How much Islamic are Islamic banks?

By Dr Abdul Karim

http://www.dawn.com/2007/03/05/ebr15.htm

ISLAMIC banks are very much in the limelight — both in Pakistan and abroad. In Pakistan, two brands of such banks are in operation. The first was the Zia model, which was struck down by the Supreme Court of Pakistan and referred to the Federal Shariat Court for reconsideration. As such, it is still operative.At the same time, a new brand of Islamic bank, which may be called the Musharraf model, has been introduced. This does not replace the existing system, which, though called Islamic previously, is now practically treated as conventional banking.The new system runs parallel to give choice to the public. This creates a very peculiar dual system of banking. Under the new arrangement, Shariah Advisory Boards have been set up at various levels to advise, approve and supervise Shariah-compliant products. On the other hand, there is no accepted Islamic code to serve as a criterion for determining whether a product is Shariah compliant or not. As Governor of the State Bank has put it, “At present, Shariah Compliance standards vary across jurisdictions since in absence of a well conceptualised framework, countries evolve their own framework drawing from their own needs and experiences.” In this perspective, the question is: how much Islamic are Islamic banks?There was no concept of an institution, some thing like the present day banking in the early days of Islam. The question can thus be answered in terms of Islamic philosophy of life and cardinal economic principles. Banking is a modern institution born out of capitalism and serves its philosophy, which, in turn, creates an individualistic acquisitive society. Concentration of income and wealth is actively promoted for the propensity to save, invest and produce more. The belief is the more wealth the betterIn sharp contrast, in Islam acquiring wealth is not an end in itself but is just a means of carrying out the obligations to God, fellow human beings and oneself, as specified by God. The Quran says, “That it (wealth) may not circulate only among those of you who are rich.” (59:8)Islamic code of conduct is anchored in justice. There should be no economic exploitation whatsoever. This is the basic rationale for prohibition of interest-based loans in Islam The Quran says, “You will have your principal, you shall not wrong nor shall you be wronged.” (2:280)Interest based banking is so deeply entrenched that Islamic banks are also conceived within the framework of that system so that there would be no disturbance in the economy. There is least concern about the ruthless exploitation of poor bank depositors for the benefit of rich borrowers. Islamic Banks are expected not to be indifferent to this phenomenon and are required to ensure justice between the two classes. Is this so? The answer unfortunately is an emphatic `No’.Banks -conventional as well as Islamic-- give a very poor deal to depositors.. Following the tight monetary policy pursued by the central bank, the return on bank advances has gone up substantially. There has been no corresponding increase in return poor depositors and banks are fattening themselves at their expense. The weighted average of return on advances has gone from 6.49 per cent in June, 04 to 10.71 per cent in September, 06, while the improvement in the weighted return on bank deposits has been from 1.21 to 3.24 per cent.. The difference, called bank spread, has thus widened from 5.28 to 7.47 per cent. This is more than twice the return on deposits.Inflation at eight per cent, the return to depositors is negative by 4.76 per cent in real terms. The stark disparity has been noticed by the State Bank Governor, who has publicly y urged banks to improve the return on deposits. The weighted averages do not tell the whole story. There is a very wide dispersion in nominal rates. As of June, 06, no less than 18 per cent of advances to the private sector under Islamic modes of financing were at rates less than eight per cent.There were advances at the zero rate to the tune of Rs.86.9 billion, or five per cent of the total advances under the Islamic modes. The advances at 20 per cent and above were Rs50.04 billion, or three per cent of total advances. This points to the special treatment of influential borrowers. For some of them, the rate is immaterial as they can hope to have their loans written off. Five major Pakistani commercial banks wrote–off 649 loans worth Rs22 billion in CY 05. Of these, 60 loans of Rs100 million and above each accounted for Rs15.7 billion. The largest loan written-off was of Rs1.98 billion followed by a loan of Rs1.16 billion. For this, Islamic teachings regarding sanctity of debt are worth recalling.As regards the return to depositors, banks prescribe a high minimum balance to be eligible for return. This ranges from Rs20 thousand to Rs100 thousand. The rate of return is also graduated for the benefit of large depositors. For instance, in case of NBP, for the half year ending December 05, the return on PLS saving deposits for balances up to Rs20 thousand was 0.2 per cent and above that it was 1.2 per cent, the ratio working out 1:6 In case of ABL for less than Rs100 thousand balance, the rate was 0.10 per cent when for Rs100 thousand and less than Rs1 million, it was one per cent. Here the ratio was 1:10 Larger balances carried higher rates.Attention has been mainly focused on the banks’ assets side, or the modes of financing. Islamic modes have been identified which are believed to be Shariah compliant. The Zia model had 12 Islamic modes of financing. One to them, which was most frequently used, was mark-up. This was struck down by the Court as un-Islamic. The Musharraf model omits this and, in terms of Section 4 (ii) of the Financial Transactions Ordinance, 2002, it has eight , namely. Musharikah, Mudaribah, Equity Participation, Salam, Istinsa, Ijara, Murahabah and Musasawamah. The main reliance of the Islamic banks is on Murabaha and Ijarah, which accounated for 38.8 percent and 33.1 per cent respectively of the loans as of September 06.The share of other modes was; Diminishing Musharikah, 12.3 per cent; Salam, 4.4 per cent;, Musharikah, 0.7 per cent and Others, 9.4 per cent respectively. It is worth noting that with the exception of Mussharikah and Mudharibah, including Equity Participation, the modes are those of trading and not financing. . It is significant that Allah does not allow equating trade transactions with interest or financing. It is in the Quran: “Those who devour interest do not rise except as rises one whom Satan has smitten with insanity. That is because they say, ‘Trade is like interest, whereas Allah has made trade lawful and made interest unlawful.” (2:276) To say, “Banks are deemed to have purchased and sold the goods,” is a far-fetched poor consolation and no justification.The modes of trading are justified for businessmen who play with their own capital as well as labour and can use any fair device to promote their business by winning stable future clients at the expense of immediate reward. In contrast, banks are not the owner of the capital, which they use, but that of depositors. Use of Arabic names instead of the known terminology may attract the naïve but not the knowledgeable.Conventional banks are primarily worried about the collateral for loan in the interest of recovery and care little for its end-use In fact, it is generally believed that the end-use of credit cannot be ascertained.In sharp contrast, Islamic banks cannot finance, directly or indirectly, those activities, which are either specifically declared unlawful or discouraged by Islam for their deleterious economic implications. This covers a very wide range from production, sale and serving of wine and other intoxicants to hoarding and cornering of goods and speculation. This demands intimate banker-client relationship. Thanks to the current anti-terrorism and money-laundering campaign conventional banks have been given the motto: “Know your client.” This brings them closer to the Islamic approach.Depositors status vis-à-vis Islamic banks has not received due attention. These banks do have profit and loss sharing accounts but this is just a misnomer as depositors do not share either the profit of the bank or its borrowers. What they, in fact, get is what banks just dole out. People place their savings with banks for various considerations. Some park it there for safe-keeping, while some do so for payment facility through bank account.There are others who hold fixed-deposits by way of investment. As such, the nature of deposit determines whether bank is a trustee, ameen or agent or partner. Return to the depositor will depend on the relevant arrangement. This whole area needs to be carefully explored to arrive at a formula which may assure justice to the depositor in the true Islamic spirit.Islam, being the religion of the poor and for the poor, assigns great social responsibility to financial institutions, conventional or Islamic, engaged in intermediation to help in poverty alleviation.In a message to a new Islamic bank just launched the State Bank Governor observed: “Above all, the growth of Islamic banking will help to create a better distribution of wealth in Pakistan and the Islamic world.”