Article : The Effect Of The Islamic Financing Modes On The Profitability Of Commercial Banks In Kenya

Title

The Effect Of The Islamic Financing Modes On The Profitability Of Commercial Banks In Kenya

Author

Roba, Adan Abdi Boyante, Mohamed, Abdi

The Islamic banking system has gained momentum worldwide. Islamic banking refers to financial services that meet the requirements of the Shari’ah or Islamic law. Also called Islamic finance or Islamic financial services, Islamic banking represents the practical application of modern Banking concepts within the overall development of Islamic Economics (Abdeen & Dale, 1984). The Shari’ah prohibits the payment of fees for the renting of money (Riba or Interest) for specific terms, as well as investing in businesses that provide goods or services considered contrary to its principles (Haraam) such as gambling, pornography, pork or alcohol. The Islamic financial system promotes the concept of participation in a transaction backed by real assets, utilizing the funds at risk on a profit-and- loss-sharing basis. The two basic financing modes for Islamic banking include Profit-and-loss-sharing (PLS), also called participatory modes, i.e., Musharakah and Mudarabah and Purchase and hire of goods or assets and services on a fixed-return basis, i.e., Murabaha, Istisna'a, Salam and Leasing. The main objective of this study was to evaluate the effect of different Islamic financing modes on profitability of commercial banks in Kenya. Specifically, the study looked at the contribution of different Islamic financing modes to return on assets of banks offering Islamic financial services. The study empirically evaluates the link return on assets of an Islamic banking portfolio in a commercial bank over a period of five years (2008-2013).
From the analysis, it is evident that Murabaha and Musharaka financing modes are the largest contributor to an Islamic banks portfolio and profitability. Other financing modes form a very small portfolio within Islamic banks i.e. Tawaruq, Ijara and Mudaraba whereas others such as Istisna'a, Salam and Bai bi-thamin ajil have never been used as modes of Islamic financing in Kenya. The analysis always shows significant relationship between return on assets of an Islamic bank and Islamic financing modes. However, there is no multi-Collinearity between the different financing modes. The study therefore recommends that more financing modes should be introduced and pursued to increase uptake of Islamic financial services. Shariah Boards of respective commercial banks should look into this. Central Bank of Kenya should also hasten the process of structuring regulations and markets for Islamic financial instruments such as Sukuk since Islamic banks are locked out of treasury bills and bonds which are considered non-compliant to Islamic banking and financing Shariah regulations.

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