Islamic/Sharia-compliant banking

July 21, 2011

Society

A lot of controversy has been generated on Islamic banking in the last few weeks.  As in everything Nigerian, discussions and opinions seem to be sharply divided between Christians and Moslems.  It’s therefore been difficult to really understand what the new system would contribute to a banking system that is thriving comparatively to the near-comatose situation in other sectors of the country’s economy and while small businesses and the average Nigerian have no access to bank loans, two intrinsic functions of banks.

I was relieved to read some of Dr. Abdasalam Ajetunmobi’s contributions on the topic in some privately-circulated essays one of which has been published by a newspaper.  I’ve chosen to share his extensive contribution with readers.  Dr. Ajetunmobi, a Lecturer in Law at the University of Portsmouth in the U.K., takes a thorough and dispassionate look at Islamic Banking which the Central Bank has adopted and three banks have already lined up to introduce.   As the first name suggests, Dr. Ajetunmobi is a Moslem but is from the Yoruba Southwest where the average man in the street does not understand – nor care – what banking systems operate as long as he can feed himself and family.

The Sharia Banking kite was first flown during Late Yar Adua’s presidency and many of us did wonder aloud why that would be pursued given the incendiary that anything religion always pours on any national discourse.

I’ve divided it into two parts: the introduction and Islamic Banking Practices which is published today and “The Implications of Islamic Banking in Nigeria” which will be published tomorrow.  Here is a paragraph that should make you want to read this essay in case you are thinking, oh, this is too long; another article on Sharia – again, I don’t think I have the time …  Those feelings would be justified in a country long and deeply divided along religious lines, especially since retired General Obasanjo-led PDP government left unchallenged some Northern Nigerian states who declared Sharia in spite of a supposed secular constitution without having the government challenge those states.  He had his selfish agenda but we all know what that unconstitutional snob has wrought on the country since.

Here is a paragraph from the essay:

“For example, Muhammad Saleem, is a Muslim and former president and CEO of a major international bank in New York, and a senior member of the bank’s credit and loan policy committee, headed the Middle East division and worked with a leading Islamic Bank based in Bahrain. In his book, Islamic Banking: A $300 Billion Deception(2005), Mr Saleem with a first-hand experience and an advisor with an Islamic bank, subjected every mode Islamic banking to a process of critical analysis and the conclusion he reached is that Islamic banks are clearly charging interest but interest payments are masked. Amazingly, he stated: “When conventional banks, acting in a transparent manner charge interest, Islamic banks charge an equal percentage point or an amount and call it a ‘commission, fee, profit or mark-up’. This is outright deception … this exercise does nothing to promote economic development, justice, fairness or honesty” (p. 56)”

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Is Islamic banking relevant to Nigeria?

By A. Ajetunmobi

There is a palpable apprehension in the country following the announcement to establish Islamic banking in the country. Given an explicitly religious dimension to Islamic banking, and given also a priori consideration of the nation’s secular status, I myself harbour great doubts about whether the nation’s Apex Bank, as an agency of the Federal Government, has the moral right to attempt to complement the existing banking systems with a full-fledged faith-based bank. Of course, new times require new ideas. With high-profile collapses and bailouts by governments in developed world in the aftermath of the global banking crisis in 2008, almost all economic literate persons will concede that outworn economic dogmas of yesteryears have to be abandoned and new paradigm for financial markets stability embraced. However, while conventional banking may have taken a battering for excesses in the financial markets, can a standalone Islamic banking in Nigeria bring in a new dimension to the problems of providing and mobilising capital for economic and social development in the country? In terms of good governance and risk management rules, and in terms of credit expansion and stimulating investments, is there any evidence that Islamic banking can really make a difference and/or create additional value to the lives of Nigerians? How is an Islamic banking different from its conventional counterpart? The answers to these questions profoundly affect, not only Islamic banking’s underlying principles, but any religious-inspired effort of every kind. In this respect, this write-up is divided into two parts:

  1. Islamic Banking practices; and
  2. The implications of Islamic banking in Nigeria.

Islamic Banking practices

For a start, Islamic banking is a financial institution that is in consonance with the ethos and value system of Islam. At its most inclusive, it is governed by the principles laid down by the Islamic Shariah (or Islamic law), principally forbidding the receipt and payment of interest on any of its transaction. However since no doctrinal standards exist in Islam, Islamic banking’s financial aspects of Shariah is open to interpretation – the principles of Shariah derive from interpretations of two sources: the Qur’an andHadith (the body of documents that records the practice, or life example of Prophet Muhammad – and some instruments may be offered or practices accepted by some institutions, but not by others, depending on where one is in the Muslim world. For instance, Muslims in East Asia, especially in Indonesia and Malaysia, are more open-minded and less restrictive in their interpretations of Islam than their counterparts in the Middle East, particularly in Saudi Arabia which hosts the Jeddah-based ‘granddaddy’ of all Islamic banks, the Islamic Development Bank (IsDB). Yet, in banking practices, harmonisation is needed at national and international levels. The lack of uniformity in Islamic banking practices makes it difficult to apply the same prudential regulatory standards – such as structuring financial instruments and financial transactions.

In an Islamic banking, it is mandatory to have a Shariah board consisting of religious scholars who will formulate permissible means of financing and oversee that the banking products are Shariah-compliant. As stated above, differences exist and are considerable within Islam, so it should not be supposed therefore that Islamic banking in Nigeria will operate under the same Islamic jurisprudence elsewhere. However, in spite of widely divergent interpretations of the Islamic sources, among the essential Islamic banking products are the following six modes of financing: (1) Murabahah – a kind of “cost-plus” transaction in which the bank buys the asset then immediately sells it to the customer at a re-agreed higher price payable by instalments; (2) Bai Salam – a kind of forward sales contract which requires the buyer to pay in advance for goods that are to be supplied later; (3) Istisna’a – another form of forward sales contract, involving a longer-term financing mechanism under which a price is agreed before the asset described in the agreement is actually built; (4) Ijarah – a form of leasing involving rights over the use of an asset under which the bank buys the asset then leases it to the customer over a fixed period in return for a pre-agreed monthly price; (4) Mudarabah – a form of investment partnership between a bank and an entrepreneur that shares the risk and losses of profits between both parties at pre-agreed level; and, (6) Musharaka – this is similar to Mudarabah except that the entrepreneur, addition to contributing time, effort, and expertise also contributes some capital to the venture.

The critical element in all the Islamic banking modes of financing is the presumed prohibition of interest, and this, it is said, constitutes a fundamental dividing point between Islamic and traditional banking practices. However, it should be noted that over 90% of Islamic banking’s portfolio is in Ijarah and Murabahah, and yet like other products, they are both based on interest, although in the case of murabahahtransactions this is clearly disguised as profit or mark-up. For example, various results of the survey, and the examination of the literature and data available on those Islamic banking around the world, show that the whole package of global Islamic banking is just economic window dressing for conventional banking system. In other words, virtually all Islamic banks engage in conventional banking type of charging interest disguised in ingenious ruses.

For example, Muhammad Saleem, is a Muslim and former president and CEO of a major international bank in New York, and a senior member of the bank’s credit and loan policy committee, headed the Middle East division and worked with a leading Islamic Bank based in Bahrain. In his book, Islamic Banking: A $300 Billion Deception(2005), Mr Saleem with a first-hand experience and an advisor with an Islamic bank, subjected every mode Islamic banking to a process of critical analysis and the conclusion he reached is that Islamic banks are clearly charging interest but interest payments are masked. Amazingly, he stated: “When conventional banks, acting in a transparent manner charge interest, Islamic banks charge an equal percentage point or an amount and call it a ‘commission, fee, profit or mark-up’. This is outright deception … this exercise does nothing to promote economic development, justice, fairness or honesty” (p. 56).

Also, two business professors, Beng Soon Chong and Ming-Hua Liu of Auckland University of Technology, New Zealand studied the main features of Islamic banking in Malaysia, the largest Islamic banking, capital, and insurance markets in the world (World Bank, 2006), and where a full-fledged Islamic banking system already developed alongside a conventional banking system. In their findings, published in thePacific-Basin Finance Journal, under the title “Islamic Banking: Interest-Free or Interest-Based?”, these professors declared that Islamic banking practices differ only cosmetically from those of conventional banking systems, concluding that: “In practice, however, we found that Islamic banking is not very different from conventional banking from the perspective of the PLS [profit-and-loss sharing] paradigm. On the asset side of Islamic banking, we found that only a negligible portion of financing is based on the PLS principle. Consistent with Islamic banking experiences elsewhere, a large majority of Islamic bank financing in Malaysia is still based on non-PLS modes that are permissible under the Shariah law, but ignore the spirit of the usury prohibition. On the liability side, the PLS principle is more widely adopted in structuring Islamic deposits. Our study, however, provides new evidence, which shows that, in practice, Islamic deposits are not interest-free.” (p. 26)

There is no denying that with almost $822 billion in assets (Maris Strategies, 2010), Islamic banking constitutes a burgeoning financial phenomenon in the world. Indeed, apart from Muslim-dominated countries such as Bahrain, Bangladesh, Brunei, Egypt, Jordan, Iran, Malaysia, Pakistan, Indonesia, Saudi Arabia and Sudan which have either partially or wholly ‘Islamised’ their banking systems, there are also banks in Europe and North America, including HSBC, Deutsche Bank, JPMorgan, Standard Chartered Bank, University Bank in Ann Arbor and Devon Bank in Chicago that have set up Islamic banking windows or subsidiaries for the benefits of growing Muslim population wanting to invest according to the guiding principles of their faith. China too has recently awarded its first licence for Islamic banking to Bank of Ningxia, paving the way for Shariah-compliant financial transitions, especially in the country’s vast retail and wholesale sectors. The visible international character of Islamic banking could also be noted in the creation of the Dow Jones Islamic Market US Index in 1999, of the Dow Jones Islamic Fund (IMANX) owned by the North American Islamic Trust (NAIT) – a Saudi-controlled non-profit institution that holds title to hundreds of American mosques – in 2000, and of the Dow Jones Citigroup Sukuk (Islamic Bond) Index in Kuala Lumpur, Malaysia in 2003. Similarly, European Islamic Investment Bank (EIIB), the first Shari’a-compliant investment bank in Britain was authorised in March 2006 to invest and take deposits. Overall, Islamic banking is practised in more than 50 countries worldwide.

On the other hand, it must be stressed that Islamic banking still represents just 1 per cent of the global financial system. And as much as many Muslims may want to believe, the growth of Islamic banking in the West is not driven by the desire to promote interest-free Islamic financial products. Rather the West is interested in the supply of funds and the opportunity to make money from wealthy Muslim countries in the Middle East. The Western owned banks know quite well that the stated principles of Islamic banking system – sharing risks and partnering with their clients on truly profit and loss sharing basis –  are not, in reality, happening and that Islamic banks are charging interest disguised in a creative way. If an Islamic bank, labels its ‘Mr Big’ a Makkah burger, so far that it has the same ingredients as ‘Mr Big’s burger, is there any difference in substance? Take for example, when a presumed interest-free Islamic bank buys its customer a car for £30,000, and requires the customer to pay back £33,000 in a year’s time or that the customer should pay five equal annual instalments of £7,913.92. Through its creative use of language, the bank will lay claim to interest-free handling commission, fee, profit or mark-up, yet, to the conventional interest-based bank, such a cost-plus transaction (murabahah) looks just like a loan at 10 per cent compound interest. In this respect, can we not remember that profit maximisation is the objective of any financier? Were it be the case that the cost, benefits, and terms and conditions to lenders in Islamic banking are totally different from the conventional banking system, banking companies in the West would not have opened up Islamic windows in the first instance. Otherwise, their central banks and bank examiners would have advised Western banks against selling Islamic products. So, it is because Islamic banking is not really interest-free, but is very similar to interest-based conventional banking, that is why western banks are accommodating Islamic banking.

Therefore, if Islamic banking is not different from the Western banking system in techniques – “Same meat, different gravy,” noted a prominent Saudi Islamic banker – in the sense that borrowers pay the same interest rate as they would to conventional banks, though under various religious guises, and depositors not receiving any higher return compared to what they would receive on their deposits with conventional banks, what is the motivation for setting up a full-frontal Islamic banking in Nigeria then? After all, since 2008, Platinum Habib Bank PLC (or Bank PHB) already has Islamic windows, engaging in a wide range of Islamic banking products, including Current Account, Savings, Investment and Hajj Target Savings Account for Nigerian Muslims wanting to live by dictates of their faith. Why not continue with such a conventional banking system that is ready to offer Islamic banking windows or subsidiaries, thereby engaging in Islamic products for the interested Muslims. Alternatively, existing traditional banks in the country could be encouraged to create specially tailored Islamic products if the demand for such is so high? It is instructive that in the world of global finance, Islamic banking shuns risk (gharar), yet the Central Bank Governor, Mallam Sanusi himself is an expert in risk management—once an Executive Director Risk & Management Control, First Bank of Nigeria Plc. The fact is, risk plays an essential role in economic life. Without risk taking, financial and capital markets would be based purely on an exchange of a single instrument every time and this may have a negative impact on the communications industry, thereby reducing the operation of investment banking to that of accounting. Of course, systemic risks could be managed by appropriate regulatory authorities in the conventional banking. Having touched on the Islamic Banking practices, we must not downgrade the implications of a full-fledged Islamic banking in the country; and so let’s now move on to the issues of that sort.

Conclusion on Friday, July 22, 2011

 




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