The Case for Respecting the Status quo in Islamic Finance

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93

The Case for Respecting the Status quo in Islamic Finance

Rodney Wilson

Emeritus Professor, Durham University, UK

ABSTRACT. There are repeated calls for the reform of Islamic banking and finance from academic economists. Critics assert that Islamic financial institutions are simply replicating conventional banks and ignoring Sharīʿah teachings. There is a very critical rhetoric on Islamic banking practice, but this is expounded without examining the facts on the ground. In contrast, in this evidence-based investigation the activities of three leading Islamic banks are examined, Al Rajhi Bank, Maybank Islamic, and Meezan Bank. All three are found to have reputable scholars on their Sharīʿah boards to ensure compliance with Islamic law. These institutions are incorporated as listed companies rather than being mutual or co-operative organizations as some Islamic economists advocate. Being a limited liability company ensures they can raise risk capital and conform to international regulations which are enforced by central banks. The three case studies reveal that the banks have been innovative in the deposit facilities offered as well as in their financing methods. Much of their financing is through leasing for vehicle acquisition and residential mortgages. Although focused on retail customers, the banks also provide commercial and investment banking services for companies and finance for small and medium sized enterprises. In summary, far from being broken, Islamic banks provide helpful financing for modern economies.

KEYWORDS: Islamic banking, Deposits, Financing services.

JELCLASSIFICATION: G21

KAUJIECLASSIFICATION:J2,J3,J4,L0

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1. The Current State of Islamic Finance Islamic finance has developed remarkably during the last half century but its impact should not be merely judged in quantitative terms. Rather, ac- cording to Rusni Hassan (2020, pp. 68-69), the influence of Islamic finance should be assessed qualitatively. She cites the quantitative success of Islamic banking in terms of the growth of deposits and financing, but asserts that some of the products Islamic banks offer are far from being Sharīʿah compliant. She is of the opinion that much of the financing offered by Islamic banks is similar to that offered by mainstream banks with little meaningful product innovation. Rather, the aim of Is- lamic banks has been business expansion and not on promoting excellence in product design; in other words, the stress is on financial growth and not on product quality (p. 74).

It is debatable, however, whether there is a tradeoff between quantity and quality. Attractive product design appeals to both clients and potential customers. Initially, clients enter Islamic financing agreements as a moral choice, but they often know little about the contracts and the rationale behind the product structure. Islamic financial institutions (IFIs), therefore, have not only to devote signifi- cant resources to informative marketing, but also to engage with clients to show how their financial needs can be met using Sharīʿah compliant contracts. IFIs play an important role in providing financial education to clients and potential clients, and their commitment to making financial instruments Sharīʿah compliant should not be understat- ed. It is far from proven that reform is needed given the integrity of existing practices.

1.1 Achievements

Since the founding of Dubai Islamic Bank as the pioneering institution in 1975, the Islamic finance industry has expanded enormously. The industry covers banking, insurance (takāful), Sharīʿah compliant fund management, and tradable financial instruments, notably ṣukūk, which are a substitute to conventional bonds. IFIs are found in all five continents, and have flourished especially in Mus- lim majority countries, but they also have a signifi- cant presence in western countries, including the United Kingdom and the United States. As there

are many accounts of these developments in Islam- ic finance, there is no need to repeat them here.

It has been a considerable achievement to find a Sharīʿah complaint substitute for virtually every financial product offered by conventional institutions. This means that those committed to Islamic financing do not have their choices restricted across the range of financial products. No product category is out of bounds, and investors, as well as those being funded, are rarely at a financial disad- vantage. Investors can get similar returns to their conventional counterparts and those seeking finance do not have to pay a premium.

1.2 Organizational Models

The most successful IFIs are stock market listed companies with investors benefiting from divi- dends and capital gains, but also having liability for losses. As with other listed companies, this business model ensures that the financial institutions have clear goals. Transparency is ensured by stock market regulation which obliges IFIs to issue detailed reports on their activities at least once every year. The major advantage of being a listed company is the ability to raise equity capital for expansion. Listed Islamic banks are well capital- ized and are all in compliance with the Basel III capital adequacy requirements. This is important both for customer confidence and financial coun- terparties with which Islamic banks have to deal.

R. Hassan favors downgrading the role of share- holders and enhancing the role of other stakehold- ers (p. 75), but without unencumbered ownership rights, investors would be reluctant to purchase shares.

In contrast, Islamic mutual organizations and co-operatives which specialize in micro finance have to rely on their members for capital. This makes expansion more difficult as the members have limited resources and cannot afford to take excessive risks. That is not to deny that mutual institutions have a role to play in supporting those with low incomes and few assets who are excluded from both the conventional and Islamic banking systems. However, it would be undesirable to pun- ish successful IFIs through tampering with their ownership structures, or even worse, forcing them

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to become co-operative organizations. There is a place for charitable institutions in Islamic finance, but the success of the industry to date is because of its pursuit of profits. It is necessary for businesses to earn money before it can be given away.

1.3 Measurement Issues

R. Hassan cites the figure of US $2.591 trillion for total worldwide Islamic financial assets at the end of 2018, an increase of 6.58 percent over the pre- vious year (p. 69). This is an impressive figure, but more useful as a measure would be the share of Islamic financial assets to total financial assets.

This would illustrate the progress of Islamic finance over time and comparisons between countries. Unfortunately, the measures available are based on value judgements and needlessly compli- cated. The statistics on relative shares in the report by Research and Markets (2019), titled Global Islamic Finance Market Growth, Trends, and Fore- cast (2018-2024), are rather dated as they refer to 2013. The report shows that the Gulf Cooperation Council (GCC) countries’ Islamic banking assets as worth $490 billion by the end of June 2013, with Saudi Arabia dominating the region with a 49% share, followed by the UAE (19%), Kuwait (16%), Qatar (11%), and Bahrain (5%). These shares are simply of Islamic banking assets and omit mainstream conventional banking assets.

The most widely cited data is from the Thomp- son Reuters’ Islamic Financial Development Re- port (Mohamed, Goni, & Hasan, 2018), which is produced annually. It provides a wealth of statistics, but none on the shares of Islamic financial assets by country. To calculate the latter metric, it is necessary to add up the assets of each Islamic bank, a figure available in the annual reports. This number should then be divided by the figure for total banking assets found in the central bank data for each country. Such a calculation should be rela- tively simple, although it may be somewhat tedious and time consuming to find the data from multiple sources.

2. Case Studies

To understand how IFIs operate, it is preferable to examine the remit and practices of particular institutions. There are hundreds of IFIs which means there is much scope for further research. However,

here, as an example, just three institutions will be examined, al-Rajhi Bank, Maybank Islamic, and Meezan Bank. In the 1970s most Islamic banks focused on trade finance, but by the 1980s and 1990s the emphasis was more on retail banking.

Post millennium, they have diversified into many areas including corporate finance and investment banking, while still striving to serve the needs of their personal customers. The purpose of these brief case studies is to demonstrate that the three banks are successfully serving their clients and misguided reform could be damaging and counter- productive.

2.1 Al-Rajhi

Riyadh based al-Rajhi is the largest Islamic financial institution in the world with total assets of SR 384 billion ($103 billion), 9 million customer accounts, 544 branches, and profits of SR 11.3 billion ($3.05 billion) in 2019. Although most of al- Rajhi’s business is generated in Saudi Arabia, it also has subsidiaries in Kuwait, Jordan, and Ma- laysia. Al-Rajhi’s initial business was in providing remittances for foreign workers in Saudi Arabia and currency exchange for pilgrims visiting Mak- kah and Madinah. Initially privately owned by the four brothers of the al-Rajhi family, the firm was designated the al-Rajhi Trading and Exchange Company. The brothers were granted a banking license in 1987 and the business was subsequently listed on the Saudi Arabian stock market. All al- Rajhi’s operations from its establishment were Sharīʿah compliant, a position which was formal- ized once it became a listed company with the ap- pointment of a Sharīʿah board to oversee operations. Since 2007, the board has been chaired by Saleh Abdullah al-Laheidan, an expert in Islamic commercial law and transactions. He supervises masters and PhD students at Iman Mohammed bin Saud Islamic University in Riyadh and serves on a number of research committees.

Al-Rajhi Bank offers a full range of banking services including current accounts which are ex- empt from fees. Clients can make automated transfers and direct debit transactions are available.

Debit cards are issued for ATM use and for retail payments. Credit cards are also available based on murābaḥah, a structure criticized by some Islamic finance academics, but which seems completely

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acceptable in the case of al-Rajhi cards. Rather than charging interest, as with a conventional credit card, the credit card holder pays a fee, the amount reflecting the type of card issued, plati- num, signature, or infinite, etc., thus reflecting the financial standing of the card holder. The credit card holder is billed each month, with a grace period of 21 days for repayments without any charge.

If the whole balance on the cardholder’s account is not paid in full by the end of the grace period, the card holder will have to pay a modest profit rate of one percent to the bank.

Much of the financing by al-Rajhi Bank is for personal customers, either for vehicle purchase through ijārah leasing contracts, or Islamic mortgages for residential property. Under the ijārah leasing contracts, the bank purchases vehicles on behalf of the client who then leases the vehicle from the bank. The client then pays monthly in- stallments to the bank for the use of the vehicle. At the end of the lease period, usually 2 or 3 years, the client takes ownership. To reduce the monthly costs, the client can agree to make a balloon payment at the end of the contract period. If circum- stances change and the client is unable to make the balloon payment, the bank can offer refinancing with the payments made in 24 monthly install- ments.

Home mortgages are structured using murābaḥah with the bank purchasing the property on behalf of the client, who makes monthly repayments over a period of 10 years or more. The repayments are fixed at the time of the agreement providing certainty to the client. However, although murā-baḥah contracts have advantages, a case can be argued for mushārakah partnership contracts as an alternative as these are better suited for long term financing through mortgages. Dimin- ishing mushā-rakah is often provided with the client owning 10 to 25 percent of the property at the start of the contract, reflecting the deposit given, but overtime the client buys out the bank’s share over a 10 to 20 year period. With this type of contract, the client only pays rent on the share of the house the bank owns, which reduces over time.

Al-Rajhi Bank provides corporate and small and medium enterprise (SME) finance as well as personal finance. Services are available of a tech- nical nature, notably point of sale (POS) terminals

and support infrastructure to facilitate payments to retailers by debit and credit card. Cash management services are also provided, although electron- ic transfers have, to an increasing extent, replaced cash payments. Saudi Arabia has embraced modern technology including e-banking services and digital solutions.

2.2 Maybank Islamic

Maybank Islamic is the Sharīʿah compliant subsid- iary of Maybank, Malaysia’s largest bank. Found- ed in 2008, it quickly emerged as the largest Islam- ic bank in Malaysia with assets worth RM 245 billion ($56.4 billion) by 2019. It is the leading provider of Islamic financial services in the ASEAN (Association of South East Asian Nations) region with overseas subsidiaries in Singapore and Indonesia, as well as branches in Hong Kong, Du- bai, and London. It is able to reduce costs and re- main competitive by using the Maybank Group systems and IT infrastructure. Although most of its customers bank online, it still maintains 407 access points, often within, or in proximity to other May- bank branches. By 2019, Maybank Islamic ac- counted for 59 percent of the financing of the en- tire group.

Maybank Islamic offers corporate and investment services, but like al-Rajhi, its main business is personal; providing deposit and payments facilities, with much of the finance being for vehicle purchase and mortgages for residential property.

Both al-Rajhi Bank and Maybank Islamic encourage personal clients to have their monthly salaries, pensions, or other income paid into their current accounts each month. Rather than holding all their funds in current accounts that yield no return, many Malaysians open investment accounts which pay a profit share instead of interest; which is pro- hibited under Sharīʿah. In Maybank Islamic, around 15 percent of deposits are in investment accounts, a percentage which is rising. In Saudi Arabia, many more affluent customers hold a portfolio that includes investment in Islamic funds. Al- Rajhi offers its own funds like most banks in Saudi Arabia, but in Malaysia although Islamic funds exist, they are much smaller in terms of the value of their assets.

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Maybank Islamic has been innovative in devel- oping new financial instruments, especially in global markets, as it provides not only foreign exchange (FX) services, but also promissory FX, an Islamic forward transaction, and Islamic cross currency swaps. Maybank Islamic is the only institution world-wide to offer Islamic Callable Range Accruals whereby depositors only earn a return when the performance of an underlying reference index falls within a specified range. This provides a vehicle to index exposure as part of a diversified investment portfolio.

2.3 Meezan Bank

The bank commenced operations in 2002 after being awarded the first Islamic commercial banking license by the State Bank of Pakistan. It provides a comprehensive range of Islamic banking products and services through a retail banking network of more than 750 branches throughout Pakistan. Meezan Bank also maintains 660 ATMs for cash withdrawals and provides on-line services through a smart phone app and the internet for showing account entries and making payments and transfers. Meezan Bank is a publicly listed company with a paid-up capital of Rs.12.8 billion ($768 million) and assets worth Rs 1,121.2 billion ($6.7 billion) in 2019. The bank operates strictly under the principles of Islamic Sharīʿah and is widely recognized for its product development capability, Islamic banking research, and advisory services. Its Sharīʿah supervisory board is chaired by Muham- mad Taqi Usmani, an internationally renowned Sharīʿah scholar.

Meezan Bank offers current and savings accounts, which can be in Pakistan rupees, United States dollars, Euros, or Pound Sterling. The savings accounts are structured using muḍārabah as the underlying contract. This structure is also used for the monthly muḍārabah certificates, as the des- ignation indicates, as well as the longer term certificates of Islamic investment that run from three months to five years. For individual and corporate clients seeking high monthly returns, the bank offers Amdan certificates which also have a variant designed for senior citizens.

Much of the consumer finance offered by Meezan Bank is for vehicle purchase supported by

an ijārah structure similar to that used by al-Rajhi Bank and Maybank Islamic. In the case of Meezan Bank, this extends to motor cycles, which are pop- ular in Pakistan, as well as cars and pick-up trucks.

For mortgages on residential property, Meezan Bank has an “Easy Home” program with diminish- ing mushārakah as the underlying Sharīʿah compliant contract. This is preferable to the murābaḥah home finance offered by al-Rajhi Bank and May- bank Islamic, as housing should be regarded as a long term family investment and not a traded commodity. The “Easy Home” program has five options; Easy Buyer, Easy Builder, Easy Renovate, Easy Replace, and Easy Enhancement. For corporate clients, Meezan Bank offers investment and commercial banking services and there is a sepa- rate division providing SME financing.

3. Morality in Islamic Finance

The lasting impact of Islamic finance is more in the realm of the development of economic thought, in particular, with respect to the concepts of risk sharing, and the moral justification of remunera- tion. Ultimately, its contribution to the academic debate on what type of financial system best serves humanity is what matters. This includes studying how savings and investment should be rewarded, and how best capital can be allocated to productive enterprises. In particular, capital accumulation is not simply about material growth, but concerns moral choices that are often not sufficiently recognized in today’s financial environment. Solidarity and trust are the lynchpins of Islamic finance, vir- tues which are absent from contemporary mainstream finance teaching and practice. The word

“linchpin” here is used figuratively to mean something that holds the various elements of a compli- cated structure together. That something is the moral teaching of Islamic finance.

Rusni Hassan is concerned with the divergence between theory and practice in Islamic finance (P.

69), but the case studies show that the products offered by all three Islamic banks are Sharīʿah compliant and serve a social and moral purpose.

The Sharīʿah governance systems seem to function well, with highly respected scholars serving on the boards, most of whom are university academics of sound repute. The listed company model adopted

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by all three banks ensures transparency and ac- countability. Although the concept of limited liability was imported from Europe and it is not a partnership contract, there is no fundamental Sharīʿah objection to organizational structures based on these premises. Admittedly, the Islamic finance industry has developed in a different way to that envisaged by Islamic economists four and five decades ago, but the model has proved successful and is highly moral.

4. The Way Forward

Rusni Hassan’s suggestions on a way forward (pp.

75-76) are worthy of debate as she has a radical reform agenda including the creation of new institutions to promote a more inclusive type of Islamic finance and methods of financing which are more aligned with the moral imperatives of Sharīʿah law.

While there is certainly merit in these suggestions, what is proposed may not bring about meaningful reform.

The need for new institutions may be questioned, especially as it is unclear how they would be funded and what authority they would have. If they were government funded bureaucracies, it is doubtful they would be effective, and whatever government funded the institutions may impose their own agenda and not encourage independent scholarship. There are already IFIs such as the Kuala Lumpur based Islamic Financial Services Board (IFSB) and the Bahrain based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) which are funded by their members. However, as Islamic banks already pay into these institutions, the value of having yet an- other organization is likely to be questioned in the Islamic financial community. Moreover, the guid- ing principles on the regulation of IFIs issued by the IFSB are recommendations and are not manda- tory. The accounting standards established by

AAOIFI are officially recognized in a number of jurisdictions but compliance by IFIs is, in practice, voluntary.

Arguably, research on Islamic finance is best undertaken in a university context where related aspects of Islamic studies are taught or researched.

Researchers in Islamic finance can then consult with theological colleagues including those focus- ing on Islamic texts. In some universities, including Durham University in England, to which I am affiliated, Islamic finance is taught and researched within the Business School. This promotes intel- lectual debate involving not only researchers in Islamic finance, but also those specializing in areas such as corporate finance, accounting, enterprise and small business, econometrics for finance, marketing, management, corporate governance, and business ethics. Such collaboration extends interest in Islamic finance into more areas and makes the research more multidisciplinary. As a result, articles on Islamic finance appear in a wider range of journals and gain more interest.

Of course, it can be argued that such work within universities is not a substitute for a new international agency dedicated to reform in Islamic finance. It remains uncertain, however, what the business plan of such an institution might be and the quality of staff it could attract. Countries would be unlikely to cede financial or monetary sover- eignty to such an institution as they welcome the freedom to draft their own proposals on Islamic finance rather than being subjected to external in- terference.

If there are financial trade-offs, it might be more appropriate to fund new initiatives on research in Islamic finance in established university programs. These might be of greater value in the long run than further institutional expansion in uncharted territory.

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References

Hassan, R. (2020). Reforming Islamic Finance: Why and How? Journal of King Abdulaziz University:

Islamic Economics, 33(2), 67-80.

Mohamed, S., Goni, A., & Hasan, S. (2018). Islamic finance development peport 2018: Building Momentum. Toronto, Canada: Thompson Reuters.

Retrieved from: https://bit.ly/3gzNfb6

Research and Markets. (2019). Global Islamic Finance Market Growth, Trends, and Forecast (2018-2024). Hyderabad, India: Mordor Intelligence.

Retrieved from: https://bit.ly/ 2CuVRRQ

Rodney Wilson was the founder of the Islamic finance program at Durham University in the United Kingdom where he continues to be an Emeritus Professor. He was a Visiting Professor at the Qatar Faculty of Islamic Studies in 2009, 2010, and 2012, and from 2013 to 2017 was Emeritus Professor at the International Centre of Education in Islamic Finance (INCEIF), Kuala Lumpur. He served as an advisor on Sharīʿah governance to the Islamic Financial Services Board, Kuala Lumpur (2007-2009), and to the Central Bank of Qatar on monetary policy and prudential ratios (2009-2010). He was awarded the IDB prize in Islamic banking in 2014 in recognition of his contributions to the subject. He has written 12 books and over 40 articles; his most recent publications being: Legal, Regulatory and Governance Issues in Islamic Finance, Edinburgh and Columbia University Presses, (2012); Economic Development in the Middle East, Routledge (2013), and Islam and Economic Policy, Edinburgh University Press, 2015.

E-mail: [email protected]

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يملاسالإ ليومتلل نهارلا عضولا مارتحا يعاود

نوسليو يندور

ماهزود تعماج ،يسخف ذاخطأ ةدحخلما تنلملما ،

:صلختسلما نيًداصخقالا نم يملاطالإ ليىمخلاو تيفسصلما حلاصلإ ةزسنخم ثاىعد كاىه

تطاظب لهب مىقج تيملاطالإ تيلالما ثاظطؤلما نأ نوسً مهنلأ ؛نييمًدامالأ ب

ةاماحم تًديلقخلا كىىبلا

ق داقخها وش لاب ارهو .تعيسشلا ميلاعح لهاجخجو تيملاطالإ تيفسصلما ثاطزامملل يى

ولذ عم هىنلو ،

.عقاىلا ضزأ ىلع قئاقحلا صحفل سقخفً

هره سهظج لباقلمابو طازدلا

ت تزلاز تطشولأ تصحفخلما

يامو ،يحجاسلا فسصم يهو ،ةدئاز تيملاطإ فزاصم فزاصلما هره نأ نازيم وىبو ،يملاطالإ وىب

يف نيقىمسم ءاملع دىجو ببظب تعيسشلل اهلاثخماب قلعخً اميف ةديج تعمظب عخمخج .تيعسشلا اهتائيه

اهلىحج نم ًلادب ةدودحم تيلوؤظم ثاذ ثامسشل تيلالما قىظلا يف فزاصلما هره جازدإ مج امل ضأز ةدايش ىلع ةزدقلا اهحىم ام ىهو ،نييملاطالإ نيًداصخقالا ضعب بلاطً امل تيهواعح ثامظىلم مل .تيصلسلما كىىبلا اهقبطج يتلا تيلودلا ثاميظىخلا عم قفاىخلاو اهلام فزاصلما ثاطازد سهظج ا

ًءصج نأ ظحلالماو .ليىمخلا قسط وأ عئادىلا ىاجم يف ءاىط ةسنخبم ثاجخىم ثزىط اهنأ رلاثلا ا

ًريبل ا

نم مغسلا ىلعو .نلاظلما ءاسش ليىمجو ويلمخلاب يهخىلما ثازايظلا ريجأج ىلاخ نم مخً اهليىمج نم سفىج اهنأ لاإ ،تئصجخلا ءلامع ىلع فزاصلما هره زيلسج ةريبنلا ثامسشلل تيزامثدطاو تيفسصم ثامدخ

لب ،زايهنالا نم نمأم يف طقف ذظيل تيملاطالإ كىىبلا نإ ،ىىقلا تصلاخو .تططىخلماو ةريغصلاو ًديفم ًلايىمج سفىج ا

تثًدحلا ثاداصخقلال .

تاملكلا ةلادلا

: ليىمخلا ثامدخ ،عئادىلا ،تيملاطالإ تيفسصلما .

فينصث

JEL G21 :

فينصث

KAUJIE :

J2,J3,J4,L0