The Islamic Banking in the United Arab Emirates - Term Paper Example

Islamic Banking System Study Introduction Islamic banking is a particular kind of banking system that differentiates itself from normal banking in the way it functions. “It is based on Islamic law of economics and works in such a framework that follows certain rules and regulations, determined by various prominent Islamic scholars and economists.” (Bhakhsh, 2010) Islamic Banking is emerged as a result of the limitations that are set by the religion on normal banking practices. The first and foremost system that the Islam prohibits is collection and payment of interest which is the primary activity and primary revenue earner of every Bank. This clearly explains the extent to which Islamic Banking will differ from normal Banking. Islam also restricts trading in various financial risks. It also restricts investment in companies dealing in tobacco, liquor and any other business that are against the general ethical principles. Though all these rules and restrictions seem to be against the conventional banking system, the concept of Islamic Banking provides solutions to run a profitable banking system even after a all these rules. Besides stringent policies that are totally against the normal banking, Islamic Baking is a growing sector and also a billion dollars sector in many countries. Islamic Banking is mostly followed in Gulf Countries. It also operates in many financial capitals of the world like London, Los Angeles, etc. This essay deals with the Islamic Banking sector in United Arab Emirates (UAE). UAE is one of the fastest growing financial capitals in the world. Being an Arab country, Islamic Banking is a highly organized business in the country. Though the region has been recently hit by a credit crunch in Dubai, it still has the potential to come out of it and continue its growth as a Banking hub. Main body Banking is one of the fastest growing industries in UAE, especially in Dubai. UAE has emerged itself as a financial hub in the world within a very limited time. Banks from across the world has set up their branches in UAE. The main reason for this is that UAE is a destination for people from all over the world. UAE is highly concentrated with expatriates from other countries. As such the banking sector operates to cater to the needs of all such people. The major features of UAE Banking sector are as follows. Less concentrated market: The banking sector in UAE is regarded as less concentrated market. The concentration is expressed as Herfindahl Index (HHI) and the index is less than 1000 in case of UAE. “The HHI is a measure of the size of firms in relationship to the industry and an indicator of the amount of competition among them.” (Dubai City guide, 2010) Strict laws: The banking system in UAE is efficiently controlled by stringent rules and regulations. “Money laundering, illegal transfers and criminal activity is controlled as well as anywhere in the Western world.” (Hardy, 2007) The discovery that fund transfer for 911 attack is done through Dubai made the government to further tighten the policies. Thus UAE Banking is said to be one of the most regulated banking sector in the world. Less leveraged: Obtaining a banking license is difficult if the banking companies does not show Shariah compliant programs for the country. This is very much essential when it comes to Government support. Apart from that the banks also need to maintain huge amount of collateral. Easy credit: Banks in UAE rely less on credit reports of the customers for assessing their credit worthiness. The banks hardly look into the credit reports before granting loans. Thus credit facility is easily available to all classes of people. This is entirely different from the banking practices in the rest of the world where they go through a series of initial process to assess the credit worthiness of the customers. But when a customer is granted loan, he/she is made to draw a check in favor of the bank for the same amount. In the event of default by the customer, the bank sends the check for collection. If the check is bounced the borrower will go to jail. He is released once he pays back the loan amount. There are a number of banks in Dubai which includes both foreign as well as domestic. “All dirhams lead back to the UAE Central Bank which governs and licences financial institutions in the UAE.” (Dubaifaqs, 2010) As of 2009 there are 52 banks in UAE. Among them 24 are UAE Banks and 28 are Foreign Banks. There are a total of 149 foreign bank branches in UAE. The foreign banks operating in UAE are National Bank of Bahrain, Rafidain Bank, El Nilein Bank, National Bank of Oman, Arab Bank PLC, Banque Misr, Calyon – Corporate and Investment Bank, Bank of Baroda, BNP Paribas, Janata Bank, HSBS Bank Middle East Ltd, Arab African International Bank, BLC Bank (France) SA, Al Ahli Bank of Kuwait, Barclays Bank PLC, Habib Bank Ltd, Habib Bank AG Zurich, Standard Chartered Bank, Citibank NA, Bank Saderat Iran, Bank Meli Iran, Blom Bank France, Lloyds TSB Bank PLC, ABN Amro Bank NV, United Bank Ltd, Doha Bank, Samba Financial Group and National Bank of Kuwait. (Appendix 1) (Centralbankuae, 2010) There are 24 local banks that operate in UAE. There are a total of 738 local bank branches in UAE. The local banks that operate in UAE are National Bank of Abu Dhabi, Abu Dhabi Commercial Bank, ARBIFT, Union National Bank, National Bank of Dubai, Commercial Bank of Dubai, Dubai Islamic Bank PJSC, Emirates Bank International, Emirates Islamic Bank, Mashreq Bank PSC, Sharjah Islamic Bank, Bank of Sharjah PSC, United Arab Bank PJSC, Ivest Bank PLC, The National Bank of RAK, Commercial Bank International, National Bank of Fujairah PSC, National Bank of UAQ PSC, First Gulf Bank, Abu Dhabi Islamic Bank, Dubai Bank, Noor Islamic Bank, Al Hilal Bank and Ajman Bank. (Centralbankuae, 2010) (Appendix 2) Size of UAE Banking System: UAE banking system is one of the fastest growing banking sectors in the world. “The UAE's banking sector still leads the rest of the GCC in terms of assets, a new report has reconfirmed. The report pointed out that assets of the UAE banking sector grew 4.3 per cent year-on-year in 2009 against a 35 per cent compound annual growth rate (CAGR) between 2004 and 2008.” (Kapur, 2010) Banking industry is one of the leading contributors to the economy of UAE. Banking is the highest non oil sector contributor to the GDP. Banking sector aids all the development projects in the country. These include mainly the oil and gas and the infrastructure projects. All these are financed mainly by the local banks of the region. (AMEInfo, 2005) Number and size of Islamic Banks: UAE has a total of eight Islamic Banks. “The UAE saw the eighth Islamic bank enter the market with the launch of Al-Hilal Bank. Headquartered in Abu Dhabi, the bank is wholly-owned by the Abu Dhabi government through its investment vehicle Abu Dhabi Investment Council, and has authorised capital of $1.09 billion.” (Borhan, 2008) Though Islamic Banks differ in the way business is done it also operates in the same business arena. Like any conventional banks Islamic Banks are also very keen on developing a good business portfolio. Infrastructure financing is one of the core business areas of most Islamic Banks. “Abu Dhabi Islamic Bank (Adib), the oldest and the only listed Islamic bank from the capital, claims to be the largest net financier in the UAE's interbank market.” (UAE Interact 2010) Other Islamic Banks are also in the league of leading lenders in UAE. Type of business performed by Islamic Banks: “There has always been a demand among Muslims for financial products and services that conform to Shariah (Islamic Law). The development of viable alternatives to conventional finance increasingly enables Muslims to participate in the financial world without violating their Islamic principles and without bearing the economic penalty that comes from non-participation, especially with the recent growth of oil prices.” (Sarah, 2010) As Islamic Banks prohibits interests they sell their shares to the public. Thus it acts as an investment company. An Islamic Bank involves in all business functions a conventional banks perform. They operate on a profit and loss structure. An Islamic Bank does not lend money to the clients; rather they act as a co investor along with the client. The profit generated from the project is shared between the bank and the client. Thus they also share the risk of the investment. They also make sure that all the investment made is compliant with the Islamic law. The different type of products of Islamic Banks are Ijara, Mudaraba, Salam, Istisna, Musharaka, Wakala, Commodity Murabhaha, Tawaraqq, Arbun Contract, diminishing musharaka, and Ijara wa Iqtina. All these are Shariah Compliant versions of usual financial products. Competition to the Islamic Banks: “From Jakarta to Jeddah to Jordan, 280 Islamic banks operate in over 50 countries, with assets estimated between $250 billion and $300 billion. Some 35 percent of these institutions are in the Middle East.” (Infosys, 2010) Islamic Banks faces competition from both conventional banks and from the Islamic Banks themselves. As the government is encouraging the establishment of more Islamic Banks, the existing players have become highly innovative in terms of the products and services. As UAE is a financial hub, Islamic Banks also face competition from the foreign players. As of now the growth and expansion of Islamic Banks are confined to within the country. But of course there are potential for growth and expansion in other parts of the world. But before going global the primary agenda of Islamic Banks are to establish themselves in the home country. Islamic Banks of UAE face competition from foreign Islamic Banks, that is, Islamic Banks from Malaysia and other countries. The two main players in UAE are Abu Dhabi Islamic Bank and Dubai Islamic Bank. They are the strongest and have dominated the market for years. Due to fierce competition there are also chances of consolidation in the market. Consolidation has already happened by the merger between National Bank of Dubai and Emirates Bank International in 2007. Foreign Banks like Citi Bank, Standard Chartered and HSBC has strengthened their presence in the region by offering innovative products and better services. All these banks have started offering Shariah compliant products. This has moved the customers away from many Islamic Banks. “Citigroup, Merrill Lynch, Morgan Stanley and Deutsche Bank are gearing up to list Islamic structured products on the Dubai International Financial Exchange. Other banking majors such as Standard Chartered, BNP Paribas, Societe Generale, and Credit Suisse are all at various stages en route to Islamic banking.” (Infosys, 2010) Growth of Islamic Banks: Islamic Banks have shown tremendous growth rate over years in UAE. Despite the economic slowdown, the growth rate of Islamic Banks in 2009 is better. “Assets held by fully Shariah-compliant banks or Islamic banking windows of conventional banks rose by 28.6 percent to $822bn from $639bn in 2008, according to The Banker’s “Top 500 Islamic Financial Institutions” survey.” (Billing, 2009) The growth rate of conventional banks all over the world was just 6.8% during this period. Islamic Banks have also expanded themselves by setting up more branches in the country. They have also gone overseas to countries that have huge potential for Shariah compliant products. Dubai Islamic Bank has opened 10 new branches in UAE in the year 2009. It has over 900000 customers. (Dubai Chronicle, 2009) UAE Banking system in itself is competing with other financial capitals of the world like London and New York. Islamic banks are equally competent like that of the conventional banks. Islamic Banking assets in the Asia Pacific region are about US$ 450 billion. (Celent, 2009) During the period between 2002 and 2008 Islamic banking sector has actually posted an year on year growth rate of 25% - 40%. It was during these years that the conventional banks started entering into this business segment. As of now Islamic banks have established themselves in the retail business segment. (Parker, 2007) Future prospects of Islamic Banks in the Country: “Islamic banking is one of the growing domains of banking which shows promise for the future. Furthermore, it has so far remained undeterred to a larger extent from the current financial crises. It is about time to develop even more innovative Islamic instruments which can meet the needs of the customers in a religiously viable way.” (Muhammad, 2009) Islamic Banks have a long way to go in the highly potential market. The prospects of Islamic Banks lie not only in UAE but also in many other countries. Some of the future prospects for Islamic Banks are as follows. Islamic Insurance: Islamic Insurance is already a high growth area in the industry. People of the country are depending more on vehicle and health insurances. Increasing number of vehicles on the road is an indication of the potential of vehicle insurance in the country. In Islamic banking terms insurance is called ‘Takaful’. “With current global Takaful contributions less than 1% of the total insurance premium universe, the scope for growth is huge.” (Ameinfo, 2010) Takaful industry leaders conduct World Takaful Conference every year to discuss the prospects of the industry in the future. The fifth Takaful Conference was held on 12th and 13th of April 2010. Islamic Mortgage: Like Takaful Conference there is also a forum for Mortgage segment. It is the GCC Mortgage Summit. “As the region's commercial and residential real estate sector looks to finds its feet following the impact of the financial crisis, the spotlight falls on financing through mortgages.” (Emiratesfn, 2010) The size of UAE mortgage market is expected o reach Dh 64 Billion by the year 2011. The real estate growth of UAE is expected to reach Dh419 Billion by 2011. Real estate and banking are the two prominent industries in UAE. Both are highly related sectors too. (Franco, 2008) Expansion: Expansion of the market will help the Islamic banks in capturing more market share. Studies have shown that there are good chunks of non Muslim population who avail the services of Islamic Banks. This throws the market open for the Islamic Banks in non Muslim countries. Some Islamic Banks have started expanding into countries like India. Islamic Banks should thus focus on expanding itself in developing countries. The concept of Islamic banking and Islamic finance was seen well accepted by all the groups of the society. Education sector: Islamic Banks have huge market potential in education segment. Abu Dhabi Islamic Bank has already entered into an MOU with Abu Dhabi Men’s College. “The move would help the students of Abu Dhabi Men's College for getting professional education in the banking and financial services. Students would be involved in the live projects of Abu Dhabi Islamic Bank. They can also get financial support from the bank to pursue their further education.” (Singh, 2008) UAE has started investing heavily in the education sector. Banks have a leading role to play in this arena. Shariah compliant education loan is a potential area for Islamic Banks. Islamic Banks in UAE has not yet capitalized on this market segment. Banks can also enter into MOU with educational institutions to reach the students easily. Unique feature of the system under study: Islamic Banking is a unique concept. Though the concept is emerged as a result of the principles and policies of a religion the concept is worth applying in the present world of derivatives and other risky instruments. Two of the most unique features of the system are as follows: Asset based system: Interest has no role in the system. Therefore this clearly avoids the concept of value of the money. An increase in the value of the underlying asset will increase the capital employed. This is a fair treatment of capital and money. Real economy: Present era is the era of futures and risky instruments such as derivatives, hedge funds etc. Such instruments are not close to the real economy as they operate in futures market. Islamic banking on the other hand considers all these instruments as ‘Haram’. “Further more, the risk-sharing concept of Mudaraba, when entrepreneurs are granted capital and share the profits with the bank, moves Islamic banks closer to the real economy.” (Ameinfo, 2008) Conclusion The previous part of the essay has given a deep insight about the concept of Islamic Banking and its status in the industry. Though the concept of Islamic Banking is an outcome of the beliefs of principles of Islam religion, it is an economic concept worth applying. UAE is the biggest Islamic Banking market in the world. The above analysis has shown that Islamic Banks are not yet fully established in UAE. Therefore Islamic banks in UAE should enter into every business area as a conventional bank enters. They should offer Islamic versions of all innovative instruments in the financial market. One of the major competitions for Islamic bank is from the conventional banks that have identified the potential of Islamic banking products. Islamic bank has a comparative advantage with that of the conventional banks. The next biggest opportunity for Islamic banks lies in the Insurance, Mortgage and Educational loans segment. These areas should be explored well for a rapid growth. The banks should also target on youth population with their retail banking products. Targeting the youth is an excellent opportunity for Islamic Banks to expand their market share. It should also target more on the corporate customers, mainly real estate companies. Globally Islamic Banking is still a small business segment. But the high growth rate coupled with rapid expansion will make Islamic Banking a major contributor to the economy. Works cited: Khair Bakhsh, 2010. Explaining the Islamic Banking system. [Online] Available at: http://www.helium.com/items/929482-explaining-the-islamic-banking-system [Accessed 10 April 2010] Dubai City Guide, 2010. UAE Banks Performance. [Online] Available at: http://www.dubaicityguide.com/site/features/index.asp?id=1739 [Accessed 10 April 2010] Frank W Hardy, 2007. Banking in Dubai. [Online] Available at: http://internationalbusiness.suite101.com/article.cfm/banking_in_dubai [Accessed 10 April 2010] Dubai Faqs, 2010. List of Banks in Dubai and UAE. [Online] Available at: http://www.dubaifaqs.com/banks-in-dubai.php [Accessed 10 April 2010] Central bank UAE, 2010. List of Foreign Banks and distribution of their branches in the UAE. [Online] Available at: http://www.centralbank.ae/pdf/bsed/ForeignBanks-English.pdf [Accessed 10 April 2010] Central bank UAE, 2010. List of Local Banks and distribution of their branches in the UAE. [Online] Available at: http://www.centralbank.ae/pdf/bsed/LocalBanks-English.pdf [Accessed 10 April 2010] Suchita Kapur, 2010. UAE banking sector’s assets largest in GCC. [Online] Available at: http://www.zawya.com/Story.cfm/sidZAWYA20100328042243 [Accessed 11 March 2010] AMe Info, 2005. Top banker foresees a leading role for UAE. [Online] Available at: http://www.ameinfo.com/53412.html [Accessed 11 April 2010] Muhammed Hairul Borhan, 2008. Eighth Islamic Bank enters UAE Market. [Online] Available at: http://www.cpifinancial.net/v2/News.aspx?v=1&aid=561&sec=Islamic%20Finance [Accessed 11 April 2010] UAE Interact, 2010. Abu Dhabi Islamic Bank largest net lender in UAE interbank market. [Online] Available at: http://www.uaeinteract.com/docs/Abu_Dhabi_Islamic_Bank_largest_net_lender_in_UAE_interbank_market/40026.htm [Accessed 11 April 2010] Sarah S, 2010. Islamic Banking. [Online] Available at: http://www.arabinsight.org/aiarticles/190.pdf [Accessed 11 April 2010] Infosys, 2010. Banking on Faith: Islamic Banking in the Middle East. [Online] Available at: http://www.infosys.com/finacle/pdf/thoughtpapers/Islamic-Banking-in-the-Middle-East.pdf [Accessed 11 April 2010] Soren Billing, 2009. Double digit growth for Islamic banking assets in 2009. [Online] Available at: http://www.arabianbusiness.com/572616-double-digit-growth-for-islamic-banking-assets-in-2009 [Accessed 12 April 2010] Dubai Chronicle, 2009. Islamic Banking outlines 2009 growth strategy. [Online] Available at: http://www.dubaichronicle.com/finance/banking/dubai-islamic-bank-outlines-2009-growth-strategy-6413 [Accessed 12 April 2010] Celent, 2009. Rise of Islamic Banking in Asia Pacific Region. [Online] Available at: http://reports.celent.com/PressReleases/20090112/IslamicBankingAsiaPacific.asp [Accessed 12 March 2010] Mushtak Parker, 2007. Islamic Banking in 2007 set for Massive Growth. [Online] Available at: http://archive.arabnews.com/?page=6§ion=0&article=90559&d=1&m=1&y=2007 [Accessed 12 Apil 2010] Saad Sarwar Muhammad, 2009. Islamic Banking and Finance: Historical Perspective and Future Prospects. [Online] Available at: http://www.economistan.com/articles/10065.html [Accessed 12 April 2010] Ameinfo, 2010. Islamic insurance industry leaders to gather in Dubai to participate at 5th Annual World Takaful Conference. [Online] Available at: http://www.ameinfo.com/229168.html [Accessed 12 April 2010] Emiratesfn, 2010. UAE mortgage market set to reach Dh64 Billion. [Online] Available at: http://www.emiratesfn.com/news/newsfull.php?newid=351069 [Accessed 13 April 2010] Jose Franco, 2008. UAE mortgage market set to reach Dh64 Billion. [Online] Available at: http://muslims.net/news/newsfull.php?newid=280867 [Accessed 13 April 2010] Gurpreet Singh, 2010. Abu Dhabi Islamic Bank and Abu Dhabi Men's College sign MoU. [Online] Available at: http://topnews.ae/content/21869-abu-dhabi-islamic-bank-and-abu-dhabi-mens-college-sign-mou [Accessed 13 April 2010] Ameinfo, 2008. Are Islamic banks the financial institutions of the future? [Online] Available at: http://www.ameinfo.com/177501.html [Accessed 13 April 2010] Appendix 1. 2. Read More