Islamic Banking: An Exemplar Yet To Be Adopted
Published in THE NEWS
Islamic
banking, a criterion of Muslim life for 14 centuries, deteriorated under
colonial rule as Muslim countries bowed to Western laws and business practices.
But the system has made a dramatic re-entry in twentieth century and notably
in the last 20 years, fueled by independence, revolution, oil wealth and
Islam's emergence as the world's fastest-growing religion. The first private
interest-free bank, Dubai Islamic Bank, was 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 the
Sudan. In the same year the Kuwaiti government set up the Kuwait Finance
House. Many banks were established in 1983 (11) and 1984 (13)
As derived from the teachings of the Islamic holy book, the Koran, and
its companion Sunna, Islamic religious law prohibits Muslims from paying
or receiving interest. Religious scholars say the ban was a response to
the aged practice of loan sharking. But in a modern society, it prevents
observant Muslims from taking out mortgages, in Islamic countries so made
PLS accounts, carrying balances on credit cards or investing in bonds,
Treasury bills or any other instrument that smacks of a guaranteed return
Which isn't to say that Islam scowls on making money or demands that Muslims
regress to an all-cash or barter economy. What's essential is that all
parties to a financial transaction share in the actual profit or loss
of a venture, and that no one gets predetermined compensation-i.e., interest.
"In the Koran and the edification of the Prophet Muhammad (PBUH),
it has always been understood that both parties [investors and lenders]
have the right to a decent rate of return," "It's just the certainty
of that return that's an issue.
Thus, "depositors" in Islamic banks are really shareholders
who earn dividends when the bank turns a profit, or who lose a portion
of their savings if it posts a loss. Paying rent for the use of a real
asset is perfectly acceptable under Islamic law. So business owners can
lease equipment through contracts called ijara, while would-be homeowners
can acquire houses through rent-to-own transactions (Murabaha). Mudaraba
agreements look a lot like Western-style limited partnerships, with one
party contributing capital, the other running the business, and profit
split based on percentage of ownership. Even investments in common stocks
are permissible, as long as the funds aren't channeled into enterprises
whose activities conflict with Islamic taboos against gambling, pork consumption,
liquor or pornography.
Resource guides list more than 120 Islamic financial institutions operating
in more than 30 countries around the globe. Islamic banks, which employ
religious scholars to ensure that all procedures conform with religious
law, boast combined assets approaching $150 billion with a growth rate
excelling 15% a year.
Most of that action is centered in the Middle East (Topmost: Bahrain:
ABC Islamic Bank, Faysal Islamic Bank, Gulf international Bank, Saudi
Arab: Al Bank Al Saudi Al Franci & Islamic Development Bank, Oman:
Oman Arab Bank, Kuwait: Bank of Kuwait and the Middle East, United bank
of Kuwait) parts of Asia(In Malaysia: Bank Islam Malaysia Berhad, India:
Al-Ameen Islamic Financial & Investment Corporation (India) Limited)
and Europe such as Faisal Finance Switzerland,
where even U.S. banks such as Citicorp have opened Islamic units. At present,
only about a dozen companies (including Amana Mutual FundsTrust,AmericanFinance
House, LARIBA Bank ,
Failaka Investments Inc. &Takaful USA ) serve the U.S. market, home
to several million Muslims. Financial industry observers say it's a segment
poised for expansion as America's Muslim population continues to spike.
These Lariba based Muslim financial Institutions even operating sphere
not abounding, are growing at a mysterious momentum and are working in
more than thirty countries of the world
For 1998, the Amana Growth Fund had a total return of 16.53%, according
to fund tracker Morningstar Inc. That compares with an average of 9.39%
for other so-called mid-cap blend funds tracked by Morningstar. Similarly,
the Amana Income Fund returned 14.07% last year, compared with the 12.44%
average for its "large value" category peers. "I can tell
you that we are currently distributing dividends/profits to our investors
and share holders in the range of 6-6.5% per annum which is far better
than return on traditional banks savings products", said Mike Maguid
Abdelaaty President of American Finance House responding to one of my
e-mails.
About 45 Islamic mutual funds have cropped up worldwide in recent years,
reflecting the growing appetite for such investments among Muslims.
One of the pioneers is MSI Financial Services. Under its system, a home
buyer enters into a partnership agreement with the company to buy a home.
The buyer puts down at least 20% of the cost, with MSI contributing the
remainder. The buyer then leases MSI's portion of the house in a rent-to-own
transaction that lets the buyer build equity in the home. Unlike a conventional
mortgage, these rental payments can move up or down from year to year
to reflect actual market conditions. If the buyer decides to sell before
the house is paid off, MSI and the buyer split the sales proceeds based
on the percentage owned by each side. The same is true in case of default.
MSI has made about 250 of these 15-year mortgages during the last few
years
the $3-billion United Bank of Kuwait (UBK) is set to make a onset into
the U.S. market. Through its U.S. operation in New York, the bank is rolling
out a home-buying product called Manzil USA;
Based on an Islamic concept called ijara wa iqtina, or "lease to
purchase," the Manzil USA program will offer features similar to
conventional mortgages, including 30-year terms and 20% down payments.
The product is scheduled for an April launch in California, where UBK
is now organizing home-buying seminars.
Main sources of deposits for an Islamic bank are Saving a/c, Current a/c,
Mudaraba a/c and Qarz-e-Hasan these incoming are dispensed mainly through
following broad categories of Islamic modes of financing
Mudaraba:
Mudaraba in essence is based on the concurrence of those who have capital
with those who expertise, where the first party provides capital and the
other party provides the expertise with the purpose of earning Halal profit
(lawful) which will be partitioned between them in ratios agreed upon.This
mode achieves the interest of both parties, the capital owner and the
Mudarib (agent).
· The capital owner may not have the time or the experience to
turn over capital and trade with.
· The agent (the Mudarib) may not have the adequate capital to
put to use his experience.
Areas of Application Mudaraba is considered to be the essential mode accredited
by the Islamic banks in their relationship with the depositors who tender
their moneys to the bank as capital owners to be invested by the bank
as Mudarib on the basis of profit sharing according to specific ratios
agreed upon.The Islamic banks use the same mode with the investors who
are capable to work whether they are physicians or engineers or they are
traders or craftsmen. The bank provides the adequate finance as a capital
owner in exchange of a share in the profit to be agreed upon.It is worth
noting that this mode is a high risk for the bank because the bank delivers
capital to the Mudarib who undertakes the work and management and the
Mudarib shall only be a guarantor in case of negligence and trespass.
The Islamic banks usually take the necessary precautions to decrease the
risk and to guarantee a better execution for the Mudaraba and pursues
this objective with seriousness.
MODES
OF LEASING (Ijara): Lease is the employment of money in operations other
than sale and purchase operations. These operations aim at obtaining the
rentals and the proceeds by receiving the benefits of the asset through
time.
The banks use the two modes of Ijara.
· Operation Lease
· Lease - Purchase
OPERATION
LEASE According to this mode the Islamic bank maintains a number of various
assets to respond to the needs of different customers. These assets usually
have a high degree of marketability. The bank lets these assets to any
party so desirous to utilize for a term to be agreed upon. After the termination
of the lease period the assets return to the bank, on its part the bank
looks for a new lessee.
Areas of Application: The operation lease transactions are suitable for
high cost expensive assets, that demand large amounts of money in order
to possess, in addition to the long time necessary for its production.
To mention but a few of these assets, aircrafts and ships for which the
demand on operation lease is increasing because of high cost and long
period of construction. The Islamic banks can carry business in the line
of operation lease in many assets such as industrial equipment and agricultural
machinery as well as the means of transportation. All these can satisfy
the immediate needs of different parties. The bank benefits from this
mode by retaining the assets in its possession and at the same time receives
returns from leasing. The lessee also benefits by covering its immediate
demand and achieving its objectives at the appropriate time without bearing
large capital cost.
MURABAHA SALE: Murabaha sale is one kind of absolute sale (asset for price)
It is selling the commodity for the purchase price plus a certain profit
margin agreed upon. This margin can be a percentage of the purchase price
or a lump sum. Murabaha Sale is divided into two types:
Ordinary Murabaha Sale:There are two parties to it, the seller and the
buyer. The seller is an ordinary trader who buys a commodity without depending
on a prior promise of purchase, then he displays it for Murabaha sale
for a price and a profit to be agreed upon.
Murabaha Sale connected with a promise:There are three parties to it.
The seller, the buyer and the bank as an intermediary trader between the
buyer and the seller. The bank here does not purchase unless the buyer
specifies its desire and a prior outstanding promise to purchase.
Areas of Application Murabaha is one of the most widely used modes of
finance by the Islamic banks. It is suitable for partial financing to
the investment activities of the customers, in industry, trade or others.
It enables the customer/investor to obtain finished goods, raw material,
machines or equipment from the local market or through import.
ISTISNA'A
SALE : The majority of the jurists consider Istisna'a as one of the divisions
of Salam, therefore it is subsumed under the definition of Salam. But
the Hanafite school of jurisprudence makes Istisna'a an independent and
distinct contract. The jurists of the Hanafite school have given various
definitions to Istisna'a, some of which are: "That it is a contract
with a manufacturer to make something" and "It is a contract
on a commodity on liability with the provision of work".The purchaser
is called "mustasnia" contractor and the seller is called "sania"
maker or manufacturer and the thing is called "masnooa" "manufactured,
built, made".
Areas of Application: Istisna'a contract opens wide fields of application
for the Islamic banks to finance the public needs and the vital interests
of the society to develop the Islamic economy.
Istisna'a contract is applied in high technology industries such as aircraft
industry, locomotive and ship building industries, in addition to the
different types of machines produced in the big factories or workshops.The
Istisna'a contract is also applied in the construction industry such as
apartment buildings, hospitals, schools, universities to whatever that
makes the network of modern life.Istisna'a contract is applicable to the
various industries as long as one can be monitored by measurement and
specifications such as the food processing industry.
Above are the most frequently practiced modes by Islamic sector of banking
with Murabaha at the top. Other categories include Musharkah (participation
in profit and loss or equity participation), Renting of service for service
charges, Qarz-e-Hasna etc. there are about thirty modes of Lariba Islamic
banking system.
One of the most important characteristics of Islamic financing is that
it provides asset-backed financing. Financing on the basis of Salam and
Istisna also creates real assets. The financier in the case of Salam receives
real goods and is able to make profit by selling them in the market. In
the case of Istisna, financing is effected through manufacturing real
assets, where in exchange, the financier earns profit. About some doubt
about the profits of Murabaha and leasing both the instruments of leasing
and Murabaha are still fully backed by assets, and financing through these
instruments is clearly distinguishable from interest-based financing.
Table below shows a real sample of financing by Islamic banking.
Term Structure of Investment by 20 Islamic Banks, 1988
Type of Investment Amount* % of Total
Short-term 4,909.8 68.4
Social lending 64.2 0.9
Real-estate investment 1,498.2 20.9
Medium- and long-term investment 707.7 9.8
Source: Aggregate balance sheets prepared by the
International Association of Islamic Banks, Bahrain, 1988.
* Unit of currency not given.
Despite a lot of work is done in most of the Arab and European countries along with USA, the progress to welcome Islamic traits in Pakistan still appeal attention. Faisal bank which is providing Islamic Banking services all around its operating area including Middle East and Europe is impeded to work on Islamic lines by SBP's policies. During the fiscal year 1998-99 amortization payment amounted to 171.9 billion rupees, 40% of budget. Total internal debt in 1998-99 was 1226.3 billion rupees. Is it not the curse of interest that more than two third of national budget has to sacrifice every year for amortization (installment + interest. The
However, since independence certain steps have been taken to regularize Islamic way of banking transactions. Conversion of current accounts into PLS (profit and loss sharing) in 80's decade was also one of the episodes of such efforts. The pace has remarkably uplifted in December 1999 when Supreme Court of Pakistan declared all kinds of banking transactions which include interest or 'RIBA' as Haraam and has requested Govt. to take certain steps in this regard. In response govt. has steeped ahead to constitute an eleven-members commission. This commission will work on converting current economic system into an Islamic economic system. However, there is need for some definite steps. It is hoped that in near future, more clear laws will be announced and more clear ways will be there to implement Islamic Economic System.
The terms World Wide Web and Electronic Commerce (EC) have surged in popularity in the last few years. Just recently, the Internet has become the hottest area for business application to Net to business application interaction as well. Businesses use electronic data transmission to increase the efficiency and speed of business transactions for all parties involved, and thus are able to lower their costs. In theory, this gives the company an important advantage against its competitors. Though the history of E-commerce is very short, yeti t provides very astonishing Figures relates to its progress. The Internet Economy grew 68 percent from the first quarter of 1998 to the first quarter of 1999 and now accounts for 2.3 million jobs, US accounts for 69% of total e-commerce revenue worldwide, Small businesses who use the Internet have grown 46% faster than those that do not, Forty-four percent of U.S. companies are selling online, the University of Texas projects the Internet Economy to grow to $507 billion this year, 300% increase in revenues enjoyed by retailers from this year to last year, Asian online retail market will grow 150% this year and climb to $7 billion in revenues, European retailers' online revenue increased by more than 200% in 1999, total online revenue in 1999 was €3.5 billion and will reach over €9 billion by the end of this year.
This is not the end of the story. These figures will be even healthier in future than now both in dollars and percentage terms. Even India is going very acceptable on the super highway of E-Commerce. Indian e-commerce transactions for the year ending March 31, 1999 were worth 1.4 billion rupees (33 million dollars), however study says that India could generate 1.5 billion dollars worth of business on the net in four years.
Beyond all these miracles Pakistani businessman
is not yet fully aware that what E-Commerce actually means? There is a
very extremity need about such literature to teach to a common citizen.
Otherwise we will lag behind this cutthroat race and will be unable to
get this competitive edge through which one can even rule the world.
Details on this article can be seen at http://ecommerce0.tripod.com
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