Islamic Bank
April 2001 Bank Management 45 I. ... Traditional banks that want to continue doing business with Muslims in the future should change radically, since certain common bank transactions are illegal for Muslims. ... With the appearance of Islamic banks, Muslims now have that alternative. In this article, I present an overview of the theory of Islamic banking (section III), and its implementation in practice (section IV). I will, however, begin with a section about the Islamic Revival, the roots of the Islamic banking movement, and a short subsection about Islamic Law. ... THE ISLAMIC BANKING MOVEMENT A. The Islamic Revival With the end of World War II, the curtain soon fell on the Colonial Period. For the first time in many centuries, large parts of the Islamic world were no longer governed by a Western-Christian regime. ... This gave a strong impulse to the Orthodox Islamic-revival movement, also known as "Islamism". ... Islamists claim that the Islamic world can only be free and prosperous if it is transformed into a truly Islamic society, free from non-Islamic elements. Islamists therefore turned their attention to every aspect of society in order to root out all non-Islamic elements. Islamist scientists proposed Islamic alternatives to the legal system and the economy. Instead of the Marxist planned economy and the capitalist economy, concepts strange to Islam, an economic theory based on the Shari’a was developed, called Islamic economics. ... Shari’a, the Islamic Law The Shari’a is not a codified law. ... The Shari’a is based on four main sources of law: the Quran, the Traditions of the Prophet and his most faithful companions, the consensus of all Islamic scholars, and deduction by analogy. ... were the Golden Age of the Islamic empire. ... No wonder that Muslims saw this as a sign from God that their leadership was truly Islamic. And when the most important questions of law were answered, consensus was reached within the Muslim community that the wisdom of the Islamic scholars and leaders of the first generations could never be surpassed. ... No free, independent development ("Idjtihad") of new concepts within Islamic law was permitted any more, except on minor issues. ... Further on, we will come to see how this ban on the development of major new concepts of law has influenced Islamic economics. ... The Rise of the Islamic Banking Movement With the rise of Islamism, opposition against the Western, interest-based banking system grew. The first thorough studies devoted to the establishment of an Islamic bank appeared in the 1940s. In the forties and fifties, several experiments with small Islamic banks were undertaken in Malaysia and Pakistan. The first great success was the establishment of an Islamic bank in the Egyptian village of Mit Ghamr, in 1963. Other successes include the establishment of the inter-governmental Islamic Development Bank in Jeddah in 1975, and of a number of commercial banks such as the Dubai Islamic Bank, the Kuwait Finance House and the Bahrain Islamic Bank, in the seventies and eighties. At the same time, the banking system in Iran and Pakistan was ‘Islamised’ to a Diederik van Schaik* Arab Bank E V I E W Vol. ... 1 April 2001 Bank nagement 46 large extent. From the second half of the eighties, however, conditions became less favourable for the Islamic banking movement, and the number of new Islamic banks began to decrease. Nowadays, there are about 170 Islamic financial institutions (not only banks), with assets totalling US$ 137 billion (Euromoney, 1998). Not only do they exist in traditionally Islamic countries, but also in the United States, United Kingdom and Switzerland. Furthermore, many ‘traditional’ banks offer Islamic services to their Muslim clientele. The Islamic banking sector is still small, but for a relatively young sector it has performed well. This section has briefly treated Islamic Law, the rise of Islamism, and the emergence of the Islamic banking movement. A discussion of the theory of Islamic banking will follow below. ... THE THEORY OF ISLAMIC BANKING A. What is Islamic Banking? There is a plethora of differing views about the definition of Islamic banking. In my own view, Islamic banking is ". ... a form of modern banking based on Islamic legal concepts developed in the first centuries of Islam, using risk-sharing as its main method, and excluding financing based on a fixed, pre-determined return". How does an Islamic bank differ from a non-Islamic bank? First of all, in its mission and objectives: because Islam is the backbone of Islamic banking, moral principles and objectives play a more important role in the operations of an Islamic bank than in a non-Islamic bank. Second, in its products: an Islamic bank offers no interest-bearing products or services, for example, and is more oriented towards risksharing products. Third, in its organisational structure and corporate governance: Islamic banks have an Islamic (religious) board, to ensure that the bank’s practices are in line with the Shari’a, and a strong social solidarity division. Because of these elements, Islamic banks have the characteristics of investment banks, commercial banks and development banks. ... Seven Principles of Islamic Economics Contrary to positive (value-free) economics, Islamic economics are clearly normative. The Islamic values are reflected in Islamic economic principles. ... From these abstract principles two more concrete Islamic economic rules will be derived. Finally, based on these rules, two "contracts" will be discussed which can be used by Islamic banks to attract funds and provide financing in a truly Islamic way. ... But let us start off with the seven main Islamic economic principles: 1. ... The Arab Bank R E V I EW Vol. ... 1 April 2001 Bank Management 47 According to Islam, money is sterile, as long as it is not combined with (spiritual) labour, "property does not breed property" (similar ideas can be found in Aristotle). ... The difference between legal and illegal risk is not always easy to determine, therefore, in concrete cases, an expert in Islamic law should be consulted. ... Therefore, Islamic scholars deduced from these principles more concrete economic rules for economic behaviour. ... Arab Bank E V I E W Vol. ... 1 April 2001 Bank nagement 48 Deutschmarks for Pounds Sterling, dates for dates, etc. ... PLS Financing Contracts Islamic jurists have worked out two forms ("contracts") of PLS-financing: joint venture (musharaka) and trust financing (mudaraba). ... Since most banks do not wish to be actively involved with the management of a venture, this form of partnership is not common among Islamic banks. ... Equity financing and investment deposits with Islamic banks are examples of mudaraba: in the latter case, the depositors are the financing partners, whereas the Islamic bank is the managing partner. The bank actively invests/finances the deposits. The bank, in its turn, then becomes the financing partner, whereas the client receiving the bank’s financing is the managing partner. Thus, a dual trust-financing relationship is the basis of an Islamic bank. To sum up, Islamic economics advise Islamic banks to base their operations on PLS. ... Therefore, most financing by Islamic banks is provided on a non-PLS-basis, by mark-up financing. ... This The Arab Bank R E V I EW Vol. ... 1 April 2001 Bank Management 49 could mean that the trader is left with an object which the final buyer asked him to buy. This may initially sound unreasonable to some readers, but the Islamic law allows it. When Islamic banks play the role of middleman, it is mostly as a financier. ... The bank only handles the documents involved, while the goods are shipped to the final buyer directly. Mark-up financing and other variants of trade financing are by far the most popular instruments of financing for Islamic banks. ... First of all, PLS-transactions usually require a medium- to long-term involvement of the bank, whereas mark-up financing is essentially a short-term transaction, thus reducing the bank’s risks.