CUSTOMERS CRITERIA FOR SELECTING AN ISLAMIC BANK: EVIDENCE FROM PAKISTAN Presented in 1st International Conference on Islamic Marketing

& Branding (Kuala Lumpur, Malaysia) Won the Best Paper Award

E-mail corresponding author: khurambukhari@bzu.edu.pk

CUSTOMERS CRITERIA FOR SELECTING AN ISLAMIC BANK: EVIDENCE FROM PAKISTAN

b

Hayat, M. Awan Khuram Shahzad Bukhari

Institute of Management Sciences Bahauddin Zakariya University, Multan Abstract: Purpose Islamic banking is an emerging financial system in the contemporary world. Currently it is found mostly in Islamic countries or in countries where OPEC oil revenues have been invested. Most of the research has therefore been oriented towards macro-environment issues, ignoring the market oriented problems. This study is micro-oriented however and attempts to determine the conditions under which Islamic banks can successfully compete with conventional banks by understanding customer attitudes towards Islamic banking products. Design/methodology/approach A sample of 250 respondents was taken from four cities of Pakistan to examine customer awareness of key products/ services being offered by Islamic banks, usage of those services and customer satisfaction with the service delivery mechanism being used by pure Islamic banks and Conventional banks with Islamic bank branches (IBBs). Data for this study collected by using a structured questionnaire containing two sections, whereas section-I contains 10 statements using Likert scale, for assessing customers preferred selection criteria for Islamic banks. These statements are developed based on past literature. Section-II deals with the questions related to the social and demographic profiles of respondents. Findings Analysis of data indicated that most of the customers value product features and quality of service as major factors for making selection of Islamic banks, and give lesser importance to religious belief as influential factor in selecting an Islamic bank. Findings suggest that there is a lack of awareness about basic conventions of Islamic financing options among respondents and customers of both the pure Islamic banks and conventional banks with Islamic bank branches do believe that the banks staff lacks ability to provide credible information about religious compliance of Islamic banking financial services Originality/value this study has practical significant for Islamic banking policy makers for understanding the key behavioral and demographical dimensions of their customers and use these dimensions for effectively positioning Islamic banking financial instruments, developing policies ; and articulating procedures to maximize customer satisfaction and to ensure better exchange of value. Key Words: Islamic Banking, Strategic Positioning, Service Quality, Determinants of bank selection, customer satisfaction, consumer behavior. INTRODUCTION At its core, Islamic banking is a prohibition-based industry emerging from Shariah (Islamic law) restrictions on riba (interest), gharar (transactions involving uncertainty or speculation such as derivative trading and insurance) and businesses associated with particular sin sectors such as alcohol, pornography or gambling (Khan and Khanna, 2010). The main prohibitions on interest based banking are because general belief that it is unjust to earn income without assuming risk (Siddique, 2001). Historically, the growth of Islamic banking can be attributed to the desire and interest of retail banking customers to invest their money in accordance with their personal and religious belief (Devlin, J.F 2002). Islamic banking emerged as a fastest growing industry and has received recognition by both Muslims and non-Muslims alike (Iqbal and Molyneux, 2005). The Islamic banking industry is now worth almost an estimated US$1 trillion and is widely considered to be one of the fastest growing sectors in the financial world. Even in the midst of a global economic crisis, Islamic banks weathered the storm to a great effect, which was thanks to strict regulations administered by Islamic law, or Sharia. The estimated size of the industry is around US$ 700 billion that is expected to reach US$ 1.6 trillion by 2012 (Oliver, 2009; Khan and Bhatti

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2008), with Islamic banking no longer considered as a business entity established only to satisfy the religious obligations of the Muslim community. Instead Islamic banking is rather as a business that essentially pursues maximizing customer value and satisfying their financial security needs (Henry and Wilson, 2004). That is why Islamic banks put more in the effort to position their salient features in line with customer needs, which requires them to monitor customer preferences for their investments and borrowing options closely so as to design appropriate business strategies (Chong and Liu, 2006). Asset base of the Islamic Banking Institutions (IBIs) in Pakistan has grown by around 60 percent per annum since 2005; resulting in steady growth in the share of Islamic banking that reached at about 5.5 percent in deposits, and 5.3 percent in assets in September 2009. Currently, IBIs comprise 6 full-fledged Islamic banks and 13 conventional banks (having dedicated IBBs) with a network of more than 550 branches.2 This is commendable achievement and is, in fact, better than some of the leading countries in Islamic financethat started Islamic finance many years earlier than Pakistan. (SBP Islamic Banking Bulletin Oct. 2009). Since 2003, the domestic Islamic banking industry has shown significant progress. Table 1 below provides a snapshot of the progress made by the Islamic banking industry in Pakistan from 2003 to 2009. Islamic Banking in Pakistan (2003-2009)
Descriptions Total assets % of banking industry Deposits % of Banking Industry Financing. & Investment. % of Banking Industry Full Fledge Islamic Banks Conventional Banks with Islamic Banking Branches No. of Branches Dec-09 366 5.6% 283 5.9% 226 4.5% 6 13 Dec-08 276 4.9% 202 4.8% 186 4.4% 6 12 Dec-07 206 4.0% 147 3.8% 138 3.5% 6 12 289 Dec-06 119 2.8% 84 2.6% 73 2.3% 4 12 150 Dec-05 72 2.0% 50 1.8% 48 1.7% 2 9 70 Dec-04 44 1.5% 30 1.3% 30 1.3% 2 9 48 Dec-03 13 0.5% 8 0.4% 10 0.5% 1 3 17

649 515 Source: SBP Islamic Banking Bulletin (Oct.-Dec 2009)

In this regard, the capacity of the Islamic banking industry to ascertain a substantial market share in challenging financial environment (particularly in a dual-banking system like Pakistan) is reliant on the manner in which Islamic banking institutions can strongly position themselves to sustain a competitive advantage and offer services and financial instruments that maximize the value of their existing and potential customers. The remainder of this paper proceeds with next section presenting a detailed literature review. The second part of the study discusses the methodology of the study in detail, with third section of the paper outlining results and discussions and the final section acknowledging the limitations and drawing conclusion of this study. LITERATURE REVIEW Research in social psychology has been valuable in providing key frameworks for understanding the complex relationship between culture and human behavior. One of the lessons learned from the field is that cultural variations have a significant impact on the way individuals view the world, which ultimately affects their behavior (Shweder 1991; Manstead 1997). Culture is an all encompassing force which forms personality, and in turn is acts as a key determinant of consumer behavior (Mooji, 2004). Without any significant differences, researches by Bristow and Asquitch (1999), Gurhan-Canli and Maheshwaran (2000), Chudry and Pallister (2002), and Mooji and Hofstede (2002) suggest that consumers from different cultural background express some significant differences, which may warrant differentiated marketing efforts. From the managerial perspective, a clear understanding of culture and the degree of influence that cultural values have on consumer behavior is pre-requisite for designing effective strategies in marketing to individuals with different nationality, religious values, geography and customs (Cui 1997). According to Sheth (1983, p. 23): An individuals personal values and beliefs about what to look for when shopping various products and services reflect that shoppers personality and may be determined by such personal traits as sex, age, race and religion. A religious group to which a person is affiliated can also serve as a frame of reference making choices of personal consumption (Siguaw and Simpson 1997).

Determinant factors of customers bank selection In the context of banking industry, the determinant factors of a customers bank selection have received significant attention in recent years. Kaufman (1967) found that the most influential factors in customers selection of a bank were convenient location to home or place of business, length of bank-customers relationships and quality of services offered by the bank. Mason and Mayer (1974) suggested that among other important selection criterions used by the customer, convenient location came on the top the priority, followed by other important factors like friendly personnel; favorable loan experience; advice of friends; and . Influence of relatives opinion. Findings of various studies reveals that consumer choice of bank depends on a multiple set of criterions including bank location, availability of loans and the default salary account of a particular bank ( Martenson, 1985). Another study by Arora et al (1985) found that customer selection of banking services is mainly determined by dependability of institutions, accessibility, easiness of processes for transactions, variety of services offered and availability of loans at competitive interest rates. Laroche et al. (1986) found that friendliness of staff plays the major role in the bank decision process, followed by hours of operations, size of waiting lines, convenience of location, and efficiency of personnel. Determinant factors of a customers selection of an Islamic Bank Religious belief as a motive to choose to bank with Islamic banks was described by many of the researchers in various contexts. (Omer, 1992) in a survey based study of customers Islamic banking services being offered by conventional banks in UK, found that the higher percentage of clients using Islamic modes of financing were Muslims. These findings further validated by (Hegazy, 1995) who found that 98.8% of total customers of Islamic banks in Egypt were Muslims. (Metawa and Almossawi, 1998) also noted that the bank-selection decisions by bank customers are predominantly religious-based decisions. Adherence to Islamic principles was found to be the most important selection criterion. In a study conducted by (Bashir, 1999) in Kuwait, and (Naser et al., 1999) who studies the preferences of Islamic banking customers in Jordan endorsed previous findings that suggested religious belief as major motivation for selecting an Islamic bank. Afurther review of various studies including (Hamid and Nordin, 2001), (Ahmad and Haron, 2002, Bley and Kuehn, 2004, Zainuddin et al., 2004, Worthington, 2005, Okumu, 2005, Dusuki and Abdullah, 2007, Rashid and Hassan, 2009, Khan and Khanna, 2010) also support the argument that religious believes serve as main motivation to select an Islamic Bank for Muslim customers. Contradictory to these findings there is a point of view that religious beliefs are not the sole reason to select an Islamic bank see (Erol and El-Bdour, 1989, Gerrard and Cunningham, 1997, Zaher and Hassan, 2001). Dusuki and Abdullah (2006) argued that despite the fact that Sharia compliant solutions are widely recognized by most of Muslim customers, some empirical studies suggest that religion is not the sole reason for selecting an Islamic banking service provider. Apart from the fact that the satisfaction of religious responsibilities may or may not be an important element in bank selection, other motives are reported to have significant a effect of the consumers decisions (Al-Ajmi et al., 2009). One of these significant bank selection criterions is the potential profits from investing in an Islamic bank. (Erol and El-Bdour, 1989) suggested that in considering motives responsible for selecting Islamic banks as depository institutions, religious motives did not stand out as being the only significant ones; bank customers are profit motivated. (Haron et al., 1994) in a comparative analysis of Muslim and non-Muslim customers of Islamic banks found that Muslim customers believe that investing in an Islamic bank can give higher returns. (Al-Ajmi et al., 2009) found that the motive financial strength and soundness is rated by clients of conventional banks higher than the rank given by clients of Islamic banks and those who bank with both conventional and Islamic banks. There is a stream of research that advocates service quality and related constructs as major determinants of customers choice of a bank. There is an agreement among several studies that service quality will remain a critical factor in determining customer satisfaction with financial services offered by different banks (Taylor and Baker 1994; Levesque and McDougal 1996; Jamal and Naser 2002; Moutinho and Smith 2000; and Al-Hawari and Ward 2006). Haron et al. (1994) studied a sample of 301 Muslim and non-Muslim bank customers in Malaysia for their preferred selection criteria used in a dual banking environment. Results of this study show that Muslims and non-Muslims almost equally value fast and efficient services, speed of transactions, staff friendliness, and confidentiality of bank. Avkiran (1999) concluded that the staff conduct, credibility, communication and easy access to teller services were discriminating factors behind selection of banking services In addition to the convenient availability of desired financial services, bank selection criterions also include the sense of security and protection against social, financial and psychological risk associated

with bank transactions (Gerard and Cunningham, 2001). Ethnic background and social orientation are also important determinants of bank selection (Devlin and Ennew, 2004). Kaynak and Harcar (2005) found that low service charges are vital for customers selection of a particular bank. Other factors like banks name and image (Ahmad and Haroon, 2002), confidentiality (Naser et al 1999 and Abbas et al 2003), friends and family influence (Metawa and Almossawi 1998 and Abbas et al 2003), provision of quality services (Ahmad and Haroon, 2002; Othman and Owen 2002; and Ababs et al 2003), and banking experience (Erol et al 1990 and Gerard and Cunningham 1997) are equally important for customers when making decision for selecting Islamic bank for financial services. Objective of the study This study is designed to investigate customers criteria for selecting an Islamic bank Pakistani context. Study was attempted to provide answers to questions like what are the criterions customer prefers to use for selecting an Islamic bank in Pakistan and what factors they mostly rely on, what makes them satisfied. Furthermore, this study concludes with setting up important implications for existing and potential players of Islamic banking industry and provides guidelines to the management about how different customer groups [s] can be targeted and what type of marketing strategies Islamic banks can use to increase their coverage and maximize value for their customers. Research Questions This study, an attempt was made to investigate the following research questions: i. In order to understand determinants of choice criteria for customer selection of an Islamic bank, this study aims to assess the effect of religious motivation, bank reputation and image, low or competitive service charges, location, quality of services, friends and family influence on customers selection of an Islamic bank. ii. Extent to which important selection criteria for an Islamic bank selection differs significantly among Islamic banking customers with different demographic and behavioral profiles. These aspects are purposely selected for empirical investigation as they have significant prevalence in literature, with their use to describe reasons for customers choice of particular banking service institution. RESEARCH METHODOLOGY This study is based on a field survey among customers of banks offering Islamic banking services in Pakistan. The sample size of 250 respondents covers four major cities of Pakistan including Karachi (Commercial Hub of the country), Lahore (Provincial Capital), Faisalabad (Major Industrial Hub) and Multan (Southern Punjab; known as city of saints). Almost all the major Islamic banks have their branch offices in the selected cities. A survey questionnaire was used to collect data. Questionnaire used in this study was divided into two sections. The first of the questionnaire, respondents were requested to indicate, on five point Likert scale, ranging from strongly agree to strongly disagree, a statement explaining the degree of their perceived importance of a factor when selecting an Islamic bank, whilst second section deals with the collection of information about the respondents personal, demographic and economic profiles. Most of the factors used in questionnaire were adapted from previous studies on bank selection criteria like (Gerard and Cunningham 1997; Ahmad and Haroon, 2002; Othman and Owen 2002; Ababs et al 2003; and Dusuki and Abdullah 2006). The questionnaire was first developed in English and then translated into Urdu by using a backward translation method with the assistance of experts in both languages, to minimize translation bias or error. A non-probability sampling technique was used for this study, with respondents randomly selected from Islamic banking customers of both full service Islamic banking institutions and conventional banks offering Islamic financing services and instruments. A total of 250 customers of Islamic banking were approached in each of the four selected cities and after seeking their consent for participation, respondents were requested to fill in the questionnaire. From a total of 250 questionnaire distributed and collected, 223 questionnaires were found as valid and complete, thus yielding a response rate of 89% which was sufficient response rate to ensure statistical reliability and generalisability (Stevens, 2002) ANALYSIS The data collected for the study was analyzed by using SPSS in order to ascertain which of the banking choice criteria were preferred by the customers of Islamic banking in Pakistan. All 10 factors ranked

according to their importance by performing Friedman test, which is an alternative non-parametric to One-Way Anova (analysis of variance). Friedman test was used for analysis of variance when data was scaled on ordinal scale and provided by the same respondent (Norrusis, 2008). Factor analysis was performed to reduce the variables which may be contributing to less variance of data. In order to examine the relationship between proffered selection criteria of Islamic bank and demographic variables (region, age, education, years of experience in Islamic banking and occupation), the Kruskil-Wallis test was used. This test was used to measure the significant variation in response, because of different demographic profiles of the respondents of the study. RESEARCH FINDINGS Ranking of Selection Criteria Test statistics for Friedman test are summarized in Table-I. The observed significance level p=0.000 at 9 degree of freedom is lower than the 0.05 confidence level, which indicates that variation among 10 selection variables are likely to hold in the population. Based on this analysis, we can make the inferences that preferred choice of selection variables is statistically significant and therefore it can be safely concluded that the customers of both the pure Islamic banks and conventional banks with Islamic banking branches demonstrate similar preferences for selecting an Islamic banking services. Results given in Table-I indicate that highest ranked selection criteria for bank selection for customers included availability of various financing options and high profitability potential. These findings corresponds to Gerrard and Cunningham (1997) and Jalaluddin and Metwally (1999), who found that high rate of return and variety of financing options were considered more important by customers as among their selection criteria of Islamic banks. On the moderate level, customers value service quality factors with an equal emphasis on low service charges and bank reputation. Religion whereas was perceived to be least important criteria for customers dealing with Islamic banks. This finding is supported by Erol and El- Bdour (1989) who suggest that the religion is not the primary motivation for Islamic banking customers. Other important factors were fast and efficient service, the banks reputation and image, and confidentiality which were found by Erol and El- Bdour (1989). Relatives and family friends also have significant influence on customer intentions about banking with Islamic banks, which is a finding that is supported by Erol, Kaynak and El-Bdour (1990). Table-I Ranking of Bank Selection Criteria (Friedman Test)
Mean Rank Bank offers a variety of financing options Profitability (potential of high returns) Low service Charges Ease of Accessing Banking services Good Repute among Commercial Banks Recommendations From Friends / Family Expertise and Professional competence of Banks Consulting staff / Advisor Your privacy and confidentiality Friendly and Responsive attitude of Bank Staff Religious Motives (Shria Compliance) 6.67 6.63 6.10 5.86 5.57 5.52 5.30 4.94 4.57 3.81 Important Rank

1
2

3 4 5 6 7 8 9
10

223 222.073 9 .000 After analyzing the customer priorities of Islamic bank selection criteria, a factor analysis was carried out with Varimax rotation and presented in Table-II. Factor Analysis Table-II Factor Analysis for Bank Selection Criteria

N Chi-Square Degree of Freedom Asym. Sig.

1 Variables Profitability (potential of high Return) Low service Charges Your privacy and confidentiality Bank offers a variety of financing options Ease of accessing banking services Expertise and Professional competence of Banks Consulting staff / Advisor Good Repute among Commercial Banks Friendly and Responsive attitude of Bank Staff Religious Reasons Only Profitability (potential of high Return) Product Features 0.627 0.706 0.537 0.702

2 Service Quality

3 Customer Subjective Norms Communality of each variable 0.717 0.555 0.552 0.520

0.792 0.796 0.536 0.817 0.825 0.699

0.742 0.645 0.510 0.695 0.712 0.643

The factor analysis of data defines customer choice of selection criteria for Islamic banks in Pakistan. Most of the studies regarding bank selection preferences and customer patronage behavior in financial services use factor analysis with varimax rotation and Kaiser Normalization (See Hegazy 1995; Metwally 1996; Al-Sultan 1999; and Gerrard and Cunningham 1997). The results in Table-II suggest that there are three factors with all 10 items of customer choice of bank selection criteria, providing a large factor loading (above 0.5 significant levels. All three factors explain a cumulative variance of 64.838 percent. Factor 1 and, Factor 2 have four significant loadings, while factor 3 has only two significant loadings. These results suggest that the selection of Islamic bank would be a combination of F1 (Product features), F2 (Service Quality) and F3 (Subjective norms that includes compliance with religious guidelines and recommendation by friends and family). Customer selection criteria and Demographics Different groups of customers with diverse demographic backgrounds were involved in this survey on the selection of Islamic baking services. To measure any significant differences in their responses or to assess whether the average perceptions about the variables studied were identical for all participating groups, with the Kruskil-Wallis test was used along with computation of x 2 (Naser et. al, 1999). The results of the relationship between the determinants of Islamic bank selection and different demographic variables associated with respondents (i.e. region, age, education, occupation and years of experience in availing Islamic banking services) have been reported in Table III. Table III
REGION VARIABLE X2 Sig X2 AGE Sig EDUCATION X2 Sig OCCUPATION X2 Sig YEARS OF EXPERIENCE X2 Sig

Religious Reasons only Profitability Recommendations Friends Easy access banking services Low service charges Customer's privacy Variety of financing options Expertise of bank's consulting staff/advisor Good repute of bank Friendly attitude of bank's staff

13.888 10.285 1.432 2.441 13.341 9.782 14.288 21.535 19.814 29.568

0.003 0.016 0.698 0.486 0.004 0.021 0.003 0.000 0.000 0.000

6.691 7.736 2.416 3.945 2.431 4.388 4.341 4.763 4.501 2.188

0.082 0.052 0.491 0.267 0.488 0.222 0.227 0.19 0.212 0.534

5.279 3.539 2.955 6.927 2.376 12.708 11.159 13.403 4.852 14.636

0.383 0.617 0.707 0.226 0.795 0.026 0.048 0.02 0.434 0.012

2.745 18.778 7.981 6.773 0.768 4.596 2.935 6.681 9.778 9.993

0.601 0.001 0.092 0.148 0.943 0.331 0.569 0.154 0.044 0.041

2.51 10.793 2.958 1.162 1.989 6.735 8.312 1.369 3.147 1.866

0.474 0.013 0.398 0.762 0.575 0.081 0.04 0.713 0.37 0.601

*Kruskil-Wallis Test Statistics

The results provide evidence that responses collected from different regions differ significantly as far as in the selection of Islamic banking services is concerned. Respondents from Karachi (the capital city of Sindh and city with the largest population in Pakistan) emphasized heavily religion as the basic reason for selecting Islamic banking services, whilst respondents from Lahore (the capital city of Punjab) were relatively least concerned about considering religion as the main motive in this regard. Karachi is

characterized with having a majority of people having a high association with religious groups/political parties, so this result is as per the expectation. For profitability and low service charges, respondents from Lahore show the highest concern, compared with Multan whose respondents had relatively the least concern about these two variables. The understandable reason for this is the industrial nature of customers in Lahore and the majority of respondents with agricultural background were in Multan. Moreover, respondents from Karachi gave relatively high weightage to customers privacy & confidentiality, expertise & professional competence of banks consulting staff and friendly & responsive attitude of banks staff. Knowing Karachi is the trade and industrial hub of Pakistan, which has relatively more sophisticated and has a higher-educated market, the results are as per the expectation. However, customers from Lahore showed a relatively higher concern for variety of financing options offered by banks, and good repute of Islamic banks with other commercial banks. Other demographic variables of age, education, occupation and years of experience in using Islamic banking services did not report as much significant differences in responses as reported by regions. However, in case of age, responses differed significantly for considering religious reason only as a determinant of Islamic bank selection. People from higher age group (above 50 years) was more associated with religion, and exhibited a higher tendency to opt for Islamic banking based on religious motives. For education as a demographic variable, respondents having qualification of matriculation or below matriculation were more concerned with their privacy and confidentiality whilst transacting with Islamic banks than compared with other education segments. Similarly, respondents having qualification below matriculation gave more weightage to the variety of financing options being offered by banks, expertise & professional competence of banks consulting staff/advisor, and friendly & responsive attitude of banks staff. In occupation, public servants took more care of good repute of bank among commercial banks and friendly & responsive attitude of banks staff. Moreover, people who had recently joined Islamic banking and had spent only 3-6 months in dealing with Islamic banks were more desirous of profitability and variety of financial services offered by banks. CONCLUSIONS AND IMPLICATIONS The analysis of the items constituting different aspects of customer selection criteria show that there are two over-riding dimensions i.e. the product features and service quality of Islamic bank, which are highly regarded by the customers of both Pure Islamic banks and customers of conventional banks with Islamic Banking branches. This study also found support for the arguments by (Erol and El-Bdour, 1989, Gerrard and Cunningham, 1997, Zaher and Hassan, 2001) suggesting that religious beliefs are not the sole reason to select an Islamic bank. Results of this study indicate that the customers of Islamic banks rank Sharia compliance features of Islamic Banking services last among other selection criterion they use for selecting an Islamic bank. Core aspects of financial services offered by Islamic banks are not compatible with the competitive financing options being offered by conventional banks. Despite of the fact that Islamic banking instruments are predominantly long-term investment oriented, most of the Islamic Banks are not considering to offer financing options of long-term nature especially a large segment of public sector employees i-e pension and saving schemes and to corporate ventures services like long term financing and mortgages. This would be off assistance in diversifying products and facilities offered by the Islamic banks in Pakistan. This study also found that employees are not well equipped with religious principles associated with different financial instruments being offered by Islamic banks. It implies that banks staff should not only be courteous, attentive and willing to help customers but also capable of demonstrating Sharia principles that can create association between customers religious motives and investment decision criterion. This is also felt that there is also need for creating public awareness about the competitive features of Islamic banking solutions and importance of sharia compliance for making investment choices. This will later help in developing a unique positioning base to distinguish Islamic banking offerings from different financial solutions available with conventional interest-based banking. Managerial implications The management of Islamic banks must acknowledge that competition with commercial banking demonstrates a need to consider product features and service quality as equally important to Sharia compliance in designing the positioning strategy of Islamic banking services. Islamic banking services should be augmented with value added services like online banking facilities, convenient and accessible customer support services and an interactive communication system to facilitate their customers needs. Internal as well as external communication systems should be made compatible to the local conditions of

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