Islamic and Conventional Credit Cards - Assignment Example

ISLAMIC AND CONVENTIONAL CARDS by Table of Contents Islamic and Conventional Credit Cards Introduction Islamic banking, originating from the Middle Eastern region, has developed into a global trend with Islamic financial establishments and companies now doing business in more than 100 countries globally. Based on the Ernst and Youngs audits firm World Islamic Banking Competitiveness Report, 2013, Alam (2013) states that Islamic banking resources with commercial banks worldwide will grow up to US $2.5 trillion in 2014 from US $976 billion in 2011. The demand for Sharia - compliant financial products and services will continue to increase, propelled by market forces of demand and supply. The increased demand is not only from clients need for differentiated products but also from corporations who want to carry out all financial dealings in conformity with Sharia laws. The increasing populations of Muslim countries will additionally propel the demand for Sharia - compliant financial services. Many Muslim nations have young populaces, with more than 60% of the citizens under the age of 21 years, in addition to annual population growth rates of more than 5%. Many conservative banks currently are also engaging in the Islamic Banking market due to its intrinsic feature of minimal exposure to operational risk. Islamic banking, because of its strict Sharia submission norms, can help clients decrease the risks related to interest based debt bankrolling that plagued conservative banks especially during the recent financial crisis that hit the mortgage market (Alam (2013). In terms of supply, the main underlying principle of development in Islamic banking is the swelling amount of financial services establishments giving Sharia compliant business solutions. Along with the new Islamic banking institutions that are being designed, there is a developing tendency among current conventional banking institutions to transform their processes to become compliant with Sharia laws. With mounting business rivalries in their home markets, some Islamic banking institutions in the Middle East have begun to multiply globally, with a preliminary attention to Africa and Asia. This amplified rivalry was leading to fresh advanced products being availed to the markets, therefore, rendering Islamic banking more enticing. Islamic Finance: A Brief History The initial phases of growth in Islamic banking contend with the concept construction where Sharia specialists examined whether the interest those banks charged was similar to riba. Before 1950s, Muslims were not officially engaging the banking services; so, they did not have any information about bank interest (Shaikh n.d). A few years later, commercial banks actively participated in the Muslim world economies. This resulted to the specialists‟ dissertations and, in the 1950s, an agreement in relation to interest being "riba" was reached, as specified in the Holy Quran. Subsequent to this, the proposition of establishing an interest-free banking institution or "halal bank‟ took centre stage. The Dubai Islamic Bank, for example, was instituted in 1976. The banking system was approved by a conservative central bank whereby it operated in the then existing traditional structure with organized legal, legislative and supervisory restrictions. Later, some other banking institutions were instituted with some banks functioning in revised, conventional banking rules and procedures. There has been exemplary growth in Islamic banking in its forty-two years of establishment. The Islamic banking industry has developed to be one of the fastest developing sectors, having experienced double – digit growth rates in the recent past. According to reports, the future development of Islamic banking is estimated to remain progressive since there are approximately 56 Muslim states and a Muslim populace of about 2.1 billion individuals (Sundararajan, Kohli and Ahmed 2014). Furthermore, some nations that have never had Islamic banking institutions in the past, nations such as Mauritius, have started operating in the industry and are operating to become a regional Islamic finance centre. Among Muslim states, Malaysia has arisen to be the international frontrunner in the Islamic finance sector. Nowadays, it is similarly a common feature to see Islamic banking institutions in the western countries, especially in regions that have a high Muslim populace such as France. Common Principles of Islamic Banking and Investment Banking Products In relation to interest, Islamic banking financial elements need to be separated from the forbidden riba. Riba is an Arabic term that is commonly known as interest in the contemporary era. Interest earning in modern banking systems forms the basis for most establishments seeking to make some profit through financial service provision. Riba denotes adding or increasing. It comprises an addition to the permitted standard for dimension on similar items when a business transaction takes place between parties, whereby one party is indebted to recompense (Dangulbi n.d.). Islamic banking involves the exchange of homogenous items between two sides but in equal measurement, quality, and size. Another is the quantity of extra addition that is instituted as a necessity for an individual or an institution to reimburse. Therefore, Riba, as in the financial matters, is the charge of debt and is well defined as provided by an increase in debt for the time it stays with the borrower. Riba is, therefore, said to be similar to interest. The basic principles and philosophies of Islamic banking are constructed upon the evasion of giving Riba, Gharar and the ban on prohibited dealings as specified in the Quran. Banking frameworks are constructed upon the underpinning of acquiescence with Sharia law. Riba is, in general, the same model of interest and is, therefore, prohibited and illegal. In its place, the notion of profit and loss distribution is practiced; fundamentally, the notion of sharing risk, as contrasted to shifting it (Dangulbi n.d.). Gharar is the indistinctness and doubt present in a contract agreement, to the extent that there may be unfair advantages between the parties. Because of the uncertain nature, it makes the transaction similar to betting. Any agreement carried out where Gharar is present is invalid. Islamic Credit Cards With the amplified significance and function of Islamic finance, ICCs (Islamic Credit Cards) were introduced into the financial sector, as Muslims are not allowed to participate in interest transactions. Concerning the likelihood of introducing and using ICCs, the endorsements of the Council of Islamic Fiqh Academy states that it is prohibited in Sharia to offer or use a Credit Card if its circumstances contain impositions of riba or interest. The council states that the rule applies even if the cardholder intends to repay within the freeze period that comes before the application of interest. Sharia Principles explain that it is not allowable for an organization to offer credit cards that have an interest-bearing rotating credit facility that needs the cardholder to pay some interest for being permitted to repay the debt in parts (Sundararajan, Kohli, and Ahmed, 2014). The different fees charges, for instance, membership fees, re-issuance fees and renewal charges, in addition to the withdrawal of funds are allowed if there is no charging of interest. Nevertheless, the use of credit cards to buy financial elements such as silver, bonds, gold and other related items is not permitted. Moreover, ICCs can also give cardholders numerous gifts and rights, like CCCs (Conventional Credit Cards), but are restricted to permissible merchandise and services (Kenjebaev 2012). Therefore, it is known that ICCs have a thinner use contrasted to CCCs, as operators cannot use ICCs to be prescribed substances in relation to places, merchandises, conservative insurance, gold, and sums of money because of the Sharia laws. According to Kante (2006), credit cards that are acquiescent with Sharia laws can be grouped into five classes. The first is a non-varying profit margin at the point of sale dealings, which is commonly used by the Shamil Banking group. Clients are charged with a fixed charge of doing business, calculated proportionally to the transaction amount. The expense is extended for a period of 1 year. The second class is a non-varying profit margin on maximum allowable credit where the charge is dependent on the extent of the permitted loan limit to a client that is settled on, upon the issuance of the ICC between the banking institution and the client. If the loan facility is not utilized, the client will get repaid with the amount of mark-up. A common bank using this method includes the Abu Dhabi banking group. The third class is the subscription fixed fee for card issuance. It is based on the bundle package that is offered to the clients. Payment is structured in parts of equal amount. ABC Islamic group in Bahrain and Saudi Arabia’s National Bank frequently uses this type of model. The fourth class is the fixed charge on revolving bank facility. This category is quite contentious among Sharia intellectuals, as the banking institutions seem to gain from the allowance of the loan facility (Kante, 2006). In this arrangement, the clients pay a fixed charge once after using their ICCs. The clients are additionally asked to pay a processing charge when they postpone payment of the unsettled balance. Sharjah Islamic banking group uses this model. The fifth and the final class is the most contentious structure known as flexible mark-up on rotating balance that is regarded as being very comparable to the conventional equivalent. The clients are required to pay in relation to the outstanding balance that is calculated in proportion to the outstanding balances. Common banking institutions using this structure are BIMB and Am Bank in Malaysia. The Underlying Contracts and the Processes Involved Being components of the Islamic structure, financial and banking systems function on the exposed sources of Islamic laws also known as Sharia. Normally, there are two principal sources of the Sharia laws; secondary sources and the primary sources. The Holy Quran and the Sunna form the primary sources. Finance and business philosophy based on the two primary sources are typically general in nature, and some declarations that are enough to expound on the common issues therefore may no longer be adequate to manage the impending issues. In this regard, Islamic religion acknowledges Ijtihad or personal reasoning through stanch and cautious procedures to develop the necessary rulings to deliberate on the issues at hand (Dangulbi nd). Therefore, in addition to the primary sources of law, there are other secondary sources, i.e. Ijmac or accord and analysis through giyas or correlation (Kante, 2006). Islamic laws relevancy and flexibility are applied within this context and it is similarly the platform where finance and business find space for extra development and innovation under the Islamic law domain. The underlying contracts can be grouped into debt financing, profit and loss sharing (PLS) and other contracts. Profit and Loss Sharing/Equity financing Contracts (PLS) Equity financing is the funding of acquisition of equity or projects founded on profit and loss sharing contracts. There are four regularly practiced PLS contracts namely: Musharaka, Musharaka Mutanagisa and Mudaraba. Islamic Debt Financing Contracts Islamic Debt Financing in Islam denotes funding the acquirement of assets, stocks and other operating capital on the foundation of exchange contracts or Cuqud al Mucawadat. There are numerous methods of Islamic debt financing (Ganeri 2002).. They include Murabaha (Profit); Bay Bithaman Ajil (Sale on a pay-later basis); (Shaikh n.d) Bay Salam (Advance payment for deferred supply of goods); Bay Istisna (Sale contract that permits cash payments to be made early or after completion of production); Ijara (contractual agreement that entails transfers of property for rental income for a particular period) and Bay al Inah contractual agreements where Islamic Credit Cards fall under. Bay al Inah Bay al Inah also known as Bayc al-Inah is commonly known as a double sale contract, where one contract is executed on a cash platform while on the other hand, it is done on a deferred basis. Within this sale contract, the individual selling trades merchandises with buyers on a cash basis that is payable right away, then the debtor immediately purchases back the merchandise for a higher amount that is to be settled in the arranged future time. Contemporary practice of Bay al Inah is normally found in Islamic Credit Cards, Islamic Bonds, Islamic Overdrafts and Islamic Personal Loans (Kante 2006). Related Issues and Controversies in the Current Practice There are many issues related to the provisions of banking and financial products under Islamic Law. Most notably, for contracts to be legally binding, the necessary stipulations of a contract need to be fulfilled. A principal essential element of a contractual agreement is ownership. The trader or seller must first possess the traded property. In the modern practice of BBA (Bay Bithaman Ajil) home ownership funding, for instance, the process of purchasing back and selling does not mirror the correct contract of the trade (Fang, 2014). The bank does not posses the traded property. In addition, the traded property is non-existent in many of the sale instances of BBA home funding while existence of the house is one of the primary stipulations of trade. Therefore, this raises the question of validity because of non-adherence of the existing BBA practice. Common Issues with ICCs (Islamic Credit Cards) Mohd Dali, Yousafzai and Abdul Hamid (2015) contend that a common ICC criticism is that its prices are said to be set much higher than the average prices for CCCs. For example, it is stated that the fees for ICCs surpass the interest rates of CCCs. In addition, the clients of ICCs are additionally charged despite the fact no business is made. Clients are reported to be in distrust over ICC pricing levels in addition to pricing structures. On the other hand, analysts argue that Islamic financial products should not be victimized to offer a lower price. The perception that is constantly in clients minds is the cheapness of Islamic financial products. The intricacies of Islamic Credit Card structures are other issues relating to ICCs. The many product propositions and prizes generate complexities that can puzzle the clients. These difficulties of products are of no value to clients, particularly during the economic slump, as the bank product can additionally implicate their financial circumstances because of a lack of understanding. Another concern raised over ICCs touches on the marketing tactics. The use of attractive marketing tactics, together with religious signs and languages, are said to have misinformed clients. For instance, In Saudi Arabia, commercials used by banking institutions in major towns use convincing strategies to make clients have faith and believe that the credit cards abide by Sharia laws with easy sanction and shortened application processes targeting mainly women. Some individuals are reported to have fallen victim to bank commercials after being enticed by the assurance of marketing promotions only to recognize later that they would have to continue paying the accrued monthly fees for a lengthy period (Mohd Dali, Yousafzai and Abdul Hamid, 2015). Another associated advertising problem, is the sale of ICCs that concentrate on product characteristics like their conventional corresponding credit cards. It is contended that individuals issuing ICC cards should also concentrate on moral values, where it is argued that it is a disappointment to see that numerous marketing tactics for Islamic Credit Cards deal with product features instead of marketing the ethical standards and notion beneath to the clients. Another concern is that certain banking institutions just refer to them as ICCs where in reality by the description they are not credit cards. For instance, Dubai Bank is famed for debiting the clients accounts at the end month after business transactions have been executed. Therefore, this form of credit card is rather known as a debit card. In addition to the concerns regarding the ICCs, Hussin (2012) argues that it is additionally important to deliberate the problems regarding the features of the credit cards from the Islamic teachings point of view. A fundamental contemplation stems from the code and the beliefs of the Islamic ethical economy that focuses on preventing living beyond ones means, as specified in the Holy Quran (Al-Araf: 31) "Drink and Eat, but do not be extravagant, for God does not love extravagant individuals". Yet, ICCs encourage persons to overindulge in luxurious activities and habits (Ganeri 2002). According to Islamic teachings, individuals need to incur debts responsibly, that paying the debt is essential, and persons need understand how to meet debt commitments when possible. For example, Muslim - Imam (2001: 824) explains that it is prohibited for a borrower to make delays in repaying of borrowed funds. The severe consequence of being in debt is seen where Prophet Mohammed refuses to lead funeral devotions for deceased persons when they are still indebted. Islam explains that borrowers should be given respite during hard times. The Quran (Al-Baqarah: 280) explains that If the borrower is in trouble, allow him some period until that time when it is easy for him to pay back. However, if it is remitted as a way of assistance, is what is best for individuals who understand Islam (Ganeri 2002). Nonetheless, credit cards are designed to yield some profit from those individuals who suspend payment. Precisely, those individuals that are already struggling will be impacted with a greater strain. Therefore, this contradicts Islam teachings. Opinions and Applications of Islamic Credit Cards The Islamic credit cards have drawn many opinions, both positive and negative in equal measure. Being a pioneer product for the Islamic community, it is hailed as an appropriate avenue that would serve stanch Muslims, who would rather not indulge in conventional credit cards. With increased demand for credit cards in the world, it is expected to propel Islamic economies forward, as it has become an essential mode of payment. Customers are also happy with the introduction of differentiated credit cards products, especially with increased internet activity. Islamic Credit Cards have many uses. They are used to finance many activities and transactions that are sanctioned under Sharia. For example, ICCs are used to pay for medication and for transfer of funds. They are also used to purchase goods and services within the confines of Sharia. However, negative opinions come with equal measure (Fang, 2014). Clients, complain about vagueness, in understanding the functions and the charges of the cards. ICCs are many times compared to Conventional cards, and the case against interest or riba. It is alleged that ICCs charge high “administrative charges,” which are compared to interest rates in conventional cards. Implementations of those “administrative costs” in Islamic banking is said to be riba, under a different term (Fang, 2014, Hussin, 2012). Some Islamic scholars additionally object in totality the usage of ICCs, arguing that they advance debts, whereas debt financing is prohibited under the Sharia laws. Critics of Islamic Credit Cards also contend that ICCs encourage individuals to spend and consume more than they require. Similarities are again drawn with CCCs, raising more questions about adherence to Sharia. Conclusion In general, customers for their suitability, protection, financial efficacies, adequacy, and reputation use credit cards. The ICCs, which were started because of the Islamic banking movement, have extra and fascinating credit card collection characteristics related to Islamic religious aspects such as Islamic trademarks and no participation of riba. Notwithstanding the various benefits obtainable through credit cards, their use is contentious because of the potential formation of financial difficulties for the clients. Therefore, caution should be exercised while using credit cards to evade possible debt penalties. Because of the negative penalties associated with credit cards, the ICCs that are supposed to be related to the Islamic ethical principles are required to have a lower undesirable effect than their conventional corresponding credit cards. Bibliography Alam, N. (2013). Impact of banking regulation on risk and efficiency in Islamic banking. Journal of Financial Reporting and Accounting, 11(1), pp.29-50. Dangulbi, S. (n.d.). Islamicity of Current Islamic Banking, Finance and Investment Practices. 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Sundararajan, V., Kohli, H. and Ahmed, J. (2014). Islamic finance. New Delhi: SAGE. Read More