Issues in Islamic Banking

Islamic banking has achieved growth rates that tremendously outpace conventional banking. While there are banking norms common to both Islamic and western financial systems, certain norms are exclusive to Islam. Some of the Islamic restrictions render certain western banking practices and transactions void.

The main prohibitions are riba and gharar. Most of the present-day Islamic scholars are of the view that riba includes both interest and usury. Gharar signifies ambiguity, uncertainty or lack of specificity in the terms of a financial contract.

As riba is prohibited, suppliers of capital become investors instead of creditors. Also, investment can only be made in permitted commodities and activities. For instance, one cannot deal in import and export of alcohol and narcotic substances. Similarly, money is not allowed to be invested in a casino.

A variety of Islamic banking instruments and transactions are available in different markets. These may be classified as equity, debt or fee based services/ products. The first includes musharaka and mudaraba; the second consists of salam, istisna, istijrar, qard, murabaha, ijara, bai-bithaman-ajil, bai-al-einah, bai-al-dayn, and tawarruq; the third comprises services based on wakala and kafala.

On the validity of some of these transactions and instruments, there is a difference of opinion among Muslim scholars. There are scholars who oppose certain practices because they find hidden elements of riba and gharar in them. They claim that some products appear Islamic only in form, not substance. Tawarruq, bai-al-dayn, and bai-al-einah are among transactions either disallowed or, at best, deemed controversial by some of the prominent scholars.

Most banks conducting Islamic operations have a panel of Muslim scholars, called shariah committee or shariah board, that determines whether a product or practice complies with Islamic provisions. Certain banks have a single shariah consultant or shariah advisor. Whether it is a sole shariah adviser or a shariah board, a particular scholar hired by a bank to accredit new products can give it an edge vis-a-vis its competitors.

Shariah scholars usually receive a fee for their services. Sometimes the fee depends on a deal going ahead. In fact, there have been cases where scholars approved conventional products as Islamic for the right price. Thus, the critics of Islamic banking came up with the term rent-a-sheikh.

According to different estimates, the number of these religious experts is between 100-200. However, there are about 12 of them who are the most sought after. As reported in Financial Times, they are making millions of dollars in yearly income. There have been mutterings not only about these scholars serving on too many shariah boards, but also about their advising direct competitors. In order to address this issue, Malaysia, in 2005, restricted scholars from serving on more than one board or committee.

As shariah can be given different interpretations, the shariah committees, at times, give conflicting rulings. A product approved by one committee can be rejected by another board within the same jurisdiction. For instance, in Jordan, a prominent shariah scholar criticised the penalty imposed on a defaulting client in murabaha, and declared that it is a kind of riba. Similarly in Britain, a famous Muslim scholar advises against taking out Islamic mortgages due to the structure being interest-bearing debt in disguise. Difference may also arise and exist between countries or regions. For example, in Malaysia, Islamic financial restrictions are construed more liberally than in the Middle East.

There are bodies and organisations— Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) is one of them— that are trying to address this lack of Islamic standardisation. However, without a consensus of religious experts there cannot be a binding, universal set of Islamic banking rules. In fact, there is a proposal to set up a supreme shariah board. Indonesia serves as a good example where a national shariah board issues rulings that are mandatory for all shariah boards in the country.

Malaysia has also proposed that a meeting be held in Kuala Lumpur for setting up global standards for Islamic banking and finance. The prime ministers of Malaysia and Qatar recently discussed this at a meeting in Doha. Such standards would eliminate confusions and resolve issues with a common approach.

Another shortcoming confronting Islamic banking is the shortage of qualified professionals at all levels. There are not many people who are equally skilled in conventional banking and Islamic law. A person well acquainted with conventional banking can easily understand any Islamic product; however, one cannot successfully develop or market such a product without knowing the rules and institutions unique to Islam.

Originating in the 70s— Dubai Islamic Bank was the first Islamic bank established in 1975— Islamic banking has developed into a global industry and has assets exceeding $900 billion. Though the share of Islamic banking is very small in the worldwide banking industry, it is showing an impressive growth, i.e., 15-20 per cent per year. According to an estimate by Moodys, it could hit $4 trillion in five years. Islamic banks have been set up not only in Muslim countries, but also in non-Muslim jurisdictions, like England and the US that have Muslim minorities.

Islamic banks take pride in the fact that, unlike their conventional counterparts, they have emerged relatively unscathed from the global financial crisis. In fact, in England, two Islamic banks, European Finance House and Gatehouse Bank, were launched in 2008, while governments in Europe were busy bailing out their banks. And while Lehman Brothers collapsed, Islamic Bank of Britain launched an Islamic residential mortgage.

Islamic banks have avoided complex debt-based structures and have relied more on retail deposits and financed real estate, private equity, and equities. In other words, Islamic banks have never been exposed to the risks that have affected their conventional counterparts. Even now, western governments and banks are considering possible regulation instead of giving up interest based and speculative transactions. Just surviving the financial crisis does not mean that Islamic banking will influence conventional banking.

To summarise, lack of uniformity in laws and deficiency of skilled professionals are some of the main hurdles faced by Islamic banks and their clients. However, the industry has a promising future— the Arab oil money is often claimed to be the main driving force. This is evident not only from the growing number of banks established specifically for practicing shariah compliant finance, but also from the increasing number of conventional banks— Citibank, HSBC, RBS, Standard Chartered, UBS, etc— engaging in shariah compliant operations.

Most importantly, Islamic banking is mainly for Muslims. Due to the prohibition of riba and gharar, Islamic banking products generally tend to be less efficient than conventional ones. Islamic bankers must be careful not to blur the lines between Islamic and conventional banking in their eagerness to attract wealthy non-Muslim clients or Muslim clients that are more interested in profits than piety.

The writer is a graduate of Harvard Law School and specializes in Islamic finance. He may be contacted at [email protected].

The article was originally published in the Daily Dawn.