Islam has had its own concepts of banking and finance for centuries, i.e., based on the Holy Quran; striving to promote equity, prohibited the charging of interest on loans because poor borrowers and wealthier lenders did not face equal risks.
Malaysia's relative religious moderation and its progressive government, which is less focused on religious issues than some Arab regimes, have allowed it to push the limits of what is permitted in Islamic banking.
Bank Negara Malaysia has established a national Shariah board of scholars to approve banking products. The board has established the benchmarks needed to standardize the industry, ensure that Islamic banks meet international financial rules and reassure customers that they are getting truly Islamic products. But it also has been progressive enough to consider how Malaysia could adapt Islam to such cutting-edge financial ideas as derivatives.
In just the last five years, Malaysian banks have introduced a staggering range of Islamic financial products. One of them was the world's first Islamic interest-less bond, or sukuk. Other products include Islamic mortgages, Islamic leases and Islamic funds that do not bear interest. Malaysia even has created a kind of Islamic ATM network so devout Muslims can withdraw money across the globe without worrying whether the banks collected interest from their deposits. However, as Islamic finance has become more mainstream, conservative Muslims have criticized it as not strict enough. Banks in more conservative Persian Gulf states initially refused to help their Malaysian peers sell the most progressive Islamic bonds because they believed they came close to offering interest. Others believe there are too many modern thinkers on Malaysia's oversight board.
Current scenario of Islamic financial institutions in Malaysia and its implications
Being profit making organizations and to remain competitive in the industry, Islamic financial institutions in Malaysia have opted the easy way out – replicate and transform conventional financial products and make it “Islamic”. The replication and transformation of conventional financial products into their corresponding Islamic analogues have implications for the regulation and supervision of Islamic financial institutions :
First, the various lending structures generate different risk and balance sheet exposures for Islamic banks that need to be carefully monitored and managed. While only a few Islamic financial products generate different liquidity profiles from conventional products, the lack of uniformity of standards for Islamic banking practices across Islamic countries makes it difficult to apply the same prudential regulatory standards such as capital adequacy requirements across the board. This calls for more harmonisation of Islamic banking practices, which includes calls for harmonisation of Shariah standards nationally and internationally.
Second, the treatment of profits/losses will have consequences for the balance sheet structure and will require adjustments to meet minimal prudential requirements. For example, in mudarabah transactions, the bank bears full financial responsibility for any losses but shares relative profits with the client. Any losses stemming from uncollateralised equity financing may require higher loan-loss provisioning and additional capital. Mudarabah transactions are essentially investment partnerships in which all the capital is provided by the financial institution while the business is managed by the entrepreneur/client. Profits are shared in pre-agreed ratios and losses are borne by the bank, which are passed on to depositors.
Third, disclosure requirements may need to be comprehensive and more frequent to inform investors of the investment techniques so they can make decisions based on their risk preference. Maintaining clear transparency and ensuring adequate disclosure of financing mechanisms are important steps towards building the necessary foundations. As part of the international effort to design a regulatory framework for Islamic finance, regulators need to factor in the differences in finance and have at least minimal standards or benchmarks to gauge compliance and assess risks. There needs to be some consistency in regulatory treatment, subject to the particular country’s legal and regulatory regime.
Fourth, we are seeing plenty of fancy marketing of new Islamic products, but marketing does not qualify as product innovation. The most important management facet of any financial institution is product development. This is especially true of Islamic financial institutions, because the Islamic finance industry is new and, therefore, behind in product assembly. Customers of Islamic banks are fed up with the market imitating the tools and methods of conventional banking. This was acceptable only when Islamic banking emerged. However, as it consolidated itself and was able to displace its rivals, its customers want new methods derived from the Holy Quran and Sunnah and distinct from fabrication and trickery. Customers no longer want irreligious credit cards or tawarruq (monetization). To achieve this, Islamic banks must look towards managing product development, as it is the heart that pumps blood to financial institutions. If this circulation stops, financial institutions die out. This could happen as a result of the inability to develop and create.
Lastly, financial centres should work together to address weaknesses in legal and institutional frameworks that are hampering product innovation in Islamic finance. There are still many countries where the legal and institutional framework is not explicit and transparent about Islamic finance, and the framework developed for conventional finance is being applied to Islamic institutions .It is, however, unclear whether this is sufficiently flexible to address and supervise Islamic finance’s unique mix of risks and special operational features. There are also many countries where Islamic finance’s legal and institutional framework is not explicit and transparent. Significant weaknesses in the legal, governance and systemic liquidity infrastructure are impeding the spread of product innovations and preventing effective supervision and risk management. There needs to be more done to set supervisory and regulatory standards. This is necessary to support industry development. Greater standardisation is needed. One way to promote this is through agreement on a set of fatwas issued by Shariah scholars.
Full Islamic versus Shariah compliant
For the purpose of this article, let us focus on Islamic banking. According to the Malaysian International Islamic Financial Centre’s (MIFC) website, Islamic banking refers to a system of banking that complies with Islamic law also known as Shariah law. The underlying principles that govern Islamic banking are mutual risk and profit sharing between parties, the assurance of fairness for all and that transactions are based on an underlying business activity or asset. These principles are supported by Islamic banking’s core values whereby activities that cultivate entrepreneurship, trade and commerce and bring societal development or benefit is encouraged. Activities that involve interest (riba), gambling (maisir) and speculative trading (gharar) are prohibited.
A) What is “full Islamic”?
To answer the above question, one must go back to the basics. Islamic banking is an instrument for the development of an Islamic economic order. Some of the salient features of this order may be summed up as:
1) While permitting the individual the right to seek his economic well-being, Islam makes a clear distinction between what is halal (lawful) and what is haram (forbidden) in pursuit of such economic activity. In broad terms, Islam forbids all forms of economic activity, which are morally or socially injurious.
2) While acknowledging the individual's right to ownership of wealth legitimately acquired, Islam makes it obligatory on the individual to spend his wealth judiciously and not to hoard it, keep it idle or to squander it.
3) While allowing an individual to retain any surplus wealth, Islam seeks to reduce the margin of the surplus for the well-being of the community as a whole, in particular the destitute and deprived sections of society by participation in the process of Zakat.
4) While making allowance for the ways of human nature and yet not yielding to the consequences of its worst propensities, Islam seeks to prevent the accumulation of wealth in a few hands to the detriment of society as a whole, by its laws of inheritance.
5) Viewed as a whole, the economic system envisaged by Islam aims at social justice without inhibiting individual enterprise beyond the point where it becomes not only collectively injurious but also individually self-destructive.
Dr Shahid Hasan Siddiqui in his article on “Islamic Banking: True Modes of Financing” posed the following questions :
i) Whether banks operating under the banner of Islamic banking have succeeded in the elimination of injustices of the interest-based system as ordained by Holy Qur'an (2:279)? The verse states the following :
“And if ye do not, then be warned of war (against you) from Allah and His messenger. And if ye repent, then ye have your principal (without interest). Wrong not, and ye shall not be wronged.”
ii) Whether banks operating under the banner of Islamic banking have contributed to the attainment of socio-economic justice in line with the objectives of Islamic economic system?
iii) Whether banks operating under the banner of Islamic banking are, for all practical purposes, not following the bench marks of interest-based system under Murabahah, Bai-Mu'ajjal or the like modes of financing?
iv) Whether the net result in modes referred to at (iii) above really differs much from the interest-based loaning?
v) Whether by adopting the modes referred to at (iii) above, banks assume any responsibility for the operational losses of the party availing finances from them?
vi) Whether sharing in the operational losses are not the essence of Islamic system of banking?
vi) Whether large scale financing on a perpetual basis, on modes approved for "Sale transactions", can continue to be made for an indefinite period by Islamic banks which are not trading houses but are financial institutions?
While attempting to firm up views in respect of above questions, it must be kept in view that Islamisation of banking system is a part of overall Islamic value system and is not merely refraining from interest-based transactions.
B) Where Islamic banks went wrong ?
Conventional banks were considered by the majority of jurist as not Islamic due to the borrowing and lending nature of their operations. Unfortunately, Islamic banks emerged according to a model that is very similar to conventional banks. On the assets side, loans were replaced primarily by credit sales and leases, with built-in interest rates are characterized as profits or rents, respectively, matching market interest rates on similar loans.
The growth of tawarruq (monetization) has become popular in retail Islamic finance, whereby the Islamic bank sells a commodity on credit to the customer, and then arranges for the customer to sell it back for cash, thus obtaining the desired credit. In this murabahah mode of financing, the bank, at the request of its client, purchases the specified goods from a third party against payment. Immediately on the transfer of ownership of the goods as also obtaining its physical or, in most cases, the constructive possession, the bank sells these goods to the client at cost plus an agreed fixed profit margin. The client then takes physical possession of the goods and undertakes to pay the price to the bank either in instalments or in lump sum, at an agreed later date.
In actual practice, practically there is no gap as in many cases, the bank makes the payment almost simultaneously or even after the goods are delivered at the premises of the client. The bank thus does not in fact assume any risk including even the risk of the goods, during the short period, the bank is supposed to own and possess these goods. The bank however, gets a return at a pre-determined fixed rate, which is not dependent on the operational results of the entrepreneur. This in any case, does not appear to be in conformity with the requirements of Shariah.
Looking at the murabahah from yet another angle, it is important to note that Allah s.w.t. has condemned riba in harshest possible terms perhaps only second to "Shirk". It does not appeal to the mind that by simply assuming some risks by banks in financing through murabahah and the like during "shifting of stocks" from the godown of the seller to the entrepreneur (party availing finance from the bank) which can also be practically avoided and ensuring a fixed return on financing while not sharing in the operational losses of the entrepreneur, which is the essence of Islamic banking, the objectives of the Shariah are met.
Conclusion
Islamic finance is a prohibition-driven industry, which aims primarily to circumvent the canonical Islamic prohibitions of riba, maisir and gharar. Since the focus of the assignment is on Islamic banking, we should emphasize on the real objective of Islamic banking system, i.e., to make a positive contribution to the fulfilment of socio-economic objectives of the society in all spheres, including trade, industry & agriculture etc.
It is important to appreciate that the requisites for total implementation and success of Islamic banking in a country, include re-shaping the society, re-structuring of the economic system and re-framing of the laws according to the dictates of Islam.
The most important and difficult task however, is the reformation of society which has to be undertaken as an on-going process.
We therefore, need to change our priorities and at least as much emphasis should be laid on improving the ethics, honesty and values of the society as is being done for expansion of "riba-free banking".
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