Islamic Banking: Road to the future?

In the broad global context of economic mayhem that is doing the rounds of news and views, where leading names have been swept into crevices of history, Islamic banking has emerged relatively unscathed because they enjoy a built-in stabiliser to help them cope with economic downturns, guided as it is by the Islamic Shariah which limits types of activities and resultantly, exposure.

There, however, is no room for complacency and there is a lot of work to be done, felt the panel at the latest episode of the Qatar Today Round Table (QTRT) which reached the consensus that Islamic banking, as a method, is not only a viable alternative to conventional banking, but it also is more human and transparent, and can be applied universally. And as with conventional banking, this form of banking is also under constant refinement and research, especially in the context of the fact that Islamic banking has less exposure to activities that are not agreed to by the Shariah and hence, safer than conventional banks, the susceptibility of which has been thrown open by the global crisis.

"As advocates of Islamic banking, we realise that there is lot of work to be done. Strong liquidity management mechanisms are an important part of developing Islamic banking further, and will lead onto the Islamic Banks maturing to the same level as the conventional banks. Greater transparency is also needed, as well as creating a 'harmonisation' of the transactions and standards," commented Professor Mohammed K Najdawi, Dean of the College of Business & Economics, Qatar University, at the recent QTRT that had Islamic bankers bring their wealth of experience to the Table.

Chaired by Professor Najdawi, the session had Khalil Shaltout, EGM & Chief Islamic Banking Officer, Al Safa Islamic Banking at Commercialbank; Ateeq-ur-Rahman, Head of Islamic Corporate, IBQ; Muhammed Ikram Thowfeek, Chief Financial Officer, Barwa Bank; Khalid Al Ahbabi, Associate Director, Amanah, HSBC Bank Middle East Limited, Global Banking and Market; Ahsan Ali, Head of Islamic Origination, Standard Chartered Bank and Dr Khalid Shams, Chair of Finance and Economics Department, Qatar University.

Every calendar year adds a new term to the business lexicon 2007 got sub-prime for us; 2008 invented meltdown; 2009 has toxic assets as its contribution.

And each has led to the other.

What began relatively surreptitiously in 2007 in the US as sub-prime mortgage in the real estate market, graduated to a global meltdown in 2008, and in Q1 2009, banks, in most advanced Western economies, are counting the toxic assets that they have accumulated in their books over time. 

Citing figures and rating reports on the prospects of Islamic banking in the region, Najdawi said, "Islamic banking and finance is probably one of the fastest growing sectors in recent years in the country and the region at large.

This growth is driven by the flow of oil, and the support of the Government in the region. According to Fitch Agency, the records of the largest five Islamic banks in the region have grown by more than 20 percent in the first quarter of this year alone. At a time when Governments in the US and Europe are concerned to save their banks or trying to stop the collapse of more banks in their financial systems, the global crisis has brought the resilience of Islamic banking to the fore since these institutions have largely been insulated from the impact of the meltdown. Islamic financial institutions have avoided the worst credit crisis in general and have continued their growth in the middle of this crisis.

"Moody's says that in the face of a sharp fall in real estate prices, stocks of Islamic banks will fall in the region of 10 and 50 percent, over the year, provided all other factors remain constant.

All big and strong banks will continue to exist, but many smaller ones will perish by being acquired by larger banks and real estate has a great hand in this entire conundrum. Islamic banks insist on taking guarantees and have adequate capital and reserves to avoid future risks this is a positive factor in their operations. However, analysts also warn that the collapse of the regional stock markets will have a negative impact on the workings of institutions that follow the Islamic Shariah in Q4 of this year."

Impact of recession

It is difficult to make a strait jacket assessment of the impact of the recession on Islamic banks since new patterns are emerging every single day as existing contracts.

"We need to break the impact in two stages in the beginning many had thought that Islamic banks are far away from the crisis and are not affected at all because of the Shariah that governs it, to keep it away from the much debated types of investments that conventional banks do, for instance, trading on loans or debt instruments or buying stocks of companies that engage in un-Islamic activities. This embargo took care of the Islamic banks at the initial stages of the financial crisis. Over time, it was gradually unearthed that Islamic banks that had exposure in the real estate market were impacted."

However, opines Dr Shams, even this is not without context and Islamic banks have to narrow their focus on approved avenues of investment, real estate being one of them.

"The drop of real estate prices contributed to the hit that Islamic banks have taken, though there are other factors like the liquidity crisis and the resultant credit crunch which made return of money difficult, leading to rescheduling of many Musawamah and Murabahah contracts which involves direct involvement of the Shariah boards which have the option of recommending the change of these contracts into Ijara, for instance, with the option of earning an income. The Qatar Government has been proactive in this crisis in two ways: first they bought some shares of banks which gave liquidity to the banks and second, the Government bought securities from them. 

"There are voices that feel Islamic banks are better to sort out the mess created by the conventional banks since the former are not affected by the systematic risks that plague the latter.

These risks affect all banks and many banks have no idea of the extent of toxic assets in their books which are a result of securitisation. Islamic banks have escaped this phase but due to the concentration risk of Islamic banks on account of the real estate depreciation, Islamic banks will invariably be hit. To my mind, Islamic banking goes back 30 years as against 150 years of conventional banks. So the scope of learning remains for both."

According to Ahsan Ali, it is the natural restriction of Islamic banks which does not allow them exposure in certain activities, which has saved these banks from the crisis. "Islamic banks are supposed to limit their exposure only to developing the real productive sectors of the economy. That is why it has remained relatively unscathed," he said.

Conventional banking Vs Islamic banking: competitors or cooperators?

Bankers and scholars are unanimous on the fact that no one type of banking will set the way out of the crisis which has made discussions on exchanges of the two parallel banking regimes.

Is this an era of competition? Or is it that of complementing? This was an issue raised by Najdawi.

"Islamic banks, to many, are charitable institutions which is not the reality.

Islamic banks are here to make money and compete with conventional banks.

This should not be lost sight of. On the aspect of complementing, Islamic banks need to learn from conventional banks which have been around for a longer duration. The best practices of conventional banks need to be adopted, in the area of customer service excellence or innovative products, which are Shariah compliant," said Muhammed Ikram Thowfeek.

As a relatively unexplored banking system, Thowfeek added that, only 20 percent of the potential economic viability of this sector has been tapped so far.

"Islamic banking is not just for Muslims, it is for the entire mankind. What needs to be seen is that this type of banking is rooted in the real economy, rather than financial structures and leveraging that caused the global economic problems. It harps on the equal partnership between the financier and his client and is a channel between fund providers and the users of funds, the latter being true of any banking system in the world. Commercial banks are helping Islamic banks develop their products," said Ali, adding, "The conventional banking products are seen as beneficial, so Islamic Banks are seeing the positive side of learning from these mistakes and experiences."

Instruments and Options

Islamic banking history, as was pointed out by Ahbabi, is about 30 years, but with the same business precepts as conventional banking i.e., to make money. With a shorter business history and operating in a niche as it does, there is a general lack of people's awareness of the options that this banking system has. This lack of information on the part of customers, limits the transparency of Islamic Banking in Qatar and the world at large. Steering the discussions in this arena, Najdawi sought the practitioner's point of view.

Khalil Shaltout said, "Islamic banks like conventional banks are guided by rules and regulations of the Central Bank of the country. One such norm pertains to the transparency in contractual arrangement between the bank and the customers. Over and above that, all banks should follow certain guidelines in making their products and offerings part of the public domain. Transparency is a function of both of these, but where customers feel that the details are not clear enough, it is their duty to ask their Islamic banker the basic details of what they are signing on.

"For instance in a Murabahah (Cost Plus) transaction, the price of the product needs to be known in advance before coming to a decision on buying an asset or commodity and selling it to a customer on a deferred leg. In a leasing or Istisna deal, for instance, the instalments should be known before hand.

"On the investment side, since Islamic banking hinges on profit sharing, the quantum of this cannot, by its very nature, be decided in advance."

Ateeq-ur-Rahman was of the opinion that it is both a lack of information on the part of the customers and expertise on the part of bankers that has given credence to this feeling of a lack of transparency. "But with growing expertise, Islamic banking is working on giving out more information. Also the fact that these banks have been less affected by the global crisis, as compared to the conventional banks, due to less exposure in the affected markets, they have gained regional strengths and strongholds in Malaysia. There are different Shariah boards that take on individual decisions and there is need for consensus on that count, across the Islamic banking landscape."

Shariah boards and their role in Islamic Banking 

At an era where management boards have come under increasing scrutiny on their role and function in the context of the recession and the shareholders' role in holding the boards accountable, are Islamic banks doing enough?

This was the question thrown at the panel by Dr Najdawi.

"It is useful to place Islamic Banking in the context of its roots. It was an alternative to loan-based finance which generated interest. Islamic banks invented other instruments that are Shariah compliant. Boards are fully aware that it is not the point of profit making alone, but to engage in the broader economy and attract more customers to its fold. Banking has two sides providing finance and attracting deposits and in both, Islamic Banking is playing a great role. Most of the deposits are  based on profit sharing (Mudarabah).

The Shariah Boards are clear about one fact that they would not put customers in duress, if the cost of finance of the banks does not increase that is the human side of this type of banking."

In Thowfeek's view, "There are various schools of thought on this different boards take different stances on the same thing, whether it be products or the way they govern the bank's business and that is wholly dependent on the extent of liberalism that the board will adopt while taking a decision. The customers and the market will have greater confidence on the board, if they are brought to the forefront of customer relationships. Today, that is not the case and they are in the backdrop and are involved only in signing of fatwas, which the customer may/may not be aware of."

Future of Islamic Banking 

Looking at the recent growth of Islamic Banking over the past five years, a positive forecast of the future can be seen, mainly because of the economic significance of Islamic States and their desire to have a Shariah-compliant financial system in place.

"Having said that, we also need to acknowledge that Islamic banks are evolving every day and the practices are being fine-tuned on a continuous basis. Sukuk, for instance, is a highly used product in the GCC since this is a funding mechanism that suits the nature of the economy of the region. In the future, Sukuk will grow as a securitized instrument and the expansion of Islamic capital market instruments," reflected Shaltout.

The opportunities that these banks now have are rich and varied it largely depends on the future direction that they take and how far they aim products at specific customer demands rather than simply taking advantage of continuous demand. This is where experts feel that economic augmentation will take place. This includes taking account of providing better service which relies on providing services that rely on specific rules governed by the Shariah Court or by the standards of the Central Bank.

However, in order for these opportunities to be fully incorporated into the mainstream system, Islamic Banks need to expand their options much further outside of their current confines whether this be merging several smaller Islamic banks into one big mega bank or to place them on a level with the big conventional banks are courses that will only emerge in the future.

For Thowfeek, the opportunities are cushioned with a real optimism, and with the current state of the financial markets, there is an exciting new opportunity to push Islamic Finance to the forefront. The increased openness of the market to alternatives for a failing system can serve as ample opportunity to advertise what this sector has to offer.

The entire collapse that is being seen now, focused on the likes of Hedge Funds, speculation and risk, ultimately all based on the interest-rate system, is partly due to mismanagement of the finances associated with this.

"This is the right time to present Islamic Banking as a solution to most of the crisis both regionally and internationally," said Thowfeeq.

"If you really look at the Islamic Banking market potential and the growth potential, only 20 percent of that has been tapped until today," he added.

"Because of the financial crisis, the whole world and those who are in finance are now focusing on Islamic Banking, and there's a new awareness of what it can do," Dr Shams said. (with inputs from Nadia Ismail)

By Aparajita Mukherjee

Link: http://www.zawya.com/Story.cfm/sidZAWYA20090507105942/Road%20To%20The%20Future/