1. Introduction

Islamic banking is mainstream banking now, with several countries having a dedicated Islamic banking framework and regulations. The developments that have taken place in Islamic banking are need-based and not planned or structured, and there is no central body to oversee the growth of business. This has led to several inconsistencies and issues affecting the quality of Islamic banking. One of the main concerns is the strictness with which the rules of Shariah are applied. The way in which products are structured and marketed may possibly have an impact on the efficiency and profitability of Islamic banks, although this has been one of the most neglected areas in the literature of Islamic finance. There has been some research focusing on comparative analysis of Islamic and conventional Banks (Shah and Hamid, 2008; Hanif, 2011; Quresh et al., 2012; Zeitun, 2012), with some of the studies using measures of profitability and efficiency. Researchers, including Ahmad and Noor (2011), Sufian et al. (2008/2009), Viverita, Brown and Skully (2007), Saleh and Zeitun (2007), Hassan (2005), Alkassim (2005), Hasan et al. (2003), Yudistira (2003), Rosly and Abu Bakar (2003), Samad and Hassan (1999), Haron (1996), Turen (1995), have focused on the performance of Islamic banks.

An important dimension which has been neglected in this literature is the quality of Islamic banking, especially focusing on core Islamic financial contracts. In Islamic banking, quality means maintaining and ensuring the pureness of the Islamic financial contracts. It also means the strictness of adherence to products that are in compliance with Shariah. Most of the existing studies have focused on the efficiency and profitability of Islamic banks as a whole, or all the Islamic banks in a country (Haron, 2004; Alkassim, 2005; Athanasoglou et al., 2006; Srairi, 2009; Moussawi and Obeid, 2010; Akhtar et al., 2011; Qureshi and Shaikh, 2012; Noor, 2012).

The present study differentiates between Islamic banks on the basis of their quality, as viewed from an Islamic perspective. To this end, the study first classifies Islamic banks into three categories: “Conservatives”, “Moderates”, and “Liberals”. This classification is based on the extent to which the banks adhere strictly to the requirements of Shariah. Because there are different ways in which banks can address the question of Shariah compliance, in the absence of a central regulating body, there are various ways in which Islamic banks can approach the issues involved in selecting appropriate products, methods and processes. To evaluate the stance of specific banks, the present authors develop an index, which they call the Khaled Khandelwal (KK) Islamic Banking Rating Model. This uses a scorecard approach to evaluate the extent to which banks are “Conservative”, and comply comprehensively with the requirements of Shariah, or “Liberal”. In between is the group of “Moderate” Islamic banks which are compliant with Shariah in more ways than the Liberals. The full details of the scoring method are given in Section III.