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Choose a bank of your choice that operates Islamic banking system (preferably a bank with a dual banking system). Choose a product in the Islamic banking and compare them to a similar products in the conventional banking.

Islamic Banking System

Overview of the project

This project will explain the detail about the Islamic bank, their operation and organizational structure. This report will illustrate the shariah regulation under which the bank is regulated and details regarding the contracts that are allowed and that are forbidden under Shariah

The main aim and objective of this report is to present the details of the Dubai Islamic Bank. The details include the background, nature and structure of the bank. It will further state the sources of funds, issues the ban are facing and ways to mitigate the issues, financial disclosures and financial performance of the bank.   

Dubai Islamic bank (DIB) not only provides the service of Islamic bank all over the world, but also maintains to keep their flag high flying. They present themselves as the champions of transparency, equality and morality in all of their activities and their establishments shows growth, modernity and diversity of the cities in which they operate. Islamic finance and banking is one of the fastest growing among the economic sectors globally and it includes greater than 400 organizations that manages globally assets more than US$ 1 trillion. The bank is rooted to the customer centred institution, where the heritage and tradition, honesty and personal services, modernity, innovation and flexibility are valued for providing the customers with complete solutions for any kind of financial requirements (Dubai Islamic Bank, 2017).

Historical background of the Islamic banking

Islamic banking system (IBS) is explained as the system of banking whose main objectives for activities and operations are found under the Shariah rules. Though the banking activities were already in existence much before the Islamic history in 1960, the Islamic bank was established in 1960’s (Iqbal & Molyneux, 2016) . If it is seen from the historical point, the Islamic banking can be segregated into three eras:

  • Early era or first era – it covers the early years of Islam till the time of Caliph ar-Rashidin
  • Middle era or second era – it covers the period from the caliphates till the collapse of  Uthmaniyah empire
  • The modern era or third era – it covers the era of the modern days Islamic banking (Hanif, 2014).

The Islamic bank does not offer any fixed interest in deposits and loans like any other commercial banks. The earnings from the Islamic banks are allocated through sharing of profits, thus each of the employers of the bank are considered as the shareholders of the bank. The agreement for profit sharing is regulated by the central bank of the country (Abedifar,  Molyneux & Tarazi, 2013)..

Organisational structure

Board of directors – The board of directors of Islamic bank are responsible for the supervision of the Islamic bank’s activities through application of effective corporate governance. Further, they govern the operation though setting up the procedures and policies. The board of directors are selected by stakeholders and they represent the interest of the stakeholders. They are also in charge of taking various high-level decisions and are responsible for appointing the chief executive officer (CEO) of the bank (Guru et al., 2015).

Organizational Structure

Shariah requirement - The Shariah operates within the regulations that are set up by three principles that are agreed upon by the Islamic jurists and scholars for years. These regulations are –

  • The interest of the community must be preferred over the individual’s interest.
  • Relieving of hardship must be preferred over promotional benefit (Meutia & Febrianti, 2017).
  • To eliminate a small amount of loss, a bigger loss shall not be prescribed and a bigger advantage always preferred over the smaller advantage. On the other hand, smaller harm can be suggested to protect against the bigger harm and the smaller benefit must not be preferred over the bigger benefit (Abdul-Rahman, 2014).

Operational practices – the Shariah requirements follow –

  • Avoidance of proscription
  • Assuring that the contract or agreement has all the required elements with the required conditions (Abedifar et al., 2015).

The prohibitions under the Shariah requirements are –

  • Trading and producing of any impure materials
  • Trading and producing of any material that are of no use
  • Riba
  • Ghahar
  • Any type of gambling (Khairi & Baridwan, 2015).

Forbidden contracts under Shariah requirements – void and forbidden contracts that involve Riba, Ghahar and gambling are:

  • Betting
  • Borrowing and lending with interest
  • Bai al-Ghahar
  • Bai al- Malaqih
  • Bai al-Madhamin
  • Bai Habl-Il-Hablah
  • Bai-al-Hisat
  • Bai al-Munabazah
  • Bai al-Mulamashah

For undertaking the contracts which are forbidden under shariah, a penalty clause is included that is enforceable by law (Gheeraert & Weill, 2015).

Introduction– the DIB is the Islamic bank from Dubai that was established in 1975. It is 1st Islamic bank that have been incorporated with the principles of the Islam and all practices. They are the largest Islamic bank from UAE. DIB is a company of public joint stock and share of the company is listed under the financial market of Dubai. They are operating more than 90 branches at present in UAE. The president and chief executive of the bank is Adnan Chilwan while the board of director’s chairman is Mohammed Al Shaibani (Léon & Weill, 2016).

Characteristics – the bank has dedicated relationship manager who are always ready to help the customers with the banking requirements and assure providing the best-in-class solutions and investment. They also assist their customers with investment deposits, cheque book with customised need, corporate saving account and investment products (Uppal & Mangla, 2014).

Conditions – the customers must notify their bank instantly in case of misuse, disclosure or loss of password for taking necessary steps. The bank may generate new password by taking the cost from the customer and the customer will be solely responsible for any misuse of his account after happening such events. The bank will be considered as notified only after the customer contact the officer of the bank at the required time following the incident (Gheeraert, 2014).

All the transactions that are implemented and accepted by the bank upon receiving the instructions from the customers direction must be at her/his own risk and cost and customer must be bound by the transaction. Further, the bank without informing the customer may deduct any amount from his account as expense, commission or fees that is payable against banking products and services as provided to the customer as approved by the bank. Moreover, the bank will not be held responsible to the customer for transferring or crediting any amount as commission or fees that is payable for banking services (Ben Naceur, Barajas & Massara, 2015).

Shariah Regulation

DIB has taken leading role in establishing a transformation that has been experienced by UAE and Dubai over the last 30 years.  The bank provides various services like treasury products, corporate banking and merchant banking throughout the corporate market and implements their innovative approaches in providing services to their clients (Shoukat,  Ali & Kamran, 2016). Their innovative services cover the financial solutions like corporate financing, project financing, commodity and trade finance, debt and capital related market products, corporate and treasury banking, securities and services related to international banking. Further, the bank is able to provide complete range of services and products that are geared to meet the complexities and demands from the corporate finance division (Zulfiqar et al., 2016).

Sources of funds

The funds derived by the Islamic banks are from the following sources:

  • Paid-up capital – this is the primary source of funds for a newly established Islamic bank. Stakeholders who establish the bank as public limited company for the social and commercial sectors are generally the owners (Abduh & Othman, 2014).
  • Deposit accounts – under the deposit account, the major source for the funds are-
  • Investment account: this is the major source of funds for the bank. They accept the deposits from the customers with the minimum limit and fixed period (Wilson, 2013).
  • Current account: this account is opened by the customers who are looking for the safe custody for their funds. Moreover, the bank is permitted by the customers through the application form to utilize their funds for the banking operations.  
  • Savings account: It is one of the key sources for funds for the banks. While the customer is opening the account with bank, they authorise bank for investing the fund that is deposited (Riaz,  Awad & Nadia, 2014).

The organizational structure of the Dubai Islamic bank reveals that it is headed by the CEO Adnan Chilwan and various other sectors like CFO, Consumer banking, Investment banking, Credit, Risk management and managing directors are covered under his supervision. Further there are chairman of the board and other directors to manage the operations of the bank (Al-Tamimi et al., 2015).  

i. Risks that are faced by the bank

The analysts of banks are worried about the short-term risks associated with the operation of the bank. The bank is not falling in favour with regard to the exposures and asset quality of the property sector. Their reducing earnings from fees and increasing uncertainties for more than 19% holding by Tamweel, the management financier is the cause of additional worries. Other risks that are faced by the DIB are as follows

  • Credit risk – this is the risk that is measures as total loans/total assets. There is positive relation among the profit and credit risk. However, if due to any factor bank fails to collect the fund, the positivity of the relation may got affected.
  • Liquidity risk – it is calculated by total loans/total deposits. The industry average for this ratio is 1:1. The bank is not allowed to provide loans more than their deposit amount
  • Capital risk – it is calculated by equity capital/total assets. Higher ratio represents less risk and vice versa
  • Operational risks –this is calculated by proxy measure cost/income. It is the risk of uncertainty with regard to the earnings of the bank due to the failures of operating system, misconduct by employees, error in calculation, lightning, flood, strikes, and similar unavoidable events or the risks associated with loss due to unexpected expenses towards operation (Kumar & Sujit, 2015).  

ii. Risk control

The procedure of management and identification of risk that are available to the bank is of two types: (1) standard procedure that involves reporting of risk, external as well as internal audit, RAROC, analysis of GAP and internal rating (2) the techniques that are required to be adapted and developed with regard to the requirements of Shariah requirements. The techniques of risk avoidance are as follows:

  • Risk elimination  or avoidance – this includes of standardization of all the businesses related to processes and activities, development of a diversified portfolio, implementation of a scheme that is incentive-based aligned with the actions. Risks can also be eliminated through selling these in the established market
  • Risk transfer – this technique involves the usage of derivatives for hedging, buying or selling of financial claims and alterations in terms of borrowings. It is very crucial to be noted that the commercial derivative instrument does not conform to the rules and regulations of Shariah.
  • Risk management or absorption – some risks are there that cannot be transferred or eliminated and have to absorbed by the bank.  This is due to firstly, the complexities of risk and difficulty in parting it from the assets. Secondly, the risks are accepted by the bank as this are required for their business. Further, these risks are agree to as the banks are specialized in handling these, for instance, the credit risk associated with the banking activities and market risk associated with activities of trading book (Iqbal, & Molyneux, 2016).

Strengths

Weaknesses

1. At present it is one of the fastest growing bank around the globe in the economic segments and it comprises of greater than 400 organizations with the task of managing the assets all over the world

2. DIB has been named as best Islamic bank in the banking sector by the Banker Middle East Magazine. The bank also established a wholly owned subsidiary, the DIB Pakistan Ltd

3. They have taken active part in generating alliances and partnership at international as well as domestic level.

4. DIB has strong capital base and financial stability

1. The lending profile of the bank is associated with the quality concerns of assets that leads to high charges for impairment

2. The bank obligates the opportunities for revenue generation through locking-up their operations to the geographical region

3. Introduction to the sector of real estate is facing with net losses that could lead to further losses in future

Opportunities

Threats

1. Focussing on the opening out of more distribution channel provides new opportunities for the bank

2. Islamic finance and banking is one of the fastest-growing economy and they have an opportunity of growing in the promising  economies

3. Introduction of new products related to finance may help them in sustaining highly competitive environment of banking

1. Fluctuations in rate of interest

2. Changes in regulatory requirements owing to the financial crisis in the international market are going to be stringent

3. Strong competition within the conventional and Islamic banks may lead to minimization of profit margin

  • Application of revised and new IFRS – the revised IFRS that are applied while preparing the financial statements are IFRS 10, IFRS 5, IFRS7, IAS 34, IAS1, IAS16 ans IAS 38.
  • Basis of preparation – the consolidated financial statements are prepared on the basis of International Accounting Standard 34, that is, Interim Financial Reporting issued by IASB. The consolidated interim information does not cover the all those information that are required for the complete financial statement as per the IFRS.
  • Estimates and judgements – the preparation of consolidated financial statement requires the management to make the estimates, assumptions and judgements that have an impact on the application of the accounting policies and the recorded amounts of expenses, income, equity, liabilities and assets.
  • Significant accounting policies – for the preparation of the statements the accounting policies are used consistently and  are consistent with the last year’s disclosed audited financial statement
  • Financial management of risk – management of the policies and objectives of financial risk of the group  are consistent with the last year’s disclosed audited financial statement
  • Calculation of share value – diluted and basic earnings per share are calculated by dividing the earning from the relevant period that is attributable to the owners of the bank, after deducting the remuneration of the directors and profits of Tier I sukuk holders by the weighted average number of shares outstanding during the relevant period.

Dubai Islamic bank and Commercial bank of Dubai

Ratios

Formula

Dubai Islamic bank

Commercial bank of Dubai

Current ratio

Current assets

 $   27,503.00

 $     10,088.00

Current Liabilities

 $   17,675.00

 $     44,269.00

Current assets/current liabilities

1.56

0.23

Debt equity ratio

total liabilities

 $1,50,470.00

 $     55,400.00

total equities

 $   24,500.00

 $       8,680.00

Total liabilities/total equity

6.14

6.38

Return on asset ratio

Net income

 $     5,685.00

 $       1,003.00

Average total assets

 $1,62,434.50

 $     60,972.00

Net income/average total assets

0.035

0.016

Asset turnover ratio

Net sales

 $     6,320.00

 $       2,278.00

average total assets

 $1,62,434.50

 $     60,972.00

Net sales/average total assets

0.039

0.037


It can be seen from the above table that the liquidity ratio that is the current ratio of DIB is much better as compared to commercial bank of Dubai (CBD). That means the DIB can meet its short-term obligation in a better way than the CBD. The solvency ratio, that is the debt equity ratio of both the banks are more or less same that shows that solvency level of both the banks are same. However, both the banks are highly solvent as the equity portion of both the banks is significantly low as compared to the total liabilities. Further the profitability ratio, that is, the return on asset ratio of CBD is low as compared to the DIB. Though the ratio is not so impressive for both the banks, DIB is comparatively in better position. Finally, the efficiency ratio, that is the asset turnover ratio of both the banks are almost same. That shows that both the banks are equally efficient. Through the all over comparison of financial performance of both the banks, it is identified that with regard to the liquidity terms and profitability aspect, DIB is in better position as compared to CBD (Dubai, 2017).

Characteristics and Conditions

Conclusion and recommendation

It is concluded from the above discussion that DIB is the largest Islamic bank from Dubai and it is 1st Islamic bank that have been incorporated with the principles of the Islam and all practices. They carry on their activities and operations as per the rules and regulations of Shariah and do not undertake the contracts and activities that are forbidden by the Shariah. Their employees are their stakeholders and the bank distributes its earning among them. The main source of their fund is the paid-up capital contributed by the stakeholders and the deposits collected from the customers. The main issue that the bank is facing is the fluctuations in the interest rate, competition from conventional banks and locking-up their funds based on the geographical region. To overcome these issues, the bank must fixed the interest to the extent possible and shall not lock-up the funds, so that it can generate additional income. Further, the bank must increase its equity contribution and pay off the debt as much as possible with the available income to reduce their solvency level.

References:

Abduh, M., & Othman, A. A. (2014). Service quality evaluation of Islamic banks in UAE: an importance-performance analysis approach. Journal of Islamic Economics, Banking and Finance, 10(2), 103-113.

Abdul-Rahman, Y. (2014). The Art of RF (Riba-Free) Islamic Banking and Finance: Tools and Techniques for Community-Based Banking. John Wiley & Sons.

Abedifar, P., Ebrahim, S. M., Molyneux, P., & Tarazi, A. (2015). Islamic banking and finance: Recent empirical literature and directions for future research. Journal of Economic Surveys, 29(4), 637-670.

Abedifar, P., Molyneux, P., & Tarazi, A. (2013). Risk in Islamic banking. Review of Finance, 17(6), 2035-2096.

Al-Tamimi, H., Hussein, A., Miniaoui, H., & Elkelish, W. W. (2015). Financial Risk and Islamic Banks’ Performance in the Gulf Cooperation Council Countries.

Ben Naceur, S., Barajas, A., & Massara, A. (2015). Can Islamic Banking Increase Financial Inclusion?.

Dubai, C. (2017). CBD.ae | Personal Online Banking, Current Account, Savings Account, Credit Cards.... Commercial Bank of Dubai. Retrieved 8 April 2017, from https://www.cbd.ae/

Gheeraert, L. (2014). Does Islamic finance spur banking sector development?. Journal of economic behavior & organization, 103, S4-S20.

Gheeraert, L., & Weill, L. (2015). Does Islamic banking development favor macroeconomic efficiency? Evidence on the Islamic finance-growth nexus. Economic modelling, 47, 32-39.

Guru, B. K., Shanmugam, B., Alam, N., & Perera, C. J. (2015). An evaluation of internet banking sites in Islamic countries. The Journal of Internet Banking and Commerce, 2003.

Hanif, M. (2014). Differences and similarities in Islamic and conventional banking.

Home | DUBAI ISLAMIC BANK. (2017). Dib.ae. Retrieved 8 April 2017, from https://dib.ae/

Iqbal, M., & Molyneux, P. (2016). Thirty years of Islamic banking: History, performance and prospects. Springer.

Khairi, M. S., & Baridwan, Z. (2015). An empirical study on organizational acceptance accounting information systems in Sharia banking. The International Journal of Accounting and Business Society, 23(1), 97-122.

Kumar, R., & Sujit, K. S. (2015). Wealth Creators in the Banking Sector in UAE during 2010-2015 Period. Asian Journal of Finance & Accounting, 7(2), 152-160.

Léon, F., & Weill, L. (2016). Islamic Banking Development and access to credit.

Meutia, I., & Febrianti, D. (2017). Islamic Social Reporting in Islamic Banking: Stakeholders Theory Perspective. In SHS Web of Conferences (Vol. 34). EDP Sciences.

Riaz, A., Awad, R., & Nadia, S. (2014). Customer satisfaction between Islamic and conventional banks: Case of Pakistan. Social and basic sciences research review, 1(2), 69-73.

Shoukat, F., Ali, S., & Kamran, A. (2016). Impact of Working Hours on the Health, Social Life & Performance on Centralized Operation Division (COD) Employees of Dubai Islamic Bank Pakistan. DEStech Transactions on Economics and Management, (iceme-ebm).

Syed, A. A. S. G. (2013). Comparative Analysis of Dubai Islamic Bank Compare with Bank Alfalah Conventional bank during Global Financial Crisis.

Uppal, J. Y., & Mangla, I. U. (2014). Islamic Banking and Finance Revisited after Forty Years: Some Global Challenges. Journal of Finance.

Wilson, R. (2013). The development of Islamic finance in the gulf cooperation council states. The Transformation of the Gulf: Politics, Economics and the Global Order, 146, 47-76.

Zulfiqar, S., Haddad, H., Al-Shehhi, Y., & Máté, D. (2016). financial performance of islamic bank in the united arab emirates, pakistan and jordan: a case comparative study with dupont approach. Annals of the University of Oradea, Economic Science Series, 25(2).

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