Islamic banking as an alternative approach: basis and legal framework
Friday, 23 April 2010
S. M. Abu Zaker
Now-a-days, Islamic banking is one of the fastest growing industries in the world. Large western multinational banks such as Standard Chartered Bank, Citibank NA, HSBC, Barclays have started Islamic modes of financing to diversify their large client base. This implies that the Islamic banking system is becoming increasingly accepted.
What is Islamic Bank? Accordingly OIC Islami Bank is a financial institution whose statutes, rules and procedures expressly states its commitment to the principles of Islamic Shariah and to the banning of the receipt and payment of riba (usury) on any of its operations.
According to International Association of Islamic Banks, "The Islamic bank basically implements a new banking concept, in that it adheres strictly to the ruling of the Islamic Shariah in the fields of finance and other dealings.
Islamic Bank runs on some basic concept derived from Qur-an and Sunnah some of which are noted below:
a) One of the most important characteristics of Islamic Financing is that it is an asset-backed financing while the conventional / capitalized concept of financing is that the banks and financial institutions deal in money and monetary papers. On the other hand, Islam does not recognise money as a subject-matter of trade, excepting in some special cases. Money has no intrinsic utility; it is only a medium of exchange.
b) The profit earned through dealing in money (of the same currency) or the papers representing them is interest, hence prohibited.
c) When the financer contributes money on the basis of Musharaka and Mudarabah, Salam, Istisna, Murabaha it is either converted into the assets having intrinsic utility, or creates real assets. Profits are generated through the sale (or rental) of these real assets.
d) Islamic law does not object to payment for the use of an asset, and the earning of profits or returns from assets are indeed encouraged as long as both lender and borrower share the investment risk together.
e) The 'depositors' are not lenders or creditors; but rather they are investors.
f) Profit must not be guaranteed based on assumption and can only accrue if the investment itself yields income.
The total size of the Islamic banking industry is currently estimated to be USD 800 billion to USD 1 trillion (or according to one estimate it will be USD 1.6 trillion by the year 2010) and an estimated global potential of USD 4 trillion.
Growth rate of Islamic banking is 15% - 20% per annum (in some Region it is somewhere around 25% to 30%). With in next 8-10 years, the Islamic banking industry is estimated to capture half of the Savings of the world's 1.6 billion Muslims. There are estimated more than 300 Islamic Financial Institutions having about 10000 branches in many countries including Malaysia, Pakistan, UAE, Egypt, Dubai, Brunei, Indonesia, Lebanon, Bahrain, Kuwait, Iran, Jordan, Saudi Arabia, Bangladesh etc. Non-Muslim country includes Singapore, the Philippines, Thailand, Sri Lanka, USA, UK, France etc.
As Islamic Banking has become a part of mainstream banking in Bangladesh, Bangladesh Bank, at last promulgated Guidelines for Islamic Banking through BRPD circular No. 15, dated 09 November 2009. By this circular Islamic banks have got a legal framework as well as recognition by Bangladesh Bank as well as Government of Bangladesh.
Though Bangladesh Bank has permitted Islami Bank of Bangladesh Ltd to carry on the banking business with Shariah Principle in 1983, there was no legal framework under which Islamic banking business can run independently. Meantime, seven banks have obtained permission from Bangladesh Bank to conduct Islamic banking business, such as Islami Bank Bangladesh Ltd, Al-Arafah Islami Bank Ltd, Social Islami Bank Ltd., Shahjalal Islami Bank Ltd., Export Import Bank of Bangladesh Ltd. and First Security Islamic Bank Ltd. Apart from that some conventional banks have got permission to open Islamic Banking Branches / Windows / Subsidiary such as Prime Bank Ltd, Dhaka Bank Ltd, Southeast Bank Ltd, The Premier Bank Ltd, Jamuna Bank Ltd, HSBC, Standard Chartered Bank, The City Bank Ltd, and AB Bank Ltd.
There are some limitations of the guideline. These are:
a). Regarding formation of Shariah Council in Section-III of the guideline it is embodied that "The Board may form an independent Shariah Supervisory Committee with experience and knowledgeable persons in Islamic Jurisprudence ". By using 'may' it has not been compulsory to form 'Shariah Council'. In this regard we like to quote from comments of expert of Islamic Banking: "An Islamic Bank does not only have to have a Board of Directors, but it also has to have a Shariah Advisory Board. This is most important where Islamic Bank operate in a society, which does not fully apply Shariah laws. The board shall posses a high degree of independence both internally and externally". So, the formation of Shariah Board must be mandatory.
b). Regarding profit sharing ratio (PSR) in appendix-III of the guideline it is mentioned that "Profit Sharing Ratio (PSR) between the Mudaraba depositors and the bank (Mudarib) should be declared before the starting of accounting year / at the time of Mudaraba Contract and to be duly disclosed to the Mudaraba Depositors".
To determine the obligation to the depositors the profit sharing ratio should not be flexible. In this regard Bangladesh Bank can set the profit sharing ratio like SLR and CRR. In Malaysia the profit sharing ratio is 70:30 which means that 70% of total income of the bank to be distributed to the Mudaraba depositors. In Bangladesh, different Islamic banks declare different profit sharing ratio. For the sake of depositors Bangladesh Bank can fix the profit sharing ratio, so that no bank can deprive the depositors.
c). Except Izara Bill Baia Investment, Islamic banks apply mark-up profit on investment account as per agreed rate of profit during disbursement of investment. That is why the figure of total investment in General Ledger carries the actual investment plus mark-up. As a result the figure of investment of Islamic Bank appears to be inflated than the outstanding actual investment. Due to inflated investment amount Islamic bank faces inconvenience in meeting capital Adequacy ratio and other obligation of Bangladesh Bank. As such, the "Investment" item under specimen of Balance Sheet (Appendix-II) of said Guidelines should be "Investments (without Mark-up)".
d). Profit earned after the expiry of investment deal cannot be transferred in to income account as per Shariah principle. The said profit is treated as compensation. The bonafide use of the compensation money (if realized later on) should be clarified.
e). In the guidelines there is a provision for the conventional banks to obtain licence for opening Islamic Banking Branch(s). Actually, it is impossible to separate the fund of Islamic banking branch. In case of transaction in General Account the fund cannot be segregated. Moreover, if the said Islamic banking branch does not deploy the fund in investment financing, the depositors may be deprived remarkably. Moreover, dual policy in same bank can create mistrust of customers of Islamic banking branch on the principle of Shariah. So, dual principle policy should not be encouraged.
f). In case of Bai-Muazzal & Bai-Murabaha, generally a deal is allowed for a maximum period of one year. Some times the borrowers ask for time more than one year for adjustment of the deal. In such case a banker can not allow (though Shariah does not object) time more than one year as existing regulation of Bangladesh Bank does not permit to allow continuous credit for more than one year. Moreover, some times before expiry of a deal (say one year) the borrower request the banker to extend validity period for justified reason. In that case under prevailing system a banker cannot extend the validity as the mark-up meanwhile has been exhausted. To cope with the situation of a bonafide borrower there should be certain clarification in the guidelines of Bangladesh Bank.
g). In case of conventional banking, outstanding amount of a continuous credit (investment) must be adjusted before expiry of the sanctioned limit. Accordingly any amount appears after the date of expiry is treated as overdue. But in case of shariah based banking a customer can take disbursement even one day before the date of expiry for a period of one year. As a validity of a deal is one year from the date of disbursement, a customer can enjoy it up to almost one year after the date of expiry of the sanctioned limit. It should have been enumerated said procedure in the guideline in question to eliminate misunderstanding about the overdue criteria.
As Malaysia has established complete modern Islamic banking, most of the countries intending to establish Islamic banking are seeking policy and technical support from Malaysia. As Bangladesh has got a long experience in Islamic banking, Bangladesh can also play a vital role in the development of Islamic banking in the world. So, we must give more attention to the system to develop and upgrade the system with in the purview of Qur-aan & Sunnah.
(The writer is Vice president and Manager of EXIM Bank, Jubilee Road branch, Chittagong.)
Now-a-days, Islamic banking is one of the fastest growing industries in the world. Large western multinational banks such as Standard Chartered Bank, Citibank NA, HSBC, Barclays have started Islamic modes of financing to diversify their large client base. This implies that the Islamic banking system is becoming increasingly accepted.
What is Islamic Bank? Accordingly OIC Islami Bank is a financial institution whose statutes, rules and procedures expressly states its commitment to the principles of Islamic Shariah and to the banning of the receipt and payment of riba (usury) on any of its operations.
According to International Association of Islamic Banks, "The Islamic bank basically implements a new banking concept, in that it adheres strictly to the ruling of the Islamic Shariah in the fields of finance and other dealings.
Islamic Bank runs on some basic concept derived from Qur-an and Sunnah some of which are noted below:
a) One of the most important characteristics of Islamic Financing is that it is an asset-backed financing while the conventional / capitalized concept of financing is that the banks and financial institutions deal in money and monetary papers. On the other hand, Islam does not recognise money as a subject-matter of trade, excepting in some special cases. Money has no intrinsic utility; it is only a medium of exchange.
b) The profit earned through dealing in money (of the same currency) or the papers representing them is interest, hence prohibited.
c) When the financer contributes money on the basis of Musharaka and Mudarabah, Salam, Istisna, Murabaha it is either converted into the assets having intrinsic utility, or creates real assets. Profits are generated through the sale (or rental) of these real assets.
d) Islamic law does not object to payment for the use of an asset, and the earning of profits or returns from assets are indeed encouraged as long as both lender and borrower share the investment risk together.
e) The 'depositors' are not lenders or creditors; but rather they are investors.
f) Profit must not be guaranteed based on assumption and can only accrue if the investment itself yields income.
The total size of the Islamic banking industry is currently estimated to be USD 800 billion to USD 1 trillion (or according to one estimate it will be USD 1.6 trillion by the year 2010) and an estimated global potential of USD 4 trillion.
Growth rate of Islamic banking is 15% - 20% per annum (in some Region it is somewhere around 25% to 30%). With in next 8-10 years, the Islamic banking industry is estimated to capture half of the Savings of the world's 1.6 billion Muslims. There are estimated more than 300 Islamic Financial Institutions having about 10000 branches in many countries including Malaysia, Pakistan, UAE, Egypt, Dubai, Brunei, Indonesia, Lebanon, Bahrain, Kuwait, Iran, Jordan, Saudi Arabia, Bangladesh etc. Non-Muslim country includes Singapore, the Philippines, Thailand, Sri Lanka, USA, UK, France etc.
As Islamic Banking has become a part of mainstream banking in Bangladesh, Bangladesh Bank, at last promulgated Guidelines for Islamic Banking through BRPD circular No. 15, dated 09 November 2009. By this circular Islamic banks have got a legal framework as well as recognition by Bangladesh Bank as well as Government of Bangladesh.
Though Bangladesh Bank has permitted Islami Bank of Bangladesh Ltd to carry on the banking business with Shariah Principle in 1983, there was no legal framework under which Islamic banking business can run independently. Meantime, seven banks have obtained permission from Bangladesh Bank to conduct Islamic banking business, such as Islami Bank Bangladesh Ltd, Al-Arafah Islami Bank Ltd, Social Islami Bank Ltd., Shahjalal Islami Bank Ltd., Export Import Bank of Bangladesh Ltd. and First Security Islamic Bank Ltd. Apart from that some conventional banks have got permission to open Islamic Banking Branches / Windows / Subsidiary such as Prime Bank Ltd, Dhaka Bank Ltd, Southeast Bank Ltd, The Premier Bank Ltd, Jamuna Bank Ltd, HSBC, Standard Chartered Bank, The City Bank Ltd, and AB Bank Ltd.
There are some limitations of the guideline. These are:
a). Regarding formation of Shariah Council in Section-III of the guideline it is embodied that "The Board may form an independent Shariah Supervisory Committee with experience and knowledgeable persons in Islamic Jurisprudence ". By using 'may' it has not been compulsory to form 'Shariah Council'. In this regard we like to quote from comments of expert of Islamic Banking: "An Islamic Bank does not only have to have a Board of Directors, but it also has to have a Shariah Advisory Board. This is most important where Islamic Bank operate in a society, which does not fully apply Shariah laws. The board shall posses a high degree of independence both internally and externally". So, the formation of Shariah Board must be mandatory.
b). Regarding profit sharing ratio (PSR) in appendix-III of the guideline it is mentioned that "Profit Sharing Ratio (PSR) between the Mudaraba depositors and the bank (Mudarib) should be declared before the starting of accounting year / at the time of Mudaraba Contract and to be duly disclosed to the Mudaraba Depositors".
To determine the obligation to the depositors the profit sharing ratio should not be flexible. In this regard Bangladesh Bank can set the profit sharing ratio like SLR and CRR. In Malaysia the profit sharing ratio is 70:30 which means that 70% of total income of the bank to be distributed to the Mudaraba depositors. In Bangladesh, different Islamic banks declare different profit sharing ratio. For the sake of depositors Bangladesh Bank can fix the profit sharing ratio, so that no bank can deprive the depositors.
c). Except Izara Bill Baia Investment, Islamic banks apply mark-up profit on investment account as per agreed rate of profit during disbursement of investment. That is why the figure of total investment in General Ledger carries the actual investment plus mark-up. As a result the figure of investment of Islamic Bank appears to be inflated than the outstanding actual investment. Due to inflated investment amount Islamic bank faces inconvenience in meeting capital Adequacy ratio and other obligation of Bangladesh Bank. As such, the "Investment" item under specimen of Balance Sheet (Appendix-II) of said Guidelines should be "Investments (without Mark-up)".
d). Profit earned after the expiry of investment deal cannot be transferred in to income account as per Shariah principle. The said profit is treated as compensation. The bonafide use of the compensation money (if realized later on) should be clarified.
e). In the guidelines there is a provision for the conventional banks to obtain licence for opening Islamic Banking Branch(s). Actually, it is impossible to separate the fund of Islamic banking branch. In case of transaction in General Account the fund cannot be segregated. Moreover, if the said Islamic banking branch does not deploy the fund in investment financing, the depositors may be deprived remarkably. Moreover, dual policy in same bank can create mistrust of customers of Islamic banking branch on the principle of Shariah. So, dual principle policy should not be encouraged.
f). In case of Bai-Muazzal & Bai-Murabaha, generally a deal is allowed for a maximum period of one year. Some times the borrowers ask for time more than one year for adjustment of the deal. In such case a banker can not allow (though Shariah does not object) time more than one year as existing regulation of Bangladesh Bank does not permit to allow continuous credit for more than one year. Moreover, some times before expiry of a deal (say one year) the borrower request the banker to extend validity period for justified reason. In that case under prevailing system a banker cannot extend the validity as the mark-up meanwhile has been exhausted. To cope with the situation of a bonafide borrower there should be certain clarification in the guidelines of Bangladesh Bank.
g). In case of conventional banking, outstanding amount of a continuous credit (investment) must be adjusted before expiry of the sanctioned limit. Accordingly any amount appears after the date of expiry is treated as overdue. But in case of shariah based banking a customer can take disbursement even one day before the date of expiry for a period of one year. As a validity of a deal is one year from the date of disbursement, a customer can enjoy it up to almost one year after the date of expiry of the sanctioned limit. It should have been enumerated said procedure in the guideline in question to eliminate misunderstanding about the overdue criteria.
As Malaysia has established complete modern Islamic banking, most of the countries intending to establish Islamic banking are seeking policy and technical support from Malaysia. As Bangladesh has got a long experience in Islamic banking, Bangladesh can also play a vital role in the development of Islamic banking in the world. So, we must give more attention to the system to develop and upgrade the system with in the purview of Qur-aan & Sunnah.
(The writer is Vice president and Manager of EXIM Bank, Jubilee Road branch, Chittagong.)