoted to this subject began to appear in this period. The first such work is that of Muhammad

Uzair (1955). Another set of works emerged in the late sixties and early
8

Islamic Bank Vr Conventional Bank

seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar (1971) and Baqir al-Sadr (1961, 1974) were the main contributors. 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 in the

governments led to the application of theory to practice and resulted establishment

of the first interest-free banks. The Islamic Development

Bank, an inter-governmental bank established in 1975, was born of this process. The first private interest-free bank, the Dubai Islamic Bank, was also set up in 1975 by a group of Muslim businessmen from several countries. Two more private banks were founded in 1977 under the name of Faisal Islamic Bank in Egypt and the Sudan.

2.2

PRINCIPLES OF ISLAMIC FINANCIAL SYSTEM The basic framework for an Islamic financial system is a set of rules

and laws, collectively referred to as Shareia, governing economics, social, political, and cultural aspects of Islamic societies. ( Zamir Iqbal, 1997). The basic principles of Islamic financial system can be summarized as follows: 2.2.1 PROHIBITION OF INTEREST: The Islamic financial system is founded on the absolute prohibition of the payment or receipt of any predetermined, guaranteed rate of return. Most of the literatures of Islamic finance agree with the Mr. Iqbal about the

prohibition of interest in Islamic finance. They used the expression "Reba" as the equivalent to interest. And all the Muslims know that Islam is prohibiting "Reba"
9

Islamic Bank Vr Conventional Bank

That Prohibition of "Reba", a term literally meaning "an excess" and interpreted as "any unjustifiable increase of capital whether in loans or sales" is the central tenet of the system. More precisely, any p o s i t i v e , fixed, predetermined rate tied to the maturity and the amount of principal (i.e., guaranteed regardless of the performance of the investment) is

considered "Reba" and prohibited. The general consensus among Islamic scholars is that Reba covers not only usury but also the charging of "interest" as widely practiced. ( Zamir Iqbal, 1997) Aggarwal & Yousef (2000) also indicated that the most important principle in Islamic finance is the prohibition of Reba, any predetermined or fixed return in financial transactions. As stated in the Quran: " Allah forbids Reba and permits trade" while there is much debate about the exact nature of this prohibition on "Reba', there exists a widespread perception that the ban on Reba implies a ban on interest 2.2.1.1 DOUBTS ABOUT PROHIBITION OF INTEREST

Recently, Islamic finance industry faced voices of some writers and specialists who scruple about the prohibition of interest by Islam. Rasul Shams (2004) is one of those writers who have doubts about this ban of interest in Islamic finance. He said that, in many English translation of Quran the word "usury" is used for the Quranic word "Reba" and not for the word "interest". According to Collins English dictionary (sixth edition 2003) the word "interest" means "a charge for use of credit or borrowed money", while "usury" is "an exorbitant or unlawfully high amount or rate of interest". If the Quranic word "Reba" means usury, usury is forbidden but not necessarily interest. Interest is a simple expression for a charge which under

competition in the credit market would be reduced to the conventional interest rate in trading and commerce. Everything above this rate is forbidden but not this conventional interest rate. (Shams, 2004)

10

Islamic Bank Vr Conventional Bank

2.2.2 RISK SHARING (OR PROFIT AND LOSS SHARING): Aggarwal & Yousef (2000) argued that the profit-and-loss sharing principle is unanimously accepted in the Islamic legal and economic literatures as the cornerstone of financial transactions. According to profit-andloss sharing principle, the bank may earn a return on invested funds provided that the bank shares in the risk of the investment and bears a loss if the project fails. (Aggarwal & Yousef, 2000). Zamir Iqbal (1997) explained that, because interest is prohibited, suppliers of funds become investors instead of creditors, the provider of financial capital and the entrepreneur share risks in return for shares of the profits. (Zamir Iqbal, 1997) 2.2.3 MONEY AS "POTENTIAL CAPITAL: Zamir Iqbal (1997) argued that Money is treated as "potential" capitalthat is, it becomes actual capital only when it joins hands with other resources to undertake a productive activity. Islam recognizes the time value of money, but only when it acts as capital, not when it is "potential" capital. (Zamir Iqbal, 1997) 2.2.4 PROHIBITION OF SPECULATIVE BEHAVIOR "An Islamic financial system discourages holding and prohibits transactions featuring extreme uncertainties, gambling, and risks" . We think this is a logic principle for a system originated from a religion; the system should respect all issues, ethics and laws related to same religion.

2.2.5 SANCTITY OF CONTRACTS "Islam upholds contractual obligations and disclosure of information as a sacred duty. This feature is intended to reduce the risk of asymmetric information and moral hazard". ( Zamir Iqbal, 1997)

11

Islamic Bank Vr Conventional Bank

2.2.6 SHAREIA-APPROVED ACTIVITIES "Only those business activities that do not violate the rules of Shareia qualify for investment. For example; any investment in business dealing with alcohol, gambling, and casinos would be prohibited" (Zamir Iqbal, 1997). As indicated above, we think this type of principles is logic for a religious

financial system, all principles and applications of such system suppose to be approved by the source religion.

2.3 Islamic Financial Instuments There are many contracts and instruments used within the industry collectively known as Islamic finance. These instruments are widely varying in the degree of their acceptance by Islamic finance specialists. In this overview we will focus on the most popular and known financing instruments. According to Aggarwal & Yousef (2000) , Alternative "interest-free" financing technique have been developed by Islamic banks and the monetary authorities of different countries. The instruments of commercial financing have been based on two principles: the profit-and-loss sharing (PLS) principle and markup principle. 2.3.1 PROFIT-AND-LOSS SHARING (PLS) INSTRUMENTS The PLS principle is unanimously accepted in the Islamic legal and economic literatures as the cornerstone of financial transactions.

According to profit-and-loss sharing principle, the bank may earn a return on invested funds provided that the bank shares in the risk of the investment and bears a loss if the project fails. (Aggarwal & Yousef, 2000). The main PLC instruments are Mudaraba and Musharaka

12

Islamic Bank Vr Conventional Bank

2.3.1.1 PROFIT-SHARING AGREEMENT (MUDARABA) This is identical to an investment fund in which managers handle a pool of funds. The having agent-manager has relatively limited liability while

sufficient incentives to perform. The capital is invested in broadly

defined activities, and the terms of profit and risk sharing are customizes for each investment. The maturity structure ranges from short to medium terms and is more suitable for trade activities. (Zamir Iqbal, 1997) Mudaraba where the bank contributes the finance and the client provides the expertise, management and labor. Profits are shared by both the partners in a pre- arranged proportion, but when a loss occurs the total loss is borne by the bank. (Abdul Gafoor, 1995) Aggarwal & Yousef (2000) explained the Mudaraba financing, as where the bank provides capital and the entrepreneur contributes effort and

exercises complete control over the business venture. In case of a loss, the bank earns no return or a negative return on its investments and the entrepreneur receives no compensation for her effort. In case of a gain, returns are split according to a negotiated equity percentage. (Aggarwal & Yousef, 2000). 2.3.1.2 EQUITY PARTICIPATION (MUSHARAKA) This is analogous to a classical joint venture. Both entrepreneur and investor contribute to the capital (assets, technical and managerial expertise, working capital, etc. ) of the operation in varying degrees and agree to share the returns ( as well as the risks) in proportions agreed to in advance. Traditionally, this form of transaction has been used for financing fixed assets and working capital of medium-and long-term duration. (Zamir Iqbal, 1997) Musharaka where a bank may join another entity to set up a joint venture, both parties participating in the various aspects of the project in varying degrees. Profit and loss are shared in a pre-arranged fashion. This is not very different from the joint venture concept. The venture is an
13

Islamic Bank Vr Conventional Bank

independent legal entity and the bank may withdraw gradually after an initial period. (Abdul Gafoor, 1995) Aggarwal & Yousef (2000) explained the Musharaka financing, as where the entrepreneur and the bank jointly supply the capital and manage the project. Losses are born in proportion to the contribution of capital while profit proportions are negotiated freely. (Aggarwal & Yousef, 2000). 2.3.2 MARK-UP INSTRUMENTS The markup principle has its historical roots in commercial trade activities. The bank finances the purchase of assets in exchange for a negotiated profit margin. Although markup instruments are widely used, their acceptability under Islamic law is disputed because they can imply a fixed return on investment for the bank. Many Islamic scholars have taken the position that markup technique, while permissible, should still be avoided or restricted. (Aggarwal & Yousef, 2000). Beng Soon Chong and Ming-Hua Liu (2007) announced that The acceptability of the non-PLS modes of financing, however, has been widely debated and disputed because of their close resemblance to conventional methods of interest-based financing. Many Islamic scholars, including Pakistan's Council of Islamic Ideology, have warned that, although permissible, such non-PLS modes of financing should be restricted or avoided to prevent them from being misused as a back door for interest-based financing. Mahmoud El-Gamal (2006) explained the reasons for the markup principle. He said: the juristic-based understanding of forbidden Reba/usury suggested that the Islamic finance has to be "asset-based", in the sense that one cannot collect or pay interest on Rented money, as one does in conventional banking. Therefore, the easiest transactions to

14

Islamic Bank Vr Conventional Bank

Islamize were secured lending operations, e.g., to finance the purchase of real estate, vehicles, business equipment, etc. (El-Gamal, 2006) The most famous and mostly used markup instruments are Murabaha and Ijara.

2.3.2.1 TRADE WITH MARKUP OR COST-PLUS SALE (MURABAHA) One of the most widely used instruments for short-term financing is based on the traditional notion of purchase finance. The investor

undertakes to supply specific goods or commodities, incorporating a mutually agreed contact for resale to the client and the mutually negotiated margin. (Zamir Iqbal, 1997) Zamir Iqbal (1997) reported that around 75% of Islamic financial transactions are cost-plus sales. Some other researchers reported that it reached more than 90% of financing activities in some Islamic banks.

(Maali, Casson and Napier , 2006) Mark-up where the bank buys an item for a client and the client agrees to repay the bank the price and an agreed profit later on. (Abdul Gafoor, 1995) Aggarwal & Yousef (2000) explained the Murabaha financing as where the bank purchases an asset on behalf of an entrepreneur. The bank resells the asset to the entrepreneur at a predetermined price that covers the original cost and an added, negotiated profit margin. Payment is made in the future in lump sum or in installments. Ownership resides with the bank until all payments are made. (Aggarwal & Yousef, 2000). The definition by Mahmoud El-Gamal (2006) is matching with the above definitions, but in addition he indicates that these are analogous to the Federal Reserves use of "matched-sale purchase". And the mark-up in Murabaha financing is benchmarked (i.e., made to track ) conventional interest rate. (El-Gamal, 2006)

15

Islamic Bank Vr Conventional Bank

2.3.2.2 LEASING (IJARA) "Another popular instrument, accounting for about 10% of Islamic financial transactions, is leasing." ( Zamir Iqbal, 1997) Leasing is designed for financing vehicles, machinery, equipment, and aircraft. Different forms of leasing are permissible, including leases where a portion of the installment payment goes toward the final purchase (with the transfer of ownership to the leasee). ( Zamir Iqbal, 1997) Leasing where the bank buys an item for a client and leases it to him for an agreed period and at the end of that period the lessee pays the balance on the price agreed at the beginning an becomes the owner of the item. (Abdul Gafoor, 1995) Aggarwal & Yousef (2000) explained the Ijara financing, as where the bank purchases the asset and allows the entrepreneur to use it for a fixed charge. The ownership of the asset either remains with the bank or is gradually transferred to the entrepreneur in a rent-to-own contract. Ijara financing is the traditional contract for what is known as leasing today. (Aggarwal & Yousef, 2000). According the explanation by Mahmoud El-Gamal (2006), Ijara is a typical structure requires the bank to create a special purpose vehicle (SPV) to purchase and hold title to the financed property. The SPV then leases the property to the customer, who makes monthly payments that are part-rent and part-principal. Rents are calculated based on market interest rate, allowing monthly payments to follow a conventional amortization table. The juristic justification of the practice is that principal parts of monthly payments increase the customer's ownership in the property, and allow him to pay less rent (on the part ostensibly owned by the bank through the SPV) over time, thus replicating the conventional amortization table. (El-Gamal, 2006) 2.3.2.3 ISTISNA'A U.A.E finance house (KFH) explained this type of financing as follow Istisnaa is a special financing facility that could be used for

financing construction projects, industrial equipment and various capital

16

Islamic Bank Vr Conventional Bank

goods. Istisnaa financing is arranged through a mechanism whereby, bank contracts with a purchaser to deliver the contracted items on a future date assuming responsibility for project completion (Istisnaa), and then appoints sub-contractors to complete the project under its supervision through a separate contract (parallel Istisnaa). On completion of the project, the contracted items are delivered to the original purchaser who has the

responsibility for paying the purchase price as agreed upon in advance. The mode of payment could be flexible depending on the advance agreement between the bank and the customer. The Banks return for financing this transaction comprises of a profit margin included in the selling price, and is usually benchmarked to LIBOR."(KFH, 2008) 2.4 Actual Islamic Banking Situation: Practice Recent years have brought an increasing flow of empirical studies of Islamic banking. The earliest systematic empirical work was undertaken by Khan (l983). His observations covered Islamic banks operating in Sudan, United Arab Emirates, U.A.E, Bahrain, Jordan, and Egypt. Khan's study showed that these banks had little difficulty in devising practices in conformity with Shareia. He identified two types of investment accounts: one where the depositor authorized the banks to invest the money in any project and the other where the depositor had a say in the choice of project to be financed. On the asset side, the banks under investigation had been resorting to Mudaraba, Musharaka and Murabaha modes. Khan's study reported profit rates ranging from 9 to 20 per cent which were competitive with conventional banks in the corresponding areas. The rates of return to depositors varied between 8 and l5 per cent, which were quite comparable with the rates of return offered by conventional banks. Khan's study revealed that Islamic banks had a preference for trade finance and real estate investments. The study also revealed a strong preference for quick returns, which is understandable in view of the fact that these newly established institutions were anxious to report positive results even in the early years of operation.
17

Islamic Bank Vr Conventional Bank

Nienhaus (1988) suggests that the relative profitability of Islamic banks, especially in the Middle East in recent years, was to a large extent due to the property (real estate) boom. He has cited cases of heavy losses which came with the crash of the property sector.

Aggarwal supposed cultural to

&

Yousef

(2000)

argued

that

Islamic

banks

are

offer instruments consistent with the religious beliefs and of Muslim societies. According to prevailing

characteristics

interpretations of Islamic law, financial instruments should emphasize profitand-loss sharing (equity). Interest is prohibited, which seems to exclude debt contracts. But their research indicates that most of the financing provided by Islamic banks do not conform to the principle of profit-and-loss sharing. Instead, much of the financing provided by Islamic banks takes the form of debt-like instruments. Aggarwal & Yousef study also, contrary to the expectations of Islamic banking's advocates; long-term majority financing of Islamic they found that Islamic banks rarely offer

to entrepreneurs seeking capital. In addition, the banks' financial transactions at least initially were

directed away from agriculture and industry and toward retail or trade financing. The study by Iqbal and Mirakhor (l987) contains extremely interesting empirical observations, although these are confined to the experience of Iran and Pakistan, both of which have attempted to Islamize the entire banking system on a comprehensive basis. Iran switched to Islamic banking in August l983 with a three-year transition period. The Iranian system allows banks to accept current and savings deposits without having to pay any return, but it permits the banks to offer incentives such as variable prizes or bonuses in cash or kind on these deposits. Term deposits (both short-term and longterm) earn a rate of return based on the bank's profits and on the deposit maturity. No empirical evidence is as yet available on the interesting question
18

Islamic Bank Vr Conventional Bank

as to whether interest or a profit- share provides the more effective incentive to depositors for the mobilization of private saving. Where Islamic and conventional banks exist side by side, central bank control of bank interest rates is liable to be circumvented by shifts of funds to the Islamic banks. Iqbal noted that the conversion to Islamic modes has been much slower on the asset than on the deposit side. It appears that the Islamic banking system in Iran was able to use less than half of its resources for credit to the private sector, mostly in the form of short-term facilities, i.e., commercial and trade transactions. The slower pace of conversion on the asset side was attributed by the authors to the inadequate supply of

personnel trained in long-term financing. The authors, however, found no evidence to show that the effectiveness of monetary policy in Iran, broadly speaking, was altered by the conversion. The Pakistani experience differs from the Iranian one in that Pakistan had adopted for a gradual Islamic process which began in l979. In the first phase, which ended on 1st January, l985, domestic banks operated both interest- free and interest-based 'windows'. In the second phase of the transformation process, the banking system was geared to operate all transactions on the basis of no interest, the only exceptions being foreign currency deposits, foreign loans and government debts. The Pakistani model took care to ensure that the new modes of financing did not upset the basic functioning and structure of the banking system. This and the gradual pace of transition, according to the authors, made it easier for the Pakistani banks to adapt to the new system. The rate of return on profit-and-loss sharing (PLS) deposits appears not only to have been in general higher than the interest rate before Islamization but also to have varied between banks, the differential indicating the degree of competition in the banking industry. The authors noted that the PLS system and the new modes of financing had accorded considerable flexibility t o banks and their c l i e n t s . Once a g a i n t h e s t u d y c o n c l u d e d t h a t

t h e effectiveness of monetary policy in Pakistan was not impaired by the

19

Islamic Bank Vr Conventional Bank

changeover. Iqbal and Mirakhor study, however, expressed considerable

uneasiness about the concentration of bank assets on short-term trade credits rather than on long-term financing. This the authors found

undesirable, not only because it is inconsistent with the intentions of the new system, but also because the heavy concentration on a few assets might increase risks and destabilize the asset portfolios. Beng Soon Chong and Ming-Hua Liu in their study about the Islamic banks (2007), they found that a unique feature that suppose to differentiates Islamic banking from Conventional banking is the PLS paradigm. In practice, however, they found that Islamic banking is not very different from conventional banking from the perspective of the PLS paradigm. On the asset side of Islamic banking, they found that only a negligible portion of financing is based on the PLS principle. Consistent with Islamic banking experiences elsewhere; a large majority of Islamic bank financing in Malaysia is still based on non-PLS modes that are permissible under the Shareia law, but ignore the spirit of the usury prohibition. On the liability side, the PLS principle is more widely adopted in structuring Islamic deposits. Their study, however, provides new evidence, which shows that, in practice, Islamic deposits are not interest-free. 2.5 Synthesis The Islamic financial system has developed some basic instruments which stick to the basics of the system. Basic instruments include cost-plus financing (Murabaha), profit-sharing (Mudaraba), leasing (Ijara), partnership (Musharaka) and forward sale (Bay' Salam). These instruments serve as the basic building blocks for developing a wide variety of more complex financial instruments. ( Zamir Iqbal, 1997). Based on the above bases and instruments, the Islamic finance are suppose to play a great role in economic development through promoting and encouraging entrepreneurs and

business firms to expand their activities.

20

Islamic Bank Vr Conventional Bank

The actuality of this situation may be compatible with the above theoretical bases or not, and the Islamic financing institutions may play its aimed role or not. But based on our literature review, we see a big gap between the theoretical bases and the actuality and applied services by Islamic banks in many countries which are subjected to researches. And many writers see that there is not a significant difference between the actual situation of Islamic banks and the conventional banks. So, based on the above, our null hypothesis for this research will be the equality of performances of both Islamic and conventional banks in U.A.E. The data analysis will show if this hypothesis is accepted or not.

21

Islamic Bank Vr Conventional Bank

CHAPTER 3. RESEARCH METHODOLOGY 3.1 3.1.1 Research Design Descriptive Design 1. Case Study 2. Correlation Study 3. Development Study 4. Survey Study

3.1.2

Empirical Design

1. Financial Rations 2. Graphs 3. Financial Statements

3.2 Population

The Population is defined as all members that are described by the characteristic select by the experimenter.

Major Islamic Bank (IB) in U.A.E. Major Conventional Banks (CB) In U.A.E. Trends of Islamic Banks in International Market. Trends of Conventional Bank sin International Market.

22

Islamic Bank Vr Conventional Bank

3.3

Tools

Categorized as primary and secondary tools

1. Primary Tools 2. Seconday Tools

: :

Internet, Online Urls. Internal case study Accounting and financial rations, Financial Statements

3.4

Limitations

There are more than fifty two (52) banks operating in U.A.E. Out of these 42 is conventional banks and ten is Islamic banks. The conventional banks are assessed performance of this bank may be not enough indication to the performance of industry of Islamic banking.

23

Islamic Bank Vr Conventional Bank

CHAPTER 4: 4.1 BANKS TAKEN INTO STUDY In this chapter we will discuss our empirical tests and their findings, a descriptive statistics of performance financial ratios will be represented. We would like to mention that, all financial ratios used in this analysis are obtained from financial Statements of banks. First of all I will introduce my selected banks which I selected to complete my research.

4.1.1 ABU DHABI COMMERCIAL BANK

Abu Dhabi Commercial Bank is 65 percent owned by the state-controlled Abu Dhabi Investment Council, and is the United Arab Emirates' third-biggest bank by assets. The bank changed its name from Khalij Commercial Bank to Abu Dhabi Commercial Bank after merging with Emirates Commercial Bank and Federal Commercial Bank on 1 July 1985. The bank is a public shareholding company with limited liability, and was incorporated in Abu Dhabi in 1975, to carry on retail, commercial, investment and merchant banking through a 33-branch network spread across the UAE, in addition to two branches in India and an offshore banking unit in the Cayman Islands. More about the company Address: Previous Name: Alternate Name: Type: Established Date: Ownership: Al Salam Street P.O.Box 939, Abu Dhabi, UAE Khalij Commercial Bank ADCB Joint stock 1st July 1985 Public
24

Islamic Bank Vr Conventional Bank

Abu Dhabi Commercial Bank (ADCB), headquartered in Abu Dhabi in the UAE, is a diversified full service Bank active in all banking services that span corporate, retail and commercial banking as well as in the areas of treasury derivatives, infrastructure finance, private banking and wealth management. ADCBs strong franchise is supported by a network of 172 ATMs across the UAE and 45 branches in the UAE as well as 2 branches in India. ADCB considers its principal competitive strengths in the retail area include its strong market share and franchise reflecting its large and loyal customer base. In addition, ADCB is indirectly majority owned by the Government of Abu Dhabi. In relation to investment banking, ADCB competes with local, regional and major international financial institutions. ADCB believes that its deep knowledge and understanding of what customers really want and need, will enable it to reach its goal of becoming one of the UAEs most modern and service orientated Banks in the UAE. During May 2008, ADCB acquired a 25 per cent, interest in RHBC, a leading Malaysian Bank in a step that will pave the way for a strategic partnership between the two financial institutions enabling them to leverage on the growing cross border banking activities between Asia and Gulf Corporation Council. ADCBs recently launched campaign Long Live Ambition is more than just a catchy slogan. Its a celebration of the UAE and its people, and of the ways in which the Bank is different. The campaign neatly captures the essence of the country, but the trick is in ensuring that it is reflected not just in the Banks branding, but in its day-to-day operations too. ADCB reflects Long Live Ambition in the way that it deals with its customers. The Bank is putting this into practice in the products and services it offers too ADCB - Accounts Active saver account. Current account Fixed deposit account Millionaire destiny saving accounts Business choice current account
25

Islamic Bank Vr Conventional Bank

Loans

Fast tract account Debit card account Ethihad guest account

Personal loans 1. Personal loans for UAE nationals 2. Personal loans for Expartriates. ADCB education loans End use loans Mortgage services 1. Mortgage refinance services 2. Mortgage overdraft Excellency mortage services 1. For UAE Nationals 2. For Expartriates. Car loans for new and used cars New Products ADIB has partnered with Etihad Airways to bring you the most rewarding Sharia compliant airline card in the UAE, the customer will be awarded up to 50,000 Etihad Guest Miles when they apply, and earn more miles every time when they use their card. They are the first UAE bank to bring you a new mobile banking service *161# Banking. Covered and Debit Cards now come with chip technology for enhanced security and peace of mind. In addition, our Covered Cards feature Paywave technology, which enables contactless payments - just wave your card over the scanner in participating outlets. The new cards will also feature a special instant finance option that will revolutionize the purchases ADCB is also upgrading womens banking with the launch of Dana, a new package of products, services and
26

Islamic Bank Vr Conventional Bank

special life style benefits designed to give our female customers the attention they deserve. From uniquely designed women-only areas and branches to highly skilled female relationship managers Dana Womens Banking gives the ladies customers special attention by people who truly understand their needs.

4.1.2 ABDU DHABI ISLAMIC BANK.

Abu Dhabi Islamic Bank was established on 20th May 1997 as a Public Joint Stock Company through the Amiri Decree No. 9 of 1997. The Bank commenced commercial operations on 11th November 1998, and was formally inaugurated by His Highness Sheikh Abdullah Bin Zayed Al Nahyan, UAE Minister of Information and Culture on 18th April 1999. All contracts, operations and transactions are carried out in accordance with Islamic Shari'a principles. The Capital ADIB commenced its operations with a paid-up capital of One Billion Dirhams divided into hundred million shares, the value of each share being ten dirhams. The shares are quoted on the Abu Dhabi Securities Market. Mission Islamic financial solutions for the global community. Vision To be the top tier Islamic financial services group. SUBSIDIARIES ABUDHABI ISLAMIC FINANCIAL SERVICES ASSOCIATES: NATIONAL BANK FOR DEVELOPMENT, ABUDHABI NATIONAL TAKAFUL, BOSNA BANK INTERNATIONAL REAL ESTATE - AL BUROOJ PROPERTIES Burooj Properties LLC is a solely owned subsidiary of Abu Dhabi Islamic Bank. The company which was established in October 2005 with a working capital of AED 500 million was created from the bank's former Real Estate department.
27

Islamic Bank Vr Conventional Bank

ADIB Securities Kawader Services Kawader is a premier recruitment Consultancy based in UAE that offers a hands-on quality service that allows us to source and work with candidates from a wide range of countries. Kawader provides Executive Search, Overseas Recruitment and Contract Staffing Services for contingencies as well as for turnkey projects and covers the following sectors: Aviation, Banking, Call Center, Construction, Engineering, Hospitality, Healthcare, IT, Media, Office Support also Facilities Management Services. National Bank for Development (NBD) - Egypt ADIB OWNERSHIP STRUCTURE Emirates International Investment co. UAE Nationals H.H Sheikh Hammad Bin Zayed Bin Sultan Al Nahyyan H.H Sheikh Khalid Bin Zayed Bin Sutlan Al Nahyyan U.A.E General Pension and Social security authority Jawaan Awaida Suhail Al Khaili The estate of HH Sheikh Nasser bIn Zayed Al Nahyan National Bank of Abudhabi. Sheikh Suroor Bin Muhammed bin Khalifa Al Nahyan Tasamim Real Estate Co. (LLC)

28

Islamic Bank Vr Conventional Bank

4.2 Islamic Banking and Conventional Banking Islamic banking and conventional banking are extremely different in many ways. The key difference is that Islamic Banking is based on Shariah foundation. Thus, all dealing, transaction, business approach, product feature, investment focus, responsibility are derived from the Shariah law, which lead to the significant difference in many part of the operations with as of the conventional The foundation of Islamic bank is based on the Islamic faith and must stay within the limits of Islamic Law or the Shariah in all of its actions and deeds. The original meaning of the Arabic word Shariah is 'the way to the source of life' and is now used to refer to legal system in keeping with the code of behaviour called for by the Holly Qur'an (Koran). Amongst the governing principles of an Islamic bank are : * The absence of interest-based (riba) transactions; * The avoidance of economic activities involving oppression (zulm) * The avoidance of economic activities involving speculation (gharar); * The introduction of an Islamic tax, zakat; * The discouragement of the production of goods and services which contradict the Islamic value (haram) On the other hand, conventional banking is essentially based on the debtor-creditor relationship between the depositors and the bank on one hand, and between the borrowers and the bank on the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money. Islamic law considers a loan to be given or taken, free of charge, to meet any contingency. Thus in Islamic Banking, the creditor should not take advantage of the borrower. When money is lent out on the basis of interest, more often that it leads to some kind of injustice. The first Islamic principle underlying for such kind of transactions is "deal not unjustly, and ye shall not
29

Islamic Bank Vr Conventional Bank

be dealt with unjustly" [2:279] which explain why commercial banking in an Islamic framework is not based on the debtor-creditor relationship. The other principle pertaining to financial transactions in Islam is that there should not be any reward without taking a risk. This principle is applicable to both labor and capital. As no payment is allowed for labor, unless it is applied to work, there is no reward for capital unless it is exposed to business risk. Thus, financial intermediation in an Islamic framework has been developed on the basis of the above-mentioned principles. Consequently financial relationships in Islam have been participatory in nature. Lastly, for the interest of the readers, the unique features of the conventional banking and Islamic banking are shown in terms of a box diagram as shown below:-

Conventional Banks 1. The functions and operating modes

Islamic Banks 1. The functions and operating modes of

of conventional banks are based on fully Islamic banks are based on the manmade principles. 2. The investor is assured of a predetermined rate of interest. principles of Islamic Shariah. 2. In contrast, it promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur). 3. It aims at maximizing profit without any restriction. 3. It also aims at maximizing profit but subject to Shariah restrictions.

30

Islamic Bank Vr Conventional Bank

4. It does not deal with Zakat.

4. In the modern Islamic banking system, it has become one of the service-oriented functions of the Islamic banks to be a Zakat Collection Centre and they also pay out their Zakat.

5. Lending money and getting it back with compounding interest is the fundamental function of the conventional banks.

5. Participation in partnership business is the fundamental function of the Islamic banks. So we have to understand our customer's business very well.

6. It can charge additional money (penalty and compounded interest) in case of defaulters.

6. The Islamic banks have no provision to charge any extra money from the defaulters. Only small amount of compensation and these proceeds is given to charity. Rebates are give for early settlement at the Bank's discretion.

7. Very often it results in the bank's own 7. It gives due importance to the public interest becoming prominent. It makes no effort to ensure growth with equity. interest. Its ultimate aim is to ensure growth with equity.

8. For interest-based commercial banks, 8. For the Islamic banks, it must be borrowing from the money market is relatively easier. 9. Since income from the advances is fixed, it gives little importance to based on a Shariah approved underlying transaction. 9. Since it shares profit and loss, the Islamic banks pay greater attention to

developing expertise in project appraisal developing project appraisal and and evaluations. evaluations.
31

Islamic Bank Vr Conventional Bank

10. The conventional banks give greater 10. The Islamic banks, on the other emphasis on credit-worthiness of the clients. hand, give greater emphasis on the viability of the projects.

11. The status of a conventional bank,

11. The status of Islamic bank in relation

in relation to its clients, is that of creditor to its clients is that of partners, investors and debtors. 12. A conventional bank has to guarantee all its deposits. and trader, buyer and seller. 12. Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al-wadiah, thus the depositors are guaranteed repayment of their funds, however if the account is based on the mudarabah concept, client have to share in a loss position.

FINANCIAL STATEMENTS

OF

Abdu Dhabi Commercial Bank &

32

Islamic Bank Vr Conventional Bank

Abdu Dhbai Islamic Bank

I. Balance Sheet of ADCB II. Profit & Loss Account of ADCB III. Balance Sheet of ADIB IV. Profit & Loss Account of ADIB

Abdu Dhabi Commercial Bank Balance Sheet At December 2010 2010 AED '000

Assets Cash and Balance with the Central Bank Deposits and balance due from banks 5,88,630 18,397,534

33

Islamic Bank Vr Conventional Bank

Loans and advances, net Derivative financial instruments Investment securitys Investment in associates Investment in Properties Other assets Property and equipment, net Intangible assets Total Assets

122,771,870 3,588,973 8,263,138 5,358,199 289,192 12,489,157 1,070,321 155,180 175,271,194

Liabilities Due to banks Deposits from customers Mandatory convertible security- liability component Sort and medium term borrowings l Deactivate financial instruments Long term borrowings Other liabilities Total liabilities Equity 4,841,865 106,134,185 29,131 21,019,694 3,487,764 8,906,109 14,279,098 158,697,846 19,573,348 178,271,194

Commitment and contingent liabilities

31,285,722

34

Islamic Bank Vr Conventional Bank

35

Islamic Bank Vr Conventional Bank

Abdu Dhabi Commercial Bank Income Statement At December 2010

2010 AED '000 For the year ended December 31,2010 Interest income Income for Islamic financing Interest expenses 7,158,894 217,541 (3,507,961)

Net interest expense Distribution to depositors

3,868,474 (186,269)

Net interest income net of distribution to depositors Net fees and commission income Net gain on dealing in derivatives Net gains from dealing in foreign currencies Decrease in fair value of investment properties Share of profit of associates Net(loss)/gain from trading and investment security Other operating income Loss on disposal of subsidiary Dividend income Operating income
36

3,682,205 956,253 169,766 142,962 (116,412) 336,294 (4,444) 160,868 (992) 9,400 5,335,900

Islamic Bank Vr Conventional Bank

Staff expenses Depreciation and amortization Other operating expenses Impairment allowance

(829,541) (108,795) (710,646) (3,287,071)

Operating Expenses

(4,936,053)

Profit/(loss) from operations before taxation Overseas income tax expenses Net profit /(loss) for the year Attributed to Equity holders of the parent Non-controlling interest

399,847 399,847 390,615 381,001 9,614

Net profit/ (loss ) for the year

390,615

Basic earnings/(loss) per share

0.04

37

Islamic Bank Vr Conventional Bank

Net profit /(loss) for the year Exchange difference arising on transaction of foreign operations Fair value charge on net investment in foreign operation hedges Fair value charges on available for sales investments Fair value charges reserved on disposal of available for sales investments Board of directors remuneration Share in comprehensive income statement items of associate

390,615 508,442 (430,544) 176,744 111,474 (5,250) 68,460

819,941 Total comprehensive income /(loss) for the year

Attributed to : 810,327 Equity holders of the parent 9,614 Non-controlling interest 819,941 Total comprehensive income/(loss) for the year

38

Islamic Bank Vr Conventional Bank

Abu Dhabi Islamic bank Balance Sheet At December 2010 2010 AED '000

Asset Cash and Balance with the UAE Central Bank Balance and wakala deposit with Islamic bank and other financial institution Murabaha and murabaha with financial institution Murabaha and other Islamic financing Ijara financing Investments Investment in associates Investment in Properties Development properties Other assets Property and equipment Total Assets 585,887 75,257,518 5,400,335

2,906,382 12,823,542 22,682,521 25,270,071 1,639,414 837,195 191,654 1,050,445

Liabilities Due to financial institutions Depositors accounts 891,390 56,517,045

39

Islamic Bank Vr Conventional Bank

Other liabilities Tier 2 wakala capital Sukuk financing instrument Total Liabilities

2,091,500 2,207,408 5,439,523 67,146,866

Equity Share Capital Legal reserve General reserve Retained earnings Proposed dividends Proposed dividends to charity Other reserves 2,364,706 1,754,899 443,182 984,069 511,783 6,816 42,122 6,107,577

Equity attribution to the equity holders of the bank Tier 1 sukuk Non-controlling interest

6,107,577 2,000,000 3,075

Total equity TOTAL LIBILITIES AND EQUITY CONTINGENT LIABILITY AND COMMITMENTS

8,110,652 75,257,518 12,156,042

40

Islamic Bank Vr Conventional Bank

Abu Dhabi Islamic bank Income Statement At December 2010

2010 AED '000 Operating Income Income from murabaha, murabaha wakala with financial institution Income from murabaha, murabaha, ijara and other Islamic financing Investment income Share of result of associate Fees and commission income net Foreign exchange income Income from investment properties Income from development properties Other income

187,719

3,453,005 75,699 14,798 343,325 29,071 5,265 (4,300) 14,441 4,119,023

Other expenses Employees cost General and administrative expenses Depreciation Provision for impairment, net (792,815) (431,210) (77,215) (749,212) (2,050,452) Profit From Operation, Before Distribution To Depositors
41

2,068,571

Islamic Bank Vr Conventional Bank

And Sukuk Holders Distribution to depositors and sukuk holders PROFIT FOR THE YEAR Attributable to: Equity holder of the bank Non-controlling interest 1,023,565 220 1,023,565 Basic and diluted earnings per share attributable to ordinary share (AED) (1,045,006) 1,023,565

0.382

42

Islamic Bank Vr Conventional Bank

4.2

DATA ANALYSIS ( Ratios analysis ) Financial statement analysis is based on accounting ratios. The following ratios are calculated to measure the performance of a commercial bank and Islamic bank. Profit margin ratio. Assets utilization ratio. Equity Multiplier Ratio. Return on assets ratio.

Return of equity ratio.

4.2.1 PROFIT MARGIN RATIO FORMULA:

TOTAL Operating Income

COMPONENTS: Net Income TOTAL Operating Income

ADIB 1,078,144 1,023,565

ADCB 818,941 5,335,900

SIGNIFICANCE: A measure of how well a bank controls its costs. It is calculated by dividing a bank's profit by its revenues and expressing the result as a percentage. The higher the profit margin is, the better the company is thought to control costs. Investors use the profit margin to compare companies in the same industry and well as between industries to determine which are the most profitable.

S. No
1.

RATIO

DESCRIPTION

CALCULATI ON 1,078,144 1,023,565

ADIB

Profit margin

Net Income TOTAL Operating Income

1.062

43

Ratio Analysis

Profit margin Ratio =

Net Income

Islamic Bank Vr Conventional Bank

S. No 1.

RATIO

DESCRIPTION

CALCULATIO N 818,941 5,335,900

ADCB

Profit margin

Net Income TOTAL Operating Income

0.1537

RATIO Profit margin

ADIB 1.062

ADCB 0.1537

2 1.5 1 0.5 0 ADIB ADCB

Profit Margin

INTERPRETATION

The Abu Dhabi Islamic Bank is in good position as compare to Abdu Dhabi Commercial bank. In ratio analysis we find great difference in profit margin ration the ration as ADIB is 1.062 and ADCB is .1537 only. Its means the ADIB is in great position to control its operating cost. A higher profit margin ratio can also mean sales are increasing faster than cost and defiantly ADIB is in a relatively liquid position as Compare to ADCB.
44

Ratio Analysis

GRAPH NO.1

Islamic Bank Vr Conventional Bank

4.2.2 ASSET UTILIZATION

FORMULA: ASSET UTILIZATION = TOTAL OPERATING INCOME TOTAL ASSETS

COMPONENTS: ADIB TOTAL OPERATING INCOME TOTAL ASSETS 1,023,565 75,357,518 ADCB 5,335,900 178,271,194

SIGNIFICANCE: A ratio that is used to determine how well a firm is managing its assets is called an activity ratio or asset utilization ratio. These ratios compare a company's sales to different asset categories. Three of the most common activity ratios compare sales to a company's accounts receivable, inventory and to its fixed assets (i.e., plants and equipment). These activity ratios are especially useful when used to compare a particular company to its industry bellwether, or to another company. The asset utilization ratio measures the extent to which the bank`s assets to generate revenue. The breakdown of asset utilization ratio separates the total revenue generated into interest income and noninterest income. S. No RATIO DESCRIPTION CALCULATIO N
1,023,565 75,357,518

ADIB

Assets utilization 2

Total operating income Total asset

1.36%

S. No

RATIO

DESCRIPTION

CALCULATIO N
5,335,900 178,271,194 45

ADCB

Assets Utilization

Total operating income Total asset

2.10%

Ratio Analysis

Islamic Bank Vr Conventional Bank

RATIO ASSETS UTILIZATION

ADIB 1.36%

ADCB 2.10%

2.5 2 1.5 1 0.5 0 ADIB ADCB Assets Utilization

GRAPH NO .2

INTERPRETATION

Asset Utilization ratio seems to like that ADCB is in good position as compare to ADIB the asset utilization ratio of ADCB is almost higher than ADIB is 54%. Theoretically ADCB is in better position than ADIB.

46

Islamic Bank Vr Conventional Bank

4.2.3 EQUITY MULTIPLIER

FORMULA: EQUITY MULTIPLIER = TOTAL ASSETS TOTAL EQUITY CAPITAL

COMPONENTS: Total Assets of the year Total Equity Capital

ADIB 75,257,518 8,110,652

ADCB 178,271,194 19,573,348

SIGNIFICANCE: Equity Multiplier measures the dollar value of assets funded with each dollar of equity capital (the higher this ratio, the more leverage or debt the bank is using to fund its assets.) It can be defined as, Amount or percentage of assets owned by each dollar of the equity invested in a business.

S. No

RATIO

DESCRIPTION

CALCULATIO N 75,257,518 8,110,652

ADIB

EQUITY MULTIPLIER

TOTAL ASSETS TOTAL EQUITY CAPITAL

9.28 times

S. No

RATIO

DESCRIPTION

CALCULATIO N 178,271,194 19,573,348

ADIB

EQUITY MULTIPLIER

TOTAL ASSETS TOTAL EQUITY CAPITAL

47

9.10 times

Ratio Analysis

Islamic Bank Vr Conventional Bank

RATIO EQUITY MULTIPLIER

ADIB 9.28 times

ADCB 9.10 times

9 7 5 3 1 ADIB ADCB Equity Multiplier

GRAPH NO. 3

INTERPRETATION

Equity Multiplier Ratio shows very minor difference as ADIB is 9.28 Times and ADCB is 9.10Times. As the graph showing almost equilibrium. The Abdu Dhabi Commercial bank is .18 Times better than Abu Dhabi Islamic Bank.

48

Islamic Bank Vr Conventional Bank

4.2.4 RETURN ON ASSETS (ROA)

FORMULA: RETURN ON ASSET (ROA) = NET INCOME TOTAL OPERATING INCOME x TOTAL OPERATING INCOME TOTAL ASSETS

OR

NET INCOME TOTAL ASSETS

COMPONENTS: Total Net Income Total Assets

ADIB 1,086,924 75,257,518

ADCB 819,941 178,271,194

A further breakdown of a bank`s profitability is that of dividing ROA into its profit margin PM and Assets Utilization AU ratio components.

SIGNIFICANCE: Return on assets is an indicator of how profitable a company is before leverage, and is compared with companies in the same industry. Since the figure for total assets of the company depends on the carrying value of the assets, some caution is required for companies whose carrying value may not correspond to the actual market value. Return on assets is a common figure used for comparing performance of financial institutions (such as banks), because the majority of their assets will have a carrying value that is close to their actual market value. Return on assets is not useful for comparisons between industries because of factors of scale and peculiar capital requirements (such as reserve requirements in the insurance and banking industries).

49

Ratio Analysis

Islamic Bank Vr Conventional Bank

S. No

RATIO

DESCRIPTION

CALCULATIO N 1,086,924 75,257,518

ADIB

RETURN ON ASSETS

NET INCOME TOTAL ASSETS

1.445%

S. No

RATIO

DESCRIPTION

CALCULATIO N 819,941 178,271,194

ADIB

RETURN ON ASSETS

NET INCOME TOTAL ASSETS

0.46%

RATIO RETURN ON ASSETS

ADIB 1.445%

ADCB 0.46%

2 1.5 1 0.5 0 ADIB ADCB

Return on Assets

GRAPH NO. 4
50

Islamic Bank Vr Conventional Bank

INTERPRETATION

The only common rule is that the higher return on assets is, the better, because the company is earning more money on its assets. A low return on assets compared with the industry average indicates inefficient use of company's assets So according to the rule ADIB ratio is 98.5% better than ADCB.

4.2.5 RETURN ON EQUITY (ROE)

FORMULA: RETURN ON EQUITY (ROI) = NET INCOME X TOTAL ASSETS TOTAL ASSETS TOTAL EQUITY CAPITAL

OR

NET INCOME TOTAL EQUITY CAPITAL

COMPONENTS: Net Income Total Equity Capital = =

ADIB 1,086,924 8,110,652

ADCB 819,941 19,573,348

SIGNIFICANCE: Return on Equity (ROE, Return on average common equity, and return on net worth) measures the rate of return on the ownership interest (shareholders' equity) of the common stock owners. ROE is viewed by investors as one of the most important financial ratios. It measures a firm's efficiency at generating profits from every dollar of shareholders' equity (also known as net assets or assets minus liabilities). It shows how well a company uses investment dollars to generate earnings growth. ROE is equal to a fiscal year's net income (after preferred stock dividends but before common stock dividends) divided by total equity (excluding preferred shares), expressed as a percentage.
51

Ratio Analysis

Islamic Bank Vr Conventional Bank

S. No 5

RATIO

DESCRIPTION

CALCULATIO N 1,086,924 8,110,652

ADIB

RETURN ON EQUITY

NET INCOME TOTAL EQUITY CAPITAL

13.406%

S. No 5

RATIO

DESCRIPTION

CALCULATIO N 819,941 19,573,348

ADIB

RETURN ON EQUITY

NET INCOME TOTAL EQUITY CAPITAL

4.19%

RATIO RETURN ON EQUITY (ROE)

ADIB 13.406%

ADCB 4.19%

52

Islamic Bank Vr Conventional Bank

14 12 10 8 6 4 2 0 ADIB ADCB Return On Equity

GRAPH NO. 5

INTERPRETATION . From the analysis of ADIB and ADCB we find Return on Equity of ADIB is 13.406% as compare to ADCB 4.19%. So The ADIB is in better position over ADCB. So the ADIB overall performance in return on equity is very good. ADIB is in position of provide dividends to owners and have funds for future growth of the company.

4.3

DISCUSSION AND FINDINGS

53

Islamic Bank Vr Conventional Bank

In This Chapter we determine whether it is possible to distinguish between conventional and Islamic banks in the Gulf Cooperation Council (GCC) region on the basis of financial characteristics alone. Islamic banks operate under different principles, such as risk sharing and the prohibition of interest, yet both types of banks face similar competitive conditions. The combination of effects makes it unclear whether financial ratios will differ significantly between the two categories of banks. We input 5 financial ratios in measurement of ADIB and ADCB to determine whether researchers or regulators could use these ratios to distinguish between the two types of banks. Although the means of several ratios are similar between the two categories of banks, so, we find that the main distinction between Islamic and convention banks are the difference in Principles.

54

Islamic Bank Vr Conventional Bank

CHAPTER 5: SUMMEARY OF FINDINGS, CONCLUSIONS, RECOMMENDATION

5.1.

SUMMARY OF FINDINGS. As a matter of fact, the Islamic banks and companies provide

significant contributions to the economic development process in U.A.E. And because of this reason the Islamic finance industry need to be in focus for more researches and developments. We think that our study itself needs to be repeated after some years to assess the performance of U.A.E Islamic banks after more maturity of this industry in U.A.E. Also the differences between the services provided by Islamic and conventional banks need to be subjected to more investigations and analysis.

We think also, there should be a more studies about the real practices of Islamic finance industry, and the differences between the theoretical bases of this industry and the actual practice. As we see many of the advocators of this industry writing about the benefits and the social role of Islamic finance, but we think they are focusing more on the theory and neglecting the actual practice

55

Islamic Bank Vr Conventional Bank

5.2

CONCLUSIONS

1-

The evaluation of the performance of Islamic banks through a number of

key ratios yields fairly satisfactory results. In general, Islamic banks are well Capitalized, profitable and stable. They also seem to be making an effective use of the resources at their disposal. However, they do not appear to be costeffective in their operations

2-

While their profitability ratios compare favorably with international

Standards, it should be noted that conventional banks depositors are guaranteed their principal amounts, and hence bear less risk than Islamic banks depositors. Therefore, the depositors of Islamic banks would genuinely expect a higher rate of Return to compensate for the extra risk. The current rates of profits on assets of the Islamic banks may not be enough to meet that expectation.

4)

The study does not lend any support to the general belief that Islamic

Banks are suffering from excess liquidity.

5)

When compared with conventional banks, Islamic banks as a group

outperformed the former in almost all areas and in almost all years. However, there are considerable variations among Islamic banks in terms of growth as well as performance. Such variations are quite natural. As a matter of fact, one objective of this study was to study the comparative performance of various Islamic banks, something that has never been done before in such detail. Similar variations are there even in the case of conventional banks.

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Islamic Bank Vr Conventional Bank

5.3

RECOMMENDATIONS

Islamic banking and finance activities are expected to grow even more rapidly in the foreseeable future providing sophisticated products and financial services. Based on our research, we think that it is very important to Islamic banks in U.A.E to pursue diversification by giving more focus to profit-losssharing financing instruments like Mudaraba and Musharaka. This will support the ethical and social expected role of Islamic finance industry. The Islamic banks also should decrease their dependence on debt-like financing instruments like Murabaha and Ijara, which form more than 90% of Islamic banks operations, as mentioned in some studies. We think also the rapid growth of Islamic banking is supported by religious Emotions of Muslim people; it is not based on a real competition in performance between Islamic and conventional banks. We think that Islamic banks should focus more in improving their efficiency for benefits of both owners and customers.

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Islamic Bank Vr Conventional Bank

Reference list:

1) www.adib.ae 2) www.adcb.ae 3) From Wikipedia, the form encyclopedia 4) Notes on Financial Institutions prepared by Mr.Imran Hasnain, Lecturer Accounting and Finance, Preston University, Ajman. 5) Notes on Banking Operations prepared by Mr.Hakim Shabir, Lecturer Banking Operations, Preston University, Ajman. 6) Code of Ethics & Business Conduct for ADCB Staff. 7) Banking law and practice by Dr. Israr Ahmad. 8) Dr. Zamir Iqbal Articals.

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