Islamic banking: The recent crisis and its aftermath
Friday, 22 April 2011
Afzalul Haq
This write-up is an endeavour to draw a portrait of the scenario of an offsite case study of Islamic banking in Bangladesh. At the very outset of the article let us have a look into some recent key events in the finance sector of Bangladesh since December 2010. Some highlights of the major events are: the interest rate in the call money market rising to more than 180 per cent; mad rush by banks to collect deposits at increasingly higher interest rates, even higher than the highest lending cap; intervention of the central bank by capping the highest interest rate on deposits; over-involvement of banks and their clients in the capital market which was directly attributable to be driven by greed; the stock market crash; and the subsequent interventions and bailout programmes. In principle, the money market and capital market should have their respective distinct features having separate regulators as well. However, both the banking and capital market operations may be involved in exclusive financial transactions i.e. transactions without real asset-backing which eventually may pave the way to create bubbles. All of the events above may therefore be the usual outcome of an interest-based economy. In the least, the aforesaid events are not an unlikely scenario under interest-based operations. Let us now look back at the recent global economic meltdown causing fall of many a 'too big to fall' financial organisations like AIG, Lehman Brothers, Merrill Lynch, Goldman Sachs, Morgan Stanley and so on. At the same time, we may parallely look into the position of Islamic Banking during that period. During that crisis, Islamic banking was globally proved to possess an auto-protective means against any deceiving bubble. It was as such considered a great and inherent quality thereof. This tone was also echoed even in the Vatican's comment on Islamic banking after the global financial meltdown that asset-backed Islamic Banking could be a better alternative to conventional mere debt financing. Naturally, what was expected in principle in our case i.e. under the scenario of December-2010, as portrayed above? It could be the time to show the nation that Islamic banking, as it is free from interest and other bubble generating factors, it must have another national milestone of reference of proof of a self-protected system. Thus, Islamic Banking could prove its immunity against national crisis (2010 -2011) vis-à-vis the international immunity as evident from the aftermath of the global financial meltdown since 2007. Unfortunately, the Islamic finance system as being practised in our country could not prove its inherent resilience in this 'acid test' as evident from recent events. Even after a lapse of two months following the severe liquidity crisis (of December, 2010) in the country, the Financial Express on February 21, 2011 reported that 24 private commercial banks out of 30 were yet to meet the safe Credit Deposit Ratio (CDR). Of the 24 banks, six were Islamic ones (out of seven Islamic Banks operating in the country). Both the systems ran beyond their means indulging in overinvestment or over-lending. Very reasonably the question is raised as to why the fate of running beyond means is similar for conventional and the Islamic banks? It is apprehended that at least many (not all) of them were also driven by the profiteering motive. They are now madly rushing for deposits, ceasing all new investments in the backdrop of the directive from the central bank to match the ratio (i.e. to bring business within the capacity). There are two ways to match the ratio, the CDR. As the delinquency resulted from over investment or excess lending, the first way is to call back the excess amount lent. The second way is to raise the deposit to the adequate level to support lent invested amount or to go for both the options simultaneously. The former becomes absurd or inadequate as no borrower is ready to instantly return the money already borrowed. So, collection of more deposits remains as the sole practical solution. As a result, rushing of many a bank at a time for more and more deposit made the market of deposit fund unhealthy and nasty. The banks' unlimited greed pushed themselves in a fix and they then started the venture to spread the contamination among the depositors. Some bankers pursued clients to withdraw their money from the existing bank and put the same in the respective pursuing banks with higher interest. The 'high and higher' competition pushed the market to indulge in unfair practices. Consequently, to fill in the huge deficit of deposits, conventional banks raised their interest rate on deposits even by more than 5.0 per cent above their prevailing rate. The rate of interest in such cases, as already stated, crossed 13 per cent, the usual highest cap of lending during that period. We are surprised that similar predetermined higher rate of profit is also being offered to the depositors by some Islamic Banks. The game still goes on. Then it becomes very difficult to find out the distinct feature of this profit and hence to differentiate the same from interest. People fail to identify the nature or virtue of Islamic banking in the eye of Shariah and the society as well. We are to take serious note of it. On the plea of market scenario (Interest-based call money market), unusual higher rate of profit is quoted by Islamic banks. This is done in the guise of so-called provisional (which is generally settled as final in any way) rate of profit on deposit, irrespective of earning from their utilization. We are afraid of it being interest. If we fail to get rid of interest, then what does Islamic banking signify? The higher the conventional banks pay as fixed interest, the higher the Islamic Banks pay as pre-determined profit. It is understood that this step is adopted to get rid of the misdeeds of greed-driven overinvestment, similarly committed by both the groups. But in principle, cost of deposit (i.e. profit paid by the bank thereon) in Islamic banking, unlike and certainly as opposed to conventional banking, must come out as the resultant output. It is an effect, nor cause or input. More clearly, it is always an aftermath of investment-income. The more the rate of investment income, the more would be the return on deposit and vice versa. How come the cost of deposit is pre-fixed, independent of or irrelevant to the income thereof? The cost of Mudaraba (profit-sharing) deposit being higher than the rate of investment-income is questionable. It is worth mentioning that operation of asset-products of Islamic Banking cannot, in most of the cases, transparently demonstrate the distinction between Islamic banking and the conventional one. Yes, a lot of reasons are there which make it difficult for Islamic banking to often explicitly demonstrate its distinction. Out of many such reasons, dominance of fixed-return based methods (Murabaha and Hire Purchase) over partnering (profit-sharing Mudaraba and Musharaka) methods, is the most important one. Fixed-return based Islamic banking modes make confusion among the stakeholders and as such the question of alikeness of profit and interest is raised by different quarters. Whereas, profit-sharing methods, by virtue of variable return, finds its way to transparently show the difference and the inherent beauty of Islamic banking as opposed to the predetermined fixed-rate. This is to be visible at least on the other side of balance sheet. On the liability side, particularly in the deposit mix of any Islamic bank of Bangladesh, there is substantial dominance of partnering (Mudaraba deposit) method. So, as far as the Mudaraba deposit product is concerned, the cost thereon (i.e. the rate of profit on Mudaraba deposit) must not be fixed or predetermined, it would rather be a dependent variable. To find the cost of deposit under Mudaraba contract, it needs a second tier calculation after arriving at an input i.e. income or revenue derived from deployment of the concerned deposit has to be worked out first. Thus, the cost of Mudaraba deposit, in Islamic banking, may be very transparently demonstrated as a function of investment income. The cost of deposit can visibly differentiate Islamic banking from its conventional counterpart. In conventional banking, it is a prefixed interest rate but in Islamic banking cost of deposit can never be an independent variable and as such must not be predetermined. A single characteristic of cost of Mudaraba deposit being the function of investment income can be the 'Radar' of Islamic banking. In Islamic banking, there should not be any undue occasion to raise the cost of deposit without referring the same to income. Showing any irrelevant and lame excuse in doing the same cannot be acceptable. In fact, unethically inflating the cost of deposit having no regard to the bank's investment income is nothing but a measure to hide the inefficiency or misdeeds of the management. The cost of inefficiency of the bankers, particularly those who claim to run on an ethical base, should not be shifted (on) to the other corners alike our political culture. Doing so would ultimately bring undue defame for the concept of Islamic banking which is now being misused by many. Again, Islamic banking is claimed to be a value-based and ethically guided operation, as derived after intensive screening from the 'modern banking' evolved through centuries. Islamic banking was supposed to be the 'real transaction', free from any artificial one and obviously interest free. Apart from the fundamental banking issue of interest (Riba) as prohibited in Islam, the share market issue has also become a highly talked about agendum in the realm of Islamic banking now-a-days. Our recent share market behaviour does not at all prove to maintain any fundamental and it seems not to be fair as well. Forget about bankers in general; we are surprised that Islamic bankers are also driven to such a speculative market. Over and above the legal permissibility, the question of ethical and moral base becomes very relevant here. We do not even understand the basis (Shariah mode) of capital market operations of different Islamic banks as is being done through their capital market units. Is the mechanism they follow in such operation permitted by Shariah? We understand that most of the participants of this market could not remain free from profiteering, which is against the spirit of Islamic banking. We apprehend that they were neither immune to the lust of sky-high profiteering nor were they protected to save themselves from the curse of interest. Irrational greed forced them into the ditch and now they are trying to come out, stepping on the ladder of interests. We must cautiously keep in mind that Islamic banks have a serious obligation to take care of the spirit of the pious depositors who, ignoring higher fixed interest rates, keep their money in Mudaraba accounts to have interest-free income. If Islamic bankers provide them with profit earning from the capital market or income corrupted owing to other wrong processes intruded into Islamic banking, is none responsible for that? There must be. We must admit that the absence of a structured Inter-Islamic Bank Money Market is substantially attributable to the situation which compelled some of Islamic banks to quote fixed profit rate. So, to get them rid of interest, it is a crying need to have our own money market for Islamic banking operators. It should also be the Islamic bankers, who should bell the cat for this purpose. No one else is supposed to initiate the job. On the other hand, we also understand that the bankers are service holders. Many of them are not in a position to take all decisions on exclusive ethical considerations. But we reiterate that they should have the capacity to make the higher management realise the fundamentals of Islamic banking. Although unfortunate, all the Islamic bankers cannot fully possess such competence. They rather succumb to the annual performance target. Bankers need do so for the sake of service, better position in the hierarchy, due to unhealthy market competition and the stakeholders' demand for profit etc. Only a few of them can trade off the situation by virtue of honesty, professionalism, skill, intelligence, personality and above all, the fear of Allah. All of us, who claim to be Islamic bankers, are not in a position to be equally committed. Under the circumstances stated above, there must be an independent and influential group of people who have the moral capacity to play a role to purify and save Islamic banking from distortion. Time has come to turn a mighty brake against distortions and misnomers, fallacy and even malpractice and abuse of Islamic banking. The divine vehicle is to be rescued from the wrong drivers, because failure of a system owing to the deviation for incompetence, wrongdoing and above all the infringement of the operators are regarded as the weakness or failure of the system or ideology itself. But how and who can save it from such distortions? Perhaps the most suitable group, in this case, may be the Shariah Council (of the respective Islamic banks, national or even global). The necessity and rationale for such a proposition is that it has been well established in the society that every Islamic bank has got a Shariah Council having a notion that all their activities are guided or at least supervised by the Council. Consequently, most of the blames, as stated, are tried to be shifted on to Shariah Councils. How? When the bankers fail to convince the client or any stakeholder that their activities are Islamic indeed, they straight refer the same to have been cleared by their Shariah Council. In fact, many an Islamic bank fulfils its desire keeping the yoke on the shoulder of the Shariah Council. Practically, the Shariah Councils are sometimes not even provided with adequate information and required clarification to reach a perfect decision. They are rather sometimes avoided to start a new product (of a bank) where objection is feared. As the Shariah Councils are associated with the Shariah clearance of any operations of Islamic banking, we must expect a bold stand from them. They remain in such a sovereign position that they can deliver suo-moto ruling that 'Such and such operations, in the name of the Islamic banking' are Islamic indeed or at all not Islamic and so on with suggestions or comments, if any. Such a brave declaration has now been inevitable because if none does so, perhaps we all shall be held responsible irrespective of Shariah Council member or the banker? We would also invite the attention of Bangladesh Bank, as the guardian of the banking industry to look into the matter. The central bank can intervene at least from the regulatory point of view; not to talk of the accountability beyond the purview of the worldly affairs. For the sake of uniformity, this noble function may also be organised by them (Bangladesh Bank) nationally. We do indicate that a national Shariah supervisory committee may be formed on behalf of Bangladesh Bank. The committee may comprise members from all the prominent schools of thoughts to be commensurate with the belief of the majority of our countrymen. All of that which has been written above is the repentance of the author who claims to belong to the Islamic banking industry of Bangladesh. This is an appeal to all concerned to show and guide us towards a way out. Let bygones be bygones and wait for His mercy and refine all our future action, to be conducted in the name of the heaven for the salvation here and hereafter. Let our conscience be awakened. The writer is the First Vice-President and Head of Islamic Banking of Bank Asia Ltd. He invites comment and feedback at afzal@bankasia.com.bd Opinions expressed in the article are exclusively of the writer himself and not necessarily of the organisation he is serving
This write-up is an endeavour to draw a portrait of the scenario of an offsite case study of Islamic banking in Bangladesh. At the very outset of the article let us have a look into some recent key events in the finance sector of Bangladesh since December 2010. Some highlights of the major events are: the interest rate in the call money market rising to more than 180 per cent; mad rush by banks to collect deposits at increasingly higher interest rates, even higher than the highest lending cap; intervention of the central bank by capping the highest interest rate on deposits; over-involvement of banks and their clients in the capital market which was directly attributable to be driven by greed; the stock market crash; and the subsequent interventions and bailout programmes. In principle, the money market and capital market should have their respective distinct features having separate regulators as well. However, both the banking and capital market operations may be involved in exclusive financial transactions i.e. transactions without real asset-backing which eventually may pave the way to create bubbles. All of the events above may therefore be the usual outcome of an interest-based economy. In the least, the aforesaid events are not an unlikely scenario under interest-based operations. Let us now look back at the recent global economic meltdown causing fall of many a 'too big to fall' financial organisations like AIG, Lehman Brothers, Merrill Lynch, Goldman Sachs, Morgan Stanley and so on. At the same time, we may parallely look into the position of Islamic Banking during that period. During that crisis, Islamic banking was globally proved to possess an auto-protective means against any deceiving bubble. It was as such considered a great and inherent quality thereof. This tone was also echoed even in the Vatican's comment on Islamic banking after the global financial meltdown that asset-backed Islamic Banking could be a better alternative to conventional mere debt financing. Naturally, what was expected in principle in our case i.e. under the scenario of December-2010, as portrayed above? It could be the time to show the nation that Islamic banking, as it is free from interest and other bubble generating factors, it must have another national milestone of reference of proof of a self-protected system. Thus, Islamic Banking could prove its immunity against national crisis (2010 -2011) vis-à-vis the international immunity as evident from the aftermath of the global financial meltdown since 2007. Unfortunately, the Islamic finance system as being practised in our country could not prove its inherent resilience in this 'acid test' as evident from recent events. Even after a lapse of two months following the severe liquidity crisis (of December, 2010) in the country, the Financial Express on February 21, 2011 reported that 24 private commercial banks out of 30 were yet to meet the safe Credit Deposit Ratio (CDR). Of the 24 banks, six were Islamic ones (out of seven Islamic Banks operating in the country). Both the systems ran beyond their means indulging in overinvestment or over-lending. Very reasonably the question is raised as to why the fate of running beyond means is similar for conventional and the Islamic banks? It is apprehended that at least many (not all) of them were also driven by the profiteering motive. They are now madly rushing for deposits, ceasing all new investments in the backdrop of the directive from the central bank to match the ratio (i.e. to bring business within the capacity). There are two ways to match the ratio, the CDR. As the delinquency resulted from over investment or excess lending, the first way is to call back the excess amount lent. The second way is to raise the deposit to the adequate level to support lent invested amount or to go for both the options simultaneously. The former becomes absurd or inadequate as no borrower is ready to instantly return the money already borrowed. So, collection of more deposits remains as the sole practical solution. As a result, rushing of many a bank at a time for more and more deposit made the market of deposit fund unhealthy and nasty. The banks' unlimited greed pushed themselves in a fix and they then started the venture to spread the contamination among the depositors. Some bankers pursued clients to withdraw their money from the existing bank and put the same in the respective pursuing banks with higher interest. The 'high and higher' competition pushed the market to indulge in unfair practices. Consequently, to fill in the huge deficit of deposits, conventional banks raised their interest rate on deposits even by more than 5.0 per cent above their prevailing rate. The rate of interest in such cases, as already stated, crossed 13 per cent, the usual highest cap of lending during that period. We are surprised that similar predetermined higher rate of profit is also being offered to the depositors by some Islamic Banks. The game still goes on. Then it becomes very difficult to find out the distinct feature of this profit and hence to differentiate the same from interest. People fail to identify the nature or virtue of Islamic banking in the eye of Shariah and the society as well. We are to take serious note of it. On the plea of market scenario (Interest-based call money market), unusual higher rate of profit is quoted by Islamic banks. This is done in the guise of so-called provisional (which is generally settled as final in any way) rate of profit on deposit, irrespective of earning from their utilization. We are afraid of it being interest. If we fail to get rid of interest, then what does Islamic banking signify? The higher the conventional banks pay as fixed interest, the higher the Islamic Banks pay as pre-determined profit. It is understood that this step is adopted to get rid of the misdeeds of greed-driven overinvestment, similarly committed by both the groups. But in principle, cost of deposit (i.e. profit paid by the bank thereon) in Islamic banking, unlike and certainly as opposed to conventional banking, must come out as the resultant output. It is an effect, nor cause or input. More clearly, it is always an aftermath of investment-income. The more the rate of investment income, the more would be the return on deposit and vice versa. How come the cost of deposit is pre-fixed, independent of or irrelevant to the income thereof? The cost of Mudaraba (profit-sharing) deposit being higher than the rate of investment-income is questionable. It is worth mentioning that operation of asset-products of Islamic Banking cannot, in most of the cases, transparently demonstrate the distinction between Islamic banking and the conventional one. Yes, a lot of reasons are there which make it difficult for Islamic banking to often explicitly demonstrate its distinction. Out of many such reasons, dominance of fixed-return based methods (Murabaha and Hire Purchase) over partnering (profit-sharing Mudaraba and Musharaka) methods, is the most important one. Fixed-return based Islamic banking modes make confusion among the stakeholders and as such the question of alikeness of profit and interest is raised by different quarters. Whereas, profit-sharing methods, by virtue of variable return, finds its way to transparently show the difference and the inherent beauty of Islamic banking as opposed to the predetermined fixed-rate. This is to be visible at least on the other side of balance sheet. On the liability side, particularly in the deposit mix of any Islamic bank of Bangladesh, there is substantial dominance of partnering (Mudaraba deposit) method. So, as far as the Mudaraba deposit product is concerned, the cost thereon (i.e. the rate of profit on Mudaraba deposit) must not be fixed or predetermined, it would rather be a dependent variable. To find the cost of deposit under Mudaraba contract, it needs a second tier calculation after arriving at an input i.e. income or revenue derived from deployment of the concerned deposit has to be worked out first. Thus, the cost of Mudaraba deposit, in Islamic banking, may be very transparently demonstrated as a function of investment income. The cost of deposit can visibly differentiate Islamic banking from its conventional counterpart. In conventional banking, it is a prefixed interest rate but in Islamic banking cost of deposit can never be an independent variable and as such must not be predetermined. A single characteristic of cost of Mudaraba deposit being the function of investment income can be the 'Radar' of Islamic banking. In Islamic banking, there should not be any undue occasion to raise the cost of deposit without referring the same to income. Showing any irrelevant and lame excuse in doing the same cannot be acceptable. In fact, unethically inflating the cost of deposit having no regard to the bank's investment income is nothing but a measure to hide the inefficiency or misdeeds of the management. The cost of inefficiency of the bankers, particularly those who claim to run on an ethical base, should not be shifted (on) to the other corners alike our political culture. Doing so would ultimately bring undue defame for the concept of Islamic banking which is now being misused by many. Again, Islamic banking is claimed to be a value-based and ethically guided operation, as derived after intensive screening from the 'modern banking' evolved through centuries. Islamic banking was supposed to be the 'real transaction', free from any artificial one and obviously interest free. Apart from the fundamental banking issue of interest (Riba) as prohibited in Islam, the share market issue has also become a highly talked about agendum in the realm of Islamic banking now-a-days. Our recent share market behaviour does not at all prove to maintain any fundamental and it seems not to be fair as well. Forget about bankers in general; we are surprised that Islamic bankers are also driven to such a speculative market. Over and above the legal permissibility, the question of ethical and moral base becomes very relevant here. We do not even understand the basis (Shariah mode) of capital market operations of different Islamic banks as is being done through their capital market units. Is the mechanism they follow in such operation permitted by Shariah? We understand that most of the participants of this market could not remain free from profiteering, which is against the spirit of Islamic banking. We apprehend that they were neither immune to the lust of sky-high profiteering nor were they protected to save themselves from the curse of interest. Irrational greed forced them into the ditch and now they are trying to come out, stepping on the ladder of interests. We must cautiously keep in mind that Islamic banks have a serious obligation to take care of the spirit of the pious depositors who, ignoring higher fixed interest rates, keep their money in Mudaraba accounts to have interest-free income. If Islamic bankers provide them with profit earning from the capital market or income corrupted owing to other wrong processes intruded into Islamic banking, is none responsible for that? There must be. We must admit that the absence of a structured Inter-Islamic Bank Money Market is substantially attributable to the situation which compelled some of Islamic banks to quote fixed profit rate. So, to get them rid of interest, it is a crying need to have our own money market for Islamic banking operators. It should also be the Islamic bankers, who should bell the cat for this purpose. No one else is supposed to initiate the job. On the other hand, we also understand that the bankers are service holders. Many of them are not in a position to take all decisions on exclusive ethical considerations. But we reiterate that they should have the capacity to make the higher management realise the fundamentals of Islamic banking. Although unfortunate, all the Islamic bankers cannot fully possess such competence. They rather succumb to the annual performance target. Bankers need do so for the sake of service, better position in the hierarchy, due to unhealthy market competition and the stakeholders' demand for profit etc. Only a few of them can trade off the situation by virtue of honesty, professionalism, skill, intelligence, personality and above all, the fear of Allah. All of us, who claim to be Islamic bankers, are not in a position to be equally committed. Under the circumstances stated above, there must be an independent and influential group of people who have the moral capacity to play a role to purify and save Islamic banking from distortion. Time has come to turn a mighty brake against distortions and misnomers, fallacy and even malpractice and abuse of Islamic banking. The divine vehicle is to be rescued from the wrong drivers, because failure of a system owing to the deviation for incompetence, wrongdoing and above all the infringement of the operators are regarded as the weakness or failure of the system or ideology itself. But how and who can save it from such distortions? Perhaps the most suitable group, in this case, may be the Shariah Council (of the respective Islamic banks, national or even global). The necessity and rationale for such a proposition is that it has been well established in the society that every Islamic bank has got a Shariah Council having a notion that all their activities are guided or at least supervised by the Council. Consequently, most of the blames, as stated, are tried to be shifted on to Shariah Councils. How? When the bankers fail to convince the client or any stakeholder that their activities are Islamic indeed, they straight refer the same to have been cleared by their Shariah Council. In fact, many an Islamic bank fulfils its desire keeping the yoke on the shoulder of the Shariah Council. Practically, the Shariah Councils are sometimes not even provided with adequate information and required clarification to reach a perfect decision. They are rather sometimes avoided to start a new product (of a bank) where objection is feared. As the Shariah Councils are associated with the Shariah clearance of any operations of Islamic banking, we must expect a bold stand from them. They remain in such a sovereign position that they can deliver suo-moto ruling that 'Such and such operations, in the name of the Islamic banking' are Islamic indeed or at all not Islamic and so on with suggestions or comments, if any. Such a brave declaration has now been inevitable because if none does so, perhaps we all shall be held responsible irrespective of Shariah Council member or the banker? We would also invite the attention of Bangladesh Bank, as the guardian of the banking industry to look into the matter. The central bank can intervene at least from the regulatory point of view; not to talk of the accountability beyond the purview of the worldly affairs. For the sake of uniformity, this noble function may also be organised by them (Bangladesh Bank) nationally. We do indicate that a national Shariah supervisory committee may be formed on behalf of Bangladesh Bank. The committee may comprise members from all the prominent schools of thoughts to be commensurate with the belief of the majority of our countrymen. All of that which has been written above is the repentance of the author who claims to belong to the Islamic banking industry of Bangladesh. This is an appeal to all concerned to show and guide us towards a way out. Let bygones be bygones and wait for His mercy and refine all our future action, to be conducted in the name of the heaven for the salvation here and hereafter. Let our conscience be awakened. The writer is the First Vice-President and Head of Islamic Banking of Bank Asia Ltd. He invites comment and feedback at afzal@bankasia.com.bd Opinions expressed in the article are exclusively of the writer himself and not necessarily of the organisation he is serving