Competition in Islamic Banking Systems

Introduction

The Islamic banking system has experienced exponential growth across the world. The system has transcended from its existence as a niche to a widespread financial system (Chong & Liu 2009). As the Islamic banks increase, change in the operations dynamism has been witnessed, which has ushered in competition. The competition in the Islamic banking is a concept that has been gaining momentum. According to Berger and Turk (2009), the competition is based on heterogeneity caused by the different Islamic teachings jurisprudence and different needs of the customers. Therefore, the main purpose of the research will be to investigate the effect of competition on profitability and the market power in the Islamic banking system. The research will concentrate on Islamic banking in Saudi Arabia.

Research Objectives

In order to establish the effect of competition on the Islamic banking system, the study objectives will include:

  1. To examine whether competition influences the profitability of the Islamic banking system
  2. To investigate the effect of competition on market power of the Islamic banking system

Justification of Objectives

Islamic banking has experienced increased competition. The different banks compete to increase their market. Bearing in mind that the Islamic banking system does not attract interest, various arguments have been raised to the effect of the competition on the financial margins. A study conducted by Weill (2011) found that both the small and the large Islamic banks were struggling with the profits. Cihak and Hesse (2010) pointed that competition puts pressure on the pricing strategies. In Saudi Arabia, financial margins obtained from various Islamic banks show inconsistent financial margins (Cihak & Hesse 2010). Some banks have shown erosion in the financial margins while others have been stable (Peter & Phillip 2007). Alkhathlan (2010) argued that the new trends and the increased demand of customers for the share of the return on profits share might end negating the core principle and advantage of the Islamic banking.

In the conventional banking system, competition is a core determinant of profitability. The competition affects the customer base of the banks. In many occasions, banks employ price competition such as lowering the interest rates in order to attract more customers (Berger & Turk 2009A). However, for the Islamic banking system, the rate of return is not pegged to the interest rate. In Saudi Arabia, the Islamic banks face a clot of competition both from the other Islamic banks and from the conventional banks. Each bank tries to gain competitive edge by the introduction of services that address the needs of the customers. Alkhathlan (2010) noted that market share determines profitability. The perspective is backed by the assumption that, efficiency leads to bigger market share; hence, increased profits.

The greater the market share, the more the market power a bank has over its products and the services it offers (Berger & Turk 2009). The perspective of market share has been extensively studied in conventional banking systems. However, in the Islamic banking there is scant information on the effect of competition on the power of Islamic banks. The available studies compare the market power between the conventional and Islamic banking system, which essentially may not give clear indications bearing in mind the principles of operations are very different. The conventional banks are driven by the return on the interest while the Islamic banks rely on Sharia law as the basis of profit sharing.

According to Chong and Liu (2009), the forces of competition in the Islamic banking revolve around the product differentiation, the operational excellence and the distribution channels employed by the banks. Therefore, the Sharia, which serves as the primary differentiator, has been vanishing very fast. In addition, the Sharia-compliant banks are not monopolistic; they face competition from other financial institutions that provide products that are based on the non-interest principle. Chong and Liu (2009) concentrate on the different competition platforms applied by the Islamic banks; they do not establish the effects of the competition in the Islamic banking system.

As competition in the Islamic banking systems intensifies, there is the need for the investors and scholars to understand the sources of differentiation applied to gain competitive edge within the Islamic banking systems. In addition, establish the influence of competition on the profits and market power of the banks. The understanding will be based on clear knowledge of the effect of competition on the profit ratios and the banking power.

Research Methodology

In order to establish the influence of the competition on the profitability of the Islamic banks, the study design will be cross-sectional and time series methods. Data will be collected from quarterly reports of various Islamic banks operating in Riyadh. Since the objective will be to determine the influence of competition on the profitability of the banks, the data will be subjected to comparative analysis. The comparison will help to determine the profit margins when there were few banking institutions and after the banking institutions increased. The assumption that will be applied in the study is that as time progresses there are new entrants; hence, competition increases. The banks to be included in the study will include the banks that have been in existence in Riyadh for the last ten years and are fully Sharia compliant. In order to determine the effect of competition on the marketing power, a descriptive study design will be applied. The descriptive study will provide the state of affairs in the Islamic banking system amidst the competition.

The inclusion of the banks to the study will be through random sampling procedure. According to Mitchel and Jolly (2010) simple random sampling is very effective in getting a representative sample from a large sample group. In Riyadh, many financial institutions employ Islamic banking system. Thus, the simple random will be appropriate. Mitchel and Jolly noted that the simple random sampling technique is free from human bias and avoids the classification errors, by giving each unit an equal chance of being selected. The study sample will be ten banks. In addition to the simple random procedure, a purposive sampling will be applied in the identification of the managers to be interviewed. The purposive sampling depends on the judgment of the researcher in the selection of the people to be included in the study. According to Creswell (2009), purposive sampling is advantageous when specific information is required from specific people. In such a case, specific information will be required from the managers on the marketing power in the Islamic banking systems. Ten managers from the randomly sample banks will be interviewed. The combination of the simple random and purposeful sampling is expected to give comprehensive data for the research.

Time schedule

Successful research entails the process of planning the various activities that are involved in the study process, organizing and controlling resources. According to Kirkland (2014), research entails setting clear timelines that involve the procedures to be followed in order to achieve specific goals. The following is the time schedule that will used to guide my research.

Activity Start time (May) Duration
Preparation 8 2
Literature review 10 6
Designing the research methodology 16 4
Pilot research 20 3
Actual study 23 5
Analysing findings 28 2
Presentation of findings 30 1

Resource Requirements

The process of conducting a study requires the formulation of objectives and putting in place the strategies to achieve the objectives. The strategies include identification of the materials and equipment that are to be used in the study and precise budgetary allocations. According to Randolph (2014, p. 36) the primary constraint to achieving the initial time plan is due to functional challenges that relate to poor resources and budget allocations. In order to complete the study, the resources that will be required will include; transportation means, budgetary allocation for the activities, tools to collect and analyse the data, equipment for storage of the data and presentation.

Conclusion

In Saudi Arabia, there have been increases in the number of players that are offering the financial solutions that are Sharia compliant. Even though the Sharia law drives the Islamic banking system, the banks have devised innovative ways by the introduction of products to attract customers and gain a competitive edge. Studies conducted on the operation of the Islamic banking system have concentrated on the platforms employed to gain competitive advantage. Recent studies such as those that carried by Berger and Turk (2009) have endeavoured to establish the role of competition in the interest-free banking system. Therefore, the study’s main objective will be to establish the effects of competition on the profit margins and the market power of the Islamic banks in Saudi Arabia.

References

Alkhathlan, K. 2010. Are Saudi Banks Efficient? Evidence using data envelopment analysis (DEA). International Journal of Economics and Finance, vol. 1, no. 1, pp. 12-34.

Berger, L and Turk, R. 2009. Bank competition and financial stability. Journal of Financial Services Research, vol. 35, no. 1, pp. 99–118.

Cihak, M. and Hesse, H. 2010. Islamic banks and financial stability: An empirical analysis. Journal of Financial Services Research, vol. 38, no. 2, pp. 95-113.

Chong, B. and Liu, M. 2009. Islamic banking: Interest-free or interest-based? Journal of Pacific-Basin Finance, vol. 17, no. 1, pp. 125-144.

Creswell, J. 2009. Research design: Qualitative, quantitative and Mixed methods approaches. Sage, Thousand Oaks, CA.

Kirkland, C. 2014. Project Management: a problem-based approach. Project Management Journal, vol. 45, no. 1, pp. 63-92.

Mitchell, M. and Jolly, J. 2010. Research design explained, Wadsworth, Belmont, CA.

Peter, V. and Phillip, W. 2007. Competing successfully in Islamic banking, Booz and Company, Albany, California.

Randolph, S. 2014. Maximizing project value: a project manager’s guide. Project Management Journal, vol. 45, no. 2, pp.22-41.

Weill L. 2011. Do Islamic Banks Have Greater Market Power? Comparative Economic Studies advance. Journal of Banking and Finance, vol. 18, no. 1, pp. 445–459.

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