SOKOINE UNIVERSITY OF AGRICULTURE

FACULTY OF AGRICULTURE

DEPARTMENT OF AGRICULTURAL ECONOMICS AND

AGRIBUSINESS

NAME: PETER, PHILEMON

REG NO: AEA/D/08/T.9788

A SPECIAL PROJECT PROPOSAL

TITLE: UNDERSTANDING THE CUSTOMER’S REACTION ON

ISLAMIC BANKING IN TANZANIA (A CASE STUDY OF KCB AND

NBC-MOROGORO)

A SPECIAL PROJECT PROPOSAL TO BE SUBMITED FOR THE

PARTIAL FULFILMENT OF THE REQUIREMENT FOR DEGREE

OF THE B.Sc. AGRICULTURAL ECONOMICS AND

AGRIBUSINESS OF THE SOKOINE UNIVERSITY OF

AGRICULTURE FOR THE YEAR 2010/2011.

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SUPERVISOR: Felix Nandonde.

ContentsCHAPTER ONE..................................................................................................................11. Introduction......................................................................................................................1

1.1 Background Information............................................................................................11.2 Significance of the study..........................................................................................41.3 Problem Statement.....................................................................................................51.4 Objective of the Study...............................................................................................51.5 Specific Objectives....................................................................................................51.6 Research Questions....................................................................................................5

CHAPTER TWO.................................................................................................................62. Literature Review............................................................................................................6CHAPTER THREE...........................................................................................................113. Methodology..................................................................................................................11

3.1 Description of the Study Area.................................................................................113.2 Research Design......................................................................................................113.3 Sampling Procedures and Sample Size....................................................................113.4 Data Collection........................................................................................................123.4.1 Primary Data Collection.......................................................................................123.4.2 Secondary Data Collection...................................................................................123.5 Data Collection and Analysis..................................................................................123.6. Schedule of Activities.............................................................................................123.7. Budget of Research.................................................................................................13

REFERENCES..................................................................................................................14

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CHAPTER ONE

1. Introduction1.1 Background InformationBanking is the business activity which involves acceptance and safeguarding of money

owned by other individuals or entities, and then lending out this money in order to earn

profit.

The Tanzania banking sector embarked on a plan for financial liberalization in 1992 in

order to sustain its economic growth. This has been accomplished through the

mobilization of financial resources as well as by increasing competition in the financial

market and by enhancing the quality and efficiency of credit allocation (Tanzania Invest,

2010). As a result of the liberalization, the banking sector in Tanzania has been booming,

particularly over the last few years, where as at 31st December 2009, the banking sector

was composed of 40 banking institutions, 27 of which were fully-fledged commercial

banks and 13 financial Institutions. Out of the 40 banking institutions, 4 were fully owned

by the Government and the rest were privately owned. With the exception of 10 banking

institutions, which were jointly owned by local and foreign investors, 16 were 100%

locally owned and 14 were 100% foreign owned. Total number of operating

branches/agencies nation-wide was 430, of which 142 were in the commercial city of

DarEsSalaam(DBSReport,2009).

Directorate of Banking Supervision (DBS, 2009) reports that in Tanzania, 41% of total

capital, sector’s total assets and gross loans deposits are in hands of three banking

institutions, namely CRDB Bank (17% total assets, 19% total loans 19% deposits and

14% of sectors Total Capital), National Microfinance Bank (NMB Tsh. 1,483.23 billion)

and National Bank of Commerce (NBC Tsh.491.99 billion). Local banks primarily

service local customers while foreign banks tend to operate as subsidiaries of large

groups, such as Citigroup and Barclays, using strategies oriented to the international

market. As a consequence, foreign banks focus on international customers and national

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clients who prefer to keep their deposits in foreign currencies (Tanzania Invest, 2010).

There are four categories of banks, oriented towards different markets and clientele

operating in Tanzania: local private banks, regional banks, international banks and

multinational banks (TBA, 2010). Overall performance of the banking industry in

Tanzania is very positive where the banking industry remained adequately capitalized

with total capital recording an increase of 24.33% at the end of 2009. The industry’s

assets increased by 17.38%, with the ratio of earning assets to total assets of 75.95%.

Total funding of the industry recorded an increase of 16.43%. The funding structure was

mainly composed of deposits which accounted for 90.83% of total funding. Return on

assets was 3.20% whereas return on equity was 18.32% (DBS Report, 2009). The

liquidity position of the banking sector is generally satisfactory and there are appealing

opportunities for new comers to the banking sector (Tanzania Invest, 2010).

Islamic banking refers to a system of banking or banking activity that is consistent with

the principles of Islamic law (Sharia) and its practical application through the

development of Islamic economics. Sharia (The Quran, Surah 2, Virse 275) prohibits the

payment or acceptance of interest fees for loans of money (Riba, usury), for specific

terms, as well as investing in businesses that provide goods or services considered

contrary to its principles (Haraam) forbidden (BOT, 2009).

The idea of Islamic banking goes back to as early as the 7th century, but it was only

commercially implemented in the last century (De Jonge, 1996). As the end of the

colonial era approached, some of the newly formed and independent Muslim states

reassessed their economic policies on the basis of Shariah principles. This marked the

beginning of the present-day revival of Islamic finance. Small scale limited scope

interest-free institutions were unsuccessfully tried in the mid-1940s in Malaysia and

1950s in Pakistan (Gafoor, 1996). From 1946 onwards, research by Muslim scholars

gradually produced principles for banking practices that were likely to be acceptable to

the banking and Islamic communities. The first successful application of Islamic finance

was undertaken in 1963 by Egypt ’ s Mit Ghamr Savings Bank, which earned its income

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from profit-sharing investments rather than from interest. By the 1970s, the push for

Islamic finance had gained momentum (Algaoud & Lewis, 2001).

In 1973 the conference of foreign ministers of Muslim countries decided to establish the

Islamic Development Bank with the aim of fostering economic development and social

progress of Muslim countries in accordance with the principles of Shariah. This marked

the first major collective step taken by Muslim countries to promote Islamic finance

(Saeed, 1996).

At this moment there are over 300 Islamic financial institutions in more than 75 countries

managing funds over $500 billion in assets. Furthermore, over the last decade, the Islamic

banking industry experienced a growth of 15-20% per annum (Bose & McGee 2008).

These institutions are not only operating in the Muslim countries but as well in other

countries where Muslims are a minority, for example, in the United States, Great-Britain,

Australia, China and France. Furthermore the Islamic banking products are not solely

used by Muslims but as well by people with other religious backgrounds. The compliance

with principles that forbid ambiguity, exploitation, deceit and fraud is appealing to many

non-Muslims as well (Venardos, 2006).There has been large scale growth into the Islamic

banking in many countries around the world during the last thirty (from 1980’s) years as

the performance growth is influenced by factors including the introduction of broad

macroeconomic and structural reforms in financial systems, the liberalization of capital

movements, privatization, the global integration of financial markets, and the

introduction of innovative and new Islamic products. Islamic finance is now reaching

new levels of sophistication (Cornelisse and Steffelaar, 2008). However, there has been

presence of Islamic financial system with its identifiable instruments and markets are still

very much at an early stage of evolution. Experience shows that, development of Islamic

banking is an initial stage of an Islamic financial system. Most of the countries in East

Africa including Tanzania are in this initial stage of development of Islamic financial

system. In 2007-2008 Bank of Tanzania (BOT) received a number of applications from

local and international promoters expressing interest to establish Islamic banking

windows or full fledged Islamic banks, where then the central bank accepted the system

to operate in the country. But in Islamic banking rules apply which differ from those in

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traditional banking as there consequences of Islamic banking for financial operations as

there goes in examining in several Islamic procedures as being introduced by Tanzania's

banking sector ever since the year 2008. In Tanzania there are three banks that offer

interest free Islamic banking services, involving Kenya Commercial Bank (KCB) which

was the first to launch such product in 2008, followed by Stanbic Bank and National

Bank of Commerce (NBC) which launched their services in April and May 2010

respectively. (BOT, 2008).

It should be noted that the Banking Act 2006: specifically prohibits a bank from

acquiring or leasing any fixed assets, “except where it is necessary for the purpose of

conducting its business as a bank or financial institution” and stipulates that the BOT

shall prescribe limits under which a bank or financial institution shall invest in fixed

assets; and requires a bank to dispose as soon as is practicable any property that it

acquires or takes possession of as a result of enforcing a security interest (BFIA 2006). A

bank may carry out “other activities determined by the BOT to be customary banking

practices or incidental to the banking business”. It is not clear whether the BOT considers

Islamic finance to be “customary banking practices” (involves the marketing and sale of

investment products and services, including the sale of securities and various funds)

(DBS, 2008). Therefore, an Islamic finance structure may be entered into by a bank or by

a separately incorporated subsidiary of the bank with the consent of the BOT. (Ringo,

2008)

1.2 Significance of the studyThis study is therefore important as it will provide baseline information on how the bank

customers especially those who are Muslims react toward the system of Islamic banking

due to fact that interest is prohibited according to Islamic laws. It will also provide

information on how the clients are benefiting from such system like those who are in

conventional banking and how the banking sector is benefiting. Apart from that also the

study will provide information on impact of such banking system on the economy of the

country since we know that Tanzania is poor country and how such system can help in

improving an economy and standards of living of people.

Also the study will contribute to social and economic understanding on banking systems

and help the clients and other citizens to make decisions on which system between

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conventional banking and Islamic banking is suitable for them to follow so as increase

their incomes.

1.3 Problem Statement

The main features of Islamic banking are the sharing of profit and losses, a prohibition of

interest, no speculation or gambling, fair and transparent dealing, fair and just

employment policies, and lastly no business should be done with unethical companies or

industries (Sijbirg, 2010). Researches have been undertaken about this subject; however,

no research has clearly investigated the benefits and drawbacks of Islamic banking from

the consumer perspective (Malik, 2010). For a risk-averse consumer it is not

remunerative to switch from a conventional bank to an Islamic bank. In contrast, a risk-

seeking depositor can reap extra return when opening a deposit account at an Islamic

bank. Sijbring (2009) found out that a consumer can generate a greater risk-adjusted

return when investing in Islamic indexes. These findings suggested that Islamic banking

is, above all, interesting for the Muslim and non-Muslim consumers who wishes to bank

according to the rules of the Shariah and besides, Islamic banking is attractive for the risk

seeking depositor or for the investor who wishes to earn greater risk-adjusted returns on

his investments.

Islamic Finance Outlook (2008) argues that, Muslim investors have become increasingly

aware of Sharia complaint nature and profitable investments of Islamic Finance. This has

led to create a tremendous demand for Sharia products. Therefore, demand rather than

supply is driving the development of Islamic products and services, fulfilling the

prediction of pioneers of modern Islamic banking.

Most of the customers join the Islamic banking service through being attracted by its

religious considerations. One of the major challenges facing Islamic banking is the fact

that it is considered by most of non –Muslim customers as faith based banking practice.

This might lead to others having perception of Islamic finance being tainted with terrorist

funding and home of anti-money laundering (Schoon, 2008).

Consumers may think Islamic banking is one of the ways of commercial banks to

generate super profits since it is interest free to the customer, but how is the case of bank

itself? Difficulty may come to the customer who knows that commercial banks are using

that money to provide loans to the lenders, he/she might decide to argue whether those

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loans are also interest free or not. This might be one of several issues the customers do

not understand. In this regard policy makers can not ignore the role of developing an

environment where Islamic banking can offer a suitable response to customers demand

for Islamic products. Therefore this research will seek to address how the clients have

been reacting toward this new banking system through understanding of service.

1.4 Objective of the StudyThe main objective of this study is to examine the awareness of Muslim and non-

Muslims customers of Islamic banking in Tanzania, particularly profit-and-loss sharing

agreements through reaction toward it; to assess its performance based on the latest

financial data available, and to offer suggestions for improvement based on the

experience of the authors and the evidence provided by literature studies in research

areas.

1.5 Specific Objectivesi. To understand the reaction of Muslim and non-Muslim customers on the

product

ii. To identify influence of reference group on the selection of the products.

1.6 Research Questionsi. Is there any aspect of Islamic banking in Tanzania that implies to positive or

negative reaction from the clients?

ii. In which way the clients and the banking institutions have an influence on

selection of the products?

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CHAPTER TWO

2. Literature ReviewIslamic financing is based upon the principle that the use of Riba (interest) is prohibited

(Gerrard and Cunningham , 1997 ). This prohibition is based upon Shariah ruling. Since

Muslims cannot receive or pay interest, they are unable to conduct business with

conventional banks (Jaffe, 2002). To service this niche market, Islamic financial

institutions have developed a range of halal interest-free financing instruments that

conform to Shariah ruling, and therefore are acceptable to their clients (Rammal, 2004).

The concept of interest-free financing was practiced by Arabs prior to the advent of

Islam, and was later adopted by Muslims as an acceptable form of trade financing. While

the system had been used on a small scale for centuries, its commercial application began

in the 1970s (Naser & Moutinho, 1997). Since then Islamic financing has experienced

worldwide acceptance, and by early 2003 there were at least 176 Islamic banks around

the world, with deposits in excess of $ 147bn (Ghanadian & Goswami, 2004). While

Islamic financing has become popular in both Muslim and non-Muslim countries, the

system has not achieved widespread success among Muslims and non-Muslims in some

of African countries. The main reason for this has been the lack of awareness about the

principles of the system among the population (Jalaludin, 2002).

A few surveys have been conducted previously to understand the attitudes of Muslims

and non-Muslims toward doing business with Islamic bank and its products. These

provide useful background information for this research, though they are not directly

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related. The findings of Haron et al. (1994), Gerrad and Cunningham (1997), and Metawa

and Almossawi (1998) arrived at similar conclusions: that the majority of respondents

would consider establishing a relationship with an Islamic bank if they had substantial

understanding of its operation. Also, they revealed that Muslims were more aware of the

existence of Islamic banking than non-Muslims, and that there was no differentiation in

bank selection criteria between Muslims and non-Muslims.

In 2002, Ahmed and Haron conducted a similar study focused on the perceptions of

Malaysian corporate customers toward Islamic banking products and services. A majority

of the respondents said that the main reasons why people select Islamic banking products

are based equally on religious and economic considerations. When asked about the

marketing of the products, a majority found it lacking.

At the World Islamic Banking Conference in 2004, a session was held on international

media perceptions of the Islamic finance industry. Khalid Almaeena (2004), editor-in-

chief of Arab News, said, “media coverage of Islamic banking has been at best

promotional and erratic, and at worst hostile and undermining.” During the same session,

James Zogby (2004) expanded upon his previous work, explaining that in the present

climate, the onus is on Islamic bankers to engage with the media and become advocates

for business in the region (WIBC, 2005) The lead panelists at the conference came to

their own general consensus on the state of the industry. They felt that the industry had

grown up and matured, but that in order to continue this growth more investment in

product development was needed as a way to widen the reach of the industry, increase

human capital, and improve reporting.

Hanson (2000) suggested that organizations should improve their services to meet the

customers' wants and requirements. In another study, service quality is considered very

important indicator towards customer understanding and satisfaction by delivering

quality services according to customers' expectations. (Spreng and Machoy, 1996).

Gounaris et al. (2003) explored the service quality in Greek banking industry and found a

varied influence of each dimension of service quality on customer satisfaction. It is

reported that service quality is important for differentiation to compete in the market and

retain the customers for long-term benefits (Curry and Penman, 2004). Service quality

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has positive influence to customer’s and financial performance (Duncan and Elliott,

2004). However, customer’s understanding of changing needs and expectations is an

essential prerequisite for the financial sector (Joseph et al., 2005). Customers’ perception

of service quality in developing countries is significantly different from the perception of

bank customers in developed countries like USA (Malhotra et al., 2005). A comparison

between Islamic and conventional banks reflects that four dimensions: Personal skills,

reliability, values, and image were significant in conventional banks. While two

dimensions of service quality, that is, values and personal skills are significant in case of

Islamic banks (Jabnoun and Khalifa, 2005). It is reported that provision of better quality

services could result into satisfied customers who understand the product (Gao et al.,

2006).

Glavell et al. (2006) conducted an empirical analysis of bank customers from five Balkan

countries and found a significant difference in the customers' understanding of service

quality in different countries. Greek customers have highest understanding towards

service quality. Service quality could be ensured by implementation of total quality

management techniques in the banking sector (Al- Marri et al., 2007). It is evident that

political, technological, environmental and socioeconomic factors influence the service

quality perceptions of customers. It is reported that Greece customers have higher levels

of service quality perceptions as compared to Bulgarian customers (Petridou et al., 2007).

Similarly, it is found that dimensions of service quality have a strong positive impact on

bank performance (Akroush, 2008).

Boyd et al. (1994) investigated the bank selection criteria on the basis of demographic

characteristics and found a significant difference between service quality understanding

of white collar customers and low income customers. It is reported that gender roles and

responsibilities are shaped due to specific cultural, social and religious factors. In Muslim

countries male is responsible for financial activities outside the home while female

performs domestic activities inside the home (Obbe, 1980; Kinsey, 1988; Ogenyi, 1997;

Iheduru, 2002). Due to these factors men have more access to banking, education and

insurance facilities as compared to women (Ajakaiye and Olomola, 2003). Ayadi (1996)

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concluded that female bank customers are engaged in lesser banking activities than male

customers due to lower income.

It is reported that customers' understanding of service quality is very important to

compete in the market (Hoffman and Bateson, 2002). Customers' understanding of

service quality is strongly dependent on customers' values and beliefs that vary from one

culture to another (Furer et al., 2002). It is found that gender affects the service quality

understanding of bank customers and they show a varied response towards different

dimensions of service quality (Spathis, 2004). Similarly, a varied pattern of customer

satisfaction and behavioral outcomes is observed among male and female bank customers

(Yavas et al., 1997). In another study, findings showed that there is difference in choice

factors by male and female bank customers in selection of their respective bank (Omar,

2008). On the basis of existing literature this study examines the understanding of bank

customers regarding service quality offered by Islamic banking.

CHAPTER THREE

3. Methodology3.1 Description of the Study AreaThe study will be conducted at Kenya Commercial Bank (KCB) and National Bank of

Commerce (NBC) Morogoro branches which are located at the center of the regional

headquarter. These banks are selected due to fact that they are the only financial

institutions in this region that provides Islamic banking services. And due to limited

funds for data collection this is the suitable area due to fact that less cost will be incurred

compared to going in other areas.

Also Morogoro as one of the regions which is near to the coastal regions is believed to

have large number of Muslims, and that is why it is selected for such studies.

3.2 Research DesignIn this study a cross sectional design will be used in which data will be collected at three

points (locations) at different time. It has been suggested that a cross sectional design in

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data collection is considered to be favorable because of the resource and time limitation

for data collection (Bailey, 1995).

3.3 Sampling Procedures and Sample SizeThe sample of 50 customers who have shariah accounts will be selected from the two

banks. From each group of bank (providing Islamic banking service), customers will be

selected randomly to collect data by self-administrated questionnaires. This study also

will adopt “personal contact” approach, that is, respondents will be approached

personally. The researcher will explain the questionnaire and the objective of survey by

telling its purpose, the meaning of the items and what is expected from the respondents.

3.4 Data Collection3.4.1 Primary Data CollectionStructured questionnaires will be developed to record the responses of customers of

Islamic banking operating at Morogoro. These questionnaires will be distributed

simultaneously by two trained administrators (including me) to 50 respondents after

Friday prayers at three different mosques during April-May 2011 at Morogoro town. The

number of people available for the survey and only those meeting specific selection

criteria (i.e. Islamic banking customer’s) will be asked to complete the questions.

Interviews on key informants and discussions will be done to supplement information in

the questionnaire.

3.4.2 Secondary Data CollectionSecondary data will be obtained using published and unpublished relevant documents

from KCB and NBC and other information will be obtained from electronic sources such

as internet as well as documentations available from other available Islamic financial

institution sources.

3.5 Data Collection and AnalysisThe data to be collected from the bank will be coded and analyzed using a tool known as

Amos. Quantitative information from discussions and reports will be analyzed using

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content and structural-function analysis. Percentages, means, frequencies and other

related statistics will be used to describe the characteristics of the study area and sample

population.

3.6. Schedule of ActivitiesThe following are the table which shows the schedule of activities.

Table 1: Schedule of activities from January 2011 to July 2011

Numbe

r

Activities Januar

y

2011

February

2011

Marc

h

2011

Apri

l

201

1

May

2011

June

2011

1 Title

submission

and

literature

review

2 Proposal

submission

3 Data

collection

4 Data

analysis

5 Report

writing

6 Submissio

n the

report

3.7. Budget of Research

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Sources of fund for this study are The High Education Student Loan Board (HESLB).The

total amount of money to be used is 180,000.The budget breakdown is shown in Table

below.

Table2: Budget of the research

Items Quantity Unit cost in Tshs Total in (Tshs)

Typing 20pages page @ 1000 20,000

Printing 60pages page @ 200 12,000

Photocopying 60pages page @ 50 3,000

Binding proposal 3 drafts @ draft 2,000 6,000

Travel cost 2trips @ trip 5,000 10,000

Meal and

accommodation

6days @ day 15,000 90,000

Communication 10 times @ call 900 9,000

Grand total 180,000

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