Islamic banking and finance

Many people think that Islamic banking and finance is a cure to all the financial woes. In fact that is not the case. Islamic banking and finance is as man-made as the conventional banking. The only difference is that Islamic banking and finance seeks basic guidance from Islamic sources like the Quran, Sunnah, Ijma and Qiyas. Only because of this Islamic banking and finance is free from some of the weaknesses and problems besetting conventional banking. There is very strong theoretical evidence that the principles of Islamic banking and finance are superior to the principles of conventional banking. This is why one would be inclined to assert that had Islamic banking and financial principles been implemented in the financial markets the problems we are facing today in financial industry would have been avoided to a great extent.

The woes of conventional banking
Conventional banking is based on interest rate mechanism, which encourages people and businesses to borrow and lend heavily. Of course there is a motive behind borrowing in the cooperate sector. For instance if I am a corporate, I would borrow from a bank only if I can anticipate some business opportunities coming up. But many times borrowing or lending takes place without any reference to economic activity. It could be purely speculative. For example, many of those who are involved in interest rate arbitrage and currency arbitrage may borrow money purely to benefit from interest or exchange rates differentials in different markets. These kinds of opportunities allow the players in financial services markets to borrow without practically having any intention to invest in the real economy. If this type of speculation persists for some time, it may lead to a financial bubble. Such frequent and heavy borrowing and lending do not go into real economy; rather it simply puts further pressure on prices. When the bubble gets enlarged, it is bound to burst and bring a financial crisis. In Islamic banking and finance, the possibility of this happening is smaller. Islamic banking and finance restricts trading in debt and other financial papers. Furthermore, there is an Islamic economic principle that disallows selling something that someone does not own or rightfully possesses. In the presence of such a restriction, financial bubbles cannot occur. This is why one could say that if the Islamic principles had been followed in conventional financial system we could have avoided the current financial crisis.

Interest makes all the difference
Interest plays a huge role in the contemporary economic systems, and in the absence of an interest rate mechanism, the whole banking system changes. Islamic banks are required to be involved in trading, i.e., buying and selling of assets, of commodities, of other items, whereas conventional banks simply borrow and lend money. For example, Habib Bank, which is a commercial bank, would not like to be involved in trading in its normal routine business. Let us say I am a corporate I go to a commercial bank to borrow one million rupees. If the bank is satisfied with my credit worthiness, it would offer me the loan for a specific period and on a specific rate of interest. However, if I had gone to an Islamic bank, it would have first asked me why I needed the one million. Had I told that I wanted to buy a few computers with the one million, the Islamic bank would decline to offer me money but would be happy to buy the computers from the market, for one million, to sell those on to me for one million plus profit. From that view point the whole transaction is very different. The bank is getting involved in trading – buying and selling the assets. Islamic bonds, called Sukuk, are structured in the same way.

Sukuk
An Islamic bond in many cases is an asset backed security. If a corporate or government wants to issue an Islamic bond it must first identify an asset that it is willing to sell to the investors. In case of Pakistan, a $600 million Sukuk, which was issued about six years back used M2 motorway as the underlying asset. National Highway Authority sold the said motorway to Pakistan Sukuk Corporation, which issued Islamic bonds sold to different corporations all over the world.

Intentions matter
Intentions are certainly important. If you go to an Islamic bank for an Islamic transaction, then you certainly would be rewarded for conducting a religious act, because you opted for a Riba-free banking transaction. The point is that it is the process of carrying out the transaction that makes all the difference. One thing that we have to understand is that all the religions put heavy emphasis on nomenclature. How does a person enter into Islam; by uttering a few words? Even in matters related with matrimony, it is utterance of a few words (ijab and qubool) that establish marriages, one utters a simple word three times and the marriage breaks up! Nomenclature, i.e., the way you say a thing makes the real difference. Islamic banking is Islamic because such banks call themselves Islamic. Why HBL and all other banks would not like to call all their operations Islamic? Because the banks themselves know that whatever they do in the name of Islamic banking is different from conventional banking. Otherwise if it were exactly the same thing then MCB would have said that from now on all our operations are Islamic. Many banks shy away from becoming Islamic banks because implementing Islamic banking requires much more effort, dedication and resources, especially in a country where laws are not entirely Islamic; as is the case in Pakistan. There is nothing to be surprising about it, as all the former British colonies have inherited their laws from former imperialistic power. This is the case everywhere in the world. An Islamic banking and finance is actually a phenomenon allowing different Muslim countries to Islamise their laws gradually starting from banking and finance then moving on to other areas. Islamic banking and finance is an excellent opportunity for the governments to Islamise their laws. In that case one could say that Islamic banking and finance is bringing a social reform as well…

Social reforms through Islamic banking
Islamic banking and finance is modernising Islamic communities. When we look at average users of Islamic banking and financial services, we find them to be young people, in their late twenties, educated and who have also lived for sometime somewhere in Europe or America. They are exposed to multiculturalism. They believe in coexistence of cultures. This is a modern perspective on life held by those who use Islamic banking. This is a social reform. This social phenomenon is allowing the Muslims to recognise that there are other practices which are not necessarily Islamic but could be allowed to be part of a system they live in. In a country like Pakistan there is recognition at least at the government level of a dual banking system. In other words the government is saying that “To those who like to have Islamic banking services we offer them an opportunity. Those who still like to have conventional banking must also have a choice.” This permission is the recognition of the fact that every person has the right to exist. Today the government of Pakistan is promoting Islamic banking in a dual banking system. What does it mean? It means that it is ready to recognise the importance of those who would like to use Islamic banking. This is also an acknowledgement of their contribution to a modern Islamic society. This means that those who have been so far averse to a conventional banking system could be engaged. They would start getting engaged in the market. Once someone starts getting engaged in the market their perspective changes. If someone is not disengaged from what is happening in the market he or she become a very different kind of person. A person who believes in doing and letting other people do. He is a person who believes in doing things, a person who believes in observing other people doing things. From that viewpoint I still emphasise that Islamic banking and finance has a role to play in bringing social reforms in a number of countries including Pakistan.

An investment tool
Islamic banking and finance can be used by the government to attract investment from other Islamic countries. Malaysia, for example, has used Islamic banking and finance as a tool to generate investment, as a result of which they are receiving a lot of capital from the Middle East. They are receiving a lot of investment from non-Muslim countries as well. Malaysia has developed expertise in Islamic banking and finance, and there is a need for a country like Pakistan to study the Malaysian model to get implications for further development of Islamic banking in the country. Malaysia is the number one player in Islamic banking and finance. Malaysian Islamic financial market has a number of Islamic banks, Takaful (Islamic insurance) companies, Islamic investment banks and fund management companies, and a very vibrant and highly developed Islamic capital market. The country has almost all the universities and other institutions of higher learning producing human resources for Islamic banking and finance industry. Many countries, for examples in Africa, are looking into Islamic banking as well. For them Malaysia provides a good example to follow and emulate. Pakistan has also done wonders in developing comprehensive a framework for Islamic banking and finance. It is important that Pakistan, like Malaysia, must start marketing its experience and expertise in Islamic banking and finance in Muslim and non-Muslim countries. This should bring some good revenue to the country.

Pakistan and Islamic banking
Lack of vision and political will has contributed to the slow growth of Islamic banking and finance in Pakistan. The Government of Pakistan in a way has given the whole Islamic banking and finance to State Bank of Pakistan. The people in the ministry of finance, planning commission etc. have no idea of Islamic banking and finance, which means that there is no ownership of Islamic finance and banking at the government level. Once the government decides to use Islamic banking and finance as a tool for bringing more foreign investment and capital, it can bring home a lot of Islamic capital. Though there is already a lot of investment coming into Pakistan from the Islamic financial institutions. The likes of Dubai Islamic Bank, Al Baraka Bank, Bank Islami and others have foreign ownerships. If the government comes up with a vision of 2020 for Islamic banking and finance and starts pitching Islamic Republic of Pakistan as a friendly state for Islamic banking and finance, a number of institutions, governments and countries would like to come here.

A role changer
There are Islamic financial institutions in Canada, France, America and UK. In UK alone five Islamic banks operational. The UK government is very supportive of this movement because it believes that this is a tool to bring Muslims into the mainstream. Right now, if one takes Islamic banking and finance out of the Muslim communities, a very narrow perception of a Muslim as an extremist or a terrorist is left behind. Islamic banking is giving a new identity to the Western Muslims. All the major banks are doing Islamic banking, which gives a lot of credibility to Islam. One could say that Islamic banking and finance has a role to bring about a change in the perception of our Western counterparts about us. In UK, the government has come up with a very comprehensive package for issuing Islamic bonds. Why? Because they think that there is a bright future and a lot of potential for growth in Islamic finance. In next five years the size of Islamic banking and finance industry would be one to two trillion dollars. Looking at this phenomenal size the Western governments and countries would like to benefit from this by engaging themselves in Islamic banking and finance.

“Durdana Najam is a freelance financial feature writer. She can be reached at [email protected]”