FACTORS INFLUENCING ISLAMIC BANKING IN KENYA: A CASE STUDY OF NAIROBI COUNTY

Transcription

1 FACTORS INFLUENCING ISLAMIC BANKING IN KENYA: A CASE STUDY OF NAIROBI COUNTY BY SAIDA ALI ADEN A Project Report Submitted to the Chandaria School of Business in Partial Fulfillment of the Requirement for the Degree of Masters of Business Administration UNITED STATES INTERNATIONAL UNIVERSITY, NAIROBI-KENYA SUMMER 2014

2 STUDENT S DECLARATION I, the undersigned, declare that this is my original work and has not been submitted to any other college, institution or university other than the United States International University in Nairobi-Kenya for academic credit. Signed: Date: Saida Ali Aden This project report has been presented for examination with my approval as the appointed supervisor. Signed: Date: Dr. George Achoki Signed: Date: Dean, Chandaria School of Business i

3 ABSTRACT The purpose of this study was to establish what factors influence utilization of Islamic banking and financial services in Kenya. The study sought to answer the following research questions, What is the level of knowledge and attitude among Kenyans about the existence of Islamic banks and the various products and services they offer?, What socio-cultural factors influence the choice of Islamic banking or financial services in Kenya?, How does political or government regulations affect Islamic banks in Kenya?. Through this study, an attempt was made to know whether customers from different age brackets, gender, educational qualification, professional background acted differently while selecting Islamic or Conventional banks. The research furthered examined how government policies and regulations including infrastructural development influenced Islamic banking. A descriptive survey design was used. One hundred and twenty five respondents were randomly sampled from four Islamic and Conventional Banks operating in Nairobi- Kenya. Quantitative data was analyzed using SPSS version 22.0 while the qualitative data will be analyzed by consolidating emerging themes. The sample size was selected using Fisher s sampling technique and reduced to one hundred and twenty five respondents for quality and accuracy purposes. Data collected from the respondents suggests that there are a number of factors that influence Islamic banking in Kenya. The study found that majority of those surveyed had heard of Islamic banking and financial products with some of them being very knowledgeable about them. Religious affiliation was the number one cited reason for choice of Islamic banking and financial services for Islamic users. Other reasons given were that: it offers cheap products, banks are conveniently located and other ethical reasons. The convenience of banking with an institution followed by the level of interest it offers ranked highest among respondents in terms of differentiating services offered by different banks. The consumers also preferred banking institutions with; high levels of confidentiality, that could provide financial advice, that offered fast and efficient transactions and they were least concerned with whether the institution provided Islamic banking or financial services. ii

4 The research also found that most people are aware of government regulation on banking services in Kenya. Some of the areas regulated by the government are: consumer protection, administration, branching and in agency banking. In Kenya, those surveyed were mostly aware of consumer protection than the other forms of government regulations. Despite all these regulations, respondents were still divided on whether these regulations affect the choice of banking preferred by a consumer. The study concluded that, both Islamic and conventional banks create competition among banks to satisfied customers and fulfill their expectations and long-term benefits for the economy. The conventional banks and the Islamic banks are different commonly based on their goals, Riba and risk sharing practices. The foregoing discussion has identified a number of factors that influence the choice of Islamic banking services over conventional banks. It is encouraging to note that there are more new users opting to have Islamic banking and financial services. The study further recommends the need for Islamic institutions to market their products and services extensively in order to reach more Kenyans and create awareness. It also suggests that Islamic banks should tone down religious affiliation in order to appeal to non-muslims. Moreover, government regulations should be applied on banking services in Kenya and be customized for the different institutions that have different services. iii

5 TABLE OF CONTENTS STUDENT S DECLARATION... i ABSTRACT... ii TABLE OF CONTENTS... iv LIST OF TABLES... vii CHAPTER ONE INTRODUCTION Background of the Study Statement of the Problem Purpose of the Study Research Questions Importance of the Study Scope of the Study Definition of Terms Chapter Summary... 7 CHAPTER TWO LITERATURE REVIEW Introduction Knowledge and Attitude towards Islamic banking in Kenya Basis and Principles of Islamic Banking Islamic banking in Kenya Socio-cultural factors and Islamic banking Government policies and regulations and Islamic banking Factors considered important by customers in non-islamic Banks Conceptual framework Chapter Summary CHAPTER THREE METHODOLOGY Introduction Research Design iv

6 3.3 Population and Sampling Design Population Sampling Design Data Collection Methods Research Procedures Data Analysis Methods Chapter Summary CHAPTER FOUR RESULTS AND FINDINGS Introduction PART I: DEMOGRAPHIC AND SOCIOECONOMIC CHARACTERISTICS Educational Level and Gender Cross tabulation Ability to Read/Write in Kiswahili and Gender Cross tabulation Occupation and Gender Cross Tabulation Age and Occupation Cross Tabulation Monthly Income by Gender Tabulation Monthly Income by any form of Savings Tabulation Monthly Income by Monthly Savings Value Tabulation Savings by Type PART II: KNOWLEDGE AND ATTITUDE TOWARDS ISLAMIC BANKING Owning a Cellphone Gender by Cellphone Ownership Tabulation Any form of Savings by Cellphone Ownership Tabulation Cellphone ownership by Savings Type Account Ownership Account ownership by gender and age Awareness of Islamic Banking and willingness to open an Islamic Bank account Reasons why one would not open an account with an Islamic Bank How much do you know about Islamic Banking and Finance? Banks that provide Islamic Banking Know banks in Kenya that provide interest free services Respondent s source of knowledge about interest free banking v

7 Trust in Islamic Banking Existing relationship in Islamic Banking Reasons for Lack of Relationship with Islamic Banking Preferred Banking Option Knowledge about charging Interest in Islam Interested in a Loan? Interested in a Loan from which kind of Bank Respondents knowledge whether Islamic banking is costlier than non-islamic and knowledge on how banks invest How respondents differentiate banking services Ranking of Bank Facilities Overall Satisfaction PART IV. ISLAMIC BANK USERS Reason for choosing Islamic Banking Duration respondent has been a consumer of Islamic banking Switching from one Islamic Bank to another Respondents reaction to an increase in price of Islamic products Satisfaction with Islamic Financial products PART V: GOVERNMENT POLICIES AND REGULATIONS Knowledge on government regulation by frameworks on banking regulation in Kenya Cross tabulation of whether government should regulated Islamic banking and whether this regulation will affect the choice of banking services Respondents awareness of consumer protection in Kenya CHAPTER FIVE DISCUSSION, RECOMMENDATIONS AND CONCLUSION Introduction Summary of findings Recommendations REFERENCES...53 ANNEX...56 vi

8 LIST OF TABLES Table 1: Demographic and socioeconomic characteristics Table 2: Educational Level and Gender Cross tabulation Table 3: Ability to Read/Write in Kiswahili and Gender Cross tabulation Table 4: Occupation and Gender Cross Tabulation Table 5: Age and Occupation Cross Tabulation Table 6: Monthly Income by Gender Tabulation Table 7: Monthly Income by any form of Savings Tabulation Table 8: Monthly Income by Monthly Savings Value Tabulation Table 9: Savings by Type Table 10: Cellphone ownership Table 11: Cellphone ownership by gender tabulation Table 12: Cellphone ownership and having any form of saving cross tabulation Table 13: Cellphone ownership by savings type cross tabulation Table 14: Account ownership of respondents Table 15: Account ownership of the respondents by gender and age Table 16: Awareness of Islamic Banking and willingness to open an Islamic Bank account Table 17: Reasons by respondents as to why they would not open an account with an Islamic Bank Table 18: Level of knowledge about Islamic Banking and Finance among respondents.. 38 Table 19: Banks that provide Islamic Banking Table 20: Knowledge by respondents of Kenyan banks that provide interest free services Table 21: Respondent s source of knowledge about interest free banking Table 22: Respondent s trust in Islamic banking Table 23: Existing relationship of respondents in Islamic banking Table 24: Respondents reasons for lack of a relationship with Islamic banking Table 25: Preferred banking option for the respondents Table 26: Knowledge of respondents on whether they know it is Haram to charge interest in Islam Table 27: Respondents interest in taking loan Table 28: Preferred bank respondents can take loan from Table 29: Respondents knowledge whether Islamic banking is costlier than non-islamic and knowledge on how banks invest Table 30: How respondents differentiate banking services Table 31: Respondents ranking of bank facilities Table 32: Satisfaction with banking services Table 33: Reasons for respondents choice of Islamic banking Table 34: Duration respondent has been a consumer of Islamic banking Table 35: Whether respondents switched from one Islamic bank to another Table 36: Respondents reaction to an increase in price of Islamic products Table 37: Respondents satisfaction with Islamic financial products Table 38: Cross tabulation of respondents knowledge on government regulation by frameworks on banking in Kenya Table 39: Cross tabulation of whether government should regulated Islamic banking and whether this regulation will affect the choice of banking services Table 40: Respondents awareness of consumer protection in Kenya vii

9 CHAPTER ONE 1.0 INTRODUCTION 1.1 Background of the Study The study examined factors that influence Islamic banking among Kenyans with specific focus on Islamic and Conventional Banks operating within Nairobi, Kenya s capital city. The basic practices and principles of Islamic banking date back to the early part of the seventh century. The origin of the modern Islamic bank can be traced back to the very birth of Islam when the Prophet himself acted as an agent for his wife's trading operations. (Islamic Finance, 1997) Western commercial banks date from about two and a quarter centuries ago, when the western world was dispensing with moral and ethical considerations in economics. The first Islamic financial institution was a mutual savings bank formed in Egypt in Since then, Islamic finance has evolved into adaptive system of international practices and regulations capable of harmonizing classical religious precepts, social responsibility, and traditionalism with the modern experiences of globalized banking. Today according to International Monetary Fund (IFM), there are over 300 Islamic financial institutions in more than 75 countries with total assets worldwide exceeding $700 billion and growths exceeding 15 percent a year. Recent surveys have shown that 37 per cent of Muslims in the United States and 67 per cent of Muslims in the Kingdom of Saudi Arabia prefer to deal with Islamic banks and financial product providers. However, in many countries modern Islamic finance has little or no presence; indeed, it is only now establishing itself as a competitive force in the countries where it does have a presence. (Jaffer, 2006) While most Muslims view Shari'a compliance as the most important factor in modern Islamic finance, not all of them are free of doubts. In some instances, this may be attributed to the popular view that Islamic finance is more about semantics and cosmetics than it is about substance. There are issues of trust to be resolved, both in regard to the products and services of Islamic finance and in regard to those who offer them. Thus beyond the need to make its 1

10 presence known to the general Muslim populace, Islamic retail finance must also work to overcome doubts and misconceptions. (Jaffer, 2006) The demand for Shari'a-compliant financial products and services differs little from the demand for the conventional equivalents they are designed to replace as Muslims throughout the world are currently using conventional financial products. It is clear that the opportunity for the Islamic financial industry is huge. The migration of consumers from conventional to Islamic has already begun and in many countries conventional banks are beginning to feel pressure to offer Shari'a-compliant products. (Jaffer, 2006) Despite this scope and imprint on the global economy, Islamic finance remains poorly understood at both theoretical and practical level. Moreover, despite a number of recent optimistic trends, Islamic finance faces several ideological and structural challenges to full integration in the globalized economy.(karasik, Wehrey, & Strom, 2005) The history of banking in Kenya traces its roots to early European trade on the East African coast, chiefly Zanzibar, in the later part of the 19th century. Despite political upheavals such as World War II and the subsequent Mau Mau uprising, banking in Kenya experienced considerable growth. The banks expanded but banking access and employment opportunities for Africans in the banking industry took time to materialize. It was only until 1910 that banking services became available to Africans. This was made possible when the Post Office Savings Bank as a department within the colonial postal service opened its doors. By March 1911 Post Office Savings Bank boasted 1,231 accounts, of which 684 belonged to Africans. Even then, the service was only available in places where officials of the colonial postal service were stationed and therefore did not reach the majority of Africans who resided in rural areas. Decades would pass, and with each the industry saw increased Africanization on both sides (bankers and customers). 2

11 Kenya s first fully locally owned commercial bank came in June 1965 when the Co-operative Bank of Kenya was registered as a co-operative society initially to serve the growing farming community. The first fully government owned bank, the National Bank of Kenya, was established in June The formation of the government-owned banks had the desired effect of speeding up the provision of affordable banking services to the majority of the population. It also prompted foreign owned banks to take measures to remain relevant in the Kenyan market and beyond. In Kenya, there are fully-fledged Islamic banks that solely offer Shari ah-compliant products; and main stream banks that provide products that are tailored to be in compliance with Islamic law. Examples of such banks targeting lower income and special customers are Jamii Bora Bank, which has carved a niche for itself not only by tailoring its banking services mainly to low-income customers but by also venturing into mortgage financing for lowincome housing, and two fully-fledged Islamic banks; First Community Bank and Gulf African Bank, that have succeeded in bringing Sharia-compliant banking services to Kenya. (KBA, 2013) 1.2 Statement of the Problem Despite this scope and imprint on the global economy, Islamic finance remains poorly understood at both theoretical and practical level. Moreover, despite a number of recent optimistic trends, Islamic finance faces several ideological and structural challenges to full integration in the globalized economy. (Karasik et al., 2005) Islamic banks come in all shapes and forms: banks and non-banks, large and small, specialized and diversified, traditional and innovative, national and multi-national, successful and unsuccessful, prudent and reckless, strictly regulated and free-wheeling, etc. Some, particularly the Islamic windows of conventional banks, are virtually identical to their conventional counterparts, while others are markedly different. Some are driven by real religious considerations, while others use religion only as a way of attracting customers. 3

12 There are considerable disagreements among scholars as to which institutions and instruments are religiously acceptable. For some, their legal structure does not allow them to carry out real Islamic business such as trading, leasing or construction activities and hence they end up doing only conventional financial operations with slight changes to appear Islamic. There is a risk that Islamic banking ideals may get diluted with conventional banking unless Islamic banks do something to establish their distinctness as Islamic banks. Non-sharing Islamic modes such as murabaha, salam, istisna'a and ijarah also provide a link between financial transactions and real economic activities, such as trading in tangible assets. But there have to be some underlying goods and services to be the objects of such modes of financing. (Institute of Islamic Banking and Insurance, n.d.) In addition, convectional banks which tend to offer Islamic banking have failed to hold to certain prescribed ideals and principles of Islamic Banking as provided for by the Shari a in the Qor an. Recent studies in the Arabian Gulf, for example, have shown that deposits in Islamic banks are rising steeply, and that in the coming decade conventional banks are at risk of losing 30-40per cent of their Muslim clientele to Islamic banks or at least to conventional banks that offer Shari'a-compliant banking products. In most of the modern world, however, Muslims remain unaware of the options now, or soon to be, open to them in the arena of Islamic or Shari'a-compliant financial products and services.(jaffer, 2006)While conventional, interestbased finance is essentially incompatible with Shari'a norms, many if not most Muslims today have become inured to it. Kenya Bankers Association (KBA) is committed to ensuring that customers make informed choices of different products and services offered by banks and which meet the diverse base of customers needs. It also ensures that banks give customers general information about the bank and the products and services they offer to meet the needs of the customers. Moreover, it ensures that banks offer niche services and products to meet the needs of a diverse customer base such as the Muslim community. For example, KBA is keen to ensure that 4

13 Shari a-compliant banking (Islamic banking) is available to the Muslim community and other persons who may be interested. (Mugambi, 2012). Although this is the case, Islamic banks need to give special ca1re to their integrity and credibility. Some critics are disappointed that Islamic banks have deviate to a great extent from the philosophic and idealistic basis that inspired their originators in the 1970s. Article 46 of the Constitution of Kenya (2010) sets out laws and acceptable practices that the providers of goods and services should adopt when engaging their consumers. In addition to the Constitution, the Consumer Protection Bill was enacted in 2012 with clauses pertaining to the provision of financial services. Therefore both banks as well as their customers should familiarize themselves with these laws.(mugambi, 2012) Lastly, there has been serious lack in researches in Islamic banking, especially in the area of customer preference and satisfaction around the world and even in Kenya. (Rashid and Hassan, 2008) Islamic banking is no longer a novel experiment. When the concept of Islamic banking with its ethical values was propagated, financial circles the world over treated it as a utopian dream. Having lived for centuries under the valueless capitalist economic system, they asked what ethics had to do with finance? Besides their range of equity, trade-financing and lending operations, Islamic banks also offer a full spectrum of fee-paid retail services that do not involve interest payments, including checking accounts, spot foreign exchange transactions, fund transfers, letters of credit, travelers checks, safe-deposit boxes, securities safekeeping investment management and advice, and other normal services of modern banking. Islamic banking because of its value-orientated ethos enables it to draw finances from both Muslims and non-muslims alike. Islamic banks are evolving financial and investment instruments that are not only profitable but are also ethically motivated. The ever-increasing application and innovation of the methodologies associated with derivative instruments that revolutionized the global financial industry have also led to a global financial crisis because of the excess greed for profit and the immense uncertainty and risk associated with these types of transactions. There are 5

14 doubts associated with the permissibility of derivative instruments under Islamic finance generally. 1.3 Purpose of the Study The purpose of this study was to provide knowledge by establishing factors influencing Islamic banking in Kenya. 1.4 Research Questions The study sought to answer the following key questions: i. What is the level of knowledge and attitude among Kenyans about the existence of Islamic banks and the various products and services they offer? ii. What socio-cultural factors influence the choice of Islamic banking or financial services in Kenya? iii. How does political or government regulations affect Islamic banks in Kenya? 1.5 Importance of the Study The results of this study will primarily be beneficial to academics and practitioners in Kenya by offering an insight into choice criteria for Islamic Banking in general. This study will provide new results about different kinds of customer preferences with regards to decision to choose Islamic Banking Islamic Bank Managers Islamic bank managers will learn and plan to offer attractive schemes for their target clients Researchers For the researcher, this study will contribute to existing body of knowledge by providing an investigation of the factors which influence the choice and decision in Islamic Banking. Indeed, this study is considered an eye-opener for Islamic Banking choice criteria which has limited previous studies. 1.6 Scope of the Study The study will be conducted in Nairobi among clients banking with selected conventional and Islamic banks for ease of reach and convenience to the researcher. Moreover, this is an 6

15 ideal population to target for banking since the utilization of banking services is highest in Nairobi than other regions of Kenya. The exercise is expected to conclude in a span of three months from the time of approval of the research proposal. 1.7 Definition of Terms a) Islamic banking refers to a system of banking or banking activity that is consistent with the principles of the Shari'a (Islamic rulings) and its practical application through the development of Islamic economics. The principles which emphasizes moral and ethical values in all dealings have wide universal appeal. The principle source of the Shari a is the Qur an followed by the recorded sayings and actions of Prophet Muhammad (pbuh) the Hadith.(Institute of Islamic Banking and Insurance, 2014) b) Banks with 'Islamic windows' are conventional banks that are not Shari'a-compliant banks. As conventional banks, they establish units or departments charged with the task of creating, promoting and operating Shari'a-complaint financial products and related services. The target market is, of course, the Muslim believer. A bank that professes to have an Islamic window is better that one that does not. A bank that is run entirely along Shari'a-compliant lines is better that one that professes to have an Islamic window. Those are the steps on the ladder that matter to the Muslim believer. (Institute of Islamic Banking and Insurance, n.d.) 1.8 Chapter Summary This chapter gives the basis and the aim of this study. It was aimed at giving a comprehensive background and the problem the study intended to fill. It is hoped that the study will be of much assistance to a wide spectrum of stakeholders in this field and of specific use to those working in Banking sector especially those with great interest in Islamic banking. The following section, Chapter Two, is the literature review which provides background information and related literature. Chapter Three will presents the methodology to be used in data collection, storage, analysis and interpretation. Chapter Four will present the research findings and analysis. Chapter Five will be the heart of this study as it will present the 7

16 discussion of the study findings, the conclusions drawn from these and the recommendations proposed by the researcher relevant to this undertaking. 8

17 CHAPTER TWO 2.0 LITERATURE REVIEW 2.1 Introduction This Chapter provides literature related to Islamic Banking in Kenya and around the world. The flow of the literature is guided by the three key research questions knowledge and attitude towards Islamic Banking, Socio-cultural influence the choice of Islamic banking and how government regulates banking sector and how this regulation impact on general utilization of banking and financial services. Islamic banking and finance is an emerging global industry founded on Islamic ethical precepts. Just as in the case of conventional banks, Islamic banks are expected to offer products that consider the needs of their customers. (Amin, Rahman, Sondoh Jr, & Hwa, 2011) This chapter therefore discusses the basis and principles of Islamic banking and how it differs from conventional banks. It also examines factors that influence customers choice to utilize Islamic financial services. It ends by describing a conceptual framework on how the perceived factors i.e. social, economic and political factors interplay and eventually influence Islamic banking. Islamic Banks hold well over US $700 billion in assets and are growing at over 15% yearly. Islamic Banking and Finance (IBF) involves wider ethical and moral issues than simply interest-free transactions. (Khan, Feisal, 2010) Its advocates argue that these make it more economically efficient than conventional banking and promote greater economic equity and justice. To what extent, then, do actual Islamic Banking practices live up to the ideal, and how different are they from conventional banking? A preliminary investigation shows that, three decades after its introduction, there remain substantial divergences between IBF''s ideals and its practices, and much of IBF still remains functionally indistinguishable from conventional banking. (Khan, Feisal, 2010) 9

18 2.2 Knowledge and Attitude towards Islamic banking in Kenya Basis and Principles of Islamic Banking Islam is a total way of life. Its system of laws permeates social, economic, political and cultural life. Islamic banks are thus one of the direct consequences of the resurgence of interest in Islam. The primary source of all Islamic jurisprudence, the body of which is known as the Shari'a, is the Qur'an and Sunnah. Thus it is the Quranic scholars to whom the leaders of Islamic economics and banking turn for guidance in setting up their internal compliance systems and processes. Therefore, in order to be Islamic, the banking system has to avoid interest because the Shari a prohibits the payment of charges for the renting of money (riba) for specific terms, as well as investing in businesses that provide goods or services considered contrary to its principles (Haram, forbidden). Another Islamic principle is that there should be no reward without risk bearing; a principle which is applicable to both labor and capital. Modern Islamic banking is based on the principle of mudarabah i.e. Islamic partnerships.(institute of Islamic Banking and Insurance, 2014) Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of Shari ah, known as Fiqh al-muamalat (Islamic rules on transactions). The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba (usury/interest). Common terms used in Islamic banking include; profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leasing (Ijarah). (Shamim Njeri Kinyanjui, 2013)The fundamental differences between Islamic banking and conventional banking, is not only in the way it practices its businesses, but above all the values which guide Islamic banking whole operation and outlook. These values prevailed within the ambit of Shariah (Islamic law) are expressed not only in its transactions, but in the breadth of its role in society as a whole. (Guyo & Adan, 2013) Islamic banking in Kenya Kenya was the first country in the East and Central African region to introduce Islamic banking in the year In this short period, two banks were licensed to exclusively offer 10

19 Shari ah-compliant products with many other conventional banks establishing a window specifically for Shari ah-compliant products. Records show that for the short period of existence, Islamic banking in Kenya has shown very commendable performance commanding combined market share of the banking sector in terms of gross assets of 0.8%. Currently, there are two Islamic banks operating in Kenya i.e. Gulf African and First Community Bank with a loan portfolio of over 4.9 billion shillings, deposits totaling 7.5 billion shillings and deposit accounts. Other banks which offer shari ah complaint products and services include Dubai Bank, Kenya Commercial Bank Ltd and Barclays Bank Ltd. (Kinyanjui, 2013) The phenomenal growth of Islamic finance has resulted into customization of products and service by conventional banks in addition to the rapid growth by the fully fledged Islamic banks (KBA, 2011). While this necessitates the critical need for the potential customers to have adequate information to make decisions on whether to invest in Islamic finance, empirical evidences on Islamic banking and finance in Kenyan context is limited. (Guyo & Adan, 2013) Islamic banking industry has been trying for the last over two decades to extend its outreach to bring it at least to the level of conventional banking. But the absence of Shariah-compliant legal framework needed to make interest-free banking acceptable (and create sound financial institutions) is the major snag behind its low penetration in the financial market. (Kinyanjui, 2013) Literature shows that the main factors influencing the choice of bank are: the pricing structure of services, friends referrals on banks, switching costs and service quality. In a South African study by Abratt and Russell (1999) on the criteria used by consumers in the selection of a private bank, it was found that price was an important criterion, modified by trust, service quality and the availability of the bank. The bank selection criteria are expected to affect a customer s overall satisfaction towards his or her bank (Levesque and McDougall, 1996). Many studies have investigated the bank selection criteria or the reasons on the basis of which customers choose to bank with specific banks (Anderson et al., 1976; Denton and Chan, 1991; Erol and El-Bdour, 1989; Erol et al., 1990; Khazeh and Decker, 1992; Kaynak et 11

20 al., 1991; Laroche and Taylor, 1988; Levesque and McDougall, 1996; Tan and Chua, 1986). These studies have identified a number of such factors: convenience (i.e. the location), friends recommendations, reputation of a bank, availability of credit, competitive interest rates, friendliness of bank staffs, service charges, adequate banking hours, availability of ATM, special services and the quality of services of checking accounts. (Guyo & Adan, 2013) A study by Dr. Wario Guyo on factors influencing selection of banks operating in a dual banking environment like Kenya concluded that the most important fact is that customers of Islamic banks view the industry much more favorably by the social and ethical goals that it serves, rather than the mechanics of its operationalization and functions. And that one of the most important reflections of customers attitude is that social-welfare factors are evidenced as more important objectives than commercial factors in their perceptions towards Islamic banking. (Guyo & Adan, 2013) Other studies have shown that many individual characteristics such as place of residence, gender, age, level of education, numeracy, employment status etc. are associated with the use of financial services. According to 2011 World Bank report, about 42 per cent of Kenyan aged 15 years and above held accounts with formal financial institutions. Though above most sub-sahara African countries and other low income countries, formal account usage differ by gender (female = 39.18%; males = 45.65%), by education (primary or less = 19.44%; secondary or above = 62.82%), by age (young adults = 40.27%; older adults = 43.53%); and by residence (rural = 37.9%; urban = 75.95%).(The World Bank, 2011)Inhabitants of rural areas are typically poorer and less likely to work in formal jobs hence rural Kenyans, are less likely to use formal banking and other formal financial services, but not informal services. By controlling for other characteristics, women are not less likely to use formal banking or other formal financial services, but they are more likely to use informal services than men and are less likely to be excluded. Income is one of the strongest predictors of usage of both formal and informal financial services more Kenyans are likely to use formal banks as their income brackets increases. 12

21 Literature also reveals that education is a strong predictor of the use of formal banking and other formal financial services. Kenyans with tertiary education are more likely to use formal banking and other formal financial services (any of the four service types) than Kenyans with secondary education who in turn are more likely to use these services than Kenyans with only a primary education who in turn are more likely to use these services than Kenyans without any formal education. Older Kenyans are more likely to use financial services than younger citizens. In addition, salaried employees are more likely to use formal financial services and are less likely to be excluded. Compared to Kenyans dependent on pensions or remittances, employed, selfemployed and agricultural workers are more likely to use bank and other formal financial services and are less likely to be excluded. They are also more likely to use informal financial services. While cell phone users typically have higher incomes, the ownership of a cell phone has an additional positive effect on the likelihood of using financial services, while it is negatively associated with the likelihood of being excluded. Numeracy is associated with greater use of formal bank services, but is not significantly associated with the use of other formal or informal financial services or with being excluded. Finally, more risk-averse people are more likely to use informal financial services and are less likely to be excluded. 2.3 Socio-cultural factors and Islamic banking Islam is the primary reason behind choosing Islamic banking. Customers in Islamic banks seriously consider whether the bank complies with Islamic Shari ah rules in all stages of banking activities (Kader, 1993; Metawa and Almossawi, 1998; Naser et al, 1999; Haron et al, 1994; Ahmad and Haron, 2002; Erol et al, 1990). The variables deemed important under religious (Islamic) construct include compliance to Shari a rules, offering of Shari acompliant services, offering interest free loans etc. However, studies have showed that Islamic belief is neither the only reason, sometimes, nor the primary reason behind choosing Islamic banking. Although the idea of Islamic banking comes from the desire of conducting financial activities in accordance with Islamic Sharia principles (Naser and Moutinho, 1997), 13

22 the popularity of Islamic banks is spreading widely with increasingly large international conventional banks by establishing Islamic window services. Unlike conventional banks, the purpose of Islamic banks is to work in harmony with the Islamic law and principles towards economic development. Due to its profit-risk sharing principles, Islamic banks, compared to non-islamic banks, seek for a just and an equitable distribution of resources (Siddiqui, 1985). This is the reason why non-muslims are also adopting Islamic banking in different parts of the world. The consequence of this is that Islamic banks face competition from both other Islamic banks and non-islamic banks. When competition intensifies and when banks start to offer more or less similar products and services, it is the customer satisfaction that can influence the performance of an Islamic bank and determines whether its competitiveness and success are vulnerable (Naser et al, 1999). Hence, effective market positioning to identify influential factors affecting customer satisfaction is of paramount importance for Islamic banks.(rashid & Hassan, 2009) A study by Hanudin Amin et al 2011 on Determinants of customers' intention to use Islamic personal financing: The case of Malaysian Islamic banks showed that the three determinants that influence the intention to use Islamic personal financing include attitude, social influence and pricing of Islamic personal financing. Religious obligation and government support are mostly insignificant predictors.(amin et al., 2011) De Mooji (2004) identified that culture is also an important factor that affect the consumer standards for selection of a financial institution. The attitude of customer in Malaysia is different from the Pakistani customers that affect the decision of customer to use the Islamic banking products and services. Dusuki and Abdullah (2007) also find that for Muslims religious views are the important and main factor that stimulates the individuals to go on Islamic banking system instead of conventional banking. Al Ajmi (2009) show that religious factor may or may not important the main thing is potential profit taken by the investor. A study conducted in Jordan has also found that religion does not play significant role to select an Islamic bank but profit motivated criteria is an important factor to choose a bank opening new branches. However, other major findings are that peer group influence plays an 14

23 important role in selecting Islamic banks as depository institution. The study explored that the demographic factors such as religion & knowledge are playing a significant role to select a bank. Researcher found that customers do not have so much knowledge about the Islamic banking products such as Muderaba, Mushaaraka, Murabaha etc., but they buy these products for the reason of religion. Study also revealed that bank s name and reputation also strongly effect on selecting a bank. In the same study, the researchers explored that reputation and image factor are evidenced as one of the important criteria in the banking selection decision. The study concluded that availability of service and social, as well as religious perspective at higher level could make Islamic Banking easier and comfortable. (Haque, Osman and Ismail, 2009). Banks with 'Islamic windows' are conventional banks (i.e. they are not Shari'a-compliant banks). As conventional banks, they establish units or departments charged with the task of creating, promoting and operating Shari'a-complaint financial products and related services. The target market is, of course, the Muslim believer. A bank that professes to have an Islamic window is better than one that does not. A bank that is run entirely along Shari'a-compliant lines is better than one that professes to have an Islamic window. Those are the steps on the ladder that matter to the Muslim believer.(jaffer, 2006) 2.4 Government policies and regulations and Islamic banking Banking sector is one of the most regulated institutions around the world and a number of reasons can be given for this heavy and costly burden of government supervision. For instance, it protects the safety of the public s savings, controls the supply of money and credit in order to achieve a nation s broad economic goals (such as high employment and low inflation), ensures equal opportunity and fairness in the public s access to credit and other vital financial services, promotes public confidence in the financial system so that savings flow smoothly into productive investment and payments for goods and services are made speedily and efficiently, avoids concentrations of financial power in the hands of a few individuals and institutions, provides the government with credit, tax revenues, and other services; and to help sectors of the economy that have special credit needs (such as housing, small business, and agriculture). 15

24 However, regulation must be balanced and limited so that, financial firms can develop new services the public demands and competition in financial services remains strong to ensure reasonable prices and an adequate quantity and quality of service to the public and privatesector. decisions are not distorted in ways that waste scarce resources (such as by governments propping up financial firms that should be allowed to fail). ( The Impact of Government Policy and Regulation on the Financial-Services Industry, n.d.) The banking industry in Kenya is primarily governed by the Banking Act (Chapter 488, Laws of Kenya) (the Banking Act ), and by the Central Bank of Kenya Act (Chapter 491, Laws of Kenya)(the CBK Act ).(Central Bank of Kenya, 2013) Any person who undertakes banking business, financial business or the business of a mortgage finance company must be licensed by the Central Bank of Kenya ( CBK ). When the CBK reviews an application for a license, the criteria it must consider include the financial condition and history of the institution, the professional and moral suitability of the persons proposed to manage or control the institution, and the public interest which will be served by granting the license. The CBK has the right, when granting a license, to endorse such conditions as it considers necessary, and may from time to time add, vary or substitute such conditions as it deems appropriate. (Kent, 2013) According to Wako, Kamaria and Kimani (2014), Islamic banks in most countries are put under the supervision of the central bank of the country and are given the same treatment given to conventional banks. With only a few instances where special Islamic banking legislation are approved to define a new relationship between Islamic banks and the central bank. This position is supported by Azizul, (1999) who believes that most Islamic banks in the contemporary world operate in a mixed environment in which interest based banks function side by side with Islamic banks. The central banks subject Islamic banks to the same controls, conditions, and regulations that they apply to interest-based banks. Azizul, (1999) notes that there are certain factors such as lack of understanding of the correct nature of Islamic financing techniques, however, that requires that Islamic banks be treated on a different footing. For instance, Central banks usually pay interest on deposits which Islamic banks cannot accept, Central banks function as lenders of last resort to 16

25 conventional/commercial banks providing loans at times of liquidity crunch. (Wako, Kamaria, & Kimani, 2014) Although the concept of Islamic Finance and Banking has generated a lot of interest and overwhelming support from both Muslim and non-muslim population in Kenya, as a regulator, CBK has faced by certain challenges which need to be addressed. Wako et al (2014), in their literature review pointed Qadeeruddin (Qadeeruddin, A., 2005)having noted CBK cautioning of possibility of Islamic Banks operating within the existing legal and regulatory framework, which posed a great challenge, after all.(wako et al., 2014) In part, all banks offering Islamic banking have established their own separate Shari ah Board to supervise and offer guidance to their respective banks on Islamic banking system. (Kinyanjui, 2013)The Prudential Guidelines significantly cover most aspects of governance and internal controls of banks in Kenya. It provides that: The board should possess, both as individual board members and collectively, appropriate experience, competencies and personal qualities, including professionalism and personal integrity. Furthermore, professionals such as lawyers, accountants and valuers involved in the provision of professional services to a licensed institution are not eligible to be appointed as directors, and senior officers and non-executive directors of a government regulatory body are similarly not allowed to be appointed as directors of an institution where there may be a conflict of interest. (Kent, 2013)The Prudential Guidelines further provide that the board must have an appropriate number of directors that is commensurate with an institution s complexity, size, scope and operations. In addition, the Prudential Guidelines introduce comprehensive provisions on consumer protection which did not exist under the previous guidelines. The Prudential Guidelines provide that the relationship between an institution and a customer should be guided by five key principles: fairness, reliability, transparency, equity and responsiveness. (Kent, 2013) Currently, there are two fully-fledged Shariah-compliant banks in Kenya, i.e. Gulf African and First Community Banks, and a growing number of conventional banks have an Islamic banking division. The challenge for Kenyan banks offering Islamic financing has been the lack of a proper legal framework, which prevented them from providing certain products. In 17

26 addition, there is ambiguity in respect of the tax treatment of Shariah-compliant financial instruments. The regulatory bodies have identified the challenges and when proper legal framework and policies are in place, the country is expected to see a significant growth in Islamic financing. (Kent, 2013) The key areas of current regulatory focus in the banking sector include licensing of new institutions that wish to be licensed to conduct banking, mortgage or financial business in Kenya. The Prudential Guidelines have introduced some stringent requirements with regard to licensing of new institutions. The CBK has also sought to govern agency banking, because of the increased interest by banks in that sector.(central Bank of Kenya, 2013) The Kenyan banking sector has recently experienced some significant changes, especially following the banking crisis that started in The Kenya Deposit Insurance Act, 2012 (the KDI Act ), which has been assented to but is yet to commence, provides for the establishment of an autonomous body called the Kenya Deposit Insurance Corporation which will replace the current Deposit Protection Fund Board, a department of the CBK. The KDI Act provides for the setting up of a deposit insurance system, and the receivership and liquidation of deposit-taking institutions.(kent, 2013) The CBK has been conducting a comprehensive review of the banking sector, legal and regulatory framework. There have been a number of proposed laws and regulations relevant to the sector put forward by the CBK. For instance, the Banking (Amendment) Bill, 2011 (the Bill ) has been published to amend the Banking Act so as to put a cap on the rate of interest charged by banks and financial institutions for loans or monetary advances. The Bill also proposes to fi x the minimum rate of interest that banks or financial institutions must pay on deposits held in interest-earning accounts. The Bill passed through its first reading on 10th November, 2011.(Kent, 2013) The government and government-influenced banks represent about a fifth of total branches in urban districts, over half in rural districts, three-quarters in semi-arid districts, and almost ninety percent in arid districts. This suggests that government influence has a positive impact in promoting access to financial services but, in the absence of an analysis to assess the costs 18

27 of government-influenced banks poor lending practices, it should not be concluded that government ownership is either the best or the cheapest way in which to maintain rural access to the banking system. The depth of outreach remains a serious problem for the Kenyan financial sector. The banks best positioned to maintain or extend outreach are government-owned banks that are also in most in need of efficiency improvement. (Beck, Cull, & Fuchs, 2010) Factors considered important by customers in non-islamic Banks Islamic banks and conventional banks both create competition among banks to satisfied customers and fulfill their expectations and long term benefits for the economy. The conventional banks and the Islamic banks are differentiated commonly on the basis of their goals, Riba and risk sharing practices. Though this will not be one of research objectives, for a better outlook, the study will contrast the bank selection factors important to Islamic and non-islamic customers. As proved by numerous theories, beside religion, there are non-religious factors such as costbenefit trade off, convenience, empathy towards customers, and efficiency of the bankers etc., considered to be important to the customer before choosing an Islamic bank. In conventional banks, different types of customers put emphasis on different factors before choosing their banks. (Rashid & Hassan, 2009) De Mooji (2004) identified that culture is also an important factor that affect the consumer standards for selection of a financial institution. The attitude of customer in Malaysia is different from the Pakistani customers that affect the decision of customer to use the Islamic banking products and services. Dusuki and Abdullah (2007) also find that for Muslims religious views are the important and main factor that stimulates the individuals to go on Islamic banking system instead of conventional banking. Al Ajmi (2009) show that religious factor may or may not important the main thing is potential profit taken by the investor. A study conducted by Azhar Sheikh et al (2010) revealed that customers of Islamic and Conventional banks in Pakistan were satisfied with the facilities provided by their banks clients of Islamic banks were satisfied with the facilities provided their banks but the 19