ISLAMIC PRINCIPLES AND MODERN COMMERCIAL PRACTICE
DAVID COWAN
Whilst reflecting on the current state of banking and economics and Islamic banking, it is fair to say that there is a nagging doubt that bankers and economists have any real locus or centre for their ideas and motivations. There is also the growing realisation that Western bankers and economists are not the source of all knowledge, and that perhaps Islamic bankers and Muslim economists have a unique contribution to make.
Islamic banking has its locus in Allah, and the banker, like all other people, is a custodian of God’s resources. The bottom line is that profit must yield to the social concerns of economic policy. The essential first principle for the Islamic banker is that he must have a moral obligation to his customer and vice versa. Each share in the good fortune of the other as productive agents on God’s earth. This principle cannot be forgotten, for it is the singular principle that makes Islamic banking what it is.
Rooted in this principle is the question of how to develop products and services for customers and what the unique contribution of Islamic banks should be. The Islamisation of a bank by itself is not enough. It will not attract customers simply by appealing to the piety of Muslims, since for most client’s factors such as convenience of location, personal relationships and especially the kind of services on offer are the basis on which an individual chooses a bank.
If an Islamic bank can offer a good network and range of services, and on top of this makes the Islamic argument compelling, only then will they be able to attract new customers. The strategy cannot be reversed. One does not convert the believer to the argument and then ask the question ‘how are we going to deliver?’ or force the customer to forgo certain services that he has been used to with a conventional riba bank.
Customers often take a good track record into account when considering opening a bank account, but Islamic banks often cannot show evidence of such a track record. Nor, on pricing, can direct comparisons be easily made between the two types of banks. Indeed, it is difficult at this early stage of Islamic banking, but investment funds have been estimated at having anything from several billion dollars up to $50b under management.
So, it is up to Islamic bankers to advertise their services. Whilst Muslims are aware of the ban on interest, owing to the explicit objection made in the Qur’an, there is a lack of awareness of the alternatives that are Islamically acceptable. The concept of murabaha is understood by some in the merchant field, but mudaraba and musharaka are still little understood techniques in the business community.
This is changing as Islamic banks become more active, but it does leave the banks with a tremendous need for education. The complexity of formulae for working out the financing of these techniques does not make the task any easier. This task is again not helped by the fact that customers have highly sophisticated requirements. Most customers are already used to the high standard of financing or services offered by the large Arab banks or the foreign banks. A customer would need to have their experience translated into Islamic banking terms and be approached in a professional and sophisticated manner.
Islamic banks will succeed if they can offer good returns on investments and deposits, good financing techniques and variety in production offerings. Traditionally, an Islamic bank’s activity has fallen into two categories. First, services which a bank renders for a fee, or on fixed charges, such as safe deposits, funds transfer, handling trade financing deals, property sale and purchase and handling investments.
Second, investment of capital on the principles of partnership of mudaraba. This is where the bank can add value particularly to entrepreneurs, providing supportive funding. In this way, the bank has acted as a partner in the business, and can additionally provide the fee-based services as well.
Many of the Islamic banks to date have generally tended to go after the business customer, followed by the private bank customer, but consumers are now being targeted more aggressively. If a customer can marry financial satisfaction with religious duty, then s/he will be a loyal customer and, indeed, prove to be a hard customer for competitors to lure away.
There must now be about 100 Islamic banking institutions operating in over 45 countries. Among these institutions there is division over what constitutes good Sharia practice. The stance taken by countries such as Pakistan and Sudan, where interest has been totally banned, does not really further the cause. Social responsibility cannot be forced; we can only offer a way towards it and encouragement to go in that direction.
Islamic banking will be more attractive to Muslims and non-Muslims alike if it is able to deliver efficient services and demand effective use of technology. Investment in technology and appropriate financial software for Islamic requirements is an essential strategy for Islamic banks.
Many banks in the Middle East are currently investing in re-engineering their back offices, replacing outmoded computer services.
One of the ways this is being done is by important Electronic Data Interchange (EDI), computer-to-computer linkages based on a standard format used by all parties to any given transactions without manual intervention, re-keying information or paper This allows banks and companies to integrate their operations internally and externally.
This would suit banks in the Middle East, where there is revolutionary change and not a gradual evolution of systems as in the West. EDI would allow an Islamic bank to think about its present situation as well as what it would like to create in the future, and create a software environment where adapting to change and new products would be built into the bank’s infrastructure.
For Islamic banking, this is the crucial point. As Islamic banking grows in market share, so, too, will the need for new financial products.
Having efficient technology is only the starting point, it gives the potential to offer a cost-effective and timely service. However, to fully utilise this base and implement what Islamic banking has to offer, education and training is also a crucial element.
Unfortunately, education is sorely lacking. Islamic banking often invokes one of two reactions, being cynically interpreted as either replacing interest with fees or dividends that match the interest rate, or simply not charging interest. Both customers and potential customers need to be educated as to the range of services available to them.
Following on from having a technically competent infrastructure, a keen commercial sense and innovative products, a well-trained staff is also needed to communicate the message of Islamic banking. The market must also be educated – there is a large Muslim population to be reached, not just in the Arab world but globally.
The opportunity exists for Islamic banks and funds to reach Muslims in all corners of the globe. An Arab banker said recently that ‘we are good at propaganda, but not so good in public relations’. Islamic bankers must learn to be communicators, to master the art of public relations, if they are to escape the backwaters of the financial world.
To reach a global audience requires good marketing, well-researched documents and a clearly stated mission. True, relations with the Western media can often be difficult, but within the last year major positive stories have appeared in prestigious publications such as the Wall Street Journal and the International Herald Tribune.
Undoubtedly the media must be used to convey the message of Islamic banking. Once the groundwork is all in place, the next question to be asked is: what is it that Islamic banks are really offering?
Islamic banks must be able to compete successfully alongside conventional banks by offering a full range of products and services to fit the requirements of most retail customers, namely, cheques, charge cards, current accounts, bill-paying/zakat payments, investment funds, and loans and mortgages.
More attention is required to the need for Islamically-based retail investment products, since much of the financial engineering which Islamic banks can do lies in the area of offering retail investments, making use of investment trusts, unit trusts and mutual funds.
Many Islamically accepted funds have been created, and they are successful in offering capital appreciation for customers, often outperforming conventional funds. More work needs to be done in defining how far banks can go in the area of international funds.
In the modern world credit cards are essential for people travelling abroad, and useful at home in reducing manual work and paper. A structure that strikes as being most beneficial would be a charge card tied to an investment fund, whereby the customer places X amount of funds into an investment which is held as security for the card, and then uses the card to leverage off those funds.
The benefits of such a card are that the bank has guaranteed repayment, and the customer is able to have liquid funds while accruing value on the initial deposit, which is being put to work. The money is thus productively used in two ways, as a means to invest and in consumer spending. For most customers this could become the norm for an Islamic credit card and current account, since cheques and bill payments can be conducted in much the same way.
Attempts are being made across this region to generate liquidity in the local stock markets, and since it is easier to find Islamically acceptable equities in these markets than abroad, this may be a good place to start. The current problem for the stock market lies in attracting investment; a circular situation arises where liquidity is required to attract investors, but without investors there is no liquidity. Funds attracted by deposits-backed charge cards could be directed into local markets and benefit the local region greatly, taking another small step towards success in the stock markets of the region.
In the area of consumer loans, there are two broad groups of people who ask for bank loans. Firstly, those who require financial assistance because they want something they cannot afford out of their own resources, or have need of something they cannot pay for. The problem in the first instance is that banks can only advance loans to consumers from whom repayment may be guaranteed in some way, and such loans should be provided for under some form of state support or subsidy.
The second group are those who have assets and a source of income to secure or guarantee repayment of the loan, and require a loan to meet a temporary need from promised future income. In this case, overdraft limits may be agreed or certificates of sale, which act like a commercial bill of exchange, may be used as security to a sale. In addition, loans may be raised on a similar basis to the charge card scheme as outlined earlier.
Mortgages, too, have to be taken into account, as in Western economies, many consumers were crippled by fluctuating interest rates on their mortgages, and struggled to repay the interest due on the loan, leaving the banks with problematic mortgage portfolios. A great many people had to leave their homes, which were left vacant and unpaid for This has a knock-on effect in the economy which begs the question as to whether interest and credit creation are desirable economic goals or effective means of financial measurement. This particular question cannot be addressed here; suffice to say that many banks had their fingers burnt in the process.
The underlying point is that Islamic banks should not encourage the creation of credit beyond the needs of their customers, nor in a way that threatens conformity with the Basle Concordant. On this last point, there is some concern that certain Islamic banks do not meet the provisions required by the Bank for International Settlement (BSI). If Islamic banks are to be accepted as part of the normal fabric of financial life, and in international markets where there is a large potential Muslim market, then falling in line with the BSI is a necessary prerequisite.
Banking success lies in three elements. First, by safeguarding depositor’s money, not protected by a guaranteed fund or financial insurer, but by bankers. Such safety will ensure the trust of one generation and gain the habit of the next. Second, funds and deposits must be invested safely with good returns, and make enough money to pass onto the customer, whilst retaining a profit for the bank. Finally, by keeping expenses low, investing in technology, good administration and delivery of service and products.
In the last twenty years Islamic banking has made a significant impact, and has made a unique contribution to the economic debate, not just in the Muslim world, but in all nations. The marriage of Islamic principles with modern commercial experience will ensure success for the next twenty years and beyond.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
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