Islamic Financial Intermediation and Banking 171
models expect the fi nancial intermediaries to participate in the full range of
maturity structures to get the benefi ts of portfolio diversifi cation, in reality,
Islamic banks shy away from instruments requiring a medium - and long -
term commitment. A cursory look at the data on the asset maturities col-
lected from six Islamic banks in 2003 makes it clear that 54 percent of their
assets had a maturity of less than one year and 39 percent, of less than
six months.^ IFIs tend not to invest in longer maturities given the lack of
liquidity of the medium - to long - term assets. With this reliance on short -
term maturity, Islamic banks are unable to offer investment opportunities to
investors who are interested in long - term investments.
Small Size and Fragmentation
Although the number of Islamic fi nancial institutions (IFIs) has grown, the
average size of their assets is still small by comparison with their counter-
parts in the conventional system. As of 2010, the assets of the world’s top
Islamic bank equated to just 2 percent of those of the top conventional
bank. Indeed, these assets amounted to only 35 percent of the conventional
bank ranked at 120th. The top conventional bank of any Muslim country
(Turkey) is ranked at 103 in the world (The Banker 2010a and 2010b).
Given their small size, Islamic banks are unable to reap the benefi ts of
the economies of scale and scope and attendant effi ciency gains.
Concentrated Banking
Islamic banks tend to be concentrated in their deposit base or asset base,
often concentrating on a few select sectors and avoiding direct competition.
For example, one IFI may specialize in fi nancing for the agriculture sec-
tor, whereas another might do the same in the construction sector without
attempting to diversify into other sectors. This practice makes IFIs vulnerable
to cyclical shocks in a particular sector. Dependence on a few select sectors,
or a lack of diversifi cation, increases an IFI’s exposure to new entrants in the
same sector, especially to foreign conventional banks that are better equipped
to meet these challenges.
This concentration of the deposit or asset base can also be viewed as a
lack of diversifi cation, which increases their exposure to risk. Kahf (1999)
showed that the average fi nancing activities of IFIs have been primarily trade
oriented (32 percent) followed by sectors such as industry (17 percent), real
estate (16 percent), services (12 percent), agriculture (6 percent) and others
(17 percent). Islamic banks are not fully exploiting the benefi ts of diversifi -
cation, which come from both geographical and product diversifi cation. At
present, they rely heavily on maintaining good relationships with the deposi-
tors to earn the depositors’ loyalty. However, this relationship can be tested
during distress or changing market conditions, when the depositors tend
to change loyalties and shift to large fi nancial institutions that are perceived to
be safer.