ISLAMIC BANKING: CONCEPT, PROBLEMS, PROSPECTS
MUAZZAM ALI
The Concept
The primary goal of Islamic banking and finance is the development of economic resources and regulation of the monetary and financial policies of the Muslim society in accordance with the Sharia.
Islam is a code of life encompassing spiritual and temporal values. This code is enshrined in the Islamic Sharia – the body of laws which is the primary source of guidance for Muslims in all aspects of life.
Islam has a unitary approach to life. It considers man to be an integral whole. In other words, the numerous functions that he performs, e.g., economic, political, social and religious are not independent of each other. In the economic field, his activities are conditioned by the social milieu, by his moral values, by his cultural heritage and, above all, by his religious beliefs.
Thus, in the Islamic framework, material pursuits are not independent of spiritual pursuits. Islam does not consider economic activity to be a mundane or base pursuit. It considers productive economic activity to be an act of worship if followed in accordance with the Sharia.
Islam does not regard economics as the be-all and end-all of human existence. It prescribes a golden mean between the two extremes of monastic rejection of the world and unbridled materialism. Islam not only allows human beings to utilize the world’s resources to the best of their ability, but also provides a framework for the achievement of this objective in a spirit of justice and brotherhood towards fellow human beings. The welfare and betterment of human beings is the objective of Islam, not only for the individual but for the whole community.
In Islam, wealth is regarded as a means and not as an end. It is a means of providing sustenance in moderation. In treating wealth otherwise, man becomes materialistic, selfish, ruthless and greedy.
In the Islamic framework, the individual’s efforts to satisfy his personal needs have to harmonise with his obligations to his family, neighbours, society and the state of which he is a citizen. The needs of the individual and those of the society are intrinsically interdependent.
Two very important norms that Islam enjoins on Muslims in their dealings with others are Al-Adl and Al-Ihsan. Al-Adl requires man to observe justice and fair play in all his dealings with other people. This means the elimination of all forms of exploitation, fraud and deception and leads to the establishment of a just society. Al-Ihsan is also important for building a caring society. It requires individuals to go beyond their minimum obligation to others and to fulfil their duty by achieving the highest standard of benevolence, kindness and sacrifice for others.
In addition to the general principles I have mentioned, Islam also has a number of specific rules. Two of the most important concern Zakat and Riba.
Zakat
An important part of the Islamic economic system is the institution of Zakat – a levy on certain categories of wealth. Zakat is not a charity, but the right of the poor, the needy, the sick, the destitute and the victims of disaster, etc. to a share in the wealth of the rich. It prevents people from hoarding wealth, since money, if not utilised, is taxable. Zakat thus acts as a powerful incentive to invest capital in productive enterprises and keep it in circulation.
Riba
Riba (interest) is totally prohibited, because Islam is against making money from money. Money must be put to productive use in creating real value for the participants in a transaction. It must be used to create substance and not as a commodity to be traded for itself Profit must be made only out of an investment that yields economic value.
Problems
Although the entry of Islamic banking into the field of international finance has been well received, it has yet to cross many hurdles before it can claim to be an institution capable of handling the needs of world financial markets.
Its initial success may be due partly to the fact that there is a niche market for Islamic funds and partly to its ethical and intrinsic values. To sustain and develop the system. Islamic banks have to strive to solve the problems that stand in the way of their growth.
I shall here highlight some of these problems.
Mobilization of Funds
In the early 1970s, the rise in oil and natural gas prices resulted in a massive increase in riches and the creation of immense surplus funds in the oil- producing Muslim countries, especially in the Gulf region.
Development in the commercial, industrial and agricultural sectors in non- oil – producing countries also created a class of rich people. So, there was no shortage of money and the stage seemed set for Islamic banking to be launched as a strong alternative to the conventional financial sector.
But this opportunity was not fully taken advantage of by those who could have done so. Why was this?
Unfortunately, the great reserves of Muslim wealth were concentrated in a few hands; those of the ruling elites, politicians, industrialists and businessmen. I am son-y that the greatest challenge to the development of Islamic banking comes from the inertia of a section of rich Muslims who could have played a major role in promoting this concept. While they profess their faith in Islamic banking, they do not match their words with their deeds. Unfortunately, their vast financial resources are not placed in Islamic banks but in conventional banks. If these Muslims had put only 10 per cent of their wealth into Islamic banking, the situation would have been quite different.
The reasons given by Muslim investors for their non-participation in Islamic banks was that these banks had not, as yet, developed to an extent where they could handle large projects and that substantial investments must therefore go to conventional banks. In saying this, they did not take into consideration that financial organisations cannot develop unless they are supported by the community or by at least a substantial group of the rich people.
Most of today is powerful conventional banks started off in a small way with meagre funds. They only grew strong and powerful with the support of their peoples. The people who backed these small organisations did so because they had great faith in them. They had the spirit of enterprise and were willing to take risks for potential gains. This pertinent fact of history must be emphasised if Islamic banking is to gain the attention of rich Muslims and revive the early enthusiasm, which inspired so many Muslims in the 1970s.
Another possible reason why rich Muslims are not supporting Islamic banks may be that conventional banking, having been well established for centuries, seems to them safer and certainly guarantees a predetermined return with little or no risk to capital.
Whatever their reasons, is it any wonder, in these circumstances, that Islamic banking has not made the progress which was certainly expected of it in the beginning and which the Muslim peoples aspired to and are still aspiring to?
As long as the rich Muslims do not place their funds in Islamic banks. Islamic banking will not be able to meet the expectations that were raised at the time of its launching.
Shortage of Trained Personnel
When Islamic banks began to be set up in the seventies, there were only a few people well versed in the knowledge and understanding of the concept behind it. In their anxiety to start an Islamic system, these banks employed people without giving them proper training either in the concept or the operations. Most of the staff was recruited from conventional banks. They had been educated and trained in conventional banking, so naturally their mindset had been shaped by the value neutral, interest-based system and they found it difficult, if not impossible, to make a sudden switch. All they were able to do was to use the conventional financial products, alter them slightly, change the name and slap the name ‘Islamic’ onto them.
The setting up and running of Islamic banks requires personnel who are not only well-versed in the theory and practice of Islamic banking, but also believe in it and are committed to it. There is an acute shortage of such personnel and this is adversely affecting the growth potential of Islamic banking.
Shortage of Investment Instruments
A major impediment to the growth of Islamic banking is the shortage of marketable financial instruments. Sadly, the Islamic financial market has reached a stage where its present sets of instruments cannot attract investors. It is therefore essential that Islamic banks embark on a plan for the development of innovations in Islamic instruments. Investors in the conventional banks have a wide range of instruments as against Islamic banks, which can offer their clients few acceptable instruments. There are a number of other issues relating to Islamic banking which need to be researched. These include:
* Project finance
* Identification of investment opportunities
* Development and standardisation of products
* Trading practice and systems of settlement
* Islamic capital markets
Islamic banks will attract investors only if a wide range of attractive instruments and a whole range of services are available.
Research and Development
The Islamic banking community unfortunately does not seem to appreciate fully the fact that Research and Development (R&D) is necessary not only for the realisation of the full potential of Islamic banking, which is enormous, 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. Conventional banking, which has been developing for more than two centuries, appreciates the crucial importance of this activity. With an in-built R&D culture, it has not only created a huge pool of highly trained and experienced R&D personnel, but also continues to allocate considerable funds to this activity.
In contrast to conventional banking. Islamic banking allocates negligible funds to the training of its staff. I hope the Islamic banking community will address this issue on a priority basis.
Transparency in Operations
Transparency in the operation of Islamic banks is of prime importance. The customers must be kept aware and taken into confidence at each step. I again reiterate that transparency in all operations is sacrosanct and essential for the success of Islamic banks.
Technology
Islamic banks will have to come to terms with rapid changes in technology and re-design the management and decision-making structures and, above all, introduce technology into its internal operations and in relation to its clients.
Realising the potential of technology in the banking sector, Western banks are spending millions of dollars to acquire new modes of operation. Islamic banks have not so far been able to harness the great potential which present- day technology offers.
The Sharia
Islamic banks operate within the parameter of the Sharia, as interpreted by Sharia scholars. Unfortunately, for historical reasons, there is a shortage of Sharia scholars who are also well -versed in the field of banking and economics. The few scholars available are hard-pressed. There is no institution to impart education in both the Sharia and banking. To solve this problem, Muslims must set up a training organisation for Sharia scholars in banking and finance.
Prospects
Despite its problems. Islamic banking has made reasonably good progress. Th e problems it faces are not insurmountable. Islamic banking is on the way to tackling some of the present problems.
Today, Islamic banks are operating worldwide and their impact on financial markets is clearly visible. This progress is an indication of the viability and dynamism of the system.
As Dr Abbas Mirakhor of IMF has said, “Those who believed that banks and financial systems could not operate in a modern economy without reliance on an interest-rate mechanism must have been surprised at the progress of Islamic banking”. During the last two decades. Islamic bankers have shown that mosque and market can grow in harmony and can make substantial contributions to the financial world order.
Islamic bankers have accepted the challenges and are trying to develop innovative financial instruments to meet the needs of modern financial markets.
They are tapping the enormous resources of the Muslim world and are trying to develop investment outlets, viable secondary markets and other instruments. Some progress has already been made in this direction.
The Sharia scholars who play a pivotal role in banking have gained experience in economic and financial matters and are in a position to assist the banks to develop instruments which are compatible with the Sharia. Gone are the days when these scholars only defined which instruments were Halal and which Haram. Now they sit together with Islamic bankers and economists in an effort to develop new instruments in keeping with Islamic principles. Impressed by the system and the growing demands for investments through Islamic instruments, many conventional banks in Europe and USA have entered Islamic banking and set up Islamic departments in their organisations. This is a testimony to the potential of Islamic banking.
The more financial instruments Islamic banks develop the more people will be attracted to them. There is little doubt that this value-oriented financial system will gain adherents in due course. I have no doubt that Islamic banking is poised to take a leap forward in the not-too-distant future.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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