Executive Summary
Islamic banking continues to be amongst the fastest expanding financial institution within the UAE banking industry. The fact is that Islamic banking has continued to operate for approximately over thirty years particularly in the Middle East. In UAE, Islamic banking accounts for over eighty percent of the total banks within the industry while conventional banks accounts for only fifteen percent. Essentially, the Islamic banking institutions mainly exist in the chief Islamic countries. Interestingly the banking system has continued to attract and retain none Muslim clients particularly the customers seeking to avoid interests.
Close association with Shariah principle characterizes Islamic banking operations. In other words, financial products and services provided by the Islamic banks are based on Shariah principles. The financial pillars include the asset backing principle, the loss and profit sharing principle, ban on certain financing economic sectors, ban on speculation, uncertainty and interests. Moreover, all Islamic banks are obliged to evade any form of interest owing to the fact that it is a prohibition in Islam. Thus, the only way out to shun interest is via creating profit and loss allotment banking system. Such a system is expected to allow Islamic banking share any accruing risks with the esteemed customers. In addition, it is also an obligation of the Islamic banks to function in accordance with the stipulated Islamic set of laws and principles.
The paper tends to examine the operation of Islamic banks taking Al Hilal bank as the case. Moreover, the paper tends to assess the basic principles behind Islamic banking as well as the concepts behind the products of the Islamic banks. In fact, the paper will tend to examine how Islamic banks work in practice. The paper will then offer recommendations for the best Islamic banking products that are supposed to be applied by the bank as well as its suppliers.
Introduction
Al Hilal bank is one of the national Islamic banks in UAE and is fully owned by the government. The bank is based in Abu Dhabi has over 19 branches across the Middle East. Al Hilal bank is one of the Islamic banks in Middle East that offer various products to over forty thousand esteemed clients. The bank’s main services include Islamic personal loans, corporate loans and investment advisory ventures. In addition, the bank offers treasury and wholesale banking products. In fact, retail and wholesale services account for over ninety-seven percent while corporate services and products contribute over three percent. The bank is also the managing trustee of Al Hilal Equity Fund, which is the largest in UAE. Further, the bank, owns one hundred percent shares in Mall Branch. Mall Branch is one of the leading banking branches in the globe.
Currently, the bank is valued at approximately four billion in terms of assets. Since its establishment in 2008, the bank has expanded in terms of revenue and market share. Moreover, the bank has opened over nineteen branches in UAE and across the Middle East. Further, the bank is currently the best retail Islamic banking in UAE. The bank operates three units including Al Hilal Takaful, which offers insurance products that cover a variety of properties and life ranging from motor vehicle to medical expenses. Besides, Al Hilal Auto provides financial services to the automobiles.
Al Hilal bank has future growth prospect given the increasing number of middle-income earners in UAE as well as other countries the firm targets. In addition, the stability and economic growth in UAE will foster the expansion of the firm. With new and innovative products the firm brings into the market, the firm will take advantage of new opportunities created by increased economic growth. Moreover, the firms’ expansion into new markets such as Kazakhstan also increases its growth prospects.
How Islamic Banks Work
The operations of Islamic banking are similar to the way conventional banks work. The differences exist mainly in the way earning are made. In conventional banks, interests are the main source of earnings while in Islamic banking interests are prohibited (Archer & Rifaat, 2007). As such, the interest earnings are the major source of the difference. In other words, Islamic banking is similar to the other banking systems in terms of operations and business models with an exception of earnings through interests. Further, whereas interest earnings are critical in conventional banks, such interests are not allowed in Islamic banks (Archer & Rifaat, 2007.
Abstinence from interests is based on the principles of Shariah that do not allow increased earnings such as interest. Studies that have been conducted indicate that Islamic banking operations are principally anchored on loss and profit sharing amid the participating banks and the borrowers (Lewis & Latifa, 2001). Furthermore, Islamic banks maintain profit through mixing commercial banking operations with investments to realize adequate rate of returns on the depositors’ funds. Essentially, Islamic banks share extra earnings with depositors and borrowers. The normal operations of the firm are combined with commercial activities in order to attain the required rate of return. However, the profit sharing process must be done in compliance with the principles and rules of Sharia (Lewis & Latifa, 2001).
In the normal circumstances where money-lending process is undertaken, Islamic banking is quite different from the conventional banking systems. In Islamic banking, the art of lending is a business contract between the bank and the borrower (Archer & Rifaat, 2007). Under the contract, the business is under the management of the borrower while the bank looks over the business. The accrued profits are shared between the two parties in an agreed rate. Besides profits earned from the lending arrangements, the Islamic banks provide other services where extra amount is charged. People keeping money in Islamic banks are considered as shareholders (Lewis & Latifa, 2001). The profits earned by the bank are shared according to the prefixed rate. In some cases, individuals may invest in joint projects with the bank. Under such circumstances, the profits for the individual will be specific for that particular project.
Essentially, the Islamic banks’ activities are controlled by the Shariah principles. In fact, one of the principles is the sanctity of the contracts. This principle states that before any execution of Islamic banking transactions, the parties involved must be satisfied that the transaction is valid according to the Shariah laws (Lewis & Latifa, 2001). In other words, the transactions should not be voidable. In fact, the principle also forms the basis in which conventional banking and Islamic banking differs. Whereas no transactional agreement is required in the conventional banking, it is necessary that such agreements be made under the Islamic banking system. In Islamic banking, the agreement have to be made and executed during the exchange of goods and services as well as during the fund disbursement under Murabaha, Salam and Istisna contracts within the Islamic banking (Lewis & Latifa, 2001).
In the case of mortgage transactions, the Islamic banking systems do not loan buyers of the items. Instead, the banks purchase the item on behalf of the buyer at a profit. However, the buyers are allowed to pay for the item in installments. Moreover, the banks are not allowed to explicitly make profits. Thus, charges for late payments are nonexistent (Rammal & Zurbruegg, 2007). In order to discourage defaults, strict collaterals are always allowed. Therefore, in Islamic banking systems, strict collaterals are common particularly in the cases of long-term loans. In Murabahah contract, the product purchased is registered under the name of the buyer right from the beginning of the transaction (Rammal & Zurbruegg, 2007).
The other important principle drawn from Shariah is the profit and risk sharing nature. According to this principle, no profit should be earned from capital invested or assets unless the earner of that profit has taken the ownership risks (Bliss, 2001). Therefore, in Islamic banking system, the deposit holder, the bank or the financial institutions and the depositor share the risks and gains (Lewis & Latifa, 2001). Similarly, in the case of borrowings, the borrower suffers losses. The losses will be shared with the lending bank according to the financial mode used, either Mudarabah or Musharakah.
Evaluation of the Products of Islamic Banking
There are various products and services the bank offer to the clients. Like any Islamic bank, the banking services follow the normal lending contractual agreements. Moreover, In order for Al Hilal to stay in business while generating sufficient returns, the Islamic bank has to ensure its products and services are differentiated from the competitors (Bliss, 2001). The lending procedures follow the Islamic banking principles but are differentiated by the additional advantages the bank offer. However, the contractual agreements in the lending procedures have to be carried out in line with the set of laws and principles of Sharia. The Sharia principles ensure that the losses and profits shared according to the pre-arranged rates. Besides, in the lending procedures, the interest earnings have to be avoided (Zaher & Hassan, 2001). Even though there are over sixteen lending products offered by Al Hilal bank, the focus will be on Murabaha, Mudarabah and Ijara
Mudarabah
Mudarabah is the type of the product where the bank enters in a contractual agreement with another party to manage the business in which the bank has provided the capital. In most cases, the party remains the owner of the business and the capital provided is in form of lending (Archer & Rifaat, 2007). The bank and the party share profits depending on the terms of agreements. In essence, Mudarabah is contractual lending procedure common in Islamic banking in which one party normally the owner of the business offers labor. On the other hand, the lending banks offer capital at an agreed rate depending on the terms and conditions of the agreement. Generally, in Mudarabah, the two parties share the returns and risks (Archer & Rifaat, 2007).
According to Ismail (2010), Mudarabah contractual agreement works in a similar form to the joint stock companies where the stakeholders invest in joint ventures and share profits and risks according to the pre-arranged agreements. Mudarabah in Al Hilal bank works in a similar manner. The funds are purposely lent out to the entrepreneurs and the profits and losses are shared. In the Al Hilal bank, the arrangement is such that the bank oversees the business processes while the entrepreneur runs the daily activities of the business. However, the return rates on the capital contributed are only agreed upon after the deduction of the expenses (Rammal & Zurbruegg, 2007). On the other hand, Mudarabah contractual agreement can also be made between money borrower and the bank to supply capital for a particular project at reduced rates of returns. To differentiate its products and services, Al Hilal bank offer Mudarabah to its clients at a reduced rate.
Murabahah
Murabahah is contractual agreement Islamic banks enter with their clients to purchase the property for resale and the payments are made in installments. In other words, the banks purchase the property on behalf of the client and the clients pay in installments though at a higher prices (Rammal & Zurbruegg, 2007). In most cases, the contractual agreement does not allow deferred payments. In Al Hilal bank, Murabahah involves an agreement where the bank purchases property for resale at an agreed return, which is paid in installments but the payment, is not deferred (Bliss, 2001). The most notable Murabaha in Al Hilal are those agreements that occur between the bank and the customer as well as those that occur between suppliers and the banks. In most cases, the contract involves the three parties where the clients make orders for a particular commodity via the bank. The bank purchases the ordered commodity on behalf of the supplier. The commodity is resold to the customer at a predetermined profit. The customer is expected to pay for the product through installments or in lump sum to the bank (Rammal & Zurbruegg, 2007).
In agreements that involve properties such as land that require long-term mortgages, the property is purchased and registered under the name of the buyer right from the beginning of the transaction. In addition, strict collaterals are always required to cover for the future default. Al Hilal applies the product to attract and retain the clients. The bank ensures that the properties bought on behalf of the customers are provided at fair prices. A fair deal the bank makes on behalf of the customers differentiates the bank’s product from the competitors (Zaher & Hassan, 2001). Moreover, the suppliers also get fair prices on the products bought on their behalf. Murabaha is widely used by most of the Islamic banks. However, most of the banks apply differentiation strategy to place their products in the market and capture a reasonable market share.
Ijarah
Ijarah is the lease agreement between the Islamic banks and the clients. Ijarah operates in a similar manner to the hire-purchase agreements where the owner of the property retain the ownership of the property until the purchaser completes the payment. However, in Ijarah, the bank leases the property to the client (Bliss, 2001). The bank retains the ownership of the property until the client completes the payment. Once the payment is completed, the ownership of the property is transferred to the client.
In most cases, Ijarah contractual agreements are referred to as the lease that ends in purchase. Lewis & Latifa (2001) claim that two parties are often involved in Ijarah contractual agreements. The parties are the bank and the client. Moreover, the bank is the owner of the property in the lease agreement. In addition, the bank remains the real property or asset owner for the period of the lease agreement. The leaser, which is the bank rent out the property in question to the client, who can only completely claim ownership of the property after full payment has been made to the bank (Bliss, 2001). The implication is that the bank has the sole right to hold the property until the maturity of the contract. On the other hand, the client can only keep the property until all payments have been made. Essentially, the prices of the property are often higher compared to the average asset price (Bliss, 2001).
Ijarah has been extensively applied by the Al Hilal bank particularly in new markets such as in Kazakhstan where the bank performs the intermediary roles between the property owners and the buyers. To differentiate the product from the competitors, the bank enters in lease agreements that take shorter time, which the clients consider as cheap at the end of the period (Zaher & Hassan, 2001). Ijarah remain critical product that Al Hilal bank should continue to offer the esteemed clients.
Recommendations
Given the above products, the company should offer Murabahah. As indicated, Murabahah is contractual agreement Islamic banks enter with their clients to purchase the property for resale and the payments are made later in installments. In other words, the banks purchase the property on behalf of the client and the clients pay at higher prices. The reason why Murabahah is the best product for Al Hilal bank is because many transactions are undertaken and the bank is likely to get more earnings from such transactions. In fact, the earnings are morally acceptable within the Sharia principles. In addition, Murabahah contractual agreement does not allow deferred payments. Moreover, payments made under Murabahah are not deferred. Futher, there are various transactions in the form of Murabahah that the bank under takes. For instance, the agreements that occur between the bank and the customer as well as that occur between suppliers and the banks. Client often make orders for a particular commodity via the bank. In addition,the bank purchases the ordered commodity on behalf of the supplier. The bank then resell the commodity is to the customer at a predetermined profit. The forms of transactions the bank enter with clients make Murabahah the best product for the bank. In addition, Murabahah is also another product involving suppliers.
Further, an agreement that involves properties such as land that require long-term mortgages, Murabahah remains the best form of transaction. Murabahah is helpful to the clients since under such agreements the property purchased is registered under the name of the buyer right from the beginning of the transaction. On the other hand, banks are secured against any risk of default since strict collaterals are always required to cover for the future default. Al Hilal should continue to use the product to attract and retain the clients.
To ensure that Murabahah work best for the clients, the bank should guarantee that the properties bought on behalf of the customers are provided at fair prices. The reason is that a fair deal the bank makes on behalf of the customers differentiates the bank’s product from the competitors. Moreover, the suppliers also get fair prices on the products bought on their behalf. The fair prices increase the firm’s competitive advantage. Murabaha should be widely used by Al Hilal bank particularly in UAE where competition is high. However, the bank should utilize the differentiation strategy in order to place the products in the market and capture a reasonable market share.
Conclusion
Al Hilal bank is one of the national Islamic banks operating in UAE. The bank is fully owned by the government. In addition, the bank is based in Abu Dhabi and has over 19 branches across the Middle East and in UAE. Al Hilal bank is one of the Islamic banks in Middle East that offer various products to over forty thousand esteemed clients. The bank’s main services include Islamic personal loans, corporate loans and investment advisory ventures. In addition, the bank offers treasury and wholesale banking products.
The advantage that Islamic banks such as Al Hilal have is that they are not vulnerable to the external financial shock such as the financial crisis experienced in the recent years. The reason is that the banking policies imbued within the Islamic principles emphasize standardization and ethical values in banking. Moreover, Al Hilal bank has some inherent qualities that have been contributing to its resilience. Prudent risk management and regulatory framework have supported these inherent qualities. Moreover, sound governance and strategic leadership have proved to be effective within the operations of Islamic banking. Besides, Al Hilal bank have adopted appropriate products that work best under the Sharia Principles.
Al Hilal ban remains to be the best bank due to its risk management and investment resilience. Besides, the bank is operating in a fast growing banking industry sector. Apart from the promising growth, the bank sound management, effective regulatory framework and strategic leadership increases its advantages for investments. Furthermore, these attributes contribute to the increased financial capabilities, which would in turn be beneficial to the investors.
References
Archer, S. & Rifaat, A. (2007). Islamic finance: The regulatory challenge. Hoboken, NJ: John Wiley.
Bliss, R. (2001). Market discipline and subordinated debt: A review of some salient issues. Economic Perspectives, 25(1), 24–45.
Ismail, A. (2010). Money, Islamic banks and the real economy. Farmington Hills, MI: Cengage Learning.
Lewis, M. & Latifa, M. (2001). Islamic banking. Cheltenham, UK: Edward Elgar.
Rammal, H. & Zurbruegg, R. (2007). Awareness of Islamic banking products among Muslims: the case of UAE. Journal of Financial Services Marketing, 12(1), 65–74.
Zaher, T. & Hassan, K. (2001). A comparative literature survey of Islamic finance and banking. Journal of Financial Markets Institutions and Instruments, 10(4), 155–199.