Islamic Banking Systems - Research Paper Example

Table of Contents Executive Summary Introduction 2 Characteristics of Islamic Banking 2 The Prohibition of Riba & the Principles behind it 3 The Role of Religious Supervisory Boards 4 Islamic Finance in the Global Economy 4 A growing market & the root causes of growth 5 Managing Risk 6 Corporate Control 6 Islamic banks in worldwide competitive environment 7 1.Product growth and improvement 8 2.Allocation 8 3.Operational Brilliances 8 Common Features & differences of the two Systems 9 Challenges for Islamic banking 10 1.Establishment of suitable risk and liquidity supervisory techniques 10 2.Acquiring reliable Shariah administration 10 3.Managing, organizing and controlling the Trustworthy personnel 11 4.Tackling legal and tax restrictions 11 Relations between Islamic & Conventional Banks 11 The Future of Islamic Banking 12 1.Endurance of Islamic Banking & Finance 12 2.Probable Shape of Islamic Banking & Finance in Future 13 3.Islamic Banks will mainly be cost-effective Institutions 13 4.Future Challenges for Islamic Banking & Finance 13 Recommendations 13 Conclusion 15 references and Bibliography 16 Executive Summary I am the Islamic banking consultant and I have been asked by a company to conduct a research project in Islamic banking focusing on the compatibility of Islamic and conventional banking. I have conducted a deep research on Islamic banking and found that Islamic banking is the kind of banking which completely relies on Islamic laws, practices and principles i.e. Shariah. The main purpose of Islamic banking is to proscribe the activity of Riba or interest in all bank dealings, so one can say that fundamental principle of Islamic banking is interest free banking. Riba or interest is also acknowledged Haram in Holy Quran. There is also a Supervisory Board whose function is to offer support associated to Shariah issues and also provides viewpoints about a range of financial markets. Islamic banking is offering very noteworthy function in Global economy by following Shariah complaint banking system. There is a societal responsiveness among the people that equity banking is more fruitful banking system around the globe. An extensive expansion has been seen in Islamic banking and in Islamic finance over the last few years. The growth of Islamic banks in non-Muslim countries is meaningful and considerable. Many countries of the world are now realizing the idea behind Islamic banking and its branches are being opened all over the world. So the growth of Islamic finance is exception in Global market. I have come to know that risk management and corporate control are the essential elements for needs consideration in the growth of Islamic banking. Islamic banks are successfully competing around the globe due to its product development and growth, and due to their operational excellence. Due to their working nature, there are differences between conventional and Islamic banking. The challenges faced by Islamic bank are to manage its risks, acquisition of Shariah scholars and tax limitations. The future of Islamic banking depends upon its power to produce standard products, market improvements in various areas or disciplines, its competition and misuse. Introduction Since the down of up to date commercial banking, Islamic economists are striving their level best to basically prove the practicability and benefit of interest free Islamic banking. In fact, Islamic banking has now become a major challenge facing Muslim thinkers, scholars and experts all over the world. Islamic banking is perhaps the most crucial field that awakes the ambition and passion of Muslim scholars to demonstrate the truth and efficiency of Islamic Economic Principles. This confront is undoubtedly very robust to work upon and very complicated to answer as well. But thanks to the several Muslim scholars who have made great effort over the last three or four decades to illuminate the welfare based rationale and proficiency of Islamic banking teachings. But there is still a long way to go. There are abundant hurdles, compound authorized issues and monstrous impediments that wait to be dominated and shattered to pieces by the inconceivable forces of belief, logic, rationale, and strategy. We must recognize that interest free banking is not only a subject of principle of fundamentalist or orthodox Muslims. In actual fact, it is the need of every culture that is a sufferer of social and commercial injustice deprivation and widespread poverty. Needless to say that we as the guardian of the last Divine message are the most responsible to establish the force virility and strong point of the logic and foundation contain in it. Beginning the middle of twentieth century projects were launched to establish banking companies which would neither pay interest nor earn interest (Gafoor). Characteristics of Islamic Banking Islamic banking corresponds to the system of banking or banking activity which is dependable with Shariah “Islamic law” which stops the payment and anthology of interest “Riba” (Economy Watch). An Islamic bank is an economic establishment whose position, rules and actions particularly express its obligation to the principle of Islamic Shariah and to the banning of the acceptance and payment of interest “Riba” on any of its operations. The most important characteristics of Islamic bank are: (Economy Watch) It offers up to date financial services in conformity with Shariah. It takes part towards monetary development of the country within the ideology of Islamic justice. It distributes potential inadequate economic resources. It helps make certain equitable allocation of wealth. The Prohibition of Riba & the Principles behind it The word Riba has been used in the Holy Quran on a number of instances. As a result it is indispensable to be acquainted with what it means or what it in fact acknowledges for. Riba has been taken out from Riba. It means adding together, raise. Consequently, Riba accurately means to add to, to develop to rise, to add, to swell. It is, on the other hand, not every enlarge or expansion which has been banned by Islam. In the Shariah, “Riba” in principle corresponds to the quantity that the borrowed pays to the lender with the actual amount" as a circumstance for the finance or for an addition in its prime of life. Therefore, there is no such differentiation between usury and interest as summed up in the Holy Quran and the Hadith (ZAMIR). The word Riba is used for excess, raise or addition implies any excess return devoid of due deliberation. In simple words, when money begets money, devoid of being swap over for goods and services, it is acknowledged as Riba. Below are its imperative characteristics: (Ahmad) It must be associated to mortgage. Settlement time if permanent. When unpaid, a prefixed amount of money to be paid. Proscription of Riba is undoubtedly confirmed in Holy Quran. Some of the verses are as under: "That which gives you as interest to raise the peoples capital increases not with God; but that which give you in charity, seeking the goodwill of God, multiplies manifold." (Surah Al-Rum, verse 39). Islam announces Riba against the Islamic law and it also comes into sight clearly in the Holy Quran. An absolute synchronization survives surrounded by all Islamic schools of deliberation about the proscription of Riba. Without a doubt the Quran is the clear-cut source of supervision in Islam for all the Muslims, a frequent conventionality survives on the actuality that Islam has proscribed to be appropriate the activity of Riba. The question whether interest is Riba or not has still been recognized. Many Ulama (Islamic Scholars) have acknowledged undoubtedly that interest is Riba. The association of recent banking system is on the foundation of a predefined payment called interest. That is the basis why the practices and values of the modern banking system are still at variance with the principles of Islam which sternly proscribe Riba (Ahmad). The Role of Religious Supervisory Boards There is no normally acknowledged codification of jurisprudence in Islam. Shariah law is free to distinguish and researchers on the whole hold shifting thoughts on key Shariah matters. Furthermore, Islamic administration of justice is not bound by a case in point, and officially authorized beliefs may turn from earlier decisions made by other Shariah researchers. The beliefs of Shariah board are noteworthy in the understanding of Islamic law and may choose any school of thought to report its decision-making method. A consistent finding on the religious observance of positive assets and transaction structures in terms of Shariah law has yet to come away. In the conventional field, this can show the way to uncertainty and misunderstanding (Ahmed). Generally there are three goals of Islamic Shariah boards which are given below: (Ahmed) 1. To give useful suggestions to Islamic financial institutions. 2. To supervise and audit transactional activities. 3. To administer, manage, and take part in the construction of new-fangled Shariah-compliant investment and business products and services. Islamic Finance in the Global Economy The current global economic disaster has produced a constructive attentiveness that the banking system based on equity is an enhanced banking and monetary way out as compared to the conventional system. This positive alertness considers the various dimensions which are being used to find out the productive capacity, social benefit and monetary strength offered by each of these systems. The facts demonstrate that in most cases profit-loss allocation system of Islam stands out to be the most industrious, within society valuable which are being experimental and noticed by the world (Martin). At the same time as conventional banks all-inclusive are nursing losses of more than 400 billion dollars from the credit predicament, Islamic banks are approximately protected. The up to date international market circumstances have given Islamic finance a vast prospects to establish that what it can do to put on weight the liquidity gap. The beginning of Islamic banking is Shariah, or Islamic law. The payment of interest is completely prohibited in Islamic law and has need of business to be associated with assets, so it prevents the kind of complexities which are very widespread in conventional financing operations. US state has also seen the progress of Islamic finance (Martin). At the present time, in London there are already five Islamic banks functioning, and in France the first Islamic bank is predictable to open in 2009. According to the usual supposition of the Banker in October 2008, Islamic financial assets go above Five hundred billion dollars all over the world; this figure could without difficulty be doubled over the forthcoming period. In the United Kingdom, the knowledge of Islamic banking has been very positive. Islamic Bank of Britain has been working as a trade bank for over four years, and it has fascinated over 40,000 clients. The world financial disaster has no great impact on these institutions and their strength predict well for the future (Martin). A growing market & the root causes of growth Although the idea of Islamic banking and "conventional" banking is dissimilar, but there are some indispensable values that relate uniformly to both. Predominantly, vigilant risk management and sound corporate control facilitate to make certain the soundness of the worldwide banking system. In the light of the thriving consequence of Islamic banks, the growing consolidation of Islamic financial services into worldwide financial centers encourages this view (Knight). In recent years, a prominent expansion has been seen in Islamic financial services and this growth is anticipated to carry on at a fast speed. Without a doubt, on the rise demand exists for these products, and an enthusiastic desire on the part of banks, in particular non-Islamic bank to proffer Islamic financial services and products. Islamic retail banking is in advance more popularity. This point is true in the Middle East and Asia Pacific countries predominantly, where a number of Islamic banks as well as banking units have been opened in current years. Islamic financial expansion is also apparent in products and services that accomplish the fundamental principle of Sharia law (Knight). Some imperative elements are there that are laid great stress and some indispensable principles that relate to both the kinds of banking. For instance, well-built corporate control, careful risk management and strong capital acceptability requirements are compulsory elements to make certain the protection and soundness of any economic system. The mounting consolidation of Islamic financial services into the international monetary essence only strengthens this point. Furthermore, the guiding principles and paradigm built by the (Islamic Financial Services Board (IFSB) are facilitating supervisors across the world to comprehend in better way, direct and manage institutions which are offering Islamic financial services (Knight). Managing Risk First and foremost, banks must have plans and techniques in place that facilitate them to discriminate, determine, organize and report all material risks. Bank management is fundamentally in charge for perceiving the nature and intensity of the risks being commenced by the institution. At present, the crucial module to stay away from any banks unpleasant circumstance is well-built risk management. And this is unquestionably as worthwhile for Islamic banks in addition to for other types of financial market (Knight). Corporate Control Corporate control structure is the indispensable necessity and is acknowledged by bank managers around the world. Indeed, devoid of strong corporate control, management and administration would not be potential. In general, sound corporate control competently clarifies the way through which decision-making development is fashioned in the organization; it is the sole answerability of the board of directors and senior management to ensure the correctness of supervisory process by controlling and managing its functions. Therefore, it is concluded that sound corporate control and risk management are the key components for a bank to better understand and manage risks. Also, Supervisors must work side by side to foster all banks to improve their risk management systems, controls and clarity. Such growth will help ensure the reliability and soundness of the international banking system (Knight). Islamic banks in worldwide competitive environment In Islamic banking, the source of competition and competitive aspects are varying fruitfully. More often than not, Shariah complaint characteristics not only present Islamic bank a competitive benefit however they also have an edge of being the only pure-play Islamic bank at place. Subsequently when the credit crisis took place and loan from wholesale markets was stopped, Islamic banks were not revealed. Though, Islamic banks are not confined from the impacts of the global recession, and the fall in oil prices will certainly have a negative impact on 2008 consequences of Gulf-based Islamic banks (Vayanos and Wackerbeck). This alarming situation has transformed dramatically over the past few years. For instance, there are more than eight completely developed Islamic banks working in Arab Emirates and numerous Islamic units of conventional banks. There are three fully fledged Islamic banks in Saudi Arabia and other remaining banks offering solutions through various allocation channels of Shariah compliant (Vayanos and Wackerbeck). In present views, there are following basis of competition for Islamic bank are as follows: 1. Product growth and improvement. 2. Allocation. 3. Operational brilliance. 1. Product growth and improvement Product growth and development has prepared great advances in Islamic finance over the last few years. These days most standard goods, be it in banking, asset supervision or money markets can be simulated in a Shariah compliant manner. These following key requirements are needed to focus product development potential: Market intelligence course of action must be there to catch the attention of customers. An energetic product development technique. A system for engagement of Shariah Board to seek approval of planned product. 2. Allocation The products of Islamic banking are naturally more complicated than their conventional complement. Additionally, having to stay away from issues around Riba “interest”, gharar “cogitation” and maysir “gambling”, Islamic dealings frequently necessitate two legs. Due to the fact, a burden is placed distribution which has to (a) clarify the facts of the products to clients, and (b) the need to connect asset/ product providers as part of the business. The answers to the above mentioned problems are simple. Top Islamic banks offer wide training to their forefront staff. This training needs to cover up not only the product salient features, but also how glowing the business is carried out (Vayanos and Wackerbeck). 3. Operational Brilliances The growing competitive edge among Islamic banks is putting pressure on prices. Simultaneously, the historic advantage of Islamic banks – deposit free of interest– is coming under great risk as customer wants to invest in pay-back products. As we have mentioned above, Islamic banks have naturally more complex operations than their usual corresponding persons. The factors mentioned above are laying stress on restrictions and inciting Islamic banks to enhance operational performance. For Islamic unit this performance enhancement is more suitable as both conventional and Islamic tasks are running side by side with the relative serious economics (Vayanos and Wackerbeck). Common Features & differences of the two Systems The salient features of the conventional banking and Islamic banking are shown below: (Rahman) Conventional Banks Islamic Banks 1. Conventional bank follows the man-made principles. 1. Islamic bank follows the principles that are offered by Islamic Shariah. 2. The investor is guaranteed of a fixed rate of interest. 2. The investor is not assured of a fixed rate of interest. 3. It aims at maximizing profit without many checks. 3. It also aims at maximizing profit but subject to Shariah controls. 4. It does not have any relation with Zakat. 4. It has relation with Zakat. 5. The fundamental function of conventional bank is lending money and getting it back with interest. 5. The basic function of Islamic banks is business based contribution with profit and loss distribution instead of interest. 6. It can charge additional money i.e. fine and compounded interest in case of debtor. 6. The Islamic banks have no terms to charge any extra money from the debtor. 7. Conventional banks are rather more worried about their own interest 7. Islamic banks give due importance to the public interest. 8. For interest-based commercial banks, loan taking process from the money market is relatively easier. 8. For the Islamic banks, it must be based on a Shariah approved basic transaction. 9. The conventional banks give greater emphasis on credit-worthiness of the clients. 9. The Islamic banks, on the other hand, give greater emphasis on the feasibility of the projects. 10. The status of a conventional bank, in relation to its clients, is that of creditor and debtors. 10. The status of Islamic bank in relation to its clients is that of partners, investors and trader, buyer and seller. 11. A conventional bank has to guarantee all its deposits. 11. Islamic bank can only guarantee deposits for deposit account, which is based on the principle of al-wadiah. 12. They make no or very little endeavor to ensure growth with equity. 12. Its ultimate aim is to ensure growth with equity. Challenges for Islamic banking The distinct and salient features of Islamic banking give rise to a set of challenges that have to be resolved by Islamic banks. These consist of: (Vayanos and Wackerbeck) 1. Establishment suitable risk and liquidity supervisory methods. 2. Acquiring reliable Shariah administration. 3. Managing, organizing and administering the talent pool. 4. Tackling legal and tax restrictions. 1. Establishment of suitable risk and liquidity supervisory techniques Risk outline of Islamic financial institutions differs from their conventional complement. The reason is that there is a difference in risk outlines of some of the Islamic financing techniques. The deficiency of short-term liquidity supervision and long-term refinancing instruments is the main challenge facing Islamic banks. So, asset-liability supervision is becoming a genuine problem (Vayanos and Wackerbeck). 2. Acquiring reliable Shariah administration Islamic finance market faces one major trouble – the lacking of universal standards. Although geological differences exist, and even inside one country, dissimilar Shariah Boards may convey different understandings. The absence of universal principles and the lack of visibility regarding the function of Shariah place an enormous burden on the marketing of Islamic financial services (Vayanos and Wackerbeck). 3. Managing, organizing and controlling the Trustworthy personnel These days, there are simply not enough persons with the required skills and ability available in the marketplace. Shariah scholars rank is achieved after many years of education and realistic skill. Hence there are very few scholars available in the marketplace and many scholars have to sit on multiple boards raising the needless question of conflict of interest (Vayanos and Wackerbeck). 4. Tackling legal and tax restrictions In numerous non-Muslim countries, Islamic and conventional banks usually do not struggle on a stage playing field. Authorized and tax limitations are there which make it difficult for Islamic banks to strive. For example, in many areas, Islamic real estate financing through the retreating Musharakah technique leads to a double taxation with transport duty on the procurement of the real estate (Vayanos and Wackerbeck). Relations between Islamic & Conventional Banks The foundation of Islamic bank is based on the Islamic belief and must reside within the limits of Islamic Law or the Shariah in all of its actions and manners. The original meaning of the Arabic word Shariah is the way to the source of life and is now used to relate to legal system in keeping with the code of behavior required by the Holly Quran. The most important ideologies of an Islamic bank are: (Rahman) The omission of interest-based (riba) transactions. The evasion of money-making actions concerning dominance (zulm). The evasion of profitable actions involving assumption (gharar). The preface of an Islamic tax, (Zakat). Islamic law outlines that a loan to be given or taken, free of charge or interest, to meet any incident. Thus in Islamic Banking, the creditor should not take advantage of the borrower. Lending money out on the basis of interest, more often leads to some kind of injustice (Rahman). The Future of Islamic Banking Islamic banking has gained fundamental place internationally in the financial world as well as in Muslim countries. As I have mentioned that no Islamic bank has failed yet. The future of Islamic bank will depend upon of how well it contributes to public benefit of the financial system to the level principles on Zakat would pertain to them. But away from this, usually they would certainly be untainted cost-effective institutions recognized by the possessor for profit earning. , independently few Islamic banks would put their attention in participatory ways of financing approach because of various religious passions of their owners. Consistency is indispensable, as well as it is bound to take place. The reason is that the universe has turned out to be a global village. Consumers or client’s perception and struggle between Islamic banks will escort to consistency of Islamic monetary products. In the end, with the exception of extraordinary state of affairs when huge and long-term fund obligations and various financial engineering is concerned, no more than price competition will tenet in the Islamic banking sector. Incidentally, one may take notice of that in the long run consistency in the financial mechanisms will necessitate consent of basic Shariah values for turning out to be financial contracts. But if this takes place, then Islamic banking would turn out to be a conflict of doctrine. Islamic banking future relies upon the following (Tahir): 1. Endurance of Islamic Banking & Finance Endurance of Islamic banking relies on the following: 1. Its cost-effective feasibility. 2. Its strength. 3. Its reaction to challenges to its exclusivity. 4. Self-belief of Depositors and Savers (Tahir). 2. Probable Shape of Islamic Banking & Finance in Future Islamic Banks as Pure Financial Institutions. 3. Islamic Banks will mainly be cost-effective Institutions Consistency of Islamic Financial foodstuffs. Constitution of Islamic business Industry. 4. Future Challenges for Islamic Banking & Finance Some of these challenges are noted below: Financial improvement in decisive Areas: Competition: Exploitation of Islamic Banking Recommendations Let us comprehend that the major force at the back of every motive whether it is an Islamic banking or no matter which else, is of belief. Let us renew and bring back together our believes. Let us put this force at the back of our every noble mission and motive. Let us consign to ourselves that we will try our level best to take away interest from our personal lives. Let us connect hands to help those who are forced to take interest based loans. Pure Islamic banking is not doubt extremely difficult to practice in the current state of affairs. But as an alternative of crying over hurdles and simply cursing the interest let us set our energies in the right direction with total commitment and with the belief that Almighty ALLAH will definitely guide us to the right solution. I have conducted this research and I will recommend few recommendations regarding Islamic banking; People are ignorant of Islamic banking concept so they should be given awareness about how Islamic banking is gaining popularity around the world. Islamic banking system should introduce some kind of advertisements for the promotion of its products and services like conventional banks do in their adds in television as well as on other kind of media. It should adopt some useful characteristics of conventional banking which are not against the Islamic rule or Shariah, whose sole purpose is to give satisfaction to the customers. Islamic scholars should adopt some techniques so that they can facilitate the people in an easy to understand manner about their products which are usually complex in nature than conventional banking. Islamic banking management should target sectors of a country where there is a majority of Muslims. Islamic banks should guarantee the deposits of customers Conclusion I have been appointed to conduct a deep research about Islamic banking. I have started this project with the background of Islamic banking. Islamic banking is considerably different with conventional banking. Islamic banking follows the principles of Shariah. Then I have discussed about ‘Riba’ which is alternatively used for interest. After this, I have discussed the role of religious Supervisory board and mentioned how this board plays a vital role in Islamic banking. Then I have discussed about the value of Islamic finance and its importance in the world’s economy and how it is competing and contributing successfully in the global economy. I have also discussed what are the main factors needed for the growth of Islamic banking around the world. At the present time, Islamic banking is a thriving thought. So far it has already been accomplished as the only banking technique in two Muslim countries; there are Islamic banks functioning glowing in numerous Muslim countries and a small amount of in non-Muslim countries also. Despite the booming acceptance there are problems. These problems are for the most part in the area of financing. By adopting minor changes in practices, Islamic banks can dispose of all their awkward, oppressive and sometimes uncertain forms of financing and presents a clean and efficient interest-free banking. All the crucial basics are already there. The unique feature of Islamic banking is participatory investments, and it can suggest dependable investment to communally and cost-effectively relevant development projects. This is an additional service Islamic banks offer in addition to the traditional services. In the last, I have suggested few recommendations. I hope that this research project will be helpful for the company. references and Bibliography Ahmed, El Waleed M. "A Unified Voice: The Role of Shariah Advisory Boards in Islamic Finance." 01 10 2007. ZAWYA.COM. 25 05 2009 . Ahmad, Shakeel. ISLAMIC BANKING AND FINANCE IN THE CONTEMPORARY WORLD. 02 2004. 26 05 2009 . Economy Watch. Islamic Banking, Islamic Bank, Islamic Banks, Islamic Banking: How it Works. 2008. 25 05 2009 . Gafoor, Abdul. ISLAMIC BANKING. 1995. 25 05 2009 . Knight, Mr Malcolm D. "The growing importance of Islamic finance in the global financial system." 06 12 2007. The Bank for International Settlements (BIS). 25 05 2009 . Martin, Josh. "ISLAMIC BANKING GOES GLOBAL ." 06 06 2005. EBSCO HOST. 25 05 2009 . Rahman, Ust Hj Zaharuddin Hj Abd. "Differences Between Islamic Bank and Conventional ." 22 02 2007. Zaharuddin.net. 25 05 2009 . Tahir, Sayyid. "Future of Islamic Banking." 23 02 2003. State bank of Pakistan, The central Bank. 25 05 2009 . Vayanos, Peter and Philipp Wackerbeck. "How do Islamic Banks compete in an increasingly competitive environment? ." 22 01 2009. SUSUK.NET. 25 05 2009 . ZAMIR, ZAHID. "PROHIBITION OF INTEREST (RIBA) IN ISLAM – THE SOCIAL, MORAL." 2007. Ethical Banking, Islamic Banking & Finance. 25 05 2009 . Read More