HOW ARE ISLAMIC BANKS CHANGING THE BANKING LANDSCAPE?
HOW ARE ISLAMIC BANKS CHANGING THE BANKING LANDSCAPE?
How are Islamic Banks changing the Banking Landscape?
Conventional banks that were once competing with non-banking financial institutions and the capital market today face the new challenge of being substituted/reintermediated by Islamic banks. Earlier academic research debated over disintermediation (reduction in the use of intermediaries between producers and consumers, for example by investing directly in the securities market rather than through a bank), or reintermediation, i.e., the transfer or bringing back of borrowing and investments from an outside credit business into the banking system, but failed to address reintermediation of conventional banks through Islamic banks as a possibility.
In a study by writers, Bushra Naqvi, S.K.A. Rizvi, Hina Ahmed Uqaili, and S.M. Chaudhry, the novel possibility of reintermediation within the banking sector is addressed, in what is the first attempt to analyse and compare Islamic and conventional banks from the perspective of reintermediated financial markets. As the authors point out, the main objective of their study is to test different financial and non-financial aspects that either help the Islamic banks in conducting activities pertaining to intermediation more vigorously or convince customers to prefer Islamic banks.
After identifying reintermediation trends led by Islamic banks, the authors investigate several bank-specific financial and non-financial characteristics that might have enabled Islamic banks to emerge as an important player in reintermediated financial markets. By keeping the focus of study on a slightly modified version of CAMELS framework where ‘S’ represents “Service Quality” the study finds that along with better capitalisation (C) and improved liquidity (L), better service quality (S) is another distinguishable feature of Islamic banks that might be linked with their high degree of intermediation. This variable is important in explaining the performance of banks as they belong to a service-oriented industry. By bringing the customers’ perspective into the analysis, a significant contribution is made in research on banking sector activity.
Although results signify Islamic banks to be important players of reintermediated financial markets, it is still too soon to say that Islamic banks have emerged as a competitive force for conventional banks. However, Islamic banks have a substantially lower non-interest income and/or fee-based income than conventional banks, and hence can be said to be more stable as well as more intermediated.
The study links two streams of literature in banking and financial markets: reintermediation and performance comparison between Islamic and conventional banks. Based on the preliminary hypothesis, results prove that conventional banks, once the major player in financial market; competing with the capital market and NBFIs, could become substitutable by their new competitor because of better liquidity and high capitalisation and this presents reintermediation within the global banking sector. The thought that Islamic banks may replace conventional banks is a likely upcoming, but not immediate, option.
This study helps identify and highlight what factors are critical for the growth and/or the survival of the banking sectors, and among many factors, service quality emerged as a critical and decisive factor. Thus, the importance of customer satisfaction along with more focus on capitalisation and liquidity have been stressed upon for the growth and survival of commercial banks.
Reference
Naqvi, B., Rizvi, S.K.A., Uqaili, H.A., & Chaudhry, S.M. (in press). What enables Islamic banks to contribute in global financial reintermediation? Pacific-Basin Finance Journal.
Doi: 10.1016/j.pacfin.2017.12.001
About the Author
Bushra Naqvi is Assistant Professor at the SDSB, LUMS. She teaches corporate finance, financial risk management, banking, and economics. She is the MBA program director at the SDSB. Her research interests include financial economics, financial markets, financial intermediation, and monetary economics. Her research has been featured in the Pacific-Basin Finance Journal, Quantitative Finance, and Economic Modelling.