Islamic Banking
Description
Ivan Tsikota:
"The history of modern Islamic banking dates back to 1975, with the establishment of Bank Faisal in Egypt (Al-Salem, 2008). Worldwide, the number of Islamic Financial Institutions (IFIs) grew from 37 in 1997 to approximately 300 in 2009. In parallel with this development the size of Islamic financial funds on the global arena is increasing. In first quarter of 2010, they managed approximately $52 billion, and unlike traditional mutual funds, whose net assets decreased by $4.1 billion from 2007 to 2009, IFIs demonstrated growth even against the background of international economic crisis (Ernst & Young, 2010).
In Iran, Pakistan and Sudan only IFIs are allowed (Aggarwal & Yousef 2000), and in some other countries, e.g. Bangladesh, Egypt, Indonesia, Jordan and Malaysia, two systems co-exist (Chong & Liu, 2009). The first non-Muslim country in which an Islamic Bank was established was the United Kingdom; it opened in 2004.
Western and Islamic banking are different not only in the financial instruments used, but also in the philosophy2. First of all, according to (Aggarwal & Tarik, 2000) it is clearly stated in the Quran that: “Allah forbids interest and permits trade”. Gharar – uncertainty and risk – is not allowed (Chong & Liu, 2009) and neither is riba3 – interest. According to Kabir & Mervyn (2007), however, ‘the objection is not to the payment of the profits, but to a predetermined payment that is not a function of the profits and losses incurred by the firm or entrepreneur’. IFIs operate basing on two concepts: profit-and-loss sharing (PLS) and the mark-up principle (MUP) (Aggarwal & Tarik, 2000).
According to the PLS concept, the person providing credit has a right to share profits from the enterprise provided s/he is ready to also share risks and losses, in case it fails. Instead of an interest rate, contractors negotiate distribution of profits (or losses). Generally, two types of contracts are used in this category: musharaka (partnership) and mudarabah (‘finance by way of trust’ (Kabir & Mervyn, 2007)). In case of musharaka, both sides provide resources for the project and share risks of losses or gains. At that, profits are distributed in a pre-agreed proportion, and losses depend on the share invested. In mudarabah contracts, one party submits funding, and another performs management thereof. Profits are distributed on a pre-agreed basis, the assets are possessed by the providing party, and managing side has the right to buy them out.
MUP applies to agreements where the creditor buys goods on behalf of the borrower, and resells or rents it out. Most common forms of financing are murabaha and ijara. In the former case the creditor acquires the asset and then resells it at the original price plus a pre-agreed margin, whereas in the latter the goods are provided for use based on a repayments scheme with the option of the ownership transfer (analogue of leasing today). It is important to state the difference between conventional interest-based lending and murabaha financing; the fee is only charged for the creditors services in acquiring goods and is not dependent on time, i.e. the delay in the repayment of debt does not incur an increase in fee." (thesis: Increasing Local Economic Sustainability)
Example
The Grameen Bank
Ivan Tsikota:
"One example of an Islamic financial institution is the Grameen Bank, which in 2006 received the Nobel Peace Prize jointly with its founder, Muhammad Yunus “for their efforts to create economic and social development from below” (The Nobel Foundation, 2006). Grameen Bank’s main scope of activity is providing micro-credits to the poorest people in Bangladesh without any collateral requirement. The model works as follows. First of all, the loans are only issued to groups of five people, who cannot be related to each other. This is done in order to ensure collective responsibility, accountability, and peer pressure. First loans are allocated to two members of the group. Any new loans are issued provided all principal debts and interests have been repaid; the group leader is the last person entitled to apply for a loan. Interest rates are kept to market level, and 5% of credit is attributed to the group fund. Seemingly simple, this model works very successfully in the Bangladesh market. According to statistics from Grameen’s official web-site, as of February 2011 it had 8.36 million borrowers, 2,565 branches, and served around 97% of villages in the country. Total amount of loans disbursed is $10.38 billion, and the repayment rate is 97%." (thesis: Increasing Local Economic Sustainability)