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Islamic Banking and conventional banking

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A Comparative Study of Islamic Banking in Pakistan: Proposing and Testing a Model

BY Ashfaq Ahmad PhD Scholar 117/FUIMCS/Ph.D(MS)-2006 FACULTY OF MANAGEMENT SCIENCES 2009

A Comparative Study of Islamic Banking in Pakistan: Proposing and Testing a Model

A thesis submitted to the

FUIEMS Foundation University, IslamabadIn partial fulfillment of the requirements for the degree of

DOCTOR OF PHILOSOPHY In MANAGEMENT SCIENCES

BY

Ashfaq Ahmad PhD Scholar FACULTY OF MANAGEMENT SCIENCES 2009

APPROVAL SHEET Approved by

External Examiner (Prof. Dr. M. Hayat Awan)

External Examiner (Dr. Mahmood A. Bodla)

Internal Examiner (Dr. Hamuyoun Naeem)

Head of the Department (Prof. Dr. M. Iqbal Saif)

Director/Dean Faculty of Management Sciences (Prof. Dr. Aftab Ahmad)

CERTIFICATE

I have supervised Mr. Ashfaq Ahmad, PhD Scholar at Foundation University Institute of Engineering and Management Sciences, Islamabad. The candidate has completed his PhD thesis successfully. The dissertation titled A Comparative Study of Islamic Banking in Pakistan: Proposing and Testing a Model is worth submission for the award of the degree.

Dr. Kashif-ur-Rehman Associate Professor Department of Management Sciences Iqra University, Islamabad

DECLARATION

I, Ashfaq Ahmad, Ph.D scholar in the subject of Management Sciences, hereby declare that the materials included in this dissertation are my own work and have not printed, published and/or submitted as research work, dissertation or publication in any form by anyone in Pakistan or abroad.

(Ashfaq Ahmad) PhD Scholar

DEDICATION

This work is dedicated to my parents, brothers and sisters who encouraged me to face any challenge.

VII

Table of Contents

Description

Page No.

List of Abbreviations List of Tables List of Figures List of Appendices Acknowledgement Abstract

XI XIII XV XVI XVII XIX

Chapter 1 Introduction 1.1 Background History of the Study 1.1.1 1.1.2 Islamic Banking Islamic and Conventional Banking

1 2 4 5 8 9 10 13 14 15 16 18

1.2 Broad Problem Area 1.2.1 Pakistani Banking Sector

1.3 Identification of Knowledge Gap 1.4 Statement of the Problem 1.5 Objectives of the Study 1.6 Significance of the Study 1.7 Definition of the Variables of the Study 1.8 Organization of the Dissertation

VIII Chapter 2 History and Development of Conventional and Islamic Banking in Pakistan 2.1 History of Banking Development in Pakistan 2.2 Prohibition of Interest in Islamic Banking 2.3 Functions of Islamic Bank 2.4 Operations and Products of Islamic Bank 2.5 Service Quality of Pakistani Banking Sector 2.6 Customer Satisfaction of Pakistani Banking Sector 2.7 Performance of Pakistani Banking Sector Chapter 3 Literature Review and Theoretical Framework 3.1 Services 3.1.1 Definition of Service and Service Quality 19 20 26 32 36 41 41 42 45 46 47 50 61 61 62 65 70 72 73 77 81 85

3.1.2 Dimensions of Service Quality 3.2 Customer Satisfaction 3.2.1 3.2.2 3.2.3 Defination of Satisfaction Customer Satisfaction in Banking Determinants of Customer Satisfaction

3.3 Bank Performance 3.3.1 3.3.2 Performance Evaluation of Islamic Banks Performance of Pakistani Banking Sector

3.4 Service Quality and Customer Satisfaction in Banking 3.5 Service Quality, Customer Satisfaction and Bank Performance 3.6 Hypotheses, Conceptual Model and Theoretical Framework

IX Chapter 4 Methodology 4.0 Research Method 4.1 Pilot Test 4.2 Main Study 4.3 Measures and Instruments 4.4 Reliability and Internal Consistency of the Variables Chapter 5 Interpretation of Results 5.0 5.1 5.2 5.3 5.4 5.5 Results Demographics of the Respondents Descriptive Statistics of the Variables Hypotheses Testing Regression Model Result Testing the Model 5.5.1 Relationship among Service Quality, Customer Satisfaction and Performance of Islamic Banks in Pakistan 5.5.2 Relationship among Service Quality, Customer Satisfaction and Performance of conventional Banks in Pakistan 5.6 Discussion 137 143 150 151 153 155 156 136 94 95 97 100 103 108 113 114 115 119 121 124 135

Chapter 6 Conclusion 6.1 Conclusion 6.2 Suggestions 6.3 Limitations and Future Research 6.4 Contribution of the Study

X 6.5 Practical Implications 6.6 Unique Status of the Study References Appendices 157 158 159 179

XI List of Abbreviations

CB IB SBP Prf DSQL CS ANOVA SEM SE df SQL Tgty Rlty Rspv Asnc Epty Csrv Helmt Smdlv TgSv Slrby

Conventional Bank Islamic Bank State Bank of Pakistan Bank Performance Dimensions of Service Quality Customer Satisfaction Analysis of Variance Structural Equation Modeling Standard Error Degree of Freedom Service Quality Tangibility Reliability Responsiveness Assurance Empathy Core Service Human Element Systemization of Service Deliver Tangibles of Services Social Responsibility

XII Cprf Iprf IBSQL CBSQL IBCS CBCS Slty Srsn PLS GDP ROI ROE UAE SOPs Conventional Bank Performance Islamic Bank Performance Islamic Bank Service Quality Conventional Bank Service Quality Islamic Bank Customer Satisfaction Conventional Bank Customer Satisfaction Service Quality Customer Satisfaction Partial Least Square Gross Domestic Product Return on Investment Return on Equity Unite Arab Emirates Standard Operating Procedures

XIII List of Tables Table Table 1.1 Table 2.1 Table 2.2 Table 2.3 Table 2.4 Table 3.1 Table 3.2 Table 4.1 Table 4.2 Table 4.3 Table 4.4 Table 4.5 Table 4.6 Table 4.7 Table 5.1 Table 5.2 Table 5.3 Table 5.4 Description Page No. 7 35 36 43 44 53 75 97 99 101 102 105 109 111 115 119 120

Difference between Islamic bank and Conventional Bank Financial performance of Islamic banks Financing Products offered by Islamic Banks (in %) Performance of Pakistani Banking Sector Performance of Islamic banks in Pakistan Dimensions of Service Quality used in Banking sector Sources and Uses of Funds by Islamic banks in Pakistan Reliability Statistics of the Pilot-Test Descriptive statistics of the Pilot-Test Selected Banks included in the Study Details regarding Branches and Respondents (City Wise) A Summary of All Variables Operational for the Study Reliability Statistics of the Scales for IB Reliability Statistics of the Scales for CB Summary of Demographics of Respondents Skewness and Kurtosis of the Constructs and Variables Descriptive Statistics of the Variables Independent Samples T-Test for difference in perception

Of Service Quality between Male & Female customers of IB 121 Table 5.5 Independent Samples T-Test for difference in perception Of Service Quality between Male & Female Customers of CB 122

XIV Table 5.6 Table 5.7 Table 5.8 Table 5.9 Table 5.10 Table 5.11 Table 5.12 Table 5.13 Table 5.14 Table 5.15 Table 5.16 Table 5.17 Table 5.18 Table 5.19 Table 5.20 Table 5.21 Summary of Correlation between Selected Variables 123

Summary of Pair wise Correlation between Selected Variables124 Summary of IBDSQL-IBCS Linear Regression model Summary of Multincollinearity coefficients Summary of CBDSQL-CBCS Linear Regression model Summary of Multincollinearity coefficients Summary of IBSQL-IBCS Linear Regression model Summary of CBSQL-CBCS Linear Regression model Summary of IBSQL-IBPrf Linear Regression model Summary of CBSQL-CBPrf Linear Regression model Summary of IBCS-IBPrf Linear Regression model Summary of CBCS-CBPrf Linear Regression model Relationship among Slty, SrSn and Prf Structural Model-Bootstrap for IB Structural Model-Bootstrap for CB Summary of Hypotheses 125 126 127 128 129 130 131 132 133 134 138 141 142 148

XV List of Figures Figure Figure 1.1 Figure 2.1 Figure 2.2 Figure 2.3 Figure 2.4 Figure 3.1 Figure 3.2 Figure 3.3 Figure 3.4 Description Role of Financial Intermediaries (Banks) Functions of Islamic bank Operations of Islamic bank Contributors towards deposits of Islamic bank Page No. 3 33 37 38

Contribution of Islamic banks towards financing products 40 Expectation-Outcome experience of bank customers Customer Satisfaction for better Performance Total Assets of the banking system Graphical display of the hypothesized relationship between Service quality and customer satisfaction 88 63 64 74

Figure 3.5

Graphical display of the hypothesized relationship between Service quality and bank performance 89

Figure 3.6

Graphical display of the hypothesized relationship between Customer satisfaction and bank performance 90

Figure 3.7

Mediating role of customer satisfaction between services Quality and bank performance 91

Figure 3.8

Conceptual model: Service quality, Customer Satisfaction and Bank Performance in Pakistan 92 136 137

Figure 5.1 Figure 5.2

Relationship among Slty, Crsn and Iprf Relationship among Slty, Crsn and CPrf

XVI List of Appendices

Appendix

Description

Page No.

Appendix I Appendix II Appendix III Appendix IV

Questionnaire List of banks operating in Pakistan Definition of Terms Results of VPLS

185 197 200 201

XVII

ACKNOWLEDGEMENT

With the name of Allah Almighty the most merciful, the most beneficent, I am very thankful to Him for His blessings and pray for complete success in this life and life hereafter. Allah Almighty equipped human beings with the light of knowledge in the era of darkness of illiteracy and lack of direction. Human beings are blessed by the set of instructions through revelation as given by the Creator of this universe.

I salute and pay my heartiest tribute to the Holy Prophet Muhammad (peace be upon him) being an ideal personality to follow his practices. The Holy prophet Muhammad (Peace be upon him) preached Islam as the religion of peace, brotherhood and welfare oriented for success in this life and in