404 chapter nine
of return on investment is higher than the rate of interest. This may
very well be the case as, given the higher level of risk for the Islamic
bank; the rate of return on investment is expected to be higher than
the rate of interest. The opportunity cost of operation may even
increase further if the central bank decided to raise the reserve ratio
on Islamic banks deposits to reduce the risk of default further.
- The third major difficulty of operation facing Islamic banks is
that they are of much smaller size than their Western counterparts,
either those operating nationally or internationally. A Western multi-
national bank for example has assets far in excess of those of all Islamic
financial institutions put together (Chapra, 2000). This makes the com-
petition much tougher particularly, as is the case, when both types
of banking systems are operating freely in the country. And in case
of financial difficulty, the small bank will go out of the market first.
But probably Islamic banks, small as they are, need not particularly
worry. They can build on establishing a good customary relationship
with their customers which would be of great help to small to medium
size businesses. If Islamic banks develop in-house expertise, reliable
financial and industrial data, and good training programmes for their
staff, they may compete well with, if not out perform, larger sized
banks in providing specialist services to small and medium size entre-
preneurs. Put another way, Islamic banks may wish to focus on pro-
viding a niche product and concentrate on the niche market rather
than competing with multinational banks. Indeed this one of the
important aspects of Islamic banking activities as advocated in Islamic
banking theory. But to be able to provide such a service at such a
level Islamic banks need to have well trained staffand capability in
risk management. This might be a particular feature that will appear
in the twentieth first century Islamic banking. - There might be a need to depart, at least partially in the transi-
tional stage, from the concentration of mark-up trade operations,
Murabaha, and become more involved in other forms of investment
financing, Mudharabah and Mushàrakah. Furthermore, the reliance
on the LIBOR bench-mark in trade financing may be creating a
feeling of skepticism regarding the validity of an Islamic mode of
finance. It might be practical for the bank to rely on LIBOR, and
similar rates, as a price taker in the banking operations. But while
this provides a practical answer to a perplexing problem, it does not