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  • 1. AbstractIn this study we had learn that Islamic financial institutions and conventional financialinstitution which situated globally. Furthermore, Islamic financial institutions establishedbecause of the principles of capitalism by charging interest is forbidden in Islamic law. Inthis way Muslim can use the new financial institution services that are acceptable by theconcept of Shariah. The main objective of this research is to investigate the relationshipbetween customer acceptance and financial institutions and the differences betweenIslamic and conventional financial institutions. Through this, we do learn about thedefinition of financial institutions. In addition, we study more about the knowledge inIslamic and conventional financial institution. Besides that, investigating on customeracceptance of these two financial institution also been done. Subsequent to this analysis,customer acceptance had been clarified. Furthermore, the financial instruments and thebenefits of Islamic and conventional financial institutions had been stated down. Throughthis study, we know that customer acceptance has significance effect on financialinstitutions. There are two limitations in this study. First, research and questionnaire ofthis study is not available due to the wide coverage of areas. Second, informationcollected may not reflect to actual by the limitation of secrecy.IntroductionAn Islamic financial institution has emerged as a competitive and a viable substitute forthe conventional financial institutions during the last three decades. It is especially truefor Muslim world where presently Islamic financial institutions strides at two separatefronts. Islamic financial institutions are developed base on the concept on Islamic Shariah.It must operate within the framework of the religion that is Quran and Sunna. InMu’amalat, it means the relationship with other human had showed the economicactivities are included. The primary motive of Islamic financial institutions is to ensurethe prohibition of Riba (all forms of unearned income). In 1940s and 50s, it started in thedevelopment of the theory and the first financial institution had introduced in 1970s. In1990s, it had focus on concentration of Islamic financial institution growing in selected 1
  • 2. countries. In 2000s, it starts to develop structured Sukuk and capital market andcommencing of mega project finance, large commercial banks and Islamic derivatives.The first service apply in Malaysia that relate to Islamic finance is Tabung Haji(Pilgrimage Fund) in 1967. In 1983, the first Islamic Bank in Malaysia had beenestablished. By the next year, the first Takaful (Islamic insurance) had introduced.Nowadays, Islamic financial institutions operate in over 70 countries. According toIbrahim Warde, the assets have increased more than fortyfold since 1982 to exceed $200billion had showed the improvement and widely use of the Islamic financial institutions.In 1996 and 1997, they have grown at respective annual rates of 24 and 26 per cent.Some foreign institutions have start to established Islamic banking subsidiaries, nowmany conventional banks are also offering ‘Islamic products’ that are sometimes aimed atnon-Muslims. The origin in the phrase financial institution is derived in the Italian phrase“banco” or desk. Financial institutions come from areas which organizations could safeloans to buy stock, as well as accumulate the money with curiosity when the merchandiseis marketed. The financial institution has come to a big revolution with the innovation oftechnology make it can serve the public within an aggressive market place that cover withhigh efficiency and more secure. Conventional financial institutions provide financialservices for its client such as guarantees, funds transfers, safety of wealth, and facilitationin international trade provide reward as a part of income. However the major driver ofoperation of conventional financial institutions is interest. It acts as financialintermediaries by allocate financial resources from its source to potential users. Since theconventional financial institutions established under the principles of capitalism andtransect business by charging interest which is forbidden in Islamic law. This is thereason why Muslims establish their own financial institutions under Islamic principles.Objective of study To investigate the relationship between customer acceptance and financial institutions. To investigate the differences between Islamic and conventional financial institutions. 2
  • 3. Literature ReviewStudies related to financial institutionsFinancial institution can categorized in three group, Deposit-taking institutions thataccept and manage deposits and make loans, including banks, building societies, creditunions, trust companies, and mortgage loan companies; Insurance companies and pensionfunds; and brokers, underwriters and investment funds (Siklos, 2001). There is broad definition for financial institution. In generally, financial institutionis an institution that provides financial services for its clients or members. According tothe Commissioner of Law Revision Malaysia (2006), financial institution means anylicensed bank, licensed merchant bank, licensed finance company, or licensed discounthouse, as those terms are defined in the Banking and Financial Institutions Act 1989. The government of Guyana has defined “depository financial institution” as alicensed financial institution which accepts deposits and other repayable funds from thepublic while “non- depository financial institution” as licensed financial institution whichdoes not accept deposits and other repayable funds from the public. According to Peter Thomas (2004), the Norway government has state thatfinancial institutions is the companies, undertakings or other institutions which carry onfinancing activity except public credit institutions and funds, public trustees offices andfoundations whose primary purpose is not to engage in commercial activity, managementcompanies pursuant to the Securities Funds Act and investment firms pursuant toSecurities Trading Act. Finally, financial institution may to include mortgage lending businesses.Mortgage lending business means that organization which finances or refinances any debtsecured by an interest in real estate, including private mortgage companies and anysubsidiaries of such organizations, and whose activities affect interstate or foreigncommerce (Kenny, Boyce and Warin, nd). 3
  • 4. Studies related to conventional and Islamic financial institutionThere are the differences between conventional and Islamic financial institution, thedifference is showed below:2.1 DepositsBoth conventional and Islamic financial institutions collect deposits from their saver.However according to Hanif (2011), there are different in rewarding their depositor.Under conventional system reward is fixed and predetermined while under Islamicdeposits are accepted through Musharaka and Mudaraba where reward is variable. Underconventional system total risk is born by the bank and total reward belongs to it afterservicing the depositors at fixed rate while under Islamic system risk and reward both areshared with depositors.2.2 Home loanHome loan interest rates are available in conventional financial institutions. According toNoriza (2009), lending with interest is not allowed for Muslim. Conventional housingloan lend money for house purchasing while Islamic banking mostly structures on buyand sell basis on purchasing a house. Thus, most of Islamic home financing involvepurchase and subsequent sale of asset at certain fixed price. Conventional financialinstitution charge interest in home loan while Islamic home financing did not usurywhich means there are no interest charges in paying back the house financing at the endof the maturity period. Customers of Islamic financial institution only have to pay backthe price that has agreed upon agreement by both parties between the bank and thecustomer after the profit margin had been calculated.2.3 Overdrafts or Credit CardsAccording to Hanif (2011), conventional banks offer the facility of overdrawing fromaccount of the customer with interest. One of its form of example is use of credit cardwhereby limit of overdrawing for customer is set by the bank. Credit card is not offered 4
  • 5. by Islamic banks except in the form of Murabaha for example provide facility of debitcard. Under conventional banking a customer is charged with interest once the facility isused. However under Murabaha, profit is due when the commodity is delivered to thecustomer. Default customer is charged with further interest for the extra period underconventional system however extra charging is not allowed under Murabaha.2.4 InvestmentsIn order to maintain liquidity conventional banks have many avenues includinggovernment securities, shorter term loans and money at call and short notices, leasingcompanies’ bonds, investment in shares and others. Conventional banks can also createliquidity by issuing the bonds against their receivables. Commercial banks are alsoprotected by central bank by providing liquidity in rainy days for interest. Interbankdeposits are also rewarded in the form of interest by commercial banks. For Islamicfinancial institutions avenues are very limited to create required liquidity at the same timeto earn some revenue by investing in short term and liquid securities. Compare toconventional, Islamic financial institution cannot invest in government securities, shortterm loans, bonds and money at call and short notices because of interest basedtransactions (Hanif, 2011).2.5 StabilityAccording to research by Beck (2010), his survey result has showed that conventional ismore stable compare to Islamic financial institution. Islamic banks are not more stableand not liquid than conventional banks due to lower profitability and lower capitalization.He found that conventional banks are more cost efficient and better capitalized thanIslamic financial institution. Higher complexities in Islamic banking might result inhigher costs and thus lower efficiency of Islamic banks. 5
  • 6. Studies related to customer acceptance on financial institutionsFrom the report from Khazeh and Decker (1992), interest rate was one of the top fivedeterminants factors that influenced the acceptance on banking decision. The evidence ofinterest rate has supported by Ongena (2009). Paying highest interest rates on savingaccounts also rank in second place for consumer to choose the financial institution in theresearch by Safakli in year 2007. Same with the Islamic financial institution, Islamicfinancial institution always offer higher interest rate compare to conventional (Rosly,2005). Gerrad and Cunningham (1997) also found that profit or interest rate served as areason for people maintaining their relationship with Islamic banks. However, therevenue of Islamic financial institution is low due to high interest rates. Customer perception of risk is also factors that influence the acceptance offinancial institution. The higher financial institution or instrumental risk, the higher returnfor the consumer (Faulhaber, n.d.). However, the consumer more prefers large financialinstitution. There is the relationship between the sizes of the financial institution to therisk. McAllister and McManus (1993) found that increasing size permitted lower riskcosts for banks resulting from inventory economies. Reputation of financial institutionwas one of the method that consumer to determine the risk of the firm (Ongena, Tümer-Alkan and Vermeer, 2010). In Islamic financial institution, according to Noriza (2009),Islamic banking products and services normally subscribe to fixed rate mechanism whichprovides certainty, clarity and predictability. Home loan financing is stable due to flatprofit rate imposes on the financing. Cost will influence the acceptance of consumer in choosing financial institution.Research of Mooradian and Ryan (2011) shows that cost of transfer is another factor thatinfluence consumer and corporate to choose the financial institution. This cost includescost of electronic payments, charges on foreign exchange, drafts, cheques and trade andexport finance charges. The situation is same in Islamic financial institution. In the reportof Marimuthu (2010), the responders have chosen the Islamic financial institution due toits low service charge and benefit. The evidence on Islamic is also supported byJuwairiah (2011) in her research. 6
  • 7. Convenience is also a factor that consumer to accept the financial institution.Convenience include factors the such as working hours of the financial institution,availability ATMs, convenient branch locations and wide branch network convenience,and the location (Haron, 2005). Kaynak and Whiteley (1999) observed that theconvenience of a bank was a primary motivation for customers in selecting a specificinstitution. In survey of Riggall (1980), community in the United States of Americafound that convenience of location to both home and work appeared to be the mostinfluential factor for bank selection by newcomers. Same with the Islamic financialinstitution, convenience factor is also support by Juwairiah (2011) that customer tochoose Islamic financial institution. Islamic financial institution gives the optional forcustomers either muslin or non-Muslim to choose what type of products that made themconvenience to have. Awareness of a person to the financial institution influences their acceptance.Public knowledge, product, marketing of financial institution affects the awareness of aperson to the financial institution (Marimuthu, 2010). Awareness also can influence byfriend or recommendation by a professional (Wangenheim, 2004). For Islamic Financialinstitution, according to Haron (2005), public has support and acceptance towards theIslamic banking. His report state that almost 100% of Muslims and 75% of non-Muslimaware of the existence of Islamic bank in Malaysia. Through his report, he shows that theevidence which Islamic bank is not meant for Muslim customers only. Same with theresult by the researcher, Dusuki (2007), customers has positive perception toward Islamicfinancial institution. Most of the responder thinks that there is good potential for Islamicbanking. Finally, religion affects the decision to choose the financial institution. Religionrank third place in Marimuthu’s (2010) survey. Islamic financial institution is not acceptsby public due to the perception that Islamic banking is for Muslim only. 7
  • 8. Discussion and FindingsCustomer Acceptance on Islamic versus Conventional Financial Institutions’ProductsThere are extremely different between Islamic financial institutions and conventionalfinancial institutions. The most notable features are the products that introduced byIslamic financial institution which are likely to those products of conventional financialinstitutions. Some of the Islamic financial accessible to investors are including theinsurance, which known as Takaful, Islamic term deposits, mutual funds, treasurydeposits and the most popular Islamic equity, Sukuk. However, Islamic financial systemare based on the Shariah principles where the activities that involved interest, gamblingand speculative trading are strictly prohibited. Syariah is supporting and encouraging asthe activities are can develop the entrepreneurship, trade and commerce and bring indevelopments of societal or benefits. In terms of Islamic finance, this principle has givedetails about the ethical concepts of money and capital, the relationships between risk andprofit and the social responsibilities of Islamic financial institutions. For conventional financial system, it is operate based on the debtor creditorrelationship between the depositors and the bank, and the relationship between borrowersand bank. Interest is considered as the price of credit which may reflect the opportunitycost of money. Conventional financial system is operate under the principles ofcapitalism and transactions business by charging interest which may prohibited in IslamicLaw. Interest charge such as on lending activities have contributed as the main source ofrevenue and funding for conventional financial institutions. Interest paying or receiving on capital or Riba is the most popular aspect ofprohibition in Islamic financial system. Those fixed rate or predetermined rate onmaturity, amount of principal and the fluctuate investments performance are consideredas Riba and it is prohibited in Syariah principle. Conversely, it is encouraged by IslamicLaw as it is the rate of return or profit on capital and there is sharing of profits. In Islamicfinancial institutions, there are no provisions to charge the extra money from defaulters.Nonetheless, they are requiring disbursing a small amount of compensation and which is 8
  • 9. proceed toward to charity. Based on the principle, the profit is determined ex-post whichhas symbolizes the creation of additional wealth through successful entrepreneurship.Interest, determined ex-ante which is the cost that is accrued regardless of the outcome ofbusiness operations and may create wealth even if there is business losses. In conventional sense, the financial institutions such as bank has play the role asmoney dealer, has reward the using money with interest under capitalism system, andthus interest is the source of revenue and fund for financial institutions. For rewardingdepositors, they may get the returns and rewards of savings in the form of fixed interestor predetermined returns. For long term depositors they may receive a higher return andhigher risks. For example a term deposit is has to deposit or saving in a financialinstitution for a fixed period by depositors. They just can withdraw it as it is maturity ornoticed earlier by depositors after numbers of days. Depositors are earning interest on theinvestments that made by the bank during their money is in the financial institution. Theirinvestments contributions are under guaranteed with the length of terms, amount ofdeposits, and others conditions that agreed by consumers and banks. Risk and uncertainty or gharar also not allowed in Islamic financial system. It isforbidden on the selling of goods and services that the seller is not in position to conveythe contracts. He also cannot sell since the goods or services are not belongs to himself.To avoid the risks, Islamic financial system has regulated that the price and nature of thegoods being transacted are defined in detail and have to be agreed by both parties. Theactivities of sale such as the short sales or sales on margin are deeply disallowed. Inconstraint, Islamic financial system has strongly recommended and provides someguidance in order to eliminate consumers’ risk and uncertainty which has supportedwithin the Syariah principle. The system has advocating risk sharing between theconsumers and Islamic financial institutions. Their loss and profit may be share byfinancial institutions and consumers which follow the term that agreed at the beginning ofagreement establish. Apart from this, Islamic financial system always promotes theircustomers with entrepreneurship opportunities and discouraging the speculative behavioramong depositors. Customers who have chosen to use Islamic financial system are alsogot the preservation of property rights. 9
  • 10. For conventional financial customers, they may experience with risks anduncertainties which may be reflected by the market price movement. Interest rate risk isthe most uncertainty that may faced by a lot of consumers. Interest rates risk has apparentin prepayment risks, reinvestment risks and re-pricing risks where each of it is relatedwith money market movements. Since conventional financial institutions are operateunder interest-based system and thus customers are getting assured with a fixed ratereturn and have a predetermined rate of interest. For example the loan activities, therewill charge the interest on the loan payments as the revenues and fund sources for aconventional financial institutions. Interest charge is a fundamental function for aconventional financial institution as we can seen the service provided such lendingprocess, there is a compounding interest charge on the payback money depends on theprinciple amount, length of loans and other related terms that agreed between banks andcustomers. While consumers investing, conventional financial system may put on greateremphasis on their return or their credit worthiness in order to last long their confidence totrade with the financial company. Customers’ satisfaction on each the Islamic financial institutions and conventionalfinancial institutions are important because this factor can help in facilitate developmentof both system. It is depends on the availability of services, quality of services offeredand transactions cost as well which can manipulate consumers confidence level to investin a financial institution. According to Saad (2012) research, customers will mostsatisfied with those financial institutions that has highly competency, friendliness, andefficiency of staff. Both of the financial institutions has a good performance but there stillnecessary for Islamic financial system to improve its service quality as customerssatisfaction is vital to affecting the competitiveness of an organization. There is alsonecessary for Islamic financial system to make more improvement for providing andupgrading facilities, customers’ services and quality of services. It is fact that Islamicfinancial institutions have to put more emphasis in behalf to getting greater acceptanceamong non-Muslims investors or customers. Some of the non-Muslims are not selectIslamic financial system as there are lack of understanding and information about it andthere are most of them have the prior perception that it is only reserved for Muslims. 10
  • 11. On the other hand, conventional financial institutions may face competitive asthere are upgrading and innovative design on Islamic financial system. Since they aregetting more information about Islamic financial system and more understanding on it,there may be changes of decision by investors. It is threaten to conventional financialsystem due to customer’s withdrawal from and disperse of money investments. It ishappened because the main objective is select for the most appropriate financialinstitution to maximizing their wealth creditworthiness. This is because Islamic system isprovide services and products that free from interest charge, various risks anduncertainties is lower as stated in above. There are researchers examine that there are more acceptance throughconventional financial system than Islamic financial system because customers are moreknowledgeable with conventional terms and products introduced. Some of the consumershave made selection on Islamic financial system due to their religious aspects. A religionfactor can be a strong driven for individual preference on selecting financial system. Thestronger commitment on religious may lead the more preferences on Islamic financialsystem (Jorg and Kuehn, 2003). However, there still have circumstances that customersprefer the conventional financial system than Islamic financial system. For example,when the interaction between consumers and conventional financial institutions are closerthen the institutions will always be the location for invest their money for create wealth.Besides that, when customers find out the term of Islamic financial system is difficult andhard to understand or learn about it, they will stay away from it. For most of consumers,they will make selection on what they most understand and more knowledge on it due toprevent uncertainties and to avoid any loss on it. Compare with non-Muslims, Muslimsinvestors are more knowledgeable on Islamic financial concepts and this has show astronger preference on Islamic financial system. Apart from these, the availability of services and products may affect decision onparticular financial institutions. For Islamic financial institutions, there are only theIslamic products and services that offered while it is differ from conventional financialinstitution, it has provided both Islamic products and conventional products and services.Since conventional financial system can served with various types’ products and services, 11
  • 12. it is the priority and underlying for consumers to trading in conventional institutions.Instruments that used in Islamic financial system are namely using Islamic terms andthere also available in conventional financial system with the common use term name.Fixed income investments such as bond are known as Sukuk in Islamic financial system.It is an investment certificate which a proportion customers interest in a pool of assetsthat yield to income and capital returns. The returns from the assets will pass to Sukukholders, the investors. Deposits or savings are contributions of savers for getting rewards regardless it isan Islamic or conventional financial institutions. Under conventional financial system, thereward is fixed and there may predetermine interest rates based on principle amount. ForIslamic financial system, the reward for customers is variable and is through the conceptMusharakah and Mudarabah. In term of risks, it is higher risk on the long term depositsthan short term deposits in conventional deposits. It is same with Islamic financial systembut there will be profit or loss sharing between depositors and financial institutions. Thereare differences between both financial system of deposits which are risk sharing andrewards. For conventional financial system, the risk is deriving from the institutions itselfand it can own the rest of reward after give out the fixed rate for depositors as agreed. Itis totally diverse from Islamic financial system where the risk and reward are sharingbetween depositors and financial institutions. Reward for depositors is always dependingon the outcomes from investments made by Islamic financial institutions. The greateroutcomes of investments bring in higher rewards for their depositors (Hanif, 2011). Financing is a popular services provided by both financial system where it is gothrough Murabaha under Islamic financial system. The purpose of both financialinstitutions provides financing services is for gaining rewards from a prolific channel.Interest payments on loan is seem like the transactions cost, processing fees for aninstitutions. Under conventional financial system, financing has served as the creditfacility that address to small and medium business or industry for return. There will becharges of fixed rate of interest on the credit which is prohibited by Islamic financialsystem. As stated, there are derivation of various loans which categorize into short termloans, overdrafts and long term loans. Within the Islamic principle, it is a cost-plus 12
  • 13. financing which used for financing assets and trading activities that the deferredpayments from customers are allowed. To achieve the requirement assets from customers,Islamic financial company have to start doing business but cannot provide loans servicesthat involved interest charge. Conventional loans are preferable selection even fixed ratecharge on because it is more simply and easier to get the loan as the terms agreed bycustomers. 13
  • 14. Islamic and Conventional Financial Institutions Instruments and ActivityIslamic finance had been improved from traditional instrument to modern instrument.The most different between Islamic Finance and Conventional Finance are on the interest(riba) factor. Islamic finance instruments are based on interest free while conventionalfinance is based on current market interest free. The term interest free brings the mean ofthe prohibition of paying or receiving interest on capital in Islamic Finance. Any positive,fixed, predetermined rate that tied to the maturity and amount of principal is consideredriba. Sharing of risk and return are one of the different between Islamic finance andconventional finance. The most commonly used instruments in Islamic finance are Murabahah,Mudarabah, Istisna’a, Ijara, Musharakah, Sukuk and etc. Here, the characteristic of someof the most used instrument in Islamic finance will be introduced: MurabahahMurabahah is one the most commonly used profit sharing method in trade financing.Murabaha contract has been applied in Islamic banking business in many ways includingproperty, vehicle, personal financing and corporate financing. A murabahah is a sale on acost-plus basis where payment of the price including mark-up is deferred to a later date. According to Chong (2009), murabahah is a contract of sale and purchase at aprofit margin between the supplier and the purchaser of the good. The cost and profitfrom the transaction must be known in advance and agreed by both parties to the contract.While Rosly (2011) mention that from a financing perspective, a murabahah contract ingeneral implies a sale based on installment payments. 14
  • 15. Source: Academy for International Modern Studies It is an investment fund where one party will provides the capital while the otherparty will provides the management. Profit sharing will be agreed in an early stage andthe loss is bear by the provider of the funds alone. The parties that provide capital are notallowed to interfere in the management of business. According to Obiyathulla (1997), thispartnership with the financier as the silent or sleeping partner but the profits derived fromthe business or investment are shared by the two parties according to a predeterminedprofit-sharing ratio. 15
  • 16. Step 1 You supply funds to the bank after agreeing on the terms of the Mudharabah arrangement. Step 2 Bank invests funds in assets or in projects. Step 3 Business may make profit or incur loss. Step 4 Profit is shared between you and your bank based on a pre agreed ratio. d Step 5 Any loss will be borne by you. This will reduce the value of the assets/ investments and hence, the amount of funds you supplied to the bank. Source: banking info Istisna’aAccording to the Islamic Development Bank (2002), Istisna’a is a contract whereby aparty undertakes to produce a specific thing which is possible to be made according tocertain agreed-upon specifications at a determined price and for a fixed date of delivery. uponIt is an instrument where the contract can be deal by referring to something that not inexistence at that time. Medium term financing is provided to meet the financingrequirement for manufacturing, supply, or sale if identified goods. 16
  • 17. Ijara (Leasing)According to Lewis (n.d.), Ijara literally means ‘to give something on rent’, andtechnically it relates to transferring the usufruct of a particular property to another personon the basis of a rent claimed from him. It is similar with conventional lease but inIslamic rules. The difference between sale ( (bay) and ijara is transfer of ownership vis-a-vis transfer of the usufruct ( (manfa’a). That is, the leased property remains in the ).ownership of the lessor and only its usufruct is transferred. In a simple word, Ijara is acontract under which the financial institution buys and leases out an asset or equipment institutionrequired by its client for a rental fee.Example: Source: banking info 17
  • 18. Step 1 You pick a car you would like to Step 2 You ask the bank for Ijarah of the car, pay the deposit for the car and promise to lease the car from the bank after the bank has Step 3 Bank pays the seller for the Step 4 Seller passes ownership of the car to the bank. Step 5 Bank leases the car to you. Step 6 You pay Ijarah rentals over a period.Step 7At end of the leasing period, the bank sells the car toyou at the agreed sale price. Source: banking info 18
  • 19. MusharakhaA Musharakha is a contract among two or more parties, each contributing some of theircapital in a joint commercial venture. Profit ratios have to be specified in advance but incase of a loss, it must be shared in proportion to the capital sums contributed (Lewis, n.d.).In Musharakha, all parties have the right to participate in the business run. Sukuk (Bond)Sukuk is an investment certificate (bond) that represents a proportionate interest in awell-defined pool of assets that yield income and capital returns. Usually set up throughthe conventional securitization process, with a special purpose vehicle acquiring theassets, the returns from the assets are passed to sukuk holders (investors). Manygovernments had used this method to raise funds for infrastructure (Tayyebi, 2008).Compare to non- Islamic bond or debenture, the bondholder will get return for providingcapital in the form of interest, while the sukuk holder will have a proprietary interest inthe assets which are being financed but did not get any interest (riba).According to Hanif (2011), conventional institution is gaining revenue throughlending and accepting deposit, interest that charged on the investor or customer istheir major drive of operation. Instrument that are widely used in conventionalfinancing are such as: mutual fund, mortgage, insurance, pension fund, credit cards,personal loans and etc. Mutual FundAccording to Debasish, a mutual fund is a trust that pools the savings of a number ofinvestors who share a common financial goal. Investor will get the issued units accordingto the amount of money that they have invested. They are known as unit holders. Allinvestor money will be collected and invest in several different instruments such as 19
  • 20. shares, debentures and other securities. The income earned through these investments andthe capital appreciation realized is shared by its unit holders in proportion to the numberof units owned by them. While the Canadian Securities Administrator (2006) defined thatmutual fund as a pool of money that is managed on behalf of investor by a professionalmoney manager and stocks, bonds or other securities will be invest by the manageraccording to the objectives of establishing the fund. For return, investor will get units orshares that represent their proportion share of the pool of fund. There are variety ofmutual fund such as money market fund, fixed income funds, growth or equity funds,balanced fund, index funds and etc. MortgageA mortgage loan is a loan secured by real property through the use of a mortgage notewhich evidences the existence of the loan and the encumbrance of that realty through thegranting of a mortgage which secures the loan. A mortgage is a loan to finance thepurchase of your home. The home is collateral for the loan, which is also a legal contractthat the debtor will sign to promise of paying the debt, with interest and other costs,typically over 15 to 30 years. If the debtor fail of can’t afford to pay the debt, the lenderhas the right to take back the property and sell it to cover the debt. To repay the debt,debtor are required to make monthly installments or payments that typically include theprincipal, interest, taxes and insurance, together known as PITI (Perkins, 2012). InsuranceCommercial insurance are almost similar with Islamic insurance (takaful). According toKhan, insurance is a risk transfer mechanism whereby the individual or the businessenterprise can shift some of the uncertainties of life on the shoulder of the other. Lifeinsurance is one of the oldest financial services provided. Insurance companies offer theircustomer a hedge against the risk of financial loss that follows death, disability, ill healthor retirement. Policy holders receive risk protection in return for the payment of policy 20
  • 21. premium that are set high enough to cover estimated benefit claims against the company,all operating expenses, and a target profit margin. There are many kind of insurance thatprovided such as: education, health, life, retirement, purchase of home and etc. Pension FundCommercial pension fund are protects individuals and families against loss of income intheir retirement years by allowing workers to set aside and invest a portion of theircurrent income. A pension plan places current savings in a portfolio of stocks, bond, andother assets in the expectation of building an even larger pool of funds in the future. Inthis way, the pension plan member can balance planned consumption after retirementwith the amount of savings set aside today. According to Zimbio (2009), although these financial instruments are comparableto conventional financial products in terms of the basic mechanism underlying theircreation, there are unique religious conditions that Islamic financial products must beable to meet. Shariah Law permit activities when the lender share in profits or lossesfrom the capital that lent out, making money by money is not allowed. Incomes on anIslamic financial instrument are prohibited getting earning through unethical (or non-Islamic) activity. All goods and services that is unethical such as pornography, lendingfor constructing a casino (gambling), trading of alcohol and etc are prohibited by Islam.The earning of interest on contracts of loan (or Riba) is also prohibited, even if interest onloans happens to be the backbone of conventional financial instruments. Islamic lawfurther prohibits debt restructuring that is based on compensations; uncertainty, risk orspeculation (Gharar) in contracts; gambling and games that are based on chance (Qimar). 21
  • 22. Why Islamic Financial Institutions Are Preferable?Islamic financial institutions have operated almost similar with conventional financialinstitutions. They also operated essential function as conventional bank. The different isIslamic financial institutions activities require in the direction of with Islamic law orSyariah rules. This is also become a benefit in Islamic financial institutions. Because offollowing in Islamic law, Islamic financial institutions have perceived as sociallyresponsible investment. They characterized by ethical norms and social commitments.Islamic financial institutions operation is integrated with ethical and moral value.Activities with unethical or unacceptable services are restricted in financing of Islamicfinancial institutions. For example, finance in liquor, tobacco and usury activity will notbe accepted in Islamic financial institutions finance. It is because those activities haveconflict with moral value by Islam. Nowadays, ethical issues are being concern in manysectors. This growth of ethical environment gives competitive advantages to Islamicfinancial institutions. They foresee that by communicating effectively about their social,environmental and economic contribution, they can strengthen their brand, enhance theircorporate reputation with customers and suppliers, and attract and retain a committed andskilled workforce (Turban and Greening, 1997). This can raise customer acceptance aswell. Hence commitment in ethical and social responsibility will lead to betterperformance in terms of profitability. Islamic financial institutions are remaining the core principle of justice in finance.Justice often means equal treatment and the equal distribution of advantages and burdens(Kamali, 2002). Profits sharing are emphasizing among financier and beneficiary inIslamic banking. Even there is profit or loss, Islamic financial institutions also distributedfairly among the two parties. This system will contribute to a more fair distribution ofwealth. Furthermore, Islamic financial institutions have different with conventionalfinancial institutions for the relationship between bank and customer. They recognizecustomers as investment partner of their business instead of borrower. Unlikeconventional financial institutions with provided fixed interest rate, Islamic banking giveshigher return to depositors if there are high profitable investments. Profit or losses 22
  • 23. generated from investment will be shared based on the pre-agreed ratio between bank andthe entrepreneur (Marimuthu, 2010). The principle of Islamic financial institutions include of commitment in socio-economic justice as well. They have committed to contribute in the achievement of socio-economic development. Islamic financial institutions have put effort in eliminateeconomic ills such as mass poverty and economic injustice. For example, Islamicfinancial institutions have provided education scholarship for student and contributefunds to poverty. Those funds to poverty are usually come from zakah, which is someonegiven a fixed portion of their prosperity to charity. This, we can say that Islamic financialinstitutions play a significant on socio-economic role that is beyond profit maximizationof their shareholder.Why Conventional Financial Institutions Satisfied?Conventional financial institutions are considered as more profitable because it includesmany types of investment and gain earning from interest rate. Islamic financialinstitutions are working with Islamic law follow by many restrictions. Islamic law statedthat investments should only support products that are not forbidden. Wealth can only begenerated by lawful trade and investment. For instance, Islamic law prohibits riba. Theyprohibited make money from money. Borrowers of Islamic financial institutions onlyhave to pay fixed repayment rates. Even borrowers can enjoy benefit in fixed rates, butfinancial institutions are not enabling to receive profit in interest rate. Besides that, moralunacceptable services also restricted in financing of Islamic financial institutions. Islamicfinancial institutions would not accept transaction in property loan with purpose toconstruction of a casino. On the other sides, conventional financial institutions areinterest base oriented. It defines money as a medium of exchange whereby there is no anindicator to evaluate a thing. Due to this, conventional financial institutions enable toearn profit from the margin between borrowing and lending rate of interest. They chargefixed or floating interest rate to depositors. Distinct in interest rate have give advantage to 23
  • 24. conventional financial institutions whereby customer with profit-motivated will moreinterest on conventional financial institutions. Regulation in Islamic financial institutions is more tight compare withconventional financial institutions. Islamic financial institutions are regulated by SyariahSupervisory Board (SSB). Shariah Supervisory Board members have responsibility toensure the takaful operations, supervise its development of Islamic insurance products,and determine the Shariah compliance of these products and the investments. EachIslamic bank will be supervised by SSB to make sure their transaction is under Syariahrequirement. This has narrowed the scope of Islamic banking. On the other side,conventional financial institutions have no exist such board. Conventional financialinstitutions enable to conduct its business operation as long as they are do not violated thelaw the guideline issued by Bank Negara Malaysia (Khir, Gupta, & Shanmugam, 2008).In other word, conventional financial institutions is aims at maximize profit without anyrestriction. Involve transaction in conventional financial institutions has not necessary to bearrisk like Islamic financial institutions. The main different when engage in any transactionare conventional financial institutions have elimination of risk while Islamic financialinstitutions is bearing the risk among two parties. Conventional financial institutions haveguaranteed all of their depositors. Depositors will only benefit for interest and not fortheir liability. For Islamic financial institutions, it promotes risk sharing between providerand user of fund. If the depositor is based on principle mudarabah, they need to bear onIslamic financial institutions liability. Other than that, conventional financial institutionshave used several derivatives such as future option and forward option to hedge risk intransaction. This is prohibited in Islamic financial institutions because it recognizes asgamble activity and believe to violating Gharar principle. Marimuthu (2010) stated thatcontracting parties in Islamic banking should have perfect knowledge of the valuesintended to be exchange in the transaction and the terms of the contract should bewell defined and without ambiguity. Uncertainly is not allowed in Islamic financialinstitutions. This also implies Islamic banking is used to bear higher risk thanconventional financial institutions. 24
  • 25. Another reason is lack of awareness of Islamic financial institutions compare toconventional financial institutions. According to Bank Negara Malaysia, current globalIslamic banking assets and assets under management have reached USD750 billion and isexpected to hit USD1 trillion by 2010. Despite the growth of Islamic financial institutions,there are still many people either Muslim or non-Muslim not familiar with Islamicfinancial institutions. The biggest challenge to promote Islamic financial institutions inthe country is lack of awareness of Islamic banking concepts among general public(Saleemullah, 2010). Many people did not really know to differentiate between Islamicfinancial institutions and conventional financial institutions. For conventional financialinstitutions, customer had familiar with its system even there is different system indifferent conventional bank. In Malaysia, number of conventional bank is still more thanIslamic bank. In Malaysia, there are 16 Islamic banks while commercial banks have 25 innumber (Bank Negare Malaysia, 2012). 25
  • 26. Licensed Islamic Bank in Malaysia Islamic Banks 1 No. Name Ownership 1 Affin Islamic Bank Berhad L Al Rajhi Banking & Investment Corporation (Malaysia) 2 F Berhad 3 Alliance Islamic Bank Berhad L 4 AmIslamic Bank Berhad L 5 Asian Finance Bank Berhad F 6 Bank Islam Malaysia Berhad L 7 Bank Muamalat Malaysia Berhad L 8 CIMB Islamic Bank Berhad L 9 Hong Leong Islamic Bank Berhad L 10 HSBC Amanah Malaysia Berhad F 11 Kuwait Finance House (Malaysia) Berhad F 12 Maybank Islamic Berhad L 13 OCBC Al-Amin Bank Berhad F 14 Public Islamic Bank Berhad L 15 RHB Islamic Bank Berhad L 16 Standard Chartered Saadiq Berhad F Sources by Bank Negara Malaysia 20121 L represent local Islamic bank and F represent foreign Islamic bank. 26
  • 27. ConclusionIn this study, Islamic and conventional financial institutions have being more developedand competitive nowadays. Instead, their development was due to the increasing in thenumbers of customers which determine their empowerment in the finance industry. Thus,we can conclude that customer acceptance has significant effect on the financialinstitutions comprises of Islamic and conventional financial institutions. In addition,customer acceptance which represents their perception of risk, interest rates offered byfinancial institutions, quality of services and others. As we seen, there is a positiverelationship between customer acceptance and products offered by financial institutions.Also, there are few factors that differs Islamic financial institutions from conventionalfinancial institutions, mainly on the instruments and activity of both financial institutions.Moreover, both Islamic and conventional financial institutions do incur benefits to theircustomers. In our opinion, we should encourage people to involve in both financialinstitutions as they possibly may compensate with better reimbursement. Well, customermust be acquainted with their acceptance or perception in order to determine theirproducts selection for example, expectation on future interest rates of the products. Lastbut not least, this study is very good learning course for our group because weacknowledged deeper understanding about financial institutions. 27
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