|
Evolution
| Rationale
| Anatomy
| Literature:
Theory
Literature:
Practice | Conclusion
| Glossary
Appendix: Islamic Financial Institutions | References
Literature:
Practice
Recent years
have brought an increasing flow of empirical studies
of Islamic banking. The earliest systematic
empirical work was undertaken by Khan (1983). His
observations covered Islamic banks operating in
Sudan, United Arab Emirates, Kuwait, Bahrain,
Jordan, and Egypt. Khan's study showed that these
banks had little difficulty in devising practices in
comformity with Shariah. He identified two
types of investment accounts: one where the
depositor authorized the banks to invest the money
in any project and the other where the
depositor had a say in the choice of project to be
financed. On the asset side, the banks under
investigation had been resorting to mudaraba,
musharaka and murabaha modes. Khan's
study reported profit rates ranging from 9 to 20 per
cent which were competitive with conventional banks
in the corresponding areas. The rates of return to
depositors varied between 8 and l5 per cent, which
were quite comparable with the rates of return
offered by conventional banks.
Khan's study
revealed that Islamic banks had a preference for
trade finance and real estate investments. The study
also revealed a strong preference for quick returns,
which is understandable in view of the fact that
these newly established institutions were anxious to
report positive results even in the early years of
operation. Nienhaus (1988) suggests that the
relative profitability of Islamic banks, especially
in the Middle East in recent years, was to a large
extent due to the property (real estate) boom. He
has cited cases of heavy losses which came with the
crash of the property sector.
The IMF study
referred to earlier by Iqbal and Mirakhor (1987)
also contains extremely interesting empirical
observations, although these are confined to the
experience of Iran and Pakistan, both of which have
attempted to islamize the entire banking system on a
comprehensive basis.
Iran switched
to Islamic banking in August 1983 with a three-year
transition period. The Iranian system allows banks
to accept current and savings deposits without
having to pay any return, but it permits the banks
to offer incentives such as variable prizes or
bonuses in cash or kind on these deposits. Term
deposits (both short-term and longterm) earn a rate
of return based on the bank's profits and on the
deposit maturity. No empirical evidence is as yet
available on the interesting question as to whether
interest or a profit-share provides the more
effective incentive to depositors for the
mobilization of private saving. Where Islamic and
conventional banks exist side by side, central bank
control of bank interest rates is liable to be
circumvented by shifts of funds to the Islamic
banks.
Iqbal and
Mirakhor have noted that the conversion to Islamic
modes has been much slower on the asset than on the
deposit side. It appears that the Islamic banking
system in Iran was able to use less than half of its
resources for credit to the private sector, mostly
in the form of short-term facilities, i.e.,
commercial and trade transactions. The slower pace
of conversion on the asset side was attributed by
the authors to the inadequate supply of personnel
trained in long-term financing. The authors,
however, found no evidence to show that the
effectiveness of monetary policy in Iran, broadly
speaking, was altered by the conversion.
The Pakistani
experience differs from the Iranian one in that
Pakistan had opted for a gradual islamization
process which began in 1979. In the first phase,
which ended on l January 1985, domestic banks
operated both interest-free and interest-based
'windows'. In the second phase of the transformation
process, the banking system was geared to operate
all transactions on the basis of no interest, the
only exceptions being foreign currency deposits,
foreign loans and government debts. The Pakistani
model took care to ensure that the new modes of
financing did not upset the basic functioning and
structure of the banking system. This and the
gradual pace of transition, according to the
authors, made it easier for the Pakistani banks to
adapt to the new system. The rate of return on
profit-and-loss sharing (PLS) deposits appears not
only to have been in general higher than the
interest rate before islamization but also to have
varied between banks, the differential indicating
the degree of competition in the banking industry.
The authors noted that the PLS system and the new
modes of financing had accorded considerable
flexibility to banks and their clients. Once again
the study concluded that the effectiveness of
monetary policy in Pakistan was not impaired by the
changeover.
The IMF
study, however, expressed considerable uneasiness
about the concentration of bank assets on short-term
trade credits rather than on long-term financing.
This the authors found undesirable, not only because
it is inconsistent with the intentions of the new
system, but also because the heavy concentration on
a few assets might increase risks and destabilize
the asset portfolios. The study also drew attention
to the difficulty experienced in both Iran and
Pakistan in financing budget deficits under a
non-interest system and underscored the urgent need
to devise suitable interest-free instruments (7)
. Iran has, however, decreed that government
borrowing on the basis of a fixed rate of return
from the nationalized banking system would
not amount to interest and would hence be
permissible. The official rationalization is that,
since all banks are nationalized, interest rates and
payments among banks will cancel out in the
consolidated accounts. (This, of course, abstracts
from the banks' business with non-bank customers.)
There are
also some small case studies of Islamic banks
operating in Bangladesh (Huq 1986), Egypt (Mohammad
1986), Malaysia (Halim 1988b), Pakistan (Khan 1986),
and Sudan (Salama 1988b). These studies reveal
interesting similarities and differences. The
current accounts in all cases are operated on the
principles of alwadiah. Savings deposits,
too, are accepted on the basis of alwadiah,
but 'gifts' to depositors are given entirely at the
discretion of the Islamic banks on the minimum
balance, so that the depositors also share in
profits. Investment deposits are invariably based on
the mudaraba principle, but there are
considerable variations. Thus, for example, the
Islamic Bank of Bangladesh has been offering PLS
Deposit Accounts, PLS Special Notice Deposit
Accounts, and PLS Term Deposit Accounts, while Bank
Islam Malaysia has been operating two kinds of
investment deposits, one for the general public and
the other for institutional clients.
The studies
also show that the profit-sharing ratios and the
modes of payment vary from place to place and from
time to time. Thus, for example, profits are
provisionally declared on a monthly basis in
Malaysia, on a quarterly basis in Egypt, on a
half-yearly basis in Bangladesh and Pakistan, and on
an annual basis in Sudan. A striking common feature
of all these banks is that even their investment
deposits are mostly short-term, reflecting the
depositors' preference for assets in as liquid a
form as possible. Even in Malaysia, where investment
deposits have accounted for a much larger proportion
of the total, the bulk of them were made for a
period of less than two years. By contrast, in Sudan
most of the deposits have consisted of current and
savings deposits, apparently because of the ceiling
imposed by the Sudanese monetary authorities on
investment deposits which in turn was influenced by
limited investment opportunities in the domestic
economy.
There are
also interesting variations in the pattern of
resource utilization by the Islamic banks. For
example, musharaka has been far more
important than murabaha as an investment mode
in Sudan, while the reverse has been the case in
Malaysia. On the average, however, murabaha, bai'muajjal
and ijara, rather than musharaka
represent the most commonly used modes of financing.
The case studies also show that the structure of the
clientele has been skewed in favour of the more
affluent segment of society, no doubt because the
banks are located mainly in metropolitan centres
with small branch networks.
The two main
problems identified by the case studies are the
absence of suitable non-interest-based financial
instruments for money and capital market
transactions and the high rate of borrower
delinquency. The former problem has been partially
redressed by Islamic banks resorting to mutual
interbank arrangements and central bank cooperation,
as mentioned earlier. The Bank Islam Malaysia, for
instance, has been placing its excess liquidity with
the central bank which usually exercises its
discretionary powers to give some returns. The
delinquency problem appears to be real and serious. Murabaha
payments have often been held up because late
payments cannot be penalized, in contrast to the
interest system in which delayed payments would
automatically mean increased interest payments. To
overcome this problem, the Pakistani banks have
resorted to what is called 'mark-down' which is the
opposite of 'mark-up' (i.e., the profit margin in
the cost-plus approach of murabaha
transactions). 'Mark-down' amounts to giving rebates
as an incentive for early payments. But the
legitimacy of this 'mark-down' practice is
questionable on Shariah grounds, since it is
time based and therefore smacks of interest.
In the
Southeast Asian context, two recent studies on the
Bank Islam Malaysia by Man (1988) and the Philippine
Amanah Bank by Mastura (1988) deserve special
mention. The Malaysian experience in Islamic banking
has been encouraging. Man's study shows that the
average return to depositors has been quite
competitive with that offered by conventional banks.
By the end of 1986, after three years of operation,
the bank had a network of fourteen branches.
However, 90 per cent of its deposits had maturities
of two years or less, and non-Muslim depositors
accounted for only 2 per cent of the total. Man is
particularly critical of the fact that the mudaraba
and musharaka modes of operation, which are
considered most meaningful by Islamic scholars,
accounted for a very small proportion of the total
investment port folio, while bai'muajjal and ijara
formed the bulk of the total.
It is evident
from Mastura's analysis that the Philippine Amanah
Bank is, strictly speaking, not an Islamic bank, as
interest-based operations continue to coexist with
Islamic modes of financing. Thus, the PAB has been
operating both interest and Islamic 'windows' for
deposits. Mastura's study has produced evidence to
show that the PAB has been concentrating on murabaha
transactions, paying hardly any attention to the mudaraba
and musharaka means of financing. The PAB has
also been adopting unorthodox approaches in dealing
with excess liquidity by making use of interest
bearing treasury bills. Nonetheless, the PAB has
also been invoking some Islamic modes in several
major investment activities. Mastura has made
special references to the qirad principle (8)
adopted by the PAB in the Kilusang Kabuhayan at
Kaunlaran (KKK) movement launched under Marcos and
to the ijara financing for the acquisition of
farm implements and supplies in the Quedon food
production program undertaken by the present regime.
So far no
reference has been made to Indonesia, the largest
Muslim country in the world, with Muslims accounting
for 90 per cent of a population of some 165 million.
The explanation is that a substantial proportion,
especially in Java, are arguably nominal Muslims.
Indonesians by and large subscribe to the
Pancasila
ideology which is essentially secular in character.
The present regime seems to associate Islamic
banking with Islamic fundamentalism to which the
regime is not at all sympathetic. Besides, the
intellectual tradition in Indonesia in modern times
has not been conducive to the idea of interest-free
banking. There were several well respected
Indonesian intellectuals including Hatta (the former
Vice President) who had argued that riba
prohibited in Islam was not the same as interest
charged or offered by modern commercial banks,
although Islamic jurists in Indonesia hold the
opposite view. The Muslim public seems somewhat
indifferent to all this. This, however, does not
mean that there are no interest-free financial
institutions operating in Indonesia. One form of
traditional interest-free borrowing is the still
widely prevalent form of informal rural credit known
as ijon (green) because the loan is secured
on the standing crop as described by Partadireja
(1974). Another is the arisan system
practised among consumers and small craftsmen and
traders. In this system, each member contributes
regularly a certain sum and obtains interest-free
loans from the pool by drawing lots. The chances of
an Islamic bank being established in Indonesia seem
at present remote (cf. Rahardjo 1988).
Finally, in
the most recent contribution to the growing Islamic
banking literature, Nienhaus (1988) concludes that
Islamic banking is viable at the microeconomic level
but dismisses the proponents' ideological claims for
superiority of Islamic banking as 'unfounded'.
Nienhaus points out that there are some failure
stories. Examples cited include the Kuwait Finance
House which had its fingers burned by investing
heavily in the Kuwaiti real estate and construction
sector in 1984, and the Islamic Bank International
of Denmark which suffered heavy losses in 1985 and
1986 to the tune of more than 30 per cent of its
paid-up capital. But then, as Nienhaus himself has
noted, the quoted troubles of individual banks had
specific causes and it would be inappropriate to
draw general conclusions from particular cases.
Nienhaus
notes that the high growth rates of the initial
years have been falling off, but he rejects the
thesis that the Islamic banks have reached their
'limits of growth' after filling a market gap. The
falling growth rates might well be due to the bigger
base values, and the growth performance of Islamic
banks has been relatively better in most cases than
that of conventional banks in recent years.
According to
Nienhaus, the market shares of many Islamic banks
have increased over time, notwithstanding the
deceleration in the growth of deposits (9)
. The only exception was the Faisal Islamic Bank of
Sudan (FIBS) whose market share had shrunk from l5
per cent in 1982 to 7 per cent in 1986, but Nienhaus
claims that the market shares lost by FIBS were won
not by conventional banks but by newer Islamic banks
in Sudan.
Short-term
trade financing has clearly been dominant in most
Islamic banks regardless of size. This is contrary
to the expectation that the Islamic banks would be
active mainly in the field of corporate financing on
a participation basis. Nienhaus attributes this not
only to insufficient supply by the banks but also to
weak demand by entrepreneurs who may prefer fixed
interest cost to sharing their profits with the
banks.
Courtesy
of Mohamed Ariff, University of Malaya
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