CHALLENGES IN ISLAMIC BANKING
SAAD ANWAR HASHMI
Sep 10 - 16, 2012
Islamic banking is an alternate mode of banking from the conventional system with products designed to be Riba free and in conformation with the core principles of Shariah. Islamic banking is relatively new as compared to conventional banking and the industry is still evolving to further streamline the products offered. Islamic banking is viewed to be safe as depositors are considered as partners or equity holders in the business sharing profit and losses. Malaysia is viewed as a model for Islamic banking. With increased knowledge of Islamic principles and reasons why Riba is forbidden, more and more have turned to Islamic banking from conventional banking. Considering that Islamic banking is three decades old, this form of banking operates alongside conventional banks for a share in business and profitability increasing competition within the banking sector looking at markets particularly in Saudi Arabia, UAE and Pakistan. Multinational banks, particular those in UK are looking at the Islamic model of banking are more keen to start a parallel business offering Islamic banking window to capture the niche market which is growing.
Despite the given positives, growth of Islamic banking on a global scale does not come without challenges. There continues to remain a wide belief that Islamic banking is no different than conventional banking and that the product structuring and returns to the bank are defined as per conventional banking models. People generally in the market who have little to no knowledge of Islamic Finance tend to be influenced from those who differ from such alternate form of banking. Conventional banks on the other hand tend to offer rates better than Islamic banks making it a challenge to pull business and deposit base. When it comes to pricing, it is generally observed that Islamic banks are more expensive than conventional banks. The reasons posted are such that transaction cost and monitoring in Islamic banking is high, therefore, rate offered to the client is higher than those offered by conventional banks. Islamic banks on the other hand invest little in marketing and rely on the belief of people to shift to Islamic banking through their knowledge of Shariah.
Another concern is with the understanding of Riba and whether Riba is completely eliminated through Islamic banking. We have established that Riba is completely and unequivocally forbidden in Islam. Islamic banks on the other hand charge Riba defined as an amount over and above the principal being lent. An amount charged over and above principal primarily comes in the form of penal rates. The reasons posted are such where Islamic Banks say that if they do not charge a penalty rate, consumers will take advantage of the system and will tend to default. The amount collected as penalty categorized under Riba is not made part of the bank profitability and ultimately given to charity which raises a core question i.e. if Riba is haram, it is as haram for one person as it is haram for the other and cannot be used for charitable purpose. It is widely believed in International markets that the problem can stand eliminated if no penal rate is charged over and above principal e.g. late payment penalty and related charges if products are structured according to core principles of Shariah and Quran.
Another controversy is Islamic banking is the rate of return offered to the deposit holders. Islamic Banking views depositors as partners where advances are lent by the bank treating the depositor as equity holders alongside the bank. The returns are based on profit and losses. The ratio with which the profit would be shared is disclosed and informed to the deposit holders on a month to month basis. Since Islamic banks tend to compete with conventional banks, returns given to deposit holders are made at par with other banks, mainly conventional banks not based on the actual return which were earned by the depositor through the invested funds for instance, if a deposit holder was entitled for a return in the partnership sharing ratio of 14%, the actual return which would be given to the deposit holder will be 8%. The reason stated is such that if the Islamic banks were to give returns in actual as earned through the partnership, a high rate of return would result in an exponential increase in the inflow of deposits being attracted through higher rates which would eventually result in liquidity issues for the bank if funds are mismanaged. The system of advances however is viewed to be safer than conventional banks since conventional banks use deposits money for advances whereas Islamic banks view the advances as a medium through which both the depositor and the bank would earn, therefore monitoring of the credit is paramount.
Islamic banks is based on the core principles of Shariah based on how monetary transaction should be carried doubt in Islam. A Fatwa is given in instances where a concept or logic is not clearly understood from either Quran or Sunnah and requires an expert opinion. No matter were Islamic Finance is carried out in the world, there are no standard global guidelines on Islamic Banking. Shariah scholars may issue a Fatwa in one country which would be different from Fatwa issued on the similar subject in another country based on the understanding of each scholar. There are differences between countries since there is no single authority which governs the laws of Islamic Banking. Based on such differences, a product structured in Pakistan will be different from those structured in Malaysia versus any other country.
A challenge which continues to be a cause of concern for the industry is the availability of human resource. Islamic Banks tend to give employment to those who bring wealth of experience from conventional banking and find it challenging to acquire new training with understanding of documentation and products. Islamic Finance training is offered in universities but only on basics rather than teaching of the mode of transaction execution and structures.
When looking at any economy in general, each transaction is centered around interest from the rate of return offered to the depositors, return on various investment, payment of principal and mark-up on debt payment where Islamic Banking constitutes to a very small portion to the overall global banking system. Islamic banks follow conventional banks to match the pricing in order to remain competitive. However, with respect to countries like Pakistan, Islamic Banking can only function in its true essence if the economy is Islamized.