Islamic Banking

Introduction

Banks play an important and active role in the economic development of a country. The global financial system (GFS) is a financial system consisting of institutions and regulators that act on the international level, as opposed to those that act on a national or regional level. Islamic banking is a classical concept. Islamic banking system has emerged as a competitive and a possible substitute for the conventional banking system during the last three decades. Islamic Banking is no longer limited to specialized institutions and has expanded both geographically and in product richness, with structured credit finance receiving most of the attention. Greater importance of the General Council for Islamic Banking and Finance Institutions (GCIBFI), the Islamic Financial Service Board (IFSB), the Islamic International Rating Agency (IIRA) and the Accounting and Auditing Organization of Islamic Finance Institutions (AAOIFI), will add consistency in accordance to Islamic laws [shariah] interpretations by religious boards and the primacy of bankable governing law as a matter of form remain essential to further growth of Islamic banking. Islamic banking transactions are governed by the codes of the shariah, which prohibits interest and regulates that income, must be resulting as return from capitalist investment.

What is Islamic Banking?

Islamic banking refers to a system of banking or banking activity that is consistent with the principles of the Shari'ah (Islamic rulings) and its practical application through the development of Islamic economics. The principles which emphasise moral and ethical values in all dealings have wide universal appeal. Shari'ah prohibits the payment or acceptance of interest charges (riba) for the lending and accepting of money, as well as carrying out trade and other activities that provide goods or services considered contrary to its principles. While these principles were used as the basis for a flourishing economy in earlier times, it is only in the late 20th century that a number of Islamic banks were formed to provide an alternative basis to Muslims although Islamic banking is not restricted to Muslims.

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Islamic Banking

The origin of Islamic Banking

The term Islamic banking became common in the 1960's, but the mechanisms and concepts of the system were implied and used since the birth of Islam. Many studies and researches have shown that Islamic finance mechanisms were used in the Muslim world throughout the Middle Ages; in conducting trade and business activities. Charging interest on loans was not common back then.

Actually, there are more than 265 Islamic banks, after a very timid start in the Egyptian town of MitGhamr in 1963, operating worldwide according to Islamic law or Shar’ia. Islamic banking and finance is deeply rooted in Islamic religion drawing most of its principles from the Holy Quran (riba). In a contextualised approach and relying principally on secondary data (Central Statistics Office, Islamic Financial Information Service, World Bank and the International Monetary Fund) the aim of this paper is therefore to enlighten local businessmen on Islamic Banking or interest-free banking and how other Islamic and non Islamic countries have implemented Islamic legislations, to furnish more particulars on how it works and whether Islamic Banking shall be able to settle properly and promptly in Mauritius in the presence of conventional banks or not whilst Islamic banking is now accepted as one of the most profitable markets in the world with $ 1 trillion in assets by 2010/2012. Mauritius is also a powerful financial hub attracting foreign direct investment (FDI) worldwide contributing to its economic success.

The coming into being of Islamic Banks:

The first private Islamic Bank, the ‘Dubai Islamic Bank’ was also set up in 1975 by a group of Muslim businessmen from several countries.  Two more private banks were founded in 1977 under the name of ‘Faisal Islamic Bank’ in Egypt and Sudan. In the same year the Kuwaiti Government set up the ‘Kuwait Finance House’.

In the ten years since the establishment of the first private commercial bank in Dubai, more than 50 Islamic Banks have come into being. Though nearly all of them are in Muslim countries, there are some in Western Europe as well : in Denmak, Luxembourg, Switzerland and the UK.

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In most countries the establishment of Islamic banking had been by private initiative and were confined to that bank. In Iran and Pakistan, however, it was by government initiative and covered all banks in the country. The Governments in both these counties took steps in 1981 to introduce Islamic Banking.

At present there are Islamic Banks in the following countries:-

01.      Afghanistan

02.       Algeria

03.       Albania

04.       Argentina

05.       Australia

06.       Bahamas

07.       Bahrain

08.       Bangladesh

09.       Brunei

10.     Cayman Islands

11.     Cyprus

12.     Denmark

13.     Djibouti

14.     Egypt

15.     Germany

16.     Guinea

33.Pakistan

34.Palestine

35.Philippines

36.Qatar

37.Russia

38.Saudia Arabia

39.Senegal

40.South Africa

41.Sudan

42.Switzerland

43.Thailand

44.Tunsia

45.Turkey

46.U.A.E.

47.U. K.

48.S. S. A.

49.Yemen.

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Islamic Banking

OBJECTIVES:

Islamic banking has been around for decades. Multiple factors are driving the global development of Islamic banking, but the root is “free interest.” Islamic banking has gained significant base in many parts of the Muslim world. The study presents a broad analysis of Islamic Banking and its development. The main objectives of this paper are:

1) To understand the concept of Islamic banking and identify the need of

Islamic banking

2) To know the basic of Islamic banking principles

3) To bring out the importance of Islamic banking and to assess evolution of

Islamic banking in Islamic countries, with examination of development

likelihood in key markets

4) To provide detailed insight into Islamic banking and challenges, according

to the International Standards

5) To Examine overall Islamic banking sector, with drill-down on banking

opportunity

6) To survey the growing literature on Islamic banking, in particular and to

trace the growth and development of Islamic banking, and to highlight its

salient characteristics.

Main Advantage of Islamic Banking system

Islamic banking banks have not been affected by the subprime crisis which has

become a worldwide crisis. Banks involved in Islamic Banking has not lost even

1pence in that crisis. Because they do not allow speculation on money, because

they do not give money just on an interest basis, but invest in businesses with a risk

sharing program. This is why islamic banking system has survived and is

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flourishing the last 2 years while conventional banking systems have been deeply

affected and are causing so much trouble to the whole world.

Problems being faced by Islamic Banking in the world in general

Most of the Islamic Banks operate on Bai- Murabaha, Bai Muazzal, Bai- Salam, Istisna, Hire Purchase/ Leasing mode of Investment i.e. Islamic Banks always prefer to run on markup/ guaranteed profit basis having Shariah coverage. For this reason some times the conventional Economists and General people failed to understand the real difference between Islamic Banking and conventional Banking.

Mudaraba and Musharaka modes of Investment are ideal but Islamic Banks are not going in these two modes, the reasons for the above are as follows:

i)         There is no systemic analysis and research and no real efforts to introduce above mentioned two modes but the practitioners blame the following factors:-

                  a)    There is lack of committed entrepreneur

b)    There is lack of committed professional who can create new   

c)     instruments.

d)    There is lack of committed sponsors who can pressurize the professionals

e)     There is shortage of skilled professionals.

Birth of Islamic Banking in Mauritius

In August 2008, amendments were made to the Banking Act 2004 that now allows banks in Mauritius to provide Islamic Banking services. Many banks showed an immediate interest in setting up Islamic windows, thus paving the way for Islamic banking in Mauritius. With the introduction of Islamic finance, Mauritius has a great opportunity to diversify its financial sector and provide new services in the fields of banking, wealth management and investment based on Shari’ah Compliance.

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Islamic Banking

If the main objective of conventional and financial institutions is based entirely on interest bearing instruments there is, however, an alternative way to interest bearing financial system in Mauritius and in the world. But can financial institutions survive without interest (or at least towards an interest-free banking) while persistently engaged in the generation of wealth, promoting economic growth and full engagement in financial activities and transactions that do not involve at all with bank interest?

Whatsoever, the first question is what is Islamic banking? According to a definition, borrowed from the International Association of Islamic Banking, an Islamic bank is a banking company which implements a new banking concept in that it adheres strictly to the rulings of Islamic Shariah in the fields of finance and other dealings and conducts all its operations conform to the Shariah without involving itself and its clients in riba1 (or interest) in any way. In addition to this definition, Islamic banks have to fulfil two basic requirements: they must operate according to Islamic principles and they must perform the functions of a sound banking.

Principles and concepts in Islamic Banking

Unlike other conventional banks, which deal mainly with civil contracts and customer care relationships, Islamic banking which also deals with trusts (waqf) has, above all, its own principles and concepts. There is an abundant literature in Islamic banking and it is impossible to mention all the publications. Islamic banking is based on one concept but how important: the concept of profit and loss sharing rather than payment of interest. This is the gist of Islamic banking

Prior to the revelation of the Quran to Prophet Muhammad, it is important to remember that most religions of the world have banned the exploitation of interest but only Islam and Islamic banks have abide strict sensuto the Holy Quran, which paved the edification of lending money but without any interest. In the overall, dealers in usury are sinners as: ‘‘Deal not unjustly, And ye shall not be dealt with unjustly9’’. Interest is also forbidden in other religion and most holy books ascertain so. In the Jewish scriptures Exodus [22:25] it is revealed that: ‘‘…if you lend money to a poor man, do not become a money lender and do not realise interest from him’’.

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Islamic Banking

The burgeoning of an important Islamic financial hub in Mauritius

The next issue is: why Islamic banking in Mauritius? Mauritius has a very important financial sector, which is dominated by the banking sector and various financial activities. According to a report of World Bank, Mauritius tops the rankings in Africa on the ease of doing business and places 27th in the global rankings. According to Jankee10: ‘Financial services trade liberalisation (FSTL) can affect financial stability via its effects on capital flows. It is presumed that FSTL allows the use of broad range of financial instruments and the presence of foreign banks can contribute to more stable capital flows. We analyze the level and volatility in net capital flows in Mauritius. Volatility of capital flows is the coefficient of variation computed as the absolute value of the standard deviation divided by the mean. The average level of FDI inflows has nearly tripled in the period 1997-2003. However, in the case of portfolio flows, we see a higher level of disinvestments in the period 1997-2003’

Knowing all these factors, the founders of Islamic banking found Mauritius to be an accurate platform for financiers, investors and Islamic banking and finance professionals and to explore the Mauritius market for new avenues in fastly emerging markets (real estate activities, foreign direct investment, tourism sector and even food hub sector) of Mauritius.

Emerging sectors. Source: CSO (2000-2012)

A sector which would probably of interest to Islamic banking is foreign direct investment (FDI)11. According to Investing Across Borders, Mauritius remains as one of the highest recipients of FDI per head of population with 217 USD.

Emerging trends of FDI-Emerging sectors. Source: CSO (2002-2009)

However there is a threat for some business men in Mauritius. Conventional banks in Mauritius should not consider Islamic banking as a challenge. Indeed, actually, more than 50 countries (France, Japan, Singapore, UK, USA) and banks (Deutsche Bank) irrespective whether they are Muslim or non-Muslim countries or Islamic banks have already recognized Islamic banking.

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Islamic Banking

Somes Additional Information on Islamic Banking

Wakalah Islamic Letter of Credit

In the case of wakalah Islamic letter of credit, the customer must pay in advance the full value of the item in question prior to the issuance of the ILC. Furthermore, the Islamic bank will receive a commission or service fee upon the service rendered to the customer. To under the process of wakalah Islamic letter of credit let’s look at this model.

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Islamic Banking

Murabaha Islamic Letter of Credit

Under the principle of murabaha (cost plus profit) where the customers is unable is unable to pay the purchase price, the bank issues the ILC and pays the purchase price to the exporter. The bank immediately sells to the customer at a markup for a deferred payment. The model of murabahah letter of credit as follow

Flow of Hiwalah

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Islamic Banking

Main Difference between Hiwalah, Sale of Contract and Bai Duyan

Item

Difference Hiwalah Sale contract Bai dayn

1 Definition Transfer/assignment of debt

Contract of exchange for consideration

Contract for the sale of debt

2 Origin Legal maxim that permits indulgence in hardship

Quranic verse that enjoins man to engage in

trade and business activity

Quranic verse that permits sale of intangible assets

3 Nature Continuity of legal rights/ Obligations

Exchange of values; for example, exchange of goods for price

Exchange of values where its payment and

delivery is deferred

4 Parties Debtor, creditor and assignee

Buyer and seller Seller and buyer

5 Subject matter

Debts Tangible goods Intangible goods

6 Purpose Assist a straitened debtor

 Obtain lawful profit Redeem the goods at maturity date

7 Consideration Not required due to it being a unilateral contract

Consideration is required due to it being a contract of exchange

Consideration is required due to it being a

contract of exchange

8 Elements Parties, acknowledgement

of debt and consent from all parties to take over the debt

Parties, goods, and price Parties, goods, price and capable of being

delivered in future

9 Effect Passing of obligations to the assignee

Passing of ownership of the goods from seller to Buyer

Passing of rights to redeem the debt

10 Features Security subsists and not discharged

Security discharge and recharge

May be repurchased

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Conclusion

With an interest-free banking risks are inevitable and how the banking sectors in Mauritius would react is still questionable in as much as banking legislations in Mauritius does not prohibit loans. From time to time, Mauritius also has to endure foreign-exchange rate with the fluctuation of the dollars, the Euros, the Yen and even the South African rands. Devaluation of the national rupee is inevitable. In addition to foreign-exchange rate and without being pessimist Islamic banking in Mauritius will inevitably face credit risk, operating risks, legal risks due to differences between principles of Sha’riah law and common law, equity risks, liquidity risks, withdrawal risks, fiduciary risks and displaced commercial risks. On the other side, “les banques islamiques ne sont pas nées de la dernière pluie” and have been able to survive in the poorest country of the world and/or in the least developed countries (Chad, Benin, Burkina Faso, Comoros, Mali, Sudan, Uganda, Sierra Leone just to name a few). So, why not Mauritius? Even the UK experienced its first Islamic Finance boom in 2003 but each country has its own specificities but there are hope and high expectations for an Islamic banking in Mauritius. Food for thought of the century is: would someone prefer an interest-free banking or zero interest banking with full risks or an interest banking but without/or few risks.

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Islamic Banking

References

Internet

Adiilah Ibrahim (2010): Opportunities and challenges of Islamic banking in Mauritius, BSC (Hons) Finance (Minor Law), University of Mauritius

http://www.theislamicglobe.com/index.php/article/17-century-banking-corporation-to-open-mauritius

http://www.conyersdill.com/publication-files/Article_194_Emerging_Islamic_Finance_Hub.pdf

http://www.islamic-banking.com/islamic_banking_principle.aspx

Online document: Clare Dunkley, “Crescent rising” www.meed.com . Accessed on 27 October 2006.

Dubai Islamic Bank “Welcome” http://www.alislami.ae/en/index.htm .Accessed on 29 December 2009.

Global HR requirements : http://www.learnislamicfinance.com/Human-Resources.htm . Accessed on 29 December 2009.

Julian Knight “Islamic banking goes nationwide”.

http://news.bbc.co.uk/2/hi/5075998.stm ” Accessed on 31 December 2009 The Islamic Financial System,

http://www.islamic-banking.com/islamic_banking.aspx

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