The first question is: Explain what Islamic Banking is and its background.
As we saw in the video the Islamic banking is the supply of financial services which comply with the "sharia", meaning the basic rules set in the Qur’an that every Muslim must follow.
It is said that this way of managing the financial transactions is the "back to basics" of the financial system, but actually this way of conducting the banking operations is rooted in the Islam. It must be remembered that the Islam is more than a mere religion, is a system that defines every aspect of the Muslims lives, including their relation with the money. In this aspect the money is considered a means not an end itself so no profit can be made from just money.
Since the raw material of banking system is money, and what the non-Muslim world knows as banking system could not be applied in the Muslim world, a sharia complying set of principles was established in order to fit the religion and the principles mentioned above.
But why is there the need to replace the traditional banking instruments? In order to give an answer I will answer the second proposed question; what are the key principles of Islamic banking? The main principles that should be taken into account when referring to Islamic banking are those contained in the Qur’an, there are two which are especially important: As we saw in the video the main basic rule is that no interest rate is supposed to be charged over the loans or in any other financial transaction. The other principle states that no investment is supposed to be made on any sector which is considered unethical by the laws of sharia.
Ever since the western banking system uses interests and invests in all the sectors that can be conceived, the instruments used by this sector are not compatible with the Qur’an principles, so they need to be modified in order to make the Muslim people investments “halal”(it means allowed, this term is the opposite to “haraam” which means forbidden)[Adapted from Wilson, R. (1997)].
So (third question) Islamic law forbids institutions from charging interests on loans. How do they make profits when lending money? They share the profits and losses of any investment the bank makes or they charge an operative fee. Meaning that a bank technically never “lends” (as to charge interests) money, but they become “shareholders” of the particular project they help finance, this means that if a bank finances some project the financial institution has a right to receive a part of the profits. And if the project loses money the bank loses as well. This can also be extended to the government bonds, which are called “sukuk bonds” as we saw in the video. An additional requirement is that the investments made have to be ethical, which leaves out of question some sectors.
But (fourth question) how do you explain the concept of ethical investments under Islamic law? As I stated before the ethical investments are those that are not classified as haraam in the sharia. Meaning that are the investments that do not go against any of the values of the Islam; such activities include gambling, alcoholic beverages industries, pork meat industries, and adult entertainment industries, among others. And, who is to determine whether an activity is allowed or not? Basically any Islamic banking institution has a Sharia Supervisory Board (SSB) which is “a committee of religious advisors whose opinions are sought on the acceptability of new instruments and who have to provide a religious audit of the bank‟s end of year accounts. SSB is defined as an independent body of specialist jurists in Islamic commercial jurisprudence.” [Ökte, M. (2010)] This means that this body determines whether an investment should or shouldn’t be made.
So far it seems really simple but when the reality has to be considered complexities emerge. Let’s take the example of an airline its business is transporting passengers and cargo, but what if part of its business incomes come from selling alcoholic beverages or carrying pork rinds? Is its entire business haraam because of that? According to (Wilson, R., 1997), the approach taken by the Islamic banking system and countries is the pragmatism, especially when relating to the western world.
The next question is how does Islamic banking system (IBS) influence the economy in the Middle East? To answer this question I will cover three main topics, wealth generation, stock market and the psychological impact (importance of believing IBS is a different alternative).
In wealth generation we find that “Islamic banking is the fastest growing sector in the Middle East. An estimated US$100 billion worth of funds are now managed according to the Sharia in this market.” [Ökte, M. (2010)]
Also “the stock markets of the Muslim World would seem to be appropriate destination for Islamic ethical investment, as they could be viewed as promoting business activities which help other Muslims.” [Wilson, R. (1997)]
As to the psychological impact; the main thing is that this system is allowing the integration of the Islamic world to the financial markets worldwide, and also an important advantage is that “the Islamic banks are roughly as profitable as their conventional counterparts, and that they are making positive contributions to various economies (Kuran, 1997: p.27). But in no way have they revolutionized financial practices.” [Ökte, M. (2010)]
Finally the last question is based on [my] research and knowledge about this topic, what is the future of Islamic Banking in terms of global expansion and growth? To explain this part I would like to present a video of Spotlight a show presented in Russia Today that is available in You Tube in the channel of Russia Today.
As we saw two different points of view that are opposed to one another, but I must choose the side presented by Mr. Aleksashenko, especially when he argues that there is no significant difference between the two systems but the risk sharing part which only limits the financing possibilities for firms. Also I have to add that the Islamic banking is not the solution for crisis such as the one we are just passing by, the main reasons for its growth and stability during the crisis is that these institutions did not have in their portfolios the toxic assets that were at the origin of the crisis. Such is the case for some Latin American banks, which were also solid and presented growth, so the solution is not a new system but a more comprehensive regulation to the financial system, because without it even the Islamic banks can generate a crisis.
Nevertheless the sharia complying banks are going to present a future growth and will expand through the globe since it is important for the Muslims to have this type of services. It is also important to say that along with the global expansion of the sharia compliant banks, the traditional banks are also going to offer sharia compliant products and services (This is the case of HSBC Amanah), and thus this will contribute to the expansion of this system until the demand is satisfied. To state in a simple manner where you have demand there will always be someone willed to make the corresponding offer.
For further readings check:
Ökte, M. (2010). FUNDAMENTALS OF ISLAMIC ECONOMY AND FINANCE: THEORY AND PRACTICE.Electronic Journal of Social Sciences, 9(31), 180-208. Retrieved from Academic Search Complete database.
Wilson, R. (1997). Islamic finance and ethical investment. International Journal of Social Economics,24(11), 1325. Retrieved from Business Source Complete database.
You Tube. CNN reportage: Could Islamic banking be the answer to the current economic downturn. In saarab40 channel last accessed april 15, 2010, permanent URL: http://www.youtube.com/watch?v=OBoRBlPvI9U
You Tube. Spotlight: Islamic banking system. In Russia Today channel last accessed april 15, 2010, permanent URL: http://www.youtube.com/watch?v=xzJTiX3HSFs
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