Islamic Finance - Essay Example

Islamic Finance Name Institution Course Date Abstract In many aspects of life, religion plays a major role in determining the way people act. To some extent, it also sets standards by which people run their lives, affecting areas such as culture, lifestyle, education, and other aspects that make constitute living in a society. Islamic religion is one of the main cultures in the world, affecting the lives of its believers in various ways. This essay analyzes the impacts of Islam on banking. It analyses the various ways in which the religion has affected the banking sector in Middle East and other areas in which Islam is common. Islamic Finance For a long time, Islamic culture and religion has been considered as that of extremism in nature, where most of their activities are carried out in strict adherence to the Shariah law. This has made Islam quite unpopular in some areas, while making it a way of life in areas where its roots are well set. There are various ways in which Islamic culture affects the way of life but one area which draws much interest in the area of finance. On this point, it is worth noting that the Islamic religion has quite a different approach to the manner in which money issues are handled. Hell (2006) observes that major tenets in the manner in which Islam believers handle finances is that money must be put to investments in industries or businesses which are ethical in nature. Furthermore, the religion does not allow taking or giving of interest, as this is taken as a way of usury. The religion also teaches that money cannot be traded for more money, as what happens with shylocks. The only use off money that can be accepted as a form of exchange is here money is exchanged for goods and services, of which can be later sold at a profit. Such an understanding makes money matters in this religion quite complex. Due to the manner in which Islam handles money, it is quite hard for its believers to store their money in common banking systems as do other people. This is mainly because rates of interests charged or offered at the banks go against the religions belief in handling money. For this reason, the Islamic Banking (IB) has come up and has become quite popular in areas of Islamic stronghold. Most of these regions are in Middle East and Northern Africa (MENA) geographical areas. For this reason, Islamic scholars and leaders set up The Asia-Middle East Investment Summit which proposed that Asia Pacific region was turning into a hub for Shariah compliant businesses. Therefore, an investment policy to pursue this course was set, and there are annual meetings to discuss progress made in each year. Main objectives of this summit are to create more intensive cross-borders co-ordination of regulatory approaches as well as offering any supervisory insights that may be called for. This would effectively facilitate the cross-border relationships. The next AMEIS meeting is scheduled for June 7th 2012 in Singapore (MEGA, 2012). Such developments indicate that IB is actually picking not only in Islamic countries, but also in other areas. Nasr (2009) gives a different approach to IB matters. He argues that for a long time, Islamic culture has been pushed aside as one oriented to violence and great disrespect for other people and their property. This can be seen through activities of atrocity propagated by some of Islamic extremist groups such as the Taliban or Al-Qaeda. However, Nasr (2009) observes that there is the business side of the religion that for a long time has remained dormant. However, in recent times, the business minded personalities in the religion have set their mind to saving it from the wrong perceptions. He explores the great wisdom endowed to the religion and explores the future it has. For such a transformation as the one called for in this case, there needs to be a well established financial institution. This is how the issue of IB comes in, taking care of the financial needs of its believers. IB is not just common in the Islamic countries, but as Hell (2006) observes, other banks in the world have adopted an aspect of Islamic banking so as to take care of the interests of Islamic clients. For instance, in Germany, Deutsche Bank rolled out a joint venture with Abraaj Capital of Dubai as well as the Ithmaar Bank of Bahrain. This joint venture saw the mobilization of around 2 billion dollars as a financial fund that is Sharia compliant. Other conventional banks have not been left behind. Rather, they have roled out programs which seem to acknowledge that IB is a reality that should be accepted by the whole world. Banks such as HSBC, Citibank, UBS and other international banks have customized their services so as to accommodate Sharia compliant funds. These Islamic models take an interest-free nature. To understate the success of Islamic banking, Hell (2009) notes that on an international scale, Islamic banking rates at about 200 billion to 500 billion dollars. The founders of this system of banking are happy with the progress made so far and are hopeful that the sector will continue enjoying as much support and success as it currently seems to be enjoying. The standards of operation of this sector are largely based on the fact that most Islamic followers have a need to have a banking institution that has their interests. This became more pronounced after the 9/11 attack where most investors from the Middle East withdrew their money from conventional Western Banks for fear of victimization. It is no wonder then that the sector is more common in areas where the religion is widespread. Secondly, the sector is built on the fact that there is no standard practice or law for Islamic finance and banking. This might not sit well with conventional banks. This is why an IB is a necessity. One good aspect of IB is that it allows the Muslim to easily fulfill their religious obligations. For instance, since charity is one of the religion’s tenets, every member is required to pay about 2.5 of their wealth to benefit the poor in the society. This can be easily done with an Islamic Banking strategy as one can just set a standing order where 2.5% is transferred to the poor. Secondly, the religion holds that greed is a vice to be condemned at all costs. For this reason, the issue of interests arises nowhere in the Islam world. Well, this might be hard for conventional banks to go by and this is probably the reason why IB has spread quite fast. It takes care of the risks and uncertainties posed by the religion, which conventional banks are not ready to take up. There are various factors that can be attributed to success of this system. One of the reasons is that the system helps to avoid risks by distributing them. Akhtar (2009) observes that in case an individual requests a loan, some of the transfer credit risk is moved from the IB’s balance sheet to the borrower’s account. This is done in a proportion previously agreed upon by both parties: the loanee and the lender. Fro this reason, it can be seen that though the system does not advocate for charging of interests, it accounts for instances where the loanee defaults. As such, the bank does not bear all the risk. Another point to note is that both parties in the transaction must ascribe to the Islamic religion. Therefore, there is trust between them that everyone will keep to his word. Tue to this, the parties are bound by their faith to keep to the dictates of a transaction. Secondly, while in a trade of goods and services, IB offers quite a wide array of financial options all of which are prudent. These options are also quite flexible in that they can be asset-backed or equity-based. This makes the services quite manageable and friendly for all who wish to engage in such transactions. Lastly, IB offers quite development based instruments on a large-scale. Though this practice creates quite a number of complexities, it takes care of this by offering much flexibility. Furthermore, it is so flexible that it allows for distribution of risks among the parties in reasonable proportions. Due to these advantages, IB has shown quite tremendous success in various countries. For instance, Akhtar (2009) observes that IB represents about 30% of assets and 45% of loans in Yemen. In Jordan, it holds about 10% of the total financial industry. Similar characteristics can be cited in Egypt, Tunisia and Morocco. In these countries, IB is in the introductory stage, except in Egypt where it has developed more. In support of IB, World Bank has launched an initiative through which Islamic Banking can be taken to higher levels of success. The initiative aims at popularizing the sector and making it acceptable in various parts of the world. As seen above, there are many prospects for IB. it seems to be in its novice stage but still making headway in an increasing pace. With such developments, it is highly likely that the world will soon be fully embracing the issue of IB. Indications of this have been seen through the involvement of some international banks where they offer Sharia compliant, interest free banking services. IB is thus gaining gradual entrance into the business world. As in every life situation, there is always the other side of the coin. Furthermore, there is nothing that is totally perfect. There must be some drawbacks in every venture. Despite its bright prospects, IB has not been spared of some challenges along the way. Price Waterhouse Coopers (2011) argues that just like any other developing industry, IB had to, and is still dealing with some challenges. A major challenge is that the sector lacks a clear and consistent framework as to how its activities should be carried out. This confusion arises as investors try to discern what is or what is not admissible under the Shariah law. This gives rise to some controversy and confusion over the issue. Market penetration is quite elusive for IB. a major reason for this is that most people are not familiar with Shariah law. As such, only Islamic communities can take advantage if IB services. This reduces its market base and confines it to given geographic locations. Another issue with this banking is that there are many risks associated with this sector. Such risks make it hard for investors to be comfortable with the venture, since nobody is keen on making losses. On another perspective, there are the international regulations and taxation structures of investment. It might be hard for IB to cope with such issues, since it is based on Islamic laws which does not give room for trading money with money. Lastly, there are the various logistical processes that have to be observed when conducting business activities in the Middle East. Such processes can be quite long and complex. This, though compliant with Sharia law, can make it quite hard for investors and traders to go on with entrepreneurial activities in the region. Therefore, unless these challenges are addressed, there is a possibility that IB might take much longer to reach the desired levels of success. Its custodians have to find means of making it globally acceptable and available for all. In conclusion, this essay has looked at Islamic banking in quite a broad perspective. It has analyzed the history of the sector and the reasons behind its formation. It has then gone on to look at the various ways in which advocates for the sector have put in efforts to popularize it. Their success so far is used as the parameter for the measure of success. To look at the exact values of its success, the essay has looked at how this sector has penetrated the markets in various countries. This helped to give the exact parameters of success. Due to the growing popularity of this sector, it is important to look at the factors contributing to the great success. This has been clearly indicated by analyzing the types of services offered by IB and the various collaboration efforts with other conventional banks. Lastly, the essay has analyzed the various challenges facing IB. From the challenges, recommendations have been drawn on what can be done to support the sector. References Akhtar, S. (2009). Symposium on Islamic Finance in Roma: Developments in MENA Region. Retrieved on 14th Feb 2012 from http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/MENAEXT/0,,contentMDK:22391906~menuPK:2246554~pagePK:2865106~piPK:2865128~theSitePK:256299,00.html Hell, I. (2006). Banks Move into Islamic Finance. Retrieved on 14th Feb 2012 from http://news.bbc.co.uk/2/hi/middle_east/5064058.stm Mega Events. (20120. Islamic Banking, Islamic Funds. Retrieved on 14th Feb 2012 from http://www.megaevents.net/ Nasr, S.V.R. (2009). Forces of Fortune: The Rise of the New Muslim Middle Class and What it will Mean for our World. Free Press. Retrieved on 14th Feb 2012 from http://books.google.co.ke/books/about/Forces_of_fortune.html?id=565MlxqceAsC&redir_esc=y Price Waterhouse Coopers. (2011). Middle East and Islamic Finance. Retrieved on 14th Feb 2012 from http://www.pwc.lu/en/middle-east/docs/pwc-flyer-islamic-finance.pdf Read More