Revisions are needed on the paper I submitted for school. I have uploaded a file titled default.pdf which explains. Any section that scored less than a 3 needs to be revised. Please read teachers comments. Aspects B3, B5, C2 - C2f, D1 and D2 require addre

Chapter 01 - Introduction

Islamic bank refers to an institution which direct all banking activities similar to conventional banking system but without interest. In short Islamic banks borrow and lend money without interest. Sharing profit and loss is one of the key tools of Islamic banking system (Al-Jarhi, 2001).

There are more than 400 Islamic banks are working in 75 countries of the world with total assets of more than $1.1 trillion in 2012 with 20% growth. (Earnest & Young Report 2012)

(Hull 2002) identified that organizations are formed to generate profits and Islamic banks also work on the same basis. (Khan, 1986) identified that the major difference between Islamic and conventional banking is prohibition of interest (Riba) as mention in Quran.

Financial system plays a very important role in the development of economy of any country and now this system is affected by very sever crisis (Stiglitz, 2003).

According to (ONS, 201I) there are nearly 2.7 million Muslims living in UK, which comprises 4.8% of the total population. Muslim community in UK create a great demand for Islamic banking products. Legal framework and regulatory authorities are doing their best to provide Islamic banking services in UK (Rahman 2012).

Causes of bank crisis

Toxic assets were the biggest issue during the subprime crisis. This term became very famous during the credit crunch. Assets are the good guys on the balance sheet? Well only when they are not toxic (Ryan 2009).

Actually investment banks pool a number of mortgages together and then use them as collateral for an investment security called CDO’S (collateralised debt obligation). When investment banks securities these loans they divide them into groups, which called tranches, based on how risky they are? In the banks point of view insecurity made its money when an investor brought into a CDO tranche. The investors in a CDO were paid when the homeowner made a mortgage payment.. in security offered different rates of return because each tranche has different risks. So investor gets high returns on last and risky tranche due to which their demand increase. Same thing was there for subprime mortgages those were also in the risky tranche. So investors were attracted for investment due to high rate of return. Securitization achieved through by transferring the lending the specifically created companies called SPV (special purpose vehicle). So investors even get the interest if subprime mortgage holders fail to make the payment because these SPV issued bonds. Ryan (2009)

Actually CDO’s are a way of repackaging the risk of a large number of risky assets such as subprime mortgages. Walter (2008)

· To analyse the performance of Islamic banks in Islamic countries against conventional banking system

· To examine the methods used by Islamic banking system against subprime crisis against conventional system.

· To identify the root causes of subprime crisis in the UK

· To establish the characteristics of subprime crisis in UK

· To draw conclusions about demand of Islamic banking products in UK

· Which banking system was near to bankruptcy in Islamic countries

· What are the main characteristics which were preventing a bank from bankruptcy during credit crisis?

· What were the root causes of subprime crisis in UK?

· Could Islamic banking fulfil non-Muslims requirements in UK?

Literature review

Hassan and Dridi (2012) compare the performance of Islamic banking and conventional banking on basis of profitability and growth in total assets during the credit crisis, and finds that Islamic banks showed better resilience during these crises. According to (Parashar & Venkatesh, 2010) Islamic banking also effected by credit crisis however their performance was still better than conventional banking system. Beck et al (2010) analysed leverage, capital ratio and return on equity of both financial system and find out that Islamic banking system is superior in liquidity reserves and credit risk. According to (Ozturk, 2008) implementation of sharing profit and loss between financial institution and investors results in full disclosure and very transparent results which leads to a very high market discipline and judicious control over unnecessary lending.

Global financial crisis pushed developed pushed developed countries like UK to develop a new financial system who to tackle such crisis. This crisis forced them to decrease their interest rates to the historical minimal level. Conventional system look has failed after this crisis and looking for a major overhaul to resolve all current problems (Ilias, 2010). Current conventional system badly affected by current financial crisis. (Trabelsi, 2011) identified that risk alleviation at different level was the main cause of this crisis.

Mishkin (1997) indicated that there are two factors which assure growth in profits of banks. These are collaterals and guaranteed bailout from central banks. According to (Kayed & Hassan 2009) root causes of financial crisis was lending without checking credit history. Wilson (2007) identifies that sub-prime borrowers were the main cause of financial crisis. Siddique (2008) and Loundy (2008) find out that failed morality causes the corruption and greed which leads to failure of relationship between investment originator and investor. According to (Mirakhor and Krichene, 2009) it was due to regulation and excessive risk taking. According to (Rahman, 2009) Islamic banking is safe because of two reasons, prohibition of interest and secondly, Islamic banking do not trade in money market which leads to no more liquidity problem which currently UK is facing now. Rahman (2009) further identified that Islamic banking does not trade in intangible assets so all complex financial derivatives are not allowed.

According to (IFSB et al, 2010) key difference between Islamic banking and conventional banking is interest. It further explained that Islamic banking does not invest in such kinds of instruments adversely affected conventional banking products during the credit crisis like toxic assets, financial derivatives and financial institution securities. According to (Beck et al, 2010) important feature of Islamic banking products is risk sharing between depositor and borrower. According to (Hassan and Dridi, 2010) key feature of conventional banking system is risk transfer and key feature of Islamic banking system is risk sharing.

According to (Dar and Presley, 2002) Islamic banking products are very expensive and less transparent as compare to conventional banking products. Alam (2004) identifies that customers always think about cost of similar services. If they get same product in cheaper prices through a conventional banking system then why they should pay extra for same services.

Mortgage backed securities allow lenders to resell the mortgage documents Amadeo (2007). This cause the creating of toxic assets which was one of the major cause of US recession which lead to worldwide effect Peavler (2010). Actually banks want to generate cash to cover up their cash flow shortfall. Such documents they were showing as their assets so they start selling them. Davidson (2008) is not agreeing that CDO are bad thing because there is huge demand for such assets because these assets caused the way to boost the demand in investment of properties.

According to (Wade, 2009) size is Islamic banking in UK is bigger than Pakistan. He further identified that not only Muslims people use Islamic banking but non-Muslims also uses because they feel more secure. As identified by (Rahman, 2009) higher cost is not the only indicator to measure the performance but risk is also very important. According to (Alam, 2004) there are lot of issues with Islamic banking in UK. Most important is double stamp duty especially in case of Islamic mortgages, as mortgage based on co-ownerships and both parties owned the mortgage. He further argued that Islamic products are expensive although there are huge number of Muslims live in UK but not every can afford such prices.

Islamic financial industry is different from conventional in operation. So there are lots of legal and accounting issues, which we have to obtain Din (2004). So there are separate recognized accounting rules. All new Islamic products must be recognized according to the Islamic laws and rules to get more transparent information. For this purpose in 1990 accounting and auditing organization for Islamic financial institutions (AAOIFI) was created. It plays a crucial role in pursuing the harmonization of shariah based rulings.

Mustafa (2013) argued that the problem is supervisory bodies in different countries like to rely on their own shariah experts so it creates a problem in showing the transactions. Secondly experts have different opinions about different products something that these are permissible in one country but in other countries expert’s opinion are different so it arises and discourage the cross border use of Islamic products and constrain the growth potential of this industry which shows the results less transparent.

According to (Collis and Hussey, 2003) there are two types of research paradigms. One is positivistic and other is phenomenological. We use positivistic for quantitative and phenomenological for qualitative research. According to (Khan, 2008) quantitative research strategy emphasis on quantification in collection and analysis of financial data. However qualitative research can be interpreted as a research strategy which focuses on words rather than quantification and analysis of data (Hussy and Hussy, 1997)

As explained in introduction chapter this research contains two parts. Part one focuses on financial analysis of banking sector in Islamic to find out there chance of bankruptcy. Second chapter focuses on implication of findings from part one in UK.

According to Fox and Long (1990) if researcher will select different types of research design it will affect his/her findings. According to (Hussy and Hussy, 1997) there are four categories of research.

These are

Descriptive research (What is going on)

Experimental research (Why is it going on)

Historical research

Developmental action research

According to (Saunders et al 2000) all social research must be structure before collection and analysis of data. According to him first you have to explore the research then describe it which leads to explaining and evaluating the research. In this report research is use descriptive research method.

Descriptive research should be taken with objective of describing all relevant aspects of research area (Saunders et al 2000). He further identified two types of descriptive research, cross sectional and longitudinal. Researcher will use cross sectional in the first part. For this purpose Altman Z score will be used to identify the bankruptcy risk in Islamic countries during a specific time horizon. In this part researcher will rely on secondary source of data which are audited financial statements which are available on the websites of financial institutes.

In the second part researcher will use explanatory and evaluation research. In this part researcher will rely on primary source of data.

This method is known as triangulation. According to (Smith, 1975) one of the principle aim of triangulation is corroboration of findings from one part with another as it reduces the risks of systematic biases. Quantitative is less expensive as there is no need to contact with financial institutes to collect the data. However for qualitative we need to analyse the strategies of individuals and need to get information through questionnaires and interviews which are time consuming and expensive. (Foddy, 1994)

There are two parts of this research

· To identify bankruptcy risk a comparative analysis of Islamic and conventional banking system in Islamic countries

· Implication of Islamic banking in UK

For first part research will undertake quantitative research method. This method emphasizes on the financial analysis to find out corporate failure rate. For this part research will use Altman Z score to find out the banks worth during, before and after credit crisis

As mentioned in literature review different countries follow different rules and they have different products. Most important thing for Islamic banks to comply with local laws. So, a comparative analysis in the same country will make it easier for us to analyse.

Although Altman Z score is the best suitable way to identify the chances of bankruptcy however there are some limitations. This method work around one point that how longitudinal process studied over a period of time. However it supposed to change constantly.

Perhaps the most important weakness is relying solely on Z score models. So all results will be based on past results and it might not reflect in the future.

This model design by Dr. Edward Altman in 1968 to measure the bankruptcy rate among the companies. It consists of five different ratios, which are also known as its variables. This model is very helpful to measure the financial health of the company. It forecasts the probability of bankruptcy. Important features of this model include accuracy up to 80% and its results are reliable up to 2 years. (Wahlen et al, 2011)

Second part of this research includes implication of Islamic banking in UK. This part mainly focuses on impact of Islamic banking on Muslims and non-Muslims living in UK and what people think about Islamic banking especially after credit crisis. Research will use qualitative method. This type of research mainly focuses on consumer perception. There are different criteria and techniques that can be used in qualitative methods. Few of the most important are as follows;

Questionnaire/Interview

Focus group

Case study

Direct observation

Role play and simulation

Researcher decided to choose close ended questionnaires because it is more appropriate method. According to (Saunders et al 2000) questionnaires are one of the most widely used data collection method. Questionnaires can be used for used for descriptive or exploratory research. Descriptive research undertakes opinion and attitudes however explanatory or analytical research will enable us to examine the relationship between variables (Gill and Johnson, 1997). According to (Saunders et al, 2000) these two purposes have different research design requirements. So we will focus on explanatory method and develop close ended questionnaires to know the attitude of people regarding Islamic banking in UK.

According to (Miller, 2011) questionnaires permit respondents time to consider their responses carefully without interference. There will be uniformity and each respondent received the identical number of questions. It can be address a large number of issues and questions of concern in an efficient way.

However (Miller, 2011) further identified that it may be difficult to obtain a good response rate due to low motivation for respondents to respond. A complex and badly designed can be misleading. In this method quality will not be as high as in other sources.

As researcher will measure the bankruptcy rates of different Islamic and conventional banks in different countries so data will be analysed between 2006 to 2011 to find out Altman Z score before credit crisis, during credit crisis and after credit crisis (post recovery period). According to (Altman et al 2010) higher score indicates better financial position of the company.

For first part data will be analysed on excel. After finding Z score of selected sample banks data will further divide into three categories. 2006 before credit crisis, 2007-2008 during credit crisis and 2009 -2011 to analyse recovery growth.

In second part data will be collected through detail questionnaires. Researcher will use SPSS software to analyse all questions and results will further analysed and matched against our research objectives to find the answer of research questions.

According to (Saunders et al 2000) population is a group of person, institutions or events which are aggregate of all cases that confirm to some design set of specifications. According to (Barnett, 1991) sampling frame is the list of record of population from which sampling units are drawn. Important point is that all members of population of interest are included in sample frame.

Different authors give different opinion about sample size. According to (Henry, 1990) sample size of 30 is thought to be a good estimate of the population as larger sample will produce more accurate results. In first part research will select six countries (Saudi Arabia, UAE, Bahrain, Kuwait and Qatar). According to (Hassan and Dridi, 2010) these banks represent 85% of the Total assets and 77% of market share. So from each country we will select three Islamic bank and three conventional banks and altogether it will be 20 banks. In second part of research a list of 33 questionnaires will be filled and data will be analysed on SPSS. All questions will be filled in London and surrounding area.

Source: (Hassan and Dridi, 2010)

In the first part researcher will only use published data. For this purpose secondary data will be used from published consolidated financial statements, research articles will be used. For second part primary source of data will be questionnaires from a sample of 33 will be filled. Precautions will be taken at the time of collection of primary data through provided enough time, concealing the true purpose of this research.

Chapter 4

This chapter focuses on the key findings of this research. As the key purpose of this report is to find out the bankruptcy changes of Islamic and conventional banks before, during and after credit crisis. Year 2006 results show the before credit crisis results that how both types of banks were performing. 2007 and 2008 shows the performance during the credit crisis. Year 2009 used to measure the recovery progress of Islamic and conventional banks.

Altman Z-score model has been used to find out the results. There was combination of 20 banks half of them were Islamic and half of them were conventional from specific regions.

Altman Z-score measures and defined the bankruptcy chances through a score.

· A score of below 1.10 indicates that bank is moving toward bankruptcy

· A score between 1.10-2.60 indicates grey area (under observation)

· A score of more than 2.60 indicates that banks is very safe and far away from bankruptcy

Source: Appendix 02