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Relationship Between Deposit Rates of Islamic and Conventional

Banking

Literature Review
The rate of return has always an important role in explaining the saving behavior of an
individual. In fact that is considered as the basic of financial activities. That’s why
different financial institutions offering different return rates on their different depository
schemes. Deposit having high maturity has high rate of return and those having low
maturity has low rate of return. For instance the current account has very shorter maturity
having offered no return, and saving deposits have high maturity offered high rate of
return.

The difference among the Islamic and conventional banking system can be judged on the
basis of risk involvement. The Islamic jurists (Ullama Keram) argued that the element of
risk should not be removed from the financial transaction, if that is removed from the
financial transaction then that transaction is no more remained the business or trade but
involved in the category of Usury(Riba). That’s why the profit rates of Islamic banks
should be accrued form one year to another year, according to the performance of the
bank, not according to the change in interest rate (Gafoor, 2001).

Just like to conventional banking, Islamic banking too provide the facility to their
customers by offering different types of depository schemes. Islamic banking accept the
capital provider’s right to utilize the best possible opportunity that arises from the factors
such as the risk involvement, rate of profit and the period of investment.
It found that Islamic banking system around the world use usually three main type of
deposits; current accounts, saving accounts and investment accounts. On current and
saving deposit the bank guaranty the depositor the nominal value that he has deposits but
gives no guaranty on return; and the investment deposits are operated fully under the
concept of profit and loss sharing (PLS) model (Ariff, 1988).

In another study analyze the relationship between total Islamic deposits and rate of
interest that offered under Islamic and conventional banking depository schemes in
Malaysia. They reached to the result that there is negative relationship between interest
rates and total interest free deposits. They argued that Islamic saving and investment
accounts holders are highly influenced by the profit motive. So if the Islamic banking has
to attract their customers then they must have to offered profit rate more than
conventional banks or has to offer some other incentives that attract customers (Haroon
and Nor Affifa, 2000).

In Malaysia a study conducted on finding causal relationship between Islamic and


conventional banking instruments. The procedures involved the Granger causality test
and unit root test. And the finding of the study shows that the conventional TDRs
Granger causes Islamic TDRs in all respects. And they conclude from their study that
Islamic banking should consider interest rates before adjusting their profit rates (Kaleem
and Md Isa, 2003).

A study that conducted by Humayon and Presley(1998), have provide a bright way to the
islamic financial; implementing and research authority that it would not be good to act as
isolated part of literature from western literature, but islamic financial can perform more
better if ;they adopted the supportive arguments that is found in the western literature. It
would too encourage the focus of west on the new modal of Islamic finance for research
(Humayon and Presley, 1998).
A study which conducted in Malaysia by Obaidullah (2005) has produced his wording on
the Islamic banking as: “that Islamic banking is facing very competitive environment due
to their strong competitor. And Islamic financial institutions could be exposed to the risk
of strong withdrawal by its customer because of the high rate they received from
conventional institutions as compare to the Islamic institutions”. In such scenario the
Islamic financial institution should have to pay such market competitive rates with which
they could retain their customers (Obaidullah, 2005).
In order to find out that weather the islamic banking and conventional banking is similar
in practice are different from each other, a study conducted on the Malaysian Islamic
banking system by Beng soon Chong and Ming-Hua Liu in 2007. They tried to find out
the Granger Causality between Islamic and conventional banking, and had found that
there is relationship between both banking systems. Although in theoretical base a unique
feature that differentiates both banking system is interest (Riba). But in practice they
found that both systems were not as much different from each other (Chong & Liu ,
2007).

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