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.

Contents
Contents...............................................................................................................................2
CHAPTER ONE..................................................................................................................3
1. Introduction......................................................................................................................3
1.1 Background Information............................................................................................3
1.2 Significance of the study............................................................................................6
1.4 Objective of the Study...............................................................................................8
1.5 Specific Objectives....................................................................................................8
1.6 Research Questions....................................................................................................8
CHAPTER TWO.................................................................................................................9
2. Literature Review.............................................................................................................9
CHAPTER THREE...........................................................................................................12
3. Methodology..................................................................................................................12
3.1 Description of the Study Area..................................................................................12
3.2 Research Design.......................................................................................................12
3.3 Sampling Procedures and Sample Size....................................................................13
3.4 Data Collection........................................................................................................13
3.4.1 Primary Data Collection.......................................................................................13
3.4.2 Secondary Data Collection...................................................................................13
3.5 Data Collection and Analysis...................................................................................13
3.6. Schedule of Activities.............................................................................................14
3.7. Budget of Research.................................................................................................14
REFERENCES..................................................................................................................15

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CHAPTER ONE
1. Introduction
1.1 Background Information
Banking 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 study

This 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 Study

The 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 Objectives

i. 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 Questions
i. 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 Review
Islamic 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. Methodology
3.1 Description of the Study Area
The 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 Design

In 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 Size

The 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 Collection

3.4.1 Primary Data Collection
Structured 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 Collection

Secondary 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 Analysis

The 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 Activities
The following are the table which shows the schedule of activities.
Table 1: Schedule of activities from January 2011 to July 2011
Number Activities Januar February March April May June
y 2011 2011 2011 2011 2011
2011
1 Title
submission
and
literature
review
2 Proposal
submission
3 Data
collection
4 Data
analysis
5 Report
writing

6 Submission
the report

3.7. Budget of Research

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)

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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 6days @ day 15,000 90,000
accommodation
Communication 10 times @ call 900 9,000
Grand total 180,000

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