Islamic Banking: A Step Forward to Economic Stability and Growth

“An Exclusive Interview with Qazi Abdul Samad ,Resident Shariah Board Member (RSBM), Bank of Khyber- Islamic Banking Group, Pakistan “ 

Qazi Abdul Samad is an eminent Shariah scholar and has sound experience of Islamic Banking & Finance. He has a strong academic background in Islamic Studies and Islamic Economics. He completed his all religious qualifications such as Shahdatul Aalimiyah from Jamia Tufheem-ul-Quran Mardan. He has also done his Masters in Islamic Studies and LLB (Hons) Shariah & Law from International Islamic University Islamabad. Presently he is Resident Shariah Board Member (RSBM) of The Bank of Khyber. He is also a Visiting Faculty Member of Centre for Excellence in Islamic Finance in Institution of Management & Sciences (IMS) Peshawar and associate with other national and international professional bodies of Islamic finance. He has delivered research-based lectures/presentations at different national and international seminars, forums, conferences, and seminars. He is a regular trainer of NIBAF since 2012. He is also a member of several professional bodies of Islamic finance. His several research topics have been published in various well-renowned newspapers and magazines.”

Q 1. keeping in view your present position what is your opinion about Islamic finance?

Islamic finance has evolved as a component of the global economy and is competitive and strong to an extent that it won’t be an exaggeration to say that is very stable than its conventional counterparts. The system links physical assets to the real economy and channels funds properly and ensures genuine underlying trades and related activities accompany business transactions.

The existence of a strong guiding Shariah framework further strengthens the entire system. Islamic financial institutions adopt a slower and insightful decision-making process when it comes to investments. They do rigorous reviews and investigation and avoid companies with risky financial practices and operations. The Shariah law also stresses proper due diligence and demand for a high standard of disclosure and transparency. Also, Islamic transactions do not tolerate ambiguity based on future events. This avoids potential conflicts, as it prohibits interest (riba), gambling (maisir), and dubious ambiguity (gharar).

Q 2. What are the basic Guidelines of Islamic Banking?

From a more practical perspective, Islamic Banking and Finance is a system which based on the following principles:

1. Risk-sharing: the terms of financial transactions need to reflect asymmetrical risk/return distribution among each participant to the transaction.

2. Materiality: all financial transactions must have “material finality,” i.e., be directly linked to a real underlying economic transaction.

3. No exploitation: neither party to the transaction should be exploited.

4. No financing of sinful activities: transaction cannot be used to produce goods banned by the Quran (e.g., alcohol, pork products, gambling, pornography, etc.)

5. Uncertainty about the terms of contract (Gharar) – that Sharia law requires a complete transparency of the contract terms. Any uncertainty about price, delivery issues, and other terms are prohibited.

6. Speculative transactions (Maisir) – according to the Sharia Law, the investments in speculative transactions, such as derivatives, are considered to be illegal.

7. No violation: The bank does not violate Sharia in all of his transactions.

Q 3. How do you ensure Shariah compliance in Islamic banking?

Shariah compliance is the backbone of Islamic banking. State Bank of Pakistan has issued a detailed set of instructions and guidelines for shariah compliance applicable to all full-fledged Islamic banks, Islamic banking subsidiaries, and Islamic banking divisions of conventional banks. The primary objective of this document is to strengthen the overall shariah compliance environment of Islamic banks through the following:

  1. That every Islamic bank shall have Shariah Board comprising of minimum three shariah scholars to decide and supervise all shariah related matters of the bank
  2. One of the shariah board members to be appointed on a full-time basis to oversee the procedures to be adopted for the implementation of the fatawas of the Shariah board.
  3. Besides Shariah Board there shall be Shariah Compliance Division, to work under the supervision of Shariah Board to act as a conduit between shariah Board and management and keep continue watch of the bank’s shariah compliance environment.
  4. There shall be an internal shariah audit and external shariah audit to have an assessment of shariah compliance environment of the bank.
  5. Beside all these, the state bank of Pakistan also conducts shariah inspection of Islamic banking operations.  

Q 4. What can be called the major inventions of the Islamic banking system? Just highlight three of those.

The selection of three will be somehow difficult among many, however, I considered the following three are new inventions of Islamic banking in the banking industry.

  1. Relationship with Depositors

From very early practices of the banking industry, the relationship between depositors and banks has been based on a lending contract. The depositors provide money to the bank and the return of depositors is determined at the time of making the deposits. All these depositor’s money is becoming a liability of the bank which is an acknowledgment of the deposits being “debt” against the bank and Interest paid to the depositors during the course is treated as an expense of the bank. In this system, the bank has to pay to the depositors the principal amount as well as interest, regardless of whether the bank makes a profit from the deposits or not. In case of bad loans, the bank has to pay the depositors from its own resources. The depositors don’t share risk with the bank.

Islamic Banking drastically changed the nature of the relationship between depositors and banks and established a new relationship based on partnership (Musharakah or Mudarabah). In this system, Islamic Banks accept deposits with a condition that this money and portion of bank equity will be put to work combined with the skill and management expertise of the bank. The profit gained will be distributed among the partners according to the agreed ratio and if the bank incurs losses, the depositors share in the losses according to the investment ratio. In this system, the depositors are not guaranteed any pre-determined return but treated as a shareholder of the bank where he is entitled to share of the profit made by the bank and their deposits are considered the capital of the partnership (Musharakah) instead of liability of the Bank. Similarly, when there are losses in the business, the depositors’ shares in these losses.

Risk is known to be one of the most important elements of investing. In the conventional system, all risks transferred to the bank, and any crises leads directly the bank to bankruptcy. While in the Islamic system, depositors automatically share the risk. So, because of this risk-sharing system, an Islamic bank is less likely to fall bankrupt as bank run is least probable. It can, therefore, be stated, that Islamic Banking is relatively more stable than conventional Banking.          

  1. Closing the Gap between Banks and Supplier

In a conventional system, banks give money to the client where he is becoming the owner of that amount, and all risks and liability transfer to him. So, any purchases he is making of that mount considered purchases of the client and in this way, the conventional system built a gap between bank and supplier.

Since Islamic Bank limits their financing to three main modes as (a) purchases of good (b) lease (c) establishment of productive project. The first two are sale transactions in which Islamic Banks first purchase the commodity and then sale or lease it out to the client. Shariah imposed several conditions for the validity of these transactions. One of these conditions is the bank shall ensure that the client really intends to purchase goods and not to obtain funds only. Secondly, the bank shall also ensure that the party from home the items will be bought is a third party and not the client or his agent. Thirdly, the bank must share the risk of the commodity. Fourthly, the bank must own and possess the goods being sold. In this way, Islamic Banking has a one to one relationship to the real goods market.

In the third mode of Islamic Banking-finance is a joint enterprise where one or more entrepreneurs approach an Islamic Bank for finance, required for a project. The bank provides total finance or becomes a partner and gets a right to participate in the project. The profit is distributed according to an agreed ratio and losses are shared in the same proportion in which the different partners have provided the finance for the project. In both cases, Islamic bank and other partner activities are based on mutual interest and share responsibilities and in this way Islamic Banking built a strong and direct relation with suppliers.

  1. Ethics and Banking

It has been noted for a long time in all societies that banks are institutions that deal with money, not with ethics. The very idea of Islamic Banking brings in ethical values of banking practices. Islamic banks are banks that abide by Islamic rules. The Shariah itself is loaded with moral values. So Islamic banks are not permitted to establish any relationship with commodities, services, and individuals whose moral practices are doubtful. Hence financing drugs, alcohol, gambling, casinos, and any environmentally harmful commodities, etc. are completely excluded from the working map of Islamic banking.

Q 5. In the end, just tell us shortly about the concept of money in Islamic Economics?

I think the long reply to the previous question has realized you to add the word shortly in your question. Islam views ‘money’ as only a medium of exchange and a measure of value. The rationale behind this principle is that every human being needs a large number of commodities for survival. The transaction of exchange is inevitable among people who have the commodities and those who need such commodities. But there must be a measure based on which price can be determined because the exchanged commodities are neither of the same type nor of the same measure which can determine how much quantity of one commodity is a just price for another. Therefore, all these commodities need a medium to measure their exact value. Hence, ‘money’ is invented as the medium to measure all the commodities, services, assets, or wealth as a whole. Money is a tool to measure the value of all commodities and it is not a commodity in itself. Money has no intrinsic value; Money has no intrinsic value; it cannot be utilized in direct fulfillment of human needs. It can only be used for acquiring some goods or services. A commodity, on the other hand, has intrinsic utility and can be utilized directly without exchanging it for some other thing.

Q 6. Earlier you have mentioned about the concept of risk transfer and risk-sharing. How the Islamic finance approach to risk can serve as a model for global reform?

The financial crisis of 2008 has motivated several academics, practitioners, and policymakers to question the fundamental stability of the conventional financial system, a system mainly based on debt financing and leveraging; with the embedded risk that the temptation of leveraging could become excessive, and this combined with the inherent asset-liability mismatch threatens the solvency of financial institutions and overall financial stability.

An alternative to the conventional financial system is a system with no debt financing, only equity or direct asset financing; where there would be no “risk shifting” as happens with debt, only “risk-sharing” as happens with equity or asset-financing. Financial institutions would be serving their traditional role as intermediaries between savers and investors but with no debt on their balance sheets, no opportunity to engage in leveraging and no predetermined interest rate payments as liabilities. Such a system has been suggested by a number of noted conventional economists over the last hundred years and it is the system whose basic principles have been advocated by Islam and to some extent by other Abrahamic religions. While a number of indicators point to rapid growth in the practice of Islamic finance, much of this growth, to our mind, has been superficial. Instead of developing a risk-sharing-friendly financial system, the practice of Islamic finance has become misaligned to replicating conventional finance.

Q 7. In the end, just describe the future of Islamic banking in Pakistan.  

Islamic finance is growing in Pakistan and the country will emerge as an Islamic finance hub considering its deeply embedded culture of Islamic values and the general tilt of the masses towards the sharia-compliant procedures. Both these things present Pakistan as a huge market for the Islamic Finance products not only for the domestic banking industry but also for the international banks as well. As per the number of surveys, almost 76% of people prefer Islamic finance than conventional banking. These survey results show that if Islamic finance is properly established in the financial markets, it can cater to the huge market.