ISLAMIC BANKING: SCOPE AND CHALLENGES
KHALED QAYUM
Islamic finance and banking has come of age. It has won the notice of the international financial community, which is evident from the large number of foreign/Western banks that are opening Islamic banking window operations. At present, according to various estimates, the amount of funds invested in Islamic finance is reputed to be between US$ 60 to 80 billion.
However, since Islamic finance is still evolving, it has not been fully accepted. People still question the viability of Islamic finance. The sceptics include novices as well as experts. The questions raised range from those about the very basic nature of Islamic banking to those about the need of Islamic finance and Islamic banking in the economy. Typical questions asked include the following:
What is Islamic banking? How different is it from conventional and Western banking?
What is the need for introducing Islamic banking in Pakistan? What advantages, if any, does it offer over and above conventional banking?
The aim of this paper is to answer some of these questions, while discussing the scope of Islamic banking and some of the corresponding challenges faced by it in Pakistan.
Islamic banking started with the advent of Islam. The nature of Islamic banking and Islamic finance cannot be understood in isolation from Islam as a creed and as a way of life. Islam is a complete way of life and Islamic finance is a very important aspect of Islam as a way of life. In fact, the two cannot be separated. One cannot have an Islamic society without Islamic finance and vice versa.
In order to understand Islamic finance, a comprehension has to be acquired regarding the Islamic framework in which Islamic finance has to operate. The following thoughts describe the framework.
Framework for Islamic Finance
Islam is not a religion in the western sense of the word. It is rather a code that covers every aspect of human life. Islamic finance is a subset of the universal set of Islamic principles and practices. Hence, the true nature of Islamic finance can only be understood by exploring and understanding the nature of Islam as a code of life. The Islamic framework is defined by the Qur’an and Sunnah of the Holy Prophet, peace be upon him.
A study of these principles highlights the fact that the Islamic view of mankind is in sheer contrast to the one espoused by secular and western thinking. The secular system views human beings as social animals, motivated by both social as well as animal needs. An extraordinary emphasis is placed on personal liberties in search of physical pleasure. The whole social order of the society is subordinated to this hedonistic pleasure hunt. The result is a society which beliefs and practises, “If it feels good, do it”.
This concept has been accepted to such an extent in the west that laws governing the behaviour of society were framed to support this view of life. This singular search for individual pleasure and over-consumption has caused irreparable damage to the natural resources of the world.
In sharp contrast, Islam considers human beings as social but moral animals. The source of morality is the divine law of the Qur’an as revealed to the Prophet and incorporated in the Sunnah, which is the sayings and practices of the Prophet, peace be upon him. The Islamic code covers not only the relationships among human beings, but also the relationship between man and his Creator. Hence, the unrestrained search for pleasure is discouraged and even prohibited.
“0 ye people! Eat of what is on earth, lawful and good” (11-168)
The Qur’an clearly declares that human beings are permitted to partake only of what is lawful and good. Things which the Qur’an or the Prophet view as not lawful or not good are prohibited. No such command exists in secular thinking.
The concept of ownership is also widely different as between Islam and secular thinking. Islam believes that ownership belongs to Allah Almighty. Human beings are nothing but trustees of Allah, who are permitted the use of the bounties bestowed on them, as long as they do not transgress or waste the resources given by Allah. The following verses describe the bounties of Allah bestowed on human beings.
“It is He Who sends down rain from the sky. From it ye drink, and out of it (grows) the vegetation on which ye feed your cattle. With it He produces for you corn, olives, date palms, grapes, and every kind of fruit. Verily this is a sign for those who give thought.
He has made subject to you the night and the day; the sun and the moon. And the stars are in subjection by His command: verily in this are signs for men who are wise. If ye would count up the favours of God, never would ye be able to number them: for God is oft Forgiving, Most Merciful.” (XVI: 10-12, 18)
Islam is neither in favour of over consumption and wastage, nor in favour of penury and hoarding.
“But waste not by excess; for God loveth not the wasters.” (VI: 141).
“Those who, when they spend, are not extravagant and not niggardly, but hold a just (balance) between those extremes.” (XX:67)
Thus, although Allah has bestowed upon human beings unlimited bounties, yet He has forbidden humans to waste or transgress in terms of exploiting the resources and bounties given by Allah. As a corollary, Islam is against the exploitation of one class of society by another class.
Islam views money as a medium of exchange. In Islam, money does not in itself produce interest or profit and is not viewed as a commodity. Islam does not favour hoarding of monetary resources or centralisation of monetary controls in the hands of a few. Since, historically, interest or usury has been one of the major vehicles used for exploitation as well as centralisation of monetary controls in the hands of few, it has been strictly prohibited. The following verses clarify the point:
“But God hath permitted trade and forbidden usury. Those, who, after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for God (to judge); but those who repeat (the offence) are companions of the fire; they will abide therein (for ever).” (II: 275)
Interest, as human suffering has shown over centuries, causes much harm to human beings. Its institutionalisation, as in the secular/western economies, causes wealth to be concentrated within the hands of the few, which is something Islam clearly forbids:
“In order that it (wealth) may not merely make a circuit between the wealthy among you.” (LIX: 7)
A study of these and similar verses of the Qur’an and Hadith, will lead the observer to believe that Islam desires to have a just society which is free of exploitation at the hands of the privileged few. Unlike communism, Islam believes in an equitable society rather than an equal society and supports free enterprise.
It is important to note that the Islamic financial system is not capitalism sans interest.
The two systems are inherently different. Islam, through its various principles guiding human life, ensures free enterprise and trade, yet provides incentives for social and personal development.
According to Islamic principles, property and wealth, along with all other forms of resources, belong to Allah, who has bestowed these on humans to enjoy these bounties, but not to degrade them. Man’s control over these resources is of a transitory nature. Every living thing, including plants and animals, has rights which human beings have to honour. Today, when mankind faces a myriad of nature -related problems, it is important to note that had the message of the Qur’an and Hadith been understood and practised, then the current efforts to revive nature would not have been needed.
Hence, from the above discussion, it becomes apparent that Islam, as a complete system of life, offers a unique approach, which is very different from the excesses of the different systems witnessed hitherto by mankind. It is against the exploitation of mankind by a chosen few. It strives for an equitable utilisation of resources rather than an equal use of resources. Islamic finance strives to apply these timeless and universally acceptable principles to the world of finance. On other hand, secular and Western financial wisdom leaves everything to the vagaries of market forces, a modern buzz word describing secular thinking on finance, which is nothing more than the law of the jungle applied to the world of finance and trade.
Banking in the Islamic System
A common misunderstanding exists today that the only difference between Islamic banking and secular banking is the use of riba. It is thought that if the element of riba or interest is removed from conventional banking, or if riba is named as something else, it would somehow sanctify and convert it into an Islamic banking system.
This concept that the removal of the element riba would convert secular banking into Islamic banking is a fallacy. The two are different because they are products of two distinct philosophies. One is based on the law of the jungle, where you either eat others or you are eaten. The other is based on the timeless and divine principles that are universally applicable. Secular banking has no intrinsic moral bindings or implications. Islamic banking is based on the moral applications of finance. Islam recognises that the creation of a just society depends on the moral application of finance and trade principles.
As far as interest, mankind has used it for a very long time. Its detrimental effects have been witnessed in societies the world over. Even the modern secular economists, such as Keynes, have recognised the harmful effect of riba, or interest. The incompatibility of riba with a just and equitable economic system is worthy of a separate discussion, but would detract from the subject at hand.
The status of the Islamic bank in relation to its clients is that of a partner, investor and trader, whereas in secular or Western banking the relationship is that of a creditor and investor. Islamic banks are thus equity based, whereas the secular/Western banks are loan based.
In principle the Islamic Bank is a triple level mudaraba. In this mudaraba the clients invest their capital and the bank itself takes on the role of a mudarib. As a mudarib the Islamic bank then invests the funds which have been entrusted to its care in businesses or ventures which it deems fit in hope of a better return. At this point, the entrepreneur becomes the mudarib and the bank itself is the provider of capital. Thus, the capital is first invested by the bank’s clients in the bank and later on is invested by the bank in businesses which may provide good returns. The money is not loaned to the entrepreneurs. It is invested in them, and like all investments, in principle it is open to the vagaries of the business cycle.
In comparison, Western or secular banking takes deposits from savers and pays them a rate of interest fixed in advance. The money is then loaned to businesses in return for an interest that is fixed in advance. The whole cycle is based on lending the money on interest fixed in advance.
A review of the secular/western system of banking and finance reveals a major anomaly, in terms of charging a fixed rate of interest on businesses that always have a variable expectation of profit. Variation is a law of nature. It is as much applicable to the business cycle as it is to anything else in the world. The logic of applying a fixed rate of interest on a business venture, where the expectation of profit at best is variable, has never been explained. In this regard also. Islamic banking and finance is superior to Western/secular finance and banking.
Scope and Challenges of Islamic
Banking From the preceding discussion it is clear that the Islamic system is comprehensive, is based on the application of moral and divine law, and is also closer to the law of nature, where everything from weather to production is subject to variation. It is also clear that an economic system based on Islamic principles and aims produces a more equitable and just society.
It is clear that Islamic banking is wider in its scope and more suited to human needs than that based on the secular or Western system of economics. However, modern Islamic banking, in comparison to Western/secular banking, is a recent phenomenon. The challenges faced by it are enormous.
Foremost of these challenges is the projection of the true image of Islamic banking which needs to be accepted not only as viable, but also indeed as superior to secular/western banking. It must be noted that Islamic banking, contrary to popular belief, is not the same as secular banking with Arabic nomenclature. This challenge requires extensive effort by Islamic banks in educating the people.
Islamic banking makes unique demands on both its management and professionals. Islamic bankers are not bankers in the Western and secular sense of the word. They in fact have to be investors, who, on behalf of their clients, act as mudaribs and invest the capital provided in businesses worthy of investment. These professionals have to face a bigger challenge, as they need to have a better understanding of industry, technology and the management of the business venture they entrust their clients’ capital to. They also have to understand the moral and religious implications of their investments.
This is in direct contrast to conventional and secular banking practices, which train credit or loan officers who are primarily focused on the security and the ability of the entrepreneurs to repay principal plus interest. As a principle, the conventional banker does not have to be concerned with the moral implications of the business venture the money is lent to. Thus, the demands on conventional bankers are fewer as compared to those on Islamic bankers/investors.
There is also a need for banking professionals to be trained in Islamic banking and finance. Most banking professionals have been trained in secular economics and banking. They lack the requisite vision and conviction about the efficacy of Islamic banking. Islamic financial institutions in Pakistan have done an excellent job in developing products and services within the framework of the Sharia. There is a need to institute not only Islamic fiqh but also the spirit behind the fiqh.
This leads us to the second most important challenge in Islamic banking, namely the marriage of the normative approach of Islamic scholars active in research in Islamic finance with the positive or pragmatic approach of the bankers practising Islamic banking. Bankers, owing to the nature of their jobs, have to be pragmatic or application oriented. There is, and will be, a tendency in bankers to mould or modify the Islamic principles to suit the requirements of the transaction at hand. Additionally, being immersed in the travails of day-to-day banking, they find little time or inclination to do any research which might make any substantial contribution to Islamic banking.
Islamic scholars, on the other hand, typically have a normative approach, i.e., they are more concerned with what ought to be. They are not knowledgeable about banking or the needs of the customers. This results in a situation, where both the bankers and scholars suffer from a communication gap. There is a need to marry these two disciplines. Both of these need to work together and help in the development of Islamic banking.
The third most important challenge for Islamic banking today is to be able to communicate and indeed produce a better set of services and products than Western secular banks, which are much more developed. The challenge for Islamic banking is to produce a better set of products which, product by product, are not only comparable to those of secular banking but indeed more customer focused. These products or services, at the same time, have to be within the framework defined by Islamic tenets.
Role of A1 Faysal Investment Bank in Islamic Banking
The Al Faysal Investment Bank was incorporated in 1991, with the dual aim of providing a good return to its shareholders and exploring and establishing Islamic banking in Pakistan. The bank was incorporated with an authorised capital of Rs. 500 million, which was later enhanced to Rs. I.O billion. Today it is the largest investment bank in the country, with a deposit base in excess of Rs. 10.0 billion and an asset base of more than Rs. 12.0 billion. Its shares are traded on the national bourses.
AI Faysal’s parent institution, Dar Al Mai AI Islami (DMI), is located in Geneva, Switzerland. It manages fiduciary funds in excess of $3.0 billion. The group is active in many countries of the world. Today, DMI’s commitments are in excess of US$ 700 million. AI Faysal offers products and services for both individuals and corporate clients. These include products in the following areas: investment products and portfolio management, financings and advisory services.
AI Faysal has been active in three of the four basic modes of Islamic financial operations, i.e., mudarabas, musharakas and murabahas. The murabaha mode has been the most commonly used vehicle owing to its ease of structuring and applicability. This is also the most commonly used mode by other Islamic banks the world over.
AI Faysal, with an aim of developing the entrepreneurial talent in Pakistan, has also participated in musharaka financings. However, the results have not been very encouraging, for to the following reasons:
a) Too many and too frequent changes in government policies.
b) Lack of desire in the entrepreneurs to declare profits and share them with the bank.
c) Non-availability of proper and timely information from the entrepreneurs.
d) Low ethical standards in society today.
e) Poor managerial skills in the entrepreneurs.
For these reasons, Al Faysal has decided to be more careful and selective in investing in the musharaka mode. Although the product has not been discontinued, extra care is exercised when providing funds for musharaka financings.
The bank has acted as mudarib in investing the funds under management. Regarding this, it faces the difficulty that being an Islamic bank, it has to fulfil the requirements of the Sharia as well as the regulations imposed by the State Bank of Pakistan (SBP). This at times restricts the options available to the bank.
Al Faysal has applied for permission from the SBP/Government to operate in the ijara, or leasing, mode, which is close to the heart of Islamic banking. The permission has not yet been granted. It is hoped that the government will realise the extra tough environment in which the Islamic banks have to operate, and grant the necessary permissions. This would further the cause of Islamic banks in the country.
Islamic banking is evolving. We have to strive continuously to develop and redefine its boundaries by providing better services as well as products. It also has to help the cause of the Islamisation of society. It is hoped that with the interest of the Pakistan Government and with the support of the people, the challenges will be met and the goals will be achieved.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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