Case Study: The Role of Islamic Banks in Economic

Al-Hallaq, s., 2007.

Abstract

The current study is designed to investigate the practice of Jordan Islamic Bank (JIB) as a case study during the period 1980-2000. The Two Stage Ordinary Least Square has been used to capture the direct and indirect effects of Jordan Islamic Bank (JIB) on the real per capita income as a proxy to economic growth. The indirect effect of total financing and investment by (JIB) as a percentage of total credit was relatively small (0.048) compared to that by conventional bank (0.50). However, this contribution should be looked at as a good start by Islamic Banks given the fact that their experience is only 20 years compared to that of Conventional Banks.

Introduction:

The history of Islamic financial institutions in Jordan is not that old. Jordan Islamic Bank (JIB) for Finance and Investment was established in 1979 with a capital of JD (4) Million divided into (4) Million shares. The Banks capital increased over the years to reach JD (38.5) Million in the year 2000. The Bank aims at accommodating the diversified economical and social needs of citizens in the fields of banking, financing and investment on a non- usurious basis. This is realized through the Bank (51) branches and (11) offices, widespread all over the kingdom. The Jordan Islamic Bank has been growing rapidly; the number of clients as well as the volume of funds mobilized and invested reflects this rapid growth. The success made by Jordan Islamic Bank, however, encouraged the Arab Bank Corporation (the largest financial institution in Jordan), to establish The International Arab Islamic Bank in 1996: to conduct murabaha transactions, leasing and other investment instruments according to the Islamic principles.

The entrance of such an institution is expected to increase competition and reduce the monopolistic position role of Jordan Islamic Bank as the only Islamic Bank in the country. Thus, it is expected that the performance of Jordan Islamic Bank will tend to improve even better due to the presence of this new competition.

However, we must keep in mind that Jordan Islamic Bank is facing the following obstacles (AL- Omar and Abdel-Haq, 1996):

JIB has found, itself forced in order to make up the disadvantage of non being able to use the central bank as lender of last resort, to make most of it financing operations short or medium term, and to hold high levels of cash in notes in case of emergencies.

Lack of enough financial instruments like bonds, for example, if the (JIB) could hold listed securities issued by high-quality corporations; this could be a substitute for cash.

The JIB has found itself forced to take a tougher line on guarantees when it agrees to finance any project. The reason for this is that, in the past, some clients have tried to take advantage of the fact that the (JIB) is not able to charge interest on late payments of bills as conventional banks. There is no penalty for late payment under Islamic Law.

Thus, when comparing the impact of (JIB) on the economic growth of Jordan relative to conventional banks, we should not be surprised if the impact of (JIB) showed less effect. However, given the above-mentioned obstacles, this is highly expected.

The importance of this study comes from the fact that there is a serious lack of empirical studies on the evaluation of Islamic Banks performance compared to that of conventional banks. Munawar Iqbal (2001) has pointed this out in his attempt to compare the performance of Islamic Banks relative to conventional banks. Iqbal study was a serious and a leading study in empirical studies on Islamic Banking. Iqbal study includes in its sample 12 Islamic banks and 12 conventional banks to fulfill the purpose of his study. The conclusion reached by Iqbal showed that the in general Islamic banks have done fairly well during the period 1990-1998. This study will be an attempt to help in filling the existing gab in empirical studies on Islamic Banking.

2. Data and Methodology

The current study will attempt to examine the role of Jordan Islamic Bank in economic growth during the period 1980-2000. Data are gathered from the annual reports of the Jordan Islamic Bank, and the annual reports and quarterly statistical bulletins of Central Bank of Jordan. The suggested model is a simultaneous macro-econometric model consists of two behavioral equations, which will be estimated using Two Stage Ordinary Least Square methods (2SLS).

3. Development of Jordan Islamic Bank Activities

Before examining how (JIB) could contribute in the economic growth of the Jordanian economy through its financing and investment, it is worth providing an over view about the development of (JIB) during the period under consideration.

3.1 Total Deposits of (JIB)

Many individuals prefer to keep their savings outside the banking sector rather than engaging in any interest dealings (Rawashdeh, Hallaq, and others, 1999). On the same regard, those who used to deal with conventional banks are forced to do so in the absence of Islamic banking system. Thus, once the system has been founded most of these funds are believed to have moved to Islamic banks (Bashir, 1984).

The Arab Bank Corporation, for example, which is the biggest financial institution in Jordan, starts to offer Islamic products and becomes a real competitor to (JIB).

3.2 (JIB) Total Financing and Investment:

(JIB) total investment comprises : Murabaha financing, Musharakah and Murabaha financing, promissory note balance financing, Installments from leases ending in ownership. However, the sectoral distribution of total investment and financing operations come as follows: Agriculture, Industry and Mining, General trade, Construction and Transport.

4. Conclusion

This study was designed to investigate the practices of Jordan Islamic Bank (as a case study) during the period of 1980-2000. The Two Stage Ordinary Least Squares were used to capture the direct and indirect effects of (JIB) on the real percept income, which has been used as proxy to economic growth.

Required:

Critically discuss the Islamic Banking and discuss its importance as a benefit to the economy. (100 words) (12 marks)

Elaborate on the basic principles of a successful Islamic financial system. (250 words) (15 marks)

Assess the growth of JIB as well as its prospective position in the Jordanian financial sector as a whole. (90 words)

Table (1-A): Development of (JIB) activities during the period (1980-2000) Financial year Total Assets Total Deposits Total financing and Investment by JIB (1) Total financing by conventional banks 12) 1980 15.5 11.6 6.8 563.9 1981 31.6 25.3 14.2 721.3 887.2 1982 45.2 35.8 26.5 1030.9 1983 71.5 58.6 37.6 1184.8 1984 102.0 82.8 63.0 1274.4 1985 126.8 102.8 171.0 1395.4 1986 161.7 127.6 95.5 1513.0 1987 197.4 158.5 109.0 1634.0 1988 222.6 177.8 124.1 1729.2 1989 242.3 144.1 187.2 1863.5 1990 244.8 190.3 148.9 1965.8 1991 356.7 193.1 296.9 1992 2218.3 435.3 369.5 243.1 1993 528.3 420.6 306.7 2616.9 3248.4 1994 570.0 356.1 462.1 3705.7 1995 621.9 418.2 508.5 3920.3 1996 618.7 422.1 502.3 3979.7 1997 650.6 513.4 461.8 4285.3 1998 706.7 527.8 481.4 4466.6 1999 490.2 756.7 543.6 4546.5 2000 853.3 564.6 531.8 Sources: (1) Central Bank of Jordan, Monthly Statistical Bulletin, different issues. (2) Jordan Islamic Bank for Finance and Investment, Annual Reports, different issues This item comprises, Murabaha financing, Murabaha and Musharaka financing, among after investments. The sectoral distribution of financing and financing operations comes as follows: Agriculture, Industry and mining, General trade, construction and transportation Table (1-A): Development of (JIB) activities during the period (1980-2000) Financial year Total Assets Total Deposits Total financing and Investment by JIB (1) Total financing by conventional banks 12) 1980 15.5 11.6 6.8 563.9 1981 31.6 25.3 14.2 721.3 887.2 1982 45.2 35.8 26.5 1030.9 1983 71.5 58.6 37.6 1184.8 1984 102.0 82.8 63.0 1274.4 1985 126.8 102.8 171.0 1395.4 1986 161.7 127.6 95.5 1513.0 1987 197.4 158.5 109.0 1634.0 1988 222.6 177.8 124.1 1729.2 1989 242.3 144.1 187.2 1863.5 1990 244.8 190.3 148.9 1965.8 1991 356.7 193.1 296.9 1992 2218.3 435.3 369.5 243.1 1993 528.3 420.6 306.7 2616.9 3248.4 1994 570.0 356.1 462.1 3705.7 1995 621.9 418.2 508.5 3920.3 1996 618.7 422.1 502.3 3979.7 1997 650.6 513.4 461.8 4285.3 1998 706.7 527.8 481.4 4466.6 1999 490.2 756.7 543.6 4546.5 2000 853.3 564.6 531.8 Sources: (1) Central Bank of Jordan, Monthly Statistical Bulletin, different issues. (2) Jordan Islamic Bank for Finance and Investment, Annual Reports, different issues This item comprises, Murabaha financing, Murabaha and Musharaka financing, among after investments. The sectoral distribution of financing and financing operations comes as follows: Agriculture, Industry and mining, General trade, construction and transportation