Islamic Banking

pic ISLAMIC BANKING IS IT REALLY ISLAMIC? By Omar Mustafa Ansari & Faizan Ahmed Memon Is it re bothy Moslem? . In this era of development and growth in Muslim finance and bank buildinging, this is a examination being brocaded at all forum by various quarters. All those who raise this question, be undoubtedly healthful-wishers of Islam, Moslem sparing system of rules and Muslim Ummah. Accordingly, objet dart we celeb prise the achievements of Muslim banking on cardinal hand, we should non be ignoring the appears and protests being raised by such quarters in order to see to it that we lay the foundations of this labor on sinewy, straight and acceptable-to-all footings.Objectives Of Moslem Banking Before discussing various objections raised on the present day Muslim banking, we should starting signal resolve to understand the clinicals of Muslim banking, which argon as follows 1. To provide shariah law compliant and responsible banking opportunities hence providi ng an opportunity to Muslims to do their banking acts a proper substance In other words, this is erect an effort to bar Riba and other prohibited elements from technical and banking minutes, in order to warrant that we do Nothing-Haram and 2. Achieving the goals and objectives of an Muslim economical system.We all pot agree that, admitn the circumstances, the Muslim banking industry is making all efforts to ensure the first objective, while the atomic number 42 objective, although no- little important, is non the prime objective of current-day Islamic banking. History Of Islamic Banking new-made banking system was introduced in Muslim countries at a succession when they were politically and economically slave to the western piece. The main banks of the western world established their branches and subsidiaries in the Muslim countries and territories to fulfill requirements of foreign business.The Muslim fellowship ecumenically avoided the foreign banks for religio us reasons unless with the qualifying of time, it became to a greater extent and to a greater extent difficult to engage in trade and other activities without making use of commercial banks. Even because, a large number of Muslims, hold their involvement to transaction activities such as current account or hundred percent change margin letter of credits. Borrowings from commercial banks or placement the access funds and saving accounts were strictly avoided by practicing Muslims in order to keep away from dealing in interest which is prohibited by Islam.With the passage of time, however, overdue to increase in cross-border transactions and other socio-economic forces attachmenting more involvement in national economic and monetary activities, avoiding the interaction with the banks became impossible. Local banks were established in Muslim countries (including the names like Muslim commercial-grade Bank) on the like lines as the interest- base foreign banks and they began to expand within the country bringing the banking system to more and more hoi polloi. Governments, businesses and individuals began to transact business with the banks, with or without liking it.This evoke of affairs drew the attention and bushel of Muslim intellectuals which gave emergence to the contemporary Islamic banking. By the midst of the last century, m whatever Muslim countries started their efforts to study the Islamic economic and banking systems. M any(prenominal) scholars, economist and experienced bankers came with different solutions to initiate the Islamic banking. Those experiences paved the itinerary for modern Islamic banking. Nowadays Islamic financial institutions (IFIs) be spread all over the world including European countries and the unite realms.In particular these come their significant presence in Pakistan, Saudi Arabia, Bahrain, United Arab Emirates, other GCC countries, Malaysia, Sudan and Iran. Who Raise The Questions? Islamic banking is a weak industry. In compliments of resources, in respect of knowledge-bases, in respect of trained-knowledgeable-sincere human resources, in respect of availability of commercial options, in respect of state support, as head as, society support, in respect of sincerity of stake-holders and WHAT NOT.With such adverse footings, unfortunately, it really has authorized weaknesses which be non only tar locomoteed by the enemies, but, atomic number 18 more severally and forcefully attacked by the FRIENDS. As a consequence, the Islamic banking and finance is facing disagreements from various quarters including au becausetic r evolutionary Islamic movements, certain(a) rigid and hard-core religious scholars, and idealistic and utopian Islamic economists (without any disrespect to them all). Can Banking ever so Be Really Islamic?The first question is raised mostly by those who either do not check any knowledge about banking, or those who have the courage to evaluate the banking systems f rom its evolution to its objectives. They spirit that the banking per-se is against the very basic concepts of Islam. They satisfying step that exclusively like the feature that there can not be any Halal pork or Islamic prostitution, there can be no Halal banking. This viewpoint is supported by the fact that, particularly in Pakistan, we have already faced a complete disaster in the name of interest-free banking and so-called IFIs particularly including Modarabas.The business line, as to whether Islamic banking is really Islamic, has two different facets. The first one is that whatever is being performed in the name of Islamic banking is apparently quite similar to the operations of a accomplished financial institution hence creates doubts in peoples mind, as to on what grounds we can call it Islamic? So they feel that it is merely a change in name and documents and in fact, it is nothing different from constituted banking. The plump for facet of this question is more impo rtant nd deals with the socio-economic factors associated with the overall Islamic financial system. Due to substance of these objections, we exit discuss these two issues before looking for other arguments. Merely A Change In Name And Documents The most common and most discussed argument against contemporary Islamic banking is that there is NO re enlist AT ALL between the stately banking and Islamic banking and this is merely a change of name and documents.The support argument, which is in-fact a derivative of the first argument, is that rase in Islamic banking, the most common crops being utilise e. g. Murabaha, Musawwama, Salam, Istisna, diminishing Musharaka and Ijara Muntahia Bittamleek are on fixed return basis. Even the Musharaka and Modaraba ground increases are engineered in a way that the earningss are virtually-fixed. One should realize the fact that unless we can distinguish an Islamic bank from a conventional bank, it would be difficult for any of us to rely on the same.Particularly, it is observed that they try to make sure that their product is similar to the conventional products in all respects, even if for that purpose they have to incorporate a hardly a(prenominal) provisions in these products which are not considered to be good or a few of them are considered Makrooh. In addition, their endeavors are focuse towards minimization of their risk through every possible option and accordingly, the essence of Islamic finance which is ground on risk taking is killed. We can note that most IFIs merchandise their products on the sticks very much similar to those used by the conventional banks.As an example, an Ijara Muntahia Bittamleek transaction introduced by an IFI might be very similar to a finance lease transaction offered by a conventional leasing company, except for a difference of Takaful / insurance cost which in Islamic mode is to be borne by the lessee and accordingly, the same is built-in the rentals. The basic reason behin d this comparison is to ensure tierce objectives. The first one, which is more important one, is to provide an even play ground to the IFIs in order to ensure their survival in the overall banking system.The second one, is that even by IFIs, it has to be ensured that their shareholders and vexors get some return and preferably a return equivalent to those of conventional banks. And the third reason is to avoid arbitrage amongst Islamic and conventional financial systems which whitethorn be exploited by a few big-guns to get the benefit of the price difference between the two parallel financial systems. For such reason, time value of money concept is used for performance measurement and pricing of financial products.Most importantly, it should be kept in mind that in some areas Haram and Halal have a very pocketable difference. For an example, only saying the name of Allah Almighty on an animal at the time of slaughter makes it Halal and permissible while by not saying that name we make it Haram or by comely a few words of acceptance in Nikah, in presence of a few persons, a man and woman become Halal for each other. Similarly, if a transaction can be engineered in a way that the same becomes shariah law compliant, then we should not conclude that the same is Haram only due to its resemblance with the interest based financing.It is also pertinent to note that since the Islamic financial dishs empyrean is in its infancy phase, as compared to the conventional banking, we unfortunately have to follow the conventional system in the pattern of financial products and are still not in a fructify to invent absolutely new financial services. During the last few centuries, the conventional banking system has well read the human necessitate and psychology and has invented a considerable number of financial products and accordingly, it is not simple to just invent a new financial tool just for the purpose of inventing one.For example, if they have running fina nce and overdraft as a financing tool, we have invented an alternate to the same in form of Istijrar with Murabaha or Musharaka based running finance model. Similarly, if they use finance leases as a financing tool, we have converted the same in a sharia law compliant form in form of Ijara Muntahia Bittamleek or in form of Diminishing Musharaka. These are only two examples, but the tally is practically very high and for each interest based financial product except for those explicitly Haram, more than one alternates have been engineered.The objective of this discussion was just to emphasize that merely an amortization schedule similar to the one offered by a conventional bank, is not a basis for declaring a Halal product to be Haram. If just a pricing model or just the similarity of a cash-flow model makes the transaction Haram, what you volition say regarding a conventional loan offered at a price much higher or much lower than the market prevailing rates for which the pricing mod el and the cash-flow model are not similar to those generally apply in the industry.Does anybody think that such dissimilarity will make it Halal? Accordingly, from shariah law principles it is rightly conclude that it is the substance of a transaction what makes it Halal or Haram and not a pricing model used to price the transaction or the cash-flow model used for the payments and repayments in monetary terms. Socio-Economic Effects Of Islamic Banking And finance Second most significant argument from such group, predominantly by certain Islamic economists and certain Islamic revolutionary movements, is about the socio-economic factors of Islamic banking.They feel that since Islamic banking is also based on expediency motive and in present form, it generally works on virtually-fixed return basis hence the same cannot attribute anything-positive towards the socio-economic changes that Islam desires. This is a crucial question and, we believe that, every conscious Muslim will res train with the concerns of those who raise the same, although the conclusions derived by different people might vary. Nobody can argue that virtually-fixed return based banking, although being shariah compliant, is not what has been desired by Islam as a complete way of aliment.In addition, the current-day Islamic banking is emphasizing more on consumer finance as compared to financing to SME sector, agricultural sector, and more importantly, on the micro-finance hence, it is not contributing enough towards the just and equitable monetary system that Islam needs. Having due regard for these arguments, may we remind you that that the Islamic economic system is not something that can work in isolation of the geo-political and legislative system, as well as, and more importantly the societys behavior towards the injunctions of Islamic shariah in personal and collective matters.Accordingly, one can easily imagine that in an economy whereby most of the businessmen are not honest in f airly presenting the financial statements of their businesses, how difficult it is to introduce a salary and loss sharing based financial solution. Similarly, in most of the cases payment of Zakat and Sadaqat depends on the individual and particularly, in view of the gigantic volume of the black economy in the country, what can be judge even if a good system for Zakat and Ushr is introduced?It needs to be emphasized that only the change in banking system is not a solution to the overall revolution of economic system unless other facets of Islamic economic system, as well as, Islamic social system are not implemented simultaneously. Accordingly, the complete musical passage of economy to an Islamic economic system can be performed, when and only when, the overall consensus of the society is substantial towards practical exercise of sharia in all the facets of human life, particularly including the giving medicational, political and legislative structures. condescension such an unsatisfactory and rather discouraging attitude of the society towards application of Islamic Shariah, it should be observe that such a situation do not relieve a Muslim from the applicability of Shariah principles, but rather increases his responsibilities in the way that it becomes his duty not only to try to abide by all applicable Shariah requirements in his personal capacity but also to put his endeavors towards improvement in such system. Consequently, in case the Islamic banking, in your opinion, is not contributing enough towards melioration of society, you cannot b maim the same alone.The responsibilities of the Muslim Ummah as a whole (or of the earth) can not be expected to be borne by a single sector only, which, at this point of time is in its infancy stages. Is It Heela Banking? This is a general discussion at various forums that contemporary Islamic banking is based on Heelas. From Shariah perspective, a Heela is an option utilized to disobey the divine guidance through engineering the circumstances and playing with the facts and intentions.Having an insight into the industry, one can not disagree with this argument to certain extent, as it has been observed in a number of cases that in-fact, certain transactions are practically applied on this basis. Having said that this argument should, however, not be used to blame the entire industry. We should acknowledge that the foundations of the industry have been built victimization the pillars which are directly derived from the beatified Quran, Sunnah and Fiqh. It is worth-noting that mostly, a Heela is applied in the execution of a transaction rather than designing of a transaction.In other words, we can safely conclude that application of Heelas in Islamic banking is not a weakness in the theories of Islamic banking, but actually is a matter of misuse / misinterpretation of basic Shariah guidance in respect of various Shariah compliant financial transactions. Accordingly, it needs to be emph asized that in order to support the growth of Islamic banking and finance on right footings, we need to fix the Shariah compliance mechanism for the industry. In addition, in the broader run, we need to eliminate the Islamic financial products which have the potential of misuse.Use Of Interest-Rate As benchmark Is It Halal? Critics, including scholars, as well as, economists, strongly condemn that most of IFIs while providing financing by way of any of the Halal transactions, determine their profit rate on the basis of the current interest-rate benchmarks prevailing in the conventional money market. Scholars are of the view that by applying these benchmarks, the Islamic banking industry makes their transactions similar to interest-based transactions and as a consequence, these transactions become doubtful from Shariah point-of-view. Economists feel further issues and that and are of he view that this thing makes these financial institutions a part of the prevailing capitalistic e conomic systems, hence this figure of transactions are absolutely not desirable by Islam. Here it would be worthwhile to have a look on the arguments by the Islamic banking for better understanding of the pricing issue. They generally give examples like suppose you enter into a supermarket in UK and see that the pork, the beef and the Halal beef are all being sold for GBP 2 per kg. Do you think that this similarity of price or the fact that these products are being sold under the same roof renders the Halal beef as Haram?Or for example in the same superstore you note that they are using the same balance for weighing these three types of meat. Do you think that using the same balance will render the Halal beef, as Haram? If not, then we should better understand the principle that it is the substance and legal form of the transaction that makes it Halal or Haram and not its pricing, rate or the cash-flow model or the institution, or even the surroundings that offers such transaction . This issue, however, needs to be addressed by the government, as well as, the market players.A strong Islamic inter-bank market will InshaAllah provide us opportunities to develop our own benchmarks for Islamic banking operations. Dealing of Islamic Banks with accomplished Banks Another strong argument against Islamic banking is against dealing with conventional banks. These dealings are of two types i. e. sharing of services and commercial transactions. As far as services are concerned, where the Islamic Banks are facilitating the foreign businesses of their customer or helping out their customers to transfer the money from safe channels.For these services, the remuneration or expense of Islamic banks is service charges which are allowed by Shariah jurists, although they recommend that such interaction should be avoided wherever IFIs are available. The second argument which is much strong is regarding the commercial transactions with conventional financial institutions. These tr ansactions generally impact to the treasury side of the Bank whereby either the IFIs place their excess liquidity with the conventional banks or run financings from them to meet their own liquidity requirements.For placement of funds with conventional banks most of Islamic banks in Pakistan are using the product of Commodity Murabaha or they invest in certain Halal assets of the conventional financial institutions. On the other hand, they normally obtain financings from the conventional banks on the basis of profit and loss sharing, although the profit rates are once again virtually-fixed. Although, most of the Shariah scholars have allowed these transactions duly considering the Shariah requirements, however, nobody can argue that it is a must to avoid all such transactions.For this purpose, however, we need to strengthen the Islamic inter-bank market and to provide further liquidity management options to the IFIs particularly, in form of strong Shariah-compliant government secur ities and a stable capital market with plenty of Halal investment funds options available. All dealings with conventional financial institutions should remain limited to the necessities which reach the extremes of compulsion. Cost Of Being A Muslim Those who have dingy memories of dealing with Islamic banks are in front-line of critics with this remark.People feel that there are serious doubts on the honesty and integrity of IFIs. They feel that these Banks are using the name of Islam to earn a few bucks more as compared to the conventional banks or rather they are exploiting the faith of Muslims by charging them, the cost of being a Muslim. On the financing side, they charge higher than conventional banks. In other words, internal rate of return on Islamic financial products is higher than the conventional products.On the contrary, it is observed that on the deposit sides they pay less as compared to the conventional banks. In addition, it is generally observed that the expected r ates, as well as, the actual rates of return offered by these financial institutions are fairly equivalent to (generally slightly less than) the rates being offered by conventional financial institutions. A justification against the first argument is that since IFIs are subject to the commodity risk, asset destruction and holding risks and the price risk, as well as their relevant costs e. g.Takaful expenses, in addition to the risks and costs that a bank faces, they are justified in their demand i. e. higher internal rate of return. Nevertheless, financial experts have generally tangle that even if these factors are considered, the pricing by these Banks is on the higher side. On the other side, in a profit and loss based model, it is agreeable that they assign weightage to different types of deposits in a manner that the total return on investment and financing pools is al laid amongst various depositors and the Bank (works as a partner).Even then, it is generally noted that IFIs are salaried less than the market. We can only hope that in near future, with increasing competition in the Islamic banking industry, this effect will minimize because of market-forces except to the extent of pricing against actual additional risk elements. merchandising Approach Of IFIs Another valid argument is about the market approach being used by these financial institutions, which adversely effects the public reliance on this mode.People raising objections on the marketing approach of IFIs have two grounds for the same. The first one is the general marketing approach being applied by the a few IFIs which include advertisement and other publicity materials including involvement of women and handed-down marketing and advertisement styles for promotion of Islamic banking business. Second ground is the marketing strategy in which sometimes it is felt that false statements are made for promotional purposes.An example of the same is the claim by a leading Islamic bank that all its day to day activities are monitored by its Shariah Advisor. simply imagine, if it is humanly possible, that a part time Shariah Advisor can look after all day to day activities of a full fledged bank with a number of branches even located at other cities. Another example is the claim by an Islamic mutual fund that it is the first one of its kind in the country, whereas another fund was operating in the country for around one year earlier to subscription for such mutual fund.They Dont Look Like Islamic formerly you enter into a glittering branch or office of an IFI, generally you do not feel any difference with a conventional bank. This issue is raised particularly by the blend of people who feel that once they enter into such location, it should look like a sacred place quite of a commercial office. You generally feel that they have over-spent on the furniture, interior-decoration and publicity stuff, which apparently, is against the injunctions of Islam.This impression is fu rther change when you see the overall environment, the dealing style of personnel and most significantly, you feel (in most of the cases) that there are ladies working for the organization without Hijab or even appropriate attire (in line with the dress-code of a Muslim woman as defined by Shariah). Although a few moderate-enlightened Muslims will not like this objection at all, nevertheless, it should be kept in mind that a common Muslim cannot digest Islamic banking while he feels that other factors of business are not really Islamic.We cant argue with these objections as these have due weightage in them and the management of IFIs should take these objections seriously. However, we should keep in mind that the prime objective of Islamic finance, is to ensure that financial matters are dealt with in line with Islamic Shariah. In other words, environment does not make anything Haram. Needless to mention, from Shariah perspective, you can always buy a Halal product from a store wher e everything else is Haram although the same needs to be avoided if other options are available. Islamic Bankers Dont Know Islamic BankingThis argument, once again, has key significance from the perspective of the overall control environment of these banks with regard to the applicability of Shariah principles. Particularly, it is astonishing when you deal with an Islamic banker, who knows very little about Islamic banking, but unfortunately, this is not very uncommon. The prime cause behind this issue is the fact that most of the IFIs have engage the conventional bankers and generally no or very little consideration is awarded to ensure that they are well conversant with the Shariah requirements with regard to the modes of finance being used by these Banks.Similarly, the IFIs do not eliminate enough on their resource-building for Shariah compliance and grooming of their staff, in comparison to what they spend for marketing. Having experience of training Islamic Bankers, as well as, performing Shariah compliance reviews, we may safely conclude that, this objection is not without substance. This accordingly, is a strongest need that the IFIs should allocate more and more resources for staff training and Shariah compliance. Monopoly Of Shariah Advisors Another objection is regarding the appointment of Shariah Boards and Shariah Advisors.People have largely noted and discussed at various forums that the major contribution in this field in Pakistan is limited to a very undersize group of jurists most of whom relate to a single family and their pupils (a single religious university). Besides this, another question is also being raised that generally the honorariums, consultancy fee and other benefits being offered to such jurists by the IFIs in Pakistan, as well as, abroad are quite high and this may jeopardize their independence. In addition, it is felt that they are the only ones who are whole and sole responsible for Shariah compliance.They approve the prod ucts, they review the transactions and in the end they perform Shariah audit themselves, which is, however, an indicative of a conflict of interest (without any doubt on their personal independence and integrity). Most of the people conversant with the business and operations of Islamic finance do not agree with this observation, because the contribution of these people to the industry as a whole is remarkable and they deserve even more than that based on their contribution and efforts in the promotion of this industry.The general concept that a Moulvi should be paid the minimum for his life, is not justifiable. If you are getting benefits from their efforts, their knowledge and skills, then they should be justifiably rewarded. Having said that, it is always agreeable that it is the right time that contributions from jurist from other schools of eyeshot should also be sought and they should necessarily be provided opportunities to enter into the field. For this purpose, it is a goo d proposition from the State Bank that a jurist should not be allowed to hold more than one remunerative position as a Shariah Advisor or member of a Shariah Board.This will ensure that fresh blood gets an option to enter into the field which will eventually improve the overall Shariah compliance in the field, as well as, will help these institutions to innovate fresh products. IFIs Use Conventional Insurance A valid objection cant argue with that. It was a real issue that according to the legal requirements, as well as, derived from real compulsion, the banks were required to obtain insurance reporting from conventional insurance companies and this practice was allowed by the Shariah Advisors to the extent of compulsion only.This situation, Alhamdolillah has changed after introduction of Islamic mode of insurance (Takaful) in Pakistani market. Unfortunately, there are a still IFIs who have not yet switched to Takaful while to-date three Takaful companies and a family Takaful compa ny have commenced operations in Pakistan and now this lame excuse of compulsion can not be exercised anymore. Now its high time that the State Bank and the Shariah Advisors should take strong steps to ensure that no business is iven by the IFIs to any conventional insurance company either in respect of owned assets, or against assets held under security. Should We relieve Prefer Islamic Banking? As a conclusion to this debate, we may say that we are required by our religion to implement a complete Islamic way of living in our individual and collective lives and the society and the government as well. The Islamic banking and financial system is a part of such system and is not construed to be applicable in isolation while other laws and customs repugnant to the Shariah requirements are still in force.However, for the sake of our own benefits, in order to avoid interest by ourselves and providing interest-free opportunities to our brothers and sisters in Islam, we should promote and support the Islamic banking and finance in the country with all our possible efforts and endeavors. We should not try to pull legs of an infant who is just trying to take his first step towards a long journey to go.However, we should try to ensure that he commences his journey on the right way, with strong footings. Such Islamic banking, may not be termed as perfect, but can provide us with a furnish from interest based transactions for the time being, and might support us in augmenting a rattling Islamic financial system, and more appropriately said, will serve as an experiment for the time when we will really be in a position to the implement the complete Islamic way of living in our beloved country.May Allah Almighty bestow us his blessings and enable us to evolve a complete system of life in accordance with the principles of life provided by the Holy Quran and the Holy Prophet (SAAWS). May Allah accept our efforts and forgive us for our mistakes in this field in our individual capacities, as well as, as a society. About Omar & Faizan Omar is a Chartered Accountant by profession, and is presently working as Partner Islamic Financial Services Group with Ford Rhodes Sidat Hyder & Co. (A member firm of Ernst & recent Global Limited).Omar enjoys vast experience in audit, Shariah compliance and providing related services to Islamic finance industry in Pakistan. He is author of a Book on Islamic finance videlicet Managing Finances A Shariah Compliant Way. Faizan holds experience in the field of Shariah audits and product development. In past, he has worked with a leading Islamic bank as Shariah Coordinator and Shariah Auditor. Presently, he is working with Ford Rhodes Sidat Hyder & Co. as Manager Islamic Financial Services. picpic