Islamic Finance for Journal of Economic Surveys-myassignmenthelp.com

Question: Discuss about the Islamic Finance for Journal of Economic Surveys. Answer: Introduction The main purpose of this assignment is to identify the similarities and differences which are present between Islamic and Conventional finance framework. In order to understand the difference between Islamic finance and conventional finance system, it is essential to first understand what the key concepts which are used in Islamic finance[1]. Modern Financial Institutions are solely based on interests which is as per Muslim law is against Sharia and it is expected that Muslims do not keep money with such financial institutions. A non-performing loan is a loan which was granted by the financial institution on which no schedule payments have been made for a period of more than 90 days. Such loans are either in default or at the risk of getting default. In other words, any loan amount which is expected to be in default then the loan is termed as a non-performing loan. In addition to this, if the debtor fails to make payments within specified period than also such will be considered as a non-performing loan. In case of a non-performing loan the lender has the right to take necessary actions to recover the principal amount of the loan. This is mostly seen when the loan is covered by an asset as a security for loans. The conventional bank will take steps like seize the asset, foreclosure process. In case of Conventional banks non-performing loans can be sold to investors in order to reduce the risks associated with a non-performing loan and in the process clean up their balance sheet. In the case of both Islamic financing institutions and conventional institutions, non-performing loan affect the business and therefore it is up to the management to manage the same effectively. In case of conventional banking system, where non-performing loans have been identified and there is a risk of default which is related to the loan than the bank in general cases creates provisions for such loans. Such non-performing loans are firstly classified on the basis of criteria which is substandard and doubtful debts. On the basis of such classifications the provisions for such debts are created. The provisions which is created for doubtful debts are generally more than the substandard category. In the case of Islamic financing as well the banks need to effectively manage non-performing loans[2]. The purpose of identifying of non-performing loan is to ensure that the banks are able to create provisions so that the impact and risks which are associated with loan term loans can be averted. A case study shows tha t Islamic banks are affected by non-performing loans and the essence of a non-performing loan is because it reflects the channelization of the loans and financing. Moreover, research show that high Non-performing loans for an Islamic bank and Conventional banks is a cause for the fall in profitability of the banks. Thus, it is important for both Islamic and conventional banks to effectively measure and maintain non-performance loans. As the risk and rewards are both shared by investors the non-performing assets risks also fall on the investors or depositors of such banks. In case of short term as well long-term loans which are to be issued by Islamic financial institutions, the viability of the project is to be analyzed carefully by the investors and then the loan amount is to be approved. As the risks of non-performing loans are to bear the investors the system is that the loan needs to be approved by the investors after he is satisfied by the viability of the project[3]. In case o f further defaults in the payment of the non-performing loans the banks can impose penalty on such non-performing[4]. The penalty which is imposed by the banks are used for the purpose of charity. As per the research the Islamic banks are developing in most parts of Saudi Arabia, parts of the middle east as well. In case of Islamic banks, equity-based sources of money are more preferred than debt-based sources. The depositors of an Islamic banks are basically shareholders of the banks. A bank which is more dependent on the equity sources like Islamic banks uses lending methods like mudarabah which is one-party joint partnership and a multi-party joint partnership which is known as musharaka. Moreover, the risks are shared by the depositors which is not the case in debt financing which is majorly used by conventional banks. In case of conventional banks, the risk are on mostly on the banks and not on the investors. another main difference between Islamic banks and Conventional banks which uses Equity financing and debt financing respectively is the basis of recording assets and liabilities in balance sheet. In case of Islamic banks, the asset side will contain certain cash which are kept as fixed assets and cash reserves and certain amount of equity as well and on the liability side investment profit and loss account deposits. As per the analysis of the work processes of a conventional banking system and Islamic banking system, Islamic banks are based on the profit and loss principle and does not charged interest whereas the conventional banks are dependent on the interest factor. The conventional banks charge interest on the loan amount which it lends to clients whereas no such interest is charged by Islamic banks and the main source of revenue is from the profits which are earned from investments which are shared with the depositors of such banks[5]. The main principles of an Islamic bank is based on the equity based policies which involves using the capital of its own and also the capital which it acquires from deposits which is used for investments through which profits for the banks are generated[6]. In case of conventional banks, the structure is based on debt policies. The major source of income for conventional banks is through lending of money as debts on which the bank charges interests following the time value of money concept[7]. As per the data which is available from secondary sources, it is clear that the Islamic banks are not responsible for the risks which are associated with the investment. In the case of Islamic banks, the risks are also to be bear by the investors same as they have share in the profits of the investments[8]. This is a point of difference between an Islamic bank and a conventional bank who borne all the risk part of the investors and also provides a fixed reward for the same. Hypothesis There is a wide range of differences between Islamic finance and conventional system of finance. The hypothesis which is used for the explanation of the same depends on the secondary data which is collected from various journals and works of other authors. The secondary data helps in the research and also is useful in developing the reasons and points which makes Islamic financing practices different from conventional system of financing[9]. The major difference which arises is that the conventional system of financing by institutions are heavily dependent on interest which is not the case in Islamic financing[10]. In the case of Islamic financing, the structure is based on the profit and loss principle which means that even though Islamic financing institutions are does not deal in interest as in the case of conventional institutions but share in the profits which are generated from the use of funds. The depositors of such Islamic institutions also have a share in the profits genera ted at pre-determined ratios which is stipulated by the institutions. The asset side of such Islamic bank show the transactions with the depositors in the asset side and transaction with the investment clients in the liability side. Whereas in the case of conventional institution shows taking deposits and paying interest and on the other side lending and charging interest are shown. In addition to this Islamic financing institution are based on the equity-based system, whereas the conventional banks are based on debt-based system. In case of conventional system, the shares capital of conventional system is that the nature of the capital is of permanent nature and in case of Islamic financial institution is that the capital is based on term investments. The process which is adopted by Islamic financial institutions for the purpose of accepting deposits from the public is quite different from the technique which is adopted by conventional financial institutions. The system which is fo llowed by Islamic financial institution follows the sharia or the rules of Islam. All the collection process of deposits is same in both cases of Islamic finances and conventional system of finance[11]. The point of difference lies in the area where the rewards are distributed for the deposits kept with institutions. In a conventional bank the rewards which are associated with deposits are fixed and generally provided in the form of interests. Whereas in the case of Islamic finance, the rewards are not fixed and the deposits are accepted through Musharaka and Mudaraba. Musharaka literally means to share profits in a partnership whereas Mudaraba is also related to sharing of profits. The difference between the two is that Musharak requires also involves sharing of losses strictly between the partners. Then there is the risk and return factor which is a point of difference between the two. In case of conventional system of financing the entire risks are borne by the banks and they pro vide securities to the depositors and the rewards totally belongs to the depositors. However, in the case of Islamic finance the both the risks and returns are equally shared by the depositors[12]. Thus, from the above discussions it can be clearly stated that there exists certain key difference in the principles which are followed and the structure of Islamic banks and conventional banks. Methodology The general differences and similarities of an Islamic banks and conventional banks can be analyzed through qualitative data analysis. Qualitative data refers to the facts and information which can be obtained for the purpose of a research through the works of other authors or journal other authors. The first step will be involving collection of data from various sources such as journals on conventional and Islamic banks which can provide information regarding the structure of the banks and also treatments of various items in the financial statements which are prepared by such banks. Then the next step will be involving detailed analysis of data which is collected from various journals and works of other authors in order to determine the structure and processes which are used by such banks and also the accounting treatments of deposits and payments and all other related information. As per the research, the financial statements can also be used to identify the difference in treatments of deposits and payments[13]. As per analysis, the partnership for profits and deposits are placed in the asset side whereas the transactions between the bank and the investment client are place on the liability side of a balance sheet. In case of a conventional banks, funds for which the banks nee d to pay interest are placed in the liability side and for the funds which are lend out and interest charged are placed in the asset side of the balance sheet[14]. Moreover, in case of Islamic banks as they do not charge interest or pay interest to the depositors of the banks, the treatments will be different for the profit sharing which is done in an Islamic bank in the financial statements. Thus, information about the difference in treatments can be collected by comparing the financial statements of both the types of banks. Then there is a difference in the strategies which are followed by Islamic banks in case of risks which are associated with the business. The risks are directly borne by the investors of the banks and not by the Islamic banks as it is in the case of conventional banks. Moreover in case of Islamic banks the principle of risk sharing is followed where the risks are shared by the depositors of the business. Results and Conclusion The results which can be drawn from the analysis work which is done above, it can be clearly stated that there exists difference between Islamic banks and conventional banks. There are various point of differences but the most crucial one is the basis on which the bank functions that is by charging and allowing interest from debtors and depositors respectively in case of conventional banks and by means of sharing profits for the investors of the company in case of Islamic banks. The Islamic banks strictly follows the Sharia framework where in some activities which are considered to unethical or prohibited in Islam are not allowed to be financed by such banks. Some of the restrictions which are discussed above relates to the prohibition of Islamic banks to allow or charge interest on the cash depositing and lending activities of the business. An aspect of Islamic finance which is not present in case of conventional banks is that the financing is either made on the principles of sharing risks and rewards or those financing which are backed by assets. Another unique feature of financing in an Islamic financing system is that it is in the form of mudaraba which can play an important role for overall development of the society. In Mudaraba form of financing a partnership is formed between funds which are provided by the banks and the skills which are there in a person who lacks the capital to have him backed and therefore it is an effective means to provide self- employment. From the analysis of the case it can be stated that the developing Islamic banks are not just there as a copy of conventional banking system. There has been difference in the working process of Islamic banks and conventional banks due to the Sharia principles which are followed by the Islamic banks. However, research shows that due to this sharia principle Islamic banks misses out on opportunities which conventional banks are able to enjoy such interest factor which covers up for the time vale of money aspect, investment in governmental bonds which bear significant amount of interests are missed out by Islamic banks. In spite of all this, the growth and development of Islamic banks have been tremendous in last two years in Pakistan and middle east countries. The system which are followed by conventional banks are different from that which are followed by Islamic banks. Reference Abedifar, P., et al., Islamic banking and finance: recent empirical literature and directions for future research.Journal of Economic Surveys, (2015)29(4), pp.637-670. Abedifar, P., Molyneux, P. and Tarazi, A., Risk in Islamic banking.Review of Finance,17(6), pp.2035-2096. (2013). Ahmed, H., Islamic banking and Shariah compliance: a product development perspective.Journal of Islamic finance.,(2014) 3(2), pp.15-29. Beck, T., Demirg-Kunt, A. and Merrouche, O., Islamic vs. conventional banking: Business model, efficiency and stability.Journal of Banking Finance, (2013)37(2), pp.433-447. Gheeraert, L. and Weill, L., Does Islamic banking development favor macroeconomic efficiency? 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