Islamic finance’s strong position
When first conceptualised in the 1950s and 1960s, it was envisioned that Islamic banks would take the form of a publically-owned social service, similar to that of education and health. Islamic banks would offer current accounts that would not earn interest and saving accounts that paid dividends on the basis of partnership. The capital made available from the saving accounts is considered as investment, thus, would be used by businessmen through partnership agreements where profits and losses would be shared between the businessmen (as the entrepreneurs — mudharib) and the bank and its account holders (as the owner of capital — rabbul maal).
As such, the proposed Islamic banking model was based on profit and loss sharing (mudharabah) and participation (shirkah), with a general consensus that Islamic banks would operate primarily based on equity-based financing. More importantly, Islamic banks are also expected to play a social role of providing inclusive financing to all segments of the society, rather than serving selected clients who are considered as creditworthy in view of their collaterals.
The products of the Islamic banks, therefore, should be uniquely designed on the basis of participatory contracts, rather than replicating the conventional banks’ products, but without the prohibited elements, namely interest (riba), excessive uncertainties (gharar) and gambling elements (maysir). According to Az-Zuhaili (2003), “[t]he primary goal of Islamic financial institutions is not profit-making, but the endorsement of wider socio-economic goals, including economic development, more equitable income distribution, and the alleviation of poverty”.
The following decades saw the dream of establishing Islamic commercial bank turned into reality with the first Islamic commercial bank, Dubai Islamic Bank, starting operations in 1975. The Islamic banking industry grew rapidly ever since, defying criticisms of the pessimists regarding the sustainability of the industry. According to a report by Ernst & Young (2015), there were more than 300 Islamic financial institutions worldwide in more than 70 countries with Islamic banking assets estimated to reach US$1.6 trillion (RM6.4 trillion).
Islamic banks offer a wide range of banking products and services that one could find in any conventional commercial bank, including current accounts, personal financing, mortgages, hire-purchase financing, and debit and credit cards. Islamic banks have grown to be efficient and profitable organisations. They were even in a better position compared with conventional banks during the global financial crisis in 2007/2008. There have been accumulating empirical evidences that the Islamic financial system, in general, fared better than its conventional counterpart in weathering the economic and financial shocks due to the global financial crisis.
The stronger position of the Islamic financial institutions is largely attributed to the inherent stability of the Islamic financial system, which is free from the prohibited elements of riba, gharar and maysir, as well as the nature of the Islamic financial transactions, which are related to real economic activities. Indeed, the thriving Islamic banking and finance industry has attracted the participation of not only the Muslim countries, but also Western financial institutions and many non-Muslim countries. Despite these impressive achievements, there remains a central unresolved issue: do Islamic banks actually promote the goals of Islamic economics as originally envisioned by the Muslim scholars? Have Islamic banks achieved or even embarked on efforts to increase income equality and reduce the income gap?
Acursory review of most Islamic commercial banks reveals that Islamic banks seemed to be focusing on similar market segment as the conventional banks. They tend to involve themselves in head-on competition with conventional commercial banks, targeting similar customer segment and focusing on sectors that would give the highest possible return. Islamic banks are also confined to the same risk-averse attitude as conventional commercial banks, and consequently, have failed to internalise and implement the ideals of the profit and loss-sharing concept. Consequently,
Islamic banks continued to be criticised due to favouring debt-based contracts rather than the equity-based contracts, resulting in a lack of financial innovations aiming at improving financial inclusion, particularly to the poor in rural areas in the form of Islamic micro-financing. These observations do not seem to suggest a focus on poverty alleviation or the promotion of an equitable distribution of wealth in Muslim society. Consequently, the financial inclusion goal is still far from fulfilled and we continue to see significant segments of society, particularly the poor, being derived from funding for their economic activities. The need to find a solution to this issue is urgent and important. Poverty remains a major issue in the Muslim world.
It is estimated that 35 per cent of the world’s poor live in Muslim-majority countries despite the fact that the Muslim world possesses 70 per cent of the world’s energy resources and 40 per cent of earth’s natural resources. In South and Southeast Asia, where 45 per cent or 720 million of the world’s Muslim population totalling around 1.6 billion live, the incidence of poverty is rampant, particularly in Muslim countries, such as Indonesia and Bangladesh.
In many non-Muslim countries such as in India and several countries in Africa, Muslims occupy the lowest income group and are among the least educated of the population. The high incidence of poverty and wide income gap in Muslim countries seemed to be contrary to the rapid development of the Islamic banking and finance. This irony further lends support to critics that the IBF is no different than conventional finance, which aims for profit making and lack of social dimension aspects. Contrary to belief, Islam and development are compatible.
Islam promotes equitable economic distribution and upholds the right of the poor through income-distribution mechanisms, such as zakat, waqf and sadaqah. This social dimension of Islamic finance, if properly strategised and implemented, could finance the needs of the poor to enable them to be economically independent. In this context, Islamic banks could play their role and provide support to the development of the Islamic social finance sector to increase financial inclusion among the poor, thus enabling them to come out of poverty.
Through this effort, the goal of Islamic banks, which is achieving maqasid al-shariah, can be realised by supporting Muslims to achieve self-actualisation goals that aim towards sustaining life, raising future progeny, developing human intellect, safeguarding faith and enjoying fruits of individual efforts through ownership. The Islamic social finance sector, which includes zakat, waqf, charities and Islamic microfinance, may prove to be a promising solution to alleviate poverty in Muslim countries. For instance, while in many Muslim countries zakat collection programmes have been rather efficient, however, an effective zakat distribution programne along with mechanisms to ensure sustainable benefits to the receivers, unfortunately, are not well developed.
This effort is even more challenging in the context of today’s complex economic situation, which requires policy makers to find efficient ways to administer zakat for true growth and prosperity, compared with the situation when zakat was first introduced in Islam. Developing the Islamic social finance sector could be challenging in the context of the Islamic commercial banking. Innovative ways would have to be explored even to the extent of considering a new model of Islamic financial institution to develop the sector.
What would be the unique characteristics of Islamic financial institution model that could provide a better platform to achieve socio-economic justice as envisioned by Islamic economics? Looking at the conventional banking industry in the developed world, one would find a diverse mix of commercial, savings and cooperative banks. This, however, was not always the case.
Before the 19th century, there existed only commercial banks. These banks were aimed at providing the rich members with financial instruments to help use and grow their wealth. The poor working classes, however, were not considered profitable for these banks and the poor were neglected, especially in rural areas. These were the conditions that prompted the establishment of banking alternatives, such as cooperative and savings banks, for the inclusion of rural poor. In this respect, Islamic banking is still in the pre-19th-century stage, as Islamic commercial banks dominate the Islamic banking industry greatly, with few other banks available to Muslims, with a lacuna for serving the financial needs of the poor.
Source: New Straits Times Online. Date: 9 May 2016.