Understanding Basics of Islamic Banking and Finance for going forward

 Muhammad Arif

Muhammad Arif
Muhammad Arif: Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), Former Head of FSCD SBP, Former Head of Research ArifHabib Investments and Member IFSB Task Force for development of Islamic Money Market, Former Member of Access to Justice Fund Supreme Court of Pakistan.

Sometime back former Governor of SBP Mr. Yaseen Anwar made some comments on the subject and he was right to say that currently Islamic Banking in Pakistan and elsewhere are mainly relying on debt based fixed income products, so they should now move towards non debt based Islamic products which in fact are the essence of Islamic Finance.

As a solution he also suggested that first we should all become pious and respectful to each other. In this way we would be able to create environment for Islamic finance. However this argument goes against the historical facts. Just see how Islam came, nobody was accepting it, but with solid footing, Hazrat Muhammad (PBU) went on with his fight.  The changes emerged with new codes and system that was brought in shape of Quranic instructions and practical examples of Hazrat Muhammad (PBU).

In recent example for implementation of Islamic Finance, Malaysian did not wait for the time till all their inhabitants turn in to disciplined and respectful to each other. For this they first brought changes in their legislation and these changes provided due support to the Islamic financial market. Since 2005 onward Malaysia has remained successful in meeting all its infrastructure requirements through Sukuk issuance.

So for Islamic finance we all need to study the dynamics of current financial system and to innovate products and market supported by due legislation. If these products can become better alternatives to conventional products than we can say that we have made some head ways towards our desired goal.

Fortunately I remained part of an international committee on this very subject. The committee was assigned to focus on development of Islamic financial market, so in nutshell I know that still we are at initial points and nothing has come in reality very substantially. But this argument goes well for conventional finance as well that has failed time and again and is in transformation after recent US and European recession.

Without going in to detail what our constitution says on the subject and what has been interpreted by the Supreme court regarding riba and what has been done by the different regimes especially General Ziaul Haq, we should try to deliberate on this subject very seriously.

Islamic finance does not recognize concept of time value of money i.e. inflation, but in fact it is not like this in the real world. The fact is that Islamic Finance currently exists as a small portion of total finance. Currently World GDP (PPP) in nominal terms is around $ 80 trillion in which Islamic countries (57 in numbers) have just GDP (PPP) of around $ 10 trillion. Hence Islamic countries GDP are 12.40% of the world GDP.

Now coming exclusively to Islamic countries they are even practicing a small part of Islamic Finance in their jurisdictions. In Pakistan it is just 14 % of total banking assets. In Malaysia it ranges around 20%.Therefore in ultimate Islamic finance is just small part of total finance, so to expect from it to become a catalyst in bringing change in the economic dimensions is futile to think at the moment.

So than what Islamic finance or Islamic banking means. To be rational it is a market niche and should be recognized like this for the time being. On conventional side they innovate many new products on daily basis so Islamic financial products are just addition on this regard.

While teaching on Islamic Economics in Sheikh Zayed Sultan Institute University of Karachi, I used to say to my students that Islamic finance is at its start and more frankly at zero. At this, once a Director of SBP commented that if you are holding this view than what you are telling to your students on Islamic economics. My answer was that I am telling them the truth and after recognition of this truth we can move forward.

To be more elaborate on the subject, I have finalized my own book on Islamic Economics which is available now. However in this book while defining Islamic economics, I witnessed that Islamic Scholars 700-800 years back like Tusi were more broad based on Islamic economics than current ones. Unfortunately we have gone further narrow in defining Islamic economics or Islamic Banking right now.

One must remember that revival of Islamic economics/finance started after decisions made in Makah conference in the decade of 70,s. Thereafter first Islamic bank was established in Egypt and onward in Dubai in 90,s. First Sukuk (bonds) were issued in Bahrain in decade of 2000. Islamic banking in current shape started just ten or twenty years back. So revival of Islamic banking or Islamic finance has a history of ten to twenty years. No doubt on evolution we have a history of 1400 years but that has no match with current financial innovations. That was the period of Islamic capitalism or Mercantilism (means trading era).

Now coming to current Islamic financial complexities, first we should know that like different sects we have different definitions for riba (interest).  In Iran they have different definition and this is so in case of Malaysia and Indonesia. We are more close to GCC and Sudan. This needs rectification and a consensus definition needs to be coined. Unfortunately difficulties in this area are the religious scholars. In one meeting we 20 countries tried to coin some definition but at this Governor of Central Bank of Sudan said that “all right I carry this definition but if religious scholars in my country do not agree with this definition than I cannot do anything”.

This subject require long deliberations as Quran and Sunnah are clear on this subject but differences arise on their interpretations by four school of thoughts i.e. Hanafi, Shafi, Hambali and Malaki who basically differ on the point that how much weight-age can be given to the logic or Ijmah on making these interpretations.

Islamic finance is more complex than conventional. If not done with precision than it carries lot of risks as all its transactions are asset based and asset also carries its own risks. Take the example of mortgage financing in US that has brought havoc for the whole world in 2007 and even now.

Now coming to the subject of debt and non based Islamic mode of financing, mostly financial institutions trade on Murhabah (leasing). On non debt based financing we have Musharkah, Mudarbah and Ijarah. Ijarah is mostly in practice, however in case of Musharkah and Mudarbah they have mostly been practiced in Iran and Sudan from the government side. But in lump sum they have not been able to control liquidity through these modes. In Iran and Sudan the inflation has always remained above 16%. Secondly uses of theses modes require expertise to price an instrument on long term basis. This is very difficult. In some countries they have tried to develop some benchmarks through floatation of World Bank (IFC) or ADB papers or LIBOR or KIBOR in Pakistan. Take example of Pakistan. Can any bank is able to price infrastructure financing on right lines. So in fact this is a difficult area both for Islamic as well conventional finance. For example once Pakistan was offered funds through a currency swap arrangement by ADB but was not accepted as its cost was significant i.e. of currency swap.

However for growth of Islamic finance in Pakistan, SBP needs to take Islamic banks in its ambit. That has been done but its monitoring system is very weak.

Government of Pakistan Sukuk now amounting more than Rs 385 billion (now its stock as of May 2019 is Rs 71 billion) is a good addition in Islamic Finance in Pakistan. While in SBP I played some role in its development. It is Ijarah based but still I hold that it needs to be transformed in to short term instrument like T-bill available on discount. For doing this government would have to change its accounting procedures, however carrying quality of short term instrument with payment on cumulative basis it would be easy to price it in the market. Bai Muajjal with stock of Rs 8.8 billion has now been introduced but its volume is still not significant keeping Islamic Banks deposits around Rs 1.25 trillion.

For issuing GOP Sukuk, government once sold Lahore Islamabad motorway to the investors (with pledge to buy it back on maturity of the bonds) for raising $600 million through international market. For domestic sukuk they are using Islamabad-Pindi Bhatian motorway, Air ports etc etc.  Externally Government has also procured $ 7.3 from Euro Sukuk.

The charm in issuance of Sukuk to provide government financing for meeting its deficit is that it automatically brings a ceiling on its borrowings since government has got limited assets.

Finally we all should recognize that overall public perception about Islamic finance is not clear in Pakistan yet and every one considers it like a conventional product. To me frankly currently banks and universities in Pakistan are not interested in giving true picture of Islamic finance. It has become a business and would result like this till it is treated like a business.  Dr Younus of Bangladesh once said that I got success in bringing idea of microfinance in to reality because I was not a banker who always indulges in making decisions on the basis of their balance sheets.


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