Conventional and Islamic Banks in Egypt Efficiency

Abstract

Egypt was the first country to introduce the concept of Islamic banking in the financial sector. It has since gained massive popularity because of its relevance among the locals. In this paper, the focus was to determine profit efficiency of conventional and Islamic banks in the country. The study relied on secondary sources, especially books and journal articles, to inform the finding. It is evident that both systems are profit efficient depending on the angle of analysis. In volatile markets, conventional banks are preferable, while in a booming stable economy, Islamic banking is more efficient.

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Introduction

Egypt is one of the nations where Islamic banking has gained massive popularity. According to Hassan and Rashid (2019), a section of the Muslim community has been avoiding conventional banks because of the riba(interest) concept that goes against the teachings of Prophet Muhammad. Both conventional banks and Islamic financial institutions have a substantial market in the country because of the diversified needs of their customers. As Habib (2018) observes, the primary difference between the two is the approach that they take to earn profits. In this paper, the researcher seeks to compare the profit efficiency of conventional and that of Islamic banks in Egypt.

Main Body: Background

The banking system in Egypt plays a crucial role in enhancing the economic development of the country. Like many other nations within the Middle East, conventional banking gained root soon after independence (Eid&Asutay, 2019). Large corporations in the country could not rely on the traditional banking approaches of managing their money, and as such, they found conventional banking to be effective and reliable (Hassan &Mollah, 2018). However, there was always a concern among religious leaders and the faithful about the concept of riba (Billah, 2019). One of the most important Islamic principles is that riba is haram (forbidden by Islamic law) because it is based on speculation. Those who practiced strict Islamic culture only used these financial institutions to facilitate large financial transactions in their organizations (Nafis et al., 2019). They could not borrow from banks and neither could they accept payments based on the concept of paying or earning interest.

The business community realized that there was a major gap in the market because products offered by conventional banks were against some of the fundamental Islamic principles. Visser (2019) explains that the unique needs of the local customers made it necessary to have a new banking system that took into consideration all the Islamic principles. In 1963, Egypt became the first country to introduce Islamic banking (Nafis et al., 2017). It was a major relief to individuals and top managers of corporate entities who found it difficult to use the conventional banking system. Islamic banking has gone through major transformations since then to ensure that its model of operation is profitable to the institution and acceptable to its customers (Hajjar, 2019). It is necessary to assess the efficiency of conventional and Islamic banks in this country.

  • H1o: Islamic banking is not as profitable as conventional banks.
  • H1a: Islamic banking is as profitable as conventional banks.

Results and Discussion

Islamic banking has gained massive popularity in Egypt because of its relevance to the locals. However, it does not mean that conventional banking has been eliminated. In fact, Salman and Razzaq (2018) explain that the two banking systems are active in the country as they serve varying interests. Table 1 below shows a comparative analysis of the two financial systems. One of the main differences is that Islamic banks share risks with customers with conventional financial institutions transfer the risk to their clients. In both cases, the institutions receive funds from depositors but they differ in the approach used to earn income from these deposits.

Table 1: Conventional Banks vs. Islamic Banks

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Conventional Banks vs. Islamic Banks

Traditionally, conventional financial institutions rely on interests from the loans they extend to their customers. In this system, depositors take their money that they do not intend to use within the near future to the bank (Mohamed &Shamsher, 2017). They are promised a certain amount of interest that they will earn from their deposits after a given period. The commercial bank will use these deposits to extend loans to customers who are in urgent need of funds. These customers will be charged a given amount of interest that they will pay after a given period when they return the borrowed amount (Iqbal&Quibtia, 2017). The interest that the borrower pays is often higher than what the bank gives to the depositor of an equal amount of money.

Islamic banking system uses a different concept that is significantly different from that of the conventional commercial banks. In this case, a depositor will take their money to the bank. They will be informed that the bank will use their money to do business. There will be an agreement about how to share the profit that the bank will earn from its business operations (Akram&Rahman, 2018). When one comes to the bank to borrow money, they have to explain the nature of their business, the expected profit, and how they intend to repay the loan. If the explanation is satisfactory, the client and the bank will agree on how to share profits gained from the business. In case it is an individual loan, the bank will buy what the client needs and sell it to them at a profit instead of charging an interest (Mohamed & Ali, 2019). Figure 1 below is a comparative analysis of the two models of banking.

Models of making profits in conventional and Islamic banking systems 
Figure 1. Models of making profits in conventional and Islamic banking systems 

The two banking systems have distinct approaches of making profits. Conventional financial institutions earn their profits primarily through interests (Kurnaz&Serçemeli, 2019). Once they release the money to the client, they do not focus on how it is utilized. Their only concern is that the borrowed money plus the interest is paid in full within the stipulated period. All the risks are transferred to the client (Abdeldayem& El-Sherbiney, 2018). On the other hand, conventional banks earn profits from their transactions. If one needs to purchase an item, the bank will buy it and sell to the customer at a profit. In case the borrower is a business entity, then a profit-sharing arrangement will be developed for the two institutions. The analysis shows that there is profit efficiency in the two institutions (Alamad, 2017). Conventional commercial banks may be considered efficient in profit making, especially in volatile markets and when lending to risky businesses, because the risk is transferred to the client (Basha, 2017). On the other hand, Islamic banks are more efficient when lending to highly profitable businesses because of the concept of sharing profits.

Conclusions

When analyzing profit efficiency of conventional and Islamic banks in Egypt, it is necessary to understand the difference in the business model that they apply. The analysis and discussion above shows that both are efficient when viewed from different angles. Conventional financial institutions have high profit efficiency when operating in volatile markets. They transfer all risks to the customer, and as such, they expect their money back whether or not the business or individual gained a net benefit from it. Islamic banks, on the other hand, are more efficient when they lend money to highly successful businesses.

References

Abdeldayem, M. M., & El-Sherbiney, R. A. (2018). A comparative study of the financial performance of the three banking modes in Egypt: Islamic, conventional, and mixed banks. Archives of Business Research, 6(5), 286-308.

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Akram, H., & Rahman, K. (2018). Credit risk management: A comparative study of Islamic banks and conventional banks in Pakistan. International Journal of Islamic Finance, 10(2), 185-203.

Alamad, S. (2017).Financial innovation and engineering in Islamic finance. Springer.

Basha, S. N. (2017). The hundred differences between Islamic and conventional banking systems.International Journal of Scientific Research and Management, 5(9), 7093-7106.

Billah, M. M. (2019). Halal cryptocurrency management. Palgrave Macmillan.

Eid, W. K., & Asutay, M. (2019). Mapping the risks and risk management practices in Islamic banking. John Wiley & Sons Singapore Pte.Ltd.

Habib, S. F. (2018). Fundamentals of Islamic finance and banking. John Wiley & Sons Ltd.

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Hajjar, M. (Ed.). (2019). Islamic finance in Europe: A cross analysis of 10 European countries. Palgrave Macmillan.

Hassan, A., & Mollah, S. (2018). Islamic finance: Ethical underpinnings, products, and institutions. Palgrave Macmillan.

Hassan, K., & Rashid, M. (Eds.). (2019). Management of Islamic finance: Principle, practice and performance. Emerald Publishing.

Iqbal, Z., &Quibtia, M. (2017). Theoretical differences between Islamic banking and conventional banking. International Journal of Business and Social Science, 8(1), 141-153.

Kurnaz, E., &Serçemeli, M. (Eds.).(2019). Contemporary research in accounting, auditing and finance. Cambridge Scholars Publishing.

Mohamed, A., & Shamsher, M. (Eds.) (2017). Islamic wealth management: Theory and practice. Edward Elgar Publishing.

Mohamed, H., & Ali, H. (2019). Block-chain, fintech, and Islamic finance: Building the future in the new Islamic digital economy. De Gruyter Press.

Nafis, A., Gupta, L., & Shanmugam, B. (2017). Islamic finance: A practical perspective. Palgrave Macmillan.

Nafis, A., Gupta, L., & Zameni, A. (2019). Fintech and Islamic finance: Digitalization, development and disruption. Palgrave Macmillan.

Saidu, S. K., Junaidu, A. S., & Jibril, R. S. (2018). Financial instruments: Islamic versus conventional. Books on Demand.

Salman, A., & Razzaq, M. G. (Eds.). (2018). Accounting from a cross-cultural perspective. Books on Demand.

Ustaoğlu, M., & İncekara, A. (2017). Balancing Islamic and conventional banking for economic growth: Empirical evidence from emerging economies.Springer International Publishing.

Visser, H. (2019). Islamic finance: Principles and practice. Edward Elgar Publishing.

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