Saturday, March 24, 2012

Looking at Islamic Banking in its Proper Context

Assalamu 'Alaikum,


This article appeared in Forum page of The Edge Malaysia, Issue 902, Mar 19-25, 2012
My Say: Looking at Islamic Banking in its Proper Context
Written by Zahid Aziz March 19 2012

The Muslims Consumers Association of Malaysia (PPIM) in a press statement dated 12 February 2012 criticized banks “who use the name ‘Islam’ in efforts to promote and sell their respective products when in reality they still oppress and use methods contrary to Islamic law.”

The Association of Islamic Banks in Malaysia (AIBIM) countered “All Islamic banking institutions in Malaysia operates in accordance with Syariah values and are well regulated in compliance with high standards…”

I believe that we are today actually guilty of failing to see Islamic banking in its proper context. To put it simply, the true environment of Islamic banking as expected by the Shariah is that it should be operating in a riba free environment, in a riba free economy. In other words it should be a sole single system operating in an Islamic economy, putting aside the wider environment of Islamic law for the moment.

What we find today is an Islamic banking system enveloped and impacted by the riba banking system operating within a riba driven economy. Practitioners of Islamic banking understand these daily pressures imposed on them by riba banking, but often, they are not able to articulate the issues to the general public. Incidentally, this is the voice I tried to give them in a thesis entitled “The negative impact of riba banking on the performance of Islamic banking in a dual system like Malaysia” that I recently submitted to a local university.

The following are a few examples dealt with in the thesis:

     Collection of deposits
Islamic banks use the concept of Mudarabah to collect deposits whereas conventional banks use interest rates. If one understands the concept of Mudarabah one knows that the Islamic bank cannot quote a deposit rate upfront; the return on the deposits will only be known on maturity. In a low-liquidity situation, conventional banks merely hike interest rates, but Islamic banks are helpless to compete.

Inability to sell ethical financing products
Ethical financing products for house financing under parallel Istisna’ (a contract of exchange with deferred delivery), for example, requires the Islamic banks to assume higher risks than conventional housing loans. If the developer abandons a housing project under parallel Istisna the Islamic bank assumes responsibility and will not burden the customer to continue paying for a house they will never own. Under conventional house financing (and incidentally the BBA house financing currently used by Islamic banks) the burden is placed squarely on the customers, who will be forced to continue to pay for a house they will never own.

However, to offer the ethical product, the Islamic banks need to price it higher than a conventional loan as it involves assumption of higher risk. The conventional housing loan is at discounted pricing because the burden of abandoned housing is placed on the customers not the banks. Give the public an option - where riba is not made haram to Muslims - society will choose the cheaper but defective conventional product because everyone believes it is always other people and not them, who will suffer the abandoned housing problem.

They actually take a gamble, willing to sacrifice x% of society who will suffer due to abandoned housing. Under the ethical Parallel Istisna’ financing, 0% of society will suffer because Islamic banks will assume responsibility for abandoned housing. Thus, we see how the dual system, and not making riba haram for Muslims, impacts Islamic banking negatively.

There are many other examples but the above should be enough to illustrate the problem. However I would like to clearly state that the current practise of Islamic banking is in no way absolved of the criticism aimed at it.

Today it is very clear Islamic banking is being practised without reference to Maqasid Shariah or Objectives of Shariah. One wonders whether the Islamic bankers who are in a position to decide are adequately educated of Maqasid Shariah. In an Islamic economy economic units must work towards achieving the objectives of Shariah.

Maqasid Shariah in respect of the economy requires among other things, for wealth to be widely distributed and not confined to the wealthy few. A wide distribution of wealth cannot be achieved in an overly debt financing biased Islamic banking system the world finds itself in today. In debt financing, preferences are always given to Islamic banking customers who can offer collateral and who have high levels of equity to meet debt to equity ratios set by Islamic banks. These debt financing conditions usually marginalise the poor and favour the rich. Thus, we see Islamic banks guilty of making the rich richer and the poor poorer.

Celebration of the poor is a hallmark of the struggle of our Prophet s.a.w. We cannot ignore the poor in economic activities. Islam does not believe in the invisible hand as believed by Western Economists to right economic wrongs. Islam demands proactive actions to uplift the plight of the poor and in the context of Islamic banking this translates into emphasis on Islamic microfinance.

How many Islamic banks today see Islamic microfinance as a responsibility they are willing to shoulder? If Islamic banking management are not motivated to do microfinance we need to ask why, and enquire whether there is a bigger systemic issue at hand.

As for the consumers, they need to understand Islamic banks are not charitable organisations but businesses. Cheap financing may translate to poor returns on deposits; will all consumers deposit their money in Islamic banks in such a scenario?

To conclude, we cannot afford to ignore the environment Islamic banks operate in. The way forward, I believe is to understand the environment, know where we are headed and, last but not least, get the right people to lead Islamic banking.

Muhammad Zahid Abdul Aziz has 20 years of experience in Islamic banking and finance and is a director of Muamalah Financial Consulting, an Islamic capital market consultancy.



1 comment:

  1. I totally agree, I am a big supporter for the idea of mass equity economy. That is the creation of an infrastructure that will inculcate mass direct investment to businesses, thus spreading the wealth. One of the example would be car equity system, where anybody having extra cash can combine and will purchase a car, that will then be rented for long term at a profit. The ownership of the car will be with purchaser till the end, while lessee enjoys value of use without riba. Imagine if the system is legislated and properly manage. This is only one example, there are plenty more, and think of potential business opportunity for the massess and debt free transaction with equity based economy.