There are an estimated 1.61 billion Muslims worldwide, making Islamic banking one of the fastest growing segments of the financial industry. Banks serving the Islamic population must comply with several very specific principles of Islamic law if they hope to retain existing customers and attract new ones. Banks must be ready with specialized products and services and they must put programs in place to train their personnel to support these products and services in order to exist in this competitive marketplace.
The basic principle of Islamic banking
follows the laws of Sharia, known as Fiqh al-Muamalat (Islamic rules on
transaction). The term "Islamic banking" is synonymous with
"full-reserve banking" and "Sharia-compliant banking." The
most prominent feature of these laws is usury - the prohibition of paying or
collecting interest on funds. The Islamic terminology for this is riba or
ribaa. The Sharia also forbids engagement in investments that include financial
unknowns such as buying and selling futures, as well as businesses that are
haraam - dealing in products that are contrary to Islamic law and values such
as alcohol, pork, gossip or pornography. These principles apply to all
individuals, companies and governments.
Banks that comply with Islamic law are
forbidden to charge interest or late payment fees, which is also considered a
type of riba. To minimize risk, banks will often require a large down payment
on goods and property, or insist upon large collateral. It is lawful for the
Bank to charge a higher price for a good if payments are deferred or collected
at a later date since it is considered a trade for goods rather than collecting
interest. Sharia-complaint banking products include Mudharabah (profit
sharing), Wadiah (safekeeping), Musharakah (joint venture), Murabahah (cost
plus) and Ijarah (leasing). Another way that banks work within Islamic laws
while trying to turn a profit is by buying an item that the customer wants, and
then selling the item to the customer at a higher price.
The Mudharabah is a partnership between an
entrepreneur and the bank. The bank is known as the rabal-maal and the
entrepreneur as the mudarib. The bank provides all of the necessary capital to
start a business and the entrepreneur does the work of managing the business.
Profits are split at an agreed ratio until the initial funds of the rabal-maal
are paid off. The rabal-maal is also compensated with additional funds based on
the profits of the business in terms previously agreed on. In the event that
the business folds, the rabal-maal shoulders the cost and the mudarib is not
compensated.
Musharakah is similar to Mudharabah, in
which an entrepreneur seeks funds for a business venture and pays the bank back
with a ratio of profits. However, there are often more than two parties who
contribute funds and become partners who can influence the business depending
on the amount of money invested. The entrepreneur also contributes funds and shares
in the risk. Any loss is proportional to the amount of capital invested in the
business.
Wadiah is a system in which a person
deposits money into a bank and receives a "gift" from the bank. The
bank is the keeper of the funds and will refund the entire amount at the demand
of the depositor. The bank rewards the amount of time the depositor keeps the
money in the bank with a hibah or gift, which is not guaranteed. The hibah is
similar to interest, but lawful according the Islamic law.
Murabaha governs the issuing of home loans
or any other type of goods needed by a borrower. An Islamic bank does not lend
money to a borrower to buy properties; rather, the bank will purchase the
property at the borrower's request at a freely disclosed price, and mark up the
price for the borrower to pay back, therefore making a profit from the
investment. The borrower is named on the title and allowed to utilize the
property immediately and pays the bank back in installments.
Another type of loan is the Ijara, in
which the bank buys the home or item and leases the property to the borrower
while retaining ownership of the property. The borrower can either use the
property for a pre-determined period of time, or pay off the purchase price and
buy out the Bank to attain full ownership of the property.
There are occasionally controversies
surrounding the interpretation of the riba, which certain scholars argue was
meant to prevent petty money-lenders from abusing borrowers, rather than a
modern bank charging a reasonable, agreed upon interest. The general consensus,
however, is that any interest is a direct violation of the law of Sharia and
therefore unethical.
While each Islamic bank has its own board
which rules on ethical banking principals, Islamic banking organizations have
been establishing standard regulations and policies. The Islamic Development
Bank has been working on international standards, policies and procedures, and
the Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI), Islamic Finance Service Board (IFSB), International Islamic Financial
Market, Liquidity Management Center and International Islamic Rating Agency are
in development to ensure accurate and fair banking practices.
Today, Islamic financial institutions
exist worldwide, participating in the $180 billion/day industry. In 1975 there
was one Islamic bank; today there are over 300 in more than 75 countries.
Islamic banks have become more prevalent worldwide and can be found in high
numbers in such countries as Indonesia, Pakistan, Bangladesh, Nigeria, Egypt,
Turkey, Iran, Sudan, Algeria, Morocco, Iraq, Uzbekistan, Afghanistan, Malaysia,
Saudi Arabia, Yemen, Syria and Kazakhstan. The total amount of deposits in
Islamic institutions, balance sheets, assets under management and private
wealth are growing at a rate of 25-40% annually.
Because oil prices and liquidity are
expected to stay at the same levels throughout 2007, budget surpluses will
remain high, pushing both public and private sectors to be involved with the
Islamic market. Many Islamic countries are investing in large infrastructure
projects, creating more than a trillion dollars in investments. There is also a
huge potential customer base. According to Standard and Poor's surveys, 20% of
the customers in the Gulf Area and Southeast Asia would choose an Islamic
banking product over a similar conventional product. There are significant
middle-class urban and suburban populations that already use conventional
banking, and therefore present ripe opportunities for Islamic banks. Most
important to note, outside of the religious and political allure of Islamic
banks, is that people are choosing their services for the safeties they offer.
The evidence is clear: Islamic banking is big business and it is growing every
day.
However, in order for Islamic banks to be
competitive with conventional products and attractive to customers, Islamic
financial products must meet the risk/reward profiles of investors and issuers
while fulfilling the tenets of the Sharia and remaining sufficiently
cost-effective. Additionally, Islamic banks must educate their personnel to
understand the tenets of Islamic law that pertain to banking, and to train them
to comply with Sharia as they serve their Islamic customer population