Islamic Banking Future Vision- Issues that hamper development of Islamic Banking.

by salikgilani (student)

University Degree Business and Administrative studies

Saad Tanzeem 2012-02-0130

Ahmed Salik Gilani 2012-02-0131

Islamic Banking Future Vision- Issues that hamper development of Islamic Banking.

Introduction:

Islamic Banking and Finance, the Shariah compliant banking for Muslims, is unarguably at the nascent stage of its development as a financial competitor and alternative to the conventional interest – based banking system practiced around the world. The rise of the Islamic banking system has been nothing short of phenomenal, and at every turn, figures have proved that their growth has by far exceeded that of their conventional system counterparts. This is impressive; keeping in mind the recent economic crisis that has shaken up the world economy. However, for Islamic Banking to fully utilize the potential that its rise has proven, some vital issues need to be addressed without which Islamic Banking and Finance cannot hope to grow further, let alone compete on equal fronts with conventional banking institutions. These issues are numerous, and due to the limitations on this paper, the major ones have been discussed in detail.

The Authenticity Issue

The first and the foremost issue that impedes the growth of Islamic Banking is the fact that there is widespread doubt and criticism regarding the authenticity of Islamic Banks. This can be summarized in just one question, which plagues the minds of those who are interested in the concept of Islamic Banking: Is Islamic Banking really Islamic? A variety of factors lead to this doubt. First of all, there is a huge divergence between the ideology and the practice of Islamic banking. The major portion of Islamic banking is based on the fact that there is a system of profit & loss sharing inherently established in its structure. However, as a contrast, the majority of the current earnings for Islamic banks do not stem from PLS based systems; rather, they arise from leasing, markup and other similar transactions, which carry virtually no risk. Many banks also derive additional earnings from foreign exchange deals and trading. This shows that banks hold a preference for receiving a set of confirmed earnings over the riskier PLS systems, which seems to be a gap between the ideology and the practice of Islamic banking. Another reason leading to this is that the products that the Islamic banks base their activities or seem to be quite similar to those used by conventional banks. This is not helped by the fact that products have grown to include various bonds, insurance and mutual funds which Is an area of great debate amongst Shariah scholars.

Possible Solution

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Possible Solution

How should this problem be solved? It should be realized that the major market that is currently targeted by Islamic banks is that consisting of people who are willing to link their financing and investing decisions with a system that might have lower and riskier returns, suffers from lack of innovative products and quality performance only because they want a harmony with their religious sentiments. If this market segment harbors doubts regarding the authenticity of this system, then Islamic banks cannot hope to succeed. The solution for this lies in two apparent methods. Firstly, wide dissemination of information should be practiced, aimed at ensuring that the general public is aware of the inherent differences between Islamic banking and conventional banking. This should include details on the products offered by Islamic banks and the methods which differentiate them from their conventional counterparts. This can only be done in conjunction with making sure that the image of Islamic banks should not get tarnished due to mismanagement of customers and individual mistakes that can lead to a general downfall in the trust placed on Islamic banks. This is the only way that this hurdle can be overcome and Islamic banking can reach its potential.

The Problem of Innovation

The second problem that Islamic banks face is the lack of innovation in the products that are currently offered by Islamic banks. This coupled with the fact that all projects have to go through a stringent, time-consuming process before they can be approved, acts as a severe deterrent for costumers. This lack of innovation leads to high concentrations of cash and of long term assets which lead to a liquidity gap. Since conventional methods are not available to Islamic banks, this creates a restriction on the means that these banks can earn a Shariah-compliant return on their assets.

Remedies

The solution to this problem lies in the personnel of the system. In order to move forward, Islamic banks should look to hire the top talent which can make a difference by initiating changes in the services and products which are currently being offered by Islamic banks. Along with this, better communication between Islamic banks can be vital in ensuring that all institutions can benefit by pooling their research and development and hence making sure that Islamic banks have a wider variety of investing decisions to choose from, when investing their assets in a Shariah-compliant manner.

Financing the Government

Another extremely important issue that Islamic banks face and one that is central to their development is the settlement of the issue of financing government deficits. The government is a major component of the demand for credit. The issue above is particularly difficult since finding non interest based financing means have proven to be very difficult. And without the solving of this issue, Islamic banking cannot hope to flourish.

Solution

Many solutions have been put forward in order to ensure government borrowing at a non fixed rate of return. Some of these are

Tying the rate of return to the change in nominal GDP, thereby removing the fixed element
Permitting the central bank to make available to the government a portion of demand deposits on a non-interest basis.

Some writers argue that if the government removes all inefficiencies and wastages and operate according to strict Islamic guidelines, then not only would the fiscal burden be much smaller, but the government would also have to account for all expenditures, removing need for further borrowing.

Regardless, this issue is vital and one that has no clear cut solution as yet. In order for Islamic banking to move forward, this must be addressed.

The following diagram shows an outline of the requirements that Islamic Banking needs to achieve and the present fulfillment status of those requirements. As can be seen, public awareness, R&D and knowledge sharing are indicators that need to be increased drastically in order to make Islamic banking a powerful alternative in the future to conventional banks.

Showing the importance and present status of issues

relating to the development of Islamic banking system

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