Islamic Banking

The Indian banking system is losing a staggering Rs 2-3 lakh crore annually, due to the delay in introducing Islamic banking laws (IBLs), analysts say.

Though Muslim parliamentarians have taken up the issue with Prime Minister Manmohan Singh and the UPA chairperson Sonia Gandhi, the Reserve Bank of India is yet to take any concrete action on introduction of IBLs.

In their presentations, the Muslim Parliamentarians have underlined that Islamic banking can be easily introduced without disturbing the basic fabric of Indian financial system.

K Rehman Khan, deputy chairman of Rajya Sabha, said that products similar to mutual funds can be introduced in line with the fundamentals of Islamic banking laws, which do not recognise interest-based banking.

However, Islamic banking laws are based on trading and thereby sharing of profit. Khan added that once the system is recognised, savings of the Muslim comumity would only make Indian banking richer and stronger.

Globally, the financial system has a corpus of about $700 billion under the Islamic banking system. Banks like HSBC and Lloyds TSB have Shariah compliant units to bring the Muslim community into the banking system.

It is learnt that several leading Indian banks like ICICI Bank are looking at various ways of introducing Islamic banking products without disturbing the fabric of Indian banking system.

"The Islamic banking system does not recognise interest-based transaction but the main element of profit is not eliminated from the system," Mr Khan said, adding that there is no reason why India cannot implement the Islamic banking system, especially as most other western countries like the UK have recognised the system.

Earlier, the Muslim leaders had proposed setting up of a non-banking finance company in line with Malaysia’s Tabung Haji for the large Muslim population in the country. Meanwhile, several banks from West Asian countries have evinced interest in entering India.

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Islamic banking is struggling to make progress in the Turkish financial sector, causing the country to miss out on the profits of its Arabic oil-rich neighbors, analysts claim.

Turkey’s inherent distrust of Islamic banking practices means that the largely secular government has so far failed to issue interest-free Islamic bonds ? a move that would allow the EU candidate country to bring in significant Islamic investment from the Middle East.

Islamic banking practices require compliance with Shariah law, which forbids the accumulation of interest among other restrictions.

In recent years, the niche banking sector has grown significantly in the Arabic countries of the Middle East, and the financial industries of European nations including the UK have also pledged to provide better services for Muslim investors.

Economic observers believe that Turkey’s failure to keep up with the trend could mean that it miss out of significant amounts of foreign Islamic investment, with other European countries benefiting instead.

Legislation designed to bring some Islamic banking practices to Turkey has so far stalled.

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By Stephanie Phang and Shanthy Nambiar

RHB Islamic Bank Bhd., a unit of Malaysia’s fourth-largest banking group, expects financing for agriculture to drive growth in assets that comply with Muslim religious tenets, said Chief Executive Officer Khalid Bhaimia.

Assets at the bank may expand more than 10 percent this year, Bhaimia said in an interview in Kuala Lumpur. Financing for farming and small and medium-sized companies will grow more than 20 percent in 2006, he estimates.

RHB Islamic is betting on rising demand for financing from plantation and commodity companies as the government encourages agriculture under a 200 billion ringgit ($55 billion) development plan. Agriculture made up 8.2 percent of the gross domestic product last year in Malaysia, the world’s largest exporter of palm oil and Southeast Asia’s second largest oil and gas producer. It also produces timber, rubber and pepper.

“Islamic finance seems to be gaining a lot of pace in terms of new funds going into these sort of products,'’ said Paul Teoh, who helps manage $272 million of Asian assets at Meridian Asset Management Sdn. in Kuala Lumpur, including Islamic bonds. Islamic finance in Malaysia is still “in its infancy so definitely we are going to see huge potential there.'’

Muslim investors may prefer to put money in commodities such as palm oil and rubber because Islamic law forbids interest payments and investment in businesses such as tobacco, alcohol and gaming.

Securing Market Share

“It’s a growing sector, so there’s a lot of potential for the bankers, not only for the Islamic banks,'’ said Chan Ken Yew, a banking analyst at OSK Research Sdn. in Kuala Lumpur. “Since Islamic banks have restrictions, this sector seems to be good for them and it makes sense for them to work even harder to secure market share.'’

Financial services companies are introducing more Islamic products to tap the funds of 1.5 billion Muslims worldwide. The global Islamic finance industry’s assets under management may have topped $1 trillion, according to a January report by the Malaysia-based International Islamic Financial Services Board.

In Malaysia, Islamic bank assets rose 18 percent to 112 billion ringgit last year, or 11 percent of the Southeast Asian country’s total bank assets. About 60 percent of Malaysia’s 27 million population is Muslim.

Under an Islamic financing concept called Murabahah, a bank may buy goods or land on behalf of a customer and sell them back at a higher price later to comply with the Islamic ban on the payment of interest. Such deals are common in short-term loans and trade finance. Commodity Murabahah involves mark-ups on asset prices in place of interest.

Plantation Companies

Malaysian plantation companies have been selling Islamic bonds to raise money for expansion. Dura Palms Sdn., a funding vehicle for plantation and investment company Teck Guan Holdings Sdn., sold 284 million ringgit of Islamic bonds in June. Boustead Holdings Bhd., a plantation and property group, raised 442 million ringgit from the sale of such securities.

RHB Islamic’s assets expanded 23 percent to 7.6 billion ringgit last year, according to its 2005 annual report.

Financing for agriculture and small and medium companies makes up about 30 percent of RHB Islamic’s financing portfolio, Bhaimia said. RHB Islamic also offers Bai Salam, or advance purchase financing, which allows the bank to finance a product to be delivered at a future date, he said.

Competition is increasing between Islamic banks in Malaysia, which has 12 such institutions, including Bank Islam Malaysia Bhd., the oldest, and Bank Muamalat Malaysia Bhd. The central bank has granted licenses to international banks, including Kuwait Finance House and Saudi Arabia’s Al Rajhi Banking & Investment Corp.

Competitive Market

“This is a very competitive market and it’s a very crowded market, and therefore you’ve got to get a strong foothold in the niche,'’ Bhaimia said.

Islamic banks in Malaysia may start merging over the next two years, he said, estimating about half the current number of such banks would be sufficient for a market the size of Malaysia.

RHB Islamic plans to expand outside Malaysia in the next five years to markets such as Vietnam, Indonesia, the Middle East and the Indian subcontinent, Bhaimia said.

RHB Capital Bhd. became the first commercial banking group to open a full-fledged Islamic financial services subsidiary last year, transforming its Islamic banking window into RHB Islamic.

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Singapore, 29 September 2005…The Monetary Authority of Singapore (MAS) today announced that banks in Singapore will be able to offer an important form of Islamic finance known as Murabaha. It is commonly used as short-term financing and in trade finance.

2. MAS issued the Banking (Amendment) Regulations 2005 to exempt Murabaha financing from the restriction in the Banking Act against non-financial activities. With the exemption, banks may offer Murabaha financing by purchasing goods on behalf of a customer and selling the goods to the customer at a marked-up price to be paid at a later date. 
 
3. MAS’ exemption of Murabaha financing follows its discussions with market participants and its ongoing review of the regulatory framework to facilitate the development of Islamic finance. Banks which offer Murabaha financing will add breadth and depth to the range of financial products and services offered in Singapore.

4. "MAS recognizes that Islamic finance is gaining global importance. It is an important complement to the suite of products and services that Singapore as an international financial centre can offer. MAS is open to introducing refinements such as this to our regulations to ensure that our framework is conducive to the development of Islamic financial services", said Mr Heng Swee Keat, Managing Director of MAS.

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Editor’s Note

New Regulation 22 allows banks to carry out the business of purchasing and selling an asset provided that the purchase is at request of the customer and is for the purpose of financing. The bank sells the asset to the customer at a marked-up price, which will be paid at a later date. The customer is under a legal obligation to take delivery of the asset. In addition, the bank should not be exposed to any market risk from this financing transaction.

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What is Islamic banking?

It is banking practised as per the Islamic principles as prescribed in the ‘shariah’ known as ‘Fiqh al-Muamalat’ (Islamic rules on transaction). The Islamic law prohibits interest on both loans and deposits. Interest is also called ‘riba’ in Islamic discourse. The argument against interest is that money is not good and profit should be earned on goods and services only, and not on control of money itself. But Islam does not deny that capital, as a factor of production, deserves to be rewarded. It allows the owners of capital a share in a surplus, which is uncertain.

How does it function?
It operates on the principle of sharing both profits and risks by the borrower as well as lender. As such, the depositor cannot earn a fixed return in the form of interest. The banks are permitted to offer incentives, such as variable prizes or bonuses in cash or kind on these deposits. The depositor — who unlike in the conventional banking system is risk-averse — is a provider of capital and equally shares the risks that the bank who lends his funds.

What are the different products offered?
Investment finance is offered by these banks through ‘Musharka,’ where a bank participates as a joint venture partner in a project and shares the profits and losses. Investment finance is also offered through ‘Mudabha,’ where the banks contribute the finance and the client provides expertise, management and labour and the profits are shares in a prearranged proportion, while the loss is borne by the bank. Trade finance is also offered through a number of ways. One way is through mark-up , where the bank buys an item for a client and the client agrees to repay the bank the amount along with an agreed profit later on. Banks also finance on lines similar to leasing, hire-purchase and sell and buy-back. Consumer lending is without any interest, but the banks cover expenses by levying a service charge. Besides, these banks offer a host of fee-based products like money transfer, bill collections and foreign exchange trading where the bank’s own money is not involved.

Where is it practised?
Islamic banks have come into being since early 70s. There are nearly 30 Islamic banks all over the world, from Africa, Europe to Asia and Australia, and are regulated even within the conventional banking system. The whole banking system in Iran has moved over to the Islamic system since the early 80s and even Pakistan is Islamising its banking system. A number of European and American banks are now offering Islamic banking products, not only in Muslim countries, but also in developed markets, such as UK. The concept is also catching up in Malaysia and Dubai.

How far is it feasible in a market economy?
Islamic experts say that with growing indebtedness of many governments and with bulk of the borrowing going to servicing of the past debt and payment of huge interests, it could be an alternative to conventional banking as practised in the rest of the world. Wherever it is practised, studies have showed that the rate of return is often comparable and sometimes even higher than the interest rate offered by conventional banks to depositors.

Is it practised in India?
In India, though there is no full-fledged Islamic bank, there are many non-bank financial intermediaries in Mumbai and Bangalore operating on Islamic principles. Their presence in the form of co-operatives in various parts of the country has been there before independence. The Reserve Bank of India has recently appointed a committee headed by a chief general manager to look into the prospects of introducing certain Islamic products in Indian banks. What is unique is that the products are structured according to norms prescribed in the ‘shariah’.

What are the drawbacks?
In many countries, these banks do not have the power of issuing cheques. Besides, many banks where they operate on a very small-scale do not have adequate internal control system because of which their accounting is not very transparent. Also, inadequate information is provided to the regulator. Wherever they co-exist with conventional banking, the central bank’s control of bank interest rates is liable to be circumvented by shifts of funds to the Islamic banks.

From  The Economic Times

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LONDON: A new mortgage scheme complying with the sharia law has come into being in the U.K. targeted at Islamic investors. The new buy-to-let mortgage is designed by Bristol & West and the Arab Banking Corporation.

Lloyds TSB had introduced some Islamic banking as a pilot scheme when it launched a sharia-compliant current account in February 2005. Subsequently, it introduced a home finance package too. The current account facility is now available in 18 branches.

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