The central feature of an Islamic financial system is the absolute prohibition of the payment and receipt of interest. Banks in an Islamic economy can strictly operate only on some type of profit and loss sharing basis. Banks in an Islamic economy are denied conventional sources of funds, such as interest-bearing deposits, and cannot undertake lending operations on the basis of predetermined rate of return. Profit sharing and equity participation are the principals on which Islamic banks have to operate. In our project we will try to investigate if Islamic banks are more superior to conventional banks in UAE. Our analyses are targeting both conventional and Islamic banks profitability ratios, liquidity ratios, leverage ratios capital structure ratios and efficiency ratios. Since UAE banking market does not include more than 6 Islamic banks, we had to include 5 of these banks and compare it to the 5 top conventional banks in UAE. Our empirical analyses come to find that Islamic banks in UAE are not Superior to the conventional banks.
Key words: Islamic bank, Conventional bank, comparing, financial analysis.
Sharia : which is Islamic law extracted from the Quran and Sunna are the major rules to follow in Islamic banking.
IN SHARIA MUSLIMS ARE NOT ALLOWED TO RECEIVE OR PAY INTEREST , WHICH IS CALLED (RIBA). THEY ARE ENCOURAGED TO TRADE, INVEST AND SHARE PROFIT AND LOSS ONLY. THE PURPOSE OF FINANCE IN ISLAM IS TO ACHIEVE WELFARE FOR ALL PARTIES; THIS IS DONE BY RISK SHARING AMONG THOSE PARTIES
Transaction deposits: as equivalent to demand deposit in conventional banking systems
Investment deposits: The bank offering investment deposits would provide no guarantee on their nominal value, and they would not pay a fixed rate of return
the common share in Islamic system differ from that of Western definition due to the way the contract addresses asymmetric information between the capital owner and the manager. Asymmetric information is where one party has more or better information than the other. This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry. Examples of this problem are adverse selection and moral hazard
In Islamic banks investors are mainly treated as shareholders
since Islamic banks are not allowed to borrow money from central banks or any other banks neither can they deal with bonds because Interest is forbidden in Islam, therefore Islamic banks tend to keep high rate of liquidity as first line of defense. Although, high liquidity ratios may affect profitability ratios but the opposite is proven by Islamic banks because they rely more on Murabaha, Mudaraba, Musharakah, Ijara and share Profit/loss investments and encourage project finance especially real estate and infrastructure projects rather than deposits.
In the case of UAE banks the overall liquidity and profitability ratio are on the scale of conventional banks and Islamic banks are having low ratios.
Islamic banks depend on retail transactions, customers of Islamic banks tend to deal with Islamic banks based on their believes that interest is forbidden. Therefore, they look for financing their projects or needs without paying interest by using alternative methods of financing offered by the Islamic banks such as Murabaha, Ijara and Musharakah. For example, Murabaha transaction is asset versus money and not money versus money as in the case of loans .
Customers who are willing to deposit their money in Islamic banks are ready to share profit and loss and bear risk , because there is no fix interest. Returns on long-term deposits depend on bank performance, in other words they share risk with the bank.
Islamic banks in UAE are not more efficient than conventional banks.
the size of the bank’s assets is too small comparing to conventional banks.
We don’t want to discourage or give a bad indications of efficiency of Islamic banks.
Our best recommendation for Islamic banks in UAE is to adopt a strict policy of lending. Our empirical analysis showed that the weaknesses of Islamic banks are in their credit risk ratios and efficiency ratios .
While Islamic banks were less affected by the initial impact of the global crisis, profitability fell substantially across both types of banks in 2008 and the first half of 2009, with declines somewhat larger for Islamic banks during the second phase. The weaker performance of Islamic banks in 2009 was largely driven by the U.A.E. and Qatar, where they had a considerably higher exposure to the real estate and construction sectors .