Islamic Banking: Problems and Prospects | | |Islamic Banking | |Before I discuss about the problems and prospects of Islamic Banking, I am discussing some primary issues such as definition, | |objective and history of modern Islamic banking. |Definition: | |An Islamic Banking is a financial institution that operates with the objective to implement and materialise the economic and | |financial principles of Islam in the banking arena. | |The Organisation of Islamic conference (OIC) defined an Islamic Bank as “ a financial institution whose statutes, rules and | |procedures expressly state its commitment to the principles of Islamic Shariah and to the banning of the receipt and payment of | |interest on any of its operations. | |According to Islami Banking Act 1983 of Malaysia, an Islamic Bank is a “company which carries on Islamic Banking business……. | |Islamic Banking business means banking business whose aims and operations do not involve any element which is not approved by the| |religion Islam. | |Objectives: | |The objective of Islamic Banking is not only to earn profit, but to do good and bring welfare to the people, Islam upholds the | |concept that money, income and property belong to Allah and this wealth is to be used for the good of the society. | |Islamic Banks operate on Islamic principles of profit and loss sharing and other approved modes of Investment.
It strictly avoids| |interest which is the root of all exploitation and is responsible for large scale inflation and unemployment. | |An Islamic Bank is committed to do away with disparity and establish justice in the economy, trade, commerce and industry; build | |socio-economic infrastructure and create employment opportunities. | |History and Present Status of Islamic Banking around the World | |The History of Islamic Banking : | |The History of Islamic Banking could be divided in to two parts.
First When it still remained an Idea, Second-When it become a | |reality-by private initiative in some counties and by law in others. | |Islamic Banking as an Idea : | |The scholar of the recent past in early fifties started writing for Islamic Banking in place of Interest Free Banking. In the | |next two decades Islamic Banking attracted more attention. | |Early seventies saw the institutional involvement. Conference of the Finance Ministers of the Islamic Countries was held.
The | |involvement of institutions and Government led to the application of theory to practice and resulted in the establishment of the | |Islamic Banks. In this process the ‘Islamic Development Bank (IDB)’ was established in 1975. | |The coming into being of Islamic Banks: | |The first private Islamic Bank, the ‘Dubai Islamic Bank’ was also set up in 1975 by a group of Muslim businessmen from several | |countries. Two more private banks were founded in 1977 under the name of ‘Faisal Islamic Bank’ in Egypt and Sudan.
In the same | |year the Kuwaiti Government set up the ‘Kuwait Finance House’. | |In the ten years since the establishment of the first private commercial bank in Dubai, more than 50 Islamic Banks have come into| |being. Though nearly all of them are in Muslim countries, there are some in Western Europe as well : in Denmak, Luxembourg, | |Switzerland and the UK. | |In most countries the establishment of Islamic banking had been by private initiative and were confined to that bank. In Iran and| |Pakistan, however, it was by government initiative and covered all banks in the country.
The Governments in both these counties | |took steps in 1981 to introduce Islamic Banking. | |At present there are Islamic Banks in the following countries:- | |01. Afghanistan | |02. Algeria | |03. Albania | |04. Argentina | |05. Australia | |06.
Bahamas | |07. Bahrain | |08. Bangladesh | |09. Brunei | |10. Cayman Islands | |11. Cyprus | |12. Denmark | |13.
Djibouti | |14. Egypt | |15. Germany | |16. Guinea | |17. Gambia | |18. India | |19.
Indonesia | |20. Iran | |21. Iraq | |22. Jordan | | 23. Kazakhstan | |24. Kibris Turkish Republic | |25.
Kuwait | |26. Lebanon | |27. Liechtenstein | |28. Luxembourg | |29. Malaysia | |30. Mauritania | |31. Morocco | |32.
Niger | | | | | |33. Pakistan | |34. Palestine | |35. Philippines | |36. Qatar | |37.
Russia | |38. Saudia Arabia | |39. Senegal | |40. South Africa | |41. Sudan | |42. Switzerland | |43. Thailand | |44.
Tunsia | |45. Turkey | |46. U. A. E. | |47. U. K. | |48. S. S. A. | |49. Yemen. | | | |Problems being faced by Islamic Banking in the world in general | |Most of the Islamic Banks operate on Bai- Murabaha, Bai Muazzal, Bai- Salam, Istisna, Hire Purchase/ Leasing mode of Investment | |i. . Islamic Banks always prefer to run on markup/ guaranteed profit basis having Shariah coverage. For this reason some times | |the conventional Economists and General people failed to understand the real difference between Islamic Banking and conventional | |Banking. | |Mudaraba and Musharaka modes of Investment are ideal but Islamic Banks are not going in hese two modes, the reasons for the | |above are as follows: | |i) There is no systemic analysis and research and no real efforts to introduce above mentioned two modes but the | |practitioners blame the following factors:- | | a) There is lack of committed entrepreneur | |b) There is lack of committed professional who can create new | |c) instruments. |d) There is lack of committed sponsors who can pressurize the professionals | |e) There is shortage of skilled professionals. | |2. The problem of forward contact/booking of foreign currency. | |The value of US Dollars ($), Pound Sterling, Euro and others are not fixed in Bangladesh, they are fluctuating from time to time| |Most of our imports and exports are made in USD and USD being a strong currency always moves upward and the exporters are in | |better position than the importer in our country.
In Bangladesh Forward Booking is required to check the exchange fluctuation for| |import of heavy/project Machineries where it take long time say one year or six months to produce the same. | |But due to the restrictions of Shariah we can not cover the risk of Exchange fluctuation by forward contract as Forward Booking | |is not permitted by Shariah. As per Shariah, currency, transaction is to be made under certain terms and conditions laid down for| |“sarf” by Shariah, such as spot possession of both the currencies by both the parties which is not available in forward Booking. |It is also prohibited to deal in the forward money market even if the purpose is hedging to avoid loss of profit on a particular | |transaction effected in a currency whose value is expected to be declined. This problem requires a solution by Shariah experts. | |3. Inland Bill Purchase/Foreign Bill Purchase : | |This is another problem of Islamic Bank where the exporters immediately after export of the goods approach to the bank for und | |before maturity of the bills to meet their daily needs. Here the Bank has to deploy billions of Taka each year but how and on | |what mode of investment ? The Bank can not take anything by providing fund to the exporter except collection fee for collection | |of the Bill, which is very poor. | |4. Unfamiliarity with the Islamic Banking System | |The first problem, is that despite the growth of Islamic banks over the last 30 years, many people in the Muslim and non-Muslim | |world do not understand what Islamic banking actually is.
The basic principle is clear, that it is contrary to Islamic law to | |make money out of money and that wealth should accumulate from trade and ownership of real assets. However, there does not appear| |to be a single definition of what is or not an Islamic-banking product; or there is not a single definition of Islamic banking. A| |major issue here is that it is the Shariah Councils or Boards at individual Islamic banks that actually define what is and what | |is not Islamic banking, and what is and what is not the acceptable way to do business, which in turn can complicate assessment of| |risk for both the bank and its customer.
More generally, the uncertainty over what is, or is not, an Islamic product has so far | |prevented standardization. This is difficult for regulators as they like to know exactly what it is they are authorising. It is | |also an added burden on the banks that have to educate customers in new markets. | |5. Portfolio Management : | |The behavior of economic agents in any country is determined partly by past experience and present constraints. The Islamic banks| |are still growing in experience in many countries.
Regarding constraints, Islamic banks in different countries do not freely | |choose arrangements, which best suit, their need. As a result, their activities are not demand-oriented and do not react flexibly| |to structural shifts in the economic setting as well as to changes in preferences It is known to the bank management that a | |certain portion of the short-term fund is normally not withdrawn at maturity; these funds are used for medium or long-term | |financing. However, a precondition for this maturity transformation is that the bank be able to obtain liquidity from external | |sources in case or unexpected ithdrawals. Islamic banks, without having an interest-free Islamic money and capital market, have | |no adequate instruments to meet this pre-condition for effective maturity transformation. On the other hand, Islamic banks can | |enhance term transformation if there is an interest-free bond market or a secondary market for Islamic financial papers. Adequate| |financial mechanism still has to be developed, without which financial intermediation, especially the risk and maturity | |transformation, is not performed properly. | |6.
The Regulatory environment | |The relationship between Islamic banks and monetary authorities is a delicate one. The central bank exercises authority over | |Islamic banks under laws and regulations engineered to control and supervise both traditional banks. Whatever the goals and | |functions are, Islamic banks came into existence in an environment where the laws, institutions training and attitude are set to | |serve an economy based on the principles of interest.
The operations of Islamic banks are on a profit and loss share basis (PLS),| |which actually do not come fully under the jurisdiction of the existing civil laws. If there are disputes to be handled, civil | |courts are not sufficiently acquainted with the rationale of the operations of Islamic Banking. Regarding the protection of | |depositors, Islamic Banks are required to let the authorities know the difference between money paid into current accounts and | |money paid into investment accounts.
Islamic banks operate two broad types of deposits: | |a) Deposits, which cover transaction balance. These have a 100 percent reserve requirement and completely safe, thus | |satisfying the needs of risk averters, and | |b) The PLS or equity account, in which depositors are treated exactly as if they were shareholders in the bank. There is no | |guaranteed rate of return or nominal value of the share. | |In non-Muslim counties (i. e. the countries with less than 50% Muslim population) the central banks are very stringent in | |granting licenses for Islamic banks to operate. In order to be established in those countries Islamic banks must also meet the | |additional requirements of other government and non-government authorities. (So, apart from legal constraints there are economic | |measures that result operations of Islamic banks in the non-Muslim world difficult). In Muslim countries also they face economic | |restrictions. Besides funding, acceptable investment outlets is a major challenge for Islamic financial institutions. |7. Absence of Liquidity Instruments | |Many Islamic banks lack liquidity instruments such as treasury bills and other marketable securities, which could be utilised | |either to cover liquidity shortages or to manage excess liquidity. This problem is aggravated since many Islamic banks work under| |operational procedures different from those of the central banks; the resulting non-compatibility prevents the central banks from| |controlling or giving support to Islamic banks if a liquidity gap should occur.
So the issue of liquidity management must come | |under active discussion and scrutiny by the authorities involved is Islamic banking. | |8. Use of Advanced Technology and Media | |Many Islamic banks do not have the diversity of products essential to satisfy the growing need of their clients. The importance | |of using proper advanced technology in upgrading the acceptability of a product and diversifying its application cannot be over | |emphasized.
Given the potentiality of advanced technology, Islamic banks must have to come to terms with rapid changes in | |technology, and redesign the management and decision-making structures and, above, all introduce modern technology in its | |operations. Many Islamic banks also lack the necessary expertise and institutional capacity for Research and Development (R & D) | |that is not only necessary for the realization of their full potential, but also for its very survival in this age of fierce | |competition, sophisticated markets and an informed public.
Islamic banking cannot but stagnate and wither without dynamic and | |ongoing programmes. In addition, Islamic banks have so far not used the media appropriately. | |Even the Muslims are not very much aware that the Islamic banking is being practiced in the world. Islamic banks have not ever | |used an effective media to publicise their activities. The authorities concerned in Islamic banks should address these issues on | |a priority basis. | |9.
Need for Professional Bankers | |The need for professional bankers or managers for Islamic banks cannot be over emphasized. Some banks are currently run by direct| |involvement of the owner himself, or by managers who have not had much exposure to Islamic banking activities, nor are conversant| |with conventional banking methods. Consequently, many Islamic banks are not able to face challenges and stiff competition.
There | |is a need to institute professionalism in banking practice to enhance management capacity by competent bankers committed to their| |profession. Because, the professionals working in Islamic banking system have to face bigger challenge, as they must have a | |better understanding of industry, technology and the management of the business venture they entrust to their clients. They also | |have to understand the moral and religious implications of their investments with the business ventures. There is also a need for| |banking professionals to be properly trained in Islamic banking and finance.
Most bank’s professionals have been trained in | |conventional economics. They lack the requisite vision and conviction about the efficiency of the Islamic banking. | |10. Blending of Approach of Islamic Scholars with the Approach of the Conventional Bankers | |Bankers, due to the nature of their jobs have to be pragmatic or application-oriented. There is and will be tendency in the | |bankers practicing in Islamic banks to mould or modify the Islamic principles to suit the requirement for transactions at hand. |Additionally, being immersed in the travails of day to day banking, they find little time or inclination to do any research, | |which can make any substantial contribution to the Islamic banking. Islamic Scholars active in researching Islamic Banking and | |finance, on the other hand, typically have a normative approach, i. e. they are more concerned with what ought to be. A very few | |of them are knowledgeable about banking or the needs of the customers. | |(ii) Problem Specific to Islamic Banking in Bangladesh | |1.
Absence of Islamic Money Market | |In the absence of Islamic money market in Bangladesh, the Islamic banks cannot invest their surplus fund i. e. , temporary excess | |liquidity to earn any income rather than keeping it idle. Because all the Government Treasury Bills, approved securities and | |Bangladesh Bank Bills in Bangladesh are interest bearing. Naturally, the Islamic banks cannot invest the permissible part of | |their Security Liquidity Reserve and liquid surplus in those securities. As a result, they deposit their whole reserve in cash | |with Bangladesh Bank.
Similarly, the liquid surplus also remains uninvested. On the contrary, the conventional banks of the | |country do not suffer from this sort of limitations. As such, the profitability of the Islamic banks in Bangladesh is adversely | |affected. | |2. Absence of Suitable Long-term Assets | |The absence of suitable long term assets available to Islamic banks is mirrored by lack of short term tradable financial | |instruments.
At present there is no equivalent of an inter-bank market in Bangladesh where banks could place, say, over night | |funds, or where they could borrow to satisfy temporary liquidity needs. Trading of financial instruments is also difficult to | |arrange when rates of return are not know until maturity. Furthermore, it is not clear whether Islamic banks in Bangladesh can | |utilise more exotic instruments, such as derivatives, that are becoming increasingly popular with conventional banks. Obviously, | |these factors place Islamic banking in Bangladesh at a distinct disadvantage compared to its conventional banking counterpart. |3. Shortage of Supportive and Link Institutions | |Any system, however well integrated it may be, cannot thrive exclusively on its built-in elements. It has to depend on a number | |of link institutions and so is the case with Islamic banking. For identifying suitable projects, Islamic banking can profitably | |draw the services of economists, lawyers, insurance companies, management consultants, auditors and so on. They also need | |research and training forums in order to prompting entrepreneurship amongst their clients. Such support services properly | |oriented towards Islamic banking are yet to be developed n Bangladesh. | |4. Organizing Relationship with Foreign Banks | |Another important issue facing Islamic banks in Bangladesh is how to organise their relationships with foreign banks, and more | |generally, how to conduct international operations. This is, of course, an issue closely related to the creation of financial | |instruments, which would be simultaneously consistent with Islamic principles and acceptable to interest-based banks, including | |foreign banks. | |5.
Long-term Financing | |Islamic Banks stick very closely to the pricing policies of the government. They can not benefit from hidden costs and inputs, | |which elevate the level of prices by certain entrepreneurs without any justification. On the other hand, Islamic banks as | |financial institutions are even more directly affected by the failure of the projects they finance. This is because the built in | |security for getting back their funds, together with their profits, is in the success of the project.
Islamically, it is not | |lawful to obtain security from the partner against dishonesty or negligence, both of which are very difficult if not impossible | |to prove. | |Prospects | |In my understanding the prospect of Islamic Banking is very bright. Muslim people everywhere want Islamic Banking. In | |Bangladesh, to give an example, 4/5 conventional Banks have opened separate Islamic branches recently. Five hundred | |applications are pending with Islamic Bank Bangladesh Ltd. or opening of new braches. IBBL has already 132 branches in the | |country. | |The position may not be same in all countries. But if Islamic Banking succeeds in any country, the position will same in every | |Muslim country in my judgment. This means, that first Islamic Bank in any country should be well managed and successful so that | |people have faith in this system. Established Islamic Banks should co-operate by lending competent officials in setting up new | |Islamic Banks. | |The problems mentioned in the preceding pages are not insurmountable.
Most of them can be solved with more research and | |dedicated efforts. IDB, OIC Fiqh Academy, Internatinal Islamic Banking organizations and individual Islamic banks should put | |more resources in research in Islamic Banking, Finance and Economic issues. Cooperation of Central Banks and the Governments. | |will be needed in some areas. I have no doubt in mind that Islamic banking will expand more and more in the entire world. | |HOME |