By John Foster, former
editor, Islamic Business & Finance magazine
The Islamic finance industry has often battled with the question:
How Islamic is Islamic banking?
The question’s pertinence was raised in March last year, when
Sheikh Muhammad Taqi Usmani, of the Accounting and Auditing
Organization for Islamic Finance Institutions (AAOIFI), a
Bahrain-based regulatory institution that sets standards for the
global industry, said that 85% of Sukuk, or Islamic bonds, were
un-Islamic.
Usmani is the granddaddy of modern-day Islamic finance, so having
him make this statement is synonymous with Adam Smith saying that
free-markets are inefficient.
Because Sukuk underpin the
modern-day Islamic financial system, one of its pre-eminent
proponents arguing that the epicentre of the system was flawed sent
shockwaves through the industry.
It also gave ammunition to the many critics who see Islamic finance
as an industry more driven by cultural identity than practical
problem solving: as a hodgepodge of incoherent, incomplete,
impractical and irrelevant ideas.
Recognisable
products
The products that modern-day Islamic bankers have created are very
similar to conventional products.
So similar, in fact, that to an outside observer they could be
considered the same.
Islamic banks now offer Islamic mortgages, Islamic car loans,
Islamic credit cards, Islamic time deposit and guaranteed return
accounts, Islamic insurance and some even offer Islamic managed and
hedge funds.
This point is conceded by Samir Alamad, Sharia, or Islamic law,
compliance and product development manager of the Islamic Bank of
Britain.
“The industry does not want to alienate its products,” he says.
“They have to be recognisable, produce the same outcome as
conventional products, but remain within the guidelines of
Sharia.”
No interest
The core of Islamic economics is a prohibition on interest.
This immediately creates a problem for Islamic banks, as
conventional banks charge borrowers an interest rate through which
they can reward their depositors and make some profit for being the
broker.
With interest ruled out it is harder to make money.
The modern Islamic banker has found a way around this prohibition,
however.
As in many Islamic products, the bank enters a partnership with its
depositors and invests his money in a Sharia compliant
business.
The profit from this investment is then shared between the
depositor and the bank after a set time.
In many cases this “profit rate” is competitive with the
conventional banking system’s interest rate for savers.
Lease
agreements
Alternatively, an Islamic banker might enter into a lease agreement
for a car or a house with an individual.
The bank would buy a vehicle outright and then lease it back to the
person who wanted it, over a time period that would ensure that the
capital was repaid and the bank made a profit.
Alternatively the bank would enter into a partnership with a person
wanting to buy a house. The bank would buy 70% of the house, the
individual 30%.
The bank then rents its share of the house back to the individual
until the house is fully paid for.
The bank makes a profit on the rent, which would be higher than
equivalent rents in the area, but on an annualised percentage
basis, would look very much like a conventional mortgage interest
rate.
To the casual observer, a spade is a spade.
Whether the product is dressed up in Arabic terminology, such
as Mudarabah,
or Ijarah, if it
looks and feels like a mortgage, it is a mortgage and to say
anything else is semantics.
Sophisticated
finance
The potential wealth locked up in oil-rich Gulf states encouraged
the conventional banks to enter Islamic finance.
HSBC established the Amanah Islamic Finance brand in 1998 and
Deutsche Bank, Citi, UBS and Barclays quickly joined the fray, all
offering interest-free products for wealthy Arabs.
However, this new generation of Islamic bankers had cut their teeth
in the City and Wall Street, and were used to creating
sophisticated financial products.
They often bumped heads with the Sharia scholars who authorised
their products as Sharia compliant.
However, these bankers had a way of dealing with this, as one
investment banker based in Dubai, working for a major Western
financial organisation explains:
“We create the same type of products that we do for the
conventional markets. We then phone up a Sharia scholar for a Fatwa
[seal of approval, confirming the product is Shari'ah
compliant].
“If he doesn’t give it to us, we phone
up another scholar, offer him a sum of money for his services and
ask him for a Fatwa. We do this until we get Sharia compliance.
Then we are free to distribute the product as
Islamic.”
No
consensus
This “Fatwa shopping”, which was carried out by some institutions,
brings us back to the Sharia scholars.
Even these scholars do not agree all the time, which means that in
some cases a product is deemed Sharia compliant in one market and
not in another.
This is especially the case with Malaysian products, which are
often deemed not Sharia complaint in the more austere Gulf.
“Often no rulings exist for modern day problems, such as use of
narcotics,” Alamad explains.
“In Islam intoxication by wine is forbidden, but at the time of the
Prophet Mohammed there was no crack cocaine.”
Modern scholars had to interpret the rules on intoxication, and the
consensus was that crack should also be forbidden to Muslims, as it
is a dangerous intoxicant.
“This is how we make rulings, whether in finance or societal,”
Alamad says. “The consensus rules, which usually will become
mandatory for all Muslims to follow, but there are some opinions
and sometimes scholars are not in the consensus.”
Banking is
banking
This makes it more important to be in the consensus, and so getting
a favourable ruling from a leading Sharia scholar is important for
a product manager.
That is why the top scholars can earn so much money – often
six-figure sums for each ruling.
The most creative scholars are the ones in the most demand, says
Tarek El Diwany, analyst at London-based Islamic financial
consultancy Zest Advisory.
“To date, most Islamic financiers have been looking at examples of
financing in Islamic history and figuring out how to apply them to
today’s financial products.”
But banking is banking.
It is the taking of a deposit and then using it to finance a
purchase or business.
The lender pays the depositor compensation for the opportunity cost
of his money, and the person borrowing the money “rents” it off the
bank.
The same symbiotic relationship occurs whether it is conventional
banking, ethical banking, Islamic banking or Presbyterian
banking.
As Majid Dawood, chief executive of Yasaar, a UK-based Islamic
finance consultancy says: “Everything that is not forbidden in
the Holy Qur’an is OK.
“Yes, the industry has to evolve, but it is only 40 years old and
its competing with a conventional finance system that is over 800
years old.”