Published On:13 July 2011
Posted by Indian Muslim Observer

Problems and prospects of Islamic banking

By Ahmad Tijjani

Banking is an important financial intermediary and vital institution in the economic structure of any country. The basic services a bank provides include receiving, collecting, transferring, paying, exchanging, lending, investing, or safeguarding money for its customers.

However, an important question that agitates the minds of those who think on Islamic banking, whether proponents or critics, is the feasibility of it in Nigeria (which operates on interest free basis). Islamic banking has the same purpose as conventional banking except it operates principally on sharing of profit and loss, and the prohibition of riba (interest). Amongst the common concepts used in Islamic banking are profit sharing (Mudarabah), safekeeping (Wadi’ah), joint ventures (Musharakah), cost plus (Murabahah) and leasing (Ijarah).

Islamic banks lend their money to companies by issuing floating rate loans. The floating rate is pegged to the company’s individual’s rate of return. Thus, the bank’s profit on the loan is equal to a certain percentage of the company’s profits. Once the principal amount of the loan is repaid, the profit sharing arrangement is concluded. So that both profit and risk are shared. Such participatory arrangements between capital and labour reflect the view that the borrower must not bear all the risk/cost of a failure, resulting in a balanced distribution of income and not allowing lender to monopolize the economy. Islamic banking is also restricted to Islamic acceptable deals, which excludes those involving alcohol, pork, gambling, etc. Thus ethical investing is the only acceptable form of investment and moral purchasing is encouraged.

The banking system currently operating in Nigeria is the conventional one. It is interest-based banking system. The whole credit system is built upon the institution of interest. Under the system, the borrower is obliged to pay a predetermined rate of interest on the amount borrowed even though he may have incurred losses. The relationship between the bank and its client is, therefore, that of creditor and debtor, this had led to so many economic and social evils among other things.

From the foregoing, it is obvious that the detrimental effects of interest (applicable to conventional banking) are evident as interest was originally forbidden by all major religions of the world (Islam, Christianity and Judaism in particular). Even the non-Muslim scholars, economists and bankers acknowledge that Islamic banking has made a place for itself in the whole world of finance. The Vatican has put forward the idea that “the principles of Islamic finance may represent a possible cure for ailing markets”. (Lorenzo Totaro (2009) “Vatican says Islamic finance may help western banks in crisis”. http:/www.bloomberg.com)

Similarly, the provision of interest can be regarded as exploitation. Islamic banking is a system that has its rules and regulations and the only system that is performed entirely free of interest. The establishment and application of Islamic banking particularly in Nigeria, is the best way to curb these socio-economic maladies in our system.

The main objectives of the banking system are removal of injustice, bringing in the optimal level of social welfare and ensuring justice in the lives of individuals and the society at large, through the concept of unity, brotherhood and social justice. It discourages and prohibits all forms of exploitation, extravagance, hoarding etc.

The main goal of the Islamic economic system is social justice and equality. It tries to be fair to one and all. It helps in promoting individual enterprise and also controls the economic system in a fair and equal manner. In the Islamic financial system, the financial institutions (banks) become a partner in business. The utilization of the funds from the institution by a business house or an enterprise is on a profit and loss sharing basis. Gains from the business as well as losses earned due to the business, are shared proportionately by the institutions and the enterprise.

But this does not mean that the investments by financial institutions are speculative. Before investing money, a thorough investigation is carried out on the risk factors associated with the business. Feasibility study of the project and necessary risk management principles are rightly undertaken to undermine the effect of loss. Investing in Islamic banks may provide more profit and less risk because the financial institution has its own interest as it acts as a partner.

There are several factors inhibiting the full implementation of Islamic banking in Nigeria. The legal factor is there, the political factor, the social factor and even the economic factor. When we look at the legal factor, we can see that the banking decree in Nigeria does not allow the establishment of any bank with a religious name but a compromise has been reached that you can open an interest free banking.

There is some significant difference between Islamic banking and interest free banking. Interest free banking is without interest but the mode of operation or the institutions it may use in its operation may not necessarily be Islamic. For example Bank PHB, Finbank, StanbicIBTC and other micro-finance banks such as Integrated Microfinance Bank, Kada Microfinance Bank, etc have these windows (which non-muslims do patronise effectively); you can transact interest free if you like but that does not mean the bank will not transact with other non Islamic institutions like brewery and other things.

So a bank can be interest-free, but its instruments might not be Islamic. It doesn’t deal directly with interest but the instruments on the people it gives loans may have some elements of un-Islamic practice. A pure Islamic banking is the one that does not deal with interest as well as its instruments, purely Islamic. They will not invest in gambling, brewery and any kind of trade that is un-Islamic. (Hence the need by the CBN to perfect the legal framework that will allow its full operational system).
Today, Islamic banks are operating worldwide and their impact on financial market is clearly visible. This progress is an indication of the viability and dynamism of the system.

As Dr. Abbas Mirakhor of IMF has said “those who believed that banks and financial system could not operate in a modern economy without reliance on an interest-rate mechanism must have been surprised at the progress of Islamic banking”. Islamic bankers have accepted the challenges and are trying to develop innovative financial instruments to meet the need of modern financial markets. They are tapping their enormous resources and are trying to develop investment outlets, viable secondary markets and other instruments. Some progress has already been made in this direction.

Islamic banking will make the bank and customers more committed to the management of assets (loans) on the one hand and interest free deposits for investments by the bank on the other. By so doing, they will woo investors in the sector. So also the equity and justice in profit sharing will provide enabling environment for investors to commit their resources.

There are teeming individuals and corporate persons that abhor interest (both muslims and non muslims). So with its non-interest elements, deposits could be generated from the investing public. Other potentials such as mortgages, trade and other infrastructure will be realized. Islamic banking will avoid speculations and impact better on the real economy. It will also create employment by funding the real sector and employing hundreds of thousands of people. The system will provide good profit and prudent practice and there are expectations that the practice will annihilate the interest being charged by conventional banking.

Through Islamic banking system, there would be provision of a full range of non-interest local and foreign currency trade and transaction processing services, collection and payment services, deposit products and loans to target customers. There would also be a strong balance sheet as a mark of commitment to high standards of banking practices and safety of depositors’ funds (because the whole system is mutually based on trust).

Based on the above explanations given, it would be clear that Islamic banking system will fully sanitize the banking sector and also reduce the socio-economic problems bedevilling the sector in Nigeria. There have undoubtedly been fluctuations in the profitability of Islamic banks and occasional losses in the world, but the general picture is one with steady growth and stability.

The benefits of Islamic banking in a growing economy like Nigeria cannot be over-emphasized. In line with the Federal Government’s desire for a single digit interest rate to spur socio-economic growth, nothing can be more apt than establishing a non-interest financial institution. Islamic banking will also contribute significantly to the overall development of the country by developing micro credit schemes aimed at improving the overall communities, thereby drastically reducing unemployment rates. There are also ample opportunities to attract Foreign Direct Investments (FDI) into the country.

[Ahmad Tijjani writes from Kaduna. He can be reached at tjbk2001@yahoo.com]

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Posted by Indian Muslim Observer on July 13, 2011. Filed under , , , , . You can follow any responses to this entry through the RSS 2.0. Feel free to leave a response

By Indian Muslim Observer on July 13, 2011. Filed under , , , , . Follow any responses to the RSS 2.0. Leave a response

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