Islamic Banking: Problems and
Before I discuss about the problems and prospects of Islamic Banking, I am discussing some primary issues such as definition, objective and history of modern Islamic banking.
An Islamic Banking is a financial institution that operates with the objective to implement and materialise the economic and financial principles of Islam in the banking arena.
The Organisation of Islamic conference (OIC) defined an Islamic Bank as “ a financial institution whose statutes, rules and procedures expressly state its commitment to the principles of Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations.”
According to Islami Banking Act 1983 of Malaysia, an Islamic Bank is a “company which carries on Islamic Banking business....... Islamic Banking business means banking business whose aims and operations do not involve any element which is not approved by the religion Islam.”
The objective of Islamic Banking is not only to earn profit, but to do good and bring welfare to the people, Islam upholds the concept that money, income and property belong to Allah and this wealth is to be used for the good of the society.
Islamic Banks operate on Islamic principles of profit and loss sharing and other approved modes of Investment. It strictly avoids interest which is the root of all exploitation and is responsible for large scale inflation and unemployment.
An Islamic Bank is committed to do away with disparity and establish justice in the economy, trade, commerce and industry; build socio-economic infrastructure and create employment opportunities.
History and Present Status of Islamic Banking around the World
The History of Islamic Banking :
The History of Islamic Banking could be divided in to two parts. First When it still remained an Idea, Second-When it become a reality-by private initiative in some counties and by law in others.
Islamic Banking as an Idea :
The scholar of the recent past in early fifties started writing for Islamic Banking in place of Interest Free Banking. In the next two decades Islamic Banking attracted more attention.
Early seventies saw the institutional involvement. Conference of the Finance Ministers of the Islamic Countries was held. The involvement of institutions and Government led to the application of theory to practice and resulted in the establishment of the Islamic Banks. In this process the ‘Islamic Development Bank (IDB)’ was established in 1975.
The coming into being of Islamic Banks:
The first private Islamic Bank, the ‘Dubai Islamic Bank’ was also set up in 1975 by a group of Muslim businessmen from several countries. Two more private banks were founded in 1977 under the name of ‘Faisal Islamic Bank’ in Egypt and Sudan. In the same year the Kuwaiti Government set up the ‘Kuwait Finance House’.
In the ten years since the establishment of the first private commercial bank in Dubai, more than 50 Islamic Banks have come into being. Though nearly all of them are in Muslim countries, there are some in Western Europe as well : in Denmak, Luxembourg, Switzerland and the UK.
In most countries the establishment of Islamic banking had been by private initiative and were confined to that bank. In Iran and Pakistan, however, it was by government initiative and covered all banks in the country. The Governments in both these counties took steps in 1981 to introduce Islamic Banking.
At present there are Islamic Banks in the following countries:-
Problems being faced by Islamic Banking in the world in general
Most of the Islamic Banks operate on Bai- Murabaha, Bai Muazzal, Bai- Salam, Istisna, Hire Purchase/ Leasing mode of Investment i.e. Islamic Banks always prefer to run on markup/ guaranteed profit basis having Shariah coverage. For this reason some times the conventional Economists and General people failed to understand the real difference between Islamic Banking and conventional Banking.
Mudaraba and Musharaka modes of Investment are ideal but Islamic Banks are not going in these two modes, the reasons for the above are as follows:
i) There is no systemic analysis and research and no real efforts to introduce above mentioned two modes but the practitioners blame the following factors:-
a) There is lack of committed entrepreneur
b) There is lack of committed professional who can create new
d) There is lack of committed sponsors who can pressurize the professionals
e) There is shortage of skilled professionals.
2. The problem of forward contact/booking of foreign currency.
The value of US Dollars ($), Pound Sterling, Euro and others are not fixed in Bangladesh, they are fluctuating from time to time Most of our imports and exports are made in USD and USD being a strong currency always moves upward and the exporters are in better position than the importer in our country. In Bangladesh Forward Booking is required to check the exchange fluctuation for import of heavy/project Machineries where it take long time say one year or six months to produce the same.
But due to the restrictions of Shariah we can not cover the risk of Exchange fluctuation by forward contract as Forward Booking is not permitted by Shariah. As per Shariah, currency, transaction is to be made under certain terms and conditions laid down for “sarf” by Shariah, such as spot possession of both the currencies by both the parties which is not available in forward Booking. It is also prohibited to deal in the forward money market even if the purpose is hedging to avoid loss of profit on a particular transaction effected in a currency whose value is expected to be declined. This problem requires a solution by Shariah experts.
3. Inland Bill Purchase/Foreign Bill Purchase :
This is another problem of Islamic Bank where the exporters immediately after export of the goods approach to the bank for fund before maturity of the bills to meet their daily needs. Here the Bank has to deploy billions of Taka each year but how and on what mode of investment ? The Bank can not take anything by providing fund to the exporter except collection fee for collection of the Bill, which is very poor.
4. Unfamiliarity with the Islamic Banking System
The first problem, is that despite the growth of Islamic banks over the last 30 years, many people in the Muslim and non-Muslim world do not understand what Islamic banking actually is. The basic principle is clear, that it is contrary to Islamic law to make money out of money and that wealth should accumulate from trade and ownership of real assets. However, there does not appear to be a single definition of what is or not an Islamic-banking product; or there is not a single definition of Islamic banking. A major issue here is that it is the Shariah Councils or Boards at individual Islamic banks that actually define what is and what is not Islamic banking, and what is and what is not the acceptable way to do business, which in turn can complicate assessment of risk for both the bank and its customer. More generally, the uncertainty over what is, or is not, an Islamic product has so far prevented standardization. This is difficult for regulators as they like to know exactly what it is they are authorising. It is also an added burden on the banks that have to educate customers in new markets.
5. Portfolio Management :
The behavior of economic agents in any country is determined partly by past experience and present constraints. The Islamic banks are still growing in experience in many countries. Regarding constraints, Islamic banks in different countries do not freely choose arrangements, which best suit, their need. As a result, their activities are not demand-oriented and do not react flexibly to structural shifts in the economic setting as well as to changes in preferences It is known to the bank management that a certain portion of the short-term fund is normally not withdrawn at maturity; these funds are used for medium or long-term financing. However, a precondition for this maturity transformation is that the bank be able to obtain liquidity from external sources in case or unexpected withdrawals. Islamic banks, without having an interest-free Islamic money and capital market, have no adequate instruments to meet this pre-condition for effective maturity transformation. On the other hand, Islamic banks can enhance term transformation if there is an interest-free bond market or a secondary market for Islamic financial papers. Adequate financial mechanism still has to be developed, without which financial intermediation, especially the risk and maturity transformation, is not performed properly.
6. The Regulatory environment
The relationship between Islamic banks and monetary authorities is a delicate one. The central bank exercises authority over Islamic banks under laws and regulations engineered to control and supervise both traditional banks. Whatever the goals and functions are, Islamic banks came into existence in an environment where the laws, institutions training and attitude are set to serve an economy based on the principles of interest. The operations of Islamic banks are on a profit and loss share basis (PLS), which actually do not come fully under the jurisdiction of the existing civil laws. If there are disputes to be handled, civil courts are not sufficiently acquainted with the rationale of the operations of Islamic Banking. Regarding the protection of depositors, Islamic Banks are required to let the authorities know the difference between money paid into current accounts and money paid into investment accounts. Islamic banks operate two broad types of deposits:
a) Deposits, which cover transaction balance. These have a 100 percent reserve requirement and completely safe, thus satisfying the needs of risk averters, and
b) The PLS or equity account, in which depositors are treated exactly as if they were shareholders in the bank. There is no guaranteed rate of return or nominal value of the share.
In non-Muslim counties (i.e., the countries with less than 50% Muslim population) the central banks are very stringent in granting licenses for Islamic banks to operate. In order to be established in those countries Islamic banks must also meet the additional requirements of other government and non-government authorities. (So, apart from legal constraints there are economic measures that result operations of Islamic banks in the non-Muslim world difficult). In Muslim countries also they face economic restrictions. Besides funding, acceptable investment outlets is a major challenge for Islamic financial institutions.
7. Absence of Liquidity Instruments
Many Islamic banks lack liquidity instruments such as treasury bills and other marketable securities, which could be utilised either to cover liquidity shortages or to manage excess liquidity. This problem is aggravated since many Islamic banks work under operational procedures different from those of the central banks; the resulting non-compatibility prevents the central banks from controlling or giving support to Islamic banks if a liquidity gap should occur. So the issue of liquidity management must come under active discussion and scrutiny by the authorities involved is Islamic banking.
8. Use of Advanced Technology and Media
Many Islamic banks do not have the diversity of products essential to satisfy the growing need of their clients. The importance of using proper advanced technology in upgrading the acceptability of a product and diversifying its application cannot be over emphasized. Given the potentiality of advanced technology, Islamic banks must have to come to terms with rapid changes in technology, and redesign the management and decision-making structures and, above, all introduce modern technology in its operations. Many Islamic banks also lack the necessary expertise and institutional capacity for Research and Development (R & D) that is not only necessary for the realization of their full potential, but also for its very survival in this age of fierce competition, sophisticated markets and an informed public. Islamic banking cannot but stagnate and wither without dynamic and ongoing programmes. In addition, Islamic banks have so far not used the media appropriately.
Even the Muslims are not very much aware that the Islamic banking is being practiced in the world. Islamic banks have not ever used an effective media to publicise their activities. The authorities concerned in Islamic banks should address these issues on a priority basis.
9. Need for Professional Bankers
The need for professional bankers or managers for Islamic banks cannot be over emphasized. Some banks are currently run by direct involvement of the owner himself, or by managers who have not had much exposure to Islamic banking activities, nor are conversant with conventional banking methods. Consequently, many Islamic banks are not able to face challenges and stiff competition. There is a need to institute professionalism in banking practice to enhance management capacity by competent bankers committed to their profession. Because, the professionals working in Islamic banking system have to face bigger challenge, as they must have a better understanding of industry, technology and the management of the business venture they entrust to their clients. They also have to understand the moral and religious implications of their investments with the business ventures. There is also a need for banking professionals to be properly trained in Islamic banking and finance. Most bank’s professionals have been trained in conventional economics. They lack the requisite vision and conviction about the efficiency of the Islamic banking.
10. Blending of Approach of Islamic Scholars with the Approach of the Conventional Bankers
Bankers, due to the nature of their jobs have to be pragmatic or application-oriented. There is and will be tendency in the bankers practicing in Islamic banks to mould or modify the Islamic principles to suit the requirement for transactions at hand. Additionally, being immersed in the travails of day to day banking, they find little time or inclination to do any research, which can make any substantial contribution to the Islamic banking. Islamic Scholars active in researching Islamic Banking and finance, on the other hand, typically have a normative approach, i.e. they are more concerned with what ought to be. A very few of them are knowledgeable about banking or the needs of the customers.
(ii) Problem Specific to Islamic Banking in Bangladesh
1. Absence of Islamic Money Market
In the absence of Islamic money market in Bangladesh, the Islamic banks cannot invest their surplus fund i.e., temporary excess liquidity to earn any income rather than keeping it idle. Because all the Government Treasury Bills, approved securities and Bangladesh Bank Bills in Bangladesh are interest bearing. Naturally, the Islamic banks cannot invest the permissible part of their Security Liquidity Reserve and liquid surplus in those securities. As a result, they deposit their whole reserve in cash with Bangladesh Bank. Similarly, the liquid surplus also remains uninvested. On the contrary, the conventional banks of the country do not suffer from this sort of limitations. As such, the profitability of the Islamic banks in Bangladesh is adversely affected.
2. Absence of Suitable Long-term Assets
The absence of suitable long term assets available to Islamic banks is mirrored by lack of short term tradable financial instruments. At present there is no equivalent of an inter-bank market in Bangladesh where banks could place, say, over night funds, or where they could borrow to satisfy temporary liquidity needs. Trading of financial instruments is also difficult to arrange when rates of return are not know until maturity. Furthermore, it is not clear whether Islamic banks in Bangladesh can utilise more exotic instruments, such as derivatives, that are becoming increasingly popular with conventional banks. Obviously, these factors place Islamic banking in Bangladesh at a distinct disadvantage compared to its conventional banking counterpart.
3. Shortage of Supportive and Link Institutions
Any system, however well integrated it may be, cannot thrive exclusively on its built-in elements. It has to depend on a number of link institutions and so is the case with Islamic banking. For identifying suitable projects, Islamic banking can profitably draw the services of economists, lawyers, insurance companies, management consultants, auditors and so on. They also need research and training forums in order to prompting entrepreneurship amongst their clients. Such support services properly oriented towards Islamic banking are yet to be developed in Bangladesh.
4. Organizing Relationship with Foreign Banks
Another important issue facing Islamic banks in Bangladesh is how to organise their relationships with foreign banks, and more generally, how to conduct international operations. This is, of course, an issue closely related to the creation of financial instruments, which would be simultaneously consistent with Islamic principles and acceptable to interest-based banks, including foreign banks.
5. Long-term Financing
Islamic Banks stick very closely to the pricing policies of the government. They can not benefit from hidden costs and inputs, which elevate the level of prices by certain entrepreneurs without any justification. On the other hand, Islamic banks as financial institutions are even more directly affected by the failure of the projects they finance. This is because the built in security for getting back their funds, together with their profits, is in the success of the project. Islamically, it is not lawful to obtain security from the partner against dishonesty or negligence, both of which are very difficult if not impossible to prove.
In my understanding the prospect of Islamic Banking is very bright. Muslim people everywhere want Islamic Banking. In Bangladesh, to give an example, 4/5 conventional Banks have opened separate Islamic branches recently. Five hundred applications are pending with Islamic Bank Bangladesh Ltd. for opening of new braches. IBBL has already 132 branches in the country.
The position may not be same in all countries. But if Islamic Banking succeeds in any country, the position will same in every Muslim country in my judgment. This means, that first Islamic Bank in any country should be well managed and successful so that people have faith in this system. Established Islamic Banks should co-operate by lending competent officials in setting up new Islamic Banks.
The problems mentioned in the preceding pages are not insurmountable. Most of them can be solved with more research and dedicated efforts. IDB, OIC Fiqh Academy, Internatinal Islamic Banking organizations and individual Islamic banks should put more resources in research in Islamic Banking, Finance and Economic issues. Cooperation of Central Banks and the Governments. will be needed in some areas. I have no doubt in mind that Islamic banking will expand more and more in the entire world.