Outline of Lectures on Islamic Banking and Finance

 

 

The Foundations

From its beginning, Islam gave a positive approach to wealth creation, recognized private property, and emphasized fulfillment of contracts and fair dealings. It set limits to freedom of enterprise designed to protect similar freedom of other individuals and protect social interest. Prohibition of interest is one of those limits as well as prohibition of gambling, fraud and hoarding. In early Islamic history, Muslims managed their finances with the help of such contracts as partnership, profit sharing, and prepaid future contracts. When Muslims came out of colonial rule in mid-twentieth century, they adapted these contracts into a new way of financial intermediation and investment management.

 

Recent History

The first modern theoretical literature on Islamic banking appeared in Urdu, Arabic, and English from the 1940s through the 60s. Modest practical steps in the 1960s were followed by the establishment of several Islamic banks in the private sector in the 1970s. The Islamic Development Bank was established in 1975. During the 1980s, Pakistan, Iran, Sudan, and Malaysia adopted the new system officially. Indonesia too launched an Islamic Bank in the 90s. Many conventional banks started offering interest free Islamic products and some even opened Islamic branches. Currently, there are approximately 200 Islamic financial institutions managing over 100 billion dollars in deposits and funds across the world.

 

Advantages and Disadvantages

The third lecture will consider two recent changes in the financial environment:

1) the decline in financial intermediation and ascendance of aggressive investment management; and 2) worldwide financial integration. In principle both are advantageous for Islamic finance, but in practice they pose great challenges. Current research in risk management in Islamic framework is very underdeveloped. However, the apparent constraints in the Islamic approach could turn out to be good for financial environment in so far as they help contain a situation going out of control. Some other issues in the regulation of Islamic financial institutions will also be discussed. It will be argued that community level initiatives in the West provide a new vista for Islamic finance along with continued progress in the state-sponsored and private corporate sector institutions in Muslim countries. Islamic banks operate under supervision of their countries' central banks. Also, they have no problems dealing with international financial institutions.

 


Glossary of Terms

 

 

 

Ijara: Leasing.

 

Istisna: Salam contracts applied to manufacturers, with the possibility of payment in installments.

 

Mudaraba: Profit-sharing between financier and entrepreneur.

 

Murabaha: A sale agreement under which the seller purchases goods desired by the buyer and sells it to them at an agreed marked up price, payment being generally deferred. Also referred to as Bay Muajjal or Bay bi Thaman Aajil.

 

Musharika: Partnership; all business partners supply capital and participate in management.

 

Riba: Interest; payment over and above the sum borrowed. Also covers exchange of unequal quantities of similar fungibles in a barter transaction.

 

Salam: Payment on the spot for goods to be delivered in the future with the price being agreed now (e.g. paying now for wheat that is yet to be grown). This is similar to a commodity forward.

 

Shariah: Refers to divine guidance as given by the Quran and the example of Prophet Muhammad and embodies all aspects of the Islamic faith, including beliefs and practices.

 

Urboon: Depositing small fraction of price in a deal to be concluded in the future. It binds the seller to wait but allows the buyer to back out of the deal, with the seller keeping the deposit.

 


Additional Resources

 

 

For more information on Islamic Banking and Finance, check out these sites:

 

www.islamicbankingnetwork.com

www.hifip.harvard.edu

www.siddiqi.com/mns/

www.halalco.com/economics.html

www.islampub.com/books/econom.html

www.islamic-finance.net

www.islamic-economics.com

 

Recommended Reading:

Towards a Just Monetary System by M. Umer Chapra, Leicester, Islamic Foundation, 1985

Islamic Banking by Mahmoud al-Gamal, Indianapolis, ISNA, 2000

Islamic Finance by Rodney Wilson, London, The Financial Times Press, 1998

Challenges Facing Islamic Banking by Munawar Iqbal et al (eds), Jeddah, Islamic Development Bank 1998

Islamic Financial Instruments for Public Sector Resource Mobilization Jeddah, IRTI, Islamic Development Bank, 1997

Development and Problems of Islamic Banks, Jeddah, IRTI, Islamic Development Bank, 1987

Muslim Economic Thinking, by M.N. Siddiqi, Leicester, The Islamic Foundation, 1988

 

Contacts:

Dr. Mohammad N. Siddiqi, LARIBA Senior Visiting Scholar

Center for Near Eastern Studies

(310) 825-1181

mnsiddiqi@hotmail.com or www.siddiqi.com/mns

 

Dr. Yahia Abdul-Rahman, Founder of American Finance House LARIBA

(626) 449-4401

yarahman@email.msn.com or www.lariba.com

 

Jonathan Friedlander, Assistant Director of Center for Near Eastern Studies

(310) 825-1181

jfriedlander@isop.ucla.edu

 

Parisa Sekandari, President of Muslim Business Student Association (MBSA)

Anderson School of Management, Class of 2002

(310) 963-0979

psekanda@anderson.ucla.edu

 


Question and Answer

 

 

IS NOT MURABAHA FINANCING LIKE INTEREST-BASED LENDING?

No, there are at least 4 differences:

A.     With conventional banking, the borrower gets cash from the lender which, in principle, can be used for any purpose. Instances abound of individuals and nations borrowing for one purpose and using the money for other (non-productive) purposes. Not so in Murabaha; the customer gets goods, not cash.

B.      Come time for repayment, a regular loan can be rolled over with the customer paying interest for the extended time (often at a rate higher than the initial). This is not possible in Murabaha. What the customer owes is a price agreed to in the beginning, which can not be increased because of delay in payment.

C.      The rate of interest has become a policy-determined variable. But the rate of mark-up in Murabaha is determined by the demand and supply of goods and services like all other prices. Murabaha financing is therefore more compatible with free market economy.

D.     At the macro level, Murabaha keeps the financing tied to real economic activity conducted through acquisition of goods and services, which is not the case with debt financing. Debt-financing contributes to higher inflation, and the availability of huge quantities of debt instruments in the market opens the door for speculative games that do not contribute to the real economy.

 

WHY DO THE SERVICES OF ISLAMIC FINANCIAL INSTITUTIONS COST MORE THAN THOSE OF THE CONVENTIONAL ONES?

This may not be the case for all services. Checking accounts in Islamic banks perform at par with any other bank. It could be true regarding home financing, financing of consumer-durables or opening a LC, etc. I think the reason lies in the much smaller size of these institutions as compared to others, which makes them incur higher unit overhead costs. This phenomenon may, therefore, prove to be transient. It could, even in the short run, be compensated by the greater trust these institutions evoke in their communities as well as their ethical approach to investment, etc.

 

WHAT ARE THE BENEFITS OF THE ISLAMIC FINANCIAL INSTITUTIONS TO THE SOCIETY?

It is widely acknowledged that the availability of Shariah-compatible banks has increased banking habit in the Muslim community. Islamic investment companies, mutual funds, and insurance companies have brought out some hoarded wealth, encouraged people to save more and helped Muslim entrepreneurs. The Islamic Development Bank is promoting trade and technical cooperation between Muslim countries. At the community level, the Islamic financial movement has provided the community with yet another cause to rally around, with the unique advantage that this activity brings them closer to the rest of humanity as it is open to all. Islamic financial institutions are the most modern face of contemporary Islam, a face with which every human being can empathize because of the promise of much needed reforms it bears.