Islamic Banking: A Different Way Of Doing Banking – An Italian Researcher Perspective

“Even in the Italian reality, as mentioned, in past centuries lending at interest was considered morally unacceptable.  With the development of the economy, however, credit modern sense – so far away from the concept of “usury” – was widely welcomed by traders and institutions were born – the banks in fact – that through the competence and professionalism of its employees, ensure the transformation of credit into an ever more modern and efficient, allowing, inter alia, to eradicate the phenomenon of wear.”

An idea very strange

I immediately seemed the idea of writing an article on Islamic banking. “Islamic banks do not charge interest …” this provocation was the director of this periodical, which is Born’s interest in the subject matter of this paper.  I must confess that it seemed inconceivable to me; I initially thought you could deal with credit unions or non-profit organizations that grant credit without profit.  In fact, books on finance, when they define the “Bank” refers to a particular type of “company” (“credit”, in fact), voted to create profit and value for its shareholders.  How does a statement like the one above could be reconciled with the parameters of profitability (in essence, of “economic survival”) own a business seemed like an interesting topic.  On this basis, I undertook a small research staff on the topic “Islamic banking”

Birth of “Islamic banking”

 The banking system was born in Muslim countries toward the end of ’80s.  At that time the major banks of Western countries began to open branches in the capitals of the countries colonized. Local people, however, remained, at least in the first period, essentially outside the banking world, for a number of reasons:

•           Reasons ‘geographical’: As mentioned, the Western banks are setting up in major shopping malls, so those living in rural areas had no access to banking and financial services.

•           Nationalistic motives: it is quite clear that population reluctant to deposit money or borrow money to institutions that represented the financial power of the colonizers viewed foreign banks with suspicion.

•           Religious reasons: the deposit services and loans were absolutely avoided in order not to incur banking generating interest income or expense, strictly forbidden by Islam.

To obviate these objections were incorporated banks that operate essentially the same management criteria of Western banks.  These institutions provide access to financial services also to rural populations.  The spread of local banks right now attracted the attention of Muslim intellectuals, from which sprang the initial thinking about the founding of a banking system “Islamic”, that is adhering to the dictates of the Koran.

How can spread throughout the time that the financial system “alternative” explains in an interview recently in the sun 24 hours Prof. Gian Maria Piccinelli, Muslim law professor at the University of Naples.  While the West has taken a process that has taken from the Commercial Law to the canon, in the case of Islamic countries has never been able to develop a system of rules independent of the “common law” of religion: “The result was the formation of a Muslim teaching cutting both an economic and legal past half century has chased the design of Islamic economy, mainly on ideological basis, constituted a viable alternative to social projects based on free capitalism and socialist statism. From this theoretical approach, combined with the surplus arising from the oil market, was born of the experience of Islamic banks.

Quran and credit operations: the concept of “Riba” and the prohibition of lending at interest

 The “religious reasons” mentioned earlier in the spreading of Islamic banks stem from some maxims contained in the Koran.  Worth disclose:

 275.  But those who feed on those who wear reborn as has been touched by Satan.  This is because they say: “Trade is like usury.”  But Allah has permitted trade and forbidden ‘s wear.  Who gives up after it has reached the warning of his Lord, taking for himself what he and his case depends on Allah.  As for those who persist, here are the companions of the Fire.  We will abide.

The explicit prohibition in the holy book refers to a concept – that of Riba . This means that for Islamic law for the collection of interest on a loan is always to be considered “illegitimate.”  Scholars have interpreted the concept of Riba as “any fixed or guaranteed interest payment on loans or deposits.  In truth, the condemnation of usury is not the prerogative only of the Islamic religion: the Catholic Church itself, in the eleventh century began a stern veto, that is usury on the loan at interest, as to them shall accompany the ‘take advantage of situations of tremendous disparities and weaknesses.  In effect, therefore, also in western Christian culture is it that the loan interest as it is maintained that a sentence that is persistent in time up to the threshold of contemporary art.  We must emphasize, however, that in Western culture, contemporary art from the age onwards, the original sentence no longer reflected reality, “it remains and is referred to a phenomenon that was now only a distant relationship with credit modern practice.”  With the expansion of modern businesses, quickly spread the “investment loan”, not the “consumer”, convicted of wear even in the common mind.  The loan was managed by investment professionals (bankers), including those who practiced usury represented a residual component.

 In essence, in Western economies the credit business grew with the advance of modern economy, and with this combination fell stiff condemnation of lending at interest.  Economic realities in Muslim, on the contrary, the prohibition of interest-bearing transactions has remained unchanged for about fourteen centuries.

 Nevertheless, it underlines how the interpretation of the system simply as “interest-free” can be confusing. In fact, the originality of the system affects much more general issues: “While the conventional financial system focuses primarily on the economic and financial operations banking, the Islamic system places equal emphasis on the moral, ethical, social and religious.”  In fact, starting from the fundamental prohibition, apparently unhistorical, the scope of interest, has imposed a banking and financial system based on the following principles:

•           Prohibition of lending at interest.  In general and absolute, as mentioned, any type of payment in exchange for the granting of a loan is prohibited.

•           Dissemination of “Profit and loss sharing finance.  According to the Islamic economic doctrine, the creditor with the debtor must share the risks and profits from the investment.  This principle is probably the most important, if you want to understand deeply the logic of Islamic banking.  Islamic law considers unacceptable to the fact of “Earning money from money” (this is, in fact, the ultimate result of applying an interest rate on an amount deposited or paid).  The currency is seen as a mere means of exchange, as a “capital potential,” that becomes real only when it is invested in a production process.  On this basis investors are encouraged to “invest” their money, becoming “partners” in an industrial project in which to share profits and risks of the business, rather than becoming “mere creditors.”  Islamic finance is based on the conviction that the supplier and the use of capital should equally share the risks of the business.  This means that, in banking, the depositor, the bank and the borrower should divide the profits and risks associated with the investment project presented by the debtor.  From a management perspective, this principle implies a strong focus on profitability of the bank on the control of developments and prospective operating and financial investment, rather than on real guarantees that the borrower may submit.

•           Ban the financing of productions prohibited.  Companies operating in productive sectors condemned by religious dictates (construction of casinos, liquor trade, production of pork, Israeli companies …) can not be funded in any way from Islamic banks.  Indeed, there is a listing with stock exchange approved by the Committee of Wise Men, which lists the titles purchased by the savings Muslim.

 Islamic banks holdings of credit to all effects

Islamic banks account for a growing slice of the overall banking system of the Islamic countries.  At the end of 1996, were operating 166 banking institutions, with managed funds amounted to 137 billion dollars, growing at an average annual rate of 10%.  In many Muslim countries they have captured a small fraction of the financial system, with the exception of Iran, Pakistan and Sudan, countries that have transformed the banking system by law based on the principles of the Islamic banking.  In almost all other nations, however, Islamic banks coexist with other commercial banks.  The Islamic banking is practiced through two models:

•           Specialized Islamic banks, offering only Islamic financial services and are completely based on Islamic principles.

•           Islamic windows, it is the complex of Islamic finance services prepared by commercial banks for the traditional customers who want to operate in a manner consistent with their religion.

 Far from being non-profit institutions, Islamic banks are “financial institutions for which the law expressly states the obligation to operate according to the precepts of Muslim law religiously motivated and whose unique element is the essence of the interest in giving and in having. ”  In view of the obligations invoked, these credit companies have developed alternative financial instruments to those interest-bearing, managing to achieve positive economic results.

 Based on the assumptions set out in the preceding paragraphs, the Muslim institutions, like the Western banks, provide collection services, employment and ancillary services.

•           The fundraising activities.  On the side of the collection, Islamic institutions operate through three types of deposits: current accounts, savings deposits and investment accounts. Current accounts provide no financial reward.  In essence, they are designed as tools that provide deposit of money to withdraw / transfer funds (by check, debit cards, bank transfers) and automatic debiting of expenses incurred by the customer.  The current account can not be combined with any credit card, since that provides technical form, always, services “interest free”.  The remuneration of savings deposits is at the discretion of management and economic depends on the bank.  This remuneration is deemed to conform to Muslim law, as it is not an essential condition of the escrow agreement.  The category of deposed that most distinguishes Islamic banks consists of the investment accounts that are configured as time deposits, so it is possible to withdraw funds deposited before the contract expires.  This product provides banking that the bank select projects worthy of funding and professionally invest the money deposited on behalf of clients.  At year end, or periodically, relegated some of the profits (or losses) of the project based on a profit – sharing ratio established substantially comparable to the profitability of term deposits of banks ‘conventional’.

•           Use activity funds.  As anticipated, use by the Islamic banks are based on the logic of profit-sharing finance.  The use activities can be traced to three conceptual frameworks: profit – sharing, financing, trade financing, lending.

o          Profit – sharing finance.  In this case, the bank providing financing for a project based on the profit outlook.  In the case of full equity sharing, the bank sits on the Board of Directors and participates in formulating the strategy of the company funded, in the case of non-voting financing, however, the operational management is delegated entirely to the customer.  From the standpoint of the legal framework, the main contracts are the Mudarabha and Musharaka.  In the first case, the bank finances the project, while the customer provides the business idea funded, its work and project management (it is, financing of non-voting).  Profits are divided between bank and customer on the basis of an agreed profit rate, while losses are borne entirely the financial institution.  In Musharaka, however, bank and customer is a new independent company (Western economy, we could talk about joint ventures), profits and losses are distributed on the basis of the percentage of participation in the new company.

o          Trade financing.  In these case studies, the bank does not anticipate a sum in cash to buy the property but shall ensure that the customer’s needs.  The contract mark – up the customer repays the cost of the asset at a fixed deadline, plus a profit for the services performed by the credit.  The other major form of financing is represented by the lease, the customer pays a periodic fee, including cost of purchase of machinery supported by the bank and a rent for the use of capital good.

o          Lending.  This is similar loans to overdrafts on current accounts.  We distinguish loans paid through the application of an annual fee (the maximum amount set by the control and supervision of the banking system) that covers the costs of investigation and administration of the loan and no – cost loans, free loan granted to small businesses and consumers need.  To highlight this second case has a weight residual value in loans to customers.

 Critical assessment of Islamic banking: an attempt at synthesis

 So far we have outlined the main features that distinguish Islamic banks.  It is worth dwelling briefly on the strengths and weaknesses of this original way of “making bank”.  Of course, here you have no claim to exhaust the critical judgments on Islamic finance, the intent is simply to present some reflections arising from a short analysis of the peculiarities of management Islamic banks.

 From a macroeconomic perspective, some scholars in the field stress that the elimination of interest allowing greater economic stability.  These authors argue that a banking system interest – based have inherent tendency to inflation, since the creation of money is not strictly linked to productive investment, because, rather, the activity of central and commercial banks.  In essence, the Islamic banking system would push for a “productive use” of money (regarded as legitimate investments in real assets and banishing the concept of financial reward in the face of the simple deposit / loan of money).  From the perspective of the management of credit, it shows how the mechanics of profit sharing potential to induce the bank to finance a more careful selection of projects to be funded and continued monitoring of strategies and operational management.  The bank, that is, must “the merits” of their business and monitor the development (in the case of full equity financing, the banker, even sits on the Board of Directors of the company borrowers of funds).

 From the perspective of the Islamic community, the system, as abundantly clear, has the virtue of “Promoting business correct to Islamic principles.”

 Heavier seem at first glance, the criticism.

 Particularly complicated is the international regulation of these banks: they should be specific laws within each national system of oversight: just this problem has limited the development of Islamic finance in many countries.

 Moreover, the fact of refusing financial transactions based on the interest, Islamic banks exclude from operation in the market for interbank deposits, limiting the company’s development.

 Finally, most critically, one gets the impression that the principles which govern Islamic banks are designed to “trick” the Quranic prohibitions: in fact, on closer inspection, the distinction between the concepts of “commissions” and “interest “is not always clear.  Consider, for example, the contract called mark – up: the percentage applied to the cost of the asset – which expresses the remuneration for the service provided by the bank – is in substance, similar to an interest rate.  Reading some authors, it seems that the opposition Islamic Banking – conventional banking is governed purely a matter of terminology.  In fact, apart from the case of credit loan shark, a modern system of loans at interest does not seem to be “morally reprehensible” as such.  Borrowing money from wherever it is observed the phenomenon, remains, in essence, a “service” – a strictly financial content – delivered to the customer.  It therefore seems that the ideological to incriminate a particular type of pricing of the service, represented precisely by the rate of interest is that there is talk of rate, rather than a commission, it is still the cost for the service rendered by the bank — as noted at the beginning, this is a service with high “social utility”, as it allows you to transfer financial surpluses to those in financial deficit. 

“Even in the Italian reality, as mentioned, in past centuries lending at interest was considered morally unacceptable.  With the development of the economy, however, credit modern sense – so far away from the concept of “usury” – was widely welcomed by traders and institutions were born – the banks in fact – that through the competence and professionalism of its employees, ensure the transformation of credit into an ever more modern and efficient, allowing, inter alia, to eradicate the phenomenon of wear.”

By Ugo Clombo from quader site

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