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ABSTRACT

Islamic banking and finance in Pakistan commenced in 1977-78 with the elimination of interest in compliance with the Principles of Islamic Shariah in Islamic banking practices. Since then, amendments in financial system to allow the issuance of new interest-free instrument of corporate financing, announcement of ordinance to permit the establishment of Mudarabah companies and floatation of Mudarabah Certificates, constitution of Commission for Transformation of Financial System (CTFS), and the establishments of Islamic Banking Department by the State Bank of Pakistan are some o the key steps taken place by the governments. Over the last few decades, the Muslims have been trying to restructure their lives on the basis of Islamic principles. They strongly feel that political & economical dominance of the west during the past centuries has deprived them of divine guidance, especially in the socio-economic fields. The aim of this study is to examine and to evaluate the performance of the Islamic banks in comparison with that of conventional banks. The study evaluates performance of the Islamic banks in profitability, liquidity, risk, and efficiency for the period of 2005-2008 for some banks for some period of 2007-2008 as the data was of there two years. Financial ratios (11 in total) such as Return on Asset (ROA), Return on Equity (ROE), Loan to Deposit ratio (LDR), Loan to Assets ratio (LAR), Debt to Equity ratio (DER), Asset Utilization (AU), and Income to Expense ratio (IER) are used to assess banking performances. The study found that Islamic banks are performing well and are going in right direction but are less profitable excluding MBL, more solvent (less risky), and also less efficient comparing to the conventional banks. However, there was no significant difference in liquidity between the two sets of banks. The reasons are due to the facts that conventional banks have longer history and experience in doing banking business and hold dominating position in the financial sector with its large share in the overall financial assets , as compared to Islamic banks, which in true sense, started only a few years back with all letter and spirit.

CHAPTER 1 INTRODUCTION

Islamic banks appeared on the world scene as active players over two decades ago. But "many of the principles upon which Islamic banking is based have been commonly accepted all over the world, for centuries rather than decades". The basic principle of Islamic banking is the prohibition of Riba- (Usury - or interest): "While a basic tenant of Islamic banking - the outlawing of riba, a term that encompasses not only the concept of usury, but also that of interest - has seldom been recognised as applicable beyond the Islamic world, many of its guiding principles have. The majority of these principles are based on simple morality and common sense, which form the bases of many religions, including Islam. "The universal nature of these principles is immediately apparent even at a cursory glance of non-Muslim literature. Usury was prohibited in both the Old and New Testaments of the Bible, while Shakespeare and many other writers, particularly those writing in the 19th century, have attacked the barbarity of the practice. Much of the morality championed by Victorian writers such as Dickens - ranging from the equitable distribution of wealth through to man's fundamental right to work - is clearly present in modern Islamic society. "Although the western media frequently suggest that Islamic banking in its present form is a recent phenomenon, in fact, the basic practices and principles date back to the early part of the seventh century." (Islamic Finance: A Euro money Publication, 1997) It is evident that Islamic finance was practiced predominantly in the Muslim world throughout the middle Ages, fostering trade and business activities. In Spain and the Mediterranean and Baltic States, Islamic merchants became indispensable middlemen for trading activities. It is claimed that many concepts, techniques, and instruments of Islamic finance were later adopted by European financiers and businessmen.

The revival of Islamic banking coincided with the world-wide celebration of the advent of the 15th Century of Islamic calendar (Hijra) in 1976. At the same time financial resources of Muslims particularly those of the oil producing countries, received a boost due to rationalization of the oil prices, which had hitherto been under the control of foreign oil Corporations. These events led Muslims' to strive to model their lives in accordance with the ethics and philosophy of Islam. Disenchantment with the value neutral capitalist and socialist financial systems led not only Muslims but also others to look for ethical values in their financial dealings and in the West some financial organizations have opted for ethical operations. Islam not only prohibits dealing in interest but also in liquor, pork, gambling, pornography and anything else, which the Shariah (Islamic Law) deems Haram (unlawful). Islamic banking is an instrument for the development of an Islamic economic order. Some of the salient features of this order may be summed up as: 1. While permitting the individual the right to seek his economic wellbeing, Islam makes a clear distinction between what is Halal (lawful) and what is haram (forbidden) in pursuit of such economic activity. In broad terms, Islam forbids all forms of economic activity, which are morally or socially injurious. 2. While acknowledging the individual's right to ownership of wealth legitimately acquired, Islam makes it obligatory on the individual to spend his wealth judiciously and not to hoard it, keep it idle or to squander it. 3. While allowing an individual to retain any surplus wealth, Islam seeks to reduce the margin of the surplus for the well-being of the community as a whole, in particular the destitute and deprived sections of society by participation in the process of Zakat. 4. While making allowance for the ways of human nature and yet not yielding to the consequences of its worst propensities, Islam seeks to

prevent the accumulation of wealth in a few hands to the detriment of society as a whole, by its laws of inheritance. 5. Viewed as a whole, the economic system envisaged by Islam aims at social justice without inhibiting individual enterprise beyond the point where it becomes not only collectively injurious but also individually self-destructive.

1.1 THE CONCEPT OF RIBA AND SALIENT FEATURES OF ISLAMIC FINANCIAL SYSTEM 1.1.1 RIBA IN QURAN & SUNNAH
The debate on definition of Riba particularly in context of present interestridden economic and financial system is almost settled among overwhelming majority of the Islamic scholars since late 1970s. Considering that modern institutionalized form of interest falls under absolute prohibition of Riba, efforts have been going on for about three decades for introducing Islamic banking system. However, still there might be some confusion in the minds of some individuals. It is pertinent; therefore, too briefly desirable as to what is Riba as prohibited by Islam. From the Holy Quran, order of revelation on Riba is as follows: And whatever Riba you give so that it may increase in the wealth of the people, it does not increase with Allah (Makki; 30: 39). And because of their (Jews) charging Riba while they were prohibited from it (Madani; 4: 161 ;). O those who believe do not eat up Riba doubled and redoubled. (Madani; 3:130). (The Shariah Advisory Board Judgment (Justice Taqi Usmanis Part) says: This Verse contains a clear prohibition for the Muslims and it can safely be said that it is the first Verse of the Holy Quran through which the practice of Riba was forbidden for the Muslims in express terms. ).

Verses in Sura Al-Baqarah (after conquest of Makkah); these Verses not only describe the prohibition of Riba, but also give a comprehensive definition of Riba as given below: Those who take riba will not stand but as stands the one whom the demon has driven crazy by his touch. That is because they say: Trade is just like Riba; whereas Allah has allowed (profit from) trade and prohibited Riba. So, whoever receives an advice from his Lord and stops (from taking Riba), he is allowed what has passed, and his matter is up to Allah. And the ones who revert back, those are the people of Fire. There they would remain forever. Allah destroys Riba and nourishes charities. And Allah does not like any sinful disbeliever.

(11:275,276). O you who believe. Fear Allah, and give up the Riba that remains outstanding if you are (in truth) believers. (11:278).If you do not do so, then be sure of being at war with Allah and his Messenger. But, if you repent, then you have your principal. Wrong not, and you shall not be wronged. (11:279) (Some exegetes explain the phase Laa tazlimoona wa laa tuzlamoon as without inflicting or receiving injustice meaning that without increase or diminution where both an increase or a decrease of the amount returned relative to the amount lent would be considered injustice). (See Al-Tabari, Jami Al-Bayani: Verse: 2:279) And if there be one (the debtor) in misery, then deferment till ease. And that you leave it as alms is far better for you, if you really know. And be fearful of a day when you shall be returned to Allah, then everybody shall be paid, in full, what he has earned. wronged. (11:280,281). The Holy Prophet (Peace be upon him) said, Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates and salt for salt like for like, equal for equal, and hand-to-hand; if the commodities differ, then you may sell as you wish, provided that the exchange is hand-to-hand.(Sahih Muslim). A man employed by the Holy Prophet (Peace be upon him) in Khaybar brought for him janibs (dates of very fine quality). Upon the Prophets asking And they shall not be

him whether all the dates of Khaybar were such, the man replied that this was not the case and added that they exchanged a saa (a measure) of this kind for two or three (of the other kind). The Holy Prophet replied, Do not do so. Sell (the lower quality dates) for Dirhams and then use the Dirhams to buy Janibs. (When dates are exchanged against dates) they should be equal in weight. (Sahih Al-Bukhari). From Farewell Pilgrimage Address of Holy Prophet (Peace be upon him): Riba is forbidden and you will be entitled to recover your principal amount .. Allah has decreed that there should be no Riba and I am remitting the amount of Riba which my uncle Abbas has to receive. Sometimes, it is claimed that Riba is not defined clearly in the Holy Quran; but the claim is not substantiated. The Verse II:279, as given in the previous section, defines Riba being anything over and above the principal of a loan or debt. Owing to the fact that interest is a focal point in modern economic life, and specially that it is embedded in operations of existing financial institutions, a number of Muslims have been interpreting it in a manner which is radically different from the understanding of Muslim scholars throughout the last fourteen centuries and that is also sharply in conflict with the categorical statements of the Holy Prophet (peace be upon him). According to Islamic teachings, any excess on the capital is Riba (interest). Islam accepts no distinction, in so far as prohibition is concerned, between reasonable and exorbitant rates of interest and thus what came to be regarded as the difference between usury and interest; nor between returns or bonus on loans for consumption and those for production purposes and so on. (Translation of the Holy Quran by Allama Yusuf Ali, Revised Edition, 1989 by IIIT, USA; P: 115). Some people argue that there was no Commercial Interest in Arabia; only a particular form (on consumption loan) was prohibited. This also is not correct according to the Supreme Courts Judgment: It is not to say that commercial or productive loans were not in vogue when Riba was prohibited. More than enough material has now come on the record to prove that commercial and

productive loans were not foreign to the Arabs, and that loans were advanced for productive purposes both before and after the advent of Islam. (SAB: Pp.546-557). All kinds of commercial, industrial and agricultural loans advanced on the basis of interest were prevalent in the Byzantine Empire ruling in Syria, to the extent that Justinian, the Byzantine Emperor (527-565 A.D) had to promulgate a law determining the rates of interest which could be charged from different types of borrowers. (SAB: Pp.548). The Arabs, especially of Makkah, had constant business relations with Syria, one of the most civilized provinces of the Byzantine Empire. The Arab trade caravans used to export goods to and import other goods from Syria. (SAB: Pp.549). The above material is more than enough to prove that the concept of commercial loans was not alien to the Holy Prophet (Peace be upon him) or his companions when Riba was prohibited. Therefore, it is not correct to say that the prohibition of Riba was restricted to the consumption loans only and it did not refer to the commercial loans." (SAB: Pp.557). The SAB has proved that commercial interest was prevalent at the time of revelation of Holy Quran and concluded: It is thus clear that the permissibility of interest can neither be based on the financial position of the debtor, nor on the purpose for which money is borrowed, and therefore, the distinction between consumption loans and productive loans in this respect is contrary to the well-established principles.

1.2. NATURE AND TYPES OF RIBA


Riba is mainly divided into two types i.e. Riba Al-Fadl and Riba Al-Nasia. The concept of Riba Al-Fadl refers to sale transactions while Riba Al-Nasia refers to loan transactions. The latter is also termed as Riba Al-Quran. Quality premium in exchange of low quality with better quality goods (Riba Al-Fadl) is prohibited e.g. in exchange of dates for dates, wheat for wheat, etc. Interest in all modern banking transactions falls under Riba Al-Nasia, about prohibition of which there is consensus of Ummah. Production/commercial loans did

exist at the time of Holy Prophet (Peace be upon him) that involved Riba AlNasia or interest in various forms. Repaying a loan in excess of principal but without any explicit or implicit precondition is established form the Sunnah of the Holy Prophet (Peace be upon him). However, an institutionalized form of gift and the practice with preconceived notion of addition that takes the form of a system, even if undetermined, would involve Riba.

1.3. RIBA ACCORDING TO SHARIAH COURT, PAKISTAN


The SAB of the Supreme Court of Pakistan declared: 1. All prevailing forms of interest, either in banking transactions or in private transactions, fall within the definition of Riba. 2. Any interest stipulated in government borrowings acquired from domestic or a foreign source is Riba and clearly prohibited by the Holy Quran. 3. The present financial system, based on interest, is against the Injunctions of Islam as laid down in the Holy Quran and Sunnah and in order to bring it in conformity with Shariah it has to be subjected to radical changes.

1.4. EARLY REPAYMENT REBATE


In case a debtor makes payment earlier than the due date can he be given any rebate in the amount payable is an issue of crucial importance in Islamic banking and finance. In the Pakistans NIB system of 1980s the banks used to charge mark up of extra 210 days with the provision that the extra charge would be remitted if the client pays the Murabaha receivable on due date. The Shariah Court declared the rebate as un Islamic. In normal Murabaha or leasing operations of Banks some clients may want early payment of their liabilities to the bank. In this respect the question arises whether banks can give some rebate to the clients.

On the subject of remitting a part of the debt against early payment and other concessions to debtors we come across three traditions of the Holy Prophet (sasm). Two traditions have been reported by Imam Baihaqi. Briefly these traditions are: (i) When the Holy Prophet (sasm) expelled Bani al Nadhir from Madina, he was told that debts are owed to some of them that have not become due; the Prophet said, Daawoo wa Taajjloo; (ii) A Companion, Miqdad bin Aswad said that he gave someone a qard of hundred Dinars. He felt need of money when the Holy Prophet sent him along with a delegation. He asked the debtor to remit ten and pay ninety Dirhams. He accepted and paid ninety Dirhams. When the Holy Prophet came to know, he said, you got yourself involved in Riba and made the other devour Riba.1 Going into details, the jurists have differentiated the two categories of loans i.e. Duyoon Haalah (loans or debts that have become due or could be called back any time,) and Duyoon Muajjalah (time of payment settled among creditor and debtor and the debt is not yet due). Remission of a part of liability in due loans is allowed by almost by all jurists on the rationale that in such loans, delay is not the right of the debtor.2 It means that if a debt has become due and it has not yet been paid, the creditor could remit a part of the amount for early payment. In this respect also Fuqaha, based on Hadith reported by Imam Bukhari as described above, say that it should not be made a condition. Shah Waliullah, in Musawwa, referring to the above two and the tradition of Kaab b. Malik and Abu Hadrad (rata) according to which the former waived half of the debt on recommendation of the Holy Prophet (sasm), has observed that the former two instances related to debt not yet due while the latter was due debt (Dayn al Haalah). He also explains that time of repayment cannot be stipulated in case of Qard while in case of credit sale (and Dayn) payment time can be settled in the contract.3

1 2 3

Baihaqi, Sunan al Kubra, 1344 H, Kitab al Buyoo Vol. 6, P. 28 Al Jassas, Ahkamul Quran, Urdu Translation, Vol 2, Pp. 387-392 Waliullah, Al Musawa min Ahadith al Muawatta, Vol. 2, Pp. 50, 51

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1.5. WHAT INTEREST DOES: THE RATIONALTE FOR PROHIBITION


The prohibition of interest is an issue concurred upon not only by Islam but all revealed religions of the world and the majority of ancient philosophers. The Greek and Roman thinkers had forbidden interest in their days. The Old and the New Testaments had similarly prohibited it. The logic as to why the religions including Islam have prohibited interest is that it exerts disastrous effects on the human societies by reinforcing the tendency of wealth accumulation in fewer hands. It leads to ever increasing share of risk free capital vis--vis risk based equity capital, resulting in business failures, unemployment and ultimately to gross inequalities of income and wealth that are bound to end-up in social strife and economic chaos. Islam is opposed to exploitation in every form and stands for fair and equitable dealings among all human beings. The rationale for prohibition of charging interest from someone who is constrained to borrow to meet his essential consumption requirements is obvious. But interest on loans taken for productive purposes is also prohibited because it is not an equitable form of transaction (C.I.I. 1980). When money is invested in a productive undertaking the quantum of profits that may accrue is not known beforehand and there is also the possibility of a loss. Therefore, charging of a fixed and pre-determined rate of interest on loans for productive purposes cannot be morally justified. Justice demands that provider of money capital should share the risk with the entrepreneur if he wishes to earn profit. Thus, there is a basic difference between Islam and capitalism in regard to the treatment of money capital as a factor of production. Whereas in the capitalistic system, money capital is treated at par with labour and land, each being entitled to a return irrespective of profit or loss, this is not so in Islam which treats money capital at par with enterprise. (Ahmad, Ziauddin: 1997). The interest based financial system is creating un-repayable debt - making a class of people richer and leaving others poorer and oppressed. The unproductive and wasteful spending both by individuals and the

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governments, which the interest-based and easily available credit has the tendency to promote, has led to a decline in savings, real investments and the employment opportunities in almost all countries around the world. The system, combined with inflation, becomes a recipe for total economic instability. This affects the poor and the middle class comprising major part of the population and thereby, the level of national savings. The cost incurred in the form of interest has to be paid by the government through increasing rates, taxes and prices of consumption goods and utilities. The governments raise taxes without providing social amenities or quid pro quo. They owe Dollars, but they cannot create Dollars as the US banking system can create. Therefore, they resort to heavy taxation or to further borrowing for servicing the previous obligations. The foreign exchange earnings, including export proceeds and remittances of workers abroad are also consumed in debt servicing. Today all developing countries are caught up in a sophisticated debt trap owing to the most striking feature of interest-based mechanism: yesterdays debt can be repaid by taking out more debt today. According to the World Economic Outlook, total external debt and debt service payments of developing countries were US$ 2,068 billion and US$ 343 billion respectively at the end of 2000. Their ratio to exports of goods and services was 140% and 23% respectively, a position which is not sustainable. Even in the developed countries, total debt as a percentage of GDP has been on the increase over the last 30 years or so. It has been proved by empirical evidence that credit, compared with equity, does not play any critical role in the modern investment and business spending. Contrary to popular misconception, a major part of funds which finance business needs in the US, for example, are raised as equity (and not loans) on the open market that is, common stocks. Kester (1986) lists debtto-equity ratio for major categories of business in the US and Japan, and shows that most of these ratios are substantially below unity, so that equity financing is much more prevalent than debt financing. This amount of debt would be reduced even further were it not for the artificial tax advantage of debt-based financing in these countries (since interest payments can be

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written off).

Mohsin S. Khan (1986) has shown that interest based credit

increases the risk of banking crises. If collateral is sufficient, modern banks would finance projects even with poor feasibility. It results in business failures. In Pakistan, the debt-equity ratio is 70: 30 or even 80: 20. Actually, however, the part of equity is even lesser and majority of the business/industrial community use almost the borrowed money. Industrialists invest a meager share from their own resources and borrow 80 per cent or even more from the banks or DFIs, generally earn a high return out of which very small portion is shared with the banks. Interest-based system generates unemployment because capital and the wealth flow to the direction of high and risk-free return without regard to the efficiency of the fund borrowing sectors. This system has built-in tendency for increase in risk free capital vis--vis the risk-based capital. Why a person will invest his own resources for establishing a factory wherein he will have to deal with unionized labor and many other problems when he can earn a high return by investing money in any risk-free financial paper issued by the government to meet mostly its revenue expenditures. This results in recession, unemployment, bankruptcies and stagflation.

1.6. PHILOSOPHICAL BASIS OF ISLAMIC ECONOMICS AND FINANCE


The structure of Islamic finance revolves around prohibition of any predetermined return derived on loan/debt (Riba) and legality of profit. Ribacommonly known as interest is a certain increase taken as premium from the debtor or a cost accrued irrespective of the outcome of the business. It represents the return on transactions involving exchange of money for money, or the addition, on account of delay in payment, to the agreed price on sale debts/ debts. It has been prohibited as it generates imbalances in the economy. Another main prohibition is Gharar which refers to uncertainty about subject matter or price of the contracts that leads to disputes and wrongful acquisition of benefits by one party and undue loss to the other.

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All gains to the principal are not prohibited. Profit has been recognized as reward of capital. Islam permits gainful deployment of surplus resources for enhancement of their value. But liability of risk of loss rests with capital itself; No other factor can be made to bear the burden of the loss risk on capital. Financial transactions, in order to be permissible, should be associated with tangible real assets. In Islamic framework money itself is not recognized as capital and as such it cannot earn a profit in itself. The provider of funds is an entrepreneur manage the as well. He will get and profit/loss
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for capital

his to

capital any

and other

wage/remuneration for his entrepreneurship/labor . In case he does not business himself provides individual/group of individuals for any business, he will have a share in the profit while the latter, the manager of the business will get wages in the form of share in the profit. But if the business suffers loss, capital owner will bear the loss while the managers labor would go wasted. Thus, earning of profit depending upon the outcome of the business is permissible. Profit symbolizes entrepreneurship and creation of additional wealth. Keeping in view the above, it can be said that financing for the purpose of earning return has to be related to certain assets exposed to direct or indirect business risk. While return from loan/debt is prohibited, as described above, time has value that can be discounted in case of credit sales only through adjustment in price, not through interest. Money is treated as potential capital - it becomes capital only when it joins hands with other resources to undertake productivity. It does not have opportunity cost as in the conventional interest based setup. While value of bullion money is represented by content, the value of paper money or debased money is determined by the official commitment and not by its physical content. Giving a rebate to the debtor before the debt is due is also not permissible according to the Fuqaha. However, when a debt becomes due, the creditor, at his own discretion, can reduce his claim of debt. (Al- Zohaely, Vol.4, P. 693) In the context of Islamic economics a loan, in money and finance, will be considered only a monetary or financial transaction where only funds exchange hands with a guarantee for repayment in full and in the same
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Labor means both human bodily and mental exertion.

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coins. On the other hand investment in Islamic context is not merely a financial or monetary transaction in which transfer of funds is the only activity. Investment will be considered only if it is a part of real activity or is itself a real activity. Thus purchasing a bond issued by the Government or any corporation or making a deposit in a conventional bank will not be considered investment because they are merely financial transactions and no real activity is involved. However, if the funds are used to purchase real goods or services and then sell them on profit then this use of funds will be treated as investment. But using the funds borrowed on interest for buying or building a physical asset will not be a permissible activity. Similarly, buying and selling a financial document will not be an investment because no real activity is involved in this exchange. As such, while earning on loans is prohibited for the reason of being interest, any return on investment is permissible and allowed. In loan transactions, exchange must be of equal amounts. If the borrowed commodity is fungible as the currency notes are, exactly its similar is to be repaid; and in the case of non-fungible goods the loan contract will be made in terms of money5. In the case of two similar goods, the condition of excess payment of either is prohibited even when it is a transaction of sale, not loan. The excess has been termed as Riba. Thus if one Ton of wheat or 1000 rupees are borrowed, one Ton of wheat or 1000 rupees will be repaid; any excess shall be usurious. Currency notes represent thaman (price) and trading in thaman has been declared by the Holy Prophet (Peace be upon him) as usurious except when exchanged hand to hand and equal for equal (in case of similar currencies). The Islamic Shariah has given some rules for exchange of currency and goods. If commodities are exchanged for one another (similar or different) the rules will be different from the situation when these are exchanged for currency notes. The Holy Prophet (Peace be upon him) in a famous Hadith has prohibited mutual exchange of certain goods except equal for equal and/or hand to hand (quoted in subsequent section of this Chapter).
According to the Hanafites, only the fungible goods may be lent or borrowed. Other schools of Islamic Fiqh, however, allow lending of every kind of property; and in case the similar is not available, its price will be paid to the lender (Al-Jaziri, Vol:2, P: 679).
5

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Explaining relevance of this Hadith, Imam Nawavi, an eminent commentator of Sahih Muslim, says that when the effective cause (illah) of prohibition of exchange of two commodities is different, shortfall or excess and delay in payment, both are permissible, as for example, sale of gold for wheat (the former being medium of exchange and the latter, edibility); when the commodities are similar, excess/deficiency and delay in payment both are prohibited, e.g., gold for gold or wheat for wheat; when the commodities are heterogeneous but the illah is the same as in the case of sale of gold for silver (the common illah being their use as medium of exchange) or of wheat for rice (the common illah being edibility), then excess/deficiency is allowed while the delay in payment is not allowed. It is imperative, therefore, that when a sale transaction is taking place among Nuqud or currencies of similar nature, or even dissimilar nature, the exchange has to take place instantly and not on deferred basis. There are numerous traditions of the Holy Prophet (Peace be upon him) to the effect. The current practice of financial institutions, insurance companies, markets of futures & options are un-Islamic because of the elements of Gharar, interest, gambling, etc. Transactions of contemporary stock markets, if cleansed of these elements, would be Islamic. The State has to play a complementary role. Coercive State action curbs the freedom of the individual and detracts from the Islamic character of the system. In addition to maintenance of law and order and administration of justice, the State has to ensure social security and provide for basic needs of the people including food, clothing, shelter, education and medical facilities in so far as its resources permit. Important Shariah maxim: Al Kharaj bil Daman or Al Ghunm bil Ghurm or laa ribh maa laa yadhman is the criterion of legality of any return on capital meaning thereby that assumption of business risk is a pre-condition for acquisition of any profit over the principal. It refers to the fact that the productive role of invested fund that justifies return on it in a real activity is the willingness and ability to bear the risk of a potential loss. Reward should depend on the productive behavior implying that interest, lotteries, gambling, etc. are prohibited. Risk involved in partnership finance is far more than that

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involved in trading modes like Murabaha or Salam and Ijarah. While the full business risk category represents the real instruments of Islamic finance, the low risk category is secondary and requires many conditions to be fulfilled to be really differentiated from interest based operations. In Salam or Murabaha, for example, the banks will receive (or deal in) certain commodities, not money, from their clients. They cannot sell commodities purchased through Salam before the same are actually delivered to them. The partners of a business conducted on the basis of Shirkah are at liberty to determine, with mutual consent, the ratio of profit allocated for each of them. The loss suffered by each partner must be exactly in the proportion of his investment. Buying/selling on credit, and lending is permissible, with or without security, with the condition that credit transactions should not involve any addition or enhancement to the principal amount of loan or debt. According to Shariah Rules, liability of the partners in a partnership firm is unlimited (not limited to the invested amount) since a partnership is not a legal person like a limited liability company. In case of business failure, and if Musharakah goes under loss, all liabilities in excess of remaining assets are to be shared proportionally by the partners. However, liability of the shareholders of Joint Stock Public Company is limited. Islamic economics has the provision of risk mitigation through forward trading on the basis of Salam, Istisnaa and Joaalah. This aspect has not only a great potential for developing agricultural and rural micro finance market but also for making future of majority of people living in rural areas. However, forward foreign exchange operations with delayed payment of any of the currency of exchange and most types of financial futures are not available in the Shariah compliant system because these instruments are a part of hedging strategies of interest-based system. Spot foreign exchange market can function without any problem. The concept of forward trading can be used only for promoting real productive and exchange purposes and not for making speculative gains. Futures trading in commodities like gold and silver that serve as thaman is forbidden. As regards currency futures, some scholars forbid them while

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others distinguish between the two cases. The first is where one currency is delivered on spot and the other is delayed; this is forbidden. The second one, that is permitted, involves the future exchange of both currencies at the previously agreed rate. About principles regulating operations in the market, the Jeddah based Council of the Islamic Fiqh Academy of the OIC in its Fifth session (10 15 December 1988) held that: a. The basic principle in the Quran and the Sunnah of the Holy Prophet (Peace be upon him) is that a person should be free to buy and sell and dispose of his possession and money, within the framework of Islamic Shariah in accordance with the divine Command: (O you who believe! Consume not each others property in vanities, unless there is trade based on mutual acceptance). b. There is no restriction on the percentage of profit which a trader may make in his transactions. It is generally left to the merchants themselves, the business environment and the nature of the merchant and of the goods. Care should be given, however, to ethics recommended by Shariah, such as moderation, contentment and leniency. c. Shariah texts have spelt out the necessity to keep the transactions away from illicit acts like fraud, cheating, deceit, forgery, concealment of actual features and benefits which are detrimental to well being of the society and individuals. d. Government should not be involved in fixing prices except only when obvious pitfalls are noticed within the market and the prices due to artificial factors. In this case, the government should intervene by applying adequate means to get rid of these factors, the causes of defects, excessive price increase and fraud.

1.7. SHARIAH BOUNDARIES FOR FINANCIAL TRANSACTIONS


The Islamic Shariah has enunciated a set of principles, which provide bases and limits for all kind of business in general, and economic and commercial

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transactions in particular. Principles enunciating justice, mutual help, free consent and honesty on the part of the parties to a contract, avoiding fraud, misrepresentation and misstatement of facts and negation of injustice or Zulm provide grounds for valid contracts. Principles providing for prohibition of Riba, Gharar, Jahl, Darar, Maysir and Qimar (gambling) define invalid and voidable contracts and demarcate the limits which should not be crossed. As a rule, Islamic law does not recognize transactions that have a proven illegitimate object or purpose. Riba and Gharar are the two main prohibitions. The basic attributes of the merchandise should consist of pure materials which should be objects of intrinsic/ legal value having some use. For that purpose, Shariah clarifies elements, as mentioned above, which are to be avoided in commerce or business transactions. In order to avoid inequitable gains and injustice, Islamic law has prescribed a number of boundaries. Gharar includes ambiguity/ uncertainty about the ultimate of a contract and the nature and/or quality and specifications of the subject matter of the contract or the rights and obligations of the parties. A sale or any other business contract which entails element of Gharar is prohibited. Examples of Gharar are: ignorance about the species being sold, about the quantity of the object and the price, lack of specification of the item being sold, e.g. saying I sell you one of the houses of this project without specifying that house, ignorance of the time of payment in deferred sales, contracting on a nonexistent object and/or inability to deliver the object, indicating more than one prices or option in a contract unless one is specifically chosen. According to Shariah scholars, a hazard or uncertainty to become prohibited (Gharar) would be major, remunerative e.g. involved in sale contracts, it should affect the principal aspects of the contract, and it may not be the need of any valid contract like that of Salam and Istisnaa. Gharar can be avoided if some standards of certainty are met, such as in the case of Salam a number of conditions are required to be fulfilled. The vendor must be able to deliver the commodity to the purchaser. It is prohibited to sell any undeliverable goods. The commodity must be clearly known and its quantity must be determined to the contracting parties. Further details about Gharar are given in the next part of the Chapter.

19

Jahl (ignorance) is a part of Gharar and means lack of clear understanding of the specifications about the very nature of the contract or the subject matter. Dharar means inflicting any undue loss or damage on the other party of the contract. The words Maysir and Qimar are used identically in Arabic language. While the word used in the Holy Qur'an for prohibition of gambling and wagering is Maysir (2:219 and 5:90,91), the Hadith literature discusses this act generally in the name of Qimar. According to the jurists, the difference between Maysir and Qimar is that the latter is an important kind of the former. Maysir derived from Yusr means wishing something valuable with ease and without paying an equivalent compensation (iwad) for it or without working for it, or without undertaking any liability against it, by way of game of chance. Qimar also means receipt of money, benefit or usufruct at the cost of others, having entitlement to that money or benefit, by resorting to chance. A person puts his money at stake wherein the amount being risked might bring huge sums of money or might be lost or damaged. Present day lotteries are also a kind of gambling. According to Pakistans Federal Shariah Court (FSC), a lottery in which coupons or tabs are given and inducement or incentives are provided by an uncertain and unknown event depending on chance, or disproportionate prizes are distributed by drawing of lots or where a participating person intends to avail a chance at prizes is repugnant to the injunctions of Islam. FSC adds that a scheme wherein the investors money is safe and intact, but the prizes to be given are related to interest generated from capital accumulated through it, is also repugnant to the injunctions of Islam. Further, transaction should conform to certain ethical standards e.g. trustworthiness/ truthfulness in business transactions and generosity in bargaining. It also requires avoiding fraud in business or trade, like false swearing, lies and hiding facts in any bargains. As all transactions involving interest payments are strictly prohibited, debt contracts cannot be sold at discount, and exchange transactions of money or goods representing money like gold and silver must be hand-to-hand and equal for equal. All financial transactions must be representation of real transactions or sale of goods, services or benefits (except Qard-e-Hasan),

20

otherwise it would mean exchange of money for money that is subject to all rules relating to Riba.

1.8 INVOLVEMENT OF GHARAR


Gharar is one of the main factors that make a transaction un-Islamic. Gharar means hazard, chance, stake or risk (khatar). In the legal terminology of the Fuqaha, Gharar is the sale of a thing which is not present at hand or the sale of a thing whose Aqiba (consequence) is not known or a sale involving hazard in which one does not know whether it will come to be or not, as sale of a fish in the water, or a bird in the air. Specifically, jurists slightly differ about coverage of Gharar6. As such, it relates more to uncertainty than to risk as we use in commercial terminology. consequences of the contract. This uncertainty relates to existence of the subject matter, rights/benefits to the parties and the Some jurists apply it to the cases of On the other hand Zahiri School of doubtfulness or uncertainty, e.g. whether or not something will take place. This excludes the unknown objects.7 Thought applies it only to the unknown to the exclusion of doubtful. Thus according to Ibn Hazm Gharar in sales occurs when the purchaser does not know what he has bought and the seller does not know what he has sold.8 However, majority of the jurists includes both unknown and the doubtful to render a transaction Gharar based and thus prohibited. Particularly, the Malikites widen the scope of Gharar on the basis of which eminent contemporary scholar Sh. Siddiqi Mohammad al-Ameen Al-Dhareer has classified the principles covering Gharar under the following heads9: I.i 1. 2. 3. 4.
6 7

Gharar in the terms and essence of the contract, includes: Two Sales in One Down-Payment (Arboon) Sale. The Pebble, Touch and Toss Sales. Suspended (Muallaq) Sale.

See Al-Dhareer, IRTI, IDB, 1997, Pp. 9-11; Hassan, Abdullah Alvi, 1993, Pp. 47, 48 Al-Dhareer, Siddiqi Al-Ameen, IRTI (IDB), 1997, p. 10; cf Ibn Abidin, Raddul Mukhtar, (iv/147) 8 Al-Muhallah Vol. Viii, pp. 343, 389, 439 9 Al-Dhareer, IRTI, 1997, pp. 10, 11

21

5. II.iii This includes: 1. 2. 3. 4. 5. 6. Sales. 7. 8. 9.

Future Sale Gharar in the object of contract.

Ignorance of the Genus Ignorance of the Species Ignorance of the Attributes Ignorance of the Quantity of the Object Ignorance of the Specific Identity of the Object. Ignorance of the Time of Payment in Deferred Inability to Deliver the Object. Contracting on a Non-Existent Object. Not Seeing the Object.

1.9. BULLION TRADE AND DELIVERY EXCHANGE OF CURRENCIES


Shariah has enjoined special rules regarding exchange of monetary values (Bai al-Sarf) according to which Nuqud (things representing money) on both sides in exchange of fungible goods must be equal for equal and hand to hand. If any article of the species of price, i.e. gold or silver, is sold for an article of the same kind, Islamic law requires that there must be simultaneous delivery and those articles must be equal in weight to one another. It makes no difference whether gold or silver is sold in the shape of coins or ornaments or otherwise. These articles are treated as price, because of the very nature of these precious metals. If gold is sold for silver or the reverse, Islamic law does not require equality in the bargain, but the delivery of the articles must be at the time of the transaction. These conditions were imposed for avoiding the effect of the application of Riba. OIC Fiqh Academy in its Ninth session (1-6 April 1995) resolved the following regarding crediting a sum of money in the bank account of a customer, in the following cases:

22

1. Where a sum of money has been credited to the account of the customer, either directly or through a Bank transfer. 2. Where a customer contracts a sale of Sarf by purchasing a currency for another currency standing in his own account. 3. Where the bank, on order of the customer, debits a sum of money from his own account and credits it to another account, in another currency, either in the same bank or in another bank, no matter whether it is credited in favor of the same customer or in favor of any other person. But it is necessary for the banks to keep in view the Islamic rules governing the contract of Sarf. If such crediting takes some time to enable the beneficiary to draw the amount so credited, this delay can be allowed, provided that it does not exceed usual period normally allowed in such transaction. However, the beneficiary of such crediting cannot deal in the currency during the allowed period until the crediting takes its full effect by enabling the beneficiary to draw the amount. The Academy in its Eleventh session (14-19 November, 1998) resolved: It is not permissible in Shariah to sell currencies by deferred sale, and it is not permissible, still, to fix a date for exchanging them. Qur'an, Sunnah and Ijma. This is evidenced in The Academy observed that contemporary

money transaction are major factors behind the financial crises and instability in the world and recommended: It is incumbent upon Muslim governments to exercise control over money markets and to regulate their activities relating to transactions in currencies and other money related transactions, in accordance with the principles of Islamic Shariah, because these principles are the safety valve against economic disaster. Some scholars have suggested the use of Salam in Fulus. However, the

forward sale or purchase of currencies in the form of Salam is not a valid contract. As described earlier, the paper money can be used only as price; it cannot serve as a commodity to be sold in Salam. The counter values to be exchanged in Salam include price on the one hand and the commodity on the other. The commodity is to be deferred in Salam and if the price is also

23

deferred, the Salam contract will mean the exchange of debt against debt which is prohibited. If price in Salam is US $ for example, and the commodity to be sold is Pak Rupee, it will be a currency transaction which cannot be made through Salam because such exchange of currencies requires simultaneous payment on both sides while in Salam, delivery of the commodity is deferred.

1.10. REFERENCE RATES


1. Reference rates would be needed for financial markets and intermediaries for executing and pricing the trade and leasing contracts. 2. Different types of reference scales are needed for different kinds of financial contracts. 3. While for Conventional finance, there is only one reference rate (interest rate), Islamic finance will have two basic groups of financial contracts: debt/semi-debt contracts and non-debt (equity) contracts, 4. Accordingly, there can be two reference scales: a. Price mark up/rent reference scale possibly through the yield on Government security. b. Sharing ratio reference scale, through the Central bank

Mudarabah ratio or Interbank Mudarabah ratio.

1.11 MAJOR ISLAMIC MODES OF FINANCING


Following are the main modes of Islamic banking and finance:

1.11.1 MURABAHA
Literally it means a sale on mutually agreed profit. Technically, it is a

contract of sale in which the seller declares his cost and profit. The parties negotiate on the margin or the rate of profit on the cost. Islamic banks have adopted this as a mode of financing. As a financing technique, it involves a request by the client to the bank to purchase certain goods for him. advance. The bank does that for a definite profit over the cost, which is stipulated in

1.11.2 IJARAH 24

Ijarah is a contract of a known and proposed usufruct against a specified and lawful return or consideration for the service or return for the benefit proposed to be taken, or for the effort or work proposed to be expended. In other words, Ijarah or leasing is the transfer of usufruct for a consideration which is rent in case of hiring of assets or things and wage in case of hiring of persons.

1.11.3 IJARAH-WAL-IQTINA
A contract under which an Islamic bank provides equipment, building or other assets to the client against an agreed rental together with a unilateral undertaking by the bank or the client that at the end of the lease period, the ownership in the asset would be transferred to the lessee. The undertaking or the promise does not become an integral part of the lease contract to make it conditional. The rentals as well as the purchase price are fixed in such manner that the bank gets back its principal sum along with profit over the period of lease.

1.11.4 MUSAWAMAH
Musawamah is a general and regular kind of sale in which price of the commodity to be traded is bargained between seller and the buyer without any reference to the price paid or cost incurred by the former. Thus, it is different from Murabaha in respect of pricing formula. seller in Musawamah is not obliged to reveal his cost. Unlike Murabaha, Both the parties

negotiate on the price. All other conditions relevant to Murabaha are valid for Musawamah as well. Musawamah can be used where the seller is not in a position to ascertain precisely the costs of commodities that he is offering to sell.

1.11.5 ISTISNAA
It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment and future delivery. Istisna can be used for providing the facility of financing the manufacture or construction of houses, plants, projects and building of bridges, roads and highways.

25

1.11.6 BAIMUAJJAL
Literally it means a credit sale. Technically, it is a financing technique

adopted by Islamic banks that takes the form of Murabaha Muajjal. It is a contract in which the bank earns a profit margin on his purchase price and allows the buyer to pay the price of the commodity at a future date in a lump sum or in installments. In case of Murabaha-Muajjal, it has to expressly mention cost of the commodity and the margin of profit is mutually agreed. The price fixed for the commodity in such a transaction can be the same as the spot price or higher or lower than the spot price.

1.11.7 MUDARABAH
A form of partnership where one party provides the funds while the other provides expertise and management. The latter is referred to as the Mudarib. Any profits accrued are shared between the two parties on a preagreed basis, while loss is borne only by the provider of the capital.

1.11.8 MUSHARAKAH
Musharakah means a relationship established under a contract by the mutual consent of the parties for sharing of profits and losses in the joint business. It is an agreement under which the Islamic bank provides funds, which are mixed with the funds of the business enterprise and others. All providers of capital are entitled to participate in management, but not necessarily required to do so. The profit is distributed among the partners in pre-agreed ratios, while the loss is borne by each partner strictly in proportion to respective capital contributions.

1.11.9 BAISALAM
Salam means a contract in which advance payment is made for goods to be delivered later on. The seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advance price fully paid at the time of contract. It is necessary that the quality of the commodity intended to be purchased is fully specified leaving no ambiguity leading to dispute. The objects of this sale are the general goods and cannot be gold, silver or currencies. Barring this, Bai Salam covers almost everything, which is

26

capable

of

being

definitely

described

as

to

quantity,

quality

and

workmanship.

CHAPTER 2 LITERATURE REVIEW

27

Dr. Anwar Iqbal Qureshi (1944) in his book Islam and The Theory of Interest reprinted in 1991 writes that Islam has fixed a zero rate of interest, and any rate above the zero rate is a usurious rate of interest. He has rejected all economic theories in support of interest without giving any rational. He further suggested that it would be possible to run modern system of banking without interest but he did not put any solution in that book or refer to any alternate mode of financing. He has suggested that lending to the needy people should be done from Bait-ul-Mal (Government Treasury) in the form of Qard-e-Hasna. He has recommended that Government should nationalize all banks and Insurance companies to run their working interest free. Dr. Muhammad Mazhar Iqbal (2003) in his paper A Broader Definition of Riba put a step forward saying, In modern finance, since stocks are treated as the subject matter of joint-stock companies and their price changes too often, their trading should also be considered as riba in barter loans. However, if some method of exchanging stocks on their par value is worked out, then their exchange needs not involve riba in barter loans. He discusses riba on the basis of Quranic verses and Hadith. In a judgment in 1991 the Federal Shariah Court of Pakistan declared the laws allowing interest repugnant to Islam10. The Federal Government of Pakistan and certain banks and financial institutions filed 67 appeals against this judgment in the Shariah Appellate Bench of the Supreme Court. In 1999 the Shariah Appellate Bench comprising of Mr. Justice Khalil-ur-Rahman, Mr. Justice Munir A Shaikh, Mr. Justice Wajeehuddin Ahmad, and Maulana Justice Muhammad Taqi Usmani, gave a decision against riba and declared all kinds of interest equal to riba and unlawful. The Commission for Transformation of Financial System set up in the State Bank of Pakistan in pursuant to the Supreme Court Judgment on Riba dated December 23, 1999 approved essentials of Islamic modes of financing including Musharakah, Mudarabah, Murabaha, Musawamah, Ijarah, Salam, and Istisna. State Bank of Pakistan provides these modes of financing to get
10

See The Text of the Historic Judgment on Interest. Introduction Pp.1.

28

comments of Banking industry and students at its web site. But still there are no prudential regulations from the State Bank of Pakistan to regulate Islamic Banks. Miriam Sophia Netzer (2004) in her paper Riba in Islamic Jurisprudence: The Role of Interest, in Discourse on Law and state writes that Shariah compliant financial instruments are those that do not contravene prohibitions in Islamic revelatory texts against riba, interest, and Gharar (speculation), in business transactions. Rasul Shams (2004) in his paper A Critical Assessment of Islamic Economics writes that those who defend the view of interest free banking as Islamic banking refer to Quran and ban all forms of interest including modern bank interest. We have doubts about this interpretation of Quranic verses. Further, Rasul Shams declares the difference in the meaning of Ar-Reba (Usury) and Rebhe (Interest) so the translation is a cause of misunderstanding. Dr. Hasan Abbas Zaki, Chairman of the Board of Directors of the Arab Banking Corporation11, sent a letter dated 22/10/2002 to the Grand Imam Dr. Muhammad Sayyid Tantawi, Rector of Al-Azhar and asked for a fatwa about the working of commercial banking. In response of this letter Dr. Muhammad Sayyid Tantawi writes, Investing funds with banks that pre-specify profits or returns is Islamically Legal, and there is no haram therein. Dr. Aqdas Ali Kazmi (2004) in his article in The News Islamic Economics and the Debate on Interest I & II had concluded about interest prohibition By disowning a useful and effective instrument of economic management, Islamic economists may not be doing any service to the cause of Islam and Islamic economic system. By focusing on elimination of the in eliminable and the inevitable i.e. interest, immense energies are being wasted while phenomena like bribery, corruption, exploitation of the underprivileged and myriad other forms of the real and the manifest riba continue to infest the Muslim world and fail to attract the full attention of the Muslim scholars.
See Riba in Islamic Jurisprudence: The Role of Interest, in Discourse on Law and State Pp.44.
11

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According to Dr. Aqdas Ali Kazmi, Profit and Loss Sharing is not a substitute of the interest rate, as it cannot perform all functions of interest in the economy. Consequently different people have different viewpoints. Some wrote the bank interest as halal and others haram according to Shariah and so two different schools of thought developed. In Pakistan two Islamic banks (AlBaraka Islamic Bank and Meezan Bank) are exclusively operating in Islamic banking whereas three commercial banks (Bank Alfalah Ltd., Faysal Bank, and Muslim Commercial Bank) have got issued licenses for Islamic banking and opened their separate Islamic banking branches. Noor Ahmed (2007) says Islamic banking has great potential for growth, but it has not made the headway as it should have due to lack of public awareness. In fact Islamic banking is accompanied with different ambiguities and queries in the peoples mind, limited products and inability to meet with all the requirements of corporate loans and services. It is moving ahead slowly to become more easy and practical choice over conventional banking. According to Atif Malik (2002) more than a billion of Muslims are living around the globe that would be willing to invest their surplus fund. So it is ideal time for Islamic banking industry to gear up its resources to attract them. Islamic banking industry is a vast industry and there are tremendous opportunities to attract investments. All that is required is persistence, determination and innovative ideas. In the opinion of Sheikh Nazim (2002) for all those (especially conventional banks) who wishes to start Islamic investment it is necessary to comply with the governing Shariah rules and its provisions. Muhammad Ayub (2008) says that Shariah compliance of the Islamic financial institutions is of vital importance for integrity and credibility of Islamic banking industry. As Islamic banks could fail as much due to non compliance with principles, as for financial imprudence, therefore it has to be ensured that the activities of the Islamic banks comply with Shariah principles. Habibur Rahman (2002) observes that throughout the world every year new banks and financial institutions based on Islamic Shariah are coming up and some conventional

30

banks have already opened their Islamic Banking windows because of the inherent strength of the system. The system has so far achieved two significant points to its credit; 1. No Islamic bank has yet failed. 2. Even by conventional standards Islamic banking has outweighed its traditional counterpart in the last two decades of the last century. Shamshad Akhtar (2007) says that IFBSs efforts to developing Islamic regulations as well as accounting, auditing and governance standards will facilitate adoption of unified principles for the development, operation and regulation of Islamic financial services. In the view point of Tahir (2005) Islamic banking is going through transition phase. New challenges are emerging for redrafting the rules. It may survive by working with more transparency, with effective corporate governance and with better interaction with relevant international, regional and national institutions and it will definitely help all those who want to contribute in the welfare of the people around the globe. Noor (2007) says that Islamic financial system employs the concept of participating in Halal business opportunities, utilizing the funds at risk on a profit and loss sharing basis. The investment in Islamic financial institutions provides potential opportunity for profit in proportion to the risk assumed to satisfy the different demands of participants in the contemporary environment and within the guidelines of the Shariah and the profit earned through rental sharing, Mudarabah, services charges may be termed as equalizer instead of mark up of Shariah complaint return. Shamshad Akhtar (2008) concludes that development of Islamic prudential regulatory and supervisory framework, which subscribes to Basel standards for conventional banking, will pave the way for development of Islamic finance, while tweaking the regulations to accommodate special risk characteristics of the Islamic finance, institutional framework and evolving approaches for supervision systems will help build confidence among investors and customers. Siddiqui (2005) says that profit and loss sharing aspect of Islamic banks can play vital

31

role in eradicating the negative effect of interest and can benefit the people in real terms. In the past studies about Islamic banks have been carried out on many diverse topics ranging from social and ethical aspects to rather descriptive kind of studies like why it is important to have interest free financial system. People have talked about the difference between Islamic banks and conventional Islamic banks and their products, the rational behind the prohibition of interest in Islamic society. There are some studies which have concentrated on the topic of different financial products that have been evolved in the efforts of presenting a workable Islamic financial system. A lot of work has been done by Islamic financial institutes to work out different financial instruments that can on one hand be good enough to satisfy the every increasing demand of corporate and individual customers and on the other hand to meet the requirements laid down by Shariah. One of the key aspect of Islamic mode of financing is the concept of trust between the borrower and the lender, in this system the ideal situation is that in which both the parties enter in to an agreement where they have full commitment to their cause (which in this case is to conduct a business concern and to make that a profitable concern). In this ideal situation different products have been proposed and implemented by different market players from time to time and academic world has been keeping an eye on this for some time now. Like there are some studies which are primarily focus on only one or two financial products and their progress in the market. For example the concept of P&L (Profit and Loss sharing) is been very well studied subject in Islamic financial world, they have given detail aspect of this and given detail accounts of different types of financing alternatives of interest in Islamic banking system based on the principle of P&L. He has given through information about investment-based, sale-based, rent-based and service-based investment alternative in Islamic banking system. Despite the fact that there have been lots of works undertaken on Islamic financial system, but the measurement of efficiency of Islamic financial institutes have been a week point in those studies, not much work is done on

32

these lines as compare to studies that have been focused on other aspects. Studies have been made to establish a relationship between profitability and banking characteristics. Some people have argued that Islamic banks can survive even in conventional banking environment in which PLS mode of financing is less dominant. He has argued that Islamic products have different risk characteristics and consequently different prudential regulation should be erected. One major aspect that he pointed out in his research is that since Islamic banks do not earn profit on their reserves (that every bank has to maintain with the central bank of the country, but these Islamic since can not earn profit on these reserves because of the interest factor involved in it) they lack behind in terms of efficiency as compare to conventional Commercial Banks. It is therefore been suggested by him that the reserve ratios of Islamic banks should not be like those of non Islamic banks but it should be some rational amount keeping in view the nature of business and the way these banks do their business. Different statistical tools have been employed by researchers to find out results. Data Envelopment Analysis is one of the most widely used tools in this respect. Lots of study in Islamic banking sector has been focused on the fact to find out the viability of Islamic banks and their ability to mobilize the savings, pool risks and facilitate transactions. Some studies have focused on the policy implications of interest free financial system. Some researchers have tried to find out a relationship between bank characteristics and overall financial environment that affects the banks performance. The writers have tried to focus their studies on the implications of external factors on the profitability of banks after controlling the financial and economics structure indicators. They have investigated the relationship between banks profitability and spread, portfolio maintain by banks and the measures to ensure the best possible return on their investment (Deposits). A common problem faced by all the researchers in this field, is that unlike other industries the banking sectors inside financial highlights are not that much easily accessible specially the lack of data that is available about Islamic banks. From the previous studies we can figure out that there are

33

some certain points that have been explored. These points can be summarized in following headings.

2.1.

DIFFERENCE

BETWEEN

ISLAMIC

AND

CONVENTIONAL BANKS
In these kinds of studies the writers have laid stress on the fact and need of why there is a need to have a separate financial system for Muslims or, what it is that make the Islamic financial system different from conventional financial system. These studies have been mainly theoretical and have laid stress on the social and ethical aspect of interest. Almost all of these studies have concluded at least one single point i.e. interest is a basis of an unequal and unjust system that provides opportunity for rich people to get even richer and puts extra pressure on poor people who can not survive with out having borrowed money. This is kind of an exploitation system where the have ones exploit the needs of have knots with their ability to provide enough liquidity to fulfill their needs and than earn extra money with out even risking their principle amount, which puts the borrower really of back foot.

2.2. FINANCIAL PRODUCTS FINANCIAL INSTITUTES

OFFERED

BY

ISLAMIC

Few studies have focused mainly on different financial products that the Islamic banks have devised during the evolution period, these banks have develop many new products that are both compliant with the needs of customers and to that of Islamic Shariah as well. Islamic banks have to be really innovative to come up with the products that they could present to their customer, who were quite use to the products that were presented to them by conventional banks and those products should not involve the element of interest in them as interest is not allowed in Islamic mode of financing. For this reasons they have to twist and turn different conventional products in order to make them in line with demands to Islamic Shariah. The given detail aspect of this and given detail accounts of different types of financing alternatives of interest in Islamic banking system based on the principle of P&L. He has given through information about investment based,

34

sale-based, rent-based and service-based investment alternative in Islamic banking system.

2.3. MEASURE OF EFFICIENCY


Different authors have tried to evaluate the efficiency of Islamic banks with different sets of tools, and have used different approaches. Like some of them have used only internal factors like ratio analysis and balance sheet items trends to measure their proficiency. Some people have used the concept of Data Enveloping Analysis with internal and external factors effecting the profitability and efficiency of banks. Some people have used the statistical tools such as T-test, correlation between different variables to find a link between the factors that determine the profitability of Islamic Banks.

2.4. FUNDS MOBILIZATION EFFICIENCY


Few studies in Islamic banking sector has been focused on the fact to find out the viability of Islamic banks and their ability to mobilize the savings, pool risks and facilitate transactions. Some studies have focused on the policy implications of interest free financial system. Some researchers have tried to find out a relationship between bank characteristics and overall financial environment that affects the banks performance.

2.5. POLICY IMPLICATIONS


Due to that fact the operations of Islamic banks differ from those of conventional banks and their commitment to not to charge and pay interest puts them in different case scenario, where they have different needs and separate set of regulations to govern their workings. Some of the regulations that were made for conventional banks hurt the operations of Islamic bank quite badly. E.g. as Islamic banks do not charge interest and nor they pay fix amount of interest on their loan they can not maintain huge amounts of reserves just to fulfill the statuary reserves condition. This high level of reserves deprives these Islamic banks to advance more loans, so as to keep their profit earning cycle going and properly employed their reserves.

35

2.6. SHORTFALL IN LITERATURE


The early studies about this topic were not conclusive enough, especially those which were more concern with the statistical aspects of performance. One of the major reason for these studies for not to be that much comprehensive enough is the fact that they did not had enough and comprehensive data available with them to perform those studies. What ever data that was available at that time was more kind of general information that is standard in financial institutions. Inability of the researchers or their lack of interest to compare the financial figures of Islamic banks with conventional banks is one major point that is lacking in some previous studies. There have been some studies where the researchers have compare the performance of two or more Islamic banks but most of the time the banks were either in same country or they were of the same group i.e. Islamic banks but very few people have tried to compare the banks from two different segments of market, namely Islamic banks and conventional commercial banks. People do have studies that were broader in their perspective like people have selected Islamic banks in one whole region or in some instances more than one geographical region,.

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CHAPTER 3 DATA AND METHODOLOGY

37

The study is aimed at comparative financial performance of Islamic banking and conventional banking in Pakistan. We will try to relate and compare the performance of the two banking groups to find the possible answer. The groups consist of the Islamic banking group and the other one is the conventional banking group. Selecting the banks was a slick process as most of the banks had already been used for different studies in past either on the basis of only one kind of banks i.e. Islamic banks or on the basis of their location as they were located in different geographical regions. This made them difficult to compare and get the desired results, as the environments in which these banks were operating were totally different from each others. To tackle this problem the researchers have to device and include different control variables in their data. Unlike other efforts where researchers have only used the data of Islamic banks we in this report have included both Islamic as well as conventional commercial banks in the set of data. This gives us an idea of how these two different set of banks which are working in the same field but in different working environment. Where for one group of banks, interest is the basic pillar of their working while for other its totally restricted. This cross group examination will help us to understand how the Islamic banks (which are generally thought as not been good performer) are working and performing in comparison to conventional banks. The banks have been selected on the basis of their total assets as it is important to have banks with similar structure to make the evaluation of the comparative results easy. Various indexes have been provided by financial management theories for measuring banks performance. Using accounting ratios is one of them. To measure performance of banks financial ratios have been used quite commonly and extensively in the literature. In this report weve performed the ratio analysis on the data obtained from the balance sheets of the banks and have grouped the ratios in different sets of ratios which are profitability ratios, liquidity ratios, risk & solvency ratios and

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efficiency profitability ratios. The analysis of the data concentrates on the figures of Islamic banks mainly because these are the main objective of this research to find answers for this set of banks. One of the major reasons of selecting the total assets of the banks is to measure the overall performance of bank is that size of the bank provides more effective control over its ability to counter any setback or problem faced in its financial operations, it also helps to control the cost factor of its operations as well. Large size of bank provides it a greater ability to diversify itself. (Basher, 2000) Evaluation of banks performance is a complicated procedure that involves the assessment of internal operations and external activities. In general, a number of financial ratios are usually used to measure the performance of financial intermediaries. In past various methods have been used in different studies to evaluate the performance of banks. There are some core methods been used by most of the studies and these methods include the method of evaluating internal performance by analyzing accounting data. Financial ratios usually provide a broader understanding of the banks financial condition since they are constructed from accounting data contained on the banks balance sheet and financial statement. Another key management element that many studies have found to be a primary factor in assessing bank performance is operating efficiency. In order to measure the operating efficiency of banks well be looking the operating ratios of banks, i.e. Return on Assets (ROA), Return on Equity (ROE). The ratios are helpful in determining the efficiency of banks in effectively using their assets in productive activities and return on equity. Both measures are closely tied to the key item in the income statement; net income. ROA and ROE have been used in most studies about structural performance and are included here to reflect the banks ability to generate income from nontraditional services. ROA shows the profit earned per rupees of assets and most importantly, reflects the ability of management to utilize the financial and real investment resources of banks to generate profits. For any bank, ROA depends on the banks decisions about its policy as well as the factors beyond control relating to the economy and government

39

regulations. Many regulators believe return on assets can best measure the efficiency of banks. ROE, on the other hand, reflects how effectively a bank management is using shareholders funds. A banks ROE is affected by its ROA as well as by the banks degree of financial leverage (equity/ asset). Since returns on assets tend to be lower for financial intermediaries, most banks utilize financial leverage heavily to increase return on equity to a competitive level. Profitability of banks are been measured through Profit margin against total assets of bank, net income to total assets and banks income to equity. Banks efficiency and ability to sustain in hostile conditions depends upon how well diversified they are in their capital structure, the ratios of return on its assets and equity. In order to see how Islamic banks have performed in comparison with the conventional banks over 4 years and 2 years, the study uses 11 financial ratios for the banks performance. These ratios are broadly categorized into four groups: (a) profitability ratios; (b) liquidity ratios; (c) risk and solvency ratios; and (d) efficiency ratios.

3.1. PROFITABILITY RATIOS


Broadly, accounting profits are the difference between revenues and costs. Profitability is considered to be the most difficult attributes of a business to conceptualize and to measure. These ratios are helpful and used to assess the ability of the business to generate earnings in contrast with its all expenses and other relevant costs during a specific time period. More specifically, these ratios indicate firms profitability after taking account of all expenses and income taxes, the efficiency of operations, firm pricing policies, profitability on assets and to shareholders of the firm. These ratios are generally considered to be the basic bank financial ratio in order to evaluate how well bank is performing in terms of profit. If a profitability ratio is relatively higher as compared to the competitor(s), industry averages, guidelines, or previous years same ratios, then it is taken as indicator of improve performance of the bank. Research applies these criteria to judge

40

the profitability of the two banks: Return on assets (ROA), Return on Equity (ROE), and Profit Expense Ratio (PER).

3.1.1. Return on Assets (ROA)


Return on assets indicates the profitability on the assets of the firm after all expenses and taxes. It is a common measure of managerial performance as it measures how much the firm is earning after tax for each rupee invested in the assets of the firm. It measures net earnings per unit of a given asset, moreover, how bank can convert its assets into earnings. Generally, a higher ratio means better and improve managerial performance and efficient utilization of the assets of the firm and lower ratio is the indicator of inefficient use of assets. ROA can be increased by firms either by increasing profit margins or asset turnover but they cant do it simultaneously because of competition and trade-off between turnover and margin. ROA is calculated as under: ROA = Net profit after tax / Total Assets

3.1.2. Return on Equity (ROE)


Return on equity indicates the profitability to shareholders of the firm after all expenses and taxes. It measures and tells how much the firm is earning after tax for each rupee invested in the firm. In other words, ROE is net earnings per rupee equity capital. By and large, higher ROE means better managerial performance; however, a higher return on equity may be due to debt (financial leverage) or higher return on assets. Financial leverage creates an important difference between ROA and ROE in that financial leverage always magnifies ROE. This will always be the case as long as the ROA (gross) is greater the interest rate on debt. Usually, there is higher ROE for high growth companies. ROE is calculated as under: ROE = Net profit after tax /Shareholders Equity

3.1.3. Profit to Expenses Ratio (PER)

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It measures the operating profitability of the bank with respect to its total operating expenses. In our research, operating profit is defined as earnings before taxes and operating expenses means total non-interest expenses. The ratio measures the amount of operating profit earned for each rupee of operating expense. The ratio indicates to what extent bank is efficient in controlling its operating expenses. A higher PER means bank is cost efficient and is making higher profits. PER is calculated as under: PER = Profit after tax /Operating Expenses

3.2. LIQUIDITY RATIOS


Liquidity ratios indicate the ability of the firm to meet its recurring financial obligations. Liquidity is important for the bank to avoid defaulting on its financial obligations and, thus, to avoid experiencing financial suffering. Liquidity ratios measure the ability of the firm to meet its short term financial obligations, maintain cash position, and collect receivables. Generally, the higher liquidity ratios mean bank has larger margin of safety and ability to cover its short term financial obligations. Because saving accounts and transaction deposits can be withdrawn at any time, so there is high liquidity risk for both the banks and other depository institutions. Banks can get into liquidity problem especially when withdrawals exceed new deposit significantly over a short period of time. Measures of liquidity are: Loan to Deposit Ratio (LDR), Cash & Portfolio Investment to Deposit Ratio (CPID), and Loan to Asset Ratio (LAR).

3.2.1. Loan to Deposit Ratio (LDR)


Loan to deposit is the most important ratio to measure the liquidity condition of the bank. Here, the loan means the advances for the conventional banks and financings for the Islamic banks. This is because Islamic banks are prohibited to extend loans and earn interest (Riba) and restricted to follow Islamic Shariah Principles while conducting their banking business operations so the only way the Islamic banks can utilize their deposits is to provide

42

financings through different Islamic financial products. Bank with Low LDR is considered to have excessive liquidity, potentially lower profits, and hence less risk as compared to the bank with high LDR. A high LDR indicates that a bank has taken more financial stress by making excessive loans and also shows risk that to meet depositors claims bank may have to sell some loans at loss. LDR is calculated as under: LDR = Loan / Deposits

3.2.2. Cash & Portfolio Investment to Deposit Ratio (CPIDR)


Another ratio to measure the liquidity of the bank is the cash and portfolio investments to deposit ratio. The higher the ratio the better is the liquidity position of the bank, therefore, the more is the confidence and trust of the depositors in the bank as compared to the bank with lower CPIDR. This ratio serves two purposes. First, it boosts the trust of the depositors in the bank as the depositors know that bank is not only having enough cash but also made some investments in securities portfolio and supposedly earning some positive returns on those portfolio investments. Secondly, they feel confident that in need of cash bank may sell these portfolio investments at any time in the secondary market which is readily available for this purpose. CPIDR is calculated as under: CPIDR = Cash & Portfolio Investments / Deposits

3.2.3. Loan to Asset Ratio (LAR)


Just like LDR, loan to assets ratio (LAR) is also an important ratio that measures the liquidity condition of the bank. Whereas LDR is a ratio in which liquidity of the bank is measured in terms of its deposits, LAR measures liquidity of the bank in terms of its total assets. That is, it estimates the percentage of total assets the bank has invested in loans (or financings). The higher is the ratio the less the liquidity is of the bank. Similar to LDR, the

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bank with low LAR is also considered to be more liquid as compared to the bank with higher LAR. However, high LAR is an indication of potentially higher profitability and hence more risk. LAR is calculated as under: LAR = Loan / Total Assets

3.3. RISK AND SOLVENCY RATIOS


Risk and solvency ratios are referred to as gearing, debt or financial leverage ratios. The degree to which a firm relies on debt financing rather equity is related with financial leverage. These ratios determine the bank probability that the firm default on its debt contacts. As the debt a firm is more, the higher is the chance that firm will become unable to fulfill its contractual obligations. In short, higher levels of debt can lead to higher probability of bankruptcy and financial distress. Although, debt is an important form of financing that provided significant tax advantage, it may create conflict of interest between the creditors and the shareholders. If the amount of assets is greater than amount of its all types of liabilities, the bank is conceived to be solvent. Deposits normally constitute liability for any type of bank whether Islamic or conventional. Borrowed money in either form12 stands second among total liabilities for almost all banks except all Islamic banks which are prohibited by Islamic Shariah from taking or giving any kind of interest-based debts13. To estimate risk and solvency of the bank, measures which usually used are: Debt-Equity Ratio (DER), Debt to Total Assets Ratio (DTAR), and Equity Multiplier (EM).

3.3.1. Debt-Equity Ratio (DER)


DER is one of the tools which measures the extent to which firm uses debt. It measures and evaluates ability of the bank capital to absorb financial shocks.
Either by issuing debt or borrowing from other financial institutions. A form of debt which is non-interest based called Qard-e-Hasan is permitted under Islamic Shariah (See badralislami.com for definition).
12

13

44

In case, creditors default in paying back their loans or the asset values decrease bank capital provides shield against those loan losses which are disturbing the financial position of the bank. A bank with lower DER is considered better and improved as compared to the bank with higher DER. DER is calculated as under: DER = Total Debt / Shareholders Equity

3.3.2. Debt to Total Assets Ratio (DTAR)


This ratio measures the amount of total debt firm used to finance its total assets. It is an indicator of financial health and strength of the bank. This provides information about the solvency and the ability of the bank to obtain additional financing for potentially attractive investment opportunities. A higher DTAR means bank has financed most of its assets through debt as compared to the equity financing. Moreover, higher DTAR indicates that bank is involved in more risky business. DTAR is calculated as under: DATR = Total Debt / Total Assets

3.3.3. Equity Multiplier (EM)


EM tells that how many times the total assets are of the shareholders equity is measure by equity multiplier. Moreover, it indicates the amount of assets per rupee of shareholders equity. Higher value of EM entails that bank has used more debt to convert into assets with share capital. Generally, the higher is the EM the greater is the risk for a bank. EM is calculated as under: EM = Total Assets / Total Shareholders Equity

3.4. EFFICIENCY RATIOS

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Efficiency ratios measure how effectively and efficiently the bank is managing and controlling its assets. It indicate the overall effectiveness of the firm in utilizing its assets to generate sales, quality of receivables and how successful the firm is in its collections, the promptness of payment to suppliers by the bank, effectiveness of the inventory management practices, and efficiency of firm in controlling its expenses. A higher value of these ratios is taken as good indicator which means firm is doing well. Ratios used to measure efficiency of the bank are: Income to Expense Ratio (IER), and Asset Utilization (AU).

3.4.1. Income Expense Ratio (IER)


Income to expense is the ratio that measures amount of income earned per rupee of operating expense. This is the most commonly and widely used ratio in the banking sector to assess the managerial efficiency in generating total income vis-a-vis assuring its operating expenses. High IER is preferred over lower one as this indicates the ability and efficiency of the bank in generating more total income in comparison to its total operating expenses. Total income in the research is defined as net spread earned before provisions plus all other income while the Other Expenses in the income statement are treated as total operating expense for the study. IER is calculated as under: IER = Total Income / Total Operating Expenses

3.4.2. Asset Utilization (AU)


How effectively the bank is utilizing all of its assets is measured by assets utilization ratio. The bank is presumably said to using its assets effectively in generating total revenues if the AU ratio is high. If the ratio of AU is low, the bank is not using its assets to their capacity and should either increase total revenues or dispose of some of the assets. Total revenue of the bank in this study is defined as net spread before provision plus all other income. AU is calculated as under:

Asset Utilization = Total Income / Total Operating Expenses

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3.5. DATA
The data used in this research includes financial figures of six banks three of them are Islamic Banks and three are conventional commercial banks which are referred as non Islamic bank in this study. There are two parts of data been used in this report i.e. Primary data and secondary data. For some detail figures annual reports of the banks had to be consulted in order to calculate the various ratios. The banks that are been reviewed in here are following. Meezan Bank Limited. Al Baraka Islamic Bank. Dawood Islamic Bank Limited. Soneri Bank Limited. JS Bank Limited. First Women Bank Limited.

The selection of banks was made keeping in mind the homogeneity of market i.e. the banks should be similar in nature. Similar in nature means that they should be roughly of same size in terms of business volume, total assets etc. The main point of similarity while choosing the banks was the amount of total assets, for this reason the problem faced was that it was hard to find six banks of different nature (i.e. Islamic and Non Islamic Banks) with roughly same size of total assets, for this reason we selected banks in pairs i.e. which

47

are quite similar to each other in terms of total assets. Likewise if we are looking to a bank from Non Islamic banking sector which has total assets of around three thousand million rupees an Islamic bank with similar size of total assets has been chosen.

TABLE 3.1: SUMMARY STATISTICS FROM BALANCE SHEET OF MEEZAN BANK LIMITED

MEEZAN BANK LIMITED


(Rupees in 000)

2005
Net Profit After Tax Total Assets Shareholders Equity Profit before Tax Advances/Loans Deposits Cash Portfolio Investment Total Debt

2006
604,251 46,438,623 4,756,409 604,251 27,031,016 34,449,441 5,897,394 2,877,554 41,675,264 1,131,374 1,027,767

2007
963,501 67,178,559 5,719,910 169,188 34,576,339 54,582,353 5,644,028 10,535,186 61,471,903 1,411,928 1,764,593

2008
621,187 85,276,070 6,341,097 992,311 39,768,481 70,233,875 5,763,710 14,286,949 79,301,092 2,713,156 2,713,156

419,455 30,675,822 2,970,940 633,116 19,740,886 22,769,262 3,956,938 1,606,490 27,651,240 611,014 718,866

Total Income Total Operating Expenses Total Operating Revenue

633,116

780,023

169,188

992,311

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TABLE 3.2: SUMMARY STATISTICS FROM BALANCE SHEET OF DAWOOD ISLAMIC BANK LIMITED DAWOOD ISLAMIC BANK LIMITED
(Rupees in OOO)

2007
Net Profit After Tax Total Assets Shareholders Equity Profit before Tax Advances/Loans Deposits Cash Portfolio Investment Total Debt

2008
32,727 9,566,710 4,085,091 60,111 5,639,877 5,063,393 418,948 2,045,146 5,491,900 73,552 434,161 60,111

51,031 6,850,534 3,652,231 32,259 3,723,752 2,888,762 380,381 1,318,657 3,184,646 51,031 166,579 32,259

Total Income Total Operating Expenses Total Operating Revenue

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TABLE 3.3: SUMMARY STATISTICS FROM BALANCE SHEET OF AL BARAKA ISLAMIC BANK AL BARAKA ISLAMIC BANK
(Rupees in OOO)

2007
Net Profit After Tax Total Assets Shareholders Equity Profit before Tax Advances/Loans Deposits Cash Portfolio Investment Total Debt

2008
(73,157) 24,197,826 2,400,217 78,545 14,377,810 18,336,159 3,248,922 1,124,428 21,832,045 327,191 572,808 327,191

245,528 22,077,113 2,446,533 314,542 12,585,549 16,964,566 3,480,878 1,153,825 19,632,360 400,348 335,456 400,348

Total Income Total Operating Expenses Total Revenue

TABLE 3.4: SUMMARY STATISTICS FROM BALANCE SHEET OF SONERI BANK LIMITED SONERI BANK LIMITED 50

(Rupees in OOO)

2005
Net Profit After Tax Total Assets Shareholders Equity Profit before Tax Advances/Loans Deposits Cash Portfolio Investment Total Debt

2006
985,298 70,729,674 5,194,290 1,448,901 35,412,248 53,000,647 5,551,302 16,724,253 65,117,771 1,739,175 1,037,006

2007
1,000,334 76,854,060 6,229,666 1,476,685 40,154,449 60,150,128 5,861,205 19,181,562 70,243,581 1,436,229 1,293,445

2008
701,041 80,977,254 6,965,749 953,233 47,575,364 61,634,491 5,646,755 14,053,177 73,864,207 974,858 1,951,625

920,233 63,345,080 3,801,914 1,400,032 32,052,544 47,605,508 4,352,608 16,390,624 58,955,421 1,441,580 801,868

Total Income Total Operating Expenses Total Operating Revenue

1,400,032

1,448,901

1,476,685

953,233

TABLE 3.5: SUMMARY STATISTICS FROM BALANCE SHEET OF JS BANK LIMITED

JS BANK LIMITED
(Rupees in OOO)

2007 51

2008

Net Profit After Tax Total Assets Shareholders Equity Profit before Tax

35,431 20,327,752 5,141,351 (62,221) 736,917 6,475,963 13,367,898 1,285,247 6,309,536 15,133,945 35,014 (62,221)

54,770 21,627,802 5,784,628 111,225 983,367 9,699,199 15,294,273 977,235 5,119,959 16,351,965 98,784 111,225

Total Operating Expenses


Advances/Loans Deposit Cash Portfolio Investment Total Debt

Total Income Total Operating Revenue

TABLE 3.6: SUMMARY STATISTICS FROM BALANCE SHEET OF FIRST WOMEN BANK LIMITED FIRST WOMEN BANK LIMITED
(Rupees in OOO)

2007
Net Profit After Tax Total Assets

2008
106,020 7,303,721

157,887 8,985,576

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Shareholders Equity Profit before Tax

1,028,116 238,422 339,650 3,063,507 7,569,059 8,096,57 3,159,640 7,897,332 537,130 238,422

1,135,800 190,443 373,249 3,304,330 5,939,308 575,929 2,264,088 6,200,688 623,610 190,443

Total Operating Expenses


Advances/Loans Deposits Cash Portfolio Investment Total Debt

Total Income Total Operating Revenue

RATIO ANALYSIS STATISTICS FOR REVIEW


TABLE 3.7: RATIO ANALYSIS OF JS BANK AND AL BARAKA ISLAMIC BANK LIMITED (AIBL)

JS BANK RATIOS
Return on Assets Return on Equity Price Earning Ratio

AIBL 2007
1.12% 10.04% 0.93

2007
0.17% 0.69% -0.084

2008
0.25% 0.95% 0.113

2008
-0.30% -0.30% -0.14

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Loan to Deposit Ratio Cash & Portfolio Investment to Deposit Ratio Loan to Asset Ratio Debt Equity Ratio Debt to Total Asset Ratio Equity Multiplier Income Expense Ratio Asset Utilization

47.34% 53.27%

63.42% 41.88%

74.18% 27.32%

78.41% 23.85%

31.86% 2.94 74.45% 3.95 0.048 0.17%

44.85% 2.83 75.61% 3.74 0.091 0.42%

57.01% 8.02 88.92% 9.02 1.19 1.81%

59.42% 9.09 90.22% 10.08 0.57 1.35%

TABLE 3.8: RATIO ANALYSIS OF FIRST WOMEN BANK LIMITED (FWBL) AND DAWOOD ISLAMIC BANK LIMITED (DIBL)

FWBL RATIOS
Return on Assets Return on Equity Price Earning Ratio 15.36% 0.70 9.33% 0.51 1.39% 0.19

DIBL 2008
1.15%

2007
1.76%

2007
0.74%

2008
0.77% 1.80% 0.138

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Loan to Deposit Ratio Cash & Portfolio Investment to Deposit Ratio Loan to Asset Ratio Debt Equity Ratio Debt to Total Asset Ratio Equity Multiplier Income Expense Ratio Asset Utilization

40.47% 52.44%

55.63% 47.82%

1.28.9% 0.58.8%

111.38% 48.66%

34.09% 7.68 87.88% 8.74 1.58 5.98%

45.24% 5.46 84.90% 6.43 1.67 8.54%

54.38% 0.87 46.48% 1.87 0.31 0.74%

58.95% 1.34 57.4% 2.34 0.17 0.76%

TABLE 3.9: RATIO ANALYSIS OF SONERI BANK LIMITED

SONERI BANK LIMITED


RATIOS
Return on Assets Return on Equity Profit Expense 24.20% 1.75 18.97% 1.40 16.1% 1.14 10.1% 0.49

2005
1.45%

2006
1.39%

2007
1.3%

2008
0.87%

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Ratio Loan to Deposit Ratio Cash & Portfolio Investment to Deposit Ratio Loan to Asset Ratio Debt Equity Ratio Debt to Total Asset Ratio Equity Multiplier Income Expense Ratio Asset Utilization 2.28% 2.46% 1.93% 1.18% 16.66 1.80 13.62 1.68 12.34 1.11 11.63 0.50 93.07% 92.07% 91.40% 91.20% 15.51 12.54 11.278 10.60 43.57% 42.03% 41.63% 31.96% 67.33% 66.81% 66.8% 77.2%

50.60%

50.07%

52.20%

58.80%

TABLE 3.10: RATIO ANALYSIS OF MEEZAN BANK LIMITED

MEEZAN BANK LIMITED


RATIOS
Return on Assets

2005
1.37%

2006
1.30%

2007
1.43%

2008
0.72%

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Return on Equity Profit Expense Ratio Loan to Deposit Ratio Cash & Portfolio Investment to Deposit Ratio Loan to Asset Ratio Debt Equity Ratio Debt to Total Asset Ratio Equity Multiplier Income Expense Ratio Asset Utilization

14.11% 0.88 86.70% 24.40%

12.70% 0.75 78.47% 25.47%

16.84% 0.72 63.35% 29.64%

9.80% 0.36 56.62% 28.55%

64.35% 9.30 90.14% 10.32 0.84 1.99%

58.21% 8.76 89.74% 9.76 1.10 2.44%

51.47% 10.74 91.51% 11.74 0.80 2.10%

46.66% 12.50 92.99% 13.45 0.68 3.18%

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CHAPTER 4 EMPIRICAL RESULTS

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MEEZAN BANK LIMITED (MBL) & SONERI BANK LIMITED (SBL) 4.1 PROFITABILITY RATIOS
4.1.1 Return on Assets (ROA)
In the comparative study of the two banks we find that ROA of Meezan bank has remained stable in comparison to Soneri bank whose values oscillate more than the Meezan bank. Though it was good in year 2005 and 2008, but soneri bank has its setup since 1992 and on the other hand Meezan bank has been established in 2000.Its expenses on the establishment of branches and assets are more due to which its return has reduced. In year 2005 ROA of the MB is 1.37% whereas of SB is 1.452%.In the next year ROA of both the banks reduced but the trend of the soneri bank was more adverse as compare to the Meezan bank. In the next year Meezan bank has performed very well raising its ROA to 1.43%, on the other hand the soneri banks trend remain decreasing and reached to 1.3% but in the year 2008 the ROA of Meezan bank decreased to the half of its previous year value which was due to expansion of its branch network.

Table 4.1
ROA MBL SBL 2005 1.37% 1.45% 2006 1.30% 1.39% 2007 1.43% 1.30% 2008 0.72% 0.87%

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Figure 4.1

4.1.2 Return on Equity (ROE)


ROE is the indicator that how much a bank has earned from its equity. When we compare the values of these two banks we see that in year 2005 ROE of the soneri bank is much better than the Meezan bank. On the other hand in year 2006 ROE of the soneri bank has declined by 6%, whereas the ROE of Meezan bank declined by 2% which shoes the prudency of the Islamic procedures and in the year 2007 Meezan bank has performed very well as compared to the soneri bank as its ROE was 16.84% and soneri banks value of ROE was 16.1%. Moving towards year 2008 ROE of the banks have declined but the decline in the value of Meezan bank is more than the soneri bank due to the establishment of new branches and expansion of branch network for which they have to incur more expanses.

Table 4.2

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ROE MBL SBL

2005 14.11% 24.20%

2006 12.70% 18.97%

2007 16.84% 16.10%

2008 9.80% 10.10%

Figure 4.2

4.1.3 Price to Expense Ratio (PER)


Profit to expense ratio shows that how much expanses bank has incurred against their profit. PER of the soneri bank is better than the Meezan bank. The reason is that the Meezan bank has to incur more operating expanses as it relatively new entrant in the market as compared to the soneri bank. But the trend of soneri bank is more declining in comparison to the Meezan bank which shows the stability of the resources of Meezan bank.

Table 4.3
PER MBL SBL 2005 0.88 1.75 2006 0.75 1.40 2007 0.72 1.14 2008 0.36 0.49

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Figure 4.3

4.2 LIQUIDITY RATIOS


4.2.1 Loan to Deposit Ratio (LDR)
Loan to deposits ratio indicates that how much the bank has ability to absorb the shocks of liquidity crunch. The lower the LDR ratio the more prudent is bank in liquidity management. While going through the data of two banks we saw that the Meezan bank has consistently declining trends, whereas the soneri bank showed the oscillating behavior. As in the year 2005 LDR ratio of the Meezan bank is quite higher than the soneri bank. When we move towards year 2006 Meezan bank has declined the value of ratio considerably showing that it is effectively operating its liquidity, while the soneri bank has the trend of stable ratios but increased in the year 2008 by 11% i.e. from 66.8% to 77.2%. On the other hand Meezan bank has the decreasing trend as its value declined from 86% to 78.47% in year 2006 and continuing the

62

decline it declined to 63.35% in 2007 and reached to 56062% in year 2008 which shows the prudency of the procedures of Islamic banking.

Table 4.4
LDR MBL SBL 2005 86.70% 67.33% 2006 78.47% 66.81% 2007 63.35% 66.80% 2008 56.62% 77.20%

Figure 4.4

4.2.2 Cash Portfolio Investment to Deposits Ratio (CPIDR)


This ratio is the pictorial of the cash and portfolio investment strength over deposits to meet its liquidity obligations. If we see the trend of the conventional bank we will come to know that it is continuously following the downward trend from year 2005 to 2008. It was 43.57% in year 2005 and has fallen down to 31.96% in year 2008.Which shoes that conventional bank is continuously decreasing its liquidity. Now if we compare it with the Islamic bank its values of all the years are lesser than that of the conventional bank

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whose main reason is that Islamic bank does not have vast or qualified market for investment therefore Islamic banks have mostly to rely on their modes of financings as its also a type of investment for them, but if we see the trend of Islamic bank its showing positive trend over the years and its just because that Islamic procedures are more prudent. Conventional banks data reveals that due to poor and non prudent procedures it has to face the declining trend.

Table 4.5
CPIDBR MBL SBL 2005 24.40% 43.57% 2006 25.70% 42.03% 2007 29.64% 41.63% 2008 28.55% 31.96%

Figure 4.5

4.2.3 Loan to Asset Ratio (LAR)


In loan to asset ratio Islamic bank has shown positive and good results over the number of years as though the values in 2005 is 64.35% and of conventional bank is 50.06%. Then in year 2006, LAR of Islamic bank decreased to 58.21% where as conventional bank has 50.07% indicating a lesser change in this year. In the year 2007 LAR of Islamic bank further

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decreases to 51.47% showing a comparative decrease where as conventional banks LAR goes to 52.2% indicating an increase. Moving towards the year 2008, LAR of Islamic bank further decreases to 46.66% showing a consistent decrease in the ratio showing that Islamic banks are performing better as its financial position reveals and conventional bank moves to increasing trend up to 58.8% which shows that major position of the assets of the conventional bank is based upon its advances so the conventional bank is more exposed to financing or credit risk.

Table 4.6
LAR MBL SBL 2005 64.35% 50.60% 2006 58.21% 50.07% 2007 51.47% 52.20% 2008 46.66% 58.80%

Figure 4.6

4.3 RISK & SOLVENCY RATIOS


4.3.1 Debt to Equity Ratio (DER)
This ratio shows that how much the debt burden is () over its equity. More the value of DER shows that the bank is more exposed to the shocks of financial

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crisis. DER of the conventional bank over the four years is showing that its trend has been downward which shows that bank is making itself to absorb the financial shocks expected in the upcoming years. Whereas the Islamic banks values over the 4 years are lower than the conventional bank but it oscillates in year 2007 and 2008. One of the reasons of this oscillation is the injection of more deposits by public into Meezan bank due to its Islamic products and the equity was not yet increased considerably with respect to change in the debt.

Table 4.7
DER MBL SBL 2005 9.30 15.51 2006 8.76 12.54 2007 10.74 11.28 2008 12.50 10.60

Figure 4.7

4.3.2 Debt to Total Assets Ratio (DTAR)


Debt to total assets ratio reveals the strength of assets over debts owed by the bank. In the analysis it is found that conventional bank is standing at 92.07% and Islamic bank is at 89.74% in year 2006. In the year 2007

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conventional bank is at 91.4% and Islamic bank is at91.5% and in the year 2008 conventional bank is at 91.2% and Islamic bank is at 92.99%. This shows the good position of Islamic bank over the years. In 2008 the Islamic bank has slightly higher value as its core deposits increased in 2007 and 2008 due to which this ratio increased.

Table 4.8
DTAR MBL SBL 2005 90.00% 93.07% 2006 89.74% 92.07% 2007 91.51% 91.40% 2008 92.99% 91.20%

Figure 4.8

4.3.3 Equity Multiplier (EM)


With the study of equity multiplier it can be assessed easily that Islamic bank has been increasing the asset strength depending upon its equity. In the study of trends from year 2005 to 2008 the conventional banks ratio is

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consistently decreasing from 16.66 to 13.62 then decreased to 12.62 and ultimately fell to 11.63. On the other hand the Islamic banks ratio increased from 10.62 in 2005 to 13.45 in 2008. Only in the year 2006 it declined and in the remaining years the performance of the Islamic bank remained better than the conventional bank.

Table 4.9
EM MBL SBL 2005 10.32 16.66 2006 9.76 13.62 2007 11.74 12.34 2008 13.45 11.63

Figure 4.9

4.4 EFFICIENCY RATIOS


4.4.1 Asset Utilization (AU)
Overall the utilization of assets of Islamic bank is more attractive and strong during the year from 2005 to 2008. Conventional bank has downward trend

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from year 2005, but in year 2005 the asset utilization value of conventional bank is comparatively higher than Islamic bank but moving towards year 2006 the difference of asset utilization start reducing as Islamic bank reaches to 2.44% in 2006 against 2.46% of conventional bank. Which shows positive growth trend in Islamic bank? In the year 2008 asset utilization of Islamic bank increased to 3.18% in comparison to the asset utilization of conventional bank which was decreased to 1.18%.This is the implication of the prudency of prudent procedures of Islamic banking which allows the Islamic bank to maintain a good growth relative to conventional bank which is declining since the financial crunch has started.

Table 4.10
AU MBL SBL 2005 1.99% 2.28% 2006 2.44% 2.46% 2007 2.10% 1.93% 2008 3.18% 1.18%

Figure 4.10

4.4.2 Income to Expanse Ratio (IER)


In the study of income to expanse ratio it is analyzed that the Islamic bank has the stable expanse position within a particular range. On the other hand the conventional bank has to bear the ups and downs in management of its

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operating expanses as well as operating revenues thus it shows that the financial shocks during the years form 2005 to 2008 affected conventional banks more as compare to the Islamic banks. In year 2008 no doubt conventional bank has performed a little better, the reason is that the Islamic bank has to develop the structure and inject procedures and also the Islamic bank cannot take the penalty to the income side because of which the Islamic bank looses that position of income.

Table 4.11
IER MBL SBL 2005 0.84 1.80 2006 1.10 1.68 2007 0.80 1.11 2008 0.68 0.50

Figure 4.11

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AL BARAKA ISLAMIC BANK (ABIB) & JS BANK LIMITED (JSBL) 4.5 PROFITABILITY RATIOS
4.5.1 Return on Assets (ROA)
The result indicates several important points of comparison of ROA between Islamic bank and conventional banks. This indicates that in financial year 2007, ROA of Islamic bank is better in comparison to conventional bank which has recovered in the financial year 2008 and Islamic banks has to face loss during the financial year 2008 because of international financial crunch as AlBaraka Islamic Bank is multi-national bank. Where as JS Bank is a local bank and newly established. So, it has avoided the loss and its position is better in financial year 2008. Financial results of 2009 of Islamic bank and conventional bank will reveal whether what trend of conventional banks ROA would continue and ROA of Islamic bank would increase or decrease. Nevertheless, banking sector in Pakistan is growing significantly but considering the last 2 years trend in ROA, both types of banks are experiencing difficulties in profitability.

Table 4.12
ROA JS BANK AL BARAKA 2007 0.17% 1.12% 2008 0.25% -0.30%

Figure 4.12

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4.5.2 Return on Equity (ROE)


Similar to ROA, from the study of ROE of both conventional banks and Islamic bank, we underpin some important points to consider. The result shows that in financial year 2007, ROE is quiet higher of Islamic bans up to 10.04% in comparison to conventional bank i.e. 0.69% which is recovered in financial year 2008 up to the value of 0.95% and Al-Baraka has to face the loss. Therefore, its ratio has gone in negative value showing the loss occurred in that year on equity.

Table 4.13 Figure 4.13


ROE JS BANK AL BARAKA 2007 0.69% 10.04% 2008 0.95% -0.30%

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4.5.3 Price to Expense Ratio (PER)


The analysis of PER indicates that Bank Al-Baraka has good revenues in financial year 2007 which was 0.93 over its operating expenses. Therefore, its value is favorable but in financial year 2008, its expenses have increased and it is also suffer loss due to which is depicts the negative impact i.e. -0.140 where as JS Bank has the negative operating revenue in financial year 2007 -0.084 and recovered in financial year 2008 with a PER 0.113. This shows positive trend but overall Islamic bank has strong position in comparison to conventional bank.

Table 4.14

PER JS BANK AL BARAKA

2007 -0.084 0.930

2008 0.113 -0.140

Figure 4.14

4.6 LIQUIDITY RATIOS


4.6.1 Loan to Deposit Ratio (LDR) 73

Islamic Bank i.e. Bank Al-Baraka has more financing as compared to conventional bank i.e. JS Bank. So, it has higher LDER with lower increasing trend but conventional bank has lowered LDR with higher increasing trends. From the results we can say that Islamic bank is more exposed to risk and for this reason it has suffered loss in financial year 2008.

Table 4.15
LDR JS BANK AL BARAKA 2007 47.34% 74.18% 2008 63.42% 78.41%

Figure 4.15

4.6.2 Cash & Portfolio Investments to Deposit & Borrowings Ratio (CPIDBR)
Islamic bank lower CPIDR because it has not such venues where the funds can be invested therefore their finances are more where as conventional banks have more options for investment. In financial year 2007 JS Bank has CPIDR i.e. 53.27% which is far better than that of Bank Al-Baraka i.e. 27.32% but in financial year 2008 CPIDR of JS bank has decreased to 41.88% and Bank Al-Baraka also decreased its CPIDR to 23.85%. Overall the liquidity position of conventional bank is better than Islamic bank in the context of

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investment but we consider the Islamic financing as an investment which can change the results of banks liquidity.

Table 4.16
CPIDBR JS BANK AL BARAKA 2007 53.27% 27.32% 2008 41.88% 23.85%

Figure 4.16

4.6.3 Loan to Asset Ratio (LAR)


LAR of conventional bank is lower in comparison to Islamic bank but with higher increasing trend i.e. 31.86% to 44.85% where as Islamic bank has also the increasing trend but with lower rate i.e. 57.01% to 59.42%. If we consider the argument of financing as an investment in islamic banking overall

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position of Islamic bank will become better. Analysis of LAR indicated that Murabaha has been the most famous and mostly used mode of financing followed by Ijara, export refinance under Islamic scheme, and Dimishing Musharaka and standing second, third, and fourth respectively in a row.

Table 4.17
LAR JS BANK AL BARAKA 2007 31.86% 57.01% 2008 44.85% 59.42%

Figure 4.17

4.7 RISK & SOLVENCY RATIOS


4.7.1 Debt to Equity Ratio (DER)
In comparison to both we will come to know that equity of conventional bank i.e. JS Bank is better than that of Islamic bank i.e. Bank Al-Baraka. As, JS Bank DER in financial year 2007 is 2.94 times which decreases to 2.83 times in

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financial year 2008 where as Bank Al-Baraka has DER in financial year 2007 is 8.02 times which increases to 9.09 time sin financial year 2008. A bank with lower DER is considered better as compared to the bank with higher DER. Therefore, conventional bank has low DER in comparison to Islamic bank who mostly depend upon deposits of the customers exposing itself to more risk.

Table 4.18
DER JS BANK AL BARAKA 2007 2.94 8.02 2008 2.83 9.09

Figure 4.18

4.7.2 Debt to Total Assets Ratio (DTAR)


As result indicates that, Islamic bank have more ratio of debt then its equity therefore its total debts are more than the conventional bank and has the higher value than the conventional bank and its assets are mostly generated by its debts. In financial year 2007 the JS bank has DTAR 74.45% which

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slightly increases to 75.61% in financial year 2008 and on the other hand Bank Al-Baraka has DTAR 88.92% which also increased with a slight change in 2008 with 90.22%.

Table 4.19
DTAR JS BANK AL BARAKA 2007 74.45% 88.92% 2008 75.61% 90.22%

Figure 4.19

4.7.3 Equity Multiplier (EM)


The analysis of another measure of risk, equity multiplier, further proves that Islamic bank has utilize its equity lesser and its debts more for the generation of its finances and investment. Therefore, its EM is higher than that of

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conventional bank and JS Bank mostly depends upon its equity as its EM value is low with decreasing trend as in 2007 it was 2.94 times which decreased to 2.83 times in 2008. On the other hand, Bank Al-Baraka has EM 8.02 times in 2007 which increases to 9.09 times in 2008 as the higher the EM the greater is the risk for the bank.

Table 4.20
EM JS BANK AL BARAKA 2007 2.94 8.02 2008 2.83 9.09

Figure 4.20

4.8 EFFICIENCY RATIOS


4.8.1 Asset Utilization (AU)

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This ratio tells us how much effectively banks are using the assets. AU of Bank Al-Baraka is better than JS bank because in 2007 AU was 1.81% which in 2008 is 1.35%. Here, the Bank Al-Baraka has earned handsome profit and JS Bank has lesser profits to its assets during the fiscal year which shows that in 2007 AU was 0.17% than that of 2008 is 0.42%. Overall position of the Islamic bank is better than conventional bank during the both financial years.

Table 4.21
AU JS BANK AL BARAKA 2007 0.17% 1.81% 2008 0.42% 1.35%

Figure 4.21

4.8.2 Income Expense Ratio (IER)

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The position of Islamic bank is better as it has lower expenses in both financial years in comparison to conventional bank which may be for the new establishment and branch network and its set up. As, JS Bank has IER in 2007 is 0.48 times which decreases to 0.09 in 2008. On the other hand, Bank AlBaraka has PER in 2007 is 1.19 times which decreases to 0.57 times in 2008. From this result, we can say that overall position of Islamic bank is stable with higher revenue to lesser expense but the trend is decreasing because of the loss occurred in the financial year 2008.

Table 4.22
IER JS BANK AL BARAKA 2007 0.48 1.19 2008 0.09 0.57

Figure 4.22

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DAWOOD ISLAMIC BANK LIMITED (DIBL) & FIRST WOMEN BANK LIMITED (FWBL) 4.9 PROFITABILITY RATIOS
4.9.1 Return on Assets (ROA)
In financial year 2007, DIBL ROA is 0.74% which is slightly less in comparison to FWBL but if we see the trend of 2008 ROA of DIBL has increased where as FWBL has decline which shows the prudency of Islamic procedures. DIBL ratio is less because it has started new operations in Islamic banking for which he has to incur a lot of capital on development of branches. Therefore, ROE is less as compared to FWBL. Financial results of 2009 of Islamic bank and conventional bank will reveal whether what trend of conventional banks ROA would continue and ROA of Islamic bank would increase or decrease. Nevertheless, banking sector in

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Pakistan is growing significantly but considering the last 2 years trend in ROA, both types of banks are experiencing difficulties in profitability.

Table 4.23
ROA DIBL FWBL 2007 0.74% 1.76% 2008 0.77% 1.45%

Figure 4.23

4.9.2 Return on Equity (ROE) 83

From the study of ROE of both banks, we see that ROE of DIBL is quiet lesser than FWBL as FWBL has started his operations for more than eleven years and DIBL is new entrant to market. The DIBL has just reached to the break even point but if we see the trend of both as per financials we can observe that there is increasing trend in the Islamic bank and vice versa. In 2007, DIBL has ROE 1.39% which increases to 1.80% in 2008. On the other hand FWBL has ROE in 2007 is 15.36% which decreases to 9.33% in 2008.

Table 4.24
ROE DIBL FWBL 2007 1.39% 15.36% 2008 1.80% 9.33%

Figure 4.24

4.9.3 Price to Expense Ratio (PER)

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According to the analysis, PER of FWBL is little better. During the analysis it is observed that DIBL has incurred expenses for its new establishments and branch network due to which its expenses are more as compared to its earnings. DIBL has decreasing trend of PER because in 2007 it was 0.19 times than that of 0.14 times in 2008 which shows that it is decreasing. FWBL has also decreasing trend as PER is 2007 was 0.70 times which decreases to 0.51 times in 2008.

Table 4.25
PER DIBL FWBL 2007 0.19 0.70 2008 0.14 0.51

Figure 4.25

4.10 LIQUIDITY RATIOS


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4.10.1 Loan to Deposit Ratio (LDR)


From this ratio, we can see the trend of both banks. We observed that LDR of Islamic bank is higher as compared to conventional bank. The main reason is that there are lesser options for investment in Islamic banking as compared to financial market. Therefore, banks have to rely on their finances as there is also a type of investment not a loan as in conventional bank. By observing the trend of LDR we can see that DIBL shows declining trend which means its position is getting better and the trend of FWBL is increasing.

Table 4.26
LDR DIBL FWBL 2007 128.90% 40.47% 2008 111.38% 55.63%

Figure 4.26

4.10.2 Cash & Portfolio Investments to Deposit & Borrowings Ratio (CPIDBR) 86

CPIDBR shows the liquidity position of the bank and if we can see that trend we will observe that liquidity position of Islamic bank is better and higher from conventional bank in both years. In 2007, CPIBDR was 58.80% which decreases to 48.66% showing a decrease where as FWBL CPBIDR in 2007 was 52.44% which decreases to 47.82% also showing a decrease but on the whole trend of both banks is declining and conventional bank declining impact is more.

Table 4.27
CPIDBR DIBL FWBL 2007 58.80% 52.44% 2008 48.66% 47.82%

Figure 4.27

4.10.3 Loan to Asset Ratio (LAR) 87

LAR indicates that FWBL is performing well but the trend is increasing at a higher which shows the more impact of liquidity in conventional banking. But if we observe the trend of Islamic bank it is also increasing but at a lower rate. LAR of DIBL in 2007 was 54.38% which increases to 58.95 % in 2008 showing an increase where as FWBL LAR in 2007 was 37.09% which increases to 45.24%. On the whole, result indicates that position of conventional bank is better but the trend of Islamic bank is quiet positive.

Table 4.28
LAR DIBL FWBL 2007 54.38% 34.09% 2008 58.95% 45.24%

Figure 4.28

4.11 RISK & SOLVENCY RATIOS


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4.11.1 Debt to Equity Ratio (DER)


DER indicates that Islamic bank DER is 0.87 times in 2007 and 1.34 times in 2008. Where as DER of FWBL is 7.68 times in 2007 and 5.46 times in 2008. This indicates that Islamic bank is relying on its capital and able to absorb the financial shocks where as conventional bank has the higher ratio which makes the conventional bank to expose itself to higher risk.

Table 4.29
DER DIBL FWBL 2007 0.87 7.68 2008 1.34 5.46

Figure 4.29

4.11.2 Debt to Total Assets Ratio (DTAR)

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This ratio shows that DTAR of conventional bank is consistently higher than Islamic bank and it makes conventional banks more risky and less solvent than Islamic bank. If we compare the values of two years Islamic banks are exposed to lesser risk as its debts are lesser to their total assets as of conventional bank. As DTAR of Islamic bank in 2007 was 46.48% which increases to 57.40% in 2008 showing an increase where as DTAR of conventional bank in 2007 was 87.88% which decreases to 84.90% in 2008.

Table 4.30
DTAR DIBL FWBL 2007 46.48% 87.88% 2008 57.40% 84.90%

Figure 4.30

4.11.3 Equity Multiplier (EM)

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Islamic bank have lesser values which indicates that Islamic bank have converted lesser assets through their debts. But conventional bank trend is different as multiplier is higher for both years with the declining trend which expose the conventional bank at more risk. EM of DIBL in 2007 was 1.87 times which increases to 2.34 times in 2008. EM of FWBL in 2007 was 8.74 times which decreases to 6.43 times in 2008.

Table 4.31
EM DIBL FWBL 2007 1.87 8.74 2008 2.34 6.43

Figure 4.31

4.12 EFFICIENCY RATIOS


4.12.1 Asset Utilization (AU) 91

As from the AU results of both banks, conventional bank is far better than the Islamic bank because Islamic bank has made its new setup and its revenues are lesser where as conventional bank is in market for longer time period and its revenues are better because it has lower establishment cost. AU of DIBL is 0.74% in 2007 which changes in 2008 with little margin and move up to 0.76% and AU of FWBL in 2007 was 5.98% which increases to 8.54% in 2008 showing positive performance of conventional bank.

Table 4.32
AU DIBL FWBL 2007 0.74% 5.98% 2008 0.76% 8.54%

Figure 4.32

4.12.2 Income Expense Ratio (IER)

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The ratio depicts that conventional bank is performing well as their operating expenses are lesser in comparison to their operating revenue because of their establish set up. On the other hand, DIBL is new entrant and its ratio is quiet lesser due to the expansion of the branches. From the calculations it is observed that IER of DIBL in 2007 was 0.31 times which decreases to 0.17 times in 2008 showing a decrease where as IER of FWBL is 1.58 times in 2007 which increases to 1.67 times in 2008 showing that conventional bank is performing well.

Table 4.33
IER DIBL FWBL 2007 0.31 1.58 2008 0.17 1.67

Figure 4.33

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CHAPTER 5 CONCLUSION AND SUGGESTIONS

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In this chapter we are going to look at the conclusion that we can drive from the data analysis of our selected data. This research was intended to find the answer to the question how good Islamic banks are performing as compare to conventional commercial banks? To find an answer past studies were consulted to get an idea of what sort of research work has been done on this topic the methods that they applied, tools been used to find out the answers to the questions similar to these ones. Following the methods thats been used by previous renowned researchers we used the similar techniques to find the performance efficiency of these banks. The results of our test on data were in line with most of the previous studies that we have consulted for the preparation of this report.

5.1. CONCLUSION
The results obtain from this research indicates that Islamic banks are working in the right direction and are performing better. They are handling the situation in correct manner which conventional banks are not handling in that specific and correct manner. The ratio analysis indicates that almost all the results were in line with the conventional banks. Therefore, the Islamic banks are showing positive signs of progress and stability. However, Islamic banks which operated their operations from financial year 2006 are relatively compared when with conventional banks were going in loss but overall they will recover as financial crunch is moving in the economy. The banks which started their operations from 2006 onwards were suffering loss because they have to spend a large amount of money on their branch operations as to expand the branches. Islamic banks major strength is that their ability to generate enough equity to fulfill the needs of the customers as compare to Conventional banks. This strength of theirs gives them the opportunity to give more advances to their customers, and in the mean time they relaxed from the pressure of having more leverage. This also indicates that the bank has ability to get higher return on their total assets and loan. One of the results also indicates that Islamic banks ability to have stiff control over their advance policy which is represented by the ever improving position on provision for doubtful debts. This shows us that they are able to get more and better rate of repayments in time from there customers. Islamic banks are

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working prudently as it reflects the true picture of Islamic financing. Islamic modes of financing are helping the Islamic banks to work efficiently and consistency in their performance. The main principles if Islamic finance includes the prohibition of Riba and the removal of debt based financing from the economy. By employing Islamic principles, the main financial instruments in Islamic finance are Mudarabah, the provision of capital in a partial equity partnership, Musharakah, fully equity partnerships, Murabaha, an instrument for financing the purchase of goods, Bai Muajjal, deferred payments on products, Bai Salam, advance sale contracts, Istisna, or manufacturing contracts, Ijarah, lease financing. On the other hand there are many people who believe that there is no major difference between the Islamic and conventional banks. Both are performing the same functions and Islamic banks are considered that they are just like conventional banks. This is a misperception, which is the result of unawareness. Therefore, it is important that intensified efforts are made for publication education and awareness regarding the distinctive characteristics of Islamic banks, their different products and ethnicity in the light of Islamic laws. It will be helpful in building the trust and boost the relationship and confidence and more important customer satisfaction. A closer review of the balance sheets of banks reveal that Islamic banks are more in the business of providing short term funds and advances, they are also less keen in providing venture capital kind of finances (Mudarabah). It is important to remember that in Islamic view, fixing the rate of profit alone is not allowed but fixation of profit & loss both is quite permissible and inline with Shariah compliance. The amount of profit can not be predetermined according to Islamic Shariah, but one can fix the rate of distributing the profit or loss of the concern according to their respective shares in the business. The difference in results is largely due to the fact that Islamic banking has longer history but in Pakistan where full-fledged Islamic banking started merely few years back. Moreover, conventional banking has a longer history, deeper roots, vast experience of learning from the financial markets mechanisms, and larger share in the Pakistan financial sector. Considering

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these facts of the matter, we dont find the results of our study surprising. However, the way Islamic banking sector is improving and growing in Pakistan, we expect Islamic banking of Pakistan to be equally or even better in performance than conventional banking in the foreseeable future. In the end, for future studies, as the time passes, when there will be more Islamic banks to study and longer time period, a similar study would generate better insight on the issue of performance comparison and provide solid evidence one way or another. By then, we would gladly join the discussion again.

5.2. SUGGESTIONS
In the end, we would like to give some suggestions so that the Islamic banks can improve their efficiency as to increase the profitability of the banks. The suggestions are related to both internal as well as external fronts. On internal front, Islamic banks first have to create awareness about the products which they are offering to the customers. Islamic banks have to improve their range of products to attract thee customers and more necessarily to satisfy them. The Islamic banks no longer can relay heavily on advances business but they should also look that how they can capture the retail banking sector as well. For small level customers the bank will have to find the innovative products. These products may include products like finances for consumer items; debit card etc. in this way Islamic bank will truly have to strengthen up their ijarah part of the business and will have to make provisions for loans and for the small items as well. As the analysis revealed that Islamic banks are more in the business of providing short term financing, they will have to do more financing in long term basis and will also have to strengthen the projects financing sector of their business. One of the major problems that Islamic bank facing is that they have high general and administration cost which is creating hurdles in their profitability. This may be because of the State Bank of Pakistan regulations as to expand their network and it also tells us that banks are not doing enough to ensure the quality of their advances and for their repayment. As few Islamic banks are new entrant to market therefore they are not earning as much as conventional banks are earning. Therefore,

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it is suggested that the Islamic banks should devise such tools to decrease this high amount of general and administration cost. There are certain things which are to do by Islamic banks but it is not completely in the control of these banks. It relates to the prudential regulations been implied by monitoring authority known as State Bank of Pakistan. Here, we are talking about the requirements of reserves that these Islamic banks have to maintain with the central bank according to the regulations. In case of conventional banks central bank pays them a certain amount of interest on this reserve but as far as Islamic banking is concerned we know that they cannot take interest as it is prohibited therefore, its very difficult for Islamic banks to compete conventional banks on equal grounds. Here, government can play a significant role as it will be helpful for Islam banks to depict the true picture of Islamic banking in Pakistan. The government should make some arrangements and develop policy for Islamic banks as they should relax the reserve requirements for these banks. In this regard so as to decrease the statutory reserve requirement for Islamic banks as this affects their operational capability and efficiency. It will be helpful for the banks as it provide them with more equity which will result in increase in their ability to provide loans to its customers which will result in increase profitability.

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CHAPTER 6
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APPENDIX

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6.1 ALTERNATIVE MODE OF FINANCING IN ISLAMIC BANKING


As per indication of the Council of Islamic Ideology (CII) (1980, Pp.4,5) the ideal and real alternatives to lending on interest under an Islamic economic system are profit/loss sharing (PLS) or qard-e-hasan i.e. loaning without any charges over and above the principal amount. However, in view of the problems faced in practically applying the PLS system (1980 Pp9,10) a number of other alternatives have been mentioned by the CII as also by other Shariah scholars. The council, however, highlighted that though the alternative methods are free of the interest element in the form in which they are specifically laid down in its report, are no more than a possible best solution from the ideal Islamic economic systems point of view. On the other hand, there is also a danger that they could eventually be misused as a means for opening a back door for interest along with its attendant evils. It is, therefore imperative that the use of these methods should be kept to the minimum extent that may be unavoidably necessary under the given conditions and that their use as general techniques of financing must never be allowed. (Usmani, Taqi, 2000) (Ayub, M, 2002). Following are the main Islamic alternatives of the conventional banking products. Islamic Banks Product. Product. Musharakah. Mudarabah. Murabaha. Salam Ijarah. Venture Capital. Venture Capital. Treasury Bill. Future Contracts. Leasing. Commercial Banks

All these Islamic banking products are discussed in detail in the following pages so the reader can understand the uniqueness of these products.

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6.2 MUSHARAKAH/ SHIRAKAH


1. In the early books of Fiqh, the business under partnership has been discussed mainly under the caption of Shirakah. Musharakah is a term used by the scholars both for broad and limited connotations. Technically, Musharakah refers to a relationship established under a contract by the mutual consent of the parties to share the profits and losses arising from a partnership business. This arrangement is also permissible according to the jurists. 2. The equal contribution of funds by the partners is not necessary. Partnership business can also be conducted by contributing labor, management, skill and goodwill and capital from both the partners. 3. In Musharakah (similarly to Mudarabah), the profit distribution ratio may differ from investment ratio in the total capital, but the loss must be divided exactly in accordance with the ratio of capital invested by each of the partners. 4. All assets of Musharakah are jointly possessed in proportion to the contribution of each partner. 5. A person can become a partner of a running concern having fixed assets by investing capital in cash/kind; merger of various partnership firms is also allowed. 6. Power of appropriation in the property and participation in the affairs of the Musharakah may be un-proportionate to the investment of capital by the partners. 7. Profit can be divided unequally and un-proportionately to the capital invested on the basis of work to be conducted for Musharakah. Fixation of a lump sum amount for any of the partners is not allowed, or any rate of profit tied up with his investment. For example distribution of profit on 50, 50 or 60, 40 basis.

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8.

Profit, in excess of the ratio of capital contribution can be divided on the basis of work done for the Musharakah.

9.

In a traditional manner the liability of the partners in Musharakah is unlimited. Therefore, if the liabilities of the business in excess to its assets and the business go in liquidation, all the exceeding liabilities shall be borne proportionately by all the partners.

10.

The partners may agree upon a condition that the business shall be managed by any one of them, and no other partner shall work for the Musharakah. If all the partners agree then each one of them shall be treated as the agent of the others in all the matters of business.

11.

Firms desiring to raise funds for investment can offer to sell Musharakah Certificates in the market. When the project is started by acquiring non-liquid assets, these certificates can be traded in the secondary market.

12.

Musharakah can be based on a written agreement between the bank and the client for a specific transaction or for a fixed period of time that can be renewed if required.

13.

A partner cannot guarantee the other partners. However, in the case of Musharakah agreements with their customers, the banks can obtain a pledge of security or guarantee to ensure safety and properly handle the Musharakah business.

14.

Banks can use the Musharakah instrument for working capital financing, project financing, import and export financing and for other types of single transactions.

6.2.1 DIMINISHING MUSHARAKAH


1. The participatory contracts that can be more suitable for ongoing projects, particularly for financial intermediaries, can be based on the concept of 'Diminishing Musharakah' (DM). In the Diminishing Musharakah contract, a party after participation in ownership of any

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business/project can liquidate its investment periodically from the ongoing business. It is a new type of contract suggested by contemporaneous jurists keeping in view the problems sensed while discussing the traditional Musharakah /Mudarabah principles in the long run economic perspective. 2. A DM contract can be consistent of two or three sub contracts, i.e. leasing by one partner its share in the asset to the other partner(s), partnership by ownership between two or more persons, and selling by one partner its share to the other partner(s). 3. We can deduce from the contemporary juristic opinions that an arrangement in which any of the parties promise to purchase or sell the leased asset, that arrangement cannot be held to be contingent or conditional. 4. In case purchasing of a house, for example, a joint ownership (Shirkatul Amwal) can be created for the purpose of Diminishing Musharakah. The financing partner will give his undivided share on lease to the partner using the house. 5. Three separate contracts are entered into in such a way that each contract is independent of the other two contracts. Sequencing of contracts should be:a. A contract between partners to create a joint ownership. b. Financing partner gives units of his share to the client on lease. c. Partner (client) will go on purchasing the units of ownership of financing partner periodically at the mutually agreed price. Accordingly, the rent will go on decreasing.

6.3 MUDARABAH
1. In typical Mudarabah financing, one party provides the necessary capital and the other provides human capital needed for the economic activity to

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be

conducted.

The

contract

of

Mudarabah

is

(also

known

as

Qirad/Muqaradah) can be traditionally applied to commerce alone, but it provides the basis of the relationship between banks, depositors and the enterprises, and according to majority of the contemporary scholars, can be applied in all sectors of the economy like trade, industry, agriculture, etc. According to majority of jurists, Mudarabah is also a type of Shirakah when used as a broad term. 2. A Mudarib who is running the business can be a person, a group of persons, or a legal entity and a corporate body. Mudarabah shall include banks, unit trusts, mutual funds or any other institutions or persons by whatever name called. 3. Mudarabah can be of various types, i.e. a multi purpose or a specific purpose, perpetual, or for a fixed period, restricted or unrestricted and close or open-ended in accordance with the conditions respective to each of them. 4. Rabbul Mal shall provide his investment in money or goods, other than receivables, at a mutually agreed valuation which shall be placed at the disposal of the Mudarib. 5. The profit shall be divided according to the proportion agreed at the time of contract and no party must be given a predetermined amount of return. 6. Rabbul Mal will have to suffer the operational loss unless it is proved that the Mudarib has been guilty of fraud, negligence or misconduct. For the Mudarib, the loss is in terms of his un-rewarded labor or entrepreneurship. 7. The liability of Rabbul Mal is limited to his investment, unless otherwise specified in the Mudarabah contract. 8. The Mudarib can invest his funds in the business of Mudarabah with the permission of Rabbul Mal. Profit of a Mudarabah project can also be

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reinvested. It also refers to the arrangement of combining Musharakah and Mudarabah. 9. At the time of entrance into Mudarabah contract, it can be agreed by both parties that no party shall terminate the contract during a specified period excluding some particular circumstances.

6.3.1 MUDARABAH CERTIFICATES


Islamic Fiqh Academy of the OIC in its fourth session (February 6-11, 1988) resolved the following in respect of Mudarabah or Muqaradah Certificates (Muqaradah is synonymous with Mudarabah - two names of the same mode of business). 1. The term 'Mudarabah Certificates' is used in place of 'Mudarabah

bonds'. 2. Mudarabah Certificates are investment instruments which call up the Mudarabah capital by floating certificates in the market, as an evidence of capital ownership, on the basis of shares of equal value, registered in the name of their owners. 3. In general the formula acceptable to Shariah for Mudarabah

Certificates must consist of the following elements: a. Mudarabah contract must present a joint share in the project, for whose establishment or financing it has been issued. Ownership remains valid throughout the duration of the project from its beginning to its end. b. The contract, regarding Mudarabah Certificates, is concluded on the basis of the terms defined in the prospectus, that offer is conveyed by subscription and acceptance by approval of the issuing authority. The prospectus must provide all data required by Shariah for the "Qirad" contract (the Mudarabah). c. The Mudarabah certificates must be negotiable at the end of the subscription period, since the Mudarib has authorized to do so once the

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certificates have been issued, taking into account the following rules prescribed by Shariah: o o If the Mudarabah capital, collected from subscription prior If the Mudarabah capital becomes debts, Mudarabah

to its use in the project, is still in the form of cash, certificates should be negotiated according to the rules applied to loans. o If the Mudarabah capital is converted into mixed assets, e.g. cash, debts, goods, benefits, Mudarabah certificates may be negotiated at the price agreed upon provided the major part of the capital is in the form of goods and benefits. d. The one who receives the funds collected from the subscribers to the certificates, for investment in the proposed project is called "Mudarib"; his ownership in the project is limited to the extent of his subscription. 4. Considering the preceding rules of exchange, Mudarabah Certificates can be exchanged in stock markets, if they are regularized by the rules prescribed of Shariah, in conformity with the principles of supply and demand, and subject to the approval of contracting parties. They can also be negotiated if, at a given period of time, the issuing authority makes an announcement or an offer to the public. 5. Neither the prospectus nor the Mudarabah contract should contain a guarantee, from the manager of the funds, for the capital or a fixed profit or a profit based on a percentage of the capital. If such clause is provided explicitly or implicitly, the guarantee condition is void, and the Mudarib is entitled to a profit equal to that of a similar Mudarabah. 6. The Prospectus of Mudarabah contract issued pursuant to it should not contain any statement obligating a sale, even if conditional or related to future. However, the Mudarabah contract may include a promise to

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sell and, in such case, sale is affected only on a contract basis, at a price fixed by qualified experts and agreed upon by the two parties.

6.4 MURABAHA WITH DEFERRED PAYMENT


1. Murabaha refers to reciprocally specified margin of profit (mark-up) in the transaction of sale where the cost of the commodity is known to the buyer. The parties negotiate the profit margin on cost and not the cost. If payment of the sale price is deferred, it also becomes Muajjal. 2. Murabaha can be used only where a commodity is intended to be purchased by the customer. Murabaha cannot work if funds are required for some other purpose,. 3. The idealistic way is that the bank purchases the commodity itself directly form the supplier and after taking its delivery, resells it on Murabaha basis. 4. Banks should make sure that the client really intends to purchase a commodity which may be subject of Murabaha. Murabaha arrangement by banks is practically a package of different contracts which come into play one after another at their respective stages. Banks must make sure that all these stages have been really observed and every transaction is effected on its due time. 5. As a seller the bank may ask the client (buyer) to furnish a security for payment of the price whether in the form of mortgage or in the form of a lien or a charge on any of his existing assets. 6. In order to ensure that the buyer pays the installments promptly, he may be asked to promise that in case of a default, he will pay certain amount of penalty for a charitable purpose. Such penalty shall not constitute bank's income and shall be utilized for charitable purposes only.

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6.5 SALAM (ADVANCE PAYMENT - DEFERRED DELIVERY OF GOODS)


1. Salam is a sale whereby the seller contracts to supply some specific goods to the buyer at a future date in exchange for an advance price fully paid on spot. 2. Seller and the buyer can agree on any price at their free will. Price in Salam can be lower than the spot sale price. 3. The buyer should pay the full price to the seller at the time of finalizing the sale. Otherwise, it will be equivalent to a sale of debt against debt, which is expressly prohibited by the Holy Prophet (Peace be upon him). 4. Although the buyer has to pay the full price at the time the Salam contract is finalized, yet the payment of hard cash is not necessary; banks may credit the seller's account or issue a pay order, in favor of the seller, which will be en-cashable on demand. 5. Salam can be applied in those commodities only that are easily available in the market and whose quality and quantity can be specified exactly. It may include any marketable goods with definable features, like raw materials, agricultural produce or manufactured goods. 6. The quality of the commodity that is intended to be purchased should be fully specified leaving no ambiguity leading to dispute. 7. Date of delivery must be well set either by linking it to a specific date or to an event whose happening is an absolute certainty although the date of its occurrence may be subject to a slight variance, provided it does not result in a conflict. 8. The banks will receive certain commodities, not money, from their clients. They cannot sell commodities purchased through Salam before they are actually delivered to them.

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6.6 IJARAH (LEASING)


1. In Ijarah/Leasing, the principal of leased commodity remains in the ownership of the lessor and only its legal right is transferred to the lessee. Any thing, which cannot be used without consuming the same, cannot be leased out like money, eatables, fuel, etc. In case such commodity is leased out, it will be considered as a loan and all the rules concerning the transaction of loan shall accordingly apply. Any rent charged on this invalid lease shall be treated as interest charged on a loan. 2. Ijarah can be used as a financing technique when a financier may buy and rent a productive asset to a person short of funds and in need of such asset. Bank may also purchase the asset as per specifications provided by the prospective lessee. 3. Different amounts of rental can be agreed for different phases during the agreed lease period, it is agreed for each phase while finalizing the lease. The lessor cannot increase the rental for any phase one-sidedly. It can be mutually agreed in the agreement that the rental will be increased by a specified amount/proportion after specified intervals. 4. All liabilities rising from ownership are contained by the lessor. Thus, maintenance of the asset, other than routine operation expenses, during the lease period is responsibility of the bank, the owner of the asset, as the benefit (rental) is linked to the responsibility. 5. In case any injury is caused to the leased assets by any misuse or negligence on the part of the lessee, he will be liable to compensate the lessor for the injury. 6. The lease period shall not commence from the date the payment is made by the lessor to supplier of the asset, but from the date the asset, in working condition, is delivered to the lessee, no matter whether the lessee has started its use or not. The lessee can be asked to pay any advance that will have to be adjusted from the rental after

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its being due. The lessor is liable to pay all expenses like freight, custom duty, etc. incurred up to the time of delivery to the lessee. 7. The lessee can be asked to undertake that, in case of failure to pay rent on its due date, will pay certain amount of penalty to be used in charity. 8. The leasing contract will be terminated if the asset finishes giving the service for which it was rented. If the asset is damaged during the period of the contract, but it can be repaired and make usable, the contract will remain valid. If the parties to the lease do not violate the terms of the agreement, the lease cannot be terminated one-sidedly. In case of termination, the lessee will be liable to pay rent up to the date of termination and handing over the asset to the lessor. He shall not be liable pay the rent for the remaining period. 9. Among two types of leasing, i.e. operating lease and finance lease, only the former is permissible which is a hire arrangement whereby rentals are dealt with in the Profit and Loss Account and the asset is shown in the balance sheet of the lessor. The finance lease is akin to an arrangement of financing whereby accounting takes the form as the user, has in real sense purchased the asset. While fixing the rent of the financed equipment, the financial institutions calculate the total cost of equipment and add the specified interest that they plan to claim on such amount during the lease period. 10. Any express or implied condition stating that the asset will go into the ownership of lessee at the end of the lease period is not in accordance with the Shariah principles. This is because one transaction cannot be tied up with another transaction so as to make the former a precondition for the other. However, as suggested by QIC Fiqh Academy, there can be a unilateral promise to gift or sell the asset at end of the lease period subject to following conditions (sic): (a) Firstly, the promise should be recorded in a separate document but not in Ijarah contract (b) The promise should not be binding on both parties

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because in that case it will be a full contract ascribed to a future date, which is not allowed in the case of sale or gift.

REFERENCES

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1. Akhtar, Shamshad (2007) , Islamic Finance Emerging Challenges of supervision, Journal of Islamic Banking & Finance, The International Association of Islamic Banks Karachi, October-December, pp 8-15. 2. Ayub, Muhammad (2008), Shariah Board, Shariah Compliance and Related Issues In Islamic Banking, Journal of Islamic Banking & Finance, The International Association of Islamic Banks Karachi, April-June pp 22-32. 3. Memon, Noor Ahmed (2007), Islamic Banking Present & Future Challenges, Journal of Management & Social Sciences, BIZTEK, spring, vol.3 No.2, pp 13-22. 4. Memon, Noor Ahmed (2008), Performance of Islamic Banking in Pakistan. Journal of Islamic Banking & Finance. The International Association of Islamic Banks Karachi, April-June, pp 63-69. 5. Rahman, Shah Muhammad Habibur (2002), Islamic Banking Issue To Be Addressed, Journal of Islamic Banking & Finance, The International Association of Islamic Banks Karachi, Jan-March, pp 25-37. 6. Siddiqui, Shamin Ahmed (2005), Understanding & Eliminating Riba: Can Islamic Financial Instruments Be Meaningfully Implemented? Journal of Management & Social Sciences, BIZTEK, autumn, vol.3 No.2, pp 187-203. 7. State Bank of Pakistan, Islamic Banking Bulletin February 2007 pp 112, Islamic Banking Bulletin Jan-Mar 2008 pp 1-23, Islamic Banking Bulletin September 2006 pp 1-19 website: www.sbp.org.pk 8. Tahir, Sayyid (2005), Future of Islamic Banking, Journal of Islamic Banking & Finance. The International Association of Islamic Banks Karachi, Oct-Dec, pp 21-23. 9. Yaquby, Sheikh Nazim (2002), Islamic Banking and Its Operations Shariah Requirements for Conventional Banks, Journal of Islamic

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Banking & Finance, The International Association of Islamic Banks Karachi, Oct-Dec, pp 58-62. 10.Al-Dhareer, S. (1997). Al-Gharar in Contracts and Its Effects on Contemporary Transactions. Available at http://www.irtipms.org/PubAIIE.asp. Accessed October 2006. 11.Ayub, Muhammad (2002) Islamic Bankinh and Finance Theory and Practice, State Bank Printing Press, Karachi, Pakistan. 12.Iqbal, M. (2003) Islamic Banking in Theory and Practice International Banking Conference 2003 Prato, Italy, 9-10 September. 13.Maudoodi, Abul Ala; Sood Islamic Publications, Lahore. 14.Quran, Yousaf Ali, Abdullah. English Translation of Holy Quran Published by: King Fahad Holy Quran Printing Complex, Al-Madina, Saudi Arabia. 15.The Council of Islamic Ideology, Government of Pakistan; Report on Elimination of Interest from the Economy, Government of Pakistan Printing Press Islamabad, June 1980. 16.The Council of the Islamic Fiqh Academy, Resolutions and

Recommendations (1985-2000), Islamic Research and Training (IRTI), IDB, Jeddah, 2000. 17.Usmani, Muhammad Taqi,(2000) Introduction to Islamic Finance Idaratul Maarif, Karachi May 2000. 18.Zaidi, Iqbal and Abbas Mirakhor; Stabilization and Growth in an Open Islamic Economy. Review of Islamic Economics, Vol. 1 No.2, 1991. 19.At Sahih Muslim, Sahih Al Bukhari, Sahih Al-Tirmizi, Miskkat Al Masabih, Sunan Abu-Dawood, Al Tirmizi, Musna Ahmed, are collection of Ahadith and are quoted in dissertation with their respective No. in the relevant book. English Translation from these Ahadith is been abstracted fro the following websites.

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http://www.road-to-heaven.com/hadith/riba_usuary.htm http://muttaqun.com/riba.html http://etori.tripod.com/on-interest.html http://www.islamonline.net 20.Usmani, Dr. M. Imran Ashraf, A Guide to Islamic Banking IBP, Karachi.

21.Ibn http://www.sunnah.org/publication/encyclopedia/html/taqlid.htm 22.Ali, Yusuf, Abdullah, The Holy Quran: Text, Translation & Commentary, Sh. Muhammad Ashraf Publishers & Booksellers, 7Aibak Road (New Anarkali), Lahore, Pakistan, 1979.

Maja,

23.

Arby, Farooq, Muhammad, State Bank of Pakistan: Evolution,

Functions, and Organization, First Edition, State Bank of Pakistan, I.I. Chundrigar Road, Karachi, Pakistan, 2004.

24.

Ayub, Muhammad, Islamic Banking and Finance: Theory and

Practice State Bank of Pakistan, Publications, 2000. www.sbp.org.pk

25.

Qureshi, Iqbal, Anwar, Islam and the Theory of Interest, Sh.

Muhammad Ashraf Publishers & Booksellers, 7-Aibak Road (New Anarkali), Lahore, Pakistan, 1991. 26.State Bank NEWS Monthly, April 2004.

27. 28.

State Bank of Pakistan, www.sbp.org.pk Supreme Court of Pakistan Judgment The Text of the Historic

Judgment on Interest, 2000. http://www.albalagh.net/Islamic_economics/riba_judgement.shtml

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29.Rasul, Shams, A Critical Assessment of Islamic Economics HWWA Discussion Paper#281, Hamburgisches Welt-Wirtschafts-Archiv (HWWA), Hamburg Institute of International Economics, Neuer Jungfernstieg 21-20347 Hamburg, Germany, 2004.

30.

Kazmi, Ali, Aqdas, Dr., Islamic Economics and the Debate on

Interest, Daily The News 10th March, and 16th March 2004. 31.Malik, M.M., Banking Law and Practice IBP (Institute of Bankers Pakistan), 2002. 32.http://www.islamic-world.net/economic/sources.html

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GLOSSARY

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Ahl al-ilm: Educated. Bai Muajjal: Deferred payment Sale. Bai Salam: Pre-paid purchase. Fatwa: Islamic legal opinion. Fiqh: Islamic law. The science of the Shariah. It is an important source of Islamic economics. Gharar: Uncertainty, hazard, chance or risk, sale of a thing, which is not present at hand. Hadith: Report of Sunnah. Halal: Anything allowed by the Shariah (lawful). Haram: Anything prohibited by the Shariah (unlawful). Ijarah: Leasing. Ijarah-wal-Iqtina: Hire purchase. Istisna: It is a contractual agreement for manufacturing goods and commodities, allowing cash payment in advance and future delivery or a future payment and future delivery. Jahiliyah: Pre-revelation, literally ignorance. Mudarabah: Profit Sharing. Mudarib: Entrepreneur-borrower. Murabaha: Cost-plus or mark-up. Musawamah: Musawamah is a general kind of sale. Musharakah: Equity Participation. Qard-e-Hasna: Benevolent loan (interest free). Quran: Devine Book of Islam. Rebhe: Interest.

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Riba: An excess or increase (Usury). Shariah: Islamic Law.

Shirkah: Musharakah. Sunnah: Custom, habit or way of life. Technically, it refers to the utterances
of the Prophet Muhammad (SAWW) other than the Holy Quran knows as Hadith, or his personal acts or sayings of others, factly approved by the Prophet. Takaful: Mutual support which is the basis of the concept of insurance or solidarity among Muslims. Riba: Usury or Interest. Riba Al-Fadl: Sale Transaction. Riba Al-Nasia: Loan Transaction. Thaman: Price. Qimar: Gambling. FSC: Federal Shariat Court. Aqiba: Consequence. Bai: Sale. Bai Sahih: Valid Sale. Bai Baatil: Void Sale. Bai Al-Sarf: Exchange of Monetary Values. Nuqud: Things Representing Money. Aqd: Contract. Mabee: Subject Matter. Khatar: Stake or Risk.

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Dharar: Two inflict any undue loss. Iwad: Compensation. Jahl: Ignorance. Maysir/Qimar: Word Used for prohibition of gambling and wagering. Muallaq: Suspended. Arboon: Down Payment. Sood-e-Mufrid: Simple Interest. Sood-e-Murakkab: Compound Interest. Khamar: Liquor. Khinzeer: Pork. Al-Fahsha: Corruption or Immorality. Tijarti Sood: Commercial Interest. Sarfi Sood: Usury (Interest on loan for personal need and expenses). Rabb-ul-Mal: Person who invests his capital. Amwal-e-Ribawiya: Six commodities in Fiqh terminology i.e. Gold, Silver, Date, Wheat, Barley, Salt. Bai Fasid: Existing sale but void due to defect. Bai Makrooh: Valid but dislike sale.

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