Table of Contents

INTRODUCTION.............................................................................................................................. 3 Background of Islamic banking in Pakistan ............................................................................ 4 Problem Statement ............................................................................................................................. 5 Literature Review .............................................................................................................................. 6 Hypotheses, Conceptual Model and Theoretical Framework ............................................................ 10 Theoratical Frame Work ................................................................................................................. 12 Reserch Design ................................................................................................................................. 13 Questionnaires ................................................................................................................................. 15

INTRODUCTION
Background of the Study
There are two banking systems that exist in Pakistan namely Islamic banking and conventional banking. The Islamic bank (IB) and conventional bank (CB) is differentiated on the basis of objectives, Riba and risk sharing practices. IB follows principles of Sharia'h given by Allah Almighty while CB follows manmade SOPs; IB generates income as profits that is variable while CB earns from the interest that is fixed; risk is shared among lender, borrower and bank in IB while CB transfers the whole risk to others; IB is trade oriented unit while CB works as a pure financial intermediary to deal on the basis of interest.

Islamic Banking world wide

In Egypt the first modern Islamic bank was established in 1963 according to the principles of Islamic finance. The Organization of Islamic Conference (OIC) also supported the Islamic financial system in 1973 at Jeddah, Saudi Arabia. Similarly a number of Islamic banks were established as Philippine Amanah Bank in 1973; Dubai Islamic Bank in 1975; the Faisal Islamic Bank of Sudan in 1977; the Faisal Islamic Bank of Egypt in 1977; the Bahrain Islamic Bank in 1979, and Meezan Islamic bank of Pakistan in 2002. In Malaysia, Islamic Banking Act was passed in 1983 to transform the interest-based conventional banks into Islamic banks. During the decade of 1990s, Islamic banking practices were initiated all over the world especially in the Muslim dominated parts of the globe. Further, the beginning of 21st century proved a success for Islamic banking as a large number of banks started to deal in products/services according to principles of Sharia'h. It is suggested that riba-free and is necessary to realize the benefits of Islamic financial system and to ensure the well being of mankind (Chapra, 1985).

Islamic and Conventional Banking

Difference between Islamic Bank and Conventional Bank Main Difference Islamic Bank
Islamic banks follow the Principles of Sharia'h given Allah Almighty to perform Operations and activities

Conventional Bank
Conventional banks follow by manmade principles to perform operations and activities

Principles

Source of Earnings

Profit, service charges and consultancy fee is the main source of earnings of Islamic banks. Profit is variable which may be negative in case of loss. Risk is shared among borrower, lender and bank.

Interest is the main source of income for conventional banks that is charged on different types of loans/products.

Risk Sharing

Risk is fully transferred to others.

Profit

It aims at maximizing the profit but subject to principles of

It aims at maximizing the profit without any restriction even at

Maximization

Sharia'h. Islamic bank works as a trading concern (Mudarib or Wakalah) to generate its income.

the cost of other stakeholders. It generates income as financial intermediary. Its prime goal is The maximization of shareholders' value at any cost. Income of conventional bank is constant even if business suffers from loss because it charges fixed rate of interest irrespective of profit volume

Objectives

Nature of Earnings

Income of Islamic banks varies depending upon business environment. It may be negative in case of loss.

Broad Problem Area

The basic aim of the Islamic banking is to perform interest-free activities. While in conventional banking investors are guaranteed a predetermined rate of interest and it aims to maximize the return In Pakistan, there are a number of conventional banks that are providing a variety of products to their customers but most of the products are riba (interest) based which are contradictory to the principles of Sharia'h. Islamic banks help Muslim Ummah to invest their savings for halal returns according to principles of Sharia'h. Islamic banks are equally beneficial for non-Muslim community by promoting brotherhood and cooperation in the society Islamic banks ensure stable economy; fair distribution of income; reduce injustice; risk sharing, lesser financial crisis; facilitate production and business activities Literature also supported that interest-free (profit and loss sharing) system is viable and superior to an interest-based system. Islamic banks deal in equity based (profit/loss) contracts that are more suitable for the economy as compared to interest-oriented conventional banks. Similarly, both banking streams provide a set of products and services that requires a comparative study to assess their performance on the basis of service quality and customers' satisfaction.

Background of Islamic banking in Pakistan

The first attempt to establish an Islamic banking system took place in Pakistan in late 1950 with the creation of a local Islamic bank in a rural area. Some homeowners religious funds deposited without interest and then loaned to small landowners for agricultural development. The borrower pays no interest on credit advanced, but little has been collected to cover its operations. The fee was much lower than the interest rate. With an Islamic financial system began in 1979-1980, when the credit needs of the specialist public sector in economic activities towards non-interest. 1 January 1981 all domestic commercial banks authorized to accept deposits, based on revenue sharing (PLS). Over the next year for three years, was taken to develop new financial instruments other than interest-bearing deposits.These are rough spheres of government and its agencies, the export invoices, investments accounted for assistance to purchase certificates of PTC, the provision of specialized credit institutions loan (which has already been transferred to non-interest bearing assets), Musharakah (PCA), mortgage purchase, hire and certified Mudarabah The first step to put the entire financial system according to Islamic principles. 1.1985 in January. All funds provided by banks to government, public sector enterprises and public companies limited by shares on the basis of Islamic modes of financing specified.On July 1, 1985, banks cannot accept interest-bearing deposits and all deposits are subject to existing rules PLS

Problem Statement

The existence of Islamic and conventional banks in Pakistan created competition to attract a large number of customers. Everyone is striving to realize greater profits by delivering quality services according to customers' expectations. A comparative study is demanded/needed based on the exiting literature to analyze the relationship between service quality, customer satisfaction and bank performance in Pakistan. This study examines how service quality affects the customers' judgments towards satisfaction and its impact on the performance of the Islamic banks as well as conventional banks in Pakistan

Literature Review
Banks are competing in a highly competitive environment to offer quality oriented services according to customers' expectations. Different aspects of banks are studied by researchers e.g. operations, service quality, employee satisfaction, customer satisfaction, financing products, bank efficiency, financial performance etc. as the key segments for research. Banks also focus on demographic characteristics of customers to assess their needs. Every bank is trying to enhance its performance by improving its service quality according to customers' expectations. It requires a study to analyze the bank services and its outcomes in the shape of customers' satisfaction and performance. This study examines the influence of different dimensions of service quality on the customer's feelings of satisfaction and its influence on bank performance. A model of service quality, customer satisfaction and bank performance is developed in the light of literature to measure the performance of Islamic and conventional banks in Pakistan

Service Quality
Business is a legal activity that is undertaken to earn a profit. Business activities can be divided into three categories i.e. manufacturing (conversion of inputs into outputs by a transformation process); trading (buying and selling of goods) and Service defined as a set of benefits delivered from a service provider to the service consumer. The service firm provides benefits (due to competency, skills, knowledge and experience etc.) to the customers for the sake of reward (fee, salary, wages, etc.). Services may be coaching, teaching, consultancy and other modes to facilitate the customers. Banks provide financial inter-mediation, consultancy and agency services that are diversified with the passage of time. Services are different from goods because they are intangible as they cannot be seen, touched or felt (Parasuraman et al. 1985; Hoffman and Bateson, 2002). Parasuraman et al. (1985) argued that evaluation of service quality is difficult as compared to physical goods Hanson (2000) suggested that service quality shows the organization's ability to meet customers' desires and needs. So organization must improve their services to meet the customers' wants and requirements. It is found that customers' perception of service quality is very important for managers to compete in the market (Hoffman and Bateson, 2002). Quality is an ability of any product to meet customers' expectations and requirements. It is a set of features, characteristics or attributes that are required or expected by the customers. There are several studies that found a relationship between the service quality offered by banks and its consequences as satisfaction level among customers. It is reported that quality is observed as a major factor in reference to customer acquisition and retention (Galloway and Ho, 1996). Morre (1987) identified that concentration on service quality leads to differentiation that enhance the competitive position of the organization for long term benefits. Service quality and customer satisfaction became core issues for the successful survival of any service organization contributes a lot to gain competitive advantage to maintain long-term relationship with customers (Zeithmal et al. 2000)

There are two perspectives regarding service quality i.e. one is European and other is Americans. European researchers focus on three dimensions of service quality to measure the performance of any product by considering functional quality, technical quality and corporate image. The Americans' perspective foucs on five dimension of service quality to measure the performance of any product are tangibility, reliability, responsiveness, assurance and empathy. Firstly, they identified ten dimensions but finally service quality is refined to five dimensions Service quality represents the answers to some queries like what is expected by customers? What is delivered? Finally is there any difference? (Woodside et al, 1989). Parasuraman et al., (1988, 1991) developed SERVQUAL instrument to measure the dimensions of service quality that is frequently used by researchers. It consists of 22 items that are compiled into five dimensions: tangibility; reliability; responsiveness; assurance and empathy. This study applied five dimensions of service quality that are explained as under: Reliability This dimension shows the consistency of services towards performance and dependability Tangibles It shows the physical aspects of the service as physical facilities, appearance of personnel and tools & equipment used for provision of Services Responsiveness It reflects the willingness or readiness of employees to provide quick services to customers. Assurance- This dimension indicates the employees' knowledge, courtesy and their ability to incorporate trust and confidence. Empathy- This dimensions shows the magnitude of caring and individual attention given to customers.

Customer Satisfaction
Every rationale customer compares the cost (price) and benefit (utility) of any product or services. Customers compare their expectations about a specific product/services and its actual benefits. This comparison results into three types of customers: dissatisfied customers (expectations are more than actual performance of the service); satisfied customers (actual benefits realized from services are equal to or more than expectations); indifferent customers (actual performance and expectation are exactly equal). Customer satisfaction has become important due to increased competition as it is considered very important factor in the determination of bank's competitiveness (Bartell, 1993; Haron et al. 1994).

Customer Satisfaction in Banking

Financial liberalization and deregulation has increased the competition among banks to attract potential customers. Every banker tries to provide superior services to keep satisfied customers. In Pakistan, emergence and growing popularity of Islamic banking products raises competition among Islamic banks. Islamic banks have to face numerous challenges in the recent age. Firstly, they are competing with their peers and secondly they have to cope with the conventional banks.Satisfied customer is the real asset for any organization that ensures long-term profitability even in the era of great competition. It is found that satisfied customer repeat his/her

experience to buy the products and also creates new customers by communication of positive message about it to others (Dispensa, 1997). On the other hand, dissatisfied customer may switch to alternative products/services and communicate negative message to others.

Determinants of Customer Satisfaction

Banking industry expanded over a number of years due to the introduction of new products and services. It may be due to an increasing number of new foreign and local banks and their working pattern as conventional banks or Islamic banks. Both streams of banks are striving to attract the potential customers at any cost. This increased competition requires the provision of quality services to have satisfied customers for sustainable benefits. It is reported that delivery of high quality services is the key to sustain competitive advantage to have satisfied customers (Shemwell et al., 1998). Sureshchander et al. (2002) investigated the relationship between service quality and customer satisfaction in the banking industry.They suggested five dimensions of customer satisfaction i.e. core service or service product; human element of service delivery; systematization of service delivery (nonhuman element); tangibles of service (servicescapes) and social responsibility An empirical study indicates a strong relationship between perceived service quality, customer satisfaction (Kayis, Kim and Shin, 2003).

Bank Performance
Bank is also one of the business organizations that offer a large number of products and service for profit Every organization is trying to enhance the performance of individuals for overall improvement of the whole organization. Performance evaluation enables the organization to assess its efficiency and effectiveness over a period of time by comparing with its objectives or with market leader to overcome its weaknesses.(Dess & Robinson, 1984). There are several criteria to evaluate the performance of banks for successful survival in the era of globalization and competition. Multiple aspects like profitability, liquidity, management performance, leverage, market share, productivity, innovation, quality of products, human resources and sales volume etc. can evaluate any organization. Four models i.e. human relations; internal process; open system and rationale goal model could represent the organizational performance (Quinn and Rohrbaugh, 1983)

Chapman et al. (1997) examined the influence of quality on the performance of an organization. The study measured the organizational performance using financial ratios It is found that there is a positive relationship between strategic quality indicators and financial performance parameters. It is reported that employees of domestic banks do not contribute towards profitability. But employees of foreign banks significantly contributed towards profitability (Arby, 2003).

Performance of Pakistani Banking Sector

Pakistani banking sector has shown an excellent growth during last few years. Financial performance of banking sector was outstanding due to sufficient profitability, strong solvency, assets management quality, better risk management practices and continuous improvements for the provision of quality services Islamic banking system has proved a successful alternative for the conventional banking System

Service Quality, Customer Satisfaction and Bank Performance

There are few studies available in the literature that investigated the relationship between service quality, customer satisfaction and bank performance It is suggested that service performance appraisal system of the organization should be improved in line with customer satisfaction in the banking sector (Kayis, Kim and Shin, 2003) Stated that satisfaction could be linked with performance because people feel satisfied when products perform according to their expectations. But When they experience dissatisfaction This Shows performance is below than their expectations. It is found that service firms show poor performance due to lack of knowledge about customers' expectation The expansion of the banking industry requires a study to assess the service quality offered by banks and customers' feelings regarding their experience and how it affects bank performance. It was documented that an increase in service quality and professional behavior resulted greater customer satisfaction and reduced customer erosion which lead to Profitability. (Hallwell, 1996).

Hypotheses, Conceptual Model and Theoretical Framework

. Parasuraman et al. (1985, 1991b) devised SERVQUAL model and investigated the service quality. They explored ten dimensions of service quality and refined into five dimensions. It was documented that an increase in service quality and professional behavior resulted a greater customer satisfaction and reduced customer erosion (Leeds, 1992). The relationship between service quality and customer satisfaction is becoming crucial with the increased level of awareness among bank customers. Demographic characteristics should be considered by the bank managers to understand their customers. Customers' perception of service quality differs in terms of gender, ethnicity, education and income. 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 Due to these factors men have more access to banking, education and insurance facilities as compared to women . Ayadi (1996) concluded that female bank customers are engaged in lesser banking activities than male customers due to lower income. Based on these studies, it can be hypothesized that there is significant difference in the perception of bank customers on the basis of gender. H1: There is a significant difference in the perception of service quality among bank customers on the basis of gender. Service quality has a significant impact on customer satisfaction and their intensions to switch. However, an improvement in service quality is necessary for higher levels of satisfaction among banking customers Curry and Penman (2004) reported that service quality is important for differentiation to compete in the market and retain the customers as satisfied for long-term benefits.Above-mentioned literature provides a foundation to hypothesize that there will positive relationships between service quality and customer satisfaction in Pakistani banking sector . H 2: There is positive relationship between service quality and customer satisfaction in the banking sector of Pakistan. Service Quality Customer Satisfaction +

Newman and Cowling (1996) found that service quality is important for banks due to link between productivity and profitability. Performance of banks could be measured as how they maintain relations with their customers. Progress of banks can be evaluated by the implementation of service quality programs to retain customers as satisfied. It can be hypothesized that there will be positive relationship between service quality and bank performance. H 3: There is positive relationship between service quality and bank performance in Pakistan.

Service Quality

Bank Performance +

Customer satisfaction is an important driver for better organizational performance especially in the banking sector due to increased competition. Several studies measured the relationship between customer satisfaction and performance of the firm It is reported that Islamic banks have shown an excellent performance. They suggest that Islamic banks should diversify their products/services according to principles of Sharia'h. There is a significant relationship between service quality and financial performance . Based on literature it is hypothesized that there will be positive relationship between customer satisfaction and bank performance in Pakistan. H 4: There is positive relationship between Customer satisfaction and bank performance in Pakistan. Customer Satisfaction + On the basis of literature it is found that customer satisfaction plays an inter-mediator role in the relationship between service quality and financial performance. It is suggested that customer satisfaction could increase the bank efficiency by reducing divergence in efficiency scores. H 5: Customer satisfaction mediates the relationship between service quality and bank performance in the banking sector of Pakistan. Bank Performance

Customer Satisfaction

Service Quality

Bank Performance

Theoratical Frame Work Service Quality, Customer Satisfaction and Bank Performance in Pakistan

Syszn Srvc Dlvry

Human Element

Tngble of Srvce

Reliability

Assurance

Service Quality

Tangibility

Customer Satisfaction

Social Rspnsblty

Core Service

Bank Performance

Responsiveness

Empathy

Independent Variable

Mediating Variable

Dependent Variable

Conceptual Model and Theoretical Framework

Reserch Design
This study examines the relationship between service quality and customer satisfaction and further how it affects the bank performance. The study aims to analyze the influence selected variables in Pakistani banking sector by a comparison of Islamic and Conventional banks. This study investigates the dimensions of service quality, determinants of customer satisfaction and bank performance. A pilot study was undertaken before conducting the actual survey. A questionnaires were distributed . Stratified random sampling method was adopted for this study Data analysis was carried out by using SPSS The population of the study comprised of the customers and employees of Islamic and conventional banks working in Pakistan. This study is based on primary data that was collected from the existing customers and employees of selected banks in Pakistan. A structured questionnaire was developed to record the responses of customers and employees of Islamic and conventional banks operating in Pakistan. Customers were selected randomly to collect data by self-administrated questionnaires. The study also adopted "personal contact" approach i.e. respondents were approached personally. The researcher explained the questionnaire and the objective of survey by telling its purpose, the meaning of the items and what is expected from the respondents. It is highly recommended that questionnaire is a reliable tool to measure the impact of customer service management on perceived business performance in banks and finance companies

Selected Banks included in the study

Islamic Banks Meezan Islamic Bank Dubai Islamic Bank Limited Albaraka Islamic Bank Limited Bank Islami Pakistan Limited First Dawood Islamic Bank Limited Emirates Global Islamic Bank Limited

Conventional Banks National Bank of Pakistan Habib Bank Limited Pakistan MCB Bank Limited United Bank Limited Askari Bank Limited Bank Alfalah Limited

Data were organized and entered into SPSS 15.0 version to apply specific statistical tools to test the hypotheses of the study. This study used to investigate the relationships among service quality, customer satisfaction and bank performance by comparing Islamic and Conventional banks working in Pakistan.

Measures and Instruments

Service firms used SERVQUAL instrument to investigate the service quality in the banking, insurance and telephone repair industries. Customers of selected banks were asked to give their responses regarding their banker by considering different aspects of service quality. Customers' responses regarding service quality are collected by a modified version of SERVQUAL model developed by Parasuraman et al. (1988, 1991). It contained 22 items divided into five dimensions i.e. tangibility, reliability, responsiveness, assurance and empathy. Each items is assessed by Likert scale as it stands for 1 = strongly disagree to 7 strongly agree . Customers of Islamic and conventional banks were approached to collect data regarding their feelings of satisfaction or dissatisfaction towards bank services. Customer satisfaction was judged by a modified version of research instrument applied by Sureshchnader et al. (2002). i.e. service or service product; human elements of service deliver; systematization of service delivery (non- human element); tangible of service (servicescapes) and social responsibility. Customers were asked to give their feelings of satisfaction related to their banking experiences. Customers' responses were evaluated on a seven point Likert scale ranging from 1 (reflects very high dissatisfaction) to 7 (reflects very high satisfaction) with respect to all 29 items. The responses were recorded regarding bank performance by considering different aspects. Every respondent was asked to rank a number of aspects regarding his/her bank i.e. quality of product, market share, internal process coordination, profitability, and personnel rotation etc. Bank performance was assessed by using five point Likert scale as 1 = Decreasing revolution to 5 = Increasing revolution Here revolution stands for development or progress in relation to specific bank in which respondent is working

Questionnaires
Part I- Bank Usage Pattern 1. Which of the following bank is your main bank (please tick)?
A B C D E F Meezan Bank Limited Dubai Islamic Bank Limited Albarka Islamic Bank Limited Bank Islami Pakistan Limited First Dawood Islamic Bank Limited Qattar Islamic Bank Limited

Service Quality
The following set of statements relate to your feelings about Islamic bank' s service. For each statement, please show the extent to which you believe your bank has the feature described by the statement. Pick one of the seven numbers next to each statement. Here circling a "1" means that you strongly disagree that your bank has that feature, and circling a "7" means that you strongly agree. There are no right or wrong answers- all we are interested in a number that best shows your perception about Islamic bank.
Strongly Disagree Your Islamic bank uses modern looking equipment your Islamic bank promises to do something by a certain time, it does so Employees of your Islamic bank tell customers exactly when services will be performed Employees of your Islamic bank give you prompt service Islamic bank are consistently courteous with you Strongly Agree

Customer Satisfaction You are requested to tick any one option given against each item to measure the level of customer satisfaction with the bank. You are required to show satisfaction level against each item as: 1=Very highly Dissatisfaction, 2 = High Dissatisfaction, 3 = Slight Dissatisfaction, 4 = Neutral, 5 = Slight Satisfaction, 6 = High Satisfaction, 7 = Very High Satisfaction 1.Diversity and range of Bank's services (having a wider range of financial services from the bank, e.g. deposits, retirement accounts, loans for purchase of cars, houses, foreign exchange, traveler's cheques, safe deposit lockers, etc.) 1 2 3 4 5 6 7 2. Bank's Service innovation (providing information/details on regular basis through post: telephonic banking; ATM; room service facility; cards to defense personnel, etc.) 1 2 3 4 5 6 7 3. Availability of most service operations in every branch/department of the bank. 1 2 3 4 5 6 7 4. Convenient operating hours and days (e.g. working on Saturday and Sunday s, extended service hours during evenings, weekdays, etc.) 1 2 3 4 5 6 7 5. Providing service as promised 1 2 3 4 5 6 7 Demographics 1. Your Gender: Male Female 2. Your Marital Status: Unmarried Married

3. Your Age: A 18-24 Years B 25-34 Years C 35-44 Years D 45-54 Years E 55 and Over 4. Your Educational Level: A Primary B Secondary\ C College D University-Master E University-M.Phil F University-PhD G Any other (please specify) 5. Your Occupation: A Student B Businessman C Education/ Medical Services D Housewife E Banker F Investor G Professional / Senior Management H Other (please specify) 6. Your Monthly household income: A Under Rs. 10 000 B Rs 10 000 to Rs. 20 000 C Rs. 20 000 to Rs. 30 000 D Rs. 30 0000 to Rs. 40 000 E Rs. 40 0000 to Rs. 50 000 F Rs. 50 000 and above

. Bank Performance

Quality product 2. Likely to decrease evolution 1. Decreasing evolution 5. Rising evolution 4. Likely to rise evolution 3. Neutral

Internal process coordination 2. Likely to decrease evolution 1. Decreasing evolution 5. Rising evolution 4. Likely to rise evolution 3. Neutral

Personnel activities coordination 1. Decreasing evolution 4. Likely to rise evolution 2. Likely to decrease evolution 5. Rising evolution 3. Neutral

Share market 1. Decreasing evolution 4. Likely to rise evolution 2. Likely to decrease evolution 5. Rising evolution 3. Neutral