Chapter One The Introduction



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Comparing the Islamic and the Commercial Banks [2011]


Chapter One

The Introduction

1.1 Background

The banking sector has a strong effect on the economy of any country, due to the fundamental role of this sector in enhancing the overall economy, including out of mediation and financial transactions that are indispensable for the economy of any country (Monnin and Jokipii, 2010). Therefore, the bank can be defined as a financial institution that trades with the money of investors, and aims to work as a financial broker between the people who have a surplus of money (depositors) and the people who have a requirement to cover their financial needs (borrowers) (Albertazzi and Gambacorta, 2010).

Accordingly, the bank is considered the most important financial institution that manages the money of the investors, and the profit of the banks will be the difference between the interest that has been paid by the borrowers and the interest that has been paid to the depositors. Moreover, the bank introduces many financial facilities and services to their customers, such as credit services, cashing cheques, issuing letters of credit and letters of guarantee, safety deposit boxes, portfolio management, foreign currency exchange services, acquisition of commercial papers, bank acceptance and underwriting of financial instruments (Bendi and D'Agnolo, 2008).

In contrast, the Islamic banking system works in the same way as commercial banks but without interest, due to the effect of the interest on the investors. Islamic sharia laws prohibited interest because the interest payments would increase the payment on the loans to the borrowers and increase the profit of the bank. Consequently, the interest payments are unfair to the borrower. Moreover, Islamic banks apply the Islamic laws in their financial investments by applying the concept of financial intermediation, which is based upon the principle of participation in the profit and loss. In addition, Islamic banks have introduced more than forty Islamic financial products to their customers, such as accepting demand and time deposits, cash transfers, cashing cheques, foreign currency exchange services, acquisition of the commercial papers and safety deposit boxes (Aishath and Wisham, 2010).

The banking sector is considered as one of the most vital industries to support the real economy. Consequently, the banking sector should be efficient and less affected by financial problems in order to save and improve the economy of the country, and the stability of the banking sector reflects on the economy of the country (Monnin and Jokipii, 2010). Recently, the financial crisis has had a strong effect on many financial institutions and led many strong firms into bankruptcy, such as the Lehman Brothers bank, Washington Mutual bank, General Motors, Thornburg Mortgage and Chrysler LLC (Mills, 2010).

According to Pichardo and Bacon (2009), the bankruptcy of the biggest companies strongly and directly affected other financial institutions and led to the increase of risk in the stock market, which reflected negatively on the overall economy. However, the effect of the financial crisis was at variance between the commercial and Islamic banks due to the difference in the financial transactions in the two systems (Ariss, 2010).




1.2 The Financial Crisis Concept

A financial crisis is a sudden drop in the price of one or more types of assets. These assets could be physical capital assets, used in the production process, machinery, equipment and buildings, or financial assets, which are the rights of ownership of physical capital or inventory such as securities, or financial derivatives, which are the rights of ownerships the financial assets, including futures, options and swap contracts (Jarboe and Furrow, 2008).

Accordingly, any collapse in the assets’ value will lead directly to bankruptcy of the value owned by financial institutions. Moreover, a financial crisis could take forms such as a debt crisis, banking crisis or currency crisis (Racickas & Vasiliauskaitė, 2010).

The financial crisis can be due to several reasons, such as inflation problems, declining margins of safety, concentration of risk, debt deflation and excess borrowing (Tropeano, 2010). Moreover, the unexpected collapse in the assets’ price could arise from the explosion of bubbles such as financial bubbles, price bubbles and speculative bubbles. The bubbles are the selling or buying of huge amounts of one or more physical or financial assets like shares, bonds and real estate by outweighing the actual price. The real price is the total present value for the expected future revenue (Ackert et al., 2009).



1.3 The Beginning of Commercial and Islamic Banks

Financial transactions started during the Roman Empire when moneylenders traded in currencies by exchanging foreign currencies to home currencies. The first real bank in the world was Banco Di San Giorgio, established in Italy on 2nd March 1408, which started applying its banking activities in 1412 (Felloni and Laura, 2004). Furthermore, the second bank was Monte Dei Paschi Di Siena Bank in Italy, opened on 27th February 1472 by the decision of the General Council of the Republic (Monte Dei Paschi Di Siena Bank, 2010), and this bank is considered to be the only bank in the world to have survived all the financial crises that have occurred (Duyn, 2010). However, after that time the demand on the banking sector started to increase all over the world and started to expand in all countries, including the Muslim countries.

Islamic principles and laws prevent Islamic banks from charging or paying interest. Therefore, Muslim people were careful in their financial transactions with the banks, in order to avoid the interest. Accordingly, they established the first Islamic bank in Egypt in 1963 that accepts Islamic laws. Dr Ahmad (Sole, 2007) founded this small Islamic savings bank, which performed financial transactions with the principle of zero-interest. Following the Islamic savings bank in Egypt, another bank was founded in 1971 and the purpose of this bank was to give financial support to those who needed financial funding by the method of sharing in profit and loss. Also, the first Islamic development bank was established in Saudi Arabia in 1973 and the aim of this bank was to improve the economy of the country. Moreover, the Dubai Islamic bank, which opened in 1975, was the first private bank organized in Asia (Okte, 2010).
1.4 Comparison between the Activities of Commercial and Islamic Banks

The financial transactions of commercial banks are based on interest and the concept of the relationship between the debtor and the lender. The bank borrows from the savings of the depositors and then lends this money to the borrowers. Accordingly, the profit of a commercial bank is the variance between the amount of interest that has been paid to the depositors and the interest that has been charged to the borrowers (Petersen & Schoeman 2008). Furthermore, other financial transactions are provided by commercial banks, including letters of credit and guarantees, and they also produce different kinds of derivative.

On the other hand, the Islamic banking system works according to the concept of the partnership that emerged between the banks and the depositors; it was a relationship of profit and loss sharing (PLS). This allows the parties to go forward in owning physical goods and the trading process (Cocheo, 2007).

The depositors in the Islamic banking system are recognised as entrepreneurs, because interest is prohibited in the Islamic sharia. Therefore, Mudaraba, Musharaka, Murabaha, Ijarah, Bai Muajal, Bi slam and prepaid purchase are considered the best substitutes for the Islamic banks to avoid interest, which is clearly forbidden in Islam (Lewis, 2010).




1.5 The Research Objectives and Questions

This research will compare the top ten conventional banks with the top ten Islamic banks. The banks have been chosen by the value of assets at the end at the financial year 2009 (Alexander, July 2010: 126).

The Top Ten Commercial Banks in the World:

Rank (2009)

Bank

Country

Assets ($ billions)

Rank by: Tier 1 Capital

1

BNP Paribas Bank

France

2965

8

2

Royal Bank of Scotland

UK

2750

4

3

Credit Agricole Group

France

2441

13

4

HSBC Holding

UK

2364

5

5

Barclays Bank

UK

2235

10

6

Bank of America Corp

USA

2223

1

7

Deutsche Bank

Germany

2162

20

8

JP Morgan Chase & Co

USA

2032

2

9

Citigroup

USA

1857

3

10

Lloyds TSB Banking Group

UK

1665

12

The Top Ten Islamic Banks in the World:



Rank (2009)

Bank

Country

Assets ($ millions)

1

Kuwait Finance House

Kuwait

37177.9

2

Al Rajhi Bank

Saudi Arabia

33347.5

3

Dubai Islamic Bank

UAE

22801.6

4

Parsian Bank

Iran

15117.4

5

Abu Dhabi Islamic Bank

UAE

12063.4

6

Al Baraka Banking Group

Bahrain

11167.5

7

Bank Rakyat

Malaysia

10397.1

8

BIMB Holding

Saudi Arabia

6595.5

9

Pasargad Bank

Iran

6169

10

Qatar Islamic Bank

Qatar

5861.5


1.5.1 Research Objectives:

  1. To explain the difference between Islamic and conventional banking systems.

  2. To evaluate the financial performance of the top ten Islamic banks in the world and the top ten commercial banks in the world over the period 2005–2009.

  3. To evaluate the financial stability of the top ten Islamic banks in the world and the top ten commercial banks in the world during the period 2005–2009.

  4. To examine the effect of the financial crisis on the top ten Islamic banks and the top ten commercial banks in the world during the period 2005–2009.

  5. To provide recommendations and suggestions that can support the banking system to face the financial crisis.


1.5.2 Research Questions:


  • How does the Islamic banking system compare with the conventional banking system?

  • What is the effect of the financial crisis on both systems?


1.5.3 Hypothesis:



  • H1: There is a negative relationship between the financial crisis and the stability of Islamic and commercial banks.

  • H0: There is no negative relationship between the financial crisis and the stability of Islamic and commercial banks.




  • H1: There is a negative relationship between the financial crisis and the performance of Islamic and commercial banks.

  • H0: There is no negative relationship between the financial crisis and the performance of Islamic and commercial banks.



Chapter Two

The Literature Review

2.1 The Introduction

As we discussed in the previous chapter about the history of Islamic and commercial banks, the Islamic banking system provides to their customers the same products and services as conventional banks with small differences between the two systems due to the principles of Islamic finance. There have been many studies that have examined the financial transactions of the two systems and evaluated their financial performance and stability.

However, during the last three decades many financial crises have occurred that have strongly affected the two types of banks, and many of the researchers have studied the financial performance and stability of commercial and Islamic banks. There were different views about their financial performance and stability; consequently, this chapter will illustrate the differences between the two systems and also illustrate how Islamic banks avoid interest in their financial transactions with their customers. Moreover, this chapter will also discuss how some studies have evaluated the financial performance and stability of the two systems in different regions and different periods with an explanation of how the recent financial crisis has affected commercial and Islamic banks.

2.2 The Principles of the Islamic Banking System

The Islamic banking system operates according to Islamic laws and Islamic sharia. Consequently, Islamic financial institutions derive their rules and principles from the Holy Quran and the sayings of the prophet Mohammad. Hence, Islamic laws prohibited Riba (interest), Gharar (risk) and Maysir (gambling) due to the negative effect of these three issues on the investor (Gait and Worthington, 2008).

Gait and Worthington (2008) define Riba (interest) as large or small increases on the value of the initial loan to the borrower who must pay this money to the lender. Therefore, Islamic finance prohibits any excess or fee on the value of the initial loan due to the negative effect this would have on the borrower. Furthermore, Gharar (Risk) is selling items or products whose futures are uncertain, which may cause risk to the buyer and make this trading the same as gambling. Finally, Maysir (betting or gambling) is forbidden in Islamic finance due to the ambiguity of this type of trading, which does not guarantee returns. Therefore, Riba (interest), Gharar (Risk) and Maysir (Gambling) are considered as the main three issues that are forbidden in Islamic finance and if these three principles are prevented in the bank then it will become a proper Islamic banking system (Cattelan, 2009).

However, the Islamic banking system applies many types of financial methods that comply with Islamic laws in order to avoid interest between the borrower and the bank, such as Mudaraba, Musharaka, Murabaha, Istisna, Ijarah and Quard Hasson (Smolarski and Schapek, 2006).


2.2.1 Mudaraba (Speculation):

Mudaraba is a contract between the borrower and the bank in order to provide financial resources to the borrower. The profits and losses will be shared between the two parties according to a specific percentage that they agree upon from the beginning of the process; the investor will be responsible for all the financial losses and another party will be responsible for all the operating losses (Vinnicombe, 2010).

2.2.2 Musharaka (Full partnership):

Musharaka can be defined as a full partnership between the bank and the investor in the profit and loss depending on the percentage that they agree upon. In general, it is seen as co-operation or a joint process between the Islamic bank and the client in order to conduct certain transactions. It is possible that an Islamic bank can perform as the money provider to finance different kinds of industries (Ibrahim, 2008).



2.2.3 Murabaha (mark-up on sale):

Murabaha is a kind of contract that is created to help the people who are not able to buy property on their own; in this type of contract the bank will purchase the property at a disclosed price and will increase the price for their clients (Vinnicombe, 2010).
2.2.4 Istisna (Manufacturing contracts):

Istisna is one of the Islamic financial transactions; in this type of contract the bank will provide the investors with the required industrial materials in order to start their business with advance cash payments or by deferred payments and date of delivery (Gait and Worthington, 2008).
2.2.5 Ijarah (lease financing):

Ijarah is a payment for a rental contract between the two involved parties, where the owner of the assets (such as building or the offices) leases the assets to the lessee, who uses the assets (Ibrahim, 2008).
2.2.6 Quard Hassan (benevolent loans):

Quard Hassan is a type of lending; in this type of lending the bank introduces the money to those who need the money to decrease their difficult financial situation. Furthermore, the bank can lend the money based on zero-interest to any of the societies for different aims, including money for expenditures related to education or marriage (Ibrahim, 2008).

2.3 Islamic Banking Transactions

The financial transactions of Islamic banks have developed since the first Islamic bank was opened in order to introduce the best services to their customers according to Islamic laws. Therefore, the Islamic banking system depends on the investment of the money belonging to the shareholders and depositors. Consequently, several studies have discussed the financial resources of Islamic banks and the usage of this money.


According to Gait and Worthington (2008), the three basic methods of Islamic deposit accounts are as follows:


  1. An Islamic current account is considered a service to provide a facility for depositors to make transactions, such as transference of funds and paying cheques in and out of the account.

This account could be paid on demand without any interest paid to the depositors. It is also possible to keep these accounts in the form of foreign currency in order to make it easier to conduct international trade.


  1. An Islamic savings account is the same as a commercial savings account. However, this savings account introduces to the customer benefits and services instead of interest due to the prohibition of interest.




  1. An Islamic investment deposit account is a special account for a customer who wants to make an investment by using their own money, according to the concept of profit and loss sharing. Therefore, Islamic investment accounts are divided into two types as follows:

  • Specified investment accounts:

In this type of account the bank will be responsible for the investment of the customer’s money in a specific investment, or in conditional investments, in specific projects or specific sectors.



  • Unspecified investment accounts:

This account introduces to the customer the opportunity to grant the bank the full authority for the investment, with regard to the bank’s ability and wishes to invest in any relevant transaction.
2.3.1 Services

Islamic banks provide many services to their customers, the same as commercial banks, such as letters of guarantee, traveller’s cheques, letters of credit, money transfers, performance bonds and foreign exchange transactions.

Moreover, Islamic banks are able to collect some types of fees, such as administrative or service fees, according to the expenditures generated on the service and provided in adherence with the Islamic sharia.

Islamic banks are also in the position to charge a commission fee when the financial transactions are for the purpose of selling and buying metals, such as gold (Gait and Worthington, 2008).


2.4 The Financial Performance and Stability of Islamic and Conventional Banks

This part will discuss some studies that have evaluated the financial performance, efficiency, stability and financial risk of the two types of banks in different regions and periods as follows.

Dr Ali (2010) evaluated the financial performance of the top ten commercial and Islamic banks during the recent global financial crisis of 2006–2009. Dr Ali made a comparison between the two types of banks in terms of total assets, total equity, net profit, market capitalization and financial indicators. The overall results illustrate that the total equity of commercial banks increased by 24% and the total equity of Islamic banks rose by 36%. Furthermore, the net profit of the commercial banks decreased from $116 billion to $42 billion. In contrast, the net profit of Islamic banks increased by 9%. Moreover, Islamic banks encountered a decline of 8.5% in market capitalization, whilst the commercial banks went through losses of 42.8%.

As a result of the strong impact of the global financial crisis on the commercial banks, five of the largest ten commercial banks in the world received assistance from governments ($163 billion); in the same period, only one Islamic bank demanded assistance from the government to restructure its position and its shares in the market.

The total return of Islamic Dow Jones declined from 2007 to 2008 by 24.7%, whilst the total returns of the MSCI world index declined by 34.7%.

Safiullah (2010) evaluated the financial performance of Islamic and conventional banks in Bangladesh by examining the interest-free Islamic banks and the interest-based conventional banks through using the Statistical Package for Social Science (SPSS) and financial ratios analysis on four commercial banks and four Islamic banks.

The results illustrate that the financial performance of the Islamic banks, under the concept of zero-interest, seems to give them better liquidity, business development and profitability than conventional banks. Secondly, the financial performance of the conventional banks, under the concept of interest, is more efficient than that of Islamic banks in terms of its commitment to community and economy. Finally, the overall result of the performance of the two types of banks in Bangladesh showed that the financial performance of the Islamic banking system in Bangladesh is more efficient than conventional banking.

In contrast, some studies have evaluated the financial performance of the two types of bank and they got different results to Dr Ali and Safiullah.

Erusan (2008) applied SPSS and ANOVA analysis on 12,600 observations from Islamic, foreign commercial and local commercial banks and finance companies, and classified these observations into one, three, six, nine, twelve and fifteen months of rates, in order to examine the performance of the return on the deposits in those types of banks by t-testing the observations.

Moreover, Erusan evaluated the fixed profit rate of commercial banks and the profit rate of Islamic banks in Malaysia over the period 2002 to 2006 by using one Islamic bank, thirteen foreign commercial banks, ten local commercial banks and eleven finance companies.

The overall results indicate that the returns on deposits in foreign banks and commercial banks and finance companies were higher than in the Islamic bank. Furthermore, the result of ANOVA showed the Islamic bank achieved the smallest mean performance in June compared with the commercial banks and the finance companies achieved the highest rate of mean performance in January compared with the other banks.

Dahduli (2009) examined the impact of the global financial crisis on the financial performance of twenty-two Islamic banks and fifty-four commercial banks in the Gulf area during the period 2000–2008, through t-testing nine financial ratios in order to compare the liquidity, profitability, credit risk and efficiency of each system. Dahduli reached the conclusion that, during normal economic conditions, commercial banks are more profitable and efficient, but have a higher liquidity risk compared with the Islamic banks.

The global financial crisis decreased the variance in profitability and efficiency between the two systems as a result of the strong impact of credit pressure on conventional banks and the good financial performance of Islamic banks. Moreover, Islamic banks were less exposed to credit risk in comparison with conventional banks.

In addition, Samad (2004) examined the financial performance of commercial banks and Islamic banks during the period 1991–2001 by examining liquidity risk, credit risk and profitability ratio. Nine financial ratios and a t-test were used to examine those banks.

Samad found that there was no variation between the two types of banks in the performance of profitability and liquidity; however, the commercial banking system is more exposed to credit risk than the Islamic banking system.
Many other researchers have examined the financial risk of commercial and Islamic banks. For example Ariss (2010), who evaluated the competitive situation of Islamic and commercial banks over the period 2000–2006 by examining a sample of 58 Islamic and 192 commercial banks in thirteen Asian and Middle East countries.

Ariss examined the sample of banks by using four financial ratios and H-statistics to evaluate and compare the competitive situation in those banks. The profitability results showed that the Islamic banks allocated a greater part of their assets to provide loans to finance their clients compared to the commercial banks. Furthermore, the Islamic banks have less exposure to financial risks than the commercial banks, and the competitive situation of the commercial banks indicates less concentration on the financial risks and their competitive advantages is greater than Islamic banks.

Moreover, The World Economic and Financial Survey (2009) indicated that the financial performance of the Islamic banks and the profitability slightly decreased in the Gulf cooperation council states; who analysed fifty conventional banks and eighteen Islamic banks in the region during the financial crisis. The survey's results revealed that commercial bank profitability fell greatly in 2008, and the Islamic banks were less prone to credit risk compared to the commercial banks.

The purpose of Cihak and Hesse’s (2008) work was to test the financial stability of the conventional and Islamic banks in Asia and the Middle East. Therefore, they used the Z-score financial analysis tool, which indicates several structures of the financial ratio analysis, for instance return on equity and return on assets, which is considered a useful instrument for measuring solvency risk for the banks that operate out of capital and reserve.

They analysed and observed 397 conventional banks and 77 Islamic banks, from the same areas, during the period 1993–2004 by comparing the Islamic and commercial banks that work in small and large capital in order to analyse the financial stability of each system.

The result was that the financial situation of the small Islamic banks was stronger and more stable compared with the small conventional banks and large Islamic banks, due to their concentration on low-risk investments. Large conventional banks were stronger than the large Islamic banks, because of the difficulty in monitoring the credits.

Some studies have evaluated the efficiency of the two systems in order to determine the most efficient system. For example Moktar, Habshi and Abdullah (2006), who measured the efficiency of twenty commercial banks, twenty Islamic windows and two fully-fledged Islamic banks in Malaysia over the period 1997–2003, using the stochastic frontier approach (SFA). The overall results illustrate that the total deposits of the Islamic banks in Malaysia increased dramatically over the period of study. Furthermore, the results of evaluating the cost and technical efficiency of the two types of bank indicate that the overall efficiency of the commercial bank industry remained the same, whereas the Islamic banks’ efficiency increased over the period of study. Although the level of efficiency of the Islamic banking system is still lower than the commercial banking system in Malaysia, it seems the Islamic banking system in Malaysia is more efficient than Islamic windows.

Yudistira (2004) measured the efficiency of eighteen Islamic banks during the period 1997–2009; his measurement was founded on an efficiency evaluation in which DEA was utilized to address the technical effectiveness of the Islamic banking industry, and the overall results showed that the Islamic banks suffered from a financial crisis over the period 1998–1999, and they improved their financial performance after that period.

Johnes, Izzeldin and Pappas (2009) assessed the efficiency of nineteen Islamic banks and fifty conventional banks during the period 2004–2009, using the DEA and six financial ratios to measure the technical efficiency.

This analysis illustrated that the Islamic banking system has a higher return on investment compared with the commercial banking system. Furthermore, regardless of the fact that the Islamic banks’ total assets are worth less than the commercial banks’, still they are more effective in using and employing their resources to create revenues and profits.

Shahid, Rehman and Niazi (2010) examined the efficiency of the Islamic and commercial banks in Pakistan. They used a sample consisting of five conventional and five Islamic banks during the period 2005–2009. They applied the DEA model in order to measure the effectiveness of the two systems according to the CRS & VRS approach.

Their findings showed that the TE of the conventional banks is better, but in CE and AE the two sectors revealed good competition. And the t-statistics shows the absence of notable differences in mean effectiveness scores between the two systems, except in 2008.

Bader, Mohamad, Hassan and Ariff (2007) evaluated the profit and cost efficiency of Islamic and conventional banks in the Middle East and North Asia during the period 1990–2005, by applying the SFA on thirty-seven conventional banks and 43 Islamic banks, based on the region and size.

The results of the analysis illustrated that the cost efficiency was 31.8% for the Islamic banks and 29.3% for the conventional banks; profit efficiency was 75.4% for the commercial banks and 75.1% for the Islamic banks. Furthermore, the findings showed that both Islamic and conventional banks are efficient in creating profit but inefficient in controlling the costs.

In 2008, Noor and Majid tested the efficiency of thirty-seven Islamic banks during the period 2001–2006 in sixteen Asian and Middle East countries, which are the largest Islamic financial markets. The DEA was used and the results indicated that the banks’ performance was good but they were inefficient in managing the usage of their resources, which might affect their financial performance in the following years.

The Islamic banks in Asia and the Middle East achieved 66.7% in technical and pure technical efficiency, while this percentage for the Asian banks was 61.4%, which indicates that the Islamic banks in the Middle East were more efficient than the banks in Asia and they performed better. Finally, the Islamic banks in Iran scored the highest percentage of efficiency (85.4%) among the Middle East and Asian countries.


2.5 The Recent Financial Crisis

The recent financial crisis or mortgage crisis that occurred in the United States of America during September 2007 had a strong effect on many financial institutions and the economies of many countries all over the world, due to the strong economic relationship between the international stock markets and the American stock market.

The recent financial crisis began when the banking sectors in the USA started to give financial facilities to borrowers to take loans in order to buy property without any confirmation of their ability to pay the loan and the interest to the banks. The demand on the real estate sector increased dramatically in the USA. The borrowers who were unable to pay their loans had their properties repossessed by the bank. The problem consequently increased when the banks could not find buyers for these houses because of the increasing value of property; therefore the purchasing power of properties declined. Thus, the fixed assets of the banks increased dramatically with a shortfall in the cash flow, which led to the banks’ inability to cover their short- and long-term liabilities. Consequently, the banks’ inability to sell these assets and cover their liabilities caused the collapse of some banks (Scardovi, Gatti and Ventola, 2010).

There were many banks and financial institutions that collapsed because of the financial crisis, such as Lehman Brothers, and this brought huge negative impacts on different sectors of human life. Another example that clearly illustrates the great negative impact of the global financial crisis can be seen in the cases of the collapse of many automotive firms in America and Europe, where many thousands of workers lost their jobs and their monthly income, the only source of revenue to pay for their family living expenses. Also, the effect of the global financial crisis extended to many sectors of human life, such as production processes, increased unemployment and the governments being unable to achieve their plans and objectives, which has led to difficulties in meeting their financial duties and commitments (Rova and Mano, 2009).


Chapter Three

Research methodology

3.1 Introduction

This chapter illustrates the methods that will be used to achieve the objectives of the study. Accordingly, there will be a discussion about the methodological topics in relation with this study as follows:



  1. Types and forms of research philosophy.

  2. The different methods for designing the research that we can use for the purpose of evaluating any topic.

  3. Illustration of methods used for data collection in terms of their content and other features.

The quality of the research is an important element, thus it will be mentioned, including a discussion regarding analysis instruments, finishing with an indication of the research's limitations.

3.2 Research philosophy:

Research philosophy is considered to be an important element for many researchers; this philosophy relies on the methods that can be applied to create knowledge by the researcher. However, there are two types of the methods to perceive the philosophy used in research: ontology and epistemology. Each method has a different effect on the research function (Johnson and Duberley, 2000).



3.2.1 Epistemology:

Epistemology is the part of the philosophy that agrees with questions, which can be useful to make the knowledge acceptable in a particular field. The main interest in epistemology is the possibility of following a specific set of procedures and rules of natural science when interested in dealing with the social world. There are three positions of epistemology and natural sciences that can be present to deal with the knowledge: positivism, interpretivism and realism (Johnson and Duberley, 2000).


3.2.1.1 Positivism:

According to Creswell (2003), positivism is one of the most important parts to researchers and it includes the introduction of the most valuable theories in relation to the research subject. Furthermore, the researcher will determine the methods that will be used to collect the data, which will be useful to enforce the theories.



3.2.1.2 Interpretivism:

According to Saunders, Lewis and Thornhill, 2007, interpretivism is considered a useful method to help the researcher understand the perceptions and behaviour of human beings.



3.2.1.3 Realism:

Realism is considered an epistemological stance related to scientific investigation; it looks like positivism in its assumption that the scientific way is best for improving knowledge and for using natural and social sciences for the same type of data gathering and interpretation (Saunders, Lewis and Thornhill, 2007).

The importance of realism is that the presence of objects in reality is independent from human thinking.

The two main types of the realism are:



  1. Critical realism.

  2. Experimental realism.

3.2.2 Ontology:

Ontology is a part of philosophy that deals with all topics regarding the domain of the nature of social structures. The important interest is to decide if social constructs are objective, or result from perspectives and works of people (constructivism) (Gill and Johnson, 2010).


3.3 Research approaches

Two research methods are available and both were used to understand this research, these are the deductive and inductive methods (Bryman and Bell, 2003).

The deductive method is used to illustrate how the research is in relation to theory; this is done by the researcher who deduces assumptions on the basis of what he knows in a specific domain, and the theoretical interest in relation to that domain, then these assumptions go through empirical investigation. The assumptions consist of perceptions that need interpretation based on research structures. To build social structures, social scientists have to decide the way to gather data in relation to the perspectives that formulate the assumptions.

The other way of understanding is inductive, which states that the theory is the output of the research. This means the presence of observations regarding specific phenomena; from observations the researcher is able to make his conclusions.

The deduction method implements some of the induction components and the researcher should collect the necessary data to conduct the theoretical reaction; it is likely that he will need more data to generate the case in which the theory may or may not hold (Bryman and Bell, 2003).

In order to introduce research that includes useful information, it must answer questions and meet objectives, and there must be an explanation about how these objectives were established or descriptive answers; the researcher may have more than one objective at the same time (Saunders, Lewis and Thornhill, 2007).



3.4 Research strategies:

Qualitative and quantitative strategies are considered to be the main two types of strategy that can be used in business research. Researchers attempt to use these strategies to decide the relevant technique to use in the procedure of data collection and analysis.

A quantitative strategy is one that uses numerical data, like those obtained from the questionnaire technique, or from graphs, while the qualitative strategy uses non-numerical data, like those from interviews, pictures and video clips. According to the objectives of this study, the researcher is going to use the quantitative strategy (Burns and Richard B, 2008).

3.5 Different research designs:

Research design illustrates the structure for data collection and analysis (Bryman and Bell, 2003); there are five types of research design considered to be useful in many types of research, as follows:



3.5.1 Cross-sectional design:

Cross-sectional design is often regarded as a social survey. It collects data on several cases, because the researcher may face variation in many variables, and he needs a greater number of participants in his sample (Burns and Richard B, 2008).



3.5.2 Comparative design:

Comparative design is applied to two or more cases in order to accomplish better understanding, because of the comparative nature of the research. This type of strategy can use the collection of qualitative or quantitative data (Bryman and Bell, 2003).



3.5.3 Experimental design:

This type of strategy is commonly used when the research aims to evaluate social subjects. This strategy depends on both dependent and independent variables (Burns and Richard B, 2008).

However, to apply this strategy, there are facts that should be taken in consideration, such as:


  1. The relevant theory should be used.

  2. Explaining any sample related with the theory.

  3. Explaining any modifications or changes in evaluating the plan and the variables.



3.5.4 Case study design:

This type of strategy is related to the place, location, country, organization, people or firm the research is concerned with. It is characterized by extensive investigations regarding the nature of the study’s question. However, the result of case studies is often more about understanding the research environment (Sekaran and Bougie, 2010).

This strategy is the most relevant strategy to this type of research, because this type of research will answer the designed questions, and it will meet the research’s objectives. A case study will be applied to the banks; it will start by explaining the Islamic banks' philosophy and showing the difference between the Islamic and the commercial banking systems.

In addition, there will be a comparison between the Islamic and the commercial banks by evaluating the financial performance of the two systems over the period (2005–2009) using statistical and financial methods. Furthermore, this research will conduct a comparison between the two systems of banks during the recent global financial crisis and between the methods they used to encounter or to avoid the impact of the crisis. This comparison will be about reducing the risk that in relation with the financial crisis to determine and apply the most effective system during the period of the study.


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