Institution

Document Sample
Institution Powered By Docstoc
					                    Islamic Banking Vs Conventional Banking




WWW.PAKASSIGNMENT.BLOG
      SPOT.COM


Send your assignments and projects
 to be displayed here as sample for
              others at

PAKASSIGNMENT@GMAIL.COM




                                                          1
                                         Islamic Banking Vs Conventional Banking




ISLAMIC ECONOMICS
Islamic banking is based on the principles of Islamic economics — an
economic framework in accordance with Islamic law (Sharia'h).

There are two types of Islamic economics:

      Caliphate , the Islamic form of government representing the
       political unity and leadership of the Muslim world (Islamic
       political framework)
      Assuming the political framework is non-Islamic, therefore,
       seeking to integrate some prominent Islamic tenets into a
       secular economic framework

Caliphate is the absolute Islamic rule, thus the economy focuses on
distribution of resources in order to meet the basic and luxurious
needs of individuals in society, and the state has a clear role in
policing, taxation, managing public assets, and ensuring the circulation
of wealth. Such a political framework in its true form does not exist in
today's world.

Assuming non-Islamic political framework simply proposes two main
tenets: no interest can be earned on loans and socially responsible
investing. This is the way conventional banking is Islamized—the first
step towards an Islamic economic framework.

Modern day Islamic scholars and academics have developed various
modes of Sharia'h complaint financing that are designed to work within
the prevailing capitalist economic framework. In order to achieve this
balance numerous concessions have been afforded to financial
institutions that would not apply if a viable interest free economic
system existed. The intention behind making these concessions is to
encourage the evolution of this type of alternative system.




                                                                               2
                                           Islamic Banking Vs Conventional Banking




ISLAMIC BANKING

Islamic banking refers to a system of banking or banking activity that
is consistent with Islamic law (Sharia‘h) principles and guided by
Islamic economics. In particular, Islamic law prohibits usury, the
collection and payment of interest, also commonly called riba.
Generally, Islamic law also prohibits trading in financial risk (which is
seen as a form of gambling). In addition, Islamic law prohibits
investing in businesses that are considered unlawful, or haraam.


Islamic finance has been gaining momentum on a global scale for the
last 30 years.

Many Islamic Banks have sprung up over the last few years. These
changes are occurring both in Muslim and in western countries, and
are driven by a global trend amongst Muslims to become more
observant of their faith. It might have been the reason why Islamic
Banking emerged, however, today Islamic Banking is sought by
Muslims and non-Muslims due to the benefits it offers.

Industry size is currently estimated at more than $400 billion, with
projected growth of 15% per annum.

Financial institutions around the globe are trying to keep pace with the
growing demand for Sharia‘h compliant products and services.




Islamic Banking Global Scenario

Over the last three decades Islamic banking and finance has developed
into a full-fledged system and discipline reportedly growing at the rate
of 15percent per annum. Today, Islamic financial institutions, in one
form or the other, are working in about 75 countries of the world.
Besides individual financial institutions operating in many countries,
efforts have been underway to implement Islamic banking on a
country wide and comprehensive basis in a number of countries. The
instruments used by them, both on assets and liabilities sides, have



                                                                                 3
                                          Islamic Banking Vs Conventional Banking




developed significantly and therefore, they are also participating in the
money and capital market transactions. In Malaysia, Bahrain and a few
other countries of the Gulf, Islamic banks and financial institutions are
working parallel with the conventional system.

Bahrain with the largest concentration of Islamic financial institutions
in the Middle East region, is hosting 26 Islamic financial institutions
dealing in diversified activities including commercial banking,
investment banking, offshore banking and funds management. It
pursues a dual banking system, where Islamic banks operate in the
environment in which Bahrain Monetary Agency (BMA) affords equal
opportunities and treatment for Islamic banks as for conventional
banks. Bahrain also hosts the newly created Liquidity Management
Centre (LMC) and the International Islamic Financial Market (IIFM) to
coordinate the operations of Islamic banks in the world. To provide
appropriate regulatory set up, the BMA has introduced a
comprehensive prudential and reporting framework that is industry-
specific to the concept of Islamic banking and finance. Further, the
BMA has pioneered a range of innovations designed to broaden the
depth of Islamic financial markets and to provide Islamic institutions
with wider opportunities to manage their liquidity.

Another country that has a visible existence of Islamic banking at
comprehensive level is Malaysia where both conventional and Islamic
banking systems are working in a competitive environment. The share
of Islamic banking operations in Malaysia has grown from a nil in 1983
to above 8 percent of total financial system in 2003. They have a plan
to enhance this share to 20 percent by the year 2010. However, there
are some conceptual differences in interpretation and Shariah position
of various contracts like sale and purchase of debt instruments and
grant of gifts on savings and financial papers.

In Sudan, a system of Islamic banking and finance is in operation at
national level. Like other Islamic banks around the world the banks in
Sudan have been relying in the past on Murabaha financing. However,
the share of Musharaka and Mudaraba operations is on increase and
presently constitutes about 40 percent of total bank financing.
Although the Islamic financial system has taken a good start in Sudan,
significant problems still remain to be addressed.

Like Sudan, Iran also switched over to Usury Free Banking at national



                                                                                4
                                          Islamic Banking Vs Conventional Banking




level in March 1984. However, there are some conceptual differences
between Islamic banking in Iran and the mainstream movement of
Islamic banking and finance.

Owing to the growing amount of capital availability with Islamic banks,
the refining of Islamic financing techniques and the huge requirement
of infrastructure development in Muslim countries there has been a
large number of project finance deals particularly in the Middle East
region. Islamic banks now participate in a wide financing domain
stretching from simple Shariah-compliant retail products to highly
complex structured finance and large-scale project lending. These
projects, inter alia, include power stations, water plants, roads,
bridges and other infrastructure projects. Bahrain is the leading centre
for Islamic finance in the Middle East region. The establishment of the
Prudential Information and Regulatory Framework for Islamic Banks
(PIRI) by the BMA in conjunction with AAOIFI has gone a long way
towards establishing a legal and regulatory framework to meet the
specific risks inherent in Islamic financing structures.

The BMA has quite recently signed MoU with the London Metal
Exchange (LME) to pool assets to develop and promote Shariah
compliant tradable instruments for Islamic banking industry. The
arrangement is seen as a major boost for industry‘s integration in the
global financial system and should set the pace for commodity-trading
environment in Bahrain. BMA has also finalized draft guidelines for
issuance of Islamic bonds and securities from Bahrain. In May 03, the
Liquidity Management Centre (LMC) launched its debut US$ 250
million Sukuk on behalf of the Government of Bahrain.

National Commercial Bank (NCB) of Saudi Arabia has introduced an
Advance Card that has all the benefits of a regular credit card. The
card does not have a credit line and instead has a prepaid line. As
such, it does not incur any interest. Added benefits are purchase
protection, travel accident insurance, etc and no interest, no extra fees
with no conditions, the card is fully Shariah compliant. It is more
secure than cash, easy to load up and has worldwide acceptance. This
prepaid card facility is especially attractive to women, youth, self
employed and small establishment employees who sometimes do not
meet the strict requirements of a regular credit card facility. Saudi
Government has also endorsed an Islamic-based law to regulate the
kingdom's lucrative Takaful sector and opened it for foreign investors.



                                                                                5
                                           Islamic Banking Vs Conventional Banking




Islamic banks have also built a strong presence in Malaysia, where
Standard & Poor's assigned a BBB+ rating to the $600 million Sharia-
compliant trust certificates (called sukuk) issued by Malaysia Global
Sukuk Inc. Bank Negara Malaysia (BNM) has announced to issue new
Islamic Bank licences to foreign players. The Financial Sector Master
plan maps out the liberalisation of Malaysia's banking and insurance
industry in three phases during the next decade. It lists incentives to
develop the Islamic financial sector and enlarge its market share to 20
percent, from under 10 percent now. A dedicated high court has been
set up to handle Islamic banking and finance cases.

In United Kingdom, the Financial Services Authority is in final stages of
issuing its first ever Islamic banking license to the proposed Islamic
Bank of Britain, which has been sponsored by Gulf and UK investors.
The United States of America has appointed Dr. Mahmoud El Gamal,
an eminent economist/expert on Islamic banking to advise the US
Treasury and Government departments on Islamic finance in June
2004.




MODES OF ISLAMIC FINANCE

MURABAHA

Literally it means a sale on mutually agreed profit. Technically, it is a
contract of sale in which the seller declares his cost and profit. Islamic
banks have adopted this as a mode of financing. As a financing
technique, it involves a request by the client to the bank to purchase
certain goods for him. The bank does that for a definite profit over the
cost, which is stipulated in advance.




                                                                                 6
                                           Islamic Banking Vs Conventional Banking




IJARAH

Ijarah is a contract of a known and proposed usufruct against a
specified and lawful return or consideration for the service or return for
the benefit proposed to be taken, or for the effort or work proposed to
be expended. In other words, Ijarah or leasing is the transfer of
usufruct for a consideration which is rent in case of hiring of assets or
things and wage in case of hiring of persons.


IJARAH-WAL-IQTINA

A contract under which an Islamic bank provides equipment, building
or other assets to the client against an agreed rental together with a
unilateral undertaking by the bank or the client that at the end of the
lease period, the ownership in the asset would be transferred to the
lessee. The undertaking or the promise does not become an integral
part of the lease contract to make it conditional. The rentals as well as
the purchase price are fixed in such manner that the bank gets back
its principal sum along with profit over the period of lease.


MUSHARAKAH

Musharakah means a relationship established under a contract by the
mutual consent of the parties for sharing of profits and losses in the
joint business. It is an agreement under which the Islamic bank
provides funds, which are mixed with the funds of the business
enterprise and others. All providers of capital are entitled to participate
in management, but not necessarily required to do so. The profit is
distributed among the partners in pre-agreed ratios, while the loss is
borne by each partner strictly in proportion to respective capital
contributions.


MUSAWAMAH

Musawamah is a general and regular kind of sale in which price of the
commodity to be traded is bargained between seller and the buyer
without any reference to the price paid or cost incurred by the former.



                                                                                 7
                                           Islamic Banking Vs Conventional Banking




Thus, it is different from Murabaha in respect of pricing formula. Unlike
Murabaha, seller in Musawamah is not obliged to reveal his cost. Both
the parties negotiate on the price. All other conditions relevant to
Murabaha are valid for Musawamah as well. Musawamah can be used
where the seller is not in a position to ascertain precisely the costs of
commodities that he is offering to sell.


ISTISNA'A

It is a contractual agreement for manufacturing goods and
commodities, allowing cash payment in advance and future delivery or
a future payment and future delivery. Istisna'a can be used for
providing the facility of financing the manufacture or construction of
houses, plants, projects and building of bridges, roads and highways.


BAI MUAJJAL

Literally it means a credit sale. Technically, it is a financing technique
adopted by Islamic banks that takes the form of Murabaha Muajjal. It
is a contract in which the bank earns a profit margin on his purchase
price and allows the buyer to pay the price of the commodity at a
future date in a lump sum or in installments. It has to expressly
mention cost of the commodity and the margin of profit is mutually
agreed. The price fixed for the commodity in such a transaction can be
the same as the spot price or higher or lower than the spot price.

MUDARABAH

A form of partnership where one party provides the funds while the
other provides expertise and management. The latter is referred to as
the Mudarib. Any profits accrued are shared between the two parties
on a pre-agreed basis, while loss is borne only by the provider of the
capital.




                                                                                 8
                                           Islamic Banking Vs Conventional Banking




BAI SALAM


Salam means a contract in which advance payment is made for goods
to be delivered later on. The seller undertakes to supply some specific
goods to the buyer at a future date in exchange of an advance price
fully paid at the time of contract. It is necessary that the quality of the
commodity intended to be purchased is fully specified leaving no
ambiguity leading to dispute. The objects of this sale are goods and
cannot be gold, silver or currencies. Barring this, Bai Salam covers
almost everything, which is capable of being definitely described as to
quantity, quality and workmanship


Islamic Banking Issues
HUMAN RESOURCE FOR SHARIA'H COMPLIANCE

Users of Islamic financial services assign primary importance to
Sharia'h compliance of the services they use. It is understandable that
Sharia'h noncompliance entails a serious operational risk and can
result in withdrawal of funds from and instability of an Islamic bank,
irrespective of its initial financial soundness. Sharia'h compliance is
hence a serious matter for an Islamic bank, in addition to its
compliance with other regulatory requirements.



UNRESOLVED FIQH ISSUES

Lack of standard financial contracts and products can be a cause of
ambiguity and a source of dispute and cost. In addition, without a
common understanding of certain basic foundations, further
development of banking products is hindered.



LEGAL FRAMEWORK

An appropriate legal, institutional and tax framework is a basic
requirement for establishing sound financial institutions and markets.


                                                                                 9
                                          Islamic Banking Vs Conventional Banking




Islamic jurisprudence offers its own framework for the implementation
of commercial and financial contracts and transactions.

Nevertheless, commercial, banking and company laws appropriate for
the enforcement of Islamic banking and financial contracts do not exist
in many countries.



EXCESS LIQUIDITY

Islamic banks have over 60 % excess liquid funds which cannot be
properly utilized due to non-availability of Sharia'h Compliant products
and instruments.

The competitiveness and soundness of financial institutions depend on
the availability of efficient financial products. Islamic banks urgently
need Sharia'h compliant products to meet a number of pressing needs.




Conventional Banking
Conventional banking is based on the principle that the more you
have, the more you can get. In other words, if you have little or
nothing, you get nothing. As a result, more than half the population of
the world is deprived of the financial services of the conventional
banks. Conventional banking is based on collateral. Conventional
banks look at what has already been acquired by a personConventional
banks go into ‗punishment‘ mode when a borrower is taking more time
in repaying the loan than it was agreed upon. They call these
borrowers ―defaulters‖. When a client gets into difficulty, conventional
banks get worried about their money, and make all efforts to recover
the money, including taking over the collateral. In conventional banks
charging interest does not stop unless specific exception is made to a
particular defaulted loan. Interest charged on a loan can be multiple of
the principal, depending on the length of the loan period.



                                                                               10
                                          Islamic Banking Vs Conventional Banking




Islamic Banking Vs Conventional Banking
Best Answer - Chosen by Voters
The main difference between Islamic and conventional banking is that
Islamic teaching says that money itself has no intrinsic value, and
forbids people from profiting by lending it, without accepting a level of
risk – in other words, interest (known as "riba") cannot be charged.

To make money from money is prohibited – wealth can only be
generated through legitimate trade and investment. Any gain relating
to this trading are shared between the person providing the capital
and the person providing the expertise.

At Islamic Bank of Britain, we generate all our profit through sharia‘a
compliant trading and investment activities. We then share the profits
with our customers at a pre-agreed ratio. In order to share profits you
must hold one of our savings or investment accounts

There are two major difference between Islamic Banking and
Conventional Banking:
1. Conventional banking practices are concerned with "elimination of
risk" where as Islamic banks "bear the risk" when involve in any
transaction.
2. When Conventional banks involve in transaction with consumer they
do not take the liability only get the benefit from consumer in form of
interest whereas Islamic banks bear all the liability when involve in
transaction with consumer. Getting out any benefit without bearing its
liability is declared Haram in Islam.

While the basics of what the business is are the same, the term refers
to operating the business within Islamic law. The main thing that
effects this business under that law is that Islam prohibits the charging
of interest. Certainly a problem in modern banking!

However, what is considered to be interest has different definitions by



                                                                               11
                                           Islamic Banking Vs Conventional Banking




different Islamic scholars...some say it can only be considered on gold
and silver...but paying back the same weight as you borrowed (the
same weight of paper money for example), is not interest. Like in all
religious things, there would seem to be some conflict and differences
between followers that may seem strange to outsiders.

So basically, modern Islamic banking may take many forms, each of
which strives to adhere to it's understanding of Islamic law.




Islamic banks playing role in Economic Development
of the Country
 Islamic banking is unique, but by no means anomalous. It is neither
 at odds with nor incomparable to conventional banking. Is it
 possible to contrast the two models?

 I-They are both financial intermediations. A financial intermediary is
 the institution that acts as a middleman between cash surplus units
 (savers) and deficit spending units (users of fund). It is quite
 obvious that the main function of conventional banks is financial
 intermediation. However, there are those who would like to think
 that there is no such thing in the Islamic economic system as
 financial intermediation and that an Islamic bank can only be
 ―sufficiently‖ Islamic if it can operate like a trader, one who buys
 and sells goods and commodities.

 The financial intermediary in conventional banking is a ―borrower-
 lender‖ institution. Since such institution will not survive unless it at
 least covers expenses, then an income must be generated from
 such arrangement. This is where interest appears. An Islamic bank,
 on the other hand, is based on a multi-tier Mudarabah. A Mudarabah
 is a partnership in profit where capital and management may joint
 together to create value. The income accruing to the Islamic
 financial intermediary is coming out of profit not from interest. The
 root of such a conception is the fact that Shari'ah doesn‘t distinguish
 between a seller being a trader or a final intermediary, unlike
 positive law where civil law is different from commercial law. In
 Shari'ah all people stand against one legal code.




                                                                                12
                                         Islamic Banking Vs Conventional Banking




II-A case in mind is Murabaha. There are those who say if an
Islamic bank does Murabaha any other form but the traders way of
doing things it will not be permissible from Shari'ah point of view,
and an Islamic bank would be in their view a ―dubious‖ conventional
bank. They say: since it is never the intention of the bank, to own
there assets and hold on to them then, such bank is not sufficiently
Islamic.

According to this viewpoint, an Islamic bank must have huge
warehouses and elegant stores full of goodies for sale. This is not
valid and those who think so miss two important points:

         Intention is of no consequence on the permissibility or
otherwise of any exchange contract in Shari'ah. In an authentic
Hadith, the Prophet (PBUH) showed one companion how to
substitute a usurious transaction by another non usurious to reach
the same purpose, He (PBUH) didn‘t object to the intention nor that
he nullified the contract on the basis of intention. Rather he
corrected the form of contract.

If the anatomy of the contract is in line with Shari'ah requirements,
then the transaction is acceptable. Hence, if bank actually buys and
then sells, with ownership passing from seller to buyer and that the
subject of contract is a good or commodity then the transaction is
correct. In conventional banking the subject of contract is money
hence any increase is usurious.

III-The way conventional banks render financial intermediation is
very simple. They borrow money and lend money. Both assets and
liabilities are one form of lending. Islamic banking function in a
rather ―elaborate‖ (not perplexing) way. They have to continuously
innovate to satisfy the needs of their clients. It is because of this we
see Murabaha, Musharakah, Mudarabah, Istisna‘a, Salam to name
just a few Islamic modes of finance. This makes the job of an
Islamic banker ―not all roses‖, but certainly a more interesting one.

IV-A conventional banker is a risk manger. He is concerned with all
kind of credit, market, interest rate, legal and other risk factors. An
Islamic banker should be just as concerned. However, there is one
added risk for the Islamic banker, this is what we may call ―Shari'ah
disobservance risk‖. Risk analysis refer to the forces that may cause



                                                                              13
                                         Islamic Banking Vs Conventional Banking




 the outcome of investment to be sub optimal. Certainly an Islamic
 investor earning non-permissible income is an outcome that is
 most undesireous, and it may cause the value of his investment to
 be reduced.

 V-Contrary to popular opinion, being concerned about time value of
 money is a similarity not a difference between Islamic and
 conventional banking. There is no basis for the current thinking that
 Shari'ah doesn‘t allow the attachment of monetary value to time in
 the contracts exchange. The contract of Salam and differed-
 payment sales fly in the face of this argument. It is only in loans
 that Shari'ah requires that no time value of money is considered
 (but replaced by great rewards in the hereafter).

 VI-A major difference, however, remains in the handling of
 delinquency and default. When a borrower delays payment of debt,
 interest will accrue on his delayed portion. Unless, such borrower
 defaults and become incapable of paying back his debt, such
 interest will compensate the conventional bank for lost business.
 This can‘t be done in Islamic banking as this is considered usurious.

 Clearly, this is a disadvantage from two aspects: Firstly, an Islamic
 bank will not have the opportunity in a Murabaha transaction for
 example, to be compensated for lost profit. But more importantly, it
 increases significantly, the Murabaha risks. Since bank clients are
 rational people who will seize an opportunity when they see one,
 they will always delay payment. One major Ijtihad of contemporary
 Shari'ah scholars, is to allow the Islamic bank to impose penalties.
 Rather than accrue such penalties as income, and hence become
 usurious, they are disposed off to charity. This way the pressure will
 mount on the debtor to pay in time, without falling into Shari'ah
 impressibility.


Operational Challenges and Prospects
Both the theory of Islamic banking and the rapid expansion of Islamic
banks recent years have demonstrated the viability and feasibility of
non-interest-based operations. This must be surprising to those who
believed that banks and financial systems could not operate in a
modern economy without reliance on an interest rate mechanism.
Indeed, experience has shown that Islamic banks are powerful means



                                                                              14
                                         Islamic Banking Vs Conventional Banking




of mobilizing resources. Operationally, however, both the Islamic
financial systems in the three countries that have adopted it as well as
individual Islamic banks face challenges that need to be addressed.
The most important among these challenges is the fact that, while it
has been relatively easy to create a system in which deposits do not
pay interest, the asset portfolios of Islamic banks do not contain
sufficiently strong components that are based on profit-sharing. The
main reasons for this are: (a) lack of a legal and institutional
framework to facilitate appropriate contracts as well as mechanisms to
enforce them; and/or (b) lack of appropriate menus containing a broad
range and a variety of maturity structures of financial instruments.
Consequently, a relatively strong risk perception has become
associated with profit-sharing methods in particular and Islamic
banking in general. This, in turn, has led to concentration d asset
portfolios of the Islamic banks in short-term and trade-related assets
with inimical effects on investment and economic development. The
problem is exacerbated by the fact that Muslim countries, as is the
case in much of the developing world, suffer from a lack of deep and
efficient capital and money markets that can provide the needed
liquidity and safety for existing assets. The absence of suitable long-
term instruments to support capital formation is mirrored in the lack of
very short-term financial instruments to provide liquidity.
a. The challenges facing individual Islamic banks
Impressive as the growth record of individual Islamic banks may be,
the fact is that at present, those banks have mostly served as
intermediaries between the financial resources of Muslims and major
commercial banks in the West. In this context, this has been a one-
way relationship, so far. There is still no major Islamic bank that has
been able to develop ways and means of intermediating between
Western financial resources and the demand for them in Muslim
countries.
It also appears that individual Islamic banks face difficulties in fund
placement because they have had a major bias towards short-term,
secured, low-return but liquid investments. The challenge for these
institutions stems from motivational and technical factors.
Motivationally, their basic aim appears to have been that of
demonstrating the viability of Islamic banking without taking too many
risks. Admittedly, this is a noble and a very important objective,
however, although they have succeeded in this effort and have



                                                                              15
                                           Islamic Banking Vs Conventional Banking




managed to create a market niche for Islamic banking, they do not
seem to have achieved the market depth that could ensure long-term
profitability and survival. This stems from the fact that they appear to
be far behind in technical innovations and financial market
developments that in recent years have revolutionized finance and
capital markets. There is no evidence that these banks have made any
large investment in research and product development, nor is there
any evidence that new financial products developed in recent years,
particularly in equity derivatives, have been utilized to any significant
degree by the major Islamic banks. This is unfortunate because the
market opportunities that these banks have been able to develop, to
allow funds from Islamic communities to be placed in Islamically
permissible portfolios, can and will be exploited by more efficient and
innovative Western financial institutions that already have or will
discover this market niche.
While there is considerable room for competition and expansion in this
field, the long-term survivability of individual Islamic banks will depend
on how rapidly, aggressively, and effectively they can develop
techniques and instruments that would allow them to carry on a two-
way intermediation function. They need to find ways and means of
developing marketable Shari‗ah-based instruments by which asset
portfolios generated in Muslim countries can be marketed in the West
as well as marketing Shari‘ah-based Western portfolios in Muslim
communities.
b. The challenge of adopting an Islamic financial system
The most important challenge for Islamic banking is in its system-wide
implementation. At present, many Islamic countries suffer from
financial disequilibria that frustrate attempts at wholesale adoption of
Islamic banking. Financial imbalances in the fiscal, monetary and
external sector of these economies cannot provide fertile ground for
efficient operation of Islamic banking. Major structural adjustments
particularly in fiscal and monetary areas are needed to provide Islamic
banking with a level playing field. Additionally, adoption of a legal
framework of property ownership and Contracts that would clearly
specify the domain of private and public property rights as well as
stipulation of legally enforceable rights of parties to contract that fully
reflect the requirements of the Shari‘ah, are necessary to allow an
operational framework conducive to efficient operation of Islamic
banking.




                                                                                16
                                          Islamic Banking Vs Conventional Banking




An Islamic financial system can be said to operate efficiently if, as a
result of its adoption, rates of return in the financial sector correspond
to those in the real sector. In many Islamic countries fiscal deficits are
financed through the banking system. To lower the costs of this
financing, the financial system is repressed by artificially maintaining
limits on bank rates. Thus, financial repression is a form of taxation
that provides governments with substantial revenues. To remove this
burden, government expenditures have to be lowered and/or revenues
raised. Massive involvement of governments in the economy makes it
difficult for them to reduce their expenditures. Raising taxes is
politically difficult. Thus, imposing controls on domestic financial
markets becomes a relatively easy form of raising revenues. Under the
above circumstances, it is understandable why governments would
have to impose severe constraints on private financial operations that
can provide higher returns to their shareholders and/or depositors.
This makes it very difficult for Islamic banks and other financial
institutions to realize fully their potential. For example, Mudarabah
companies that can provide higher returns than the banking system
would end up in direct competition with the banking system for
deposits that are used for bank financing of fiscal deficits.
While Muslim countries may, for legitimate reasons, opt for an Islamic
financial system, for the economy as a whole to benefit fully from the
operations of such a system, it is necessary that (a) government
expenditures are fully rationalized, (b) revenues from taxation, and
those derived from property legitimately placed within the government
domain by the Shari‘ah, are raised to meet the expenditure needs the
government, (c) the financial sector is liberalized so that returns to
this sector reflect returns to the real economy, (d) equity markets are
developed to allow financing of investment projects outside banking
institutions, and, finally, (e) the structure of the banking system
should be such as to allow strong banking supervision and prudential
regulation commensurate with the risks involved in various
transactions.* To accomplish the last objective, the banking structure
can be tiered in accordance with principal Islamic financial
transactions. It is reasonable to assume that risks involved in
Musharakah or Mudarabah financing, are different from those involved
in trade-type financing. It follows, therefore, that prudential
regulations of these transactions should be different.




                                                                               17
                                         Islamic Banking Vs Conventional Banking




Motivating Factors for Islamic Banking

Motivation and renewed interest in Islamic finance industry stems from
its strong economic, financial and social considerations, backed by its
unique features.
Most significant is its appeal to add to financial diversity and
innovation being skewed towards:

  (i)      Asset backed and equity based transactions, which
           promote entrepreneur friendliness and consideration
           of project viability

  (ii)     Equitable distribution of risks and rewards among
           the stakeholders;


  (iii)    inculcating market discipline and higher ethical
           standards given its emphasis on non-exploitation
           and social welfare.

In the wake of high Asian domestic savings rates and build up of the
region‘s foreign exchange reserves as well as oil surpluses of Middle
East in the last few years, Islamic finance is now also emerging as a
way to wealth management, both of richer nations and high
net worth individuals.




                                                                              18

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:40
posted:7/21/2011
language:English
pages:18