Finance

    When most western capitals were reeling under the 2008-2009 global recession, many Middle Eastern countries were largely unscathed. Some Islamic financial experts now argue that had the Islamic financing system been in place on Wall Street, the 2008-2009 global crisis would have been averted. Western capitalism has been at the forefront of global financing for decades. The 2008-2009 global economic crisis depleted the financial resources of some of the worlds biggest companies. Finance Ministers from the United States to Europe, and Japan, stepped in to rescue some of them because they were deemed too big to fail. Credit default swaps and a variety of other derivatives as well as a general lack of government oversight were largely blamed for triggering the financial crisis which continues to be responsible for record unemployment in most western countries. Most derivatives are derived from mortgage papers, and a slew of debt denominated instruments which are simply repackaged and sold to investors all over the world.  When millions of people in the United States defaulted on their sub-prime mortgages, these derivatives became worthless, and billions of dollars worth of insurance claims were filed with global insurance power houses such as AIG. Global financial institutions such as Citibank, Bank of America, Chase, and others, could not cope with the fallout and had to be bailed out by the United States government. Some experts claim that this global recession is a wake up call to Wall Street and government regulators.  This paper examines the validity of such claims, and compares the Islamic and conventional banking and financing styles.
   
     Islamic financing has experienced unprecedented growth in recent years. Unlike mainstream financing, which thrives on anticipated interest and cut throat competition, Islamic financing aims at leveling the playing field by banning interest and financial instruments which have the potential to take unfair advantage of vulnerable investors (Khan  Bhati 2008 1). Unlike conventional financing where interest rates play an important role, Islamic financing encourages stakeholders to share risks. By sharing risks, partners have an incentive to be more judicious, and this preserves capital, and reduces the incidence of financial risk.
The Islamic and conventional banking and finance philosophies lead to the following obvious questions
Research Questions
Is Islamic banking and finance considered a serious threat to conventional banking and financing
Can Islamic banking and finance attract large numbers of non-Islamic customers
What can conventional banking and financial institutions learn from the Islamic banking and finance systems
Is Islamic banking and finance safer than conventional banking and finance

Why these Questions are Interesting
    These questions are interesting because the success of Islamic banks proves that there is a serious alternative to conventional banks and financial institutions. Kuwait is widely regarded as the home of the largest Islamic banks in the world. According to Khojab (2006), Islamic bank assets in Kuwait will exceed 56 billion in 2010. The Gulf region of the Middle East is the proud home of most of the largest Middle Eastern banks and financial institutions. Countries in this region have announced the merger of their central banks and financial institutions in 2010. This is expected to have a dramatic impact on banking and finance not only in the Middle East, but worldwide. Experts now expect the financial resources of the global Islamic banking and finance system to reach 4 trillion in 2010 (Alam 2006). Financial experts also estimate that 40 to 50 of the savings of the worlds 1.5 billion Muslims will be held by Islamic banks in the next two years (Arekat 2006 Cader 2007).

Review of the Literature
    Among the numerous studies which have been conducted on conventional and Islamic banking and finance systems, one stands out. Hassan et al (20091) studied the differences in mean cost, revenue, and profit efficiency scores of conventional versus Islamic banks. These researchers studied the financial records of 40 banks in 11 Organisation of Islamic Conference (OIC) countries, from 1990-2005.

     The main database software used in the study was the BankScope system, and the DEA nonparametric efficiency method, which was first introduced by Farrell and was used to process the information. The study revealed that Islamic banks functioned as smoothly as conventional banks. One other similarity found across the board was that conventional and Islamic banks did a better job in the use of their assets, but they were not as adept at creating additional wealth. Practically every bank missed the chance to earn 27.9 additional income, and almost every bank in the study lost 20.9 more money with the same amount of resources (Hassan et al 2009).

    An important difference noted in the study was that conventional banks buy bank deposits at low interest rates and then turn around and sell or lend the money to borrowers at higher rates of return (Iqbal  Molyneux 2005). Islamic banks, on the other hand, do not request or receive interest payments when they lend to customers, and they do not pay interest to customers who deposit money. Rather than paying or receiving interest, Islamic banks were found to share profits based on a formula which shares risks and profits in an equitable manner (Arif 2006).

    Other studies were carried out to measure the progress of Islamic banks by using the growth ratios of mainstream banks (Hassan  Bashir 2003 Bader, Shamsher  Taufiq 2007). Additional studies have also focused on determining whether mainstream banks are more efficient than Islamic banks (Bader 2007). The researchers first studied Islamic and mainstream banks separately. After that, the two systems were compared and contrasted (Bader et al (2007)..

    Overall, the studies showed a general weakness in both conventional and Islamic banks in dealing with cost, revenue and profit efficiency (Hassan et al 2009 3). The studies showed that there was room for improvement in these areas across conventional and Islamic banking systems. The studies also determined that the typical bank is much better at handling its resources than at creating additional wealth. In terms of smooth functioning, no significant differences were found between mainstream and Islamic banks.

Proposed Research Methods
    A quantitative correlational method will be used in this study. Such a method will enable the researcher to examine the correlation between the profit and loss trends of a major Islamic bank in the Middle East, and a publicly held conventional bank over a period of five years. The quantitative research method has been a well-established way for researchers to carry out comparisons of two or more variables (Natukho, Graham  Muyia 2009). A quantitative correlational method will be more efficient at determining if the correlations are statistically significant. According to Creswell (2005325), a correlation is a statistical test to determine the tendency or pattern of two or more variables or two sets of data to vary consistently.  Such a design will offer a chance to identify and explain any relationships between the variables (Creswell 2005).

    A quantitative research method is most appropriate because much is known about the subject under study. A qualitative research method is normally used as an exploratory tool on a subject about which not enough information is available to offer a deep understanding of an important phenomenon. Quantitative research methods can be used to pinpoint narrow and broad-based phenomena from the experiences of those involved. Data in a quantitative study is collected with the use of closed-ended questions, or from public databases. Quantitative research is conducive to a statistical analysis, but in qualitative research text analysis is the basis of the data (Creswell 2005).

    The quantitative methodology is appropriate in the description and explanation of hard data, while qualitative studies are more appropriate when the researcher is interested in understanding an area of research which is still unknown (Creswell 2005 Salkind 2006). Researchers use the quantitative research design when they are interested in understanding the relationship between two or more variables. Statistical techniques can be used to determine how the variables are correlated. Since this study will compare Islamic banking and finance with conventional banking and finance, a statistical analysis will be used (Creswell 2005).

Data Sources
     The primary data source for this study will be the annual reports of one major Middle Eastern bank of the researchers choice, and one major conventional bank of the researchers choice. The period to be reviewed will be from 2004 - 2009. The banks to be selected for the study will be banks which issue annual reports to their stakeholders at the end of each year, and make these reports available to the general public. The specific data to be reviewed will be the banks balance sheets and their profit and loss statements, which will be studied over a five-year period to determine the differences and similarities of these trends between the two banks for the given period.

Reflections
Potential Practical and Empirical Obstacles
    The potential obstacles inherent in this study have to do with the availability of data. The researcher will need at least the annual report of each bank to be studied for a period of five years, from 2004 - 2009. The researcher is concerned that these documents may not be available to the general public, and that the banks may not want to share the information with non-bank customers. The annual reports may be available, but they may not have the detailed information which the researcher will need to conduct the study. In this case, it will be necessary for the researcher to obtain the information from the banks. Any contact with bank personnel or anyone else will be in accordance with professional and academic ethical standards as described below.

Informed Consent
    Cone and Foster (2003) argue that it is important to clearly disclose all aspects of a research study to the participants. Each participant will sign an informed consent agreement which spells the purpose of the study. The agreement will also comply with the Nuremburg code requirements and guidelines for voluntary participation in research involving human subjects (Ellis  Earley 2006). Each participant will be informed in writing that he should feel free to terminate the relationship at any time, without the fear of retribution. All participants who choose to remain in the study will receive a copy of the signed informed consent agreement.

     According to Cone  Foster (2003), the use of strict confidentiality policies and procedures will enhance the integrity of the study. The informed consent agreements will be signed before any interview is conducted. A copy of the informed consent agreement will be labeled as Appendix A, and will become part of the dissertation.

Conceptual and Theoretical Framework
    The study will be conducted under the guidance of the conceptual and theoretical framework of the Islamic interest ban theory, which is considered the most vexing item in the Shariah code of banking and financing laws (Djojosugito 2008). Islamic banks continue to deal with risks emanating from their compliance with Shariah guidelines. Even though Shariah has been around for decades, modern Islamic banking and finance rules and regulations only date back to 1975, when the first Islamic commercial bank, the Dubai Islamic Bank, was established (Djojosugito, 2008). Today, Islamic banks face legal, moral and ethical dilemmas about the possibility of inadvertently infringing on the guidelines of Shariah. Justice and equal treatment are non-negotiable requirements of the Islamic banking code (Djojosugito). Even though interest payment may be illegal, capital still has to be paid for.

     But Islam considers capital an ingredient of production, which is not expected to be the source of interest from the future financial rewards of investment. Islamic law, however, permits a profit-sharing (Djojosugito 20083) mechanism, which operates by means of a ratio, rather than by a rate of return, to be used to compensate legitimate stakeholders. Islamic law further stipulates that wealth needs to be multiplied for the benefit of all, and it is unjust and unfair for anyone to demand the payment of interest for the mere use of his money (Djojosugito 2008, 20083). Profit sharing is only half of the investment equation. Any losses from a business transaction constitute the other side of the investment, and these should be divided in an equitable manner among the various stakeholders (Djojosugito 2008).

    Finance scholars agreed back in the 1940s that when capital is put into proper use, a companys net worth is boosted. During the 1950s, to the 1970s inclusive, five different finance theories emerged, but due to space limitations, only two will be discussed here. The early gearing or leverage theory asserted the argument that a reasonable amount of debt associated with capital is not a bad idea as long as the level of indebtedness is manageable (Shubber  Alzafiri 2008).  The MM model advocated by Modigliani and Miller contended that capital ought to be set apart from its acquisition cost because of the arbitrage practised by investors (Shubber  Alzafiri 20081).

    While these theories apply to capital, it is fair to say that Islamic banks operate very differently from mainstream banks. In Islamic banking, the application for a loan and the funding of that loan cannot be predicated on any expectation of a future interest payment. Islamic bank deposits are not guaranteed to be recovered, and no specific rate of growth is expected to accrue to these deposits (Shubber  Alzafiri 2008). This implies the existence of an inherent partnership between depositors of funds, Islamic banks, and anyone who may use those deposits. The depositor is, however, not assured in advance or at any time that the money deposited will experience any growth, even though it may be used repeatedly by others. A practical reality of this arrangement is that Islamic banks fund up to 75 their day-to-day transactions with deposits in their vaults, without paying or promising to pay any returns on these deposits. This reality places a unique type of risk on cash deposited in Islamic banks, as well as a moral and ethical dilemma now, and in future, on Islamic banks all over the world (Shubber  Alzafiri 2008).

Impact of this Study on the Researchers Career
    This study promises to be enlightening to the author as a researcher in a political field, because it may bring him face-to-face with a variety of Islamic and conventional bank executives. Through this study, the author hopes to gain a much deeper understanding of the philosophies behind Islamic and conventional banking and finance systems. The study is, therefore, an excellent learning opportunity to the researcher.

    The information gathered during this study has revealed some important unique characteristics which set Islamic banking and finance systems apart from conventional banks and financial institutions. The rationale behind the Shariah code is fairness and equity (Clarke 20095). This philosophy dictates an equitable division of losses between the lender and the borrower. Under an investment mechanism known as musharaka, a commercial borrower is expected to include a percentage of his profits in monthly loan installment payments to the lender (Clarke 2009).

     This percentage can fluctuate depending on the performance of the borrowers business. Another intriguing aspect of Islamic banking and financing is that a venture capital practice known as mudaraba, precludes the collection of loan processing fees from a borrower, if he can show the lender or the partner that he did not make a profit (Clarke 2009). All these are very unique aspects of Islamic banking and finance which set them apart from mainstream banks. They also give the researcher an interesting glimpse into what to expect from this study.

    The researcher will continue to conduct research on the Islamic banking and finance system and how Shariah law continues to affect it. Clarke (2009) posits that there is a lot to be learned from the Islamic banking and finance system, because Shariah law ensures that banks should operate in a deliberate conservative manner. Financial instruments cannot be used to back other financial instruments in a bank or investment transaction because this could lead to excessive returns (riba). Such deals must be backed by brick and mortar assets such as buildings, land, and tangible products such as petroleum, wheat or corn. The broad spectrum of laws guiding banking and financial transactions constitutes nough material to keep the researcher very busy immediately after this limited study.