Banking - Classical Capitalism, Islamic Finance, and Microcredit - Case Study Example

Banking: ical Capitalism, Islamic Finance and Microcredit The financial services industry has undergone revolutionary changes in the last 25 years. These include the development of new financial instruments such as sub-prime loans, hedge funds and others. On a second level, the development of the Internet has had a profound impact with online banking the most apparent on the consumer level. Finally, globalization has had an impact on financial services industry in the same way it has impacted on everything from manufacturing to intellectual property. However, there have also been other changes in the industry that do not necessarily follow the above mentioned meta-trends. First, globalization is commonly seen as an integration of developed and less-developed countries leading to a homogenization of sorts. For instance, the emergence of a middle-class in China and India is often mentioned as an example of globalization homogenizing the world, as is the global reach of brands such as Nike and Ford. Globalization has also lead to the increasing mobility of the population. This in turn, has sometimes not created homogenization, but differentiation. An example of this would be the development of Islamic finance—financial organizations that are based on Islamic principles rather than capitalist or Western financial models. Analysts generally identify the first of these as “a savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in 1963.” (Ariff, 1988, p. 42) Many significant Islamic financial institutions then developed in the 1970s such as the Dubai Islamic Bank, the Faisal Islamic Bank of Sudan and the Baharain Islamic Bank. More recently, with the widespread immigration of Muslims to the United States banks such as the Devon Bank in Chicago have developed. Its website describes it in this way: “Devon Bank offers Islamic financing services designed to avoid conventional interest common in traditional banking products.” (http://www.devonbank.com/Islamic/) The emergence of Islamic financial services corporations is an example of globalization leading to leading to more differentiation rather than homogenization. Throughout the world, and particularly in the United States, it is a new and a different development for there to be financial institutions that offer financial services based on Sharia law (and of course compliant with the legal requirements of their host countries. Devon Bank makes this plain on its homepage: “Our products are created to meet your needs by a staff versed in both U.S. and Islamic legal requirements, and then submitted to appropriate government regulators and Shariah scholars.” (http://www.devonbank.com/Islamic/) A third model of banking, different from both traditional capitalist banking and Islamic banking has also emerged in the last twenty years. This is the banking of microcredit. It was developed by a Muslim, Mohammad Yunus, in a Muslim country, Bangladesh, yet is not banking founded on Sharia law. It is also not banking founded on classical capitalist principles. Unlike traditional capitalist banking, microcredit focuses on very small loans: Therefore, the term microcredit. Also, unlike traditional banking loans are often made to borrowers who have little or not assets or the traditional sureties needed to get a loan. However, it is also not Islamic banking because, unlike Islamic banking, charging interest is permitted and, indeed, like classical capitalist banking microcredit is based on loans and interest. The difference from capitalist banking is the size of the loans is much smaller and the need for collateral or security is much less. Therefore despite homogenization of globalization and the spread of the Internet it will be argued that banking has become more varied and differentiated in the last 25 years. This will be demonstrated by comparing and contrasting three financial institutions, each representing one of the three styles of banking. First, Chase, a typical American bank will be considered. (https://www.chase.com/) Then the mentioned above Devon Bank of Chicago will be considered as an Islamic bank, finally the original microcredit bank the Grameen bank will be considered. (http://www.grameen-info.org/) The final section of the discussion will be an opinion about living in capitalist country and globalization and still following the rules of Islamic banking. The classical capitalist model of banking is based on interest. According to OSullivan and Sheffrin, interest is defined as the cost of borrowing (or renting) money. (OSullivan and Sheffrin, 2003, 261) For example,when an individual receives a mortgage to purchases a home they are using the lenders money and the interest is the fee they pay for the use of that asset (the money) equivalent to the purchase price of the house. On the other side of the coin when a person places money in a savings account or purchases a government bond the interest is the fee they receive for giving that asset (money) to the bank or government. At a bank such as Chase a variety of services are offered to consumers. Some of these involve a set or service fee, but interest is generally the basic manner in which the bank (or the consumer) earns money. The consumer earns money, as noted above, on government bonds (purchased through the bank) and savings accounts (money placed in the bank). The bank earns money on the services it offers such as credit cards, home finance (mortgages), home equity loans, auto financing and education financing. (http://www.jpmorganchase.com/corporate/About-JPMC/client-solutions.htm) All of these services are based on interest. The money provided to the consumer is known as credit and credit is generally backed by collateral. If I get a loan to buy a car the car itself is the collateral. If I fail to pay the loan in a timely manner the bank will repossess the car and sell it to get its investment back. If I own a home valued at $250,000 and receive a home equity loan the collateral (equity) that secures the loan is the asset (the house) I own. Equity or assets are the security that will persuade the bank to lend me money knowing that its loan is safe and if I do not repay it they have another way to get their money back. Sometimes the interest is paid to the individual for investing his money in the bank or products it sells and on other transactions the individual pays interest on money that the bank provides to it. Always the transactions are based on interest and secured by assets. This type of financial system raises problem for Muslims who wish to practice the principles of their religion in all aspects of their daily life. The concept of interest is a problem for them. In “Overview of Islamic Finance”, Mahmoud Amin El-Gamal outlines the problem of interest-based transactions for Muslims. “The majority [of Islamic jurists] found those practices to be violations of Islamic prohibitions against usury (Arabic term: riba … interpreted in its classical Biblical sense of any interest charge on loans, as opposed to the modern identification of usury with exorbitant interest).” (El-Gamal, 2006, 3) Therefore, a devout Muslim should not collect interest nor should it be paid. This makes most bank transactions based on interest including mortgages, auto financing and credit cards a religious issue and a religious, moral and ethical problem. It is not that Chase Bank intends to offend Muslims and it is not that they want to exclude Muslims as clients. It is simply to state the manner that they do business is seen as a violation of religious laws by many Muslims. The Devon Bank and other Islamic banks offer similar products that are not violations of Sharia (English term: Islamic law) and allow devout Muslims to use financial instruments similar to mortgages and auto financing that are not interest-based. El-Gamal identifies three types of credit or retail financing that satisfies Sharia law (is juristic) and American legal requirements ( is legal and regulatory). Murabaha is a buy-sell-back arrangement. If a consumer wants to buy a car the Devon bank buys it and then sells it back to the consumer with a mark-up. According to El-Gamal, “the mark-up in Murabaha financing is benchmarked (i.e., made to track) conventional interest rates.” (El-Gamal, 2003, 4) In this way in dollar terms neither the bank nor the customer pays a penalty (more than they would if they paid interest to Chase Bank while the Devon Bank still makes a profit) without being engaged in a transaction involving interest. Second, El-Gamal identifies, “lease-to-purchase or diminishing partnership arrangements” (Arabic term: Ijara or Musharaka Mutanaqisa). A special purpose vehicle (SPV) purchases the vehicle and leases it to the customer. The customer makes monthly payments that are deemed to be part payment on the principle (with no interest) and part rental. As the principle is paid down the banks percentage of ownership of the vehicle diminishes and the customers increases. Again, “rents are calculated based on market interest rates, allowing monthly payments to follow a conventional amortization table.” (El-Gamal, 2003, 4) Again, neither the bank nor the customer pays a penalty (more than they would if they paid interest to Chase Bank while the Devon Bank still makes a profit) without being engaged in a transaction involving interest. Third, in banks in the Gulf Cooperation Council (GCC) three-party contracts (Arabic term: Tawarruq) have been introduced. This is the most complicated and least common form of consumer finance. It is best illustrated with an example. The bank buys $1000 worth of wheat and sells it to the customer for $1100. The customer then sells it back to the original owner for $1000. The customer has $1000 in hand and owes the bank $1100. The banks profit is $100 but it is not interest it is a mark-up and the customer has the $1000 that they needed (to borrow, in terms of classical capitalism). (El-Gamal, 2003, 5) Each of these identified financial instruments has three key features. They all allow the borrower access to financial instruments equivalent to mortgages, auto financing or loans that satisfy the requirements of Islam and impose no financial penalties on the borrower. Second, they are all acceptable in legal and regulatory terms. Third, they provide a profit to the institution that arranges them, such as the Devon Bank. Therefore, they are religiously (morally and ethically) acceptable, they are legal, and the impose no financial burden or penalty on either party. Overall, they make financing available to devout Muslims. The Grameen Bank (Grameen means "rural" or "village" in Bangla language) and its practice of microcredit is a third type of financial institution that emerged in a Muslim country (Bangladesh). The Grameen Banks goals and processes are simply identified on its homepage, “Banking for the poor”. (Grameen Bank, http://www.grameen-info.org/ ) This is another alternative to the classical capitalist model of banking. It is such a radical idea that its purpose and process is best described by the website, “Grameen Bank (GB) has reversed conventional banking practice by removing the need for collateral and created a banking system based on mutual trust, accountability, participation and creativity.” Its founder, Muslim and Nobel Prize winner, Professor Mohammad Yunus: “reasoned that if financial resources can be made available to the poor people on terms and conditions that are appropriate and reasonable, these millions of small people with their millions of small pursuits can add up to create the biggest development wonder." (Grameen Bank, “About Us”, http://www.grameen-info.org/index.php?option=com_content&task=view&id=16&Itemid=164) The Grameen bank is not an Islamic financial institution because it does charge interest. However, it differs from classic banks because it does not require that a borrower have capital, assets or security. Also, it makes very small loans (often less than $100) that a bank like Chase would never consider. It lends to individuals (97% women) that would never be considered by a traditional or classic bank. Since it started in 1976 it has made millions of small loans and expanded outside of Bangladesh. The recent book Saris on Scooters states the importance and wide ranging impact of microcredit in rural India. The two dozen stories collected by Sheila McLeod Arnopoulos present various stories of microcredit on the individual, family and village level. The level the Grameen bank targeted, and continues to serve along with hundreds of other similar programs that have entered the field. Arnopoulos volume is important for two reasons. Her field research was conducted on the micro-level during 21 months spent in India between 2001 and 2008 in the villages and with the families she writes about . She describes how microcredit ran the local bootlegger out of Pamtrampalli and offers hope to former child laborers. (Arnopoulos, 2010, 21-26, 185-198) So it proves that small lending to individuals without collateral will work. It also proves that this kind of lending can have far-reaching social benefits. It is for this reason that Yunus won the Nobel Prize for economics in 2006. Clearly, there are alternatives to the classic, interest-based financial system that is represented by the most financial institutions such as Chase Bank. There is Islamic finance that functions in the GCC states and even in the U.S. The Devon Bank based in Chicago is one example, the Dubai Islamic Bank, the Faisal Islamic Bank of Sudan, the Baharain Islamic Bank and Bank Islamic Malaysia are global examples. The other type of alternative is the Grameen Bank and other financial institutions that use microcredit (small unsecured loans). Both of these alternatives to classic, capitalist financial institutions are legal and have now functioned for many years. In the case of the Grameen Bank and its founder Nobel Prize winner, Professor Mohammad Yunus, this alternative has even won the awards of the world. This demonstrates that there are options for devout Muslims living in classic, capitalist countries like the U.S. If a Muslim in the United States is comfortable, morally and religiously, with the interest-based financial system they can bank at Chase or any of the other typical American banks. However, if they believe that they must follow Sharia law and bank at an Islamic financial institution with no interest-based service then they have this option. Also, using this option they have all the services of a classic, capitalist bank and do not have to make any kind of extra cost or special payment. References Financial Institutions Bank Islamic Malaysia. http://www.bankislam.com.my/. Chase Bank. http://www.devonbank.com/Islamic/. Devon Bank. http://www.devonbank.com/Islamic/. Grameen Bank. http://www.grameen-info.org/. Works Cited Ariff, Mohammed (1988) “Islamic Banking.” Aisan-Pacific Economic Literature. 2:2 (September 1988) 46-62 Arnopoulos, Sheila McLeod. (2010). Saris on Scooters. Dundurn Press: Tonowanda, NY. El-Gamal, Mahmoud Amin. (2006). “Overview of Islamic Finance” Occasional Paper No. 4. (August 2006) Department of the Treasury (U.S.) Office of International Affairs. OSullivan, Arthur and Steven M. Sheffrin. (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall Read More