Deficiencies that need to be addressed for Islamic banking


1. Islamic banking industry still use LIBOR/KIBOR linked financial contracts which are akin to debt financing than the more preferable participatory modes of Mudarabah and Musharakah. Hence, same state of affairs in this regard from past to present does not show a promising picture from the viewpoint of having an egalitarian, Islamic principles and value based distinctive financial system.
2. It is an empirical fact that Islamic banks prefer to offer debt related products in all debt based financing modes; there are two legs of transactions. In one leg, the bank purchases the asset which the client needs from the vendor. Often, client is made the agent to purchase that asset on bank’s behalf. In second leg, the bank sells or leases the asset to the client. Before the Islamic bank purchases the asset in first leg, it asks the client to give a unilateral undertaking. Through this, the client undertakes to purchase the asset from the bank in second leg of the transaction. Islamic banks being financial intermediaries are using the same interest based index as benchmark for pricing. Already, they are not charged General Sales Tax (GST) on their sale of assets to clients in second leg of transaction and the Government by not levying GST regard an Islamic bank as a financial intermediary and not as a trading concern.
3. In his book, “Introduction to Islamic Finance?, the respected scholar, Maulana Mufti Muhammad Taqi Usmani sahab writes: “It should never be overlooked that, originally, Murabaha is not a mode of financing. It is only a device to escape from “interest” and not an ideal instrument for carrying out the real economic objectives of Islam. Therefore, this instrument should be used as a transitory step taken in the process of the Islamization of the economy, and its use should be restricted only to those cases where Mudarabah or Musharakah are not practicable.”
4. Imran & Mark finds through a research survey that investment behavior is often influenced by the degree of religiosity of the individual. Further it has been found that Muslim investors also had “Western style? wealth maximization objectives.
5. Islamic banks through their advertising campaigns are promoting consumerism in society and they leave behind the Islamic virtues of ‘Shukr’ (thankfulness), ‘Sabr’ (patience), ‘Tawakkul’ (steadfastness), ‘Infaaq’ (payment to charity), refraining from ‘Israaf’ (extravagance), ‘hubb-e-maal’ (love of wealth) and ‘hubb-e-dunya’ (love of materialism). Instead of creating awareness about these virtues with their position as an Islamic institution or an institution working in conformity with Islamic rules and principles, what Islamic banks have been unable to do is to create awareness among the masses about the Islamic virtues mentioned above. Islamic banks have no products for financing education, health, microenterprises etc. Their clients are mostly blue chip companies’ which when take financing from Islamic banks, it is largely a favor to Islamic banks. One can say that Islamic banks are commercial institutions and not charity based institutions. Yes, this would not have been too much disappointing had they conducted their operations with this proposition only. The irony is that Islamic banks build up the case for Islamic banking and finance citing the prohibition of Riba from Quran and Ahadith, its evil consequences in life hereafter, benefits of Qarz e Hasan, fruits of participatory and equity modes of financing are missing and thereafter they move towards commercial co-existence and long term complementarity in between conventional and Islamic banking.
6. The recent growth experience and product innovation directed towards coming up with more sophisticated products using debt based structure exhibit that growth has taken more precedence over Sharia compliance in letter and spirit. Regarding the economy wide effects of Islamic banking, we must note that the Islamic banks use predominantly the debt based modes of financing and price these products using interest based benchmarks which are used by conventional banks. This done even on a large scale is going to provide no better results to the economy than the conventional banking at present or even in future. Almost 100% of all the financing products of Islamic Banks are linked with interest based benchmark, whether it is Diminishing Musharakah, Murabaha or Ijarah etc. Hence, all of the “debt based modes of financing” priced using interest based benchmark are equally less ideal. Islamic banking spreads are higher than conventional banks in Pakistan. Islamic banks may defend themselves by saying that they: 1. Finance companies that have higher risks. 2. Provide more consumers financing which has higher risks. 3. Have high cost of deposits. 4. Have fewer avenues for parking liquidity. 5. Have high operating expenses etc. These justifications may seem valid and reasonable, but if we think deep, there are problems with this line of reasoning. Regarding the possible justifications for higher spreads in Islamic banks, it must be noted that Islamic banks always provide “secure? financing. For this they finance assets and have legal claims on the assets if the client does not come up with their repayments.
7. Islamic banks after having spent a decade of Islamic banking operations in Pakistan have to reflect on answers to the following points: 1. How justified are high Islamic banking spreads (difference between average financing and average deposit rates) which have reached to 218.40 percent at one point of time and are one of the highest in the world and more than two percentage points higher than conventional banks in Pakistan? 2. How justified is the argument to seek special privileges from the regulators when Islamic banks use the same benchmark rate but the difference is that their spreads (margins) are even higher than the conventional banks?
8. How do they justify their position and analyze their performance on social and egalitarian grounds when most of their products are priced using the same benchmark of the conventional banking industry, which is LIBOR/KIBOR?
9. Equity financing is regarded as the most ideal mode of financing in an Islamic economy by Islamic scholars. Why it is hardly used in financing the clients with a contribution of less than 2 percent in total financing?
10. Trust and documentation problems did not hinder 700 companies to get registered on Karachi Stock Exchange while thousands of public limited companies are operating in Pakistan as well. Why Islamic financial institutions could not help support more IPOs either through investment banking operations or alternate institutional structure?
11. Lastly and most importantly, they must reflect on what was the real reason for prohibition of Riba? If it was exploitation, then should an alternate system claiming to be founded on Islamic principles not differ in any substantial way in terms of cost? Unfortunately, if there is any difference, it shows that Islamic financing schemes are costlier than conventional.
12. Going forward, it is hoped that after having completed one decade of successful operations of Islamic banking they may now exhibit exemplary growth after finding solutions to the above areas.


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