Business between Islamic and conventional banks
Dr. M. Mizanur Rahman | Tuesday, 17 June 2008
BANK is a very old institution that is contributing to the development of an economy and is treated as an important service industry in modern world although its interest-based operations are in conflict with the Qur'anic injunction against usury. Interest-free banking had for some time been an idea talked about by many Muslims but it was not until the sixties that the idea was tried out in practice at the Mit Ghamr Savings Bank in Egypt. It was so successful that, since then, the Islamic banking framework has developed into a fully-fledged system, catering for all types of business requirements, virtually in all the Muslim countries as well as some western countries. It may be mentioned here that though this Islamic banking has started a couple of decades before but within this short time, Islamic institutions and instruments have developed in many countries across the world.
However, the West first laughed at the idea of doing banking without interest as totally unrealistic. Then, seeing that the first Islamic banks prospered, they watched cautiously, worried about their intentions. Gradually, perhaps owing to necessity in various circumstances, the two types of banks began to find ways of doing business with each other. Now, they not only co-operate, but many conventional western banks have also opened Islamic departments.
Islamic banks and financial institutions have now developed new instruments to deal in an interest-free manner with many if not almost all of the types of financing that conventional banks deal with, including consumer finance, housing finance, venture capital, equity finance, trade finance, barter and international syndication of trade finance.
Islamic banks are now an integral part of the banking system, not only in Islamic countries but also in the West, including the US. It is inconceivable that they should try to operate in isolation, disregarding conventional banks on the basis of the prohibition of interest in Islam. It is also inconceivable that conventional banks should disregard Islamic banks having regard to the share size of the global Muslim population, which in numerical terms comprises almost one-fifth of the world's population. Additionally, the volume of trade between Muslim countries and the rest of the world, but particularly between Muslim countries and The European Union, the United States and Japan, is such that whether or not it is desired by either party, conventional and Islamic banks are forced by circumstance to establish correspondent relationships.
It may be mentioned here that as these two types of banking system are based on two different fundamental bases (e.g., Islamic banking is profit-loss based, while conventional banking is interest-based), so Islamic bank can neither borrow from, nor invest any money in the conventional banks on interest basis. But, besides these types of business relationship, there is much scope for co-operation between the two, including correspondence services, foreign trade financing, co-financing of projects and lines of leasing. Temporary placing of funds with each other (other than on an interest basis) is unavoidable if an adequate supply of liquidity is to be ensured. The exchange of business information could also be very useful.
It would also help relations to have common training programmes for bank personnel in feasibility studies, accounting, auditing, supervising, monitoring, computer skills and communication techniques. The details are given below:
1. Correspondence services: Co-operation between Islamic banks and conventional banks exists in respect of all international and domestic bank transfers and even the collection of bills (except for discounting). The purchase and sale of travellers' cheques, issuing and acceptance of draft cheques, remittances to and from abroad and similar facilities can all be provided by Islamic banks.
For these purposes, Islamic banks are required to open interest-free operating accounts with their correspondent banks. Arrangements should be made that when these accounts are overdrawn, they do not bear interest as long as they keep within certain arranged margins. Any overdraft should be made up by immediate replenishment of the account.
Arrangements can also be made for a bank to act as a correspondent for another in areas where no branch of the other bank exists. Each of them opens an operating account with no creditor or debtor for interests and each will collect bills, drafts, cheques and remittances for the other or its customers. These services may be performed for an agreed commission.
2. Documentary credit:Islamic banks can open credit accounts with other banks and use them for importing commodities from another country when there is no Islamic bank in the exporting country or when the supplier wants to open an account at a certain bank.
An Islamic bank may ask a correspondent bank to add its confirmation to letters of credit opened on behalf of foreign suppliers to importers. It would keep a surplus in its account with the correspondent bank to cover their obligation to the supplier. In this regard, there are certain considerations to be taken into account.
i) The Islamic bank should not delay the transfer of the value of documentary credits to a correspondent bank abroad, to save the latter from being charged interest.
ii) Import business conducted by an Islamic bank should not involve facilities for payment on the part of suppliers in return for interest because this procedure often entails drawing guaranteed drafts on importers for the benefit of suppliers, which does not comply with the nature of Islamic banks. Foreign banks may accept dealings with Islamic banks on the basis of agreements made by a simple exchange of letters giving the latter facilities up to an agreed ceiling without charging interest should the account go into the red. In return, Islamic banks agree to keep a reasonable amount of cash in their accounts and cover any debit as soon as possible.
As partial security, the correspondent bank, on adding its confirmation, debits the Islamic bank with a certain cash margin. Thus, Islamic banks need only keep a sufficient balance in the correspondent bank's account to cover the cash margin of the letters of credit and not the whole value of these letters.
3. Exchange of funds between Islamic and conventional banks Exchange of funds between Islamic and conventional banks without involving interest may take the following forms:
i) Islamic banks accept funds on the basis of mudarabah from conventional banks in the form of an investment account with a return calculated according to the yield of the investment pool. Such a return will be the same as the one paid by Islamic banks to their clients.
ii) Where an Islamic bank has surplus funds of one currency but is in need of funds in another, it can conduct a barter arrangement with a conventional bank. A deposit is made of the surplus currency in return for the same sum in the needed currency over an agreed period and either side charges no interest. At the end of the agreed period, each bank restores its original funds.
iii) Financial co-operation can also take place in the area of joint financing on the basis of musharakah, leasing, lines of leasing, and hire purchase. Many Western banks in the Middle East have interest-free services and can finance hire purchase and leasing arrangements jointly with Islamic banks. Joint equity participation is possible to the extent that the conventional bank is willing to share the risk. A conventional bank could consider providing part of the share capital to establish an Islamic bank or augment its resources. However, the OlC Fiqh Academy has not approved the taking up of the equity of interest-based institutions, companies or firms by Islamic banks. As a matter of fact, co-operation between Islamic banks and conventional institutions in the area of financial co-operation is no longer a matter of speculation; rather it is a reality and now these two types of banks have transactions worth billions and trillions of dollars across the world.
4. Exchange of information :Islamic banks, being, by their nature, more involved in monitoring of their client's businesses than their conventional counterparts, are in a position to provide the latter with reliable information about the study of projects and the track records of individuals and companies. Equally, a client who applies for funds to an Islamic bank may have an account at a conventional bank, to which the former may want to apply for details about his reputation, experience and financial details. It is obviously mutually beneficial to all banks to co-operate on these matters.
5. Associations, syndicates and societies: All Islamic banks should have representatives in banking associations and societies that will be of benefit to them in keeping them in touch with what is going on in banking circles in general. Through periodicals and circulars, Islamic banks will hear of national and international events that will affect their own business and decision-making.
Such associations and societies arrange meetings where banking problems can be discussed and solved and officers from Islamic banks should be encouraged to participate actively in these meetings. They are the ideal places for acquainting people from conventional banks with information about how Islamic banks serve the national economy by doing business in accordance with the injunctions of the shari'ah.
6. Training programmes for bank personnel: The conventional banking sector backed by 200 years of history undoubtedly has a vast amount of skills and knowledge that may be useful to Islamic banks and financial institutions. The transfer of this knowledge and these skills is not without benefit to conventional bankers. In the final analysis, co-operation with Islamic banks is a viable economic proposition for conventional banks. Not only can they charge for the educational service, but association with Islamic banks can add value to the product of conventional banks operating in Islamic environments, where the populations do not have any significantly different consumer taste than their western counterparts.
Islamic banks should participate with conventional banks in training programmes for their personnel. Such programmes may be arranged by banking societies, universities or training centres. As well as becoming familiar with conventional banking methods, they will be able to inform the conventional banking personnel about Islamic methods and such mutual knowledge will pave the way for smooth co-operation later.
In addition, Islamic banks will want to set up their own training programmes to give their personnel a deeper understanding of the concept of Islamic banking so that they may put it into operation in their work. Conventional banking personnel may be invited to these sessions to make them familiar with the way Islamic banks work, which, again, will pave the way for co-operation when the need for it arises.
Therefore, it may be concluded here that there are hundreds of Islamic and conventional financial institutions which have made relationship with each other for developing correspondence both at the national and international levels. This relationship made the Islamic bank a successful institution across the world only in three decades' time. This growth in the Islamic market has become a challenge to both sides and increasing competition has made further co-operation desirable for the banking system as a whole.
The writer is an economist and researcher. He can be reached at email: mizan12bd@gmail.com
However, the West first laughed at the idea of doing banking without interest as totally unrealistic. Then, seeing that the first Islamic banks prospered, they watched cautiously, worried about their intentions. Gradually, perhaps owing to necessity in various circumstances, the two types of banks began to find ways of doing business with each other. Now, they not only co-operate, but many conventional western banks have also opened Islamic departments.
Islamic banks and financial institutions have now developed new instruments to deal in an interest-free manner with many if not almost all of the types of financing that conventional banks deal with, including consumer finance, housing finance, venture capital, equity finance, trade finance, barter and international syndication of trade finance.
Islamic banks are now an integral part of the banking system, not only in Islamic countries but also in the West, including the US. It is inconceivable that they should try to operate in isolation, disregarding conventional banks on the basis of the prohibition of interest in Islam. It is also inconceivable that conventional banks should disregard Islamic banks having regard to the share size of the global Muslim population, which in numerical terms comprises almost one-fifth of the world's population. Additionally, the volume of trade between Muslim countries and the rest of the world, but particularly between Muslim countries and The European Union, the United States and Japan, is such that whether or not it is desired by either party, conventional and Islamic banks are forced by circumstance to establish correspondent relationships.
It may be mentioned here that as these two types of banking system are based on two different fundamental bases (e.g., Islamic banking is profit-loss based, while conventional banking is interest-based), so Islamic bank can neither borrow from, nor invest any money in the conventional banks on interest basis. But, besides these types of business relationship, there is much scope for co-operation between the two, including correspondence services, foreign trade financing, co-financing of projects and lines of leasing. Temporary placing of funds with each other (other than on an interest basis) is unavoidable if an adequate supply of liquidity is to be ensured. The exchange of business information could also be very useful.
It would also help relations to have common training programmes for bank personnel in feasibility studies, accounting, auditing, supervising, monitoring, computer skills and communication techniques. The details are given below:
1. Correspondence services: Co-operation between Islamic banks and conventional banks exists in respect of all international and domestic bank transfers and even the collection of bills (except for discounting). The purchase and sale of travellers' cheques, issuing and acceptance of draft cheques, remittances to and from abroad and similar facilities can all be provided by Islamic banks.
For these purposes, Islamic banks are required to open interest-free operating accounts with their correspondent banks. Arrangements should be made that when these accounts are overdrawn, they do not bear interest as long as they keep within certain arranged margins. Any overdraft should be made up by immediate replenishment of the account.
Arrangements can also be made for a bank to act as a correspondent for another in areas where no branch of the other bank exists. Each of them opens an operating account with no creditor or debtor for interests and each will collect bills, drafts, cheques and remittances for the other or its customers. These services may be performed for an agreed commission.
2. Documentary credit:Islamic banks can open credit accounts with other banks and use them for importing commodities from another country when there is no Islamic bank in the exporting country or when the supplier wants to open an account at a certain bank.
An Islamic bank may ask a correspondent bank to add its confirmation to letters of credit opened on behalf of foreign suppliers to importers. It would keep a surplus in its account with the correspondent bank to cover their obligation to the supplier. In this regard, there are certain considerations to be taken into account.
i) The Islamic bank should not delay the transfer of the value of documentary credits to a correspondent bank abroad, to save the latter from being charged interest.
ii) Import business conducted by an Islamic bank should not involve facilities for payment on the part of suppliers in return for interest because this procedure often entails drawing guaranteed drafts on importers for the benefit of suppliers, which does not comply with the nature of Islamic banks. Foreign banks may accept dealings with Islamic banks on the basis of agreements made by a simple exchange of letters giving the latter facilities up to an agreed ceiling without charging interest should the account go into the red. In return, Islamic banks agree to keep a reasonable amount of cash in their accounts and cover any debit as soon as possible.
As partial security, the correspondent bank, on adding its confirmation, debits the Islamic bank with a certain cash margin. Thus, Islamic banks need only keep a sufficient balance in the correspondent bank's account to cover the cash margin of the letters of credit and not the whole value of these letters.
3. Exchange of funds between Islamic and conventional banks Exchange of funds between Islamic and conventional banks without involving interest may take the following forms:
i) Islamic banks accept funds on the basis of mudarabah from conventional banks in the form of an investment account with a return calculated according to the yield of the investment pool. Such a return will be the same as the one paid by Islamic banks to their clients.
ii) Where an Islamic bank has surplus funds of one currency but is in need of funds in another, it can conduct a barter arrangement with a conventional bank. A deposit is made of the surplus currency in return for the same sum in the needed currency over an agreed period and either side charges no interest. At the end of the agreed period, each bank restores its original funds.
iii) Financial co-operation can also take place in the area of joint financing on the basis of musharakah, leasing, lines of leasing, and hire purchase. Many Western banks in the Middle East have interest-free services and can finance hire purchase and leasing arrangements jointly with Islamic banks. Joint equity participation is possible to the extent that the conventional bank is willing to share the risk. A conventional bank could consider providing part of the share capital to establish an Islamic bank or augment its resources. However, the OlC Fiqh Academy has not approved the taking up of the equity of interest-based institutions, companies or firms by Islamic banks. As a matter of fact, co-operation between Islamic banks and conventional institutions in the area of financial co-operation is no longer a matter of speculation; rather it is a reality and now these two types of banks have transactions worth billions and trillions of dollars across the world.
4. Exchange of information :Islamic banks, being, by their nature, more involved in monitoring of their client's businesses than their conventional counterparts, are in a position to provide the latter with reliable information about the study of projects and the track records of individuals and companies. Equally, a client who applies for funds to an Islamic bank may have an account at a conventional bank, to which the former may want to apply for details about his reputation, experience and financial details. It is obviously mutually beneficial to all banks to co-operate on these matters.
5. Associations, syndicates and societies: All Islamic banks should have representatives in banking associations and societies that will be of benefit to them in keeping them in touch with what is going on in banking circles in general. Through periodicals and circulars, Islamic banks will hear of national and international events that will affect their own business and decision-making.
Such associations and societies arrange meetings where banking problems can be discussed and solved and officers from Islamic banks should be encouraged to participate actively in these meetings. They are the ideal places for acquainting people from conventional banks with information about how Islamic banks serve the national economy by doing business in accordance with the injunctions of the shari'ah.
6. Training programmes for bank personnel: The conventional banking sector backed by 200 years of history undoubtedly has a vast amount of skills and knowledge that may be useful to Islamic banks and financial institutions. The transfer of this knowledge and these skills is not without benefit to conventional bankers. In the final analysis, co-operation with Islamic banks is a viable economic proposition for conventional banks. Not only can they charge for the educational service, but association with Islamic banks can add value to the product of conventional banks operating in Islamic environments, where the populations do not have any significantly different consumer taste than their western counterparts.
Islamic banks should participate with conventional banks in training programmes for their personnel. Such programmes may be arranged by banking societies, universities or training centres. As well as becoming familiar with conventional banking methods, they will be able to inform the conventional banking personnel about Islamic methods and such mutual knowledge will pave the way for smooth co-operation later.
In addition, Islamic banks will want to set up their own training programmes to give their personnel a deeper understanding of the concept of Islamic banking so that they may put it into operation in their work. Conventional banking personnel may be invited to these sessions to make them familiar with the way Islamic banks work, which, again, will pave the way for co-operation when the need for it arises.
Therefore, it may be concluded here that there are hundreds of Islamic and conventional financial institutions which have made relationship with each other for developing correspondence both at the national and international levels. This relationship made the Islamic bank a successful institution across the world only in three decades' time. This growth in the Islamic market has become a challenge to both sides and increasing competition has made further co-operation desirable for the banking system as a whole.
The writer is an economist and researcher. He can be reached at email: mizan12bd@gmail.com