Islamic Banking & Finance Page 24-5-2019

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Questions related to Islamic Banking and Finance

  • Which types of alternative economies are out there aside of Islamic economics?

Thinking about alternative economies we typically come across, e.g., community economies, household economies, Islamic banking – they all somehow challenge existing capitalism. The concept of “the economy” first called “political economy” and then later “economics” are phenomena of capitalism. Once upon a time, during the period in which folks like Adam Smith did “political economy” their conceptual framework focused on the production and distribution of wealth, thus Smith called his major work “The Wealth of Nations”. Later, the term “political economy” was abandoned by stripping out the “political” and reconceptualizing the analysis of the economy in terms of choice, i.e., “economics” was defined as the study of choices made in the presence of scarcity. At first, the focus of this new “science” (The French call economics “la science economique” and Paul Samuelson, the famous Nobel Prize winning economist whose introductory text book became the template for all those that have followed, called economics the “Queen” of the social sciences.) was choices made by consumers and firms, which was, at first, called “price theory” and nowadays is called “microeconomics”, with some room left for what we now call “macro” concerns, e.g., aggregate economic phenomena. Since Keynes, that part blossomed into “macroeconomics”, on par with microeconomics – although neoliberal types think all macro is really micro, i.e., market driven. But then they worship (and make a fetish out of) “the market”….. Here’s the thing: whether you do political economy or economics you are accepting the concept of “the economy” – a concept that only makes sense within capitalism. Why does it only make sense in capitalism? Because only in capitalism is the incredible diversity of human activity and its equally diverse results thought of in such reductive terms as “production”, “wealth”, “labor”, “capital”, and measured systematically in terms of exchange value, i.e., money. Marx shows how such reductionism rationalizes exploitation and results in alienation. Polanyi shows – by looking at non-capitalist (mostly earlier) societies – how such concepts and their application are unique to capitalism. In his terms, in capitalism market relations of exchange – which were once quite limited and marginal to every social order – became “disembedded” from the social fabric and became the template for a new fabric, i.e., capitalism.

So, now in 2019 one can try to “go beyond” capitalism by reweaving social relationships (to retain the metaphor) in non-reductive ways, where there are myriad activities with myriad results but no aggregation through the application of one unique measure (be it labor time, or money). Polanyi and the study of (structuralist) anthropology and history more generally are helpful because they reveal a wide variety of social relations very different from capitalism. Most folks find it hard to imagine worlds without all the familiar reductions of activity to “production” or “consumption” or “choice”, without monetary measures of value but with many, often competing measures of value. Just how hard it is to escape can be seen in the work of Pierre Bourdieu who strives mightily to recast thinking about social relations but winds up still employing such capitalist concepts as “profit” and “capital.” Marx, himself, because he eschewed utopian speculation could only, for the most part, offer critiques of capitalism but no new vocabulary for a post-capitalist society (beyond the one totally under-defined name of “communism” – not to be confused with 20th Century “socialism” or “communism”, Soviet-style). None of which means we can’t find examples of non-capitalist social relationships existing in the interstices of contemporary society, on small or large scale. Some Marxists have contributed a bit to identifying such constructions – especially those I call “autonomist” Marxists, which includes an array of folks – but so have deep ecologists who have sought out alternative non-capitalist relationships between humans and the rest of nature and these days those who are busy not just identifying but building “commons”, call them “commoners” who are experimenting with various forms of  “communing”. That’s why I mentioned the Zapatistas who have been building their “commons” in imaginative ways despite the ever present pressure of surrounding capitalism with its economists, police, military and paramilitary goons. They emphasize their indigenous Mayan cultures but they have been and still are very much part of Mexican history that includes the 500-year imposition of various aspects of Western culture and “economic” relationships. As a result, they, just like many others, strive to create something new while freeing themselves of existing constraints imposed by capitalist society.

  • Could Islamic Banking have prevented the financial crisis?

What you call ‘Islamic banking’ is what we call ‘non-interest banking’ in the Western part of the world. Non-interest banking or Islamic banking is banking without charging interest on loan. I assume that you are referring to the 2007-2009 financial crises. Your question subtly assumes that interest rates (or high interest rates) charged on loan played a significant role in the recent financial crisis. If you feel you are very sure about this, then you will first need to prove that the 2007-2009 global financial crises was caused by the presence of interest on loan, or caused by high interest on loans (or securitized loans). While the literature boasts that Islamic banking rules improves the performance of individual banks that adopt those rules, ‘Islamic banking’ or ‘non-interest banking’ itself is not an explanation for a systemic financial crisis, or a global financial crisis. Why? Because… In an interconnected banking/financial system where banks are interconnected by financial claims and obligations, a financial crisis will most likely occur when defaults/failure of one bank leads to successive defaults/failure of other banks connected to it. As you can now see, Islamic banking does not have a systemic property that can have widespread implications for all banks in the global financial system purely because only few banks in the world today adopt Islamic banking rules, compared to conventional banks. Two, the absence of Islamic banking is not a cause for the financial crisis because the crisis was not caused by high interest rates rather the crisis began as a result of falling house prices when debtors could not even repay the principal on the mortgage loan repayment. The demand for houses fell short of supply, and as a result banks made losses on the mortgage-backed securities they held which had now become worthless. Many banks that made losses were too-big-to-fail and too-interconnected-to-fail, therefore the crisis became widespread. As you can see, the crisis has little (or nothing) to do with charging interest or high interest on loans (which is opposed to Islamic banking). Charging interest on loan is normal because it is a reward to the lender and it reflects the riskiness of the borrower. The cause of the crisis was not interest rates rather it was caused by (i) greed by Wall Street bank CEOs (ii) lack of regulatory oversight (iii) excessive bank leverage and capital shortage, among other factors, liquidity withdrawal from the inter-bank market, among other factors. As you can see from the points above, interest rates (or high interest rates) were not a significant cause of the crisis, therefore, the argument that ‘Islamic’ banking could prevent the financial crisis is not a valid argument.

  • When do entrepreneurs prefer Islamic Banking/Finance over Conventional/Traditional Finance?

Entrepreneurs prefer Islamic Financing when the firm is doing poor business and prefer Traditional Debt financing if the firm is doing good – so that they need not part with their huge share of profits.

I believe an entrepreneur prefer Islamic Banking for one (or more) of the following reasons:

  1. Question of religion (some may prefer the concept of Islamic banking – where there is no interest – on the basis of religious preferences
  2. Predictability (fix installments/repayments; there is no exchange rate risk, interest rate risk…)
  3. The project that was financed remains the property of the bank, until the loan is repaid. This decreases the risk for the bank; hence the additional charges are smaller
  • Should the Islamic Banks aim basically to be profitable oriented?

Islamic banking can be based on profit oriented. However profit orientation must be based on objectives of the shariah which is based on preserving the public interest and preventing haram·

  • I have taken deposits and financing relation but I am not finding the literature review for Islamic banks that is my re-searchable topic. However finding it on conventional banks, both banks have the same windows but different intentions. Please guide?

There is enough literature on Islamic Banking. However, one can adapt variables from the conventional banking literature and justify why the selected variables are relevant in Islamic banking context.

  • Can anyone distinguish Interest and Profit through mathematical function?

It is a myth prevailing in the Banking Software industry that interest term can just be replaced by Profit for Islamic Banking Software. Interest is a pre-defined, pre-determined additional amount (based on a rate) which the principal offered demands whereas Profit is the expected amount on undertaking the risk of sale (uncertainty) as we know the profit is the reward for undertaking the risk of uncertainty. So this is the way to distinguish Profit and Interest by defining mathematical functions.

  • Is IFIs revenue recognition based on EPRM (Enterprise Protection Risk Management) appropriate?

Revenue recognition (@ income recognition) of financial products of Malaysian Islamic banks is based on the ‘Effective Profit Rate Method’ (especially for products with fixed rate such as Al Ijarah Thumma Al Bay @ lease). This method is an adoption of the well known ‘Effective Interest Rate Method’, where the word ‘interest’ is replaced with ‘profit’. Do we think the method is a fair technique to the customer of IFIs? If the customer would like to make a prepayment (full settlement before the end of contract period), would the method resulted in a ‘kind’ of punishment to the customer for early settlement? I strongly think customers would be unfairly treated by the IFIs under ‘effective profit rate method’.  Often, customers are not even aware that their repayments to the IFIs are calculated based on this method.  Therefore, in the event of an early settlement by a customer, he will have a surprise of his life when finding the total settlement amount to be much higher, even though the total repayments which have been made should result in a lower full settlement amount. No thanks to this innovative ‘effective profit rate method’ which is borrowed from conventional system.  This can be seen as a form of disincentive for customers whom opt for early settlements.  Whilst it is not intentionally designed by IFIs to explicitly punish customers, the motive is quite apparent which is to protect IFIs’s interest and to transfer risk rather than risk sharing.

  • Can Islamic banks survive without revenues generated from Murabahah?

Islamic banks are in the comfortable zone generating income from Murabahah financing on the ground of “Darurah” or necessities. There are marginal efforts to completely becoming independent of this non-profit and loss mode of financing. My heart says yes but my mind says no. The current research tends to show the overdependence on Murabaha and Murabaha like products. Some of our colleagues call it “Murabaha Syndrome” and some others name it “Islamic bank rent”. By considering current socio-economic conditions, lack of trust, asymmetric information problem (adverse selection and moral hazard) and more importantly peoples mind send, we are far away from PLS or so called risk sharing contracts. So for time being, we have to bear with the true sale Murabaha which has of course Shari’ah mandate.

  • Can Islamic banks fully implement profit and loss sharing? Who’s to blame? Academician, Bankers or Regulators!!

Despite the increased in the assets size and rapid expansion all over the world especially emerging economies countries, profit and loss sharing or partnership based financing is not popular against its fee based counterpart; the question remains unanswered whether today’s Islamic banks are really Islamic or just partly Islamic? Especially when risks exposed are almost transferred and absorbed by Islamic banks client. E.g. Murabahah mark up based financing. (The most popular mode of finance accounted more than 80% of its total finance). I believe that all parties should be primarily understand and real implemented or perform the real teaching of Islam. Believe on that system we also must be following and implementing to achieve the goal and objectives.

  • Any suggestion of database/software for Islamic Banks financial data?

Fitch database has data for Islamic banks. To access the database, you have to ask Fitch for permission to access the database. Access to the database must be paid for. However, you should be able to freely access Fitch database if your university has already subscribed to Fitch. Bankscope database stopped operating in December last year.

  • Can Islamic Bank not to benchmark against interest rates?

Pricing is a main concern for Islamic financial instruments since it is new to the market and has yet to develop any suitable mechanism to determine its price. Currently, the London Interbank Offered Rate (LIBOR) is the most common benchmark adopted in determining the price of financial tools profit or rental-based return, which is undesirable under the Sharia law because it is an interest-based benchmark.

There are several challenges in setting the price for Islamic financial instruments include:

  1. i) The absence of an Islamic benchmark rate due to a lack of agreement among the issuers. Hence, it has to depend on the conventional market benchmark rates (such as LIBOR or EURIBOR) to determine the pricing of the Islamic instruments.
  2. ii) A relatively small number of participants lead to low liquidity, lack of market depth, and a lack of critical mass of issuances.

iii) The absence of a standard price validation mechanism to assist in distributing up-to-date news and upcoming related issues.

  1. iv) The lack of a focused risk based pricing mechanism related to Islamic finance.
  2. v) The lack of risk mitigation to manage and hedge the risk of fluctuations in the market value of instruments on account of movements in the benchmark rate.
  3. vi) Only certain listed assets are to be accepted as guarantees.
  • Can Islamic banks ever be Islamic?

Theoretically one can argue that there cannot be any financial institution like banks in Islamic economics paradigm as the real sense of existing banking practice contradicts with the fundamental Islamic finance principles. The debate on whether Islamic banks ever be Islamic has been going on since the inception of the first Islamic bank in Egypt, Mit Ghamr. So, what’s the current position among academics and practitioners after 5 decades of tremendous development in Islamic Finance?  Islamic bank in current form cannot be 100% pure Islamic, since it still use fiat money and apply fractional reserve banking system. Contracts can be purified, but convert to intrinsic money needs International cooperation, while convert to 100% banking system needs to have new ‘Islamic’ Basel different from Basel III. Some circles prefer to call Islamic banking as Ethical Banking at the moment.

  • What can be an Islamic capital asset pricing model?

In reality, there is no ‘risk free rate’. The rate of return on US Treasuries is used as a proxy. In Islamic finance, the rate of return on AAA-rated Sukuk (e.g. IsDB) could equally be used as a proxy.

  • Does the accounting treatment of financial leasing in Islamic and conventional banks reflect the fact of leasing?

The Islamic accounting standards reflect the fact of leasing in financial leasing operations, the product appear as assets in FS of Islamic Bank. The bank bears full ownership risks during the lease period In traditional banks, accounting reflects the fact of the transaction as a debt rather than a lease, the asset appears in the client’s assets rather than the bank. The rent is considered a debt on the customer since the first day of the contract.

  • Why there is clear lack of Mudarabah’s application by contemporary Islamic finance institutions despite its historical importance in Muslim countries?

The essential problem of Mudharabah application is “trust”, which translates into asymmetric information between parties. Islamic bank has no hesitation to apply mudharabah when IB act as mudharib receives investment deposits from depositiors (rabbul maal), since IB has better information. But, IB reluctants to extend mudharabah financing, since this time IB as rabbul maal has less information on the project invested with mudharabah financing.

  • What is the new issue of financial system in the Malaysia and Pakistan?

 Roles of the Islamic banks in the monetary transmission process is the main issue now..

  • How can institutional theory be applied in Islamic economics to explain the individual and consumer behavior in Takaful market?

The following paragraph has written by Leonard L. Berry in the chapter 6 of “Handbook of Relationship Marketing” edited Jagdish N Sheth and Atul Parvatiyar can be the answer.

“In conclusion, psychological, sociological, and Institutional theory of consumer behavior indicates that individual consumers are constantly facing limitations of choice that the normally yield to and accept. Consumers accept these limitations because they reduce perceived risk and uncertainty, psychological tension and limitations of consumers’ memory and information-processing capabilities; they promise rewards or threaten punishments; they have the potential to build expertise and confidence and to optimize decision making; they fulfill social and esteem needs, self-efficiency, faith and fear: and they instill aspirations for a superior lifestyle. It is interesting to note that institutional and social influences are greater than personal influence of choice reduction. That is, consumers often comply with institutional mandates and social norms, even in situations in which they may think that the group norm or institutional mandates are against their own self-interest.”

  • Why Islamic banks hold sukuk to maturity?

One of the most problem faced by the holder of sukuks is the non-compliance to Shariah, In other words, The holder isn’t allowed to sell sukuks in second market ( Murabahah, Salam, Istisnaa) Because It’s sell of debt and Islam prohibits sell of debts. So, the solution is to hold the Sukuks to maturity.

  • Is there any study comparing the average profit rate spread in Islamic banks versus the average interest rate in conventional commercial banks?

The spread is the difference between the interest rate on deposits and the interest rate on loans in commercial banks. Whereas, the spread in Islamic banks is the difference between income on Islamic financing/ investment transactions and the expense on customer deposits.

  • Can Islamic finance support stability and inclusion?

Since the global financial crisis, policymakers have sought to press the “reset” button to strengthen financial intermediation that is performed by conventional banks and non-bank financial institutions. The aim has been to address the fault lines that helped trigger one of the most devastating financial crises in a century, and to enable a more inclusive, stable financial system that promotes stability as well as economic development and growth. Islamic finance offers several features that are consistent with these objectives. Islamic finance refers to financial services that conform to Islamic jurisprudence, or Shari’ah, which bans interest, speculation, gambling and short-sales; requires fair treatment; and institutes sanctity of contracts. And these principles hold the promise of supporting financial stability, since a key tenet of Islamic finance is that lenders should share in both the risks and rewards of the projects and loans they finance.

  • What do we know about the future requirements of Islamic finance?

These are: (1) increased recognition within the conventional finance community of the legitimacy and sustainability of Islamic finance; (2) increased recognition within the Islamic finance community that cooperation with the conventional community and conventional finance is both appropriate and acceptable; (3) an increased focus on the objectives (maqasid, broadly defined) of Islamic finance and how the practice of Islamic finance might be nudged in the direction of greater sensitivity to those objectives; and (4) a tentatively expanding willingness to objectively reconsider some oft-repeated, and rather dogmatic, assertions that have guided the development of Islamic finance.

  • Does Islamic Banking (interest free banking) requires a different regulatory framework than conventional banking?

Yes Islamic banks require a different regulatory framework than conventional banking because there is difference in the treatment of investment deposit and some investment assets.

  • What effect does zakat have on social welfare of the community?

Zakat is the third pillar of Islam and it is an obligatory. This is the payment that a free and rational Muslim who owns a certain amount of wealth has to observe. Its importance in Islam is manifested by the numerous pairings of its obligation to that of prayer (salah) in the Quran. Among the fundamentals of Islam, it has the most direct economic implications on Muslims for it involves the distribution of wealth from the affluent in society to those in need. The amount of Zakat payable on cash or kind is 2.5%. However, it is substantially higher for crops and cattle – ranging from 5% to 10%. Many organizations are using zakat to empower poorer communities by providing skills training and purchasing equipment that can be used to generate income. .

  • Can anyone enlighten how interest free Islamic banks operate in Islamic countries of the world and how they earn their profit to pay their staffs? I want to know how they enter into a saving contract and their requirements when taking a loan and how they invest to make profit in order to be able to pay the tellers and other junior and senior staffs.

Islamic banks are financial institutions which identify their objectives, principles, practices and operations with the spirit and guidance of Islamic law “Shariah”. Any Islamic bank does not lend money except interest-free loans while loans on service charge, not exceeding the actual administrative cost of such loans, have also been permitted by Islamic rulings. To replace interest, the ideal mode of financing under the Islamic banking system is “Profit and Loss Sharing” (PLS) basis. In this mode of financing, the losses are shared by the financier along with the entrepreneur in the ratio of their respective capitals. The profits are, however, shared in an agreed ratio. The rates of returns are thus replaced by ratios. There are also various other modes of financing in addition to PLS system including: cost-plus sale, deferred payment sale, purchase with deferred delivery, made to order, leasing and loans with a service charge.

  • Why is Islamic banking not growing at the expected growth rate?

Islamic Finance is a comparatively recent development. Many issues are still debated, and there is a huge need for research in developing the “nuts and bolts” of the business side, even if the legal side is rather well developed. Given the huge potential of the Islamic Market worldwide, even if it will be a slow development it is nevertheless a sizable one. There are several challenges facing Islamic Finance Organizations (IFO’s):

  1. IFO’s must convince the Muslims that it is truly Islamic, not classic finance painted to seem Islamic
  2. IFO’s must develop new business strategies fitting their business model, “imported ” business strategies are less effective considering the market specifics they target.
  3. IFO’s must develop their products to fit the needs of financing of the businesses and people while circumventing the classic way and following the Muslim way. This is a challenge because classic finance means are perfected based on a long experience and a huge practice base worldwide.
  4. IFO’s need to be competitive comparative with classic finance organizations regarding the services they provide. This is a tough nut to crack, especially outside Islamic countries. Just being Islamic will convince few Muslim businessmen, unless some benefits are very clear and measurable for them.
  • Islamic Insurance A modern approach with particular reference to western and Islamic Banking

Some Muslims believe insurance is unnecessary, as society should help its victims. Muslims can no longer ignore the fact that they live, trade and communicate with open global systems, and they can no longer ignore the need for banking and insurance. Aly Khorshid demonstrates how initial clerical apprehensions were overcome to create pioneering Muslim-friendly banking systems, and applies the lessons learnt to a workable insurance framework by which Muslims can compete with non-Muslims in business and have cover in daily life. The book uses relevant Quranic and Sunnah extracts, and the arguments of pro- and anti-insurance jurists to arrive at its conclusion that Muslims can enjoy the peace of mind and equity of an Islamic insurance scheme.

 

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