Islamic Banking
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The Islamic finance is base on four principles:1.Risk taking, when related to a commercial or productive venture, the socially productiveactivity, it should be reward. Compensation is permissible as well.2.All loans must finance socially productivity.3.Financial risk rest with the lender.4.No interest (Riba) and “predetermined fixed sum”irrespective of the outcome of thebusiness.It causes the evolution of new financial instruments and lead inconsistence in interpretation between separate Islamic Banking systems.In some Muslim countries, Koranic prohibition was intended to protect the poor private borrower from usury, and the charging of interest business barrowers could not be challenged. In the United Arab Emirates, the courts have decides that compound interest is illegal, but simple interest is permissible. In Turkey, nominal interest is not a real interest burden on borrowersThe accounts type for investorsNot debtor-creditor contract relationship but a partnership. There are two Sharia contracts1.Al wadiah (safekeeping)a.Demand deposit accounts(current account):b.Saving accounts, time deposit and require notice before withdrawal.2.Mudaraba (agency)a.With authorization: account holder authorize the bank to invest money in. (specifiedperiod)b.Without authorization: bank choose for holder, no specified period for share the profit.Difficulty for these in international Context:PLS (Profit and Loss share) causes conflict with protection of depositors. (highest priority)The investment current accounts in banks cannot guarantee the deposited will be repaid in full.Current Solution: 1. Establish a deposit insurance company. 2. New deposit contract (risk-free financing: mark-up or leasing)--------------------------------------------------------------------------------------------------------------------------------- Institutional structures in Islamic Banking:The Joint Stock Bank.Provide a further independent investment accounts. Bank is given discretion for the investment)The Joint Stock Bank in Middle East feature:1.Shari- a supervisory board advise and supervise the bank operations and ensureadherence to Islamic Law.2. Zakat fund, draw a fixed percentage from bank capital and investment profit, donations and grants. The funds are used for social welfare project: interest-free loans for students,individuals.总结：The Joint Stock Banking System: All banks are Islamized, based run on PLS basis.Weakness1.Inadequate amount of saving for community’s development needs. Since no risk-freeassets such as bonds, government securities or interest on savings accounts.2.Unable to provide short-term loans. Eg: Unable to assess a profit on six month loan.3.Monetary policy loss flexibility, since its conventional tools are unavailable in ainterest-free bank.4.The hidden form of riba may be involved in the bank s’ use of funds hat not legitimatelyearned in any way.5.Existence of inflation may cause the lost of saving account depositor since no interestrate. Further, it suffer the bank since the loan return will be less than when the value it borrowing.6.Risk-free return made the bank looking for short-term investment/ creating the shortagefor longer-term project.Strengths1.If entire banking system is Islamized, it may encourage hoarder to holding funds ratherthan deposit them with conventional banks.2.Who defaulting on timely payments or understating profit on PLS. will have poor creditrating in whole system. It push people do honest and good.Nationalized BankingAdd up with the “public interest”, because banking involves the interests of the entire community. Another justification: it is pre-empt the possible occurrence of riba arises from the concentration of economic and political power in the private banking sector. Also, it is no ownership interest in leading, so the role is: “pure intermediaries.”---------------------------------------------------------------------------------------------------------------------------------Instruments offered by Muslim banks follow with Islamic financing PrinciplesMudarabah.The profit sharing is known as mudarabah. This is also called investment accounts, with depositor required to give a minimum period of notice for withdrawals. The rate of profit is declared by the bank at the end of financial year after the accounts are audited. The profit will precedence to depositors over dividend payment to shareholders.Under this contract, any loss is borne only by the bank,any claim for indemnity from entrepreneur or arranging insurance cover is prohibited.Weakness:1. The bank is not allowed to intervene in the routine of the business. 2. Although bank have the inspection right, but the entrepreneur have the complete freedom with the decision. 3. Both bank and entrepreneur has the right to cancel the contract at will. And bank hasthe right to return the mudaraba liquidation. This uncertainty makes business planning difficult.IjaraIts conventional banking sense, may be defined as contractual transaction: the owner of a specific capital asset rents this asset to an end user for a period of time and for pre-agreed rental. The owner is the lessor and the user is the lessee. The end, the lessee could has the option to gain ownership or not.In order to conform the “Sharia”, the Islamic leasing contract is base on profit sharing. The rental base on the probability of the asset the client lessee so it is fixed percentage of annual profit.Principles of Ijara.1. A real use and an active and physical use.2.Rent must be agreed pre-agreed. To prevent the speculation. Rent must be fixed and excludethe interest or riba.3.The term or tenure of the lease must be related the actual economic life of the assets.4.Certain assets are unacceptable, cannot be leased. Eg: gambling equipment.5.The cost of insurance and maintenance of the leased asset has to borne by lessor.6.The client may have an option, purchase or not.Difficulties arising in the context of Ijara.1.Investment horizon. Most Islamic banks do not wish to invest in medium to long termarrangements, prefer short-term opportunities. Ijara is a binding contract, so not preferred here.2.They prefer liquid instruments due to lack of access of Islamic banks to the interbank.3.In conventional leasing, if a lessee defaults the lessor, lessor can sell the assets to a thirdparty.4.Jurisdictional issues. Normal commercial law or shari’a?Musharaka.Musharaka is participation financing,Equity financing: creating specialized companies in the fields of trade, construction, transport and agro-industries. Equity participant: the share of profits formula and mode of distribution should be clearly set out.But usually passed over by such banks in favour of ijara.Deficiency: 1. Will lack of experts to adequately carry economic, technical and financial perspectives. 2. Risk of leakage of confidential plan. 3. If the statement not clear about operating according to Shari’a principles, it will be prohibit and not provide funding. 4. Sleeping partner. Sometimes wish to exercise control may good or not. 5. Determination of liability for debt may cause problem since the partnership.Murabaha:Murabaha is a cost plus contract, the bank buys the goods for the client and thereafter sells them to the client for cash or on credit. Short-term method of financing precludes its usage in projectfinance.Stages: 1. A promise from the client to buy commodity and agree amount of increase over the price. The mark-up covers handling charges, transaction costs and the risk premium.2.The purchase of the commodity by the bank from the manufacturers. The bank undertakes all proceedings prior to purchase, including studying the market and obtaining the best price.3. The murabaha sale between the bank and the client after the bank has acquired the commodity. After the bank obtain the title to the goods, a contract of sale will be signed with client.Murabaha complies with Shari’a because it involves two types of risk:1.Risk during the purchase transaction all on bank: physical losses, unacceptable quality,delivery delay.2.Risk during the collection of the debet. (bank cannot set a guarantee from client, If theclient refuse to pay, the credit will be bad.)Criticism of Murabaha:1.It is too short term.2.Possible of fixed interest fees charged by the bank in the name of mark-up.3.Pressure to the foreign exchange resource. And accelerate consumption of non-productivegoods.Conventional Bank instruments Forbidden under Islamic Law.1.Interest not allowed. All interest paid in financial transactions whether connected or not withother bank services is not allowed. Fixed deposits’ prefixed interest, floating interest are not allowed.Zero coupon bonds may have zero coupon, but since it issued at a discount, not the purchase value and face value. All interest-bearing securities are not allowed. Related activity such as syndication of interest-bearing bonds and underwriting are not allowed.2.Discounting Commercial paper. Islamic banks cannot buy or sell commercial paper atdiscount, since the commercial paper represents a debts, if it is acceptable under Sharia, it should be dealt with full value with no discount or premium. As current practice of conventional banks is deal with commercial paper by discount, it is avoid by Islamic banks. 3.Documentary Credit. The finance of documentary credit offer by bank link with the basis ofinterest is prohibited. However, the bank purchase and own the title of good, with mark up on murabaha, it is acceptable. Profit of share being determined according with pre-agreed formula.Subprime crisis with Islamic banking. (好的方面)Religious principles as the foundation of the Islamic finance require financial contracts be just and fair, ensure contract both sides are not exploited.Interest is one source of exploitation, especially in subprime situations, high interest exploitedthe low-income people. As a risk to reflect, traditional bank this discriminatory fee was considered was justified. But the unemployment made the low-income pay interest hard have the ability. Islamic housing credit is lending both sides share the risk, rather than the entire risks passed on to customers. In the most commonly used gradually less partnership conditions, Banks could offer formed partners to 90% of the purchase price, customer accounts for at least 10%. In the case the customer has no ability to payback; Banks may provide an interest-free loan let them and ability in the economic recession continued payments. Traditional mortgage, the customer is unable to pay, the bank repossessed houses the auction. For Islamic finance regulation, because the risk sharing principle, even temporarily unable to repay, customer can still keep house. Of course, the Islamic bank will assess credit risks loans more conservatively than traditional Bank. Bank of America to the subprime borrowers charge high fees, Once the mortgages sold out in the financial market, whether the subprime borrowers have ability to payback or not is no mean to consider for the banks.Even during the crisis, Costumer could enjoying Islamic bank’s inner stability, because do not need to pay interest to savers, depositors share interests with Banks. Therefore, the economic downturn, depositors only reduces revenue.The benefit sharing system reduces the risk of bank, it means that they rarely go bankrupt. Because the bank built on the basis of early warning mechanism, even in economic downturns the interests of depositors also would be protected.Islamic banking offers than traditional banking more feasible choice, the money collecting cycle is relatively short. All of the Islamic Banks follows Basel III agreement, all follow Islamic bonds is base on real assets, they use classical banking model, base on capital accumulation not from the lending. And not involved in interest and derivative products, the risk of enterprise financial leverage low therefore with high safety.。
