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Sunday 19 May 2013

ISLAMIC BANKING: PRINCIPLES AND PRODUCTS.


Islamic banking is simply a system of banking that is consistent with the tenets of Islamic law ( Sharia).Islam prohibits the charging or payment of interest and this forms the basis of distinction between Islamic finance and banking on one hand and the conventional banking on the other.
Islamic banking practice is a new phenomenon in the Kenyan market. Although it was widely practiced in the Middle East and some European countries especially The United Kingdom, legislation made it impossible in Kenya. Consequently many Muslims as a matter of faith avoided banks and thus remained unbanked. It was not until a few years ago that major banks such as Barclays and KCB sought to tap into this market and introduced sharia-compliant products and services within their mainstream banking. Barclays bank was the first bank to venture into this territory, probably taking the cue from its parent in the UK where Islamic banks and products were already in existence.
 The Sharia based products of these banks were widely accepted and set the stage for the advent of Islamic banking in Kenya. When the banking regulation was finally amended, removing prohibitions on trading in and holding of fixed assets, First Community bank and The Gulf African bank were established. These two fully-fledged Islamic banks have seen tremendous growth in the past two years and within a short time, Kenya is fast developing as the Islamic finance hub of East Africa. The Central bank of Kenya has acknowledged the importance of these banks and how they have contributed in bringing the unbanked into the banking halls. The two banks currently command 1 percent of the market share with a customer deposit of 7.5 billion and a loan portfolio of 5 billion shillings.
The products offered by sharia-compliant banks are not very much different from the traditional banking products and services. They range from debt financing to capital markets, insurance (takaful), asset management, hedge funds, Sukuk (Islamic bonds), currency swaps and many more. However, all these products must be offered within the confines of the Islamic law. As earlier mentioned, Islamic law does not permit the indulgence in interest based financial transactions. The principle being that it is unacceptable to increase the value of any commodity by merely lending it to another person but rather profit should be earned on goods and services through trade only. The probihibition of interest in Islam stems from the fact that it is exploitative and unjust. The creditor only provides the capital but is guaranteed a fixed amount of profit. The debtor on his part puts in effort and time in the business but is made to bear all the losses. This increases the gap between the haves and the have-nots.  As an alternative to interest, Islam encourages direct investment where the creditor shares in whatever profit or loss the business incurs. Thus profit from trade is allowed and profit sharing (Mudarabah) enables banks to sustain their business and report profits.
In a mudarabah agreement, the bank lends money to an entrepreneur who invests it in a viable and desirable business. The profits made out of the business are then shared between the bank and the entrepreneur according to a predetermined ratio. In case of a loss, the bank suffers all the loss by way of a reduction in the amount of loan due. This continues until the loan is fully repaid.
The rule is that there should be no reward without risk bearing and is applicable to both labor and capital. As no payment is allowed to labor unless it is applied to work, so no reward for capital should be allowed unless it is exposed to business risk. There are at least three reasons for considering mudarabah arrangement to be more just than the normal debtor-creditor relationship:
1)      Both parties agree on the ratio in which profits will be shared between them.
2)      The treatment of both parties is uniform in the event of loss, since if the provider of the capital (the bank) suffers a reduction of the principal, the entrepreneur (borrower) who manages the business is deprived of a reward for his labour, time and effort.
3)      Both parties are treated the same way if there is any violation of the agreement. If the entrepreneur violates any of the stipulated conditions, or if he does not work, or is instrumental in causing loss to the business by negligence or bad management, he will have to return the whole amount of the principal. If , on the other hand, the bank violates any of the conditions, for example by withdrawing funds lent  before the  agreed time, the entrepreneur will have to be paid an amount equivalent to what he would have earned in similar work.
It is important to note that Islamic banks only finance businesses that are considered lawful under the Islamic law. Sharia allows all economic activities in the framework of protecting public interest and adherence to ethics. They therefore do not provide funds for investment in undesirable ventures such as alcohol, gambling, drugs, cigarettes etc.
If the customer wants to buy a certain asset, for example a house or a motor vehicle, the bank acquires the specified asset and sells it to the customer at cost plus a profit margin. The customer then pays the price on a differed basis in installments. The asset is registered in the name of the buyer from the start of the transaction. This is called murabaha. The bank has to expressly mention the cost price of the commodity and the profit margin must be mutually agreed upon. There are no additional penalties for late payment since the profit of the bank cannot be determined explicitly and as such any additional charges are assumed to have been included in the initial profit. To protect itself against default, the bank asks for strict collateral.
Using this arrangement, Barclays bank recently introduced La-Riba personal finance which allows clients to purchase goods and equipment from Nakumatt supermarket outlets, and La-Riba vehicle finance where customers can buy motor vehicles from CMC motors and DT Dobie on Sharia compliant terms.
Hibah (gift) is a voluntary payment made by a debtor to a creditor. It is used by banks to share a portion of the profits made by using the funds of their customers in saving accounts. This may appear similar to interest and may have the same impact but unlike interest which is a contractual obligation that must be paid, hibah is paid voluntarily at the discretion of the bank. The bank pays such gifts to encourage clients to maintain deposits in their accounts that the bank can lend to borrowers.
Other products offered include Ijarah (lease), Ijarah thuma al bai (hire purchase), Musharakah (joint venture), Bai al-Inah (Sale and buy-back agreement) and qard Hassan (interest free loan).
Islamic banks and banking institutions that offer Islamic banking products and services  are required to establish Sharia Supervisory Board(SSB) to advice them and ensure that the operations and activities of the bank comply with shariah principles. Such boards are made of religious scholars who are well versed with Fiqh al-muamalat (Islamic rules on transactions) in addition to modern business, finance and economics. The products of the bank must be certify by this board before they are offered to the customers .A major challenge facing the Islamic banks in Kenya is the lack of qualified Islamic banking personnel in the country and the few scholars who are there are highly sought after, making them  sometimes serve in more than one board.
In the wake of the recent financial crisis, the merits of Islamic banking as an alternative banking model came into focus. This is because it offers safe guards against the excesses that precipitated the crisis. Islam not only prohibits investment in unlawful activities which is deemed harmful to the society but also transactions involving excessive gharar (uncertainty about the terms of the contract or the subject matter) and all forms of gambling are prohibited. For example, one cannot sell what he or she does not own. Islamic banking is therefore not necessarily confined to muslims.Many of the basic tenets of Islamic banking are applicable beyond the Muslim world since they deal with simple morality and common attention to human dimension of the economy. It is therefore not surprising that many non-Muslim bank customers have opted for the relative safety of these banks’ products and services. In Kenya, both banks have witnessed a surge in the number of non-Muslim clients which they term beyond expectations and still signs point to a continuing growth of Islamic finance not only in Kenya but the world over.

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