In simple there are two main systems which are functional in the financial sector on the globe. Islamic finance and conventional finance are two different way of borrowing and financing. It is meant that Islamic finance is only for Muslims, which is not true. There is competition between the two systems. The Muslims specifically find more reasons for adopting Islamic finance. The laws of the governments apply to the both systems. In specific meanings, financial services authority ( FSA) governs the both the systems. The assets of Islamic finances are growing very fast and it is expected that by the year 2010, the volume of assets of Islamic finances would touch $1 trillion, (Iqbal and Molyneux, 2005).
The Muslims countries especially Saudi Arabia, Kuwait, and Malaysia are applying and working under the Sahrah laws, and therefore are practicing Islamic finance systems, (Iqbal and Molyneux, 2005). Of course there are threats to the Islamic finance where the Islamic laws prohibit, this is in fact causing challenges to the Islamic banking, (Rosly, 2005).
Keeping in view the importance of the subject, the followings are the objectives such as:
Explanation of the implications of the application of Islamic principles in banking and financial intermediation.
It is noticed the apparently limiting factor which has indeed halt the Islamic banks refers to right people on board with the right level of commitment. Although Sharah laws are written but the people who are practicing is very few. The reason is related to the non availability of Islamic finance academicians. This is the more surprising implication. The impact of this can be seen in terms of poor and slow growth of Islamic finances. The human resources, who are the actors in Islamic finance, are not enough to beat the challenge.
While in answering the implications, HSBC, is perhaps the first bank, who accepted the challenge and opened window for Islamic banking. The bank in reality financed mortgages to the Muslims, and then later other banks are on the way to copy HSBC. There are some implications, such as ongoing costs are higher than the conventional banks. However the competition in the market did urge the people to get Islamic mortgages instead from the conventional banks. Next implication refers to control of prices; therefore the Islamic banks must control the prices, as failing to this would destroy the efforts carried out in the Islamic banking. Therefore, the managements in the Islamic banking system need to have their own pricing control boards instead to depend upon others.
Probably, this is last but not the least implication, where in staff that work in the Islamic banking, have firstly worked for the conventional banking, at this point the way of working differs significantly. Hence more education and training required to the Islamic banking staff. As According to Armstrong (2009) training to staff makes difference. Therefore this implication can be minimised through providing short term trainings to the working staff.
There are also basically Islamic laws under particularly Shari'ah, strictly opposes the financial activities where there is a risk. Therefore to help the people the conditions regarding there was high demand from the Islamic people to have very different type of financial institutions, where the people could operate their accounts in the advanced world, especially Islamic accounts. In reality, the banks in the UK, who are operating Islamic accounts, or finances, they are obliged to abide by the rules such as FSA. The failing to the application of FSA means failure of the Islamic banking system.
Understand the implications of the traditional Islamic concepts of musharakah and mudarabah for the practical commercial operations of banks and financial institutions:
Murabahah (Cost plus):
There are differences in between the two terms of situation in Islamic banking. In case of this, it means that it involves the sale of goods at a price which also includes profit. This is specifically is connected to the two parties. It means one party is selling to the other. Therefore in Islamic this should be known to the both parties. In other words, this is the right of second party to know the details of actual value including profit.
Musyarakah (Joint venture):
This is differentiated in reference to business and trade. Particularly, Musyarakah means a joint business venture or a partnership, where the profit is generated and distributed. IT is specifically indicated that the loss will be distributed as per basic philosophy, as the ratios of investment.
Therefore parties involve in the trade must be aware that the distribution of profit and loss is one of the most important issue, which needs to understood by those who are involved. It means that might be one is giving more than when compared.
Draw comparisons between the conventional and Islamic banking business models.
The comparison between conventional and Islamic banking is the base line for differentiating between the two. It is advocated that in conventional system, the money, which is financed, is for the longer terms and this is given or provided to the borrower by various means such as long-term bonds and equities.
In addition, the most important sources also include investment banks, mutual funds, insurance companies and pension funds. The banking administration runs these funds through appropriate legislation. It means that the banks are using money, but works with the laws. Most significantly, bonds are too used in financing the businesses and etc.
Contrary to above, the Islamic banks do not use/deal/apply where there is even a doubt of single penny of interest, especially bonds with interest money is never used. This gives rise to the higher equity. In including, the most of the products in Islamic banks are based on goods and commodities while prices and currency rates go up and down frequently, creating a big risk. This is another difference the Islamic banking system has to increase the prices for making the balance into the accounts.
Now question comes on mind, how these types of risks can isolated and hence removed. In Islamic banking, the products are interest free, and this is the only attraction to which people think that interests are not allowed, could purchase those products, and it is assumed that the balance of the market remain in control.
There is another argument at this point, that the UK's four large banks borrow money from other banks or one from the other. It means cycle of borrowing runs in among the four major banks, and borrower agrees and pays the interest. So question is there how the Islamic bank borrows money, it is a still question. But generally speaking the Islamic does not practice such exercises. However this further needs to be investigated.
Therefore the main issue rests with both the systems is about liquidity, and this uis the major challenge in Islamic banking system. This is the most threatening issues and demands its solution.
Now we have to notice, how the conventional banks are resolving the issues of liquidity. AS a matter of fact, the conventional banks use many tools and instruments to keep the bank's book balanced. These options are not allowed in Islamic banking.
To come out from this situation, a scheme was introduced in the Islamic Republic of Bahrain, where a Liquidity Management Centre (LMC) was created during 2002, and main purpose was to study the issue and to bring the solution. IT was suggested the LMC that a facility be created of an inter-bank money market that will permit the Islamic banks to effectively manage their asset-liability mismatch and invest their surplus liquidity. In a similar approach, the Dubai International Financial Centre was created primarily to serve the vast region of Western Europe and East Asia.
In principle, the issues of conventional banking and Islamic are nearly different. The conventional banks have simple ways of borrowing money, but the same is not true. The only commonality refers to the equity. The strong the liquidity, the strongly the bank can finance for a project. In the Islamic banking system to make liquidity strong these two centres are working in line of the Islamic banking, and there are hopes attached to this.
It is also noted that Islamic banking laws, principles, and interests' free finance are still not as clear, it should as per the Islamic laws say.
Islamic law says that the ideas of accountability and transparency must prevail, and perhaps the same is true for conventional banking. One point we must understand and then present that being the clamant of these terms in the banking system, why the conventional banking could not save the western banks. The people are still waiting to get the answers from the respective authorities.
The main difference between the conventional banking and to that of Islamic banking basis upon a particular 'word called interest. This is not permitted in Islamic banking and at the same is allowed in the conventional banking. In the eyes of western financial authorities, this condition or situation is very strange. The data shows that in the western countries, there was not interest till the 16th century, so then an again another question comes why this interest started. Initially this was started by some of the groups in the western society. The majority Christian countries themselves maintained such a ban for 1,400 years. It means those who opposed and did not let it to function were religious, as the advancement of age forwards, the dangers of interests in the lives of commonly people.
The Carhart model displays a preference of Islamic funds for growth and small cap investing. However, Islamic mutual funds from the same country tend to invest in a variety of different international regions. Hence, we cannot sufficiently assess their financial performance and investment style without controlling for their exposure to regional and global equity market benchmarks and investment styles. To control for these regional and global factors, a three level Carhart model, which controls for equity market and investment style exposure such as?
- in a nation,
- in all other nations of a region,
- and in all other regions of the world.
Now there is another argument whether or not can we apply the same approach to the conventional banking models, the answer is yes, but the results and circumstances can vary.
Application of appropriate techniques for the evaluation of the financial performance and efficiency of Islamic banks.
It is seen and believed that Islamic banks profitability measures answer very positively to the increases in capital and loan ratios. It shows that adequate capital ratios and loan portfolios play an empirical role in explaining the performance of Islamic banks. In addition, another technique, where the Islamic banks fund for short terms basis, and hence generate profits. It is pre-determined that loans are interest free, and this is the very attraction to the customers for making and seeking the difference significantly.
Very commonly it is argued that finances invested thorough the Islamic banking system would be interest free. The costs will be determined after adding profits in it. The Islamic bank remain the owner of the on going method of investment, therefore it is advocated that there are crystal clear chances that this will grow positively, and its performance will be judged accordingly.
Iqbal and Molyneux, (2005) after analysing the situation did notice that the presence of challenges to the Islamic basking systems basically is the hindrance in performance evaluation. The people get the money from the Islamic banks, and pay the even higher instalments in comparison, so how could it is possible that the people would go to Islamic banking as compared to conventional banking.
There is another issue which is also a reason for performance evaluation. This is referred to a debate on Islam Channel, where there were representatives from Islamic banking, and Islamic scholars. The Islamic bank's representative argued that the alternate is here, come and join , but the scholars did not agree. Their point if view was about the total interest free. The bank's person said that the way we are dealing it is 99.9 percent interest free. But the scholars did object it and found it completely interest free.
Identification of the challenges currently facing the Islamic banking sector, the impact of the crisis and the prospects and opportunities for future growth and development
Undoubtedly, the Islamic banking system is seriously competing the conventional banking system. Therefore we have to see here why Islamic banking is not competing the conventional banking systems. It is already said and held that the absence of Shariah-compliant legal framework needed to make interest-free banking acceptable (and create sound financial institutions) is biggest point, which is dragging Islamic banking away from the conventional baking. In case there are disputes, again we require to apply legal system of Islamic laws, and apparently, it seems very difficult. To create Islamic courts in the west is another problem and issue, therefore we have to notice and find the amicable ways of funding and responses from the Muslims especially and others generally. As there is again problem to find the judges of that qualifications and well conversant to the Islamic banking systems, and hence it will remain a challenge and threat. The same levels of problems are being faced by the staff in the Islamic banks.
It is also said and argued that there should be some kind of amendments to the courts, as there is a similarity to the universal banking; therefore, laws and regulations have to be amended accordingly. While there is no Islamic banking law, this gives rise to the agreements and their enforcements, this way the costs of such disputes could touch the skies. To implement this Islamic banking universally, certain amendments in the law are required. This challenge refers to the balance sheet. It is a practice that assets funded through Ijara, Murabah etc., on balance sheet because section 7 of Banking Ordinance 1962 does not allow a bank to own property or asset which section 9 prohibits to enter into any kind of trade. To satisfy the criteria of a balance sheet, the assets which are owned by the name of the Islamic bank are shown on the balance sheet. However, in comparison, the conventional banks are showing all assets on their annual balanced sheets. Therefore to address this challenge is not possible or at least to satisfy the criteria of western banks. The following challenge is about the monthly payment agreement/or contracts. IN regarding housing mortgages, the house remains the property of the bank, but the occupant's name also appears on the documents. This finance is applied on the terms of Diminishing Musharaka by the Islamic banks. This term helps to create joint agreement, this between the owner and bank. With regarding Ijara, this term is used and rather applied to get monthly payments from the person who fell into an agreement of having mortgage. However there is a great risk, but the bank is not protected against bank's investment. Basically the owner by book pays the rent to the bank, and this way it is argued and advocated that it remains interest free. Although the bank puts its profit upon the total mortgage price and then sells to the person. The probably, this the last challenge, where the Islamic banks are different than the conventional banks. This is about PLS deposits. These deposits base totally on the principles of profits and losses (Musharaka or Murabaha). In the circumstances, there is a loss, then this is rightly transferred to the depositor directly. There is another indirect challenge, this is related to Ijara. It is said that Ijara is subject to compulsory insurance, which is against Islamic laws and becomes highly suspicious.
The above information did answer some of the implications, issues, difficulties, and challenges. Being this, there are still very charming and attractive ways for Islamic banking. This is a reality that the population of the Muslims in the west is increasing, it is therefore indicated that the basic needs of housing, businesses and etc are also increasing proportionately. Therefore it is the way of financing to the small businesses. It simply suggests that there remain a hidden potential for the Islamic banking. Its future is more secure in the retail and whole sale markets.
In the UK, London is the biggest capital of finances, and the connection between the UK and the Middle East are growing and coming very close. Therefore as a matter of fact, the UK government has made it possible by softening its FSA , so that the application of Islamic laws could bring the Muslims in the main stream of competition to that of conventional banking. The Islamic laws definitely stops of using, having, dealing interest based transaction. The UK's biggest four banks have already facilitating the Muslims in particular to go side by and hence , there are equal opportunities been created for the people in the UK.
The Kingdom of Saudi Arabia, Malaysia, and some other countries, including UAE, and Bahrain are practicing interest free economy. The only problem which is very thin and sharp refers to liquidity, and this is main difference between the conventional banking and Islamic banking. The conventional banks use bonds where interests are included and against those bonds , the banks finance and get the money back by the methods of instalments.
capitalment and the City are actively promoting this objective. London's emerging role as a hub for Islamic finance is underpinned by the factors outlined in this paper, in particular, a wide skills base, innovation and flexibility and historical links with the Middle East. These will remain strong. The government's tax and legislative framework has established a level playing field for a variety of Islamic products such as mortgages, bonds and insurance. This could lead to the availability of new retail products, the expansion of wealth and asset management services and the development of Sukuk and other wholesale markets.
The FSA has been, and is, willing to play its part in supporting these developments, within its regulatory powers under FSMA. Although we cannot promote Islamic finance (or any other particular kind of finance), we can give a clear regulatory framework which is flexible enough to adapt to changes in the market. We are keen to see the industry expand, although we recognise this will bring new regulatory challenges. If there is future growth in this market, it should benefit UK consumers and develop London further as an international financial centre.
Islamic banking has become not just a reality, but a thriving, international, commercially-viable industry, with an appeal far outside the religious group for which it was designed.
- Iqbal, M. and Molyneux, P. (2005). Thirty Years of Islamic banking. (Palgrave Macmillan : London)
- Iqbal, M. and Molyneux, P. (2005) Arab Banking and Financial Systems (Palgrave Macmillan : London)
- Rosly, S.A. (2005). Critical issues on Islamic banking and financial markets. AuthorHouse.
- www.Islam Channel.com
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- http://www.nzibo.com/IB2/Challenges.pdf, accessed on 29-03-2010
- http://www.misys.com/cds-portlets/digitalAssets/3/1748_Islamic_Banking_-_Whitepaper_-_Jan_09.pdf, accessed on 5-04-2010
- http://www.schweitzer-online.de/static/content/Downloads/2007/IBnews-IslamicFinance200708EN.pdf, accessed on 10-04-2010