Modern Banking And Islamic Banking

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

Islamic financial services industry is estimated to amount to $2.6 trillion (or about 0.7 percent of total financial assets [Financial Stability Board {FSB}, 2019]). The potential for growth of this form of finance is nonetheless considerable, given that its penetration rate in large and populous economies, such as Indonesia and Turkey, is still below 20 percent. Most Islamic finance assets are concentrated in the banking sector, which has grown in systemic importance. While Islamic banks account for only one percent (or $1.6 trillion) of global banking sector assets ($146.6 trillion), they represent at least 15 percent of the total banking sector in 14 countries.

In ancient societies banks helped money function as a medium of exchange. Money changers sat at their tables in the market place and exchanged coins from foreign cities for those of their home city. The result was increased liquidity.

In the medieval period, the emergence of secretive global banking networks, mapped onto state finance and the wool trade, was a signal that a new function was emerging: banks as lenders, operating at the centre of a commercial economy.

Fast forward to the 21st century and banks have an extra function: they stand at the centre of a global economy where money is invented on spreadsheets, spent via electronic card, and where speculative money transactions each day exceed the size of the global economy.

In the space of 25 years the industrial economies of the west have become financialised: credit is the primary form of the surplus extracted from people’s work, consumption and ordinary life. Long before you choose your new car, or begin your college course, the loans you take out will have been bundled for sale on the global securities market, with a precise prediction as to your likelihood of default built in.

So when we export banking to the global world we are not exporting just a modern version of the money-changers table. We are exporting – alongside the useful stuff – access to what Warren Buffett called “financial weapons of mass destruction”.

Yet the rise of banking and financial services in the developing world is unstoppable – above all in Asia, where economists predict the emergence of a billion strong new middle class by 2030.

While all the media attention focused on these innovative new channels, less attention was paid on what was flowing through the channels, and in which direction. The answer, of course, is financial profit, which always flows upwards from the poor to the banks, even as positive spillovers happen within the recipient communities themselves.

Ultimately, in a functional capitalism, banks and financial services should exist to mobilize the savings of an emerging middle class into productive industries.

That they no longer do this efficiently in developed world capitalism was one source of the 2008 crisis. Corporations, wary of the power of finance, seek to amass cash mountains, or issue their own paper to the bond markets direct; meanwhile banks go in search of alternative sources of profit, with the result that – at the heart of the neoliberal system – is a finance mechanism prone to sudden liquidity surges (as in India) and liquidity crises (Lehman Brothers).

The solution in the developed world has, to date, been to bury bad debt in opaque places, to print money, and to recapitalize banks. Those who hoped that, alongside this, we should see the rise of a diverse, semi-socialized banking sector were dismayed as, for example, the caja de ahorro sector in Spain, and then the Co-operative Bank in the UK, entered crises contingent on mismanagement and their entanglement with politics.

Yet the rise of a diverse finance sector, with mixed ownership, and the re-separation of high risk activities and savings is the only form in which the advanced world banks can revive. And by revival we mean completely free of bailout money, completely free of implicit guarantees by the state, and completely free of the trillions of manufactured money currently shoring up their balance sheets.

For poor countries, where mass access to banking is only starting, it is worth considering how you would design an emergent banking sector if you could start from scratch.

What happens when it’s not just a lack of physical banks preventing communities’ access to financial services, but ethical issues too? Here comes the Islamic Banking to resolve the issue.

Islam is the world’s second largest religion with more than 1.5 billion followers, making up more than 23% of the world’s population. Of these, 650 million Muslims hover at or below the poverty line. But although Islamic-compliant finance is a huge industry globally, when the international community talks about improving access to financial services in developing countries, making services Islamic-compliant is rarely top of the agenda.

Islamic-compliant financial products can take several forms and business models. However, the principles of Islamic finance are universal: you cannot make money off money. No one can charge or pay interest, or invest in items that Islam forbids such as alcohol and gambling.

Even with its explosive growth, Islamic finance makes up just 1 percent or so of global financial assets. Champions of the approach argue that in the aftermath of the 2008 financial crisis, it can appeal beyond devout Muslims to other customers worried about the stability of the financial system or to those interested in ethical banking practices. They say sharia-based financing promotes stability because it prohibits speculation and the practice of overloading companies with debt. Money is channeled toward investments in enterprises that produce actual goods and services, rather than buying and selling on financial markets. Skeptics note that ethical banking enthusiasts are usually interested in an institution’s environmental policies and engagement with the local community, not whether it forbids profiting from alcohol, tobacco, gambling and pornography, as sharia requires. More women are entering management at Islamic financial companies, helping to address one concern among critics. Others worry about institutions being exploited to funnel money to Islamic terrorists, an issue raised in a U.S. State Department memo about Islamic finance in the U.K. After Christian groups in South Korea raised the same issue, the government put off making tax changes to accommodate Islamic finance. The industry is also challenged by high costs due to the complexity of the instruments and the fees paid to scholars to certify sharia compliance. And many products, such as hedging instruments and short-term government securities, are in short supply. Progress in establishing common standards for sharia compliance has been gradual, restricting the acceptability of Islamic bonds in some jurisdictions.


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