Introduction
Islamic banking developed in the United Arab Emirates (UAE) after the formulation of laws that govern Islamic banking. In 1985, articles 1, 2 and 3 of the laws were established to control Islamic banks as well as other fiscal institutions operating in UAE. The laws are formulated in accordance with Shariah laws and government laws. Thus, any Islamic bank must adhere to the mentioned Shariah laws in order to maneuver in UAE. The banks have authorization to engage in profitable, investment and economic related activities. Additionally, the banks can lend, receive deposits and act as agents in UAE. However, Shariah laws must be taken care of when offering these services. The number of Islamic banks has increased in UAE in the last two decades, and this has contributed to fast growth of the region (El, 2010). The first bank to offer interest free banking in the region is Dubai Islamic Bank. This paper reviews development and strategies used in Islamic banking system, in UAE, while focusing on strategic management of the subsector to ensure success.
Overview
The banking sector in the United Arab Emirates (U.A.E) has experienced tremendous growth in the recent past. The number of commercial banks increased in the region. By 2008, the number of commercial banks had reached 60 and the assets of various commercial banks were up to 52%. The commercial banks in the region are both local and international organizations (Azzam, 2002). Development of the sector has also enabled growth of other sectors of U.A.E economy. The private sector has benefited a lot. This has made banks seek funding from other regions to enable expansion.
The growth in this sector has led to new trends in the market. Focus has been in the rise of Islamic banking in the region over the recent years. Demand for institutions that are Shariah compliant has enabled fast spread of Islamic banks in the region. Total assets of Islamic banks in the region rose from 12.7% to 14.2% between the period 2002 and 2006 (Oxford Business Group, 2007). Foreign banks with operations in U.A.E adopted Islamic banking methods or designed products appealing to residents of the region. Most of these banks noticed opportunity for growth, popularity of the products and the available demand.
Banking sector in UAE is dynamic and adopts changes that take place worldwide. The role of Islamic banking in the region increases and becomes more popular yearly. It has enabled UAE to be the financial center of Middle East. The global financial crisis did not have a significant impact in the region, and this has attracted international banks to the region. Well established international banks such as JP Morgan, Citibank, Credit Suisse and Lazard have opened regional offices in UAE to tap the market. Some of the local banks in the region include:
- Abu Dhabi Banks: National Bank of Abu Dhabi, Abu Dhabi Commercial Bank, Union National Bank, Abu Dhabi Islamic Bank and First Gulf Bank.
- Dubai Banks: Dubai Islamic Bank, Emirates Islamic Bank and Emirates National Bank of Dubai.
- Sharjah Banks: Bank of Sharjah and Sharjah Islamic Bank
- Ajman Banks: Ajman Bank
- Ras Al Khaimah Banks: National Bank of Ra’s Al Khaimah
- Fujairah Banks: National Bank of Fujairah
Need For Strategic Management
Islamic banking is based on beliefs and pillars of Islamic community. The fact that Muslims too are business people and need financial services gives a reason for existence of Islamic banking. The global financial crisis affected this subsector of the banking industry in UAE. During the period of financial crisis, most banks found ways of adapting and ensuring that they make profits. The methods used by banks can range from manipulation of interest rates for both loans and deposits. However, Islamic banks and products designed to meet financial needs of Muslims have to find other ways. There is a need for strategic management methods for these banks so that they are profitable and survive crises such as the global financial crisis (Iqbal, 2011).
Background
Development of Islamic banking in the last two decades is among the major changes in the world’s economy. The financial sector experienced many changes and developments including the development of automated teller machines, internet banking and more recently, mobile banking (Fahim & Porzio, 2010). Islamic banking developed and brought new ideas such as Islamic socioeconomic, removal of interest rates due to beliefs and introduction of ethics in financial institutions. It introduced new techniques and ways of investing to enable economic development. It has considerably altered the political, societal, as well as fiscal orientations globally.
By definition, Islamic banking is a financial system where an organization/entity accumulates and uses the wealth it has to benefit its shareholders and the society at large. Concurrently, it employs Shariah principles with respect to finance as mentioned earlier. This is a critical provision when considered decisively. Islamic banking system is a banking system based on Islamic laws and Islamic provisions manages the economy (Ayub, 2007). Islam prohibits the collection and use of interest, also known as Riba. The laws of Islam expect that banks do not engage in activities related to gambling, pork and pornography. Thus, Islamic banking caters for the needs of consumers who are Muslims and enables them get the experience non-Muslim consumers get.
Islamic financial system has pillars that guide the banking sector in UAE. These pillars enable the idea of Islamic banking to be possible. These pillars are based on Islamic banking principle, which gives guidelines, laws and rules known as Shariah. Shariah guides the entire society and deals with issues such as culture and economy (Iqbal & Greuning, 2007). Shariah can be traced in Quran, which is Muslim’s holy book. The correct interpretations of these rules from the Quran guide the principles used in Islamic banking.
The first principle concerns interest, an activity considered inappropriate in Islam. Islamic banking, therefore, prohibits banks from charging interest on loans. Additionally, banks do not give clients interest on the deposits that they make (Suwaidi, 1994). Generation of profits by banks is prohibited as this is unhealthy. In addition, charging interest brings about inequality and infringement of rights. These are hostile and unethical, yet Islam is a peaceful religion and expects profits to be earned honestly. Interest charging in the banking sector results in to imbalance in the social system. Islamic banking expects the borrower and the bank to share profits and losses. This phenomenon is socially right in the Muslim community thus Islamic banking is acceptable (Saeed, 1996).
The second principle is avoidance of risk taking in Islamic banking. This is not encouraged since it benefits suppliers and not the borrower. Financial capital can be provided through Islamic banking but any profits or losses that occur have to be divided by both the bank and the borrower. This ensures avoidance of risk taking in the financial sectors and financial undertakings.
The third principle is based on the definition attached to capital. The general definition of capital includes any probable money. Potential money can be added to capital at hand and be used in production. However, Islamic banking only recognizes capital at hand (Iqbal & Greuning, 2007). This does not mean that Islamic banking does not recognize the value of money.
The fourth principle is the prohibition of speculative activity. Speculation involves uncertainty and puts capital at risk and thus considered unethical. This is the reason for the prohibition of gambling in Islamic banking. Additionally, there is the principle expecting purity of contracts. Islam is a religion that expects individuals to be pure and thus contract made under Islamic banking are expected to be pure (Suwaidi, 1994). Therefore, it is necessary for all contracts in Islamic banking to disclose all information.
Strategic Management of Banking Risk in Islamic Banking
According to Pock A., (2006), banking risk determines the competitiveness and volatility of the industry. It determines the processes in banking and guides banks, in decision making processes. All banks have to consider the risks are likely to occur during their operations. This applies to Islamic banking operations too, and there are factors that an Islamic bank must consider. These factors mainly involve financing of products and the structure of the products offered by Islamic banks.
- Debt instruments incorporating Murabaha (the resale amount based on cost as well as profit markup), Salam (opposite Murabaha), Istina (long-standing lending) and Qard al-Hasan (interest-free loans).
- Quasi-debt instruments: Incorporate Ijara, which refers to leasing contracts bestowed on assets with respect to given durations and certain terms applied. Under these conditions, the bank bears all risks and determination of assets values is based on the prevailing market prices.
- Profit and loss allotment instruments: this contains Musharaka requiring the bank and the customer to execute financial projects in cooperation. The amount each contributes in financing the project dictates ownership. In addition, distribution of profits and losses is decided by the two parties, and the terms must not be violated by either party.
- The fourth instrument is Islamic bonds, which includes Sukuk. Sukuk is a monetary certificate similar to bonds used in the conventional financial systems. Certain types of bonds are prohibited in Islamic financing, for example, bonds that earn interest.
- The fifth instrument is safe keeping of funds. Islamic banks are considered to be trustees of funds and thus individuals can operate accounts in them, and the bank assures them the safety of the funds deposited.
- Finally, banks are agents, and they undertake financial transactions on behalf of individuals.
All Islamic banks do not charge interest, and the principles that guide them are almost the same across the subsector. The practice of Islamic banking can; however, have different practices in different countries depending on government policies, laws, goals and circumstances (Pock, 2006). However, some of the practices are uniform across different countries.
Islamic Banking Depositing Accounts
Islamic banks offer accounts that are similar in structure with convectional accounts. These are personal savings accounts, investment accounts and savings accounts. However, their operations differ considerably. Individuals can make deposits but must be assured by the bank that they will get the whole amount back from the bank in case they want to withdraw it (Jaffer, 2005). The methods that the banks use in attracting clients do not promise profit or interest on deposits that they make. In the investment account, the deposited amount by a client in to the account is not assured (Gup, 2008).
Financing Methods in Islamic banking
The methods used in financing under Islamic banking include trade financing, lending and investment financing. Investment financing is divided in to three main categories namely Masharaka, Mudarabha and estimated rate of return (Schoon, 2010). Musharaka refers to when the bank teams up with another group and undertakes a venture jointly. The groups involved in the venture participate in varied degree in the project and profit or loss from the project has to be known before the project begins. Mudarabha involves the provision of finance to an individual while the individual provides his expertise and managerial abilities. In this method, profit and losses that can accrue from the project have to be known before beginning of the project. However, losses are met by the bank. Under the estimated rate of return, the bank calculates and estimates profit that it can get from a project. The project is then implemented and in case the profit earned is more than the estimated value, the extra profit goes to the client. If a loss occurs, then the bank must take a lower rate (Schoon, 2010).
Trade financing is divided in to five categories in Islamic banking. These are mark-up, leasing, hire purchase, sell and buy back and letter of credit. The lending facility, on the other hand, is separated in to two categories. These are the service charge loans and the no-cost loans. These loans do not have interest charges as they are Shariah compliant. Other services the Islamic banks involve in include money transfer and currency trading in which the banks do not engage in collecting commissions (Schoon, 2010).
Islamic Banking Strategies in UAE
Strategic management methods are required to manage Islamic banking in UAE due to the complexities that it has. The designs made ensure that banks perform presently and also in the future. Strategic management of Islamic banks in UAE consists of three stages. The first stage is the strategic analysis of the environment. This involves the studying of the society and the institution. Based of the findings of the study, a bank can determine available opportunities, the influence of UAE society, the risks involved and the strengths and weaknesses of the institution (Hassan & Mahlknecht, 2011). Strategic planning is then done based on these four factors. The plans should enable the institution attain the goals it has, and the policies formulated must be Shariah compliant.
The second stage is the execution of the plans stage and involves implementation of policies and plans made in the first stage. It involves thorough analysis of the policies and plans and the effect they will have in operations and in the balance sheet. In addition, this stage determines standards and procedures used in operations. The third stage is the examination stage in which performance is evaluated. This stage examines whether the plans have been effectively implemented and correct procedures have been applied (Hassan & Mahlknecht, 2011). Mistakes are corrected at this stage, and adjustments are made to ensure goals are attained.
Islamic banks in UAE need proper functioning human resource departments to ensure success in the subsector. Thus, human resource strategic management is necessary in ensuring success of Islamic banking. Planning work force and planning human resource strategy are different. Workforce strategy focuses on employment and compliment human resource strategy. Human resources strategy involves examination of the environment and developing goals of human resources management that support the general goals of the bank (Ṣabrī, 2008). In addition, it involves the application of work plans and policies that support the general strategy of the bank.
Challenges that Islamic banking faces in UAE
According to Schaffer, Agusti & Earle, (2009), the challenges facing Islamic banking are numerous and are related to competition, Islamic principles, capital, and competition in the sector among others. It has many weaknesses and principles that complicate operations in an environment with much competition. The subsector must design itself so as to attract higher numbers of customers and enable it acquire capital (Kim & McKenzie, 2010). The subsector must be innovative and develop rules and standards in order to grow. Additionally, it has to put regulatory mechanisms that are inline with rules set by financial markets operating under Islamic laws.
Market Discipline in UAE
The United Arab Emirates is a new state and develops faster than many economies worldwide. Creativity and development of new ideas are adopted faster and thus UAE’s economy and market continue to improve annually. This makes the banking sector vital in the economy. The government recognized the contribution of the banks and did assist 10 Islamic banks with capital investment. The rise in the number of Islamic banks in the region indicates the preference and demand for the Islamic banking products. The banks have goals and objective to become global financial leaders and give priority to UAE (Hassan & Lewis, 2007). The banks are international financial institutions and are among driving forces of UAE economy. These banks observe market discipline and ensure that their products are tailored based on Shariah laws because of these reasons. In addition, success can be achieved by Islamic banks by combining market discipline with use accurate information and giving of incentives (Venardos, 2010).
Conclusion
Islamic Banking sector is yet to develop considerably compared to conventional banking systems. It is mainly implemented in countries operating under Islamic laws. The subsector does not face much competition in these countries since conventional banking methods are less applicable. The challenges that the subsector faces are immense and are related mainly to financing and capital acquisition. Islamic banks must ensure that policies are designed in a way that they enable business and at the same time comply with Shariah laws so as to avoid these challenges. Proper formulation of policies used in Islamic banking ensures profitability and workability of interest free banking system. The general structure of Islamic banking system has all necessary components that ensure success in operations. However, adjustments and minor modifications may be necessary. Such modifications and adjustments can make Islamic banking easily applicable in Non-Muslim nations. Additionally, they can be alternative to conventional banking in Non-Muslim nations and can spark further development in the banking sector. Islamic bank play a crucial role in the development of infrastructure in UAE and participate in the provision of investment capital. In addition, they participate in the derivatives market and promote the growth of small and medium enterprises (Ledgerwood, 2006). However, it is the methods of management used in Islamic banking that has led to its success.
References
Ayub, M. (2007). Understanding Islamic finance. Hoboken, NJ: John Wiley & Sons.
Azzam, H. T. (2002). The Arab world facing the challenge of the new millennium. London: Tauris.
El, T. A. M. (2010). Islamic Banking: How to Manage Risk and Improve Profitability. Hoboken, MA: John Wiley & Sons Canada.
Fahim, K. & Porzio, M. (2010). Islamic banking and finance in the European Union: A challenge. Cheltenham: Edward Elgar.
Gup, B. (2008). Handbook for directors of financial institutions. Cheltenham: Edward Elgar.
Hassan, K. & Mahlknecht, M. (2011). Islamic capital markets: Products and strategies. West Sussex: Wiley.
Hassan, M. K., & Lewis, M. K. (2007). Handbook of Islamic banking. Cheltenham: Elgar.
Iqbal, Z & Greuning, H. (2007). Analyzing risk in Islamic financial institutions. Washington, DC: World Bank.
Iqbal, Z. (2011). An introduction to Islamic finance: Theory and practice. Singapore: Wiley.
Jaffer, S. (2005). Islamic retail banking and finance: Global challenges and opportunities. London: Euromoney Books.
Kim, S & McKenzie, M. (2010). International Banking in the New Era: Post-crisis Challenges. Bradford: Emerald Group Pub.
Ledgerwood, J. (2006). Transforming microfinance institutions: Providing full financial services to the poor. Washington, DC: World Bank Pubns.
Oxford Business Group. (2007). The Report: Abu Dhabi 2007. London: Oxford Business Group.
Pock, A. (2006). Strategic management in Islamic finance. Wiesbaden: DT Univ.-Verl.
Ṣabrī, N. (2008). Financial markets and institutions in the Arab economy. New York: Nova Science Publishers.
Saeed, A. (1996). Islamic banking and interest: A study of the prohibition of riba and its contemporary interpretation. Leiden: BRILL.
Schaffer, R., Agusti, F., & Earle, B. (2009). International business law and its environment. Mason, OH: South-Western Cengage Learning.
Schoon, N. (2010). Islamic banking and finance. New Delhi: Spiramus.
Suwaidi, A. (1994). Finance of international trade in the Gulf. London: Graham & Trotman.
Venardos, A. (2010). Current issues in Islamic banking and finance: Resilience and stability in the present system. Singapore: World Scientific.