Literature Review Of Islamic Banking

The Islamic PerspectiveThe fundamental sources of Islam – Quran and the Sunnah (teaching and traditions) of the Holy Prophet Muhammad (Peace Be Upon Him) – provide guidelines for economic behaviour and a blueprint of how economic system should be organized. (Khan S. Mohsin & Mirakhor, Abbas 1992)Islam is not a new religion; it is the same truth that God revealed through all His prophets. All religions are the same in essence, whether given, for example, to Noah, Abraham, Moses, or Jesus, or to the holy Prophet of Islam. For a fifth of the world’s population, Islam is both a religion and a complete code of life. Economic growth is the main transmission channel for development. Islam does not contradict growth; it promotes sustainable development and growth. The ultimate objectives of an Islamic economic system are achieving development, based on socio-economic justice, care and compassion for all, in terms of complete human personality. Tools prescribed to achieve the socio-economic objectives of the Islamic economic system are the system of Zakat, prohibition of Riba and the Islamic Law of Inheritance. Prohibition of Riba is the cornerstone of Islamic financial transactions; the basis of cooperation between capital and enterprise in Islam is sharing of the risks and gains between the two. (Hussain, Dr. Ishrat 2004) In Islam the practice of paying and receiving interest is prohibited between individuals and the state as much as between one individual to another. (Siddiqi, Muhammad Nejatullah 1983)Those interested in Islamic economics have been endeavouring to develop and crystallize economic concept and theories which confirm to the Islamic ideology and postulates. (Modeling Interest – Free Economy: A Study in Macro-Economics and Development 1991)
Concept of Interest in Islam
“Those who devour Riba shall rise up before Allah like men whom Shaitan has demented by his touch; for they claim that trading is like usury. But Allah has permitted trading and forbidden usury. He that receives an admonition from his Rabb and mends his ways may keep what he has already earned; his faith is in the hand of Allah. But he that pays no heed shall be among the people of fire and shall remain in it forever.” (Surah Al Baqarah 275)A very important pillar of this model is the prohibition of Interest or Riba, which is made clear by the following Qur’anic verse in which Allah (SWT) says:“O, believers, fear Allah, and give up what is still due to you from interest (Riba), if you are true believers. If you do not do so, then take notice of war from Allah and His Messenger. But, if you repent, you can have your principal. Neither should you commit injustice nor should you be subjected to it.”
(Surah Al Baqra 278-279)Islam is a complete religion; it provides guidance for each and every aspect of human life. Economics is one of the most important aspects, as every human being needs involvement in some kind of economic activity for survival. Islam has provided a complete economic model for a establishing a healthy society. With the expanding focus and scope of Islamic finance worldwide, there is a rapid proliferation of feasible solutions that cater to almost all financial requirements. Ahmad, Khurshid (1981) &<http://www.nbp.com.pk/EcomomicBulletin/Economic%20Bulletin%20Jan-Feb%202005.pdf>Whenever a contract involves a guaranteed profit for one party, riba (interest) is involved (Aly, Remona 2005)
Mortgages Concept in Islamic Banking
According to documented Shariah jurisprudence opinion which is known as Fatwa, the proposed arrangement is having the following transactions:To create joint ownership in the property (Shirkat-al-Milk) Giving the share of the financier to the client on rent. Promise from the client to purchase the units of share of the financier. Actual purchase of the units at different stages. Adjustment of the rental according to the remaining share of the financier in the property. (Muhammad Taqi Usmani 1998) It's a transaction in which a buyer purchases a home through a rent-to-own agreement. A conventional mortgage, in which a buyer repays a loan with interest, violates the Quran, which forbids the payment or receipt of interest.http://www.islam-finance.com/FAQ.htmlThe Holy Quran forbids "riba", which is interest, or usury. Yet Muslims need money and banks need to make a living. Systems are devised to get round the ban. For example, instead of a Muslim holding a mortgage for a house, the bank can own the house and make arrangements for the Muslim gradually to buy it off the bank over a period of years. (Moore, Charles 2004) & <http://www.lariba.com/knowledge-center/faqs.htm#question1>
Government steps
As the part of the Islamization of economic structure the all commercial bank convert their some work to non – interest basis. But the procedure by their selves was un – Islamic declared by Federal Shariat Court (FSC) in 1991, the govt. and other banks were to go appeal in Supreme Court of Pakistan. The Shariat Appellate Bench of Supreme Court of Pakistan upheld the previous decision in 1999. In the light of this order government of Pakistan form a committee to judge the strength and risks of conversion of the interest based system in to Islamic finance system. Because it was not possible to implement this in short term. The State Bank of Pakistan issued criteria for the establishment of Islamic banks in private sector and it decided to promote Islamic banking parallel with the conventional banking. (Hussain, Dr. Ishrat 2004) (For further details See Appendix A)Pakistan’s government is to issue licences for new Islamic banks, the first time that new banking licences would be issued in a decade, according to Shaukat Aziz, finance minister. The decision appears to be a reversal of Pakistan's earlier policy of a cap on the number of private banks in the country with a view to encouraging mergers to build up national banking networks, replacing small, regional banks. However, it is driven mainly by concerns over the controversy surrounding the future of Islamic banking in Pakistan. (Bokhari, Farhan 2002) & (Bokhari, Farhan 2001)Despite annual growth of about 15 per cent, analysts say Islamic banking is being held back because Muslim scholars have yet to define how compatible the newest financial products are with Islam. David Waite from Gulf International Bank in London said market research had shown 20 per cent of people from Islamic countries would be attracted to investments compliant with Islamic Shariah law, but only if the right products and the necessary performance are there. “From a marketing perspective, the sharia compliance brings the customer to you. The performance sells it to them,”<http://216.109.124.98/search/cache?p=%27Islamic+Banking+in+Pakistan%27&ei=
Role of State Bank of Pakistan
Since 1991 verdict by Supreme Court that initially sought a conversion of the banking and finance system along with Islamic principles. On appeal, the court's ruling was toned down but central bank officials say that rather than converting the entire financial system to an Islamic one, the authorities are now working to create either a network of new Islamic banks or "windows" offering Islamic services within conventional banks. (Bokhari, Farhan 2003)The Governor of State Bank of Pakistan reiterated the central bank’s commitment to promote Islamic banking on sound footings, provide a comprehensive and secure regulatory framework to establish Islamic banks as a parallel banking system, comparable and compatible with the conventional banking system and at the same time making sure that it is Shariah compliant. (Hussain, Dr. Ishrat 2004)State Bank of Pakistan plans to license two overseas banks by mid 2006 to offer services that comply with Muslim principles, seeking to attract overseas lenders to offer service that comply with Shariah and promote Islamic finance.(Zamir, Haris & Nambiar, Shanthy 2005)Pakistan’s leading bankers become uncomfortable when pushed to say how they plan to cope with an Islamic system of banking. But, the central bank governor, is convinced that the change to an Islamic system would not spell disaster for the country's economy, adding that "nobody wants to see disruption". (Bokhari, Farhan 2001)
Corporate governance with reference to Islamic banking
The former Governor, State Bank of Pakistan, Dr. Ishrat Husain has pressured upon the banks to adopt best international practices in corporate governance. He said by keeping an eye on the economy that market risk is now becoming one of the major challenges faced by the financial institutions and that management boards should be vigilant in this area also. Particularly the management of Islamic institutions emphasized that sound Corporate Governance envisages setting up an environment of trust, transparency ethics, responsible behavior, checks and balances. (Hussain, Dr. Ishrat 2003)2.7
Variation in banking procedure & risk
Islamic banking is a system of finance totally based on the sharing of risk and profit, rather than on the payment of interest or the payment of predetermined rates. While in the capitalist economy the interest is the price of money when conventional banker rents / lends it. The rate of interest is determined by central bank as a result of the fiscal and monetary policy measures. Few Westerners take it seriously as a way for a modern economy to do business. In some ways, this is a mistake. In one view, the mistakes that have led Western banks and economies into their present financial troubles are precisely the errors that Islamic banking tries to avoid. Many Muslim countries have developed a variety of partnership agreements to allow lending without interest. Under such schemes, banks receive a contractual share of the profits generated by borrowing firms. Along with boosting the welfare of general public, this approach has many advantages, such as encouraging equity and discouraging debt. (Banking Law, Banking Industry in Pakistan…….. (1992) The Economist Vol. 323, Iss. 7753) & <http://www.lariba.com/knowledge-center/faqs.htm#question1>
Banks in Pakistan (total and Islamic)
Total financial institutions in Pakistan are 70, which include nationalized schedule banks, specialized banks, private schedule banks, foreign banks, developing financial institutions, investment banks, discount and guarantee houses, houses finance companies, venture capital companies and micro finance banks (Please see the appendix E & F).<http://www.finance.org.pk/survey/chapters/06-Money%20and%20Credit.PDF >The total number of banks having Islamic Banking Licence has increased to five. M/s. Meezan Bank Limited, Al Baraka Islamic Bank, Bank Islami Pakistan Limited and Emirates Global Islamic Bank Limited are the other four banks having Islamic Banking Licences. Meezan Bank and Al Baraka Islamic Bank are currently operating in Pakistan with 36 branches. In addition to these banks, 31 branches of nine conventional banks are also providing exclusive Islamic banking services to their customers in all the four provinces of the country.<http://www.sbp.org.pk/press/2005/Dubai_IBL.pdf > & Zamir, Haris & Nambiar, Shanthy (2005)In Asian economy , there are signs of growth in financial sector on the retail side. Countries such as Malaysia, Indonesia and Pakistan offer opportunities because of their large populations." Yet, while there are signs of a growing demand for Asian Islamic banking products, analysts have yet to produce credible estimates of market size and growth potential in the region. The global Islamic banking market is still a grey area, with estimates ranging from Dollars 50bn to Dollars 200bn. (Bokhari, Farhan 2004) & (Mcsheehy, Will 2004)
Image of the banks
The leading financial institutions are rapidly progressing in the country. At the end of year 2004 all local and foreign financial institutions have 6581 local and overseas branches. And they are earning huge profits and also enjoy good credit rating, maintaining huge deposits and advances portfolio. Most of the top 16 financial institution (as shown in Appendix F) are dealing in home finances. (For further details please see Appendix F, G, H & J)<http://www.nbp.com.pk/EcomomicBulletin/EB%20for%20Jul-Aug%202005.pdf>
People needs for homes, their income level and how banks treat them
According to 1998 census, the total number of housing units throughout the country was 19.3 million. The annual requirements of the houses is 820,000 units annually, this huge number become due to backlog of previous years. Particularly for the low income groups. The maximum loan amount has been increased from Rs.5 million to Rs.10 million, the debt equity ratio go down for lower income group and maximum period reached from fifteen to twenty years.After the discussion with the manager mortgages and credit initiation units heads of different banks including Islamic banks, it came into the knowledge that almost these institutions are hesitating the extension of finance to the following categories. It is surprising to come into the knowledge the one side the Islamic institutions raise the slogan for the welfare of the general public on the other hand they are not providing the facilities to below mentioned categories and treated as negative occupations.
1.Lawyers
2.Journalists (Publishers & Editors can be looked on case to case basis).
3.Agriculturists unless where agriculture income is the main source of income
4.Law enforcement personnel even if they have a business concern
5.Commission based business e.g. stockbrokers, real estate agents, commodity rokers.
6.Business involved in rental business.
7.Business involved in giving away goods on loans or instalments.
8.Businesses with pronounced cyclical trends displayed in their cash flows e.g. ice factories; cold storage & warm clothing related businesses.
9.Speculative business i.e. property buying & selling, stock purchase and selling.
10.Government contractors / suppliers dealing with or owing money to GOP.
11.Construction/Real Estate related business where there is no permanent/proper office. 12.Transporters
13.Entertainment Business
14.People related to entertainment business.
15.Jewellers (smaller ones only)
As mentioned point number three in the above category, the institutions are not granting the loans to the agriculturalist. The bank’s policy contravene the policy of the govt. because Pakistan is a agricultural country and in such country the institutions are not giving the loan facilities to the people having the main source of income from agricultural. As mentioned in the above list number 18 the institutions are not sanctioning the finance to the members of stock exchange except the Karachi stock exchange member. It is the contradiction with the policy of the bank because the members of stock exchange located in Lahore have the same worth just like Karachi stock exchange member
Comparison of instalments amount
The most expensive asset that any of us will generally purchase is our homes. The overall cost of this can vary radically depending on the mortgage product. Ensuring that you have selected the most competitive mortgage can result in substantially lower cost of borrowing. To add to the mainstream mortgage choices available there are a number of Shariah compliant products now on the market which are becoming more easily accessible and more competitive. (Mian, Hamza 2006)As mentioned in appendices K & L the comparison of instalment amount on the same amount of finance for the same period. For the comparison it isber. assumed that if a person gets finance amounting to Rs. 1,600,000/- from an Islamic financial institution for twenty years and other person gets same finance amount, for the same period from other conventional financial institution. (Please see the appendices K & L). The person took finance from an Islamic institution have to pay amounting to Rs. 3,528,000/-, on the other hand the person got finance from ordinary or conventional institution have to pay amounting to Rs. 4,248,952/-. This tendency reflects that the financing option from conventional bank is more expensive than the Islamic mode of mortgage finance. <http://www.lariba.com/knowledge-center/faqs.htm#question1
Problems of Islamic Banking
As defined by the governor of State Bank of Pakistan the followings are the challenges faced by the Islamic banking structure in Pakistan.Lack of effective enforcement of contracts.Inefficiency in the system of early recoveryIneffective code of conduct for professionalsLack of public awareness about Islamic financial system and its availability.Minimum income level.Area restrictions.Negative occupation.Minimum equity requirementCorruption In an In an article in ‘The Economist’ on the subject Islam and changes of interest rate the author explained that from a bank's point of view, mark-up loans are a relatively easy way to lend without receiving interest. In other ways, however, Islamic banks are less obviously suited to modern economies. Judging whether a company will make profits in the future is harder than
making a decision about its current ability to repay a loan.