A REVIEW OF CONTEMPORARY PRACTICES OF ISLAMIC FINANCIAL INSTITUTIONS FROM THE SHARIAH
PERSPECTIVE
Mohamed Noordeen Mohamed Imtiyaz Kulliyyah of Economics and Management Sciences
International Islamic University Malaysia
ABSTRACT
Compliance to Shariah requirements is an important aspect of sustainability of Islamic financial institutions. Contemporary debate on above is a healthy aspect its emphasis Islamic finance industry to be strictly shariah compliant. There are continuous arguments and reviews are pondered on the certain contemporary practices of Islamic financial Institutions. This paper analyzes the practices of Islamic banking from shariah practitioner’s perspective. In order to gather data, this paper employed qualitative approach by conducting semi structured interviews with two practicing shariah committee members of Islamic financial institutions in Malaysia. The responses where thematically analyzed. The outcome of the study congregated the views of shariah experts and real examples to support our evaluation of the contemporary practices of Islamic banks. All the discussions and recommendations highlighted in this study are part of academic exercises for the progressive and productive improvement of Islamic banking industry
Keywords: Islamic Banking, Shariah Principles, Banking practices of Islamic banks
21 INTRODUCTION
Islamic banking is defined as banking system which is in consonance with the spirit, ethos and value system of Islam and governed by the principles based on Islamic law (Shariah) it follows Shariah called fiqh-muamalat (Islamic rules on transactions) the rules and practices of fiqhmuamalat came from the Quran and Sunnah and other secondary sources of Islamic law such as opinions collectively agreed among Shariah scholars, analogy and personal reasoning. Interest free banking is a narrow concept denoting a number of banking instruments or operations which avoid interest. Islamic banking, the more general term, is based not only to avoid interest-based transactions banned in Islamic Shariah. Nevertheless also to avoid unethical and un-social practices and void receipt and payment of interest in its transactions and conducts its operation In practical sense, Islamic Banking is the transformation of conventional money lending into transactions based on tangible assets and real services and whose operation is based on Islamic principles of transactions of which profit and loss sharing (PLS ) is also key feature in Islamic banking and participating the business with the client as financier in different as financial positions, The model of Islamic banking system leads towards the achievement of a system which helps achieve of objectives of an Islamic economic prosperity.
The objectives of this study are to understand the fundamental norm and function of Islamic banking, to realize how different Islamic banking is from the conventional banking in terms of products, services offer and pricing and to identify whether or not Islamic banking are significantly different from conventional especially ideologically and practically. Furth more study aims to evaluate the consciousness of Islamic financial Institutions in aspects of shariah compliance.
What is Islamic banking
The Organization of Islamic Cooperation (OIC) defined Islamic Bank as “a financial institution whose statutes, rules and procedures expressly state its commitment to the principles of Islamic Sharia and to the banning of the receipt and payment of interest on any of its operations (Hassan, 1999, p.60). In the last two decades, Islamic banking has been prominent player in the global financial arena and at same time many principles of Islamic banking system have been well accepted all over the world.
Basic principles which are taken into consideration while executing any Islamic banking transaction are principles which are based on Islamic law, which can be summarized as follows:
First, sanctity of contract: Before executing any Islamic banking transaction, the counter parties have to satisfy whether the transaction is halal (valid) in the eyes of Islamic Shariah.
Second, risk sharing: Islamic jurists have drawn two principles from the saying of prophet Muhammad (SAW). These are “Alkharaj Biddamaan” and “Alghunun Bilghurum”. Both the principles have similar meanings that no profit can be earned from an asset or a capital unless ownership risks have been taken by the earner of that profit.
Third, no financing of sinful activities meaning that transaction cannot be used to produce goods and provide transactions relate interest banned by Qur’an.eg alcohol, pork products gambling and cannot involve in (El Hawary et al., 2004; Imtiyaz et al., 2017).
22 Fourth, economic purpose/activity: Every Islamic banking transaction has certain economic purpose/activity. Islamic banking transactions are backed by tangible asset or real service. Five fairness Islamic banking inculcates fairness through its operations. Transactions based on dubious terms and conditions cannot become part of Islamic banking. All the terms and conditions embedded in the transactions are properly disclosed in the contract/agreement.
Difference and Similarities between Islamic and Conventional Banking
Islamic and conventional banking has some basic difference in theory and practice which draws a demarcation line between the two institutions. Although the basic function of the two institutions is to collect savings and transform them into junk amount and then lend to business firms, government, public sector organizations and individuals, yet the mode of the collection of surplus funds from the savers and lending it to the borrowers is different. In the same way, the two institutions used to lend money to the borrowers but the objective and purpose of lending money and invest are also different.
ISLAMIC BANKING CONVENTIONAL BANKING
Objective The objective of Islamic bank is to stimulate business activities through profit-and-loss sharing and, in this way, it accelerates circulation of wealth and facilitates distribution of income.
The objective of the conventional bank is to maximize the wealth of the shareholders and in this way accumulate wealth through the institution of interest.
Money as commodity
Money is not a commodity though it is used as a medium of exchange and store of value. Therefore, it cannot be sold at price higher than its face value or rented out Thus, Islamic bank does not use money to multiply its wealth and it has opposite concept of money.
Money is a commodity besides medium of exchange and store of value.
Therefore, it can be sold at price higher than its face value and it can also be rented out.
Earnings Profit on trade of goods or charging on providing service is the basis for earning profit.
Time value is the basis for charging interest on capital.
Profit and Loss sharing
Islamic bank perfectly operates on the basis of
Profit and loss sharing. In case, the businessman has suffered losses, the bank will share these losses based on the mode of finance used Mudarabah, Musharakah because there is no mismatch between the asset and liabilities of Islamic bank or business firm because their depositors or investors are ready to share lose in case of economic shock
Interest is charged even in case the organization suffers losses by using bank’s funds. Therefore, it is not based on profit and loss sharing. Because borrowers are fully responsible to take any kind of risk and prone loss in case of business failures he/she has to lose collateral.
Exchange The execution of agreements for the exchange of goods & services is a must,
While disbursing cash finance, running finance or working capital finance, no
23 while disbursing funds under Murabaha,
Salam & Istisna contracts basically the difference lies in agreement of reward.
Under conventional system reward is fixed and predetermined while under Islamic deposits are accepted through Musharaka and Mudaraba (Ahmad A. , feb 2010)
agreement for exchange of goods &
services is made.
Redistribution Islamic financial system has a clear vision about equitable distribution of resources and enhancement of human being particularly poor class. Zakat is compulsory tax on the wealth of rich, plays a vital role in eradication of poverty and uplift of the living standard of the poor people (Awan, November 14, 2009 )
An unequal distribution of income persists because those who benefit from income inequality are unwilling to accept changes that favor the poor. People are unwilling to agree to redistribution because those who will be rich know fairly early in life their chances of being rich.
Source: Awan, (2009), Imtiyaz et al., (2017), Salman and Nawaz (2018)
Islamic banking is functioning in the same business environment where conventional banks operating as well and perform all those functions and services which are anticipated from a typical financial institution. Any financial system is estimated to assist in running the economy by providing the following services grouped in two headings. First difference is that savings mobilization from savers to entrepreneurs in savings mobilization procedure is extension of credit facility to business and industry for return. Both Islamic and Conventional are providing financing to productive channels for reward. The difference lies in financing agreement. Second; Facility utility services that banks simplify are transfer of funds, facilitation in international trades, consultancy services, safekeeping of valuables, and any other service for a fee. There is no restriction on provision of such services and is not against the Sharia. Under both type of institutions for reward irrespective a bank is operating under conventional system or Islamic system and conventions. The difference lies in agreement of reward and contracts. Under conventional system reward is fixed and predetermined while under Islamic deposits are accepted through Musharaka and Mudaraba (Hanif, 2011b)
Benchmarking
Islamic bank uses interest rate as their benchmark to determine the profit/mark up. It is a tool that helps the institutions to identify the profit rate. However, Islamic bank represent valid trading, transaction through assets that compliant with Shariah. Recently, the BBA (Bai Bithaman Ajil) being in subject of most crucial towards clients as it marks up the higher profit rate compare to existing conventional banks and it is considered as injustice towards client. Therefore, Islamic bank offering Musharaka Mutanaqisah (diminishing partnership) to replace BBA, which is internationally acceptable, and it is most suitable for all earners. In this model, gradually the client becomes the owner and client pay the rental for benefiting the asset. The rental rate determined according to the current rental rate of specific place and types of property. (Imtiyaz et al., 2017)
24 It is saying that Tawarruq model is the arrangement of debt financing. It is indirectly debt financing. However, the arrangement being made through this model considers as Shariah compliant where few parties participate. This model involves the asset and transfers the assets through buy and sell. The Islamic bank do not directly pay the cash; therefore, it is Shariah compliant. Trade is permissible. But the critics about markup price which consider as profit rate.
Islamic banks use their markup/ profit rate based on conventional benchmark. In permissible trading, business people, manufacturer also use individually market price, it does not hike price according to their own benchmark. Islamic bank finances through business/ trading while they follow the market trend and market price. However, Islamic bank still improving and it does not have own benchmark to use as benchmark for their profit mark-up.
Problem statement
Considering the above concerns this paper wishes to analyses the contemporary arguments and debates about the practices of Islamic financial Institutions with the opinions of the industry practitioners. Forthcoming section provide the relevant literatures on the issue and follows by the research methodology. Thereafter a thematic analysis of findings was presented followed by a discussion and conclusions
LITERATURE REVIEW
The essence of existing literature is to comprehend past studies on issues of Islamic banking according studies concentrated in different countries. Islamic finance has developed in the range of fund, saving money, protection, home loan, and resources administration business with yearly development rate of 10-15 %. Base on the literature available today, there are several discussion goings about the level of adherence to initial Shariah principles of Islamic banking and finance by contemporary Islamic financial institutions regardless of operation aspects such as rate of charge, operation, earning and so on.
Kahf (2005) indicated that Islamic banks are profit orient association with the distinction that they have urged on themselves to lead their undertakings inside of the point of confinement of the decisions of Shariah and to accord to its general destinations. These goals infer that the Islamic banks would be enthusiastic to help all types of stores, enhance the quality of customer services, increase the base of banking services, protect capital, provide humanitarian and social services, as well as work towards the other factors that raise the profit margin .however .the mind proposals on the strategy Islamic wants to enhance assessment and performance additionally propped up is based on paper which have shown people for the developing exact writing on Islamic banking an account effectiveness and efficiency but it comes reality its clear they have motive profit . For instance, the study analyzes and concentrate that relative profitability among Islamic banks the advantages of the shareholders and also the profit circulated to the investors both should to be considered as yield. This is because of exceptional nature of Islamic banks that are to work for the benefit of shareholders and additionally the investors. Beng Soon C and Ming hua L (2007) believed that Islamic banks are not very different than conventional from the basis of PLS paradigm since it is found that Islamic investment rates are closely similar to conventional deposit rates. Through the bivariate Granger causality test using monthly data of conventional deposit rate and Islamic investment rate in Malaysia from April 1995 to April 2004, found that Mudharabah
25 deposits rates and al Wadiah savings rate are not free from interest as it is using similar rate of conventional deposit rate. It is difficult to convince the pious clients of Islamic banking and finance when the form and substance of Islamic banking products are replicating conventional products.
At the other end of the spectrum, many scholars and researchers believe that Islamic banking is almost Islamic. According to Mahmood (2007), the Islamic banking practices are different from the conventional banking system. He observes apparent similarities and differences between both Islamic and conventional banks. The analysis and survey among 200 bankers and 200 bank customers in Dhaka Bangladesh found that bankers are more conscious than the customers about the nature and working of Islamic banking, while both groups are aware about prohibition of interest and the substitute in the form of profit sharing. In contrast to collecting deposits as loans or investment (Mudarabah). In addition, Shubbar (2010) mentioned the rate of return of deposits in the majority of conventional banking is fixed and irrespective of the investments performance, while it is uncertain and dependent on the overall performance of the investments in Islamic banking.
Notwithstanding, as stated by Shubbar (2010), Islamic indices are relatively more stable than conventional ones since they have slightly a lower volatility and a good ability to adapt themselves with the market fluctuations and changes, in addition to Islamic banks are not permitted to invest in stocks freely since the risk related with such investment is very volatile and involves speculation which are both banned under Islamic law. Vadillo (2006) stated in his paper that Islamic banking cannot be exist in the banking industry, it can be only the institution to transferring money regardless expanding the amount of credit as he mainly described based on western system.
Yasin (2001) stated that in terms of legal framework governing Islamic banking for example in Malaysia there are different issues of law and its application to Islamic banking. The reason of difficulty with the legal framework for Shariah laws in Malaysia is that the application of Islamic law is restricted only to family law and religious offences; the law relating to commerce and business (mu’amalat) is still either the statute law or the English law. Shari’ah Courts only have jurisdiction over matters falling under the State list. Thus, Shariah compatibility in implementation of financial contracts and debate determination gets to be questionable a lawful danger. For instance, of Islamic banking relating to Bai Bithaman Ajil (BBA) were decided by the Civil Court (High Court) and not by a Shari’ah court. Without of a fully comprehensive legal framework for Islamic banking, priority gets to be critical hotspot sources for law. Islamic banking and finance in Malaysia, the legal regulatory regime is lagging behind but still. Legal reforms are urgently needed in order to facilitate the smooth running and operation of the Islamic banking system.
From another point of view, Islamic banks practicing more different and multifaceted than conventional. Murabahah is the most popular financing in Islamic banks where banks are eligible to provide loans on through service charges as it is considered to be permissible under Shariah.
Imtiyaz et al., (2021)
RESEARCH METHODOLOGY
According to the objectives of study, we have collected data through interviews and discussed on the findings and other relevant topics. In this paper, we have divided into two parts, first part, we
26 have disclosed the question and answers from interviewees and second part, we have discussed on findings with sub categories
FINDINGS FROM INTERIVEWS
Below are the several themes derived from the findings from semi structured interviews with 02 Islamic financial practitioners in Malaysia.
Profile of interviewees
First interviewee is a prominent Shariah scholar (R1) who are currently serving in several Islamic banks in Malaysia. The Second interviewee is presently serving as a member (R2) of Shariah supervisory committee of an Islamic bank in Malaysia
FINDINGS AND ANALYSIS
Theme-1: Islamic banking units operate as windows of conventional banks
Participating interviewees were questioned about the practice of operating Islamic banking units under the patronage of a reputed conventional bank (windows). The participating interviewees expressed that as long as the particular Islamic window comply with all requirements of the shariah on their operational activities, then there is no harm on in such window concept. Following are the views expressed by the interviewees;
Nothing wrong on this. Important thing is we need to Islamize transections to the extent that all of that is in line with Sharia and in order to meet the rights (Huquq) of Stakeholders. There was a practice of interest during of Prophets (PBUH)’s period as well. In initial Stage he too subject operate under that system but gradually introduced the riba free system. So, working under conventional or fractional reserve system is not an issue as Islamic banks cannot operate in an isolated World. For example, a country like Malaysia has many contractual obligations to be honored with other countries while involving in Islamic Banking, this is in line with objectives of Shariah (Masqasid Shariah). (R1)
“In Malaysian context, Bank Negara Malaysia (BNM) introduced an Islamic regulatory framework and to ensure the Islamic banks perform Shariah compliant manner. There are many guidelines for Islamic banks to follow the Shariah compliant. Bank Negara Malaysia implemented a serious step to prevent non-Shariah compliant activities by Islamic bank. The Islamic bank will be under serious offense if Bank Negara discovered that Islamic bank involved in non-Shariah compliant activities. Similarly, Islamic bank including windows have their own Shariah advisory board to ensure the bank’s activities are strictly Shariah compliant.
I think Shariah advisors and takaful keep trying to ensure the best performance align with Shariah compliance. Therefore, I totally agree that Islamic bank is really Islamic” (R2)
According above opinions, participating interviews strong advocate that the Islamic banks and Islamic windows are taking utmost effort to follow the shariah regulations and guidelines in order to be shariah compliant. These finding are further supported by studies of Imtiyaz et al., (2017) and Razak et al., (2011).
27 Theme-2: Risk averse financing
Participating interviewees expressed mixed opinions about the risk averse approach of Islamic financial institutions and its heavy dependency of debt-based financing methods compare to profit sharing financing avenues. Below are the views expressed by the interviewees
“According to the available Islamic Literature, Debt Financing has more legal evidence than risk sharing financing methods. Debt financing Products such as Murabaha has more strong evidences from Hadith, but in case of Mudharaba financing. It has little evidence from Islamic Literature. In fact, Islamic banks are using public funds and it has a right to invest such funds in an appropriate avenue in order to protect interest of its depositors and shareholders without exposing them into a high-level risk. With the implementation of BASL requirement, banking industry faces rigorous procedures in risk screening before extending facilities. On the other hand all clients of Islamic banks are not trustworthy and god fearing.
Extending risk sharing products in such environment will provide undue advantages to the clients in that nature. Ultimately it will affect the Islamic finance Industry.
Initially Islamic banks in Malaysia not charging any penalty on late payments and giving a grace period. But Muslims and non-Muslims customers misused these facilities. Customers shown more discipline in meeting obligations to conventional banks and delaying payments to Islamic banks. This create unfair playground to Islamic banks. Because of these Islamic banks also charge a late fee and give it on charity (R1).
“We should understand that one of the fundamental of Islamic financing is profit sharing. It is the trademark of Islamic finance. So, it is not fair to the industry to completely divest the profit-sharing based financings. I believe that the Islamic financing should not be aligned to conventional banking system where you have to adhere to the certain requirements which make Islamic banking industry to be completely risk averse. We should keep it in the mind not that Islamic banking is just a part of Islamic financing. Islamic financing is a very broad concept and it is the challenge in the hand of stakeholders of the industry to come up with innovative avenues where we can by-pass above requirements which tie to the Islamic financial Institutions be risk averse” (R2)
According above opinions, participating interviews presented different perspective of the issue.
One Interviewee on the view that the risk averse approach is important to protect the depositor’s and shareholder concerns. Contrarily, other interviewee in the opinion that Islamic financial Institutions should not deviate from it is essence such as profit-sharing concept. These finding are further supported by Razak et al., (2011).
28 Theme-3: Benchmarking with market interest rates
Questions were raised with participating interviewees on their views on practice of benchmarking financing rates with the conventional market interest rates by Islamic financial institutions’.
Following are the views expressed by the interviewees;
“Because Islamic financial Institution are business entities and while serving to the society it has to meet its shareholder interests as well. For example, if a Muslim rice shop owner charges a higher price, nobody will criticize him because if customer value his product they will pay a higher price. Similarly, Islamic banks too can charge a price which will cover its all cost. Blaming Islamic bank based on its price is unfair.
However, now the rates of Islamic banks are highly competitive with conventional banks in Malaysia” (R1).
“Different people have different views on their own perspective, especially in Pakistan, India. In Malaysia, we cannot avoid interest rate. Unless we have only Islamic banking system, then we may able to avoid interest. Interest rate used as tool for calculation. Some scholars argued that it is just tool/ benchmark. Therefore, it is not an issue to complain since in transaction, the Shariah principles exist such as trade, assets, ownership. It is only use to calculate profit rate since bank requires a benchmark to mark up. For this reason, it’s not good to say Islamic bank not Islamic.
It is very harsh and direct. This is will lead Shariah scholars in trouble” (R2).
According the above findings, both interviewees are in support of benchmarking rates with the conventional interest rate. Their argument was there is no harm in using such benchmark for pricing and calculation purposes and to keep the Islamic financial institutions’ competitive in the industry. Above findings are consistent with the studies of Imtiyaz et al., (2022).
Theme-4: Least concern to serve the poor sector of society
Participating interviewees were questioned about the Islamic financial Institutions’ least concern on serving poor in the society. Interviews expressed different perspectives of the issue. One interviewee expressed the religious perspective of the issue while other interviewee raised the practical consequence of the issue. Following are the views expressed by the interviewees;
“Islamic banks are corporate entities and want to make profits in order to survive in the competitive in market. Zakat and Waqf entities are available to address social welfare of the poor and low-income earning sectors in Muslim Community.
According to Islamic teachings, when someone wants to give a financing facility to a person, first he should assess the repayment capability of deficit party. It is not Islamic,
29 that giving a financing facility to a person who is not in a position to honor the repayment. This is accordance with objectives of Shariah (Masqasid Shariah) (R1).
I’m in the opinion that Islamic banks need to revisit their current strategies in extending financings. Because financial inclusiveness is one of important globally accepted Sustainable Development Goals (SDG). Again, it is depending on the risk appetite. But Islamic bank need to find ways to be inclusive by targeting different income groups of the society. It is a challenge for product designers in Islamic banks to formulate deposit and financing methods to attract all strata of the society (R2).
According to above findings participating interviewees expressed their concerns about the issue.
One of the interviewees expressed that Islamic banks are should concern on profit maximization in order to satisfy the its depositors and shareholder while the other interviewee highlighted the importance of financial inclusiveness and need of an innovative deposit and financing products to address the all levels of the society. These opinions are consistent with previous studies of Imtiyaz et al., (2022).
DISCUSSION
According the analysis of findings from the interviews it is important consider concerns highlighted by the participating interviewees. Firstly, issue of Islamic banking windows was discussed and participating interviewees in the opinion that as long as the particular Islamic bank unit (windows) follows the all the prescribed shariah guideline, there is no reason to oppose for such practice. Secondly, the risk averse approach of Islamic banks was analyzed and participating interviews expressed mixed opinions for and against the practice. Thirdly, in the issue of benchmarking with market interest rates by Islamic bank were discussed in detailed and participants expressed different perspective of the issue. Participating interviewee in an opinion that in order to be competitive, Islamic banks tend emulate the current financial market rates.
Lastly the issue of least concern on serving the poor sector was discussed, the participating interviewees in the highlighted the importance of innovative formulation of Islamic financial solutions to cater all levels of the society
CONCLUSION
Based on above discussion, Islamic Banks are indeed providing an immense service to Muslim Ummah while competing with conventional giants in an environment all infrastructures were tailor made to latter. As other Banks are profit making Islamic bank also exist to make profit but in accordance with Shariah based way. Someone may perceive this profit motive as an un-Islamic approach. But these profits are not un-Islamic and Islamic bank purify these incomes with Zakat and charity Activities as other businesses do. Even though Islamic finance and banking industry is
30 pondered with plenty of criticism and allegations, its progress in an important notable factor and as in every industry there will be pros and cons but as Muslims it is duty to protest that industry.
One can use his academic writing and oration abilities to criticize the practices of Islamic banking and finance industry as un-Islamic but it will not contribute to the society rather it will distance Ummah from the Industry and will continue to use riba based financing. In spite of critiques about the industry, scholars and orators should suggest sustainable solution which will make the way forward to Islamic financial industry to thrive.
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