ISLAMIC BANKING VIA CONVENTIONAL FRAMEWORK
Banking if it is to be understood conventionally as the business of collecting deposit and provision of loan is truly out of context as far as Islamic perspective is concerned, basically because Islam prohibits any act of commercialization of credit and loan. Loan is supposed to be at all times viewed as an act of benevolence the motivation of which is to help people in needs free of charge.
However problems arise when 30-40 years ago some Muslims wanted to have their own banks albeit based on their own version where there was no loan given on interest as this would constitute commercialization of debt and credit. But they had to face the reality of that time where they found out that in many parts of the Muslim land, nearly all laws governing banking and provision of credit were (and still in many jurisdictions) based on a framework that authorized financial intermediation by banks and credit institutions where interest was paid and charged. So in the beginning Islamic banks were allowed to operate within such a framework in a way that they were said to be different from their conventional counterparts because they did not manifestly charge interest. This was generally known then as Interest-free Banking Scheme/System.
Up to a certain level it was later realized however that to be banks within the conventional framework they were allowed to operate in, the Islamic banks had to face stiff competition from the interest based banking institutions. Given that they were business entities whose objective was to make profit for their shareholders this position in the market was not viewed lightly by the players. To ensure their survival they had to continue to be in business in a profitable manner, facing all the competition from their conventional peers. Whether they liked it or not it was a matter of life and death for them that profit must be made otherwise they had to close their doors.
The problem is that profit as it is understood in Islam can only be created out of real trading activities where real (as opposed to financial ones) assets are traded for profit. In banking, real assets are of no relevance because bankers by definition are supposed to deal with financial assets rather than real physical ones such that in the majority of cases, in line with regulatory laws in many jurisdictions including the Muslim one, banks were not allowed to hold real assets except in a very small proportion. The catch here is that how come an Islamic bank be said to have made certain amount of profit where there has been no clear proof that it had conducted real trading of (physical) assets during the relevant period. On the other side of the river, they could see very clearly their conventional counterparts were freely making profit out of their so called business of selling loan/credit based on interest which is in real fact selling money/debt for money/debt at a differential rate for profit. Such profit if viewed from Islamic perspective is no other than Riba’; the unlawful profit from Islamic point of view.
Hence the dilemma faced by the early Islamic banks was centered upon the question of how they can continue operating as banks but at the same time would not be involved in the same practice as undertaken by the conventional ones. Soon it was discovered that the Islamic concept of Murabahah (including sale on credit-BBA) sale was very close to the conventional act of provision of credit and loan although it did not involve money lending as such given the fact that Murabahah is a sale contract be it on cash or deferred payment basis. So the early Islamic banks moved to adopt this transaction as the backbone for their business activities. The end result was that more and more transactions were done on the basis of Murabahah with deferred payment as a standard practice, the manner of which was gradually heavily criticized by the early proponents of the Islamic banking movement like Dr. Al-Qardawi and the late Dr. al-Najjar and some other concerned ulama like Dr. Al-Salus. Dr. Qardawi for example, although initially had forcefully defended the legality of Murabahah as a transaction, however after seeing that Islamic banks had over indulged in it, had called on them to minimize their reliance on this transaction. The criticism by many was centered around the issue of Islamic bank’s over indulgence in Murabahah such that they had neglected other modes of trading allowable in Islam, and that by creating debts out of Murabahah transactions in a massive scale they had behaved more like conventional banks as far as provision of credit was concerned. (This is not however in any way related to the controversy pertaining to commodity murabahah which is more serious in nature.)
Another associated problem faced was related to the fact than once these banks were involved in Murabahah debt creation in a massive scale as described above, they had to address the issue of owning too much assets (in their balance sheets) in the form of financial assets i.e debt owed to them by customers as a result of murabahah transactions that were in the majority given on deferred payment basis. With this situation they were said to be starved for not knowing how to liquidate the non liquid assets (debts). At that time many Islamic bankers were heard saying that there were not enough instruments in the market for them to manage this liquidity problem. Meanwhile their conventional peers had all the freedom to liquidate their debts in various debt/interest –based instruments available in the money or capital market. For them this was quite natural and well within the framework within which they were regulated; a framework that allow for financial asset or debts to be sold and purchased freely on prices that are known as interest rate.
Islamic banks could not do just that given the interest factor in trading financial assets not at par value that without doubt would gave rise to riba’. Conceptually what Islamic banks should do was to use the debts to purchase real assets for the purpose of trading with a view to creating profit for themselves and their customers. But the reality was that, not many were willing to become real traders and be involved in real treading of physical assets. One common reason given was that as bankers they were not supposed to do that because bankers had no concern with assets except the financial ones. The problem is that profit cannot be made out of trading in financial assets that naturally gives rise to riba.
Because of the above predicament, it was claimed that the Islamic banks had behaved in a manner similar to any other bank where they wanted to remain as mere financial intermediaries truthful of course to the framework within which they were allowed to operate. Even though they may claim that they were actually involved in trading of real assets, they were said to be doing all they could to free themselves from all risks associated with owning the assets they were supposed to be trading with. All risks were shifted to their customers such that hardly that any form risk was left with the bank although like even in the case of ijarah for instance, the bank was said to be the owner of the leased asset, but the customer needs to bear all the risk.
The issue here is that if they had only functioned as mere financial intermediaries and not like real traders who assumed ownership risk associated with the assets under possession, then it was doubtful as to whether they had conducted real or actual trading of physical assets in the manner prescribed by the Shariah to justify their profit. The basic rule of sale is that a trader can only trade with assets that are truly in their ownership and possessions, the premise that is out of context as far as banking is concerned given the framework that asks of them to be merely holders of financial assets (money/debts) only.
Even today where in some jurisdictions with the introduction of specific legislation that does not prohibit Islamic banks from holding real assets, it seems the same conventional framework is still being followed in practice,, where Islamic bankers are still skeptical to take on the role of real traders of physical assets with all the necessary risks that they cannot free themselves from. Thus it is doubtful according to some observers whether the so called Islamic banks have properly managed to conduct themselves within the necessary trading framework as explained above.
Additionally, the indication is that more and more Islamic banking products are introduced where the practice points toward the widespread trading of financial assets rather than the real ones although in many circumstances real assets were brought in to give the cloak of legitimacy to many practices said to be doubtful. In many occasions some Islamic banks without reservation involved themselves in sale and purchase of debt at discount via many financial instruments invented for financing purposes. Some other even were actively involved in Private Debt Securities where debts were sold and purchased at discount, not to mention other forms of debt-based securitization and the so called Islamic derivative contracts that are said to be badly needed for risk management. The truth is that by operating within the conventional framework where market instability is self-induced by allowing financial assets to be freely traded, Islamic banks have created trouble for themselves. Those so called derivative instruments are actually meant to address the problems created by interest-based system that has caused so much trouble to the world financial stability. It is a pity indeed to find out that some Islamic institutions being enticed into the black hole without proper comprehension on their parts.
In the same context, if one were to look at any financial statement issued by Islamic financial institutions currently in operation hardly that one could find any statement related to the number or unit of real assets recorded in the statement (the balance sheets) as if throughout the period under reporting the institutions concerned had taken in no real asset whatsoever into their ownership. If this situation is true, from where did they generate profits as reported in the financial statement as profit must have come from trading of real assets in the of ownership the trader. This fact shows either that truly the institutions did not effectively own any asset or the financial statement was prepared in the conventional manner when the institutions were viewed as traders of financial assets rather (just like their conventional peers) than the real ones as required by the Shariah. Either way the issue begs more questions than answers as to why the reporting had failed to reflect the true state of affairs of the relevant parties.
Perhaps Islamic banks need to be taught a lesson by a massive financial crisis like the ones faced by their conventional peers to make them pay attention to the true teaching of Islam that profit shall only be created out clear real trading of real assets and not the financial ones. By then hopefully the financial statement would have undergone changes!