The conventional financial and banking system was exposed for its flaws during and following the epic failure of global financial system in 2007-08. But, at the same time, Islamic banking remained largely unaffected and displayed unique resilience.
Since then, Islamic banking has boomed around the world and is projected to continue improving its market share in the future.
In Pakistan, Islamic banking Industry (IBI) has witnessed discernible consolidation and its network of pure Islamic banks has significantly improved. According to the last Islamic Banking Bulletin released, the market share of IBI has witnessed tremendous growth of Rs65 billion during last quarter from October to December 2016. Besides, deposits of IBI grew by Rs97 billion. In addition, the market share of Islamic banking and deposits in overall industry stands at 11.7 and 13.3 % respectively.
Even though consumers in search of a Halal alternative to conventional finance found solace in advent of new Islamic products, large fraction of consumers have refrained from indulging in Islamic banking largely sighting the fixed nature of returns on deposit, analogous to conventional system.
State Bank of Pakistan (SBP), along with the Islamic banks, has been continuously making efforts to create a regulatory framework which is customized to the needs of Islamic banking.
In an attempt to persuade and convince consumers on the use of Shariah compliant products, the State Bank of Pakistan amended its regulation and exempted the Islamic banks from using the interest based benchmark for some of its financing products. This has given the Islamic banks liberty to device products based on pure Islamic rules and regulations.
But, majority of potential and existing consumers have remained skeptical and confused about the status of Islamic banking. People have long raised the questions regarding the legitimacy of the system. This piece is an attempt to answer some of the relevant questions and clear the ambiguity surrounding the legality and permissibility of the Islamic banking products particularly opening of saving accounts.
The common notion against the IB is that since the rates/returns on both Islamic banking and conventional banking are fixed, how could we believe in its legitimacy. The problem is a lack of knowledge and expert individuals/bankers in Islamic banking who fail to convince the potential customers on legitimacy of Islamic banking. There is a huge difference in operational mechanism of Islamic banking as compared to conventional banking.
One must acknowledge that Islamic banks invest the money only in businesses that are legal and exclusively follow Islamic doctrines. There is no investment in non-trading fixed and other assets such as land, building, furniture, computers, IT systems, etc. Deposits are invested only in legally permissible trading businesses unlike the conventional banks which invest indiscriminately without consideration for Sharia doctrines.
In current circumstances, as conventional banking continues to hold the majority of the world market share, customers are used to securing high returns. Islamic banking has to counter the existing market leaders and the best way forward for them is to ensure the returns on nearly fixed rates. This does not mean that Islamic banks will be acting analogues to conventional banks. Rather, they have devised policies and practices which could certainly impact the profit and loss distribution. For example, Islamic banks have established a Profit Equalization Reserve (PER) out of the Net Income (NI) of the pool. The monthly share towards the PER must not exceed over 2% of net income and accumulated balance should not exceed the threshold level of 30%. Therefore, Islamic banks in order to compete with traditional banks and persuade the potential customers are allowed to improve the returns to their depositors during those periods when the profits witnessed are below the expectations of the savers in the Islamic banks.
One of the most fascinating products of Islamic banking is Mudarba arrangement with Islamic banks. In such arrangement, depositors act as Rubbulmal, while the bank acts as a Mudarib. The bank performs the business activities for Rubbulmal which must accept losses and profits. In case of losses, the latter have to incur all losses and the former will only incur loss of time and resources used for investment of the Rubbulmal. Under the Islamic doctrines, trade is allowed as it has equal chance of profit and loss. Mudarba arrangement is a practical example of such doctrines. Customers face no such scenarios under conventional banking and expect the predetermined returns, which makes it haram.
At this rather early stage of Islamic banking, banks do not want to discourage the customers from switching to Islamic banking. Therefore, under current the Mudarba arrangement, in order to absorb the losses, Islamic banks have created Investment Risk Reserve (IRR) to cover the future investment losses. In case of losses, after the deductions of Mudarib (bank), the rest is contributed towards the IRR out of the up to 1% of the total profit available for distribution among the depositors.
People may show discontent for Islamic banking based on presumptive attitude but the in-depth analysis of its mechanics, reasoning and intuition behind the nicely crafted products clearly depicts that Islamic banking offers a potent and legal alternative to conventional banking. It must be embraced with open heart and should be given time to develop fully and play its part in encouraging equity and fair play in society replicating the Islamic teachings in true sense.