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Abstract

In this study we had learn that Islamic financial institutions and conventional financial

institution which situated globally. Furthermore, Islamic financial institutions established

because of the principles of capitalism by charging interest is forbidden in Islamic law. In

this way Muslim can use the new financial institution services that are acceptable by the

concept of Shariah. The main objective of this research is to investigate the relationship

between customer acceptance and financial institutions and the differences between

Islamic and conventional financial institutions. Through this, we do learn about the

definition of financial institutions. In addition, we study more about the knowledge in

Islamic and conventional financial institution. Besides that, investigating on customer

acceptance of these two financial institution also been done. Subsequent to this analysis,

customer acceptance had been clarified. Furthermore, the financial instruments and the

benefits of Islamic and conventional financial institutions had been stated down. Through

this study, we know that customer acceptance has significance effect on financial

institutions. There are two limitations in this study. First, research and questionnaire of

this study is not available due to the wide coverage of areas. Second, information

collected may not reflect to actual by the limitation of secrecy.

Introduction

An Islamic financial institution has emerged as a competitive and a viable substitute for

the conventional financial institutions during the last three decades. It is especially true

for Muslim world where presently Islamic financial institutions strides at two separate

fronts. Islamic financial institutions are developed base on the concept on Islamic Shariah.

It must operate within the framework of the religion that is Quran and Sunna. In

Mu’amalat, it means the relationship with other human had showed the economic

activities are included. The primary motive of Islamic financial institutions is to ensure

the prohibition of Riba (all forms of unearned income). In 1940s and 50s, it started in the

development of the theory and the first financial institution had introduced in 1970s. In

1990s, it had focus on concentration of Islamic financial institution growing in selected

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countries. In 2000s, it starts to develop structured Sukuk and capital market and

commencing of mega project finance, large commercial banks and Islamic derivatives.

The first service apply in Malaysia that relate to Islamic finance is Tabung Haji

(Pilgrimage Fund) in 1967. In 1983, the first Islamic Bank in Malaysia had been

established. By the next year, the first Takaful (Islamic insurance) had introduced.

Nowadays, Islamic financial institutions operate in over 70 countries. According to

Ibrahim Warde, the assets have increased more than fortyfold since 1982 to exceed $200

billion had showed the improvement and widely use of the Islamic financial institutions.

In 1996 and 1997, they have grown at respective annual rates of 24 and 26 per cent.

Some foreign institutions have start to established Islamic banking subsidiaries, now

many conventional banks are also offering ‘Islamic products’ that are sometimes aimed at

non-Muslims. The origin in the phrase financial institution is derived in the Italian phrase

“banco” or desk. Financial institutions come from areas which organizations could safe

loans to buy stock, as well as accumulate the money with curiosity when the merchandise

is marketed. The financial institution has come to a big revolution with the innovation of

technology make it can serve the public within an aggressive market place that cover with

high efficiency and more secure. Conventional financial institutions provide financial

services for its client such as guarantees, funds transfers, safety of wealth, and facilitation

in international trade provide reward as a part of income. However the major driver of

operation of conventional financial institutions is interest. It acts as financial

intermediaries by allocate financial resources from its source to potential users. Since the

conventional financial institutions established under the principles of capitalism and

transect business by charging interest which is forbidden in Islamic law. This is the

reason why Muslims establish their own financial institutions under Islamic principles.

Objective of study

� To investigate the relationship between customer acceptance and financial

institutions.

� To investigate the differences between Islamic and conventional financial

institutions.

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Literature Review

Studies related to financial institutions

Financial institution can categorized in three group, Deposit-taking institutions that

accept and manage deposits and make loans, including banks, building societies, credit

unions, trust companies, and mortgage loan companies; Insurance companies and pension

funds; and brokers, underwriters and investment funds (Siklos, 2001).

There is broad definition for financial institution. In generally, financial institution

is an institution that provides financial services for its clients or members. According to

the Commissioner of Law Revision Malaysia (2006), financial institution means any

licensed bank, licensed merchant bank, licensed finance company, or licensed discount

house, as those terms are defined in the Banking and Financial Institutions Act 1989.

The government of Guyana has defined “depository financial institution” as a

licensed financial institution which accepts deposits and other repayable funds from the

public while “non- depository financial institution” as licensed financial institution which

does not accept deposits and other repayable funds from the public.

According to Peter Thomas (2004), the Norway government has state that

financial institutions is the companies, undertakings or other institutions which carry on

financing activity except public credit institutions and funds, public trustee's offices and

foundations whose primary purpose is not to engage in commercial activity, management

companies pursuant to the Securities Funds Act and investment firms pursuant to

Securities Trading Act.

Finally, financial institution may to include mortgage lending businesses.

Mortgage lending business means that organization which finances or refinances any debt

secured by an interest in real estate, including private mortgage companies and any

subsidiaries of such organizations, and whose activities affect interstate or foreign

commerce (Kenny, Boyce and Warin, nd).

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Studies related to conventional and Islamic financial institution

There are the differences between conventional and Islamic financial institution, the

difference is showed below:

2.1 Deposits

Both conventional and Islamic financial institutions collect deposits from their saver.

However according to Hanif (2011), there are different in rewarding their depositor.

Under conventional system reward is fixed and predetermined while under Islamic

deposits are accepted through Musharaka and Mudaraba where reward is variable. Under

conventional system total risk is born by the bank and total reward belongs to it after

servicing the depositors at fixed rate while under Islamic system risk and reward both are

shared with depositors.

2.2 Home loan

Home loan interest rates are available in conventional financial institutions. According to

Noriza (2009), lending with interest is not allowed for Muslim. Conventional housing

loan lend money for house purchasing while Islamic banking mostly structures on buy

and sell basis on purchasing a house. Thus, most of Islamic home financing involve

purchase and subsequent sale of asset at certain fixed price. Conventional financial

institution charge interest in home loan while Islamic home financing did not usury

which means there are no interest charges in paying back the house financing at the end

of the maturity period. Customers of Islamic financial institution only have to pay back

the price that has agreed upon agreement by both parties between the bank and the

customer after the profit margin had been calculated.

2.3 Overdrafts or Credit Cards

According to Hanif (2011), conventional banks offer the facility of overdrawing from

account of the customer with interest. One of its form of example is use of credit card

whereby limit of overdrawing for customer is set by the bank. Credit card is not offered

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by Islamic banks except in the form of Murabaha for example provide facility of debit

card. Under conventional banking a customer is charged with interest once the facility is

used. However under Murabaha, profit is due when the commodity is delivered to the

customer. Default customer is charged with further interest for the extra period under

conventional system however extra charging is not allowed under Murabaha.

2.4 Investments

In order to maintain liquidity conventional banks have many avenues including

government securities, shorter term loans and money at call and short notices, leasing

companies’ bonds, investment in shares and others. Conventional banks can also create

liquidity by issuing the bonds against their receivables. Commercial banks are also

protected by central bank by providing liquidity in rainy days for interest. Interbank

deposits are also rewarded in the form of interest by commercial banks. For Islamic

financial institutions avenues are very limited to create required liquidity at the same time

to earn some revenue by investing in short term and liquid securities. Compare to

conventional, Islamic financial institution cannot invest in government securities, short

term loans, bonds and money at call and short notices because of interest based

transactions (Hanif, 2011).

2.5 Stability

According to research by Beck (2010), his survey result has showed that conventional is

more stable compare to Islamic financial institution. Islamic banks are not more stable

and not liquid than conventional banks due to lower profitability and lower capitalization.

He found that conventional banks are more cost efficient and better capitalized than

Islamic financial institution. Higher complexities in Islamic banking might result in

higher costs and thus lower efficiency of Islamic banks.

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Studies related to customer acceptance on financial institutions

From the report from Khazeh and Decker (1992), interest rate was one of the top five

determinants factors that influenced the acceptance on banking decision. The evidence of

interest rate has supported by Ongena (2009). Paying highest interest rates on saving

accounts also rank in second place for consumer to choose the financial institution in the

research by Safakli in year 2007. Same with the Islamic financial institution, Islamic

financial institution always offer higher interest rate compare to conventional (Rosly,

2005). Gerrad and Cunningham (1997) also found that profit or interest rate served as a

reason for people maintaining their relationship with Islamic banks. However, the

revenue of Islamic financial institution is low due to high interest rates.

Customer perception of risk is also factors that influence the acceptance of

financial institution. The higher financial institution or instrumental risk, the higher return

for the consumer (Faulhaber, n.d.). However, the consumer more prefers large financial

institution. There is the relationship between the sizes of the financial institution to the

risk. McAllister and McManus (1993) found that increasing size permitted lower risk

costs for banks resulting from inventory economies. Reputation of financial institution

was one of the method that consumer to determine the risk of the firm (Ongena, Tümer-

Alkan and Vermeer, 2010). In Islamic financial institution, according to Noriza (2009),

Islamic banking products and services normally subscribe to fixed rate mechanism which

provides certainty, clarity and predictability. Home loan financing is stable due to flat

profit rate imposes on the financing.

Cost will influence the acceptance of consumer in choosing financial institution.

Research of Mooradian and Ryan (2011) shows that cost of transfer is another factor that

influence consumer and corporate to choose the financial institution. This cost includes

cost of electronic payments, charges on foreign exchange, drafts, cheques and trade and

export finance charges. The situation is same in Islamic financial institution. In the report

of Marimuthu (2010), the responders have chosen the Islamic financial institution due to

its low service charge and benefit. The evidence on Islamic is also supported by

Juwairiah (2011) in her research.

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Convenience is also a factor that consumer to accept the financial institution.

Convenience include factors the such as working hours of the financial institution,

availability ATMs, convenient branch locations and wide branch network convenience,

and the location (Haron, 2005). Kaynak and Whiteley (1999) observed that the

convenience of a bank was a primary motivation for customers in selecting a specific

institution. In survey of Riggall (1980), community in the United States of America

found that convenience of location to both home and work appeared to be the most

influential factor for bank selection by newcomers. Same with the Islamic financial

institution, convenience factor is also support by Juwairiah (2011) that customer to

choose Islamic financial institution. Islamic financial institution gives the optional for

customers either muslin or non-Muslim to choose what type of products that made them

convenience to have.

Awareness of a person to the financial institution influences their acceptance.

Public knowledge, product, marketing of financial institution affects the awareness of a

person to the financial institution (Marimuthu, 2010). Awareness also can influence by

friend or recommendation by a professional (Wangenheim, 2004). For Islamic Financial

institution, according to Haron (2005), public has support and acceptance towards the

Islamic banking. His report state that almost 100% of Muslims and 75% of non-Muslim

aware of the existence of Islamic bank in Malaysia. Through his report, he shows that the

evidence which Islamic bank is not meant for Muslim customers only. Same with the

result by the researcher, Dusuki (2007), customers has positive perception toward Islamic

financial institution. Most of the responder thinks that there is good potential for Islamic

banking.

Finally, religion affects the decision to choose the financial institution. Religion

rank third place in Marimuthu’s (2010) survey. Islamic financial institution is not accepts

by public due to the perception that Islamic banking is for Muslim only.

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Discussion and Findings

Customer Acceptance on Islamic versus Conventional Financial Institutions’

Products

There are extremely different between Islamic financial institutions and conventional

financial institutions. The most notable features are the products that introduced by

Islamic financial institution which are likely to those products of conventional financial

institutions. Some of the Islamic financial accessible to investors are including the

insurance, which known as Takaful, Islamic term deposits, mutual funds, treasury

deposits and the most popular Islamic equity, Sukuk. However, Islamic financial system

are based on the Shariah principles where the activities that involved interest, gambling

and speculative trading are strictly prohibited. Syariah is supporting and encouraging as

the activities are can develop the entrepreneurship, trade and commerce and bring in

developments of societal or benefits. In terms of Islamic finance, this principle has give

details about the ethical concepts of money and capital, the relationships between risk and

profit and the social responsibilities of Islamic financial institutions.

For conventional financial system, it is operate based on the debtor creditor

relationship between the depositors and the bank, and the relationship between borrowers

and bank. Interest is considered as the price of credit which may reflect the opportunity

cost of money. Conventional financial system is operate under the principles of

capitalism and transactions business by charging interest which may prohibited in Islamic

Law. Interest charge such as on lending activities have contributed as the main source of

revenue and funding for conventional financial institutions.

Interest paying or receiving on capital or Riba is the most popular aspect of

prohibition in Islamic financial system. Those fixed rate or predetermined rate on

maturity, amount of principal and the fluctuate investments performance are considered

as Riba and it is prohibited in Syariah principle. Conversely, it is encouraged by Islamic

Law as it is the rate of return or profit on capital and there is sharing of profits. In Islamic

financial institutions, there are no provisions to charge the extra money from defaulters.

Nonetheless, they are requiring disbursing a small amount of compensation and which is

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proceed toward to charity. Based on the principle, the profit is determined ex-post which

has symbolizes the creation of additional wealth through successful entrepreneurship.

Interest, determined ex-ante which is the cost that is accrued regardless of the outcome of

business operations and may create wealth even if there is business losses.

In conventional sense, the financial institutions such as bank has play the role as

money dealer, has reward the using money with interest under capitalism system, and

thus interest is the source of revenue and fund for financial institutions. For rewarding

depositors, they may get the returns and rewards of savings in the form of fixed interest

or predetermined returns. For long term depositors they may receive a higher return and

higher risks. For example a term deposit is has to deposit or saving in a financial

institution for a fixed period by depositors. They just can withdraw it as it is maturity or

noticed earlier by depositors after numbers of days. Depositors are earning interest on the

investments that made by the bank during their money is in the financial institution. Their

investments contributions are under guaranteed with the length of terms, amount of

deposits, and others conditions that agreed by consumers and banks.

Risk and uncertainty or gharar also not allowed in Islamic financial system. It is

forbidden on the selling of goods and services that the seller is not in position to convey

the contracts. He also cannot sell since the goods or services are not belongs to himself.

To avoid the risks, Islamic financial system has regulated that the price and nature of the

goods being transacted are defined in detail and have to be agreed by both parties. The

activities of sale such as the short sales or sales on margin are deeply disallowed. In

constraint, Islamic financial system has strongly recommended and provides some

guidance in order to eliminate consumers’ risk and uncertainty which has supported

within the Syariah principle. The system has advocating risk sharing between the

consumers and Islamic financial institutions. Their loss and profit may be share by

financial institutions and consumers which follow the term that agreed at the beginning of

agreement establish. Apart from this, Islamic financial system always promotes their

customers with entrepreneurship opportunities and discouraging the speculative behavior

among depositors. Customers who have chosen to use Islamic financial system are also

got the preservation of property rights.

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For conventional financial customers, they may experience with risks and

uncertainties which may be reflected by the market price movement. Interest rate risk is

the most uncertainty that may faced by a lot of consumers. Interest rates risk has apparent

in prepayment risks, reinvestment risks and re-pricing risks where each of it is related

with money market movements. Since conventional financial institutions are operate

under interest-based system and thus customers are getting assured with a fixed rate

return and have a predetermined rate of interest. For example the loan activities, there

will charge the interest on the loan payments as the revenues and fund sources for a

conventional financial institutions. Interest charge is a fundamental function for a

conventional financial institution as we can seen the service provided such lending

process, there is a compounding interest charge on the payback money depends on the

principle amount, length of loans and other related terms that agreed between banks and

customers. While consumers investing, conventional financial system may put on greater

emphasis on their return or their credit worthiness in order to last long their confidence to

trade with the financial company.

Customers’ satisfaction on each the Islamic financial institutions and conventional

financial institutions are important because this factor can help in facilitate development

of both system. It is depends on the availability of services, quality of services offered

and transactions cost as well which can manipulate consumers confidence level to invest

in a financial institution. According to Saad (2012) research, customers will most

satisfied with those financial institutions that has highly competency, friendliness, and

efficiency of staff. Both of the financial institutions has a good performance but there still

necessary for Islamic financial system to improve its service quality as customers

satisfaction is vital to affecting the competitiveness of an organization. There is also

necessary for Islamic financial system to make more improvement for providing and

upgrading facilities, customers’ services and quality of services. It is fact that Islamic

financial institutions have to put more emphasis in behalf to getting greater acceptance

among non-Muslims investors or customers. Some of the non-Muslims are not select

Islamic financial system as there are lack of understanding and information about it and

there are most of them have the prior perception that it is only reserved for Muslims.

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On the other hand, conventional financial institutions may face competitive as

there are upgrading and innovative design on Islamic financial system. Since they are

getting more information about Islamic financial system and more understanding on it,

there may be changes of decision by investors. It is threaten to conventional financial

system due to customer’s withdrawal from and disperse of money investments. It is

happened because the main objective is select for the most appropriate financial

institution to maximizing their wealth creditworthiness. This is because Islamic system is

provide services and products that free from interest charge, various risks and

uncertainties is lower as stated in above.

There are researchers examine that there are more acceptance through

conventional financial system than Islamic financial system because customers are more

knowledgeable with conventional terms and products introduced. Some of the consumers

have made selection on Islamic financial system due to their religious aspects. A religion

factor can be a strong driven for individual preference on selecting financial system. The

stronger commitment on religious may lead the more preferences on Islamic financial

system (Jorg and Kuehn, 2003). However, there still have circumstances that customers

prefer the conventional financial system than Islamic financial system. For example,

when the interaction between consumers and conventional financial institutions are closer

then the institutions will always be the location for invest their money for create wealth.

Besides that, when customers find out the term of Islamic financial system is difficult and

hard to understand or learn about it, they will stay away from it. For most of consumers,

they will make selection on what they most understand and more knowledge on it due to

prevent uncertainties and to avoid any loss on it. Compare with non-Muslims, Muslims

investors are more knowledgeable on Islamic financial concepts and this has show a

stronger preference on Islamic financial system.

Apart from these, the availability of services and products may affect decision on

particular financial institutions. For Islamic financial institutions, there are only the

Islamic products and services that offered while it is differ from conventional financial

institution, it has provided both Islamic products and conventional products and services.

Since conventional financial system can served with various types’ products and services,

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it is the priority and underlying for consumers to trading in conventional institutions.

Instruments that used in Islamic financial system are namely using Islamic terms and

there also available in conventional financial system with the common use term name.

Fixed income investments such as bond are known as Sukuk in Islamic financial system.

It is an investment certificate which a proportion customers interest in a pool of assets

that yield to income and capital returns. The returns from the assets will pass to Sukuk

holders, the investors.

Deposits or savings are contributions of savers for getting rewards regardless it is

an Islamic or conventional financial institutions. Under conventional financial system, the

reward is fixed and there may predetermine interest rates based on principle amount. For

Islamic financial system, the reward for customers is variable and is through the concept

Musharakah and Mudarabah. In term of risks, it is higher risk on the long term deposits

than short term deposits in conventional deposits. It is same with Islamic financial system

but there will be profit or loss sharing between depositors and financial institutions. There

are differences between both financial system of deposits which are risk sharing and

rewards. For conventional financial system, the risk is deriving from the institutions itself

and it can own the rest of reward after give out the fixed rate for depositors as agreed. It

is totally diverse from Islamic financial system where the risk and reward are sharing

between depositors and financial institutions. Reward for depositors is always depending

on the outcomes from investments made by Islamic financial institutions. The greater

outcomes of investments bring in higher rewards for their depositors (Hanif, 2011).

Financing is a popular services provided by both financial system where it is go

through Murabaha under Islamic financial system. The purpose of both financial

institutions provides financing services is for gaining rewards from a prolific channel.

Interest payments on loan is seem like the transactions cost, processing fees for an

institutions. Under conventional financial system, financing has served as the credit

facility that address to small and medium business or industry for return. There will be

charges of fixed rate of interest on the credit which is prohibited by Islamic financial

system. As stated, there are derivation of various loans which categorize into short term

loans, overdrafts and long term loans. Within the Islamic principle, it is a cost-plus

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financing which used for financing assets and trading activities that the deferred

payments from customers are allowed. To achieve the requirement assets from customers,

Islamic financial company have to start doing business but cannot provide loans services

that involved interest charge. Conventional loans are preferable selection even fixed rate

charge on because it is more simply and easier to get the loan as the terms agreed by

customers.

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Islamic and Conventional Financial Institutions Instruments and Activity

Islamic finance had been improved from traditional instrument to modern instrument.

The most different between Islamic Finance and Conventional Finance are on the interest

(riba) factor. Islamic finance instruments are based on interest free while conventional

finance is based on current market interest free. The term interest free brings the mean of

the prohibition of paying or receiving interest on capital in Islamic Finance. Any positive,

fixed, predetermined rate that tied to the maturity and amount of principal is considered

riba. Sharing of risk and return are one of the different between Islamic finance and

conventional finance.

The most commonly used instruments in Islamic finance are Murabahah,

Mudarabah, Istisna’a, Ijara, Musharakah, Sukuk and etc. Here, the characteristic of some

of the most used instrument in Islamic finance will be introduced:

� Murabahah

Murabahah is one the most commonly used profit sharing method in trade financing.

Murabaha contract has been applied in Islamic banking business in many ways including

property, vehicle, personal financing and corporate financing. A murabahah is a sale on a

cost-plus basis where payment of the price including mark-up is deferred to a later date.

According to Chong (2009), murabahah is a contract of sale and purchase at a

profit margin between the supplier and the purchaser of the good. The cost and profit

from the transaction must be known in advance and agreed by both parties to the contract.

While Rosly (2011) mention that from a financing perspective, a murabahah contract in

general implies a sale based on installment payments.

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Source: Academy for International Modern Studies

It is an investment fund where one party will provides the capital while the other

party will provides the management. Profit sharing will be agreed in an early stage and

the loss is bear by the provider of the funds alone. The parties that provide capital are not

allowed to interfere in the management of business. According to Obiyathulla (1997), this

partnership with the financier as the silent or sleeping partner but the profits derived from

the business or investment are shared by the two parties according to a predetermined

profit-sharing ratio.

� Istisna’a

According to the Islamic Development Bank

party undertakes to produce a specific thing which is possible to be made according to

certain agreed-upon specifications at a determined price and for a fixed date of delivery.

It is an instrument where the contract can be deal by

existence at that time. Medium term financing is provided to meet the financing

requirement for manufacturing, supply, or sale if identified goods.

Source: banking info

the Islamic Development Bank (2002), Istisna’a is a contract whereby a

party undertakes to produce a specific thing which is possible to be made according to

upon specifications at a determined price and for a fixed date of delivery.

It is an instrument where the contract can be deal by referring to something that not in

existence at that time. Medium term financing is provided to meet the financing

requirement for manufacturing, supply, or sale if identified goods.

Step 1

You supply funds to the bank after

agreeing on the terms of the

Mudharabah arrangement.

Step 3

Business may make profit or

incur loss.

Step 2

Bank invests funds in assets or

in projects.

Step 5

Any loss will be borne by you. This will reduce

the value of the assets/ investments and hence,

the amount of funds you supplied to the bank.

Step 4

Profit is shared between you and your

bank based on a pre agreed ratio.

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Source: banking info

is a contract whereby a

party undertakes to produce a specific thing which is possible to be made according to

upon specifications at a determined price and for a fixed date of delivery.

referring to something that not in

existence at that time. Medium term financing is provided to meet the financing

You supply funds to the bank after

agreeing on the terms of the

arrangement.

Business may make profit or

Bank invests funds in assets or

Any loss will be borne by you. This will reduce

the value of the assets/ investments and hence,

the amount of funds you supplied to the bank.

Profit is shared between you and your

d on a pre agreed ratio.

� Ijara (Leasing)

According to Lewis (n.d.),

technically it relates to transferring the usufruct of a particular property to another person

on the basis of a rent claimed from him. It is similar with conventional lease but in

Islamic rules. The difference between sale (

vis transfer of the usufruct (

ownership of the lessor and only its usufruct is transferred. In a simple word, Ijara is a

contract under which the financial in

required by its client for a rental fee.

Example:

Lewis (n.d.), Ijara literally means ‘to give something on rent’, and

technically it relates to transferring the usufruct of a particular property to another person

on the basis of a rent claimed from him. It is similar with conventional lease but in

Islamic rules. The difference between sale (bay) and ijara is transfer of ownership

transfer of the usufruct (manfa’a). That is, the leased property remains in the

ownership of the lessor and only its usufruct is transferred. In a simple word, Ijara is a

contract under which the financial institution buys and leases out an asset or equipment

required by its client for a rental fee.

Source: banking info

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give something on rent’, and

technically it relates to transferring the usufruct of a particular property to another person

on the basis of a rent claimed from him. It is similar with conventional lease but in

is transfer of ownership vis-a-

). That is, the leased property remains in the

ownership of the lessor and only its usufruct is transferred. In a simple word, Ijara is a

stitution buys and leases out an asset or equipment

Source: banking info

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Source: banking info

Step 2

You ask the bank for Ijarah of the car, pay

the deposit for the car and promise to lease

the car from the bank after the bank has

Step 3 Bank pays the seller for the

Step 1

You pick a car you would like to

Step 4

Seller passes ownership of the car to the

bank.

Step 7

At end of the leasing period, the bank sells the car to

you at the agreed sale price.

Step 5 Bank leases the car to you.

Step 6 You pay Ijarah rentals over a period.

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� Musharakha

A Musharakha is a contract among two or more parties, each contributing some of their

capital in a joint commercial venture. Profit ratios have to be specified in advance but in

case of a loss, it must be shared in proportion to the capital sums contributed (Lewis, n.d.).

In Musharakha, all parties have the right to participate in the business run.

� Sukuk (Bond)

Sukuk is an investment certificate (bond) that represents a proportionate interest in a

well-defined pool of assets that yield income and capital returns. Usually set up through

the conventional securitization process, with a special purpose vehicle acquiring the

assets, the returns from the assets are passed to sukuk holders (investors). Many

governments had used this method to raise funds for infrastructure (Tayyebi, 2008).

Compare to non- Islamic bond or debenture, the bondholder will get return for providing

capital in the form of interest, while the sukuk holder will have a proprietary interest in

the assets which are being financed but did not get any interest (riba).

According to Hanif (2011), conventional institution is gaining revenue through

lending and accepting deposit, interest that charged on the investor or customer is

their major drive of operation. Instrument that are widely used in conventional

financing are such as: mutual fund, mortgage, insurance, pension fund, credit cards,

personal loans and etc.

� Mutual Fund

According to Debasish, a mutual fund is a trust that pools the savings of a number of

investors who share a common financial goal. Investor will get the issued units according

to the amount of money that they have invested. They are known as unit holders. All

investor money will be collected and invest in several different instruments such as

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shares, debentures and other securities. The income earned through these investments and

the capital appreciation realized is shared by its unit holders in proportion to the number

of units owned by them. While the Canadian Securities Administrator (2006) defined that

mutual fund as a pool of money that is managed on behalf of investor by a professional

money manager and stocks, bonds or other securities will be invest by the manager

according to the objectives of establishing the fund. For return, investor will get units or

shares that represent their proportion share of the pool of fund. There are variety of

mutual fund such as money market fund, fixed income funds, growth or equity funds,

balanced fund, index funds and etc.

� Mortgage

A mortgage loan is a loan secured by real property through the use of a mortgage note

which evidences the existence of the loan and the encumbrance of that realty through the

granting of a mortgage which secures the loan. A mortgage is a loan to finance the

purchase of your home. The home is collateral for the loan, which is also a legal contract

that the debtor will sign to promise of paying the debt, with interest and other costs,

typically over 15 to 30 years. If the debtor fail of can’t afford to pay the debt, the lender

has the right to take back the property and sell it to cover the debt. To repay the debt,

debtor are required to make monthly installments or payments that typically include the

principal, interest, taxes and insurance, together known as PITI (Perkins, 2012).

� Insurance

Commercial insurance are almost similar with Islamic insurance (takaful). According to

Khan, insurance is a risk transfer mechanism whereby the individual or the business

enterprise can shift some of the uncertainties of life on the shoulder of the other. Life

insurance is one of the oldest financial services provided. Insurance companies offer their

customer a hedge against the risk of financial loss that follows death, disability, ill health

or retirement. Policy holders receive risk protection in return for the payment of policy

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premium that are set high enough to cover estimated benefit claims against the company,

all operating expenses, and a target profit margin. There are many kind of insurance that

provided such as: education, health, life, retirement, purchase of home and etc.

� Pension Fund

Commercial pension fund are protects individuals and families against loss of income in

their retirement years by allowing workers to set aside and invest a portion of their

current income. A pension plan places current savings in a portfolio of stocks, bond, and

other assets in the expectation of building an even larger pool of funds in the future. In

this way, the pension plan member can balance planned consumption after retirement

with the amount of savings set aside today.

According to Zimbio (2009), although these financial instruments are comparable

to conventional financial products in terms of the basic mechanism underlying their

creation, there are unique religious conditions that Islamic financial products must be

able to meet. Shariah Law permit activities when the lender share in profits or losses

from the capital that lent out, making money by money is not allowed. Incomes on an

Islamic financial instrument are prohibited getting earning through unethical (or non-

Islamic) activity. All goods and services that is unethical such as pornography, lending

for constructing a casino (gambling), trading of alcohol and etc are prohibited by Islam.

The earning of interest on contracts of loan (or Riba) is also prohibited, even if interest on

loans happens to be the backbone of conventional financial instruments. Islamic law

further prohibits debt restructuring that is based on compensations; uncertainty, risk or

speculation (Gharar) in contracts; gambling and games that are based on chance (Qimar).

22

Why Islamic Financial Institutions Are Preferable?

Islamic financial institutions have operated almost similar with conventional financial

institutions. They also operated essential function as conventional bank. The different is

Islamic financial institutions activities require in the direction of with Islamic law or

Syariah rules. This is also become a benefit in Islamic financial institutions. Because of

following in Islamic law, Islamic financial institutions have perceived as socially

responsible investment. They characterized by ethical norms and social commitments.

Islamic financial institutions operation is integrated with ethical and moral value.

Activities with unethical or unacceptable services are restricted in financing of Islamic

financial institutions. For example, finance in liquor, tobacco and usury activity will not

be accepted in Islamic financial institutions finance. It is because those activities have

conflict with moral value by Islam. Nowadays, ethical issues are being concern in many

sectors. This growth of ethical environment gives competitive advantages to Islamic

financial institutions. They foresee that by communicating effectively about their social,

environmental and economic contribution, they can strengthen their brand, enhance their

corporate reputation with customers and suppliers, and attract and retain a committed and

skilled workforce (Turban and Greening, 1997). This can raise customer acceptance as

well. Hence commitment in ethical and social responsibility will lead to better

performance in terms of profitability.

Islamic financial institutions are remaining the core principle of justice in finance.

Justice often means equal treatment and the equal distribution of advantages and burdens

(Kamali, 2002). Profits sharing are emphasizing among financier and beneficiary in

Islamic banking. Even there is profit or loss, Islamic financial institutions also distributed

fairly among the two parties. This system will contribute to a more fair distribution of

wealth. Furthermore, Islamic financial institutions have different with conventional

financial institutions for the relationship between bank and customer. They recognize

customers as investment partner of their business instead of borrower. Unlike

conventional financial institutions with provided fixed interest rate, Islamic banking gives

higher return to depositors if there are high profitable investments. Profit or losses

23

generated from investment will be shared based on the pre-agreed ratio between bank and

the entrepreneur (Marimuthu, 2010).

The principle of Islamic financial institutions include of commitment in socio-

economic justice as well. They have committed to contribute in the achievement of socio-

economic development. Islamic financial institutions have put effort in eliminate

economic ills such as mass poverty and economic injustice. For example, Islamic

financial institutions have provided education scholarship for student and contribute

funds to poverty. Those funds to poverty are usually come from zakah, which is someone

given a fixed portion of their prosperity to charity. This, we can say that Islamic financial

institutions play a significant on socio-economic role that is beyond profit maximization

of their shareholder.

Why Conventional Financial Institutions Satisfied?

Conventional financial institutions are considered as more profitable because it includes

many types of investment and gain earning from interest rate. Islamic financial

institutions are working with Islamic law follow by many restrictions. Islamic law stated

that investments should only support products that are not forbidden. Wealth can only be

generated by lawful trade and investment. For instance, Islamic law prohibits riba. They

prohibited make money from money. Borrowers of Islamic financial institutions only

have to pay fixed repayment rates. Even borrowers can enjoy benefit in fixed rates, but

financial institutions are not enabling to receive profit in interest rate. Besides that, moral

unacceptable services also restricted in financing of Islamic financial institutions. Islamic

financial institutions would not accept transaction in property loan with purpose to

construction of a casino. On the other sides, conventional financial institutions are

interest base oriented. It defines money as a medium of exchange whereby there is no an

indicator to evaluate a thing. Due to this, conventional financial institutions enable to

earn profit from the margin between borrowing and lending rate of interest. They charge

fixed or floating interest rate to depositors. Distinct in interest rate have give advantage to

24

conventional financial institutions whereby customer with profit-motivated will more

interest on conventional financial institutions.

Regulation in Islamic financial institutions is more tight compare with

conventional financial institutions. Islamic financial institutions are regulated by Syariah

Supervisory Board (SSB). Shariah Supervisory Board members have responsibility to

ensure the takaful operations, supervise its development of Islamic insurance products,

and determine the Shariah compliance of these products and the investments. Each

Islamic bank will be supervised by SSB to make sure their transaction is under Syariah

requirement. This has narrowed the scope of Islamic banking. On the other side,

conventional financial institutions have no exist such board. Conventional financial

institutions enable to conduct its business operation as long as they are do not violated the

law the guideline issued by Bank Negara Malaysia (Khir, Gupta, & Shanmugam, 2008).

In other word, conventional financial institutions is aims at maximize profit without any

restriction.

Involve transaction in conventional financial institutions has not necessary to bear

risk like Islamic financial institutions. The main different when engage in any transaction

are conventional financial institutions have elimination of risk while Islamic financial

institutions is bearing the risk among two parties. Conventional financial institutions have

guaranteed all of their depositors. Depositors will only benefit for interest and not for

their liability. For Islamic financial institutions, it promotes risk sharing between provider

and user of fund. If the depositor is based on principle mudarabah, they need to bear on

Islamic financial institutions liability. Other than that, conventional financial institutions

have used several derivatives such as future option and forward option to hedge risk in

transaction. This is prohibited in Islamic financial institutions because it recognizes as

gamble activity and believe to violating Gharar principle. Marimuthu (2010) stated that

contracting parties in Islamic banking should have perfect knowledge of the values

intended to be exchange in the transaction and the terms of the contract should be

well defined and without ambiguity. Uncertainly is not allowed in Islamic financial

institutions. This also implies Islamic banking is used to bear higher risk than

conventional financial institutions.

25

Another reason is lack of awareness of Islamic financial institutions compare to

conventional financial institutions. According to Bank Negara Malaysia, current global

Islamic banking assets and assets under management have reached USD750 billion and is

expected to hit USD1 trillion by 2010. Despite the growth of Islamic financial institutions,

there are still many people either Muslim or non-Muslim not familiar with Islamic

financial institutions. The biggest challenge to promote Islamic financial institutions in

the country is lack of awareness of Islamic banking concepts among general public

(Saleemullah, 2010). Many people did not really know to differentiate between Islamic

financial institutions and conventional financial institutions. For conventional financial

institutions, customer had familiar with its system even there is different system in

different conventional bank. In Malaysia, number of conventional bank is still more than

Islamic bank. In Malaysia, there are 16 Islamic banks while commercial banks have 25 in

number (Bank Negare Malaysia, 2012).

26

Licensed Islamic Bank in Malaysia

Islamic Banks

No. Name Ownership1

1 Affin Islamic Bank Berhad L

2 Al Rajhi Banking & Investment Corporation (Malaysia) Berhad

F

3 Alliance Islamic Bank Berhad L

4 AmIslamic Bank Berhad L

5 Asian Finance Bank Berhad F

6 Bank Islam Malaysia Berhad L

7 Bank Muamalat Malaysia Berhad L

8 CIMB Islamic Bank Berhad L

9 Hong Leong Islamic Bank Berhad L

10 HSBC Amanah Malaysia Berhad F

11 Kuwait Finance House (Malaysia) Berhad F

12 Maybank Islamic Berhad L

13 OCBC Al-Amin Bank Berhad F

14 Public Islamic Bank Berhad L

15 RHB Islamic Bank Berhad L

16 Standard Chartered Saadiq Berhad F

Sources by Bank Negara Malaysia 2012

1 L represent local Islamic bank and F represent foreign Islamic bank.

27

Conclusion

In this study, Islamic and conventional financial institutions have being more developed

and competitive nowadays. Instead, their development was due to the increasing in the

numbers of customers which determine their empowerment in the finance industry. Thus,

we can conclude that customer acceptance has significant effect on the financial

institutions comprises of Islamic and conventional financial institutions. In addition,

customer acceptance which represents their perception of risk, interest rates offered by

financial institutions, quality of services and others. As we seen, there is a positive

relationship between customer acceptance and products offered by financial institutions.

Also, there are few factors that differs Islamic financial institutions from conventional

financial institutions, mainly on the instruments and activity of both financial institutions.

Moreover, both Islamic and conventional financial institutions do incur benefits to their

customers. In our opinion, we should encourage people to involve in both financial

institutions as they possibly may compensate with better reimbursement. Well, customer

must be acquainted with their acceptance or perception in order to determine their

products selection for example, expectation on future interest rates of the products. Last

but not least, this study is very good learning course for our group because we

acknowledged deeper understanding about financial institutions.

28

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