The ‘safer’ alternative to banking
By Sasha Harrinanan Thursday, June 30 2011
Islamic banking is being touted as a safer alternative to conventional banking, when it comes to investing your money or obtaining financing to purchase property.
This was the message from three experts in Islamic finance who spoke at UWI’s Fourth Biennial International Conference on Business, Banking and Finance, held from June 22 to 24, at Hilton Trinidad.
According to the Institute of Islamic Banking and Insurance, Islamic banking refers to a system of banking or banking activity that is consistent with the principles of the Shari'ah (Islamic rulings) and its practical application through the development of Islamic economics. The principles which emphasise moral and ethical values in all dealings have wide universal appeal. Shari'ah prohibits the payment or acceptance of interest charges (riba) for the lending and accepting of money, as well as carrying out trade and other activities that provide goods or services considered contrary to its principles.
What does this mean, in practical terms, for someone looking to borrow money?
Director of Shari’ah Compliance & Product Development at the Islamic Finance Advisory and Assurance Services (IFAAS), Shaher Abbas, explained the difference between Islamic and conventional banking.
“Interest is prohibited under Shari’ah, so the operational processes are different, contracts are different. For example in a conventional bank if you wanted to buy a car, the customer would get a loan that has to be paid back with interest. An Islamic bank would actually buy the car then re- sell it to the client for a profit.
“The bank becomes a trader, a dealer, involved directly in the assets they are willing to finance. The contract becomes a sale contract rather than a lending one. The client gets to use the car while paying installments, so the outcome is similar in that way to conventional banks, except we don’t charge interest,” Abbas said.
While conventional banks have to comply with normal State and banking regulations, Abbas noted Islamic banks have dual governing models. They have to comply with State regulations and Shari’ah (Islamic law). The latter has four basic rules for financial transactions - no interest, no uncertainty, no gambling and no unfairness.
“Islamic banks will typically earn income from sales, go into partnerships and gain equity investments, lease properties because that is acceptable, and charge fees for services they provide to clients,” he said
Abbas told Business Day this inherent level of conservatism was the main reason Islamic banks came through the 2008 global financial crisis in good shape.
“The 2008 financial crisis started with toxic assets that were based on derivative products structured on home mortgages in the United States. Because they were based on interest and had a lot of uncertainty, Islamic banks were not allowed to handle this type of product. However they were impacted indirectly by the global recession when markets contracted and real estate values depreciated. Because Islamic banks hold properties not loans, a drop in property values led to a devaluation of their assets,” Abbas noted.
While Islamic banks remain in good shape, the IFAAS director said they have had to create more provisions for devalued assets. The period 2008 to 2010 also saw a drop in business as the recession affected many client’s finances.
IFAAS founder and managing director, Mohammed Farrukh Raza, made the case for the introduction of Islamic banking in Trinidad and Tobago.
“If Islamic finance became available here, it would very likely attract new investments from cash-rich countries. There is a big possibility of funding construction projects through Islamic ‘securitisation’. This would also open access to a lot of new markets. There is also a sizeable domestic market for loans.
“This presents a very good opportunity to deliver something that is new, different and good to all Caribbean communities, regardless of their faith,” Razza said.
The main challenge, Razza pointed out, is the education of stakeholders and potential customers about Islamic finance. He suggested a public awareness campaign and argued that the rules of Islamic banking make it far simpler to grasp than those of conventional banks.
Senior lecturer in Political Economy at Durham University in the United Kingdom, Dr Mehmet Asutay, told Business Day about the community benefits to be derived from Islamic banking.
“They tend to become involved in the community and become partners with their clients, rather than just lending them money to be paid back with interest. That’s because Islamic finance does not encourage a debt-based economy. Transactions have to be asset-based financing and that directly relates to economic growth issues rather than people just putting their money in the bank and earning just the returns,” Asutay said.