Wednesday, September 29, 2010

Banking on Islamic Finance

By Zohaib Bin Akbar,
The recent global financial crisis has opened a debate over the loopholes in conventional banking system. Many scholars and finance experts are of the view that Islamic banking is an alternative to the conventional banking system, which is foolproof enough to restrict any other financial crisis in the future.
Although the Islamic banking industry has been operating from the past 30 years in the Middle Eastern countries, yet it has gained popularity and curiosity around the globe after the financial crisis of 2008. The main objective of Islamic finance is to create a society of investors, unlike the conventional banking system, which has made and created the society of borrowers and lenders from the past 800 years.
Islamic banking activities are to promote public interest, prevent malpractices, contribute towards the development of socio-economic justice and create investment society not a debt-ridden society. They focus on the real sector of the economy.
All financing under Islamic banking is asset backed, i.e. every financial activity should have an under lying asset. There is a concept of IWADH in Islam, which is one of the pillars of Islamic banking. It states that every economic activity undertaken should involve certain amount of ‘risk’, there should be ‘hard work’ or ‘effort’ put in it and there should be a ‘liability’ involved.
The three main things, which are not allowed under the purview of Islamic banking, are Al-riba (interest or usuary), gharar (extreme uncertainty), mysir (gambling). Anything in excess for which no effort or hardship has been put in is considered as riba. Thus, Interest is one form of riba and therefore, it is not allowed in Islam. Gharar refers to the extreme uncertainty or it may be referred as what we have today is speculation. Mysir refers to the game of chance. For example, gambling or betting, which is not allowed as it leads to a zero some game. In gambling the future outcome of an event is predicted without proper collection of facts, analysis and interpretation.
Every product that Islamic bank offers is based on contracts like Mudaraba (partnership), Musharaka (joint venture), Murabaha (cost-plus), Ijara (leasing), and some hybrids combining two contracts (Musharaka Mutanaqisa) etc. Islamic bank involves itself in real time trading or investment activities by doing partnership with its customer through the above-mentioned contract of Mudaraba, or may be by the contract of joint venture (Musharaka) and therefore earns profit. The other sources of revenue for the bank are the service charge that they earn for providing facilities of letter of guarantee or letter of credit to its customers, either corporate or individual.
Today, Islamic banks around the world have a bigger non-Muslim customer base than Muslim counterparts. Many conventional banks like HSBC, Citi, Standard Chartered, RBS, etc have started Islamic banking windows.
It regards the public interest above all other motives or objective. Moreover, the creditor and debtor relationship in the conventional banking system have widened the gap between the rich and the poor (i.e., the rich are getting richer and vice-versa), and have become a real cause of many financial crises over the years and around the world.
Many countries around the world have already made necessary regulatory changes to pave way for Islamic banking, Today, Islamic banking is not only in the Muslim world but also in many non-Muslim countries. Malaysia is the hub for Islamic finance in Asia and it is competing very closely with UK to become the hub for Islamic finance in the world. Even countries like France have recently made necessary changes in order to attract Islamic finance investments. Soon Indonesia, which has the largest Muslim population in the world, is going to kick start the Islamic banking in the country.
India, which has the second largest Muslim population in the world, with a sound and strong economic fundamentals and being the second fastest growing economy, should also fasten up the desired regulatory changes and work towards the implementation of Islamic banking in the country.
(The author is MBA in Islamic Banking & Finance from International Islamic University Malaysia (IIUM). He can be contacted at
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