ISLAMIC FINANCE THEORIES AND PRACTICE: A CASE STUDY OF MALAYSIA IN COMPARISSON TO SAUDI ARABIA

Supervisor: Dr. Fayeq AlAkayleh

Islamic finance is growing at an accelerated pace across the globe. Recent statistics indicate that Islamic finance has grown at an annual rate of 20 percent.

Such growth seems to indicate its broad appeal and flexibility to the challenges facing the international finance framework. Islamic finance is flexible to shocks since it emphasizes on sharing risks and provides a stronger link to actual activities.

Nonetheless, there is no strong evidence to prove the stability of the Islamic banks. The banks are subject to the same risks that affect non-Islamic banks. Thus, there is need to come up with risk management practices that can deal with these idiosyncratic risks.

This essay critically analyses case studies in Saudi Arabia and Malaysia and proposes possible recommendations that could be useful in enhancing Islamic finance theories.

Keywords: Islamic finance, Financial stability, Conventional banks, Risk, Financial cricis

Abstract

The Islamic finance theory and practice is a relatively young field in the market. It was only recently that it clocked 40 years.

The most distinct feature that separates Islamic finance practices from the conventional finance practice is the compliance to Shariah laws instead of applying the conventionally set laws.

The field has an extremely promising potential with record annual growth recorded all over the globe.

It established 24% growth in 1996 and 26% growth in 1997 when it was just one and a half decades old.

Islamic finance and banking practices have strict rules about riba (interest) and usury.

So far, the largest players in the Islamic finance industry have remained Islamic nations, the leading of which include Iran, Malaysia and Saudi Arabia

Introduction

Many scholarly works done about the Islamic finance theories and practice. The most famous perhaps is the book by the same title written by Tariqullah Khan.

Khan points out that the practice of Islamic finance differs immensely from the theory itself.

He says that the theory relies on a PLS finance system in place of the interest that conventional finance relies on. But the practice of the Islamic finance, not conforming to the theory, relies a lot more on the “mark-up principle which underlies deferred trade” (Khan T. , 1996).

Three banks were the first to be established, one was in Karachi, the other, Tabung Haji was in Malaysia and a third one in Egypt was a savings-investment bank in Mit Ghamr. Out of these three, only Malaysia Tabung Haji survived. (Siddiqi, 2006).

Literature Review

The very first scholars and researchers to work on the matter are responsible for compiling what is more commonly known today as the theory of Islamic finance.

This research was fueled by the need to come up with an appropriate alternative to the western interest based finance models which were not in sync with the Islamic holy writing.

The PLS finance system was only ever applied at the very beginning of Islamic finance institutions. The dawn of Islamic finance practice marked the end of the Islamic finance theory that relied on PLS.

Instead of adopting PLS, the founders of Islamic finance institutions in Malaysia and Saudi Arabia took up on a new principle called ‘mark-up principle.’ (Khan T. , 1996)

• The Islamic finance theory

The Islamic finance practice is widespread in Malaysia as well as Saudi Arabia. The two countries are part of the world’s leading country in Islamic finance practice.

The very first Islamic bank, Tabung Haji was situated in Malaysia.

Islamic finance practice in Malaysia is very advanced while it still shares the market with conventional banking systems.

Malaysia has been a trend-setter for many of the practices that we observe in Islamic finance today.

Saudi Arabia’s practice of the Islamic finance has also seen a significant increase over the course of its development.

Currently, Saudi Arabia remains among the top three leading countries in Islamic finance.

• The Islamic finance practice

Data collection results came in from the sampled areas and I established that the viable total of unspoilt questionnaires numbered roughly over 3000.

Only three fifths were filled in the proper manner.

From these returned results, graphical representations were derived.

Data collection

The data used in the research were collected using questionnaires and presented in the form of frequency distribution tables.

The data were then processed using (T-test), a reliable statistical method of analysis.

If the value derived from the test is found to be greater than the tabularized value, then the null hypothesis formulated in the course of the research process is rejected (Pock, 2007). T-test uses the formula outlined below.

Method of data analysis and presentation

Out of 226 questionnaires administered to respondents, 98.7% were returned back while 1.3% was not returned.

72.3% of the responses from the returned questionnaires were male, while 22.7% were female.

Out of the 222 responses, 5% were between age 18-25, 36.7% were between 26-35 ages, 25.8% between 36-45, 22.6% between 46-55, 7.7% between 56-64 and above 65 were 2.3%.

4.1% of the respondents were educated to the primary school level, 10% to the high school level, 40.7% to the college level, 36.7% to the university level, and 8.6% to the postgraduate level.

Data Presentation, Analysis and Interpretation of Results

  Number Percenta

ge

Valid

Percent

Cumulative Percent

Friend 40 18.3% 18.3% 18.3%

Family 82 37.6% 37.6% 55.9%

Colleague 46 21.1% 21.1% 77%

Advertisement 42 19.3% 19.3% 96.3%

Other 8 3.7% 3.7% 100%

Total 218 100% 100%  

Q2: Where did you first hear about or realize the existence of the Islamic financial system?

The table above shows that 18.3% of the respondents first heard about or realized the existence of the Islamic financial system from their friends. 37.6% heard from family, 21.1% heard from colleague, 19.3% heard from advertisement and 3.7% heard from other sources apart from the mentioned.

  N Mean Std.

Deviation

Std. Error

Mean

Where did you first hear about

or realize the existence of the

Islamic financial system?

218 1.1743 1.03705 0.07024

The one-sample statistics above tells us that we have 218 observations represented by N, the mean number is 1.17 and the standard deviation is 1.03. The standard error of sampling mean is 0.07 approximately 7%, which is an acceptable percentage of standard error.

Table 7: One-Sample Test

 

Test Value = 1

t df Sig. (2-tailed)

Mean

Difference

95% Confidence

Interval of the

Difference

Lower Upper

Where did you first hear

about or realize the

existence of the Islamic

financial system?

2.482 217 .014 .17431 .0359 .3127

Interpretation: The second column of the one sample test above gives the calculated t-test value as 2.482, the third column gives the degrees of freedom as 218 (218-1 = 217), the fourth column shows the two-tailed significance (the 2-tailed p value) and the fifth column shows a mean difference of 0.1743. Using the table of critical t values to determine critical t with 100 degrees of freedom, level of significance (α) at 5% one-tailed, the critical t is 1.660.

Decision: We determine if we accept the alternative hypothesis or accept the null hypothesis. The decision rule is that if the one-tailed calculated t value is more than the critical t value and the means are in right order we accept alternative hypothesis (H1). From the table of t values the critical t is 1.660 and the observed t is 2.482 making the observed t higher so than we can reject the null hypothesis (H0) and accept alternative hypothesis H1. Hence there is a significant relationship between the Islamic financial system and the membership in the system, as well as where one first realized the existence of the system.

Hypothesis 2: Ho: There is a significant relationship between the Islamic financial system and the membership in the system, as well as where one first realized the existence of the system.

H1: There is no relationship between the Islamic financial system and the membership in the system as well as where one first realized the existence of the system.

Objective: To validate There is a significant relationship between the Islamic financial system and the membership in the system, as well as where one first realized the existence of the system.

  Numbe

r

Percentag

e

Valid

Percent

Cumulative

Percent

0-20% 15 7% 7% 7%

21-40% 37 17.1% 17.1% 24.1%

41-60% 42 19.4% 19.4% 43.5%

61-80% 57 26.4% 26.4% 69.9%

81-100% 65 30.1% 30.1% 100%

Total 216 100% 100%  

Q5: Out of an average of 100%, how would you rate the quality of service you receive at your Islamic finance institution?

From table 8 above, 15 respondents rated the quality of service received between 0-20%, 37 respondents rated 21-40%, 42 respondents rated 41-60%, 57 respondents rated 61-80%, and 65 respondents rated 81-100%.

  N Mean Std.

Deviation

Std. Error

Mean

Out of an average of 100%,

how would you rate the quality

of service you receive at your

Islamic finance institution?

216 1.1759 1.04172 0.070

Table 9: One-Sample Statistics

The one-sample statistics above tells us that we have 216 observations represented by N, the mean number is 1.175 and the standard deviation is 1.041. The standard error of sampling mean is 0.070 approximately 7%, which is an acceptable percentage of standard error.

Table 10: One-Sample Test

 

Test Value = 1

t df

Sig. (2-

tailed)

Mean

Difference

95% Confidence

Interval of the

Difference

Lower Upper

Out of an average of

100%, how would you

rate the quality of

service you receive at

your Islamic finance

institution?

2.482 215 .014 .17593 .0362 .3156

Interpretation: The second column of the one sample test above gives the calculated t-test value as 2.482, the third column gives the degrees of freedom as 216 (216-1 = 215), the fourth column shows the two-tailed significance (the 2-tailed p value) and the fifth column shows a mean difference of 0.17593. Using the table of critical t values to determine critical t with 100 degrees of freedom, level of significance (α) at 5% one-tailed, the critical t is 1.660.

Decision: We determine if we accept the alternative hypothesis or accept the null hypothesis. The decision rule is that if the one-tailed calculated t value is more than the critical t value and the means are in right order we accept alternative hypothesis (H1). From the table of t values the critical t is 1.660 and the observed t is 2.482 making the observed t higher so than we can reject the null hypothesis (H0) and accept alternative hypothesis H1. Hence there is a close relationship between the Islamic finance system and the services they offer.

Hypothesis 3: Ho: There is a close relationship between the Islamic finance system and the services they offer.

H1: There is no relationship between the Islamic finance and the services they provide.

Objective: To validate that there is a close relationship between the Islamic finance system and the services they offer.

  Number Percenta

ge

Valid

Percent

Cumulative

Percent

Saudi Arabia 162 75.3% 75.3% 75.3%

Malaysia 53 24.7% 24.7% 100%

Total 215 100% 100%  

Q10: Which country do you currently reside?

  N Mean Std.

Deviation

Std. Error

Mean

Which country do you currently

reside?

215 1.1767 1.04408 0.07121

Table 12: One-Sample Statistics

Table 11 Hypothesis 3

Table 13: One-Sample Test

 

Test Value = 1

t df

Sig. (2-

tailed)

Mean

Difference

95% Confidence

Interval of the

Difference

Lower Upper

Which country do you

currently reside?2.482 214 .014 .17674 .0364 .3171

Interpretation: The second column of the one sample test above gives the calculated t-test value as 2.482, the third column gives the degrees of freedom as 215 (215-1 = 214), the fourth column shows the two-tailed significance (the 2-tailed p value) and the fifth column shows a mean difference of 0.17674.

Using the table of critical t values to determine critical t with 100 degrees of freedom, level of significance (α) at 5% one-tailed, the critical t is 1.660.

Theoretical findings

There is a close relationship between the age, gender, and education level of the respondents to their membership in the Islamic financial institution.

All the previous studies referenced in the course of this research, especially in the literature review section prove that various demographics can influence membership in the Islamic financial institution.

The institution should consider a critical step of creating their customers with the ideal that they are faced with different choices concerning religion and other demographics (Khan & Barnes, 2015).

The financial institution should develop effective measures to build a loyal customer base and deal with competition from the other institutions in the same locality.

Findings, Conclusions, and Recommendations

The findings represent the data collected after administering the questionnaires to the respondents from Malaysia and Saudi Arabia. The questionnaires were filled by members who were either users or not users of the Islamic finance system.

From the research findings, it is evident that the male gender was more associated with the Islamic finance system when compared to the females.

The number of respondents aged between 26 to 35 years of age also used the Islamic finance system more followed by those between 36-45 years.

Based on the level of education of the respondents, the highest number associated with the Islamic banking system where those in their college and university level. The other groups of respondents in the postgraduate, secondary and primary grades were less interested in the Islamic finance system.

• Empirical Findings

Based on religion, the Muslims were more affiliated to the Islamic banking system. Nonetheless, 72.9% of the respondents also confirmed to be customers of the Islamic bank.

Most of the respondents learned about the Islamic financial system through family followed by colleagues. Also, most of the respondents have been associated with the Islamic financial system since 6-10 years and receive Murabaha as one of the popular services.

The Islamic finance institution is rated highly at 81-100%. Most of the users agreed that they would recommend the services of the system to other people. A greater percentage of the members of the non-Islamic financial institutions are also planning to maintain their active membership in the institution.

During the research, 75.3% of the responses were generated from Saudi Arabia while 24.7% were from Malaysia. The predominant religion in Saudi Arabia was also found to be Islam.

Based on the findings of the research study, the following are the recommendations:

The Islamic financial institution should create more awareness of the institution among the female gender and offer specialized services that target the women in society.

Benchmarking programs should be introduced to the institution to ensure the Islamic financial system is on par with the other international practices. Such programs will help the bank improve the quality of services to meet the competition available in the international arena (Iqbal & Mirakhor, 2011).

The Islamic finance theory based banks ought to increase their level of market

effectiveness. The financial system has various weaknesses, especially when projected from an international perspective. The institution ought to address these weaknesses if they are to capitalize on growth and competition.

Recommendations

(2011). global islamic finance. Islamic Finance. (2015, June). Retrieved from wikipedia:

http://en.wikipedia.org/wiki/Islamic_banking religious-projections. (2015, april 2). Retrieved from pewforum:

http://www.pewforum.org/files/2015/03/PF_15.04.02_ProjectionsFullReport.pdf

Abdus Samad, N. D. (2006). Islamic-Banking-and-Finance. Retrieved from asadulhoque.tk/: http://asadulhoque.tk/wp-content/uploads/2013/04/Islamic-Banking-and-Finance.pdf

Albalawi, S. H. (2006). Banking System In Islamic Countries: Saudi Arabia and Egypt. stanford university.

Al-Gazali, A. (1990). Development: An Islamic perspective. Pelanduk Publications.

Iqbal, Z., & Mirakhor, A. (2011). An introduction to islamic finance : theory and practice. Singapore: John Wiley & Sons (Asia).

 

Bibliography

Khan, M., & Barnes, M. (2015). Islamic Banking: Principles, Theory and Practice. Saudi Arabia: Meteor Content Providers.

Khan, T. (1996). Islamic Finance: Theory and Practice. Loughborough University.

Krichene, N. (2012). Islamic capital markets : theory and practice. New York : Wiley.

Maududi, A. S. (1961). Sood. Islamic Publicatiom. Pock, A. v. (2007). Strategic management in Islamic finance. Wiebaden:

Deutscher Universitats-Verlag. Siddiqi, M. N. (2006). ISLAMIC BANKING AND FINANCE IN THEORY AND

PRACTICE: A SURVEY OF STATE OF THE ART. Warde, I. (2000). Islamic Finance in the Global Economy. EDINBURGH

UNIVERSITY PRESS.

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