REFLECTIONS ON ISLAMIC BANKING – PART I
MUAZZAM ALI
This is a brief assessment of the strengths, weaknesses and opportunities of Islamic banking and some of the possible pitfalls that Islamic banks should avoid.
But before that I will touch on the salient features of the concept of Islamic banking and its present operations.
Concept
Islamic banking is not an end in itself It is a means to an end. Islamic banking is an instrument for the implementation of the Islamic economic order.
The main features of the Islamic economic order are:
1. To strive to build a society based on social justice, equity, moderation and balanced relationships. It is a system embodying eternal values, safeguarding the rights of men and women and constantly reminding them of their obligations to themselves and society.
It forbids all forms of exploitation and honours labour. It encourages men and women to earn their living by honest means, and to spend their earnings in a rational way.
All activities must conform to the Sharia (Islamic Law). Dealings in interest, gambling, pornography, alcohol and drugs etc., are forbidden. Forbidden also are deals that Islam considers abhorrent.
All resources available to huma n beings must always be put to optimum use, and no one has the right to hoard them or to keep them idle, or to squander them, or use them for wanton display, be it the individual, the community, or the state.
Development is an essential requirement and participation in economic activity is obligatory for everyone. Members of the society must work hard and always seek to produce more, so as to be able to participate in the process of Zakat and to contribute to the welfare of others.
The general impression – that the removal of the element of interest from banking is enough to render a bank Islamic – is only partially true, as Islamic banking is much more than interest-free banking.
Just as a Muslim has to affirm in totality his faith in La illaha, illallah, Mohammadur Rasul-Allah, an Islamic banker has to implement all the salient features of the Islamic economic order.
Present Operation of Islamic Banking
Islamic banking re-emerged on the world scene over two decades ago after remaining dormant for centuries.
When the concept of Islamic banking with its ethical values was reintroduced after this interregnum, financial circles the world over treated it as a Utopian dream. Having lived for centuries under the value-neutral capitalist economy, they asked what ethics had to do with finance. However, attitudes are changing and in the last few years Islamic banking has succeeded in achieving general acceptance.
Today, more than one hundred and fifty Islamic financial institutions are operating world-wide, with thousands of employees.
They are managing funds to the tune of billions of dollars. Their clientele is not confined to Muslim countries but is spread all over Europe, in the United States and in many far-off lands. Islamic banking continues to grow at a rapid pace. Because of its value-orientated system, it draws finances both from Muslims and non-Muslims alike.
The surge of interest in Islamically acceptable financial instruments has also encouraged conventional banks – including those in the West – to have an active participation in the Islamic banking system.
So much for the history of Islamic banking. Now let us consider something much more important – the building blocks that must be developed to maintain the momentum of sustainable growth for the Islamic financial market.
If we were to perform a standard business review, known as a SWOT analysis (Strengths, Weaknesses, Opportunities, Threats) on the Islamic financial market, what would we find?
Strengths
(a) The devotion of its clients to the moral correctness of our banking system.
People who are banking with Islamic financial organisations have a commitment to the ideals and philosophy of Islamic banking and have made a covenant to abide by the Islamic concept. They have thus a committed clientele, which may not always be the case as far as clients in Western banks are concerned, for whom commitment may be only towards gaining higher profits.
(b) Th e sheer breadth of geographical locations.
Islamic banks are spread over the world and are not confined to any one region or country, thus giving them an international network to draw upon for their operations.
The development of proper banks run on Islamic principles, offering steady long-term solutions to their customers, would find acceptance in the prime market of Muslims but would also create a second market within the general population.
Weaknesses
1. Lack of Auditing and Accounting Standards
We still have to evolve adequate accounting and auditing standards to rival the Western GAAP (General Accepted Accounting Standards), and to facilitate the analysis of our own financial difficulties.
A sound accounting system plays an important role in the management of a business enterprise. The prevailing accounting system has developed over centuries within the socio-economic framework of the capitalist system. As such, its concepts, values, rules and procedures are defined by the characteristics of the capitalist system.
The Islamic socio-economic system is fundamentally different and necessitates the creation of an accounting system geared to the requirements of the Sharia. In this connection, some elements of the prevailing accounting systems for the conventional banks may be adopted by Islamic banks as long as they do not go against the requirements of the Sharia. Such elements must be scrutinised carefully before they are adopted.
The creation of an accounting system and auditing standards for Islamic banks is a major undertaking and would be best achieved by a central organisation. In this connection, the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) has been doing commendable work for more than a decade with very meagre resources.
It is hoped that the big Islamic banking groups will come forward and provide them with the needed resources so that they can implement their programmes expeditiously.
2. Education and Training
An area which merits considerably greater attention than it has received so far is that of manpower training and education.
There is no denying that in any organisation, the human factor is by far the most important. You can have a well-designed system, well defined procedures and rules, good documentation and the latest technology; but without adequately educated and trained manpower you cannot expect to achieve much. To give an example, a novice cannot be expected to produce good music even with the best instrument.
The independence of Muslim countries following the Second World War was marked by a resurgence of Islam. A logical outcome of this was, among other things, a strong desire among the Muslim masses for the introduction of Islamic financial organisations.
The implementation of this was not easy, as there was little knowledge or past experience of Islamic banking to draw upon. Nonetheless, the challenge was taken up by some Islamic scholars and professionals running conventional banks. They did a commendable job and set the ball rolling.
However, the establishment of an increasing number of Islamic financial institutions and the need to develop Islamic banking to meet the needs of modern markets created an acute shortage of adequately educated and trained manpower. This shortage is growing and proving to be an obstacle in the expansion and development of Islamic banking.
Although a few organisations have set up training institutions, much more needs to be done. Recognising the future needs, the London-based Institute of Islamic Banking and Insurance, three years ago, organised a post-graduate, distance-learning diploma course in Islamic banking and insurance. It currently has on its rolls well over two hundred students from 30 countries.
I hope that many more organisations will set up educational and training institutions. The people inducted in these institutions must be selected carefully. They must not only have the required educational background and intellectual abilities, but must also believe in Islamic banking and be strongly motivated.
One of the most important aspects of building long-term institutions is the fostering of team work and the development of sound motivation-building systems. I hope Islamic bankers will commit themselves to a longer-term plan of investing in training and thereby building organisations which will be both professional and profitable.
3. Research and Development.
The Islamic banking community unfortunately does not seem to appreciate fully the fact that research and development is necessary, not only for the realisation of the full potential of Islamic banking, which is enormous, but also for its very survival.
It must be emphasised that in this age of fierce competition, sophisticated markets and informed public, Islamic banking cannot but stagnate and wither without effective research and development (R&D) 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.
There are a large number of issues relating to Islamic banking which need to be researched. These include:
• Project finance
• Identification of investment opportunities
• Development and standardisation of products
• Standardisation of documents
• Trading practice and systems of settlement
• Islamic capital markets
In contrast to conventional banking, Islamic banking allocates negligible funds to R&D and does not have enough R&D qualified personnel. I hope the Islamic banking community will address this issue on a priority basis.
To set up really effective R&D is expensive, but it can pay high dividends and more than off-set the expenditure.
Having looked at the strengths and weaknesses, we now go on to the opportunities and the threats facing us.
Opportunities
Much of the organisational framework is already available to Islamic banks. We must therefore make use of it and develop along with it – rather than being a parallel system in conflict with conventional banking.
We have the opportunity to exploit developments in technology to deliver high quality products in a cost-effective way, so that good and efficient service become, a hallmark of the Islamic banking system. Such service is heavily dependent upon electronic technology and in today’s computer-age we indeed have access to it. The large and still-growing market is waiting for us to satisfy its requirements, and we must not let this opportunity slip by.
Threats
The emergence of major Western banks at the retail level offering Sharia-acceptable products should be taken seriously Major Western organisations, with their international networks and access to the latest technologies, their expertise and marketing techniques, do pose a serious threat to smaller Islamic banks in different parts of the world.
In recent times, some Western conventional banks have not only opened Islamic windows but have also set up fully fledged Islamic banks. On the face of it, this trend seems a welcome step, yet in the long-term, they will pose a serious challenge to Islamic banks. The motive behind these entrants into Islamic banking is not a commitment to the Islamic economic order, but simply a desire to take advantage of a niche market for purely commercial reasons.
There is yet another threat that Islamic banks and financial organisations face. Many Islamic organisations place their funds with conventional banks and request them to invest these on their behalf in Islamic instruments. Such Islamic banks are not doing the cause of Islamic banking any service. They only mobilise funds from Islamic clients and hand them over to Western banks for investment.
This is not Islamic banking. If this tendency is not checked, a day may come when the Islamic investor may decide to just do away with the middlemen and go directly to the Western banks using Islamic instruments. The Islamic banks must therefore develop their own instruments and acquire the expertise for investment.
Presently, such banks, to put it mildly, are acting as agents of conventional banks. Let there be a reversal of roles. If the Western banks want to invest in Islamic instruments, they should come to the Islamic banks and ask them to operate these funds in accordance with the concept and philosophy of Islam.
This is not intended in any way to undermine the contribution of Western banks to the promotion of Islamic banking. They have played an important role in this connection. They have given much needed credibility to Islamic banking. They have also given practical training to a large number of people in operational banking. Because of their expertise in financial affairs, they have developed financial documentation, and we greatly appreciate their efforts.
It is unfortunate that the greatest hindrance 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. The Islamic banks are not patronised by them. It is Muslims of middlelevel income who keep Islamic banks alive.
Threats to Islamic banking again come from bankers in Islamic institutions. Instead of developing financial instruments and products based on the Islamic philosophy, they try to use conventional products by putting on them a veneer of Islam.
They do not use their intellect to find out new methodologies to satisfy the financial requirements of Muslims. Instead, they resort to the easiest way to “Islamise” conventional instruments.
The continuation of these practices will damage Islamic banking more than anything else. Our bankers in Islamic banks must be imaginative and liberate themselves from the yoke of the value-neutral capital system.
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. Transparency in all operations is sacrosanct to the success of Islamic banks.
Pitfalls
I now refer to possible pitfalls. We should learn from the mistakes of conventional banks and study and examine the causes of the recent set-backs suffered by banks such as Barings, Morgan Grenfell, Kleinwort Benson, Sumitomo Bank and many others.
The crises in these banks were caused by:
i) The desire of the management to make a ‘quick buck’;
ii) The fund managers in each of these cases were endowed with the gift of the gab and a glib tongue, and lulled their bosses into believing that they could perform better than anyone else. Unfortunately, their bosses perceived them as ‘star performers’;
iii) A laxity of internal, and management, controls.
When a fund manager offers to secure more profit than is normal, the management should sit up and take notice. The lure of extraordinary profit may well be an alarm signal and must be seriously examined by the management. In order to safeguard against such pitfalls, the management should have strict and effective internal auditing and independent evaluation of projects.
It is my sincere hope that the Islamic banking community will be able to take heed of these and other pitfalls, and build towards a successful future upon the solid foundations of our past achievements.
Edited By Asma Siddiqi
Institute Of Islamic Banking And Insurance London
Comments
John Doe
23/3/2019Lorem ipsum dolor sit amet, consectetur adipisicing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua. Ut enim ad minim veniam, quis nostrud exercitation ullamco laboris nisi ut aliquip ex ea commodo consequat.
John Doe
23/3/2019Lorem ipsum dolor sit amet, consectetur adipisicing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua. Ut enim ad minim veniam, quis nostrud exercitation ullamco laboris nisi ut aliquip ex ea commodo consequat.
John Doe
23/3/2019Lorem ipsum dolor sit amet, consectetur adipisicing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua. Ut enim ad minim veniam, quis nostrud exercitation ullamco laboris nisi ut aliquip ex ea commodo consequat.