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Barriers to adoption of Islamic banking in Pakistan

Irfan Butt
Suleman Dawood School of Business, Lahore University of Management Sciences, Lahore, Pakistan

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Nausherwan Saleem and Hassan Ahmed

Lahore University of Management Sciences, Lahore, Pakistan

Muzammil Altaf
Lahore University of Management Sciences, Lahore, Pakistan and Altaf and Sons Publishers, Karachi, Pakistan

Khawaja Jaffer
Lahore University of Management Sciences, Lahore, Pakistan, and

Jawad Mahmood
Lahore University of Management Sciences, Lahore, Pakistan and Millennium Industries Pvt Ltd, Lahore, Pakistan
Abstract
Purpose The purpose of this paper is to report the ndings of a pilot study conducted in Pakistan, about the barriers perceived by users and non-users of Islamic banking when selecting Islamic banks. Design/methodology/approach This study was conducted to include two types of banking customers, users (customers of Islamic banks only and, Islamic and conventional banks both) and non-users (customers of conventional banks only). The qualitative research included in-depth interviews with managers of Islamic banks and two focus groups with users and non-users, respectively. The survey questionnaire that was subsequently designed received 109 responses. The analysis includes hypothesis testing, factor analysis, and cluster analysis. Findings A narrow branch network, inconvenient branch locations and perception that Islamic banks do not completely follow Islamic principles acted as barriers for non-users when selecting Islamic banks. Further, a religious ruling against Islamic banks was not considered an important barrier when selecting Islamic banks. Originality/value This research outlines an alternative methodology of looking at bank selection criteria, by measuring the other side of the coin, i.e. the barriers perceived by users and non-users of Islamic banking when selecting Islamic banks. Compared to the prevailing literature on the subject, such an approach is enlightening and can have enormous potential as it directly measures the perceived barriers towards Islamic banking. Furthermore, this pilot study is also an important contribution to the limited literature on consumer attitudes towards Islamic banking in Pakistan, where the operations of Islamic banks are still in their formative stage. Keywords Pakistan, Islamic banking, Consumer perception, Barriers, Branch network, Islamic principles, Consumer behaviour, Islam Paper type Research paper

1. Introduction With the rapid growth of the global economy along with the expanding economy of Islamic countries, Islamic banking is evolving to play a vital role in the world.

Journal of Islamic Marketing Vol. 2 No. 3, 2011 pp. 259-273 q Emerald Group Publishing Limited 1759-0833 DOI 10.1108/17590831111164787

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Exponential growth in the last decade has resulted in Islamic banks expansion in over 53 countries with a total of 400 banks. In Pakistan, Islamic banking started with the prohibition of Riba (interest) in 1970, with most of the practical steps taken in 1980. It is estimated that total assets of the Islamic banking industry will reach over Rs 1 trillion by the year 2012. The branch network is expected to exceed 1,200 branches in ve years. The deposits are expected to reach about Rs 1 trillion. In combination with the introduction of new sectors into the fold of Islamic banking, i.e. Islamic micronance and agriculture services, it is projected that the Islamic banking industry will capture a 12 percent share of the total banking industry in the year 2012 (State Bank of Pakistan, 2008). An underlying basis of operations and services differentiate the Islamic banking system from the conventional banking system. According to the State Bank of Pakistan, Islamic banking is dened as a banking system which is in consonance with the spirit, ethos and value system of Islam and governed by the principles laid down by Islamic Shariah. Interest free banking is a narrow concept denoting a number of banking instruments or operations which avoid interest. Islamic banking is structured not only to avoid interest-based transactions prohibited in Islamic Shariah but also to circumvent unethical and un-social practices. In a practical sense, Islamic banking is the transformation of conventional money lending into transactions based on tangible assets and real services. According to Islamic Shariah, Islamic banking cannot deal in transactions involving Riba (an increase stipulated or sought over the principal of a loan or debt). Furthermore, they cannot deal in the transactions having the element of Gharar (deception) or Maiser. Moreover, they cannot deal in any transaction, the subject matter of which is invalid (haraam in the eyes of Islam). Islamic banks focus on generating returns through investment tools which are a Shariah compliant. Islamic Shariah links the gain on capital with its performance. Operating within the ambit of Shariah, the operations of Islamic banking are based on sharing the risk which may arise through trading and investment activities using contracts of various Islamic modes of nance (State Bank of Pakistan, 2008). The client base of any nancial institution plays a pivotal role in determining its success. Customers require personalized services and full knowledge in order to ensure that their wealth is invested in a safe manner. Thus, it becomes vital for all nancial institutions to have adequate knowledge of consumer perceptions regarding products and services in order to effectively achieve market growth. Most of the research on understanding consumers perceptions of Islamic banks investigates bank selection criteria of consumers. However, there is hardly any study which explores the barriers which prevent or discourage consumers from adopting Islamic banks. This paper attempts to achieve a better understanding of consumer perceptions by studying the barriers, in order to help Islamic banks utilize potential opportunities through marketing strategies. There has been limited research in Pakistan on consumer perception of Islamic banks. A review of literature on Islamic banking from across different countries has shown that diverse economic conditions play an important role in determining consumer behavior. Hence, research done on Islamic banking in different countries may not necessarily apply to conditions present in Pakistan. Both of these factors contribute to the underlying motivation to research in greater detail on consumer perception with

regard to Islamic banks in Pakistan with the intent of providing greater knowledge to consumers as well as Islamic banks. 2. Literature review There has been considerable research in the area of consumer perception and Islamic banking all over the world. Specic research studies pertinent to our study include research done on bank selection criteria and customer awareness and satisfaction with respect to Islamic banks. Popular research carried out in this eld includes work done by Khattak and Rehman (2010) in Pakistan, Erol and El-Bdour (1993) in Jordan, and Dusuki and Abdullah (2006) in Malaysia. In Bahrain, Metawa and Almossawi (1998) conducted a study on bank selection criteria which identied factors that affected consumer behavior and bank selection. They pointed out that the religious factor was the most important determinant of bank selection followed by rate of return. A more recent study in Bahrain by Al-Ajmi et al. (2009) highlighted the exact standing of religious motives in the bank selection criteria. Al-Ajmi et al. (2009) explain that previous studies of Almossawi (1998) faced certain limitations and authors tried to address those limitations by introducing ve different factors involved in bank selection criteria. The study concluded that across all three sub-samples of users of Islamic banks, users of conventional banks and users of both Islamic and conventional banks, the three most important motives for bank selection were service quality, friendly personnel, and competent personnel. Similarly, a number of studies have been conducted to consider economic factors for bank selection criteria for traditional banks. Gait and Worthington (2008) outlined that customers for traditional banks consider protability factors such as low service charges and higher returns to be one of the most important factors in their decision. Bank selection criteria and reported underlying factors have appeared to differ across conventional and Islamic bank users, across countries and demographic characteristics. This can be seen clearly from the difference in ndings reported by a variety of research studies. Apart from bank selection criteria, there has also been research conducted on customer awareness of Islamic banking basis and products and services offered by them. In Pakistan, around 68 percent of the respondents knew about the basic services like current account and saving accounts. However, they knew little about products such as Ijara, Musharkah, etc. (Khattak and Rehman, 2010). Gerrard and Cunningham (1997) conrmed the same in a study carried out with Muslims living in Australia, which was later also conrmed by Rammal and Zurbrugg (2007). On the other hand, in Jordan, results showed that a high proportion of respondents were aware of Islamic nancial products and in addition, were not only using conventional products in Islamic banks, but also knew about key Islamic Banking terms (Naser et al., 1999). 3. Qualitative research 3.1 Design and methodology For the purpose of qualitative phase of the research, two different sources of data were considered. First, in-depth interviews were conducted with Islamic bank experts, in order to nd out more about the banks own perspective about what customers feel about Islamic banks and to better gauge their banking preferences and attitudes. The aim was

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also to identify and explore areas that would be considered for discussion subsequently in the research. Second, two sets of focus groups were conducted one with users of Islamic banks and other with users of conventional banks, to reveal the varying differences of opinion that exists between users and non-users of Islamic banks to form the primary basis for the questionnaire development. Two major areas of measurement were identied for further research. First, customers awareness regarding factors such as the underlying principles of Islamic banking, products and services, the risk and return characteristics and cost and benet analysis, societal impact, and marketing by Islamic banks was gauged. Second, the research enriched our understanding of customers bank selection criterion for the above-mentioned factors. Within this, the barriers towards Islamic banking faced by non-users and the motivations for users were also considered. 3.2 Findings of qualitative research It was generally found that there were wide differences in the opinion of users and non-users in the focus groups. Also, non-users exhibited a lower level of awareness of Islamic bank products and services. However, when asked about the basis of Islamic banking in Islam, users and non-users both were keen to point out Riba (interest) as the underlying basis. Differences in opinions emerged where people were asked whether they believe the present system to be Islamic or not. Users saw the current system to be a mere turn-around of the conventional system. General awareness of the risk and return characteristics of Islamic banks was also relatively low among users and non-users. Some of the key ndings that emerged from the qualitative research and had not been considered before were as follows: . Managers of Islamic banks were generally aware of the problems faced by users as these were echoed by the users in the focus groups. . Non-users pointed out ambiguity in products and transactions as a barrier in selecting Islamic banking along with multiple religious rulings regarding Islamic banking. . The societal impact of Islamic banks was generally well known. However, it was not considered as an important factor for bank selection. . Non-users pointed out the need to improve marketing methods for Islamic banks to successfully increase market share. . Complex transaction procedures of Islamic banks were also seen as a major barrier by non-users when selecting Islamic banks. 4. Research questions Based on the results and ndings of the qualitative research, it was decided to rene the research objectives and incorporate the wide variety of opinions to include the following: . to investigate the barriers that users and non-users face when selecting Islamic banking; . to understand the users and non-users understanding of the underlying principles of Islamic banking; and . to understand the users and non-users perception of the extent to which the current Islamic banking system is following Islamic principles.

5. Quantitative research 5.1 The instrument A questionnaire was designed to collect data from the target population. Special care was taken to omit the use of the word, barrier in the questionnaire to remove any potential biases in responses. The questionnaire was structured into two major sections. The rst section aimed at gathering basic information about the respondent such as age bracket, income bracket, gender, marital status, type of bank used, Islamic banks products used if any, and the duration of banking experience. The second section consisted of six questions, each with their own objective. The rst question aimed at gathering an insight into what users and non-users of Islamic banks perceived to be the underlying basis of Islamic banking. The second question aimed at measuring, on a scale of 1-10, the extent to which Islamic banks are following Islamic principles. Questions 3 and 5 measured, on a ve-point Likert scale, ranging from strongly disagree to strongly agree, the level of agreement that users and non-users have towards carefully constructed statements depicting Islamic banks current situation. Questions 4 and 6 measured, on a ve-point Likert scale, ranging from not important at all to extremely important, the level of importance that users and non-users attach to the aspects mentioned in questions 3 and 5. The rationale for such a division was to identify important barriers towards Islamic banking. For example, if a non-user strongly disagrees with the statement that Islamic banks are currently completely Riba-free and rates this factor as extremely important for selecting Islamic banks, then, it can be considered as a barrier for that non-user. After designing the questionnaire, it was pre-tested with a pilot sample of ve participants. The method used for pre-testing was participative pre-testing whereby the participants were asked to not only ll the questionnaire but also suggest possible problems with the phrasing of the questions and statements in order to bring greater clarity and ease of understanding for the respondents. Once pre-testing was completed, the questionnaire was amended in light of the suggestions received from pre-testing participants. The nal sample that was selected did not include participants from the pilot sample. 5.2 The sample The survey was administered in December 2010, and was distributed by the authors to walk-in customers at 20 branches of Islamic and conventional banks, including Islamic bank windows in Lahore. The branches were selected using random sampling, out of a sampling frame including 900 branches of banks. In the branches themselves, systematic sampling was used such that a questionnaire was given to every third customer entering the branch premises and respondents were asked to ll the questionnaire on the spot. The number of responses received in this manner came out to be 109, out of which 12 questionnaires were discarded due to missing information. The nal sample, therefore, of 97 responses, consists of 45 non-users of Islamic banks, and 52 users of Islamic banks. The latter category also includes those customers which are currently using the services of both conventional as well as Islamic banks. Although the focus of the study is to gauge what barriers non-users face when selecting Islamic banks, users of Islamic banks were included in the sample in order to nd the basis for differentiation and to check the differences in level of agreement about current Islamic banking system, and the difference in level of importance attached to these

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aspects of Islamic banking. The aim was to extract the opinion of non-users and the experience of users. Within the sample, 74.2 percent of the respondents were male and 21.6 percent were female. The majority of the respondents (54.2 percent) fall within the ages 26-40, while nearly 26.8 percent fell within the 18-25 years of age category. Almost 52.6 percent of the respondents were married, with 36.1 percent single, and the remaining constituting of missing values. Almost 81.4 percent of the respondents earn less than Rs 100,000 per month, while a small amount of respondents earn more than Rs 100,000 per month. The majority of the respondents (51.5 percent) hold at least a Masters or a PhD degree, while 34 percent hold a bachelors degree. 5.3 Results and analysis 5.3.1 Underlying principles of Islamic banking. The instrument was constructed in a way to rst test the top of mind awareness of users and non-users regarding the underlying principles of Islamic banking and then ask them to rate, on a scale of 1-10, to what extent these underlying principles are currently being followed by the Islamic banking industry. The results showed that both users and non-users agreed on the fact that Riba-free banking was the most important principle of Islamic banking. Investment in Halal businesses was the second most important principle as viewed by users and non-users, both. Further, equal distribution of wealth and prot and loss sharing appeared the next in importance as part of the underlying principles. Surprisingly, only 60 percent of non-users (28 out of 45) marked Riba-free banking as an underlying principle of Islamic banking as compared to 90 percent of users (46 out of 52) who marked Riba-free banking as an underlying principle. This may signify the lack of understanding of the concept of Riba and how it is being used in conventional banking. Further, on a scale of 1-10, the users and non-users rated that Islamic banking is following Islamic principles at an average of 5.75 and 4.88, respectively. This rating suggests that on average people perceive that Islamic banking is moderately following Islamic principles. In order to check the difference in the means of users and non-users, an independent samples t-test was conducted on a 95 percent signicance level. It suggested that there was no statistically signicant difference in opinion of both users and non-users whether Islamic banking is following Islamic principles. 5.3.2 Factor analysis. As previously mentioned, the instrument was designed in a way to check the users and non-users level of agreement and level of importance regarding various aspects within Islamic banking. The level of agreement depicted the current situation of certain aspects, as perceived by the users and non-users, in Islamic banking and the level of importance showed the importance of these aspects when consumers select Islamic banking. Principal component analysis with orthogonal (varimax) rotation was selected to reduce the number of factors while the eigenvalue having a value of more than one was set as the criterion used in determining the number of factors. Factor analysis was run on both agreement and importance category separately. Various unloaded and invalid variables were discarded during the several runs of principal component analysis. The following rotated component matrices will show the identied factors in both categories which validly explain the communality within the variables of a particular factor.

Table I shows the factors identied under the level of agreement category. Table II shows the factors identied under the level of importance category. Three factors were successfully identied in both the categories. The factors are given below: (1) Level of agreement: . services currently offered by IB; . Islamic principles which IB currently follow; and . branch network of IB. (2) Level of importance: . services preferred by customers; . Islamic principles which IB should follow; and . IB should have wide branch network with convenient locations.

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Services IB IB IB IB IB IB IB IB IB IB offers tele-banking offers internet banking offers online fund transfer offers SMS banking offers ATM 1Link/Mnet invests in Halal businesses is completely Riba-free banking promotes equal distribution of wealth has conveniently located branches has a wide network of branches 0.873 0.846 0.778 0.741 0.716

Level of agreement in Islamic principles

Branches

0.886 0.880 0.706 0.885 0.815

Notes: Extraction method: principal component analysis; rotation method: varimax with Kaiser normalization; IB, Islamic Bank

Table I. Factor loadings for the three factors in the agreement category extracted using principal component extraction and orthogonal rotation

Services Internet banking Tele-banking SMS banking ATM 1Link/Mnet Online funds transfer Investment in Halal businesses Completely Riba-free banking Equal distribution of wealth Conveniently located branches Wide network of branches 0.910 0.896 0.873 0.809 0.738

Level of importance of Islamic principles

Branches

0.885 0.877 0.813 0.885 0.860

Notes: Extraction method: principal component analysis; rotation method: varimax with Kaiser normalization

Table II. Factor loadings for the three factors in the importance category, extracted using principal component extraction and orthogonal rotation

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The factors identied in the agreement category (Table I) explain around 69.3 percent of the total variance. Of the variance explained, these factors explain 32.4, 21.4, and 15.6 percent, respectively. The factors identied in the importance category (Table II) explain around 76.2 percent of the total variance. Of the variance explained, these factors explain 36.8, 23, and 16.3 percent, respectively. In both the categories, services was considered as the most important factor in explaining the total variance. Islamic principles were the second most important factor and highlighted the three most important underlying variables which dene Islamic principles behind Islamic banking. Lastly, branch proximity and network coupled into an important factor, branches, which highlighted the customer need of accessibility for the Islamic banking industry. In order to check the internal consistency and reliability of the variables within each factor, the Cronbachs a values were calculated. For the agreement category of factor, they were found to be 86, 77, and 70 percent for services, following of Islamic principles and branches, respectively. Similarly, for the importance category, the Cronbach a values came out to be 91, 84, and 73 percent for services, following of Islamic principles and branches, respectively. Since all of the Cronbach a values came out to be greater than 70 percent, the variables within each factor were considered reliable and internally consistent. 5.3.3 Hypothesis statements and explanation. In order to reach some conclusive results from the research, a number of hypothesis statements were generated in order to test them through statistical techniques. Broadly speaking, the hypotheses aim to test the differences that exist between users and non-users perceptions regarding Islamic banks. In addition, they will reveal which of the factors can be considered as barriers by non-users towards Islamic banking. The following alternative hypotheses were formed, based on ndings of the qualitative research and the overall research objective (the hypotheses were paired together to measure the same factor using the two dimensions of level of agreement and the level of importance attached to that factor): H1a. There is a difference in the level of agreement about the extent of services offered by Islamic banks, between users and non-users of Islamic banks. H1b. There is a difference in the level of importance that users and non-users attach to services offered by Islamic banks. H2a. There is a difference in the level of agreement that users and non-users have about the extent to which Islamic banks are following Islamic principles. H2b. There is a difference in the level of importance that users and non-users attach to following of Islamic principles by Islamic banks. H3a. There is a difference in the level of agreement that users and non-users have towards Islamic banks branch locations and network. H3b. There is a difference in the level of importance that users and non-users attach to Islamic banks branch location and network. H4a. There is a difference in the level of agreement about the presence of religious rulings against Islamic banks between users and non-users.

H4b. There is a difference in the level of agreement that users and non-users attach to the presence of religious rulings against Islamic banks. Apart from the tests of the above hypotheses, further analysis was also conducted on other variables which is covered Section 5.3. The results of testing of H4a and H4b can also be found in Section 5.3.5. 5.3.4 Hypothesis testing. To identify importance barriers towards Islamic banking, the hypotheses stated in the previous section were tested by comparing the difference of the means for users and non-users, using the independent samples t-test at 95 percent signicance level. It was seen that the users of Islamic banks agree to a reasonable degree that Islamic banks are offering ATM/1-Link, internet banking, tele-banking, SMS banking and online fund transfer services (with a mean of 3.89 out of 5) and consider them very important (with a mean of 3.85 out of 5). Non-users agree to a slightly lesser degree, compared to users, that Islamic banks are offering these services (with a mean of 3.59) and attach slightly greater level of importance to them (with a mean of 3.97). Hence, comparing the means for level of agreement and level of importance for non-users, we can see that services could be a plausible barrier for non-users. We can test the difference between users and non-users means to conrm this. For H1a, it was found that the difference in level of agreement between users and non-users about the extent of services offered by Islamic banks was statistically insignicant. Similarly, for H1b, the difference in level of importance attached to services offered by Islamic banks, was also seen to be statistically insignicant. Hence, the major nding from these hypotheses points to the fact that since, there is no differentiating factor between users and non-users attitudes and preferences towards Islamic banks services, hence the services offered by Islamic banks cannot be a barrier for non-users for selecting Islamic banks. Users of Islamic banks consider Islamic banks to be following Islamic principles to a reasonable degree (with a mean of 3.48 out of 5) and attach a high level of importance to this factor for selection (with a mean of 3.76 out of 5). However, for non-users it was found that the mean for level of agreement was less (2.96 out of 5) while the mean for level of importance for this factor was higher (3.94 out of 5), compared to users. Again, we can test the difference for level of agreement and level of importance between users and non-users to conrm whether this is a barrier for non-users. For H2a, it was found that the difference in the level of agreement between users and non-users about the extent to which Islamic banks are following Islamic principles was statistically signicant. In the case of H2b, the difference in the level of importance attached to this factor was statistically insignicant. This has an important interpretation for the research. Since users agree to a greater extent that Islamic banks follow Islamic principles, compared to non-users, and the difference is statistically signicant, and since they both attach the same level of importance to this factor, hence it can be reasonably judged that non-users perceive this to be a barrier towards Islamic banking. For the branches factor, users of Islamic banks agree to a reasonable degree (with a mean of 3.52 out of 5) that Islamic banks have branches in convenient locations and a wide branch network, and attach a reasonable level of importance to this factor (with a mean of 3.51 out of 5). However, for non-users, it was seen that the mean is considerably lower for level of agreement (with a mean of 2.52 out of 5), while there is not much difference from users in the level of importance attached to this factor (with a mean of 3.31 out of 5). Therefore, H3a was similarly tested and it was found that the difference

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in level of agreement users and non-users have about the convenience of branch locations and width of branch network is statistically signicant. After testing H3b, the difference in level of importance attached by both to this factor was statistically insignicant. Hence, it can be said that compared to users, non-users disagree more with Islamic banks having convenient locations and a wide branch network and attach the same level of importance as users to this factor. Therefore, the branches factor can be seen to be an important barrier for non-users towards selecting Islamic banking. Therefore, from the above discussion, the following of Islamic principles and branches of Islamic banks have been veried to be important barriers that non-users face when selecting Islamic banks, while the services offered by Islamic banks were seen to be unimportant. 5.3.5 Other variables. As mentioned in Section 5.3.2, some of the unloaded variables were ignored during the analysis. This section would highlight the importance of these individual variables and report results of independent tests that were conducted to verify whether these variables act as a barrier or not. The following variables have critical importance in relation to the Islamic banking industry. Some of these variables fall under the banner of criticisms of Islamic banking; while others are seen as important for competition with conventional banks. These factors were: (1) religious rulings against Islamic banks; (2) risk of loss on deposits for Islamic banks customers; and (3) difference in level of returns on deposits compared to conventional banks. Each of the variables will be seen under the agreement and importance category in order to compare means of each variable under both categories. Furthermore, an independent samples t-test will be administered between users and non-users in each category. This test will particularly show whether the difference in opinion of users and non-users is statistically signicant or not. Under the agreement category, we can see that users and non-users were generally unaware of the religious rulings against Islamic banking with a lower mean of 3.02 and 2.82, respectively. However, for both users and non-users no religious rulings against Islamic banking was an important factor when selecting Islamic banking as signied by a higher mean of 3.48 and 3.63, respectively. Thus, people attaching a neutral opinion about the prevalence of religious rulings against Islamic banks and a relatively higher importance of no religious rulings during bank selection, does not make this variable a plausible barrier. Furthermore, the t-tests on H4a and H4b also showed that there was a statistically insignicant difference between users and non-users under the agreement and importance category, when testing this variable. Thus, religious rulings against Islamic banking are not a barrier for people when selecting Islamic banking. Furthermore, looking into the loss on deposits variable both users and non-users identied that either there was a negligible risk of loss or they were uncertain whether there would be a loss or not. On the other hand, no risk of loss was not a very dening variable for a consumer when selecting Islamic banking. With statistically insignicant difference between users and non-users in both categories, we can safely conclude that people were indifferent about loss on deposits. This nding can be backed through the fact that State Bank regulations and past performance of Islamic banks has shown no loss on deposits of consumers.

Lastly, it was seen that both users and non-users rated low on the returns of Islamic banks are higher than conventional banks variable. Furthermore, higher returns than with conventional banks was itself not an important criteria when selecting Islamic banking (3.1 and 3.05). This nding shows that Islamic banks not having a higher return than conventional banks is not at all a barrier. However, on the other hand it was identied that non-users attached relatively higher importance (3.54) to equal returns to conventional banks and consequently also perceived to some extent that Islamic banks did offer an equal return (3.40). With no statistically signicant difference between users and non-users, we can conclude that this variable is not a barrier. 5.3.6 Cluster analysis. In order to classify respondents into groups that are relatively homogeneous within themselves and heterogeneous between each other, cluster analysis was performed to identify possible clusters in respondent population under both categories of importance and agreement. As mentioned before, under the agreement category respondents gave their opinion regarding the current situation of Islamic banking. This basically showed the different perceptions regarding Islamic banking prevalent in the industry. Similarly, under the importance category, different consumer preferences were highlighted by the degree of importance they attach to a given variable during bank selection. Cluster analysis was conducted separately on each of the two categories. Hierarchical Wards method followed by K-means clustering was used to identify the distinct clusters within each category. Three clusters were identied under the agreement category, where as two clusters were identied under the importance category. The three clusters identied under the agreement category, signied the three consumer mindsets regarding Islamic banking, present in the respondent population. Figure 1 will distinguish between each of the three clusters. Cluster 1 perceives that although Islamic banks are providing satisfactory services, they are not able to follow Islamic principles and provide a wide branch network.
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0 Cluster 1 Services_A Cluster 2 Principles_A Cluster 3 Branches_A

Figure 1. Clusters in level of agreement category

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Cluster 2 highlights that Islamic banks are providing exceptional level of services and are also adequately following Islamic principles and striving for a reasonable branch network. Cluster 3 highlights that Islamic banks lack in the provision of services and an adequate branch network, but they have managed to follow Islamic principles. The demographics of these clusters show that the age brackets are widely dispersed within clusters 1 and 2, as both have more than 50 percent in the bracket of 26-40, and the remaining 50 percent is distributed in the other age brackets. However, in cluster 3s both age brackets of 18-25 and 26-40 have around 47 percent representation each in the cluster. There was no signicant difference in the level of education of respondents in the three clusters as most of them were graduates and post-graduates. In clusters 1 and 2, 45 and 55 percent of the respondents had incomes below Rs 50,000, where as in cluster 3 more than 77 percent of the respondents had income below Rs 50,000. This can be due to the age distribution of the respondents as most of them might be young professionals. In clusters 1 and 3, more than 55 percent of the respondents were non-users, where as in cluster 2 more than 65 percent of the respondents were users. This aspect signies the fact that users who are actually using Islamic banking have rated Islamic banks high on these three factors, as done in cluster 2. Under the importance category, the two clusters show the level of importance a respondent attaches to each of the factors when selecting Islamic banking (Figure 2)
5

Figure 2. Clusters in level of importance category

Cluster 1 Services _I Principles_I

Cluster 2 Branches_I

Cluster 1 represents a set of respondents who attach moderate importance to these three factors. Cluster 2 represents a set of respondents who attach great importance to these factors during bank selection. Both the clusters had the same distribution in terms of the age of the respondents. However, in cluster 1, 35 percent of the respondents were postgraduates, whereas in cluster 2 more than 65 percent were postgraduates. Higher education may be a reason for higher levels of importance being attached to each of the factors. Both clusters almost had the same percentage of users and non-users within them. This could simply mean that there may be two sets of users and non-users, one which attaches immense importance to these three factors during bank selection, whereas the other which prefers other factors than these such as higher returns, etc. It would not be surprising to say that more than 65 percent of the respondent population belonged to Cluster 2. 6. Research implications and contribution of research towards literature This study outlines an alternate way of looking at bank selection criteria of customers of Islamic banks, by focusing instead on the other side of the coin, i.e. the barriers faced by non-users towards Islamic banks. Compared to the current literature on the subject, the methodology used in this research is the rst of its kind and could have enormous potential. In addition, considering the dearth of literature that currently exists about Islamic banking in Pakistan, this study would make a signicant contribution in understanding the nature of the customer mindset when he makes a decision between conventional and Islamic banks. The ndings themselves have important research implications. First, religious factors such as Riba-free banking, investment by Islamic banks in Halal businesses and equal distribution of wealth, and factors specic to branches of Islamic banks, such as convenient locations and a wide branch network, were seen to be important barriers that non-users face when selecting Islamic banks. Hence, the management of Islamic banks should concentrate more on improving the awareness of people regarding underlying basis of Islamic banking and how they are following that basis. Second, they should also try making their branch network more accessible to the banking customer. Currently, only Meezan Bank in Pakistan has reasonable branch coverage, while the rest of the Islamic banks only have a few branches and that too, only in urban centers. 7. Research limitations and directions for future research As mentioned earlier, this research was conducted as a pilot study and so currently has a number of shortcomings that should be addressed through further research in the future. First, the sample size of 97 respondents (including both users and non-users) should be extended to include more respondents in order to get more accurate and representative results. Second, respondents from other cities such as Karachi and Islamabad can also be included in the sample so that the results of the study can be generalized to a greater population. Third, the survey questionnaire was administered in only one language, i.e. English, due to a lack of time. Therefore, any future research should ensure that the survey questionnaire be translated into Urdu to include non-English speaking population in the sample also. Fourth, currently those respondents who use Islamic banks only, and those who use both conventional

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and Islamic banks, were grouped together to form one group; users of Islamic banks. The future research can separate those who use Islamic banks only so that analysis can be performed on three different groups of people, those who use Islamic banks only, those who use conventional banks only, and those who use both. Fifth, during the course of the research, it was seen that considerable differences exist in the service quality and branch network between the Islamic banks in Pakistan themselves. Therefore, further research can be conducted into how the perceptions of customers vary across various Islamic banks in Pakistan. 8. Concluding remarks It was found that most users and non-users perceive Riba-free banking to be the primary basis for Islamic banks. Users and non-users both also felt Islamic banks to be moderately following Islamic principles. While considering barriers faced by non-users of Islamic banks, it was identied that the perception that Islamic banks do not follow Islamic principles, constituted a major barrier for non-users when selecting Islamic banks. Non-users were also dissatised with the branch network and locations of branches of Islamic banks, and hence found them to be a barrier. Moreover, it was found that the services offered by Islamic banks were competitive with the banking environment and hence, did not constitute a barrier. Similarly, both users and non-users felt the same way about religious rulings against Islamic banking, and hence it was found that non-users do not consider them to be a barrier. Other factors such as the return offered by Islamic banks, and the risk of loss on deposits were also not found to be important barriers for non-users when selecting Islamic banks.
References Al-Ajmi, J., Hussain, H.A. and Al-Saleh, N. (2009), Clients of conventional and Islamic banks in Bahrain: how they choose which bank to patronize, International Journal of Social Economics, Vol. 36 No. 11, pp. 1086-112. Erol, C. and El-Bdour, R. (1993), Attitudes, behavior, and patronage factors of bank customers towards Islamic banks, International Journal of Bank Marketing, Vol. 7 No. 6, pp. 31-7. Gait, A. and Worthington, A. (2008), An empirical survey of individual consumer, business rm and nancial institution attitudes towards Islamic methods of nance, International Journal of Social Economics, Vol. 35 No. 11, pp. 783-808. Gerrard, P. and Cunningham, J.B. (1997), Islamic banking: a study in Singapore, International Journal of Bank Marketing, Vol. 15 No. 6, pp. 204-16. Khattak, N.A. and Rehman, K.U. (2010), Customer satisfaction and awareness of Islamic banking system in Pakistan, African Journal of Business Management, Vol. 4 No. 5, pp. 662-71. Metawa, S. and Almossawi, M. (1998), Banking behavior of Islamic bank customers: perspectives and implications, International Journal of Bank Marketing, Vol. 16 No. 7, pp. 299-315. Naser, K., Jamal, A. and Al-Khatib, K. (1999), Islamic banking: a study of customer satisfaction and preferences in Jordan, International Journal of Bank Marketing, Vol. 17 No. 3, pp. 135-51. Rammal, H. and Zurbrugg, R. (2007), Awareness of Islamic banking products among Muslims: the case of Australia, Journal of Financial Services Marketing, Vol. 12, pp. 65-74.

Further reading Ahmed, I. and Shabbir, G. (2005), Frequently asked questions on Islamic banking, available at: www.sbp.org.pk/departments/ibd/FAQs.pdf (accessed 7 October 2011). Erol, C., Kaynak, E. and El-Bdour, R. (1990), Conventional and Islamic banks: patronage behavior of Jordanian customers, International Journal of Bank Marketing, Vol. 8 No. 4, pp. 25-35. Islamic Banking Department (2008), Pakistans Islamic banking sector review, available at: www. sbp.org.pk/ibd/Islamic-Bkg-Review-03-07.pdf (accessed 10 November 2011). Metwally, M. (1996), Attitudes of Muslims towards Islamic banks in a dual-banking system, American Journal of Islamic Finance, Vol. 6 No. 1, pp. 11-17. About the authors Irfan Butt received his PhD from Carleton University, Canada and MBA from the Thunderbird School of Global Management, USA. His industry experience includes working for multinationals in the Middle East. His research interests comprise international marketing, country-of-origin, positioning strategies and emerging markets. His research has appeared in the Electronic Journal of E-Government, the Indian Journal of Business and Economics, Budapest Management Review and the Proceedings of the American Marketing Association (AMA), Administrative Sciences Association of Canada (ASAC), and Australia New Zealand Marketing Academy (ANZMAC), amongst others. He has received various best paper awards for his research. Irfan Butt is the corresponding author and can be contacted at: irfanbutt@lums.edu.pk Nausherwan Saleem is currently a student of Accounting and Finance. His major area of interest is consumer market research and nance. In order to diversify his area of research expertise, he has been working on an Islamic banking project measuring consumer perceptions of customers in Pakistan. Currently, he is also working on a senior project on Islamic microcredit institutions in Pakistan. He will be graduating from LUMS this year and hopes to pursue a career in Market Research afterwards. Hassan Ahmed is an undergraduate research student at the Lahore University of Management Sciences, majoring in Accounting and Finance. Muzammil Altaf is currently studying for BSc Honors in Accounting and Finance from Lahore University of Management Sciences (LUMS), Pakistan. Major areas of interest include the study of Islamic sciences and modern banking, commerce and management science and how the former can be implemented in the context of the latter. He is working on a senior project on the history and future prospects of micronance institutions in Pakistan, with special emphasis on the Islamic micronance industry and also serving as a Senior Executive Member at the LUMS Religious Society (LRS). Khawaja Jaffer is a research student at LUMS. Jawad Mahmood is currently doing a BSc Honors in Accounting and Finance from Lahore University of Management Sciences (LUMS), Pakistan. His major eld of interest and research is marketing and Islamic nance. He is one of the senior research associates at LUMS exploring the Islamic Shariah role and possible implementation in the micronance institutes of Pakistan, also focusing on developing a Halal model of micronance as well digging deep to nd the true social and nancial impact by the micronance institutes in Pakistan over the last decade of its prominence. At LUMS, he has been a long serving executive member of the LUMS Religious Society (LRS), promoting Islamic lifestyle in an academic manner and opening discussion on various issues relating to Islam.

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