ENHANCING THE COMPETITIVENESS OF ISLAMIC BANKS
JEREMY MARTIN
Conventional banking on a commercial basis is of course very much older and more established than the practice of Islamic banking in the Western world and Islamic banks inevitably are being, and will be, compared to their older brethren.
Whether we like it or not, we must accept that investors realise that from conventional banks they can receive about 5% annually with a degree of certainty. It is this degree of confidence and certainty that gives conventional banks a major advantage.
One reason is that the products of conventional banks have been worked out and finely tuned over centuries. Islamic banks start with the same principle of needing to attract deposits from customers and have added amendments as to what they can do with the funds. They are trying to alter and reinstate products that, to an extent, have been used for many years and in some cases discarded by conventional banks many years ago.
It is easy to argue, therefore, that Islamic banks have one inherent disadvantage. Indeed, they do, but this is to an extent balanced by the fact that many Muslims and many Islamic institutions would far rather work with an Islamic than a conventional bank. In the short term, these Islamic products are likely to be less competitive, but as time goes on and more and more expertise is put into Islamic banking, this advantage will be whittled away.
It is difficult for an Islamic bank to compete in the short term with a conventional bank that has products which have been polished and honed over the years. Funds deposited for a month or three months in a conventional bank have a definite return, which is not the case with Islamic banks. Th e question of short term or long term is important.
If a Western investor has money for one month or even three months, he may well be tempted to put it into a bank or building society and earn some interest. If, however, he has the money at his disposal for five or ten years, he will look for a project, or towards the property market or stock-market.
Project finance is where Islamic banks ought to come into their own and be at a positive advantage but, to really benefit from the advantage, two things have to be done:
i) Political stability in Islamic countries must be attained. Instability caused by what the media describe as “Islamic fundamentalism” is bad for our business.
ii) Islamic investors must be encouraged to think long term and not short term. That is easier said than done but once achieved it would prove of enormous benefit to the Islamic banking system. Long-term Islamic banks should produce a greater return for their customers than conventional banks.
Depositors and investors like profit, and banks like to have happy and contented customers. As mentioned already, Islamic banks have great problems competing short term, but long terra they should do well. In certain Middle Eastern countries Islamic banks are at a positive advantage in that they are allowed to own property, whilst conventional banks are not. That is an advantage which should be used more. Anything that can be done by governments to reduce political risk would also help.
Another way forward is to increase expertise in the Islamic banking field. It is growing fast and progress is being made, but better trained and better qualified staff means that jobs will be done better, more quickly and more efficiently. It would be of great benefit to the industry if there were more university courses in Islamic banking. The Institute at Markfield near Leicester is setting an example in this country but any pressure that can be brought to bear to introduce and improve university courses in Islamic banking in Malaysia, Pakistan and the Middle East will help to create a new generation of highly qualified Islamic bankers.
Cynicism is a real problem at the moment. On a recent trip to Saudi Arabia, several Saudis said to me that the return they received from Islamic banks was substantially worse than that received from conventional banks. Even worse, they thought that the money invested with Islamic banks was then reinvested into conventional banks to earn interest. They quoted the BCCI (Bank of Credit and Commerce International) crash, pointing out that many Islamic banks lost a lot of money which they had deposited for large rates of interest with BCCI.
The best way to benefit Islamic banks is to make the products more competitive and more attractive. If a businessman comes up with a good idea which he thinks will produce 100% profit over the year he has the option of borrowing from a conventional bank or an Islamic bank.
If he borrows from a conventional bank, he will pay interest of about 10%. If he does this, and it really is a good idea he will keep 90% and give 10% to the conventional bank. If the deal is done with an Islamic bank, it is likely that he will be sharing a proportion of the profits and that the percentage may heavily exceed 10%. If a longer-term approach could be coupled with a buy-back guarantee (as happened with UK – BES schemes), projects such as development projects would receive a major boost.
If, on the other hand, he has a bad idea or one that might make a little profit, he still pays 10% to the conventional bank, but under a mudaraba the bank bears the financial loss. There is therefore a temptation from the point of view of the businessman when he has a good idea to go to the conventional bank, but if he is not so confident about it, he will go to the Islamic bank. Whilst there are grounds for a businessman to think along these lines an Islamic bank is at a distinct disadvantage. That conception is what we need to change to be more competitive and produce packages which will attract the businesses with the best ideas.
The Islamic Development Bank will invest in poor Islamic countries on a profit-sharing basis for long-term projects. The more banks that will do the same, the better, but the banks have to persuade customers to go along with the proposal. Customers with philanthropic motives will invest with Islamic banks.
Banks must also make an effort to persuade customers also to be philanthropic and visionary with the way banks make their investments. Europe now has an economic community; the GCC is working increasingly together in the Arabian Gulf. Thought should be given to an economic community for Islamic countries, so that wealthy countries, such as the oil-producing nations of the Arabian Gulf area, are more willing to invest in the poorer countries without the oil revenues. Islam could be a catalyst to enable this to happen.
Legal systems in certain countries have been described as a problem for Islamic banks. However, this seems to be doubtful, since Saudi Arabia, for example, has a legal system which has always been Islamicallybased and has not been heavily influenced by other systems. Kuwait, Bahrain and the UAE have been influenced by British law, but Sharia law has always co-existed. Saudi banks may not charge interest but they are permitted to charge commissions which, in practice, have many similarities. It is in fact not the system which causes difficulties but the speed with which it is implemented.
Delay is a great enemy of Islamic bankers. Conventional banks will simply charge more interest as the delay goes on. Islamic banks cannot, so systems must be put in place to reduce banks’ difficulties and enable the banks to recover funds from customers more quickly and easily. Pakistan has introduced laws to this effect and the more quickly other countries do so as well, the better. This is important and more local laws would be of great help to Islamic banks in many countries.
It is equally important to avoid delay when putting a deal together. One way to do this is to increase co-operation between supervisory boards and Sharia committees. I personally have considerable experience of good ideas being put forward and being referred back to Sharia committees, which causes delay, cost and loss of opportunity.
This happened when I was involved for the first time in an Islamic Property Fund. The Fund was leveraged to reduce tax and increase profitability and efficiency. We had to keep going back to the Sharia Committee to put forward technical, and what seemed to us to be minor, amendments. In the end the Committee’s blessing was obtained – but it took longer than expected, costs were increased and opportunities lost.
A central register of decisions could avoid all that happening again and that would benefit all concerned. It would be very beneficial to have a central register of Sharia committee decisions which are universally accepted. If there were a register where bankers and lawyers and depositors could go to find out whether an idea were acceptable or not without spending time and incurring expense going through a different committee, then it would be an enormous advantage to the entire industry.
Any steps to build up and keep a written record of decisions of Sharia committees and supervisory boards would help the industry. We must aim for uniformity between, for example, Malaysia, Iran, Saudi Arabia and Morocco. At the moment it is not there. There are practical difficulties about this – but it is a goal for which we should all aim.
As already mentioned, one advantage of an Islamic bank over a conventional bank is that there are countries where an Islamic bank can own property and a conventional bank cannot. That is an advantage that should be used. Another one, surprisingly, is enforceability of claims. Certain ‘ruling families’ in certain countries have a reputation for making it difficult for claims to be made against them and enforced.
In practice, a Sharia judgement is much more likely to be enforced than a judgement from a civil court. The thinking behind it is that certain ‘ruling families’ see their authority as coming from Islam. They must therefore observe and obey any Islamic Court, this being the very foundation of their position.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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