My Say: Looking at Islamic banking in its proper context

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The Muslim Consumer Association of Malaysia (PPIM), in a press statement dated Feb 12, criticised 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 that “all Islamic banking institutions in Malaysia operate in accordance with syariah values and are well regulated in compliance with high standards …”

I believe that we are today guilty of failing to look at Islamic banking in its proper context. To put it simply, the true environment of Islamic banking, as expected by the syariah, is that it should be operating in a riba-free environment in a riba-free economy. In other words, it should be a sole 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 an 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 (incidentally, the al-bai bithaman ajil [BBA] house financing is 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 a discounted price because the burden of abandoned housing is placed on the customers and not on the banks. Give the public an option — where riba is not made “haram” to Muslims — and society will choose the cheaper but defective conventional product because everyone believes it is always other people, not them, who will suffer from an abandoned housing problem.

They actually take a gamble, willing to sacrifice x per cent 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” to 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 practice of Islamic banking is in no way absolved of the criticism aimed at it.

Today, it is very clear that Islamic banking is being practised without reference to maqasid syariah or the objectives of syariah. One wonders whether the Islamic bankers who are in a position to make decisions are adequately educated about maqasid syariah. In an Islamic economy, economic units must work towards achieving the objectives of syariah.

Maqasid syariah, 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 that 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-equity ratios set by the 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 that they are willing to shoulder? If Islamic banking management is not motivated to do microfinance, we need to ask why and whether there is a bigger systemic issue at hand.

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

To conclude, we cannot afford to ignore the environment that 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 at Muamalah Financial Consulting, an Islamic capital market consultancy

This article appeared in The Forum column of The Edge weekly edition March 19- March 25, 2012

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