Posted: June 30th, 2015
A COMPARISON BETWEEN ISLAMIC AND CONVENTIONAL FINANCE: CASE STUDY OF FIRST FINANCE QATAR
Abstract
This paper has made a comparison between Islamic and conventional finance in an attempt to establish which system is more effective. In order to achieve this, the paper has discussed the features of Islamic banking and the features of conventional finance. The similarities and differences between the two banking systems were evaluated. The two schemes were evaluated for profitability, risk management, stability, and overall efficiency. First finance Qatar provided the data needed to conduct the study. Sixty participants were selected to participate in the study. An in-depth discussion of the two systems of finance was discussed and the conclusions made. Recommendations have been provided on which scheme is better and how the financial systems should be structured.
Table of Contents
1.2 Statement of the Problem.. 6
1.6 Justification of the study. 7
CHAPTER TWO: LITERATURE REVIEW… 10
CHAPTER THREE: RESEARCH METHODOLOGY.. 23
3.4 Sampling procedure and sample size. 24
3.5 Statistical implication of the sample size. 24
3.6 Data collection Instruments. 24
3.9 Data Validity and Reliability of Research Instruments. 26
3.11 Limitations encountered. 27
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS. 29
Interpretation of Statistical Test 36
Issues Associated with Conventional Finance. 43
Issues Associated with Islamic Finance. 46
CHAPTER FIVE: CONCLUSIONS AND RECOMMENDATIONS. 47
CHAPTER ONE: INTRODUCTION
1.0 Overview
This section offers the background to the study defines the research problems and presents the research objectives, research questions, hypotheses, aim, justification, scope, assumptions and limitations of the study.
1.1 Background Information
The international expansion of Islamic finance in the recent past has been tremendous. Prior the financial crunch of 2008, sharia compliant assets were projected to have grown by approximately ten percent (Akkizidis & Khandelwal, 2008). The balance sheets of sharia compliant financial institutions totaled 463 billion dollars by the end of 2006. Following the global crunch, the Islamic Finance Banking Sector has constantly augmented. The 2008 global crunch raised concerns in the current baking schemes. The main issue discussed included the stability and solidity of worldwide financial schemes (Ayub, 2007). A variety of causes were acknowledged to have contributed the most to the crunch. The causes encompass financial innovation and progressive, sophisticated financial engineering techniques, which were developed in pursuit of short-term gains and market share and which prompted excessive leverage and imprudent risk-taking practices. A majority of the techniques by the conventional banks entailed speculations and estimations of future prices of the basic assets. However, for a majority of the occasions, the market values of these products were not an accurate anticipated performance of the actual economy (Al-Mutairi & University of Durham, 2010).
The market values were a product of distorted and misguided information conveyed to the market participants by the few big players who have constantly dominated the market. This scenario eventually led to the creation of a parallel market disconnected from the actual market and whose size has grown numerous times the size of the real market producing because of market bubbles. This scenario was made probable by approaches of excessive expansion of credit, which was encouraged by imprudent market practices based mainly on risk transfer techniques to diversify risk and hedge vulnerable positions. The above techniques are applicable to conventional banking sectors (Aldohni, 2012).
The uniqueness about Islamic banking is that it is founded on the philosophies that evade speculation and all trade transactions involving the unduly amount of uncertainty in a way that is considered harmful to market participants and the entire public. These philosophies protected Islamic banks during the global crunch and have proved that the fundamentals in which Islamic banks operate are essential in ensuring the stability of financial systems and global systems. Other basic aspects of Islamic banking that reduces risks are the profit and loss sharing scheme of their balance sheet and the treatment of debt-based assets. Firstly, Islamic finance advocates for deposit holders be treated as investors, hence treated as quasi-equity holders. However, the major consequence of this aspect is that any loss arising from assets funded using these deposits would be borne by account holders. In practice, this provides Islamic banks with inbuilt stabilizer. The aspect alters liabilities automatically in response to any value change in the price of assets (Al-Amine, 2008). This feature makes Islamic banks immune from any shocks that would erode banks under conventional banking settings.
Secondly, Islamic finance evades trade of debt and, therefore, regulates lending activities only to real assets (Balala, 2011). The implication is that Islamic finance has not only ensured limiting Islamic banks’ lending ability of the real economy, which consequently guarantees the prevention of bubbles while simultaneously opening novel investment opportunities. However, Islamic finance have means of financing that differ to a great extent to those available to conventional banks. The approach exposes Islamic banks to different kinds of credit risks as compared to conventional finance (Demirguc-Kunt et al., 2010).
1.2 Statement of the Problem
Islamic banks operate on sharia philosophies of finance. In this mode of operational finance, transactions are Riba free and evade unethical practices, partake actively to attain goals and aims of Islamic economy (Dar, Harvey, Presley, & Loughborough University, 2008). Contrary, conventional banks place emphasis on the designed philosophies where predetermined rate of interest is the major goal. There has been growing concern by economists to establish which mode of banking is more effective. The major goals of all financial institutions, particularly banks are to make money through a process of credit creation. The process involves activities such as giving loans with a high interest (Cattelan, 2013).
Conventional banks have mastered this process of credit creation. They do not employ ethical practices when collecting their loans. There have been issues of foreclosures for clients that fail to pay their loans in the specified period. This is one of the unethical practices associated with conventional banking (Vicary & Chee, 2010). Islamic banks on the other hand, are cautious of the organizational processes. They are out to ensure that ethical and fair practices are implemented, which would be appreciated by the clients. Economists are therefore concerned, which amongst the two approaches of banking are more effective in terms of liquidity, profitability, solvency and overall activity. Islamic banking adheres to Islamic law. Islamic law prohibits the earning of interest on lending money, hence, Islamic banks must not accept or pay interest during their daily activities (Bianchi, 2013). On the contrary, conventional banks make their money by lending money to their clients. They then use unethical means to get back their money.
1.3 Aim of the study
The goal of the inquiry was to evaluate the performance of Islamic banking against conventional banking in terms of profitability, liquidity and activity analysis. The study aimed to measure the performance of the individual approaches and recommend on an effective banking approach.
1.4 Research Objectives
The main objectives of this study were:
- To find out whether Islamic finance is performing better than conventional finance.
- To find out the profitability of Islamic banking compared to conventional finance.
- To find out the activities involved in Islamic finance that differ from conventional finance
1.5 Research questions
- What is the impact of Islamic finance on the global economy?
- What kinds of strategies are used in Islamic finance and how do they compare to conventional finance?
- What are the similarities and differences between Islamic and conventional finance?
1.6 Justification of the study
The global crunch that occurred in 2008 is a precise indication of the ineffectiveness of the conventional finance systems (ʻUs̲mānī, 2002). The crunch occurred in some of the world strongest economies. These strong economies mainly employ conventional finance systems (Venardos, 2005). Therefore, there is need to investigate the activities involved in Islamic finance and establish whether some principles of Islamic finance can be embraced by other economies (Warde, 2010). The study would help in identifying some of the practices in Islamic finance that can be adopted in conventional finance. The study would also provide new concepts that can be borrowed from conventional finance and employed in Islamic finance (Visser, 2009).
The similarity is enshrined in the fact that both approaches have the same goals but different methods. The research would investigate how the different approaches can be adopted simultaneously in order to achieve the best possible scenario. Furthermore, the financial area is a vital sector of the economy because of its role in routing savings back into the stream. The flow forms the base for all models of the macroeconomy. The circular flow will change following new injections or leakages from it. Withdrawals are in the form of savings, taxes, and imports. Organizations purchase capital goods from other firms, and this spending creates an injection referred as an investment. Savings channel into the flow when households buy financial assets like stocks. Savings return to the flow in the form government expenditure, investment expenditure, and exports. Macroeconomist concern themselves with the flow because of its critical inference to the real sector.
The equilibrium between injections and withdrawals maintains a constant flow of income, consumption, creation, and factor costs. This concept is the principle of macroeconomic equilibrium. The increasing level of manufacture remains constant. When savings are more than the investment, disequilibrium will transpire. Firms will have less market for their produce. They will lower the level of production. This action means that they will require fewer raw materials and fewer laborers. Unemployment will rise in the economy. If the investment is greater than the savings, disequilibrium will also occur.
Not all easily spendable assets are cash. Liquid assets serve a related purpose for money. They are easily transformable to cash without an influence on the product bought. They comprise government bonds, stocks, and money market tools. Tax, refunds, certificate of deposits, trust fund, and court payment are more examples liquid assets. Most people hold their financial properties in the form of currency because of its liquidity and resolve to function as a medium of exchange. It is unanimously acceptable to all individuals and makes the economy flow smoothly. Money stores wealth, act as a unit of account and standard of value. The properties of money make it very effective in the real sector. Without money, the real sector would be obliged to use barter trade system. This property means the buyer has to have what a seller wants and vice versa. This scenario is rare, and the cost of trading would rise and be ill-timed.
The most basic role of cash is to aid as a medium of exchange. Money buys goods and facilities and pays debts. People in the economy have diverse needs for their trades. Money helps them obtain the services and products they require easily. The alternative to money would be barter trade. This trade dictates a double coincidence of wants, a situation that is very rare. A person raising goats and is in need of maize has to get a seller offering maize for goats for instance (Gnos, 2011). Money as a unit of account has three important features. It is divisible, fungible, and countable. Money is a mutual denominator used to quantify the relative values of merchandise and services. The absence of money means that we would have to measure the worth of goods and services in the relationships of other goods and services. To achieve this role, the relative value of money to the average of all other prices of commodities and services does not change very quickly. This property helps in keeping a net worth of individuals, businesses, and the government because everybody is using the same ruler to quantify salary, expenditures, and fortune (Dornbusch & Fischer 1978).
Money is one of the economic assets that store wealth. Families may opt to save part of the income they obtain. Saving increases their worth. No interest is applicable by storing money, but the liquidity of the money is still high. Money usefulness as a store of wealth depends on how it maintains its value in the money market. The stored money purchases goods and services later. A baker can sell his cakes and earn some cash from it. He then stores the cash in his savings box for a few days before using it to purchase furniture. Money stores value. If not for inflation, it perfectly stores a value (Havrilesky & Boorman, 1982).
CHAPTER TWO: LITERATURE REVIEW
2.1 Islamic finance
Islamic finance attributes to a banking scheme or enterprise that is compliant with Islamic regulations and principles (Rehman, 2010). The organizational processes under this system must adhere to the Islamic laws and hence aid to developing Islamic economies. The major principle of the system of finance is that the banks should not partake in credit creation by charging money on the loans given to clients. The converse is applicable to conventional finance where the banks charge hefty interest on loans during their process of credit creation. According to Salem (2013), the Islamic finance system was incepted in in 1963 in Egypt. It was introduced in pilot phases to test the validity of the concept. There were numerous political issues associated with the concept that caused the system to be discontinued (Song & Oosthuizen, 2014). Nevertheless, the project proved that the Islamic concept of finance could be adopted. However, the concept made some progress that paved the way for an unambiguous market for Islamic finance. The outcome of the efforts led to the introduction of the concept in 1970 at a reasonable rate. A number of Islamic banks were opened in Arabic and Asian nations. Previously, the banks were mainly situated in Muslim countries. Currently, the banks are operating in over sixty countries worldwide.
Islamic banks are now operating in non-Muslim nations that have a Muslim minority population, such as Germany, France, and the United Kingdom (Sundararajan et al., 2011). Since the inception of the banking system, numerous economist researchers have examined the effectiveness of the banking aspects such as profitability, liquidity, community involvement, solvency, and risk. The aspects of Islamic banking were appraised in the early nineteen eighties to the late nineteen nineties. Since then, there have numerous attempts to compare and contrast Islamic finance against conventional finance. The major aim of these attempts is to establish which system is more effective in terms of financial ratios and the general welfare of the clients.
A recent study conducted by Bashir (2000) inspected the elements of Islamic finance efficacy across eight countries in the Middle East. The study used bank-level data across all nations on balance sheets and income statements of fourteen banks that embraced the concept on the annual basis from 1992 to 1997. The study portrayed how the Islamic banks perform under different precise settings for macroeconomics, taxation, and market structure. The results indicated that the banks had a direct relationship between capital and loan. The acceptable capital ratios and loan portfolio were vital to the bank’s profitability (Sundararajan et al., 2011). Islamic banking has emerged over the past years, and considerable advancement has been seen taking place in the Islamic banking sector globally (Kim & McKenzie, 2010). Following the global crunch in 2008, the concept of Islamic finance has gathered even more momentum than ever before. The banking aspects of Islamic banking enabled the banks to withstand aftermaths of the crunch more effective than their conventional counterparts (Laḥasāsinah, 2014). This concept has been the main reason behind numerous studies that attempt to analyze their effectiveness.
The studies have portrayed that the crisis affected conventional banks differently as compared to Islamic finance (Laḥasāsinah, 2014). The features of Islamic banking model aided the banks to regulate the adverse impact of the crunch on profitability. However, the weakness of the credit risk amongst the Islamic banks led to a decline in profitability amongst the Islamic banks compared to the conventional banks. Islamic banks have a joint share of profit or losses with their clients (Kim & McKenzie, 2010). This concept helps the banks to increase the number of customers that are attracted to the relationship that the bank has with them. This increases the amount of capital in the Islamic banks. Moreover, the banks do not charge losses on the loan they give to the clients. The banks make money by sharing the profits that will be derived from the businesses that the lenders, venture into (Krasicka & Nowak, 2012). At a first glance, Islamic concept seemed inapplicable. It goes against the major principle of credit creation that is evident in conventional banks. This is because the banks do not charge interest on all loans that are offered to the clients. Critics argued that the risk involved with this scheme was too high for a financial institution to take.
Islamic compliant banking products are financial products that adhere to the prescriptions of the Koran (Krasicka et al., 2012). Particularly, Islamic financial transactions cannot entail interest paid to borrowed principal. The Islamic principles do not allow customers to pay any fixed or predetermined rate (Krasicka et al., 2012). Instead, the Islamic regulations stipulate a profit-loss risk sharing arrangements, purchase, and resale of goods and services and the provision of financial services for a fee. Another vital aspect of Islamic finance is that it prohibits financial institutions from trading in financial risk products like derivatives (Kumar, 2014). In order to meet all the set standards by Islamic finance, banks have incepted novel products that do not attract interest imply a specific extent of risk sharing between the depositor and the lender.
Sharing of risk involves a mutual collaboration between the client and the banks. Everyone has an important part to play in the partnership (Kumar, 2014). The banks offer capital while the clients use their expertise and knowledge to start projects that will bring in profits that will be shared in a ratio that was specified by the banks. In the event of losses, the bank is exclusively affected while limited liability provisions cover the client. However, major investment decisions using the capital acquired have to be approved by the bank, though the client is at liberty of engaging in a business of his or her choice.
The Mudaraba contract has the bank as one of the major investors, with profits and losses being shared among all the stakeholders (Ismal, 2013). This collaboration between the investors is mirrored on the deposit side, with investment accounts or deposits that do not imply a fixed, preset return but profit-loss sharing. Such investment deposits can be linked either to a bank profit level or a particular investment account on the asset side of a bank’s balance sheet.
Another alternative is the Murabaha contract, which is similar to the leasing concept under conventional finance. By involving the buying of goods, it gets around the prohibition to make a return on money lending (Millar & Anwar, 2008). By leasing contracts, the bank buys purchases an investment good on behalf of the client and then sells it to the client, accepting slow payments and a profit margin in the form of a fee. On the deposit side, one can distinguish between non-remunerated demand deposits viewed as depositor’s loans to the bank, thus similar to demand deposits in many conventional banks worldwide. Qatar is one of the most populated countries in the GCC region. The country is amongst the region’s major economy. The nation’s economic controller, which is the CMA, has indicated that it will expose up the limited Qatar financial market to overseas investors. This action is anticipated to boost the nation’s economy and start the move away from the energy segment. Moreover, the introduction of international investors is expected to upgrade the complete financial market set where revolutionary products such as derivatives are broadly traded.
The derivatives market section comprises of over the counter preferences, currency swaps, forward rate contracts, exchange-traded foreign exchange futures and choices as well as interest rate derivatives. Qatar started partaking in the derivatives market activities since two thousand and one. The combined foreign exchange and derivative market turnover reported as by SAMA for the ten commercial banks in Qatar amounted to fifty-five billion in April two thousand and one. This value represents a daily turnover of two point five billion dollars. The total amount of transactions in that year was estimated at 666 billion dollars. The derivative market represented 0.1 percent of the total transactions. However, there exists an extensive misunderstanding in the nation that the single aim of derivatives stands based upon theoretical principles. The dislike to the usage of derivatives throughout this country is not merely because of the obvious basic failure of many global organized products following the downfall of Lehman Associates in two thousand and eight, but also owing to an undesirable over-simplified explanation of derivative tools.
In their meekest arrangement, derivatives have a major commercial purpose in controlling investor acquaintance to market disparities. Additionally, they play a role in lowering transaction costs and providing investors with convenience to fresh markets. As things presently stand, certain Islamic organizations and stakeholders from Qatar are more open to variations in market situations. For example, in the greater GCC area, currencies are linked to the United States dollar. In extremely structured dealings, the money will have contact with the non-US cash instabilities and the likelihood of an impending attaching from the United States dollar. Cash contacts on this form could most certainly be prevented through the use of derivatives.
The Qatar derivatives market is in the path of growth. Given the scope of the economy and the extent of openness, annual joint turnover in the market is projected to have become about 3.5 times nominal GDP, related to fifteen times of gross domestic product in the US. Murabahah precisely is an extensive form of Sharia complaint planned finance used in the country. The Murabahah process of organizing can also be utilized as a technique to simplify frequent derivatives. Despite its predominant use, Murabahah remains not approved when utilized to ease Islamic derivatives. The rationality of this concept falls in the intended utilization of the concept. People working in the financial sectors are coming up with groundbreaking arrangements and systems that will avert from Murabahah so that misuse for planned use does not happen.
The Islamic cash switch draws welfares from the dropped subsidy charges of both sides of a business deal. This action is attained through the ability of derivatives to raise money cheaply with the help of a different party other than swapping capital on the external exchange. The refusal of this method of derivative in Qatar originates from the point that the purpose to exchange currency, which by itself, is not renowned as a business benefit from an Islamic perspective. Qatar has promptly become a solid nation for derivatives. Forex trading was announced over ten years ago when Arabic trader announced offerings from agents such as FX Solutions. However, since the precise moves observed in two thousand and eight in the cost of crude oil, many Arabian stakeholders have changed their concern into worldwide markets such as cash and commodities from the indigenous stock market.
FX is not a recognized strength class by the financial regulator. However, firms who have central bank approval from further GCC nations are excused from local guidelines. Frequent brokers have opened offices in Qatar. They have done this bypass porting their current GCC authorization or working with resident training businesses. The derivatives market is a liquid market internationally. People can trade in any major currency at any time of the day or the night. Due to the above facts, Qatar is slowly approving the concept of derivatives in the local market. However, the compliance of the practice of sharia law has not been entirely accepted by Islamic organizations. This action has made the process to take a rather slower rate in the region.
2.2 Conventional finance
The conventional system of banking entailed the banks giving loans with interest to make money. The process is termed as credit creation, which is the major mode of operation (Kettell, 2011). The conventional banks create money by progressing money to clients. Deposits from the clients serve as loans to the banks. The banks then utilize the money saved to lend to other customers at a higher interest rate. The rate is explicitly higher than the rate at which the bank gives money in deposited accounts by the customers. Essentially, the banks generate money by the lender’s ability to pay the principal borrowed plus the interest (Kamso, 2013). The debtor may lose his house, car, or any property that he or she pledged as security for the loan. This practice greatly reduces the risk involved with conventional finance. The lender, hence, struggles to pay the loan to avert cases of foreclosure by the bank. The banks do not create the money from the deposits of clients.
The banks take advantage of the fact that not all the customers withdraw all their savings at once (Jobst & International Monetary Fund, 2007). Early banking had no control on the amount of currency that can be made by the banks. The bankers made money by loaning money that does not exist. The process was successful until several wealthy investors withdrew all their money at once. The banks do not possess this money and therefore foreclosed. This situation is referred to as a loan to the bank and is the worst-case scenario that can happen to a bank. Due to this event, the public lost assurance in the banking scheme. It would have been appropriate to outlaw the method of creating money from nothing. Nevertheless, the large volumes of credit that had been created by the banks had become vital to trade growth. The practice was therefore controlled. This regulation was made likely by the fraction reserve system. The regulation was enforced by surprise inspection of the conventional banks.
The fractional reserve scheme has grown to become the foremost money scheme of the world. Money has changed functions from representing worth to representing debt. Privately generated credit by the conventional banks can be converted to government issued credit. Governments and banks can both create money. This concept poses the question of how much money is in circulation. Previously, the total money in existence was limited to the aspects of the commodity that was utilized as money (Millar & Anwar, 2008). For instance, for gold to rise in circulation, the miners had to go to the gold mines and mine more gold. Currently, money is created as debt. New money is made whenever someone takes a loan. The whole amount of currency that can be made has only one real limit, which is the total quantity of debt.
Nowadays, the government reserves comprise of two things. The first is the government delivered currency that the bank has put in the central bank, and the second is the quantity of the previously existing debt currency that the financial establishment has earned (Kettell, 2011). To demonstrate this scenario, deliberate a new bank that has opened with no account holders. The investors of the bank make a one thousand dollar credit to the reserve of the central bank. The mandatory reserve ratio is 9 to 1. This ratio is equivalent to ninety percent of the deposits made. The money put by the bank to the central bank is denoted to as high-powered money. The banks can generate new loans utilizing the money stored by customers since the high-powered money is increased by a factor of nine. The client who comes to the new bank looking for a loan of ten thousand dollars to buy a new car exemplifies this concept. The customer makes his request for the ten thousand at the new bank.
The ten thousand dollars is not acquired from other sources by the bank. However, it is typed in the debtor’s account as a bank loan. The borrower then inscribes a cheque on that credit to purchase the car (Kamso, 2013). The car vendor then deposits the newly generated ten thousand dollars in their bank. Contrary to the banks high-powered money, this money cannot be increased by the reserve ratio. It is instead reduced by the reserve ratio (Ismal, 2013). The quantity of money that the financial establishment can give as a loan using the ten thousand is nine thousand dollars.
A thousand dollars are stored as a reserve as obligated by the law. The third party will be given the nine thousand dollars as a loan. When the person deposits the nine thousand in their bank, it generates a new loan of eight thousand dollars that can be given by the bank. If the money lent is not deposited at the bank the course of credit creation discontinues. The process can nevertheless proceed to a level where one hundred thousand dollars is created from the primary one thousand dollars as provided by the reserve ratio. The approach is the main principle underlying conventional banking (Jobst & International Monetary Fund, 2007). The conventional finance system is a closed loop. The money lent by one bank becomes a deposit in another bank and vice versa. The original reserve of one thousand dollars can permit the bank to collect interest of up to one hundred thousand dollars of currency it never had. Despite the presumptions of many people that the government makes money, the government made money only accounts for five percent of the total money in existence. The rest, ninety-five percent, is generated when debtors sign forms of indebtedness to the bank.
The banks can only attain this process of credit creation by a partnership with the government. The government passes legal tender laws that legalize the process. The government also allows bank credit to be paid to the government issued currency. Thirdly, the government courts enforce debt, thereby compelling loan defaulters to pay. The assets that debtors pledge to forfeit in case they do not pay their loans are the only objects of real value in the process of credit creation. In the real world, people can be able to acquire loans based on the resources they possess. However, in the conventional finance, the banks can promise to pay money that they do not have. The banks, hence, do not possess much money to give out as loans. They simply create the money using the reserve ratio scheme and loan it to the clients at high-interest rates.
The circular flow of revenue stays viable when there are frequent injections and withdrawals from the flow. Households earn an income from their particular places of work and are at freedom of spending or saving the money. Saving the money by individuals steals from the circular flow of income. Spending by the individuals represents an injection to the circular flow. Conventional banking scheme plays a major role in this flow. It offers income for people to start small businesses and, therefore, earn income. Deprived of the process, the banks would not be able to make money and would, consequently, be out of business. The people would lack places to borrow money since the government alone cannot cater for the financial requirements of all the people. The regulation of the process is also vital to maintaining the economy.
The debt generated by banks is significant in guaranteeing that there is money in the circulation. A state where all debts are paid generates a scenario where there is no money in the economy. No loan is equivalent to no money. The tenet is demonstrated by the great depression. The money supply during this period shrunk radically as the loans dried up. Given the existing economic conditions, it is almost unmanageable for an individual to succeed commercially minus taking loans. The loans should though be taken when they are needed and not wanted. A person should ensure that they have a stable income before taking a loan. They should further have a plan of how they are going to pay for the loan they take. In addition to these deliberations, the debtors should have a backup plan for paying the loans they take. Tentatively, unforeseen circumstances may arise. The business started could for example flop or operate at further debt. In such a situation, the debtor should have disposable assets such that can be sold to pay off the debt. A house should never be taken as a disposable asset and should be protected by not taking loans against it.
More money inflow should increase the volume of trade otherwise; inflation would occur. The banks play their part by raising the money supply in the economy. Other stakeholders play their parts for the volume of trade to increase play. For instance, trade expansion requires the consumption of resources. The use of the resources should be regulated to control the effects that may arise from exhausting the resources. A country should operate within the limits of its non-renewable resources by renewing many renewable resources.
The banks create money that is equal to the principal. The interest money is not created by the banks. The debtors are expected to get the money for paying the interest from the general money supply. An interesting fact is that the same process has created the money in the overall supply. A major problem arises with permitting a few people in the banking sector to regulate the money supply. The people will control all industry and commerce actions. They will further decide who gets the credit they require and who does not. The administration should make, issue, and supply all the money and credits needed to fulfill the spending power of the government and the purchasing power of clients. By the execution of these ideologies, the citizens will be saved enormous sums of interests.
The opportunity of making and delivering currency is not only the ultimate privilege of government, but it is the administration’s utmost creative prospect. Until the control of the subject of money and debt is restored to government and documented as, it is most noticeable and sacred concern, all conversation about government and equality is idle and pointless. Once a country parts with control of its currency, it matters not who makes the country’s laws. Usury once in the process will ruin a nation. The current banking scheme generates money out of nothing. This process is maybe the most amazing piece of sleight hand that was ever devised. Several activists have though faulted this procedure and have proposed for the execution of previous money systems or adoption of novel finance systems. They argue that the scheme places too much power in certain individuals. The past systems, however, had many flaws that prompted the adoption of the modern banking system.
There are several regular measures of the money supply. They comprise of the financial base, M1, and M2. M1 comprises of a total of cash held by the community and transaction expenditures at reservoir organizations. M2 consists of M1 plus saving deposits of less than one hundred grand, small-denomination time credits and trade currency market joint fund dividends. L is M3 plus other stuff where M3= (M2+large deposits + other stuff) Economist includes the most general definition for M2 when discussing money supply because current economies often include relocations between different account types. A firm may transfer ten grand from a money market account to its checking account. This handover would upsurge M1, which does not contain the currency soak funds while maintaining M2 stable since it contains money markets (Dornbusch & Fischer 1978).
The Banks make their money by loaning cash at charges upper than the cost of the money they advance; a process referred to as credit creation. A bank is a corporation that sells money to clients. The major source of currency for the bank is the deposits made by the customers. The bank could also borrow money from the central bank and lend it at a higher rate. When a bank gives a loan, it credits an account counted in M2.The banks have the ability to generate cash. Deposits from customers are a liability to the bank. The bank earns by handling the stored money in a way that earns more interest than the rate at which the customer’s money earn (Gnos, 2011).
Monopolists face no economic rivalry for the products or services they vend. They draw their influence from the trade barriers that possible competitors may face. The decisions they make concerning the service they offer is affected by internal features within the business. For example, they could lessen the value of their product because of reduced cost of manufacture, unlike competing firms that lower the price of commodities when the competing firms lower the price of similar goods. The monopolist raises the price of merchandise and services minus the fear of losing customers. In this case, customers cannot turn to another service supplier. (Havrilesky & Boorman, 1982).
Monopolistic competition is a scheme with a large number of small firms that yield similar but not identical products. The firms can sell a range of products at a narrow range of prices. The concept translates into a moderately elastic demand curve. If the firm wants to sell a bigger quantity, it must reduce the price. The monopolistic competitive firm yields the quantity of output in a short span of time that produces the maximum difference between revenue and price, which is the profit. The profit maximizing is achievable by the equality between marginal revenue and marginal cost. At this manufacturing condition, the firm cannot increase revenue by changing the level of manufacture (Havrilesky & Boorman1982).
CHAPTER THREE: RESEARCH METHODOLOGY
3.0 Introduction
This chapter offers the population, sampling procedures and tools that the researcher utilized to get the relevant data needed for the study. It also shows the procedures that were used for data analysis and interpretation.
3.1 The study area
This study was carried out in Qatar. The areas were chosen because of the numerous Islamic finance institutions that are available in the region. In addition, Islamic banking is a homogeneous population; hence the choice of location is not a variable that can affect the research.
3.2 Research Design
This study adopted a survey research. A survey is an effort to gather data from members of a large target population in a bid to govern the status of that populace with respect to one or more variables. Survey research is concerned with the precise assessment of the characteristics of the whole population of the people. It seeks to elicit information that defines current phenomena by inquiring individuals about their insight, attitudes, actions or values (Portal et al., 2012). For the aim of this research, survey research was used to establish the similarities and differences in conventional and Islamic finance.
3.3 Research population
The research population for this study was the employees and the management of first finance Qatar.
3.4 Sampling procedure and sample size
The selected sample consisted of sixty respondents. Stratified sampling was used because the study was concerned with Islamic finance and conventional finance. Purposive sampling was further used to select first finance Qatar. The two strata formed of Islamic finance and conventional finance helped the researcher to collect information on Islamic finance independently from conventional finance. Random sampling was employed to get participants in first finance Qatar. The sample consisted of sixty participants.
3.5 Statistical implications of the sample size
Hypothesis testing is usually prone to two types of errors. Firstly, the researcher may commit type one error that entails rejecting the null hypothesis when the null hypothesis is true. The process leads the researcher to making wrong conclusions about the study. Secondly, the researcher may commit type two error that entails accepting the null hypothesis when it is false. Both types of errors reduce the validity of the research and hence lead to wrong inferences. With a constant small sample, only one type of the above error can be reduced at a specific time. However, when one increases the sample size, both types of errors can be reduced simultaneously. Increasing the sample size will, therefore, reduce the chances of errors and hence increase the validity of the analysis. Due to the above reasons, the researcher used a sufficient sample size of sixty respondents. The errors in hypothesis testing can compromise the results and hence make the study findings inaccurate. A large sample size is, therefore, efficient to reduce the chances of these errors.
3.6 Data collection Instruments
Usually, surveys gather data through interviews and self-administered questionnaires and observation. The facts for this research were collected through self-administered questionnaires and content analysis of Islamic finance systems. Two instruments were used instead of one. The combination aimed to establish if the information provided in the questionnaires concurred with that of content analysis done by the researcher while observing the Islamic finance system in first finance Qatar. In addition, qualitative research advocates for the use of at least two research instruments.
3.7 Questionnaire
Questionnaires were used to get information from both the management and the employees at first finance Qatar. The entries in the questionnaires included the research questions for the study and the objectives of the study. It helped the researcher to gain primary data that are directly linked to the objectives of the study, hence helped in making the right inferences about Islamic finance. Questionnaires are preferred in survey research because of the numerous advantages that are derived from using them. Firstly, the participants can be given the research questionnaires and would be required to fill them during their free time and hand in them later. This approach favors most companies since the employees and the management are usually busy and cannot get time to fill the questionnaires during working hours.
The questionnaires were administered by the researcher and were collected on a different day when the employees and the management had completed filling in the entries. The number of questionnaires administered was 67, and the return rate was 60. A pilot study was conducted before the main study to establish any weaknesses in the questionnaire. This is because a pilot study brings to light the flaws if any of the questionnaires and the survey techniques. Changes were then made where necessary before the questionnaires were administered.
3.8 Content Analysis
Content analysis is a careful, detailed, systematized examination and clarification of a specific body of material in an effort to categorize outlines themes, partialities, and meanings (Rubin & Chung, 2013). One of the major benefits of using content analysis is that it can be virtually modest. Moreover, it may also be used non-interactively, that is, no one needs to be interviewed or fill out lengthy questionnaires. Content analysis is also cost effective.
, the materials necessary for conducting content analysis are easily and inexpensively accessible. It also offers a method by which to study a process that occurs over long periods of time that may reflect trends in a society. One major weakness of the content analysis is that it may difficult to locate unobtrusive content relevant to the particular research questions (Seupel, 2010). That is; content analysis is limited to examining already recorded messages. The unobtrusive nature of the work means that the researcher relies on existing content rather than generating their own. However, when the content analysis is undertaken as an analysis tool rather than as a complete research strategy, such weakness is minimal. For instance, if researchers use content analysis to analyze data or responses to open-ended questions, this weakness is virtually non-existent.
The researcher conducted a content analysis of Islamic finance in first finance Qatar. Numerous bodies of material from various sources were studied carefully. They included journals, previous research and internet sources that were related to the study
This study analyzed:
- The strategies used in Islamic finance.
- The unique features that were embraced by Islamic finance.
- The impact of employing Islamic finance in the economy of Qatar.
- The benefits, challenges that are involved in Islamic finance.
3.9 Data Validity and Reliability of Research Instruments
Validity is the point to which outcomes obtained from the analysis of the data truly represent the phenomenon under inquiry. It is a measure to which data gathered using a particular instrument to represent a specific domain of indicators or content of a particular concept. The developed questionnaires were piloted to establish whether they could be used to collect relevant data and to identify any problems that are likely to occur at the time of the actual data collection process. It ensured hat the items on the questionnaire were clear to the respondents.
Furthermore, data from the questionnaires and content analysis of the researcher tally implying that the information obtained is valid. The concepts of Islamic finance that were mentioned by the employees and the management harmonized with the data obtained from content analysis of first finance Qatar. The two departments were sampled purposively for the piloting process. Fifteen adults to participate in the study were selected through simple random sampling. The results from the pilot study were examined to establish any weaknesses in the research tools. Changes were then made where necessary before the questionnaires were administered.
3.10 Data Analysis
The data gathered was analyzed using both descriptive and inferential statistics. Descriptive statistics enabled the researcher to analyze, interpret responses from the questionnaires and do a content analysis of first finance. Inferential statistics, on the other hand, allowed the researcher to generalize the results obtained from the sampled adults to the entire population Islamic finance in Qatar.
3.11 Limitations encountered
Some workers were reluctant in accepting to fill the questionnaires at first because they thought it was a waste of their time. Others thought that they would be held accountable for their responses. Nevertheless, the researcher guaranteed them that the info they would give was to be used for purely academic purposes by the researcher, and anonymity would be upheld.
3.12 Ethical considerations
In any research undertaken, there are important ethical considerations that the researcher must be aware of before embarking on the research. The researcher adhered to the following issues during the research:
- Anonymity
The researcher disclosed information conveyed by the adults, but their identity was protected using numbers. The questionnaires were numbered, but the respondents were instructed not to write their names on the questionnaires.
- Voluntary and informed consent
The researcher disclosed the real purpose of the research.
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
Data Presentation
| Benefits of Islamic finance | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | no minimum balance requirement | 13 | 21.7 | 21.7 | 21.7 |
| preferential rates on remittances | 10 | 16.7 | 16.7 | 38.3 | |
| free cheque book | 14 | 23.3 | 23.3 | 61.7 | |
| zero interest | 23 | 38.3 | 38.3 | 100.0 | |
| Total | 60 | 100.0 | 100.0 | ||
The benefits of Islamic finance encompass no minimum balance requirement for the account holders, preferential rates on remittances, free cheque book and zero interest on loans granted by the banks. Not all the above benefits are available in conventional finance. Clients under conventional require paying for the above services in order to access them.
| What kinds of strategies are used in Islamic finance | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | profit-loss sharing | 9 | 15.0 | 15.0 | 15.0 |
| prohibited from financial risk products | 16 | 26.7 | 26.7 | 41.7 | |
| the avoidance of economic activities involving speculation (gharar) | 17 | 28.3 | 28.3 | 70.0 | |
| discouragement of the production of goods and services, which contradict Islamic values (haram) | 18 | 30.0 | 30.0 | 100.0 | |
| Total | 60 | 100.0 | 100.0 | ||
The strategies employed in Islamic finance include profit-loss sharing between the banks and the debtors, prohibition from financial risk products such as derivatives, avoidance of economic activities involving speculation, oppression, and Islamic values. The banks place emphasis on partnership with the clients.
| What is the impact of Islamic finance on the global economy? | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | reduces chances of a global crunch | 39 | 65.0 | 65.0 | 65.0 |
| ensures a constant flow of revenue | 21 | 35.0 | 35.0 | 100.0 | |
| Total | 60 | 100.0 | 100.0 | ||
Islamic finance reduces the chances of a global financial crisis. The tenet was exemplified by the 2008 global crunch. The Islamic banks were slightly affected due to their mode of operation, which allows for a profit-loss arrangement between the banks and debtors. Islamic finance ensures a constant flow of revenue to the economy. The Islamic banks provide revenue to the clients.
| Differences between Islamic and conventional systems | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | rewards are fixed in the conventional system while rewards are variable in Islamic | 22 | 36.7 | 36.7 | 36.7 |
| risks are borne exclusively by conventional banks while risks are shared in Islamic banking | 17 | 28.3 | 28.3 | 65.0 | |
| conventional banks charge interest on loans while Islamic banks charge a profit on investments | 21 | 35.0 | 35.0 | 100.0 | |
| Total | 60 | 100.0 | 100.0 | ||
The differences between Islamic and conventional finance include rewards, risks, and interests. The rewards are fixed in conventional banking while rewards are varying in Islamic finance. Risks are borne exclusively by the conventional banks while they are shared in Islamic finance. Conventional banks charge interest on loans while Islamic banks charge profits on loans.
| Similarities between Islamic and conventional finance | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | They both provide revenue for the economy | 34 | 56.7 | 56.7 | 56.7 |
| The longer the time of investment the higher the returns | 26 | 43.3 | 43.3 | 100.0 | |
| Total | 60 | 100.0 | 100.0 | ||
The similarities between Islamic and conventional finance is that they both provide revenue to the economy, and more money is derived from longer periods of investment
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | based on sharia regulations | 9 | 15.0 | 15.0 | 15.0 |
| promotes risk sharing | 10 | 16.7 | 16.7 | 31.7 | |
| aims at a maximizing profit but to sharia restrictions | 12 | 20.0 | 20.0 | 51.7 | |
| participation in a partnership is the fundamental function of the Islamic banks | 16 | 26.7 | 26.7 | 78.3 | |
| promotes developing projects | 13 | 21.7 | 21.7 | 100.0 | |
| Total | 60 | 100.0 | 100.0 | ||
Islamic banking is based on sharia regulations and principles and promotes risk sharing between the bank and the debtor. Additionally, it aims at maximizing profit, but the profit has a limit based on sharia restrictions, places emphasis on partnerships and promoted developing projects with much vigor.
| Features of conventional finance | |||||
| Frequency | Percent | Valid Percent | Cumulative Percent | ||
| Valid | operate on man-made principles | 15 | 25.0 | 25.0 | 25.0 |
| The investor is assured of a pre-determined rate of interest | 10 | 16.7 | 16.7 | 41.7 | |
| aims at a maximizing profit without any restriction | 10 | 16.7 | 16.7 | 58.3 | |
| charging interest is the fundamental mode of operation | 17 | 28.3 | 28.3 | 86.7 | |
| little emphasis on developing projects | 8 | 13.3 | 13.3 | 100.0 | |
| Total | 60 | 100.0 | 100.0 | ||
|
Chi-Square Tests |
|||
| Value | df | Asymp. Sig. (2-sided) | |
| Pearson Chi-Square | 30.000a | 2 | .000 |
| Likelihood Ratio | 41.455 | 2 | .000 |
| Linear-by-Linear Association | 24.000 | 1 | .000 |
| N of Valid Cases | 30 | ||
Interpretation of Statistical Test
A chi-square test was performed on the effectiveness of Islamic banking against the effectiveness of conventional finance. A chi-square value of 30.0 with two degrees of freedom was obtained from the analysis. The two variables had a p-value 0.000. The value indicates that there is a significant independence between the two variables. The p-value is less than the alpha level of significance, which has a default value of 0.05. It indicates that the independence between the effectiveness of the Islamic finance and conventional finance is statistically significant, and hence the two approaches can achieve significantly different results.
Discussion
Islamic finance has various attractive features that have been responsible for the wide growth of the concept over the past few decades. The features encompass free financial services, zero interest, and ethical practices, which are not applicable in conventional finance (Ismal, 2013). Clients of Islamic financial institutions have access to basic banking services at no cost. The services include free chequebook, preferential rates on remittances, and no minimum balance requirements (First Finance Company (Q.S.C.), n.d.). These services are convenient and cater for the needs of all members of society. The fact that the accounts do not have a minimum balance requirement makes it possible for people from different occupations to open accounts with the Islamic banks. They can then put the amount of money that is disposable and withdraw it when the need arises. This is a very important aspect that clients require the financial institutions to provide. Urgent needs may arise and cause the clients to empty their savings in order to solve the needs. There have been instances in conventional banking where clients cannot access their cash due to the systems that are set by the bank. The clients suffer since they are unable to access their money. As such, they may end up requesting for loans from the same bank, which they will pay further interest (Jobst & International Monetary Fund, 2007).
Furthermore, Islamic banking places a great emphasis on ethical practices. Before granting loans, the banks have to be aware of what kind of business the debtor is going to engage in (First Finance Company (Q.S.C.), n.d.). Unethical businesses such as pornography, poaching and hoarding are prohibited. The banks have a say in which investors will be allowed to invest in the businesses that are started. In the event that the debtor is unable to pay the debt, the banks do not a foreclosure or freeze the assets of the defaulter. Favorable methods are employed to ensure that the bank gets back its capital, and the debtors make profits for their businesses (Millar & Anwar, 2008).
The strategies involved in Islamic finance are quite different from the strategies that are used by conventional banks. Islamic banks advocate for a profit-loss arrangement between the bank and the debtor (Kettell, 2011). The banks foster a partnership that entails two major aspects. The first aspect is the provision of capital by the bank while the second aspect is the skill, which is provided by the debtor. The debtor is required to come up with ideas that will use the capital provided by the banks to make a profit. The bank, however, has to be aware of the business started and therefore has to approve it before the capital is provided (First Finance Company (Q.S.C.), n.d.). This is because the banks do not charge any interest on the money provided. They will only share the profits that will be obtained after the business is in operation. The banks, therefore, put measures that will ensure the businesses started by the lenders are profitable so that they can get back their capital and share the profits. Islamic finance prohibits against taking part in financial risk products such as derivatives (Kamso, 2013). This is again due to the high risks that are involved with the process.
The banks avoid activities that are involved in speculation, oppression or against Islamic laws. For instance, the banks do not offer loans to clients who want to start pork business. This is because the Islamic laws prohibit its members from eating pork (Iqbal et al., 2011). In addition, the banks do not only consider the profitability of a venture, they consider other elements such as the effect of the society. For instance, the banks would decide against a very viable business option that would bring in high revenues if it goes against the basic laws of Islam. The banks would rather engage in businesses that would have low daily and annually turnovers as long as the business complies with all the rules and regulations that are set by the business. This concept is greatly challenged by critics who insist that all legal activities should be exploited to make profits. They, for instance, argue that the banks should provide loans to business such as pork and then sell them to other religions that do prohibit pork.
A major impact of Islamic finance is that it lowers the chances of a global financial crisis such as the one that occurred in 2008. This is because of the profit-loss arrangement that the banks have with their clients. The stability of the Islamic finance system is strong enough to withstand a crisis and hence can be employed in the world economy to prevent such crisis (Hasan, 2012). The global crunch affected all the countries in the world, including some of the world strongest economies such as the United States and the United Kingdom. The two economies employed a conventional system of banking. There is a great activity on financial risk products such as derivatives and the Forex market (Imady & Seibel, 2006). In this, type of finance, the higher the risk, the higher the amount of money that may be derived from the process. People operating in this type of banking have hence acquired a tendency to stop engaging in physical and actual businesses and take part in the derivatives market (Hassan & Lewis, 2007).
The derivatives market does not contribute to the growth of the economy in actual terms. It involves a client buying shares of a specific market when they are lowly priced and hoarding them until they are expensive (Hussein, 2004). As a result, the actual amount of goods and services in the region reduces as people try to capitalize in the derivatives using some or all of their income. However, this is a very risky venture that if goes wrong would be a major trigger of a financial crisis. People may invest a lot in shares of a company that may eventually fail, or they may buy shares, which reduce drastically in value. A situation, therefore, arises where the people lose all their money in the form of shares and hence are left with no money to conduct more business. This was a major cause of the 2008 financial crisis that affected many countries (Hayʼat Markaz Qatar lil-Māl, 2010). Due to this, Islamic finance strongly suggests against the participation in such activities. The banks urge the clients to take part in business activities that would be less profitable but involve less risk. Furthermore, the banks require the clients to make profits in their business, but the profits have restrictions based on sharia regulations. This approach of Islamic finance greatly reduces the chances of errors that are evident in conventional banking. In the end, one may argue that the profitability of the Islamic banks would surpass the conventional banks due to the lower chances of errors (Hayʼat Markaz Qatar lil-Māl, 2010).
The rewards in conventional finance are fixed or predetermined while the rewards in Islamic finance are varying (Iqbal et al., 2011). Clients in conventional finance have the liberty of determining the best business. As long as they have security, they can pick any amount of loan that can be serviced by the security in the event of default. Alternatively, they can store their money in the banks in order to earn an interest. The money stored in the banks has a predetermined rate of rewards that it will accrue (Imady & Seibel, 2006).
Contrary, Islamic finance has a varying rate of rewards that will be obtained by storing the money in the banks. The banks would share the profits with the account holders depending on how much profits the projects instigated made (Hussein, 2004). This concept is very beneficial to the clients who may end up making more money than they had anticipated when they deposited their money into the accounts. However, the rewards may also vary negatively if started projects by the banks did not make much money as projected. Clients view this concept of Islamic finance to be very fair and hence may end up storing much of their money in the banks instead of engaging in risky businesses. The banks would then have access to more capital that they can use in their operation (Hayʼat Markaz Qatar lil-Māl, 2010). They would have enough money to give people requesting for loans and start businesses. When banks have more access to capital, they will ensure that there is sufficient flow of money in circulation to prevent instances of lack of money in the economy. Sufficient flow of money in the economy is vital in ensuring that the economy of the country grows and trade is expanded. This will in turn improve the quality of life of the citizens, as they would be able to buy more goods.
The similarities between conventional finance and Islamic finance entail the provision of money to the economy and more money for longer investments. Both finance systems help in providing money to the economy, which helps the citizens to perform basic tasks like buying and selling goods and services (Iqbal et al., 2011). The conventional banks perform this task by the process of credit creation. They charge interest on loans that are supplied to the clients. The clients are expected to pay back the money, which they will obtain from the overall money supply. The clients use the money to engage in business. The continuous business ensures that more money is available in the economy. Islamic banks on the other hand make money from a profit sharing arrangement with the clients (Imady & Seibel, 2006). They charge money on all the investments that are made by the depositors. The obtained money from the investments of the Islamic banks is used by the banks to give more people that want to make investments. The continuous investment by the clients in various businesses ensures that more money is available in the economy (Hayʼat Markaz Qatar lil-Māl, 2010).
The second similarity between conventional finance and Islamic finance is that a longer time of investment reflects a higher the rate of returns derived from the process (Iqbal et al., 2011). Clients in conventional banking have a higher return if they can leave deposits for longer. For instance, a fixed deposit account of three years would earn more rewards than a fixed deposit for one year. In Islamic finance, the clients earn more rewards when they invest longer in a business. This is because the rewards are not fixed hence will increase as the time of investment increases (Imady & Seibel, 2006).
Islamic finance has various distinctive features that set it apart from conventional finance. Firstly, Islamic finance advocates for a profit-loss sharing system between the bank and the debtor. The clients do not suffer the losses alone in the event of failure (Hayʼat Markaz Qatar lil-Māl, 2010). This is very different from conventional banking which places all the risk on the client’s side. Once the conventional banks have granted the loan requested by the clients, they expect a predetermined amount to be paid back regardless of how the business started would turn up. A majority of the conventional banks have taken over the assets owned by the debtors when they failed to pay back their loans. Secondly, Islamic finance operates on sharia principles (Hassan & Lewis, 2007). The law acts as a guide against unethical practices and activities that increase risk. The sharia principles dictate many aspects that have to be adhered to. Many of the specifications by sharia entail the practice of activities that are beneficial to others and do not cause harm. Sharia prohibits profitable businesses that have a harmful effect to the society (Hayʼat Markaz Qatar lil-Māl, 2010).
Islamic finance promotes developing projects that do not have much capital. Such projects would have been easily discarded under conventional finance (Hassan & Lewis, 2007). These projects ensure that upcoming business people, especially the youth who are unemployed get access to cash so that they can carry out their projects with the aim to make some income for themselves (Hasan, 2012). There is no charging of interest on money that is granted in Islamic finance. The banks do not charge the customers an extra interest on the money borrowed from them (Iqbal et al., 2011). However, loaning of money is based on activities that will bring in an income and not activities such as the personal luxury of buying cars or going for holidays. This is because the banks have to be assured that the debtor is taking part in a financial activity that will bring in an income (Hussein, 2004).
On the other hand, conventional banking is guided by fabricated principles (Imady & Seibel, 2006). All trades are deemed viable regardless of their impact on the society. As long as the trade would bring back the capital borrowed and earn profits. The banks do not regulate the type of business that the clients partake. They do not decide what other investors will be allowed to join the business once it has picked up. Charging of interests is the fundamental operation in conventional finance. The banks lure people to take loans, as it is their major way of earning revenue. The majority of the banks offer loans to developed projects and people who already have a source of income. There are often many rules that prevent many people from accessing the loans. For instance, the banks only grant people that are employed, or those who have an active bank account owing to the nature of their business.
These regulations lock out many people that seriously need loans to start their business. After granting the loans, the banks follow-up to ensure that the clients are using the money for the intended use they stated when requesting for the loan. For instance, when a client requests a loan to buy a lorry for commercial purposes, the bank ensures that the clients buy the lorry. This is because the bank wants an assurance that it will be able to get back the money invested in the clients when they fail to pay the loan. Conventional banking aims at maximizing profits with no set limits. The more profits made by the businesses ensures that the banks get more money that they can use to grant more loans hence make money. The banks take advantage of the money system and the fractional reserve system that are set up by the central bank. The system allows banks to make money under regulation by the central bank. Conventional banks use unethical means to obtain money from defaulters. For instance, a person that is unable to pay their mortgage will be kicked out of their homes so that the houses can be sold.
Issues Associated with Conventional Finance
The preceding generation did not have entire access to the services of credit cards by financial institutions. They had to pay cash for all services and merchandise that they needed. This is mostly because the rules set at that time by the government determined the amount of interests that the banks could charge to their customers who borrowed loans. The banks had to inspect loan applicants to confirm that they had the capability and assets to pay for what they had borrowed. The outcome of the process was that very few people obtained the loans (Leonard & Reiter, 2009). Nevertheless, two decades ago, Congress adopted new laws that gave banks freedom to set their individual interest loans (Leonard & Reiter, 2011). The banks then placed less focus on the eligibility of loan applicants. They provided loans to all applicants and run media campaigns on the benefits of taking loans. The majority of the world population took the credit cards. They had no idea of the inference of their actions. The banks were able to get more revenue if customers delayed their payments. This is because the banks charged higher rates on delayed payments and the longer, the clients took to pay the higher amount they paid.
The existing economy coerces many people to apply for credit cards so that they can access necessities. The access to the credit card amenities ensures that the holder can access any service without cash. At the first instant, they sound like a very smart option that people should use as long as they have a stable income. They, however, put the customers in debt. The debt in turn steals from the future of the debtors. Credit card balances cause back payments on regular bills. Mortgage loans are responsible for overdue child support payments. Old medical bills consume the retirement account. Paycheck advances overdrafts on one’s checking account. Once the clients realize that debt is expensive, they try to consolidate the debt. They, however, fall trap to other unwanted circumstances based on the actions that they take. Some of the people end up taking other loans to pay previous loans. This practice is very unfavorable since loans do not have an easy way out. Sections of the customers are tempted to take a home equity loan. They are tempted by the advice they get from financial experts. This is nonetheless, a great risk since the clients are risking their dwellings to pay off debt (Leonard & Reiter, 2011). In the event of foreclosure, the banks eject the customers from their homes and sell the houses in order to recover their money.
Many of the clients also fall victim to credit counselors who claim that they work for non-profit establishments. The counselors offer debt consolidation option to the customers that are just a scheme to make them more money. Customers should be cautious in the methods they choose to get out of debt. The best-advised approach is to pay off the debts one at a time and not to delay the payments (El-Gamal, 2006). Many hard working people desire to buy a home. Buying homes require that the individual takes loans from banks. It is the dream of a lifetime. The desire is intensified by the motive to offer a good abode for their children. There are nevertheless several critical concerns that have to be made prior to performing this chore. One needs to pay the steal from tomorrow debt (Great Britain, 2008). This is vital as it determines the amount of liquid currency that will be accessible to buy the house. Debts often lower the value of people. A financial assessment of a person with much debt is unfavorable to purchase a house. The debt is like a hole in an individual’s pocket that keeps consuming whatever one earns in the future. Paying debts imply that an individual can collect resources and afford a bigger mortgage (El-Gamal, 2006)
Secondly, a person should save until they can manage to make a sizeable down payment on a target house. It is advisable to apply for the mortgage with at least ten percent of the total money required (Fahim & Porzio, 2010). It is, however, preferable apply for the mortgage when one has seven twenty percent of the worth of the house. This is a great practice as prerequisite monthly payments reduce the total amount one pays. Banks nowadays have no limit to the amount of mortgages they provide to customers. This is because they target to sell many mortgages to the maximum number of clients at the highest price possible. They make their money through this process; hence they would not control the loans they offer (El Tiby, 2011).
The third fact to consider is a reasonable mortgage. It is not sensible to buy a mortgage that is too expensive and will take many years to pay off. Many things happen in life after obtaining a home. Children will require fees for their school and money for their upkeep. A very costly mortgage would reject the family necessities and luxuries. The money coming in every month would inevitably go into reimbursing the mortgage. People should buy houses that they can afford. It is not advisable to buy a house that is out of your price range. The money spent in the house could be used for other needs that are vital. Many people are often driven by their tastes and blindly buy a house that they cannot afford. Cost should be the main determinant to be reflected before buying the house (Great Britain, 2008). Buying a house is a lasting solution. You will spend the rest of your life there unless you decide to sell it. People should hence buy houses that they are happy staying in. The houses should be their source of joy and their haven after a day’s work. The tests however vary for various people. Some people may prefer a house on the top of the hill while others may see it as.
After regarding the above features, people should evaluate themselves to see if buying a house is the best choice for them. Buying a house is an extremely good action, but not the best action for everyone. The timing for buying the house should also be considered. It is not compulsory to buy a house when you have just started earning and you have not set your finances straight. People should wait for when the time is right when they are ready economically and mentally to handle their own house, as it needs many services (Fahim & Porzio, 2010).
Issues Associated with Islamic Finance
The features of Islamic banking make it less profitable since they are not willing to take risks (First Finance Company (Q.S.C.), n.d.). One of the basic essentials of a successful businessperson is the ability to take risks. Most of the time, higher risks result into higher rewards. This concept is translated for financial institutions. Since the institutions have access to more capital, they are in a better position to make more risky investments such as participating in the derivatives market. This will ensure that the institution will make more money. However, the Islamic institutions do not take part in such risky endeavors. The resulting outcome is that they make enough money, but not as much as they would have made when they took part in risky ventures. This concept reduces the profitability of the Islamic banks, though it may be argued that it helps them not to take part in non-profitable actions.
CHAPTER FIVE: CONCLUSIONS AND RECOMMENDATIONS
Conclusions
Conventional finance has been the system of operation for many years. The system evolved from traditional schemes that involved barter system of trade. The system has features that make it work in the modern economy. The majority of the features is, however strict and may be considered unethical. This is because the system places less focus on the means and modes that are used to obtain more revenue. Conventional banking entails banks that make money from granting the customers loans. They do not put restrictions on the types of businesses that the customers should engage in. Customers in this mode of banking are at liberty of choosing the kind of business that they want to start. However, they should ensure that they pay the loan took in the specified period. Failure to this, they will lose their assets that they gave as security for taking the loans. Employed people attach their pays lips in their loan application, hence giving the banks the right to deduct a specified amount of time. This practice ensures that they pay all the money they took.
The process is unfair since it favors selected people in the society. For instance, employed people are in a better place to get the loans compared to their unemployed counterparts. The employed people do not require the loans as much as the unemployed people since they get a monthly income. However, since the banks in conventional finance cater for the risk entirely, it selectively determines the people that will get access to the loans. Though the banks have made much progress in the amount and number of people that they advance loans, there is still a very big section of people that cannot access the loans. Banks under conventional finance require that the customers applying for the loans possess some physical assets that will act as security for the loans. For instance, they require that the customers have land, car, or other assets that can be disposed easily by the bank. However, a majority of the unemployed population do not have such possessions. They only possess expertise and knowledge that they can harness to make viable businesses. They do not get access to these loans and are hence forced to source other funds from different sources.
In their attempt to obtain the funds, some of them sought loans from microfinances that have less strict regulations on their loans. The loans are however small and come with a very huge interest. Engaging in business with such small amounts and high interests results into increased chances of failure. Some of the people opt not to take the loans and hence do not make any financial progress in their lives. The individuals turn to odd jobs and may end up engaging in illegal activities due to the frustrations of the banking systems. No access to loans results to widening of the gap between the rich and the poor. The rich people are able to get access to more loans so that they can intensify their businesses. Conventional banks are more focused on this population of people that have more income. Some banks are exclusively renowned for serving only the rich in the society. This is because of the regulations that are set by the management of the banks. For instance, some banks place very high minimum balance that many middle-class citizens cannot afford. Therefore, conventional finance can create a precise segregation in the society. The segregation will include people that do not have much money failing to meet the requirements of the banks hence staying away from the banks. This trend is not good for the economy since it will limit the number of people that can access financial services and may hence dampen the economy.
A good banking system should not be considered in monetary terms only. It is like the quality of life that is derived from using the system. Quality of life is a significant concept that is employed in economics to determine whether the conditions and the amount of money derived are significant. Similarly, a good banking system should not only provide money to the clients, but should positively affect the society. For instance, the banks provide money without caring what the clients will invest in. The clients may then engage in businesses such as pornography, poaching and hoarding. The banks would have played their part, but the money would be used to engage in activities that would erode the culture of the society and evade taxes.
Conventional banks have the aim of maximizing the profits with no restriction on how much they can make. They therefore engage in all kinds of activities that ensure they meet their goals. These activities are often the high-risk activities such as the derivatives market. The outcome of these actions is that the banks may face a high profit or loss in their operations. Islamic banks on another consider what the clients will engage in when they get access to the loans. Apart from the conventional sharia regulations, the banks ensure that the clients do not engage in activities that will bring harm to the economy. The clients have to indicate what types of business they will engage in. The banks decide which investors will join the business that the customers. Islamic banks employ ethical practices when dealing with customers. They do not take the assets of customers when they fail to pay the money borrowed from the banks. Instead, the banks have a profit-loss sharing structure that allows the banks to share the profits or loses with the firms. This mode of operation is very effective since it allows the customers to access the loans and take part in various economic activities.
Recommendations
Both systems of finance have advantages and disadvantages. Conventional finance has the ability of making more profits due to the high risks that are taken. This ensures that more money is available in the economy. Islamic finance on another hand is more stable and can withstand adverse economic conditions such as the 2008 global crunch. It is more considerable of the overall impact of the business to the society. It is a very complex task to determine, which, amongst the two schemes, is more effective. This is because they both have advantages and disadvantages that have been discussed above. A suitable approach would be to borrow concepts from each scheme and come up with a system that combines the best elements from each system.
For instance, conventional finance should adopt the profit-loss sharing arrangement to a certain degree. This does not necessarily need to be on the same extent as the Islamic finance. Conventional finance should also support more developing projects and upcoming individuals that do not have much income. Conventional finance should make the following changes in its operations. Predatory lending is an emerging issue in conventional finance. Individuals are approached by salespersons and are encouraged to take the loans. The loans regularly have high rates of foreclosure that are set by the financiers and not the bank. Individuals are happy to take the loans sine it helps them with their present needs, and they are not worried about how they will pay back. The lenders target low middle-class earners who do not have liquid cash to make big purchases. Overdue payments result in foreclosure and families lose their households. Families with homes that are mainly paid off are the targets.
Lending should be limited since it takes advantage of low hard working citizens. The lenders come with excellent presentations that entice the people to take the loans. Once people apprehend that the loans are costly, they further make mistaken decisions while trying to pay off the loans. They, for example, take a home equity loan so that they could reimburse their loan. The appropriate authorities should dictate the terms under which a person will be qualified for predatory lending and put up rules. The regulation concerning the matter could contain only people with properties that have the financial worth of the loan they are requesting for should take the loan. The event of foreclosure should also be made public, and lenders would be obligated to tell the people of what would happen when they failed to pay a loan in time. This feature would discourage people from taking unnecessary loans that they can manage to live without. Publicity campaigns should be run by financial organizations to advise individuals on the best choices for lending that are offered. This practice would help the citizens to make the right decisions and avoid cases of foreclosure.
Islamic finance on another hand should engage in activities that are more risky since they are more profitable. They should for instance intensify the derivative market. This process is more risky, but would guarantee more profits for the financial institution. The changes in the financial system should be implemented in pilot phases. This would allow for weaknesses and flaws to be detected in the early stages and hence make the correct alterations that would ensure the financial system is effective. A system that would incorporate the best elements from both systems would be more effective compared to each scheme individually. Conventional finance has a high profitability but a high risk involved. Islamic finance has a low profitability but is more stable due to the less risks that are involved. A combined system would therefore entail a scheme that is profitable, stable and involves less risk.
The relevant institutions granted the mandated to make policies on the financial systems should therefore come up with a combined system of finance. This practice would solve much of the issues that are involved in both systems individually. The government should introduce education programs to educate the public on the effects of taking loans. This is because conventional finance is mainly focused on granting loans to clients and charging interest. This is because they make money through this process. However, they may entice the public to take loans that they do not require. The public should be educated on what will happen when they are unable to repay the loans. The effects of overdue payments should be made public so that people can know what will happen when they fail to take the loans they have borrowed.
Buying homes is one of the foremost reasons that people take loans. Therefore, much knowledge should be provided in this sector to help individuals make wise choices that will help the financial system thrive more. This is because when the clients make unwise decisions, they end up taking losing their assets and can therefore not engage in further financial activities. They may be declared bankrupt and lose the eligibility of being granted loans. The solution of a good and effective financial system is therefore founded on people making wise decisions regarding financial aspects like loans and businesses.
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