IMPACT OF BANKING REGULATION ON THE EFFIENCY AND PERFORMANCE OF ISLAMIC BANK

Topics: Bank, Basel II, Fractional-reserve banking Pages: 14 (3052 words) Published: June 28, 2014
Chapter 1
Introduction

Islamic banks today exist in all parts of the world and are looked upon as a viable alternative system. While it was initially developed to fulfill the needs of Muslims, Islamic banking has now gained universal acceptance.Islamic banking has been in existence since the 1970s, and it has shown tremendous growth over the last 30 years. The practice of Islamic banking now spreads all over the world from the East to the West, all the way from Malaysia, Bahrain to Europe and the US. As of 2004, the size of the banking industry assets has reached hundreds of billions of dollars from merely hundreds of thousands of dollars in the 1970s. Since early 1990s, studies that were focused on the efficiency of financial institutions have become an important part of banking literature (Berger and Humphrey, 1997).

Islamic banks are governed by Shari’a principles which make their functioning different from conventional banks. First, Shari’a forbids trading in speculative activities (gharar), dealing with derivatives and investing in non-permissible (haram) sectors and products such as tobacco, alcohol and pork. Shari’a also prohibits Islamic banks from paying or receiving interests (riba) to/from their financial and commercial transactions. The prohibition of interest makes the investment approach adopted by Islamic banks unique since they operate on profit/loss sharing arrangements. This principle requires banks to share with their customers the profits and losses resulting from co-funded projects.Product development must follow the guidelines and adhere to shari’a prior to its introduction. Islamic banking product need to be endorsed by the internal shari’a supervisory board. The variations in product, which have the same contract, may be due to the different interpretations by the shari’aadvisors.

Islamic banking has adapted the sharing of profit and loss through numerous ways. The first approach was through partnership (Musharaka), or the sharing of investments by the bank without being part of the management teams. Then there was Mudrabah approach, which was based on the mark-up for a resale or leasing contract, called ijara, which in Western banks works on interest (Bellalah and Ellouz, 2004). Operating a bank in this manner would increases the stability of the banking system because it encourages banks to diversify their investments to minimize risk and increase profits. This practice in turn tends to attract more investors and thereby helps banks operate more efficiently. The Shariah banking systems conduct through four different business laws. The first is the principle of the lender and borrower sharing in the final profit and loss. The second is fix charges established beforehand. The third is assessing no interest, and the fourth is the lender-borrower alliance.

Regulation is necessary to ensure economic stability and better banking performance, but it should not cross the limit. That is, the regulation should be cautious and balanced one and it should not exert any undesirable influence of grave consequences on the economy and banking arena.” (Hassan and Chowdhury, 2004). In terms of accounting standards, Islamic banks follow the regulations of their domicile. Application of International Accounting Standards (IAS) is possible if IAS is accepted throughout their countries. In addition to IAS, standards prepared by AAOIFI should be implemented to the accounting framework. Accounting standards prepared specially for Islamic banks will provide better accounting practices that are in line with Islamic financial products.They will also ensure reliability of financial statements and comparability.

1.1 Problem Statement
Impact of standardized banking regulation around the world has an effect to the efficiency and performance of Islamic banks. To what extent financial and policy indicators that impacts the overall performance of Islamic banks. comparative performance indicators of Islamic Banks...
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