BANKING WITH A DIFFERENCE, ISLAMIC BANKING

When one hears the words Islamic banking one might immediately try to associate the words Islam and banking and wonder, how different can a money making business be whether it is Islamic banking or conventional mode of banking? Is it just a name or is there more to the way how this kind of banking is done?

There are an estimated 1.61 billion Muslims worldwide, making Islamic banking one of the fastest growing segments of the financial industry. This banking system is not only appealing to the Muslim audience but in fact has much more to offer individuals, companies and governments who are interested in banking with a difference, a system that differs in the spirit of contract, a system that brings an element of honesty in a cold banking scenario where usually only money talks, a system that places importance on the ethics and the way banking is conducted.

The Islamic banking system differs fundamentally from the conventional banking system in its central idea that giving or taking interest (Riba) is prohibited. This system of banking bases its objectives and operations on the Qur’anic principles. The basic principle of Islamic banking follows the laws of the Sharia or Islamic law and this religious motive that governs the system of banking changes the whole structure about the way money is made and shared between the investor/borrower and the banker. Unlike conventional banks, Islamic banks share business risks with investors and borrowers. Another fundamental difference between conventional and Islamic banking from a risk perspective is in the nature of risk taking. There are no fixed rates promised and no false promises made, the bank becomes a partner and therefore the relationship created between them is much different than the conventional way of banking. The thought processes and the fundamental idea that drives and governs Islamic banking are religious and therefore it makes all the difference in its perception, implementation and accountability which cannot be found in the conventional banking system that is driven by collateral alone. Though it must be mentioned that Islamic bank attaches varying degrees of importance to the elements of capital, collateral, character and condition unlike conventional banks that focuses on collateral alone, Islamic bank gives priority to the character of the customer. But there is a similarity between the two banking system on the issue of priority attached to the security and soundness of a project submitted to the bank for financing.

During a time of economic recession the greatest since the Great Depression it does pose the question, is it about time that other ways of banking be explored? At Davos in January 2009, the World Economic Forum released a report on the future of global financial system and it commented on the Islamic financial system that it is capable of minimizing the severity and frequency of financial crises by getting rid of the major weaknesses of the conventional financial system. Then how does an interest free banking framework function?

Instead of interest the system in use is a Profit-Loss Sharing (PLS) mechanism for resource allocation and financial intermediation. Banks that comply with Islamic laws are forbidden to charge interest or late payment fees, which is also considered a type of Riba. To minimize risk, banks will often require a large down payment on goods and property or insist upon large collateral. It is lawful for the bank to charge a higher price for a good if payments are deferred or collected at a later date since it is considered a trade for goods rather than collecting interest. Sharia-complaint banking products include Mudharabah (profit sharing), Wadiah (safekeeping), Musharakah (joint venture), Murabahah (cost plus) and Ijarah (leasing).

Another way banks work within Islamic laws while trying to turn a profit is by buying an item that the customer wants and then selling the item to the customer at a higher price. For example, if someone wants to buy a house, a conventional bank will loan the customer the money to buy the house and charge interest on the loan but an Islamic bank will buy the house and rent it to the customer at a higher price. The bank will own the house until the rental payments are made after which the ownership is transferred to the customer. This is a joint venture.

The Mudharabah (cost surplus) is a partnership between an entrepreneur and the bank. The bank is known as the rabal-maal and the entrepreneur as the mudarib. The bank provides all of the necessary capital to start a business and the entrepreneur does the work of managing the business. Profits are split at an agreed ratio until the initial funds of the rabal-maal are paid off. The rabal-maal is also compensated with additional funds based on the profits of the business in terms previously agreed on. In the event that the business folds, the rabal-maal shoulders the cost and the mudarib is not compensated.

The Sharia or Islamic law also forbids engagement in investments that include financial unknowns such as buying and selling futures. In Islamic banking the money has to be from an Islamic deposit and it cannot be used to deal with something synthetic (like the recession), the goods have to be tangible. Therefore the risk involved is much lesser. It also forbids businesses that are haraam – dealing in products that are contrary to Islamic law and values such as alcohol, pork, gossip or pornography. These principles apply to all individuals, companies and governments.

In 1975 there was one Islamic bank; today there are over 300 in more than 75 countries. Today, Islamic financial institutions exist worldwide, participating in the $180 billion/day industry. The total amounts of deposits in Islamic institutions are growing at a rate of 25-40% annually. Because oil prices and liquidity are expected to stay high, budget surpluses will remain high, pushing both public and private sectors to be involved with the Islamic market. Many Islamic countries are investing in large infrastructure projects, creating more than a trillion dollars in investments.

There is also a huge potential customer base. According to Standard and Poor’s surveys, 20% of the customers in the Gulf Area and Southeast Asia would choose an Islamic banking product over a similar conventional product. There is significant middle-class urban and suburban populations that already use conventional banking and therefore present ripe opportunities for Islamic banks. Most importantly, outside of the religious and political allure of Islamic banks people are choosing their services for the safeties they are offered.

The evidence is clear: Islamic banking is big business and is growing by the day. The 25-40% tremendous annual growth rate of Islamic banking is a testimony that this system of banking based on values and ethics instilled and driven by religion emphasizes on the conduct of doing business, promoting an honest way of making money and is becoming a fast growing niche in the financial world. With a growing customer base especially in the emerging markets and a distrust of conventional banking in such economic times of recession, people are willing to explore and experiment new secure modes of banking that is disciplined and puts an emphasis on basic issues of business, ethics and religion- Islamic banking seems to be the lucrative answer.

1 comments:

Singh is King said...

Although interest-based transactions are forbidden in Islamic banking, it does not forbid all profits on capital.But It is true that Over the recent decades, Islamic banking has developed into a separate discipline with a growth rate of 15 percent per year. It is accepted worldwide because it provides guidelines for setting up better discipline for the implementation of monetary and fiscal policies. http://www.lawisgreek.com/islamic-banking-philosophy-and-modes-of-islamic-banking/

 

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