Outline of Lectures
on Islamic Banking and Finance
From its beginning, Islam gave a positive approach to wealth creation, recognized private property, and emphasized fulfillment of contracts and fair dealings. It set limits to freedom of enterprise designed to protect similar freedom of other individuals and protect social interest. Prohibition of interest is one of those limits as well as prohibition of gambling, fraud and hoarding. In early Islamic history, Muslims managed their finances with the help of such contracts as partnership, profit sharing, and prepaid future contracts. When Muslims came out of colonial rule in mid-twentieth century, they adapted these contracts into a new way of financial intermediation and investment management.
The first modern theoretical literature on Islamic
banking appeared in Urdu, Arabic, and English from the 1940’s through the
60’s. Modest practical steps in the
1960’s were followed by the establishment of several Islamic banks in the
private sector in the 1970’s. The
Islamic Development Bank was established in 1975. During the 1980’s,
The third lecture will consider two recent changes
in the financial environment:
1) the decline in
financial intermediation and ascendance of aggressive investment management;
and 2) worldwide financial integration.
In principle both are advantageous for Islamic finance, but in practice
they pose great challenges. Current
research in risk management in Islamic framework is very underdeveloped.
However, the apparent constraints in the Islamic approach could turn out to be
good for financial environment in so far as they help contain a situation going
out of control. Some other issues in the
regulation of Islamic financial institutions will also be discussed. It will be argued that community level
initiatives in the West provide a new vista for Islamic finance along with
continued progress in the state-sponsored and private corporate sector
institutions in Muslim countries.
Islamic banks operate under supervision of their countries' central
banks. Also, they have no problems
dealing with international financial institutions.
Glossary of Terms
Ijara: Leasing.
Istisna: Salam contracts applied to
manufacturers, with the possibility of payment in installments.
Mudaraba: Profit-sharing between
financier and entrepreneur.
Murabaha: A
sale agreement under which the seller purchases goods desired by the buyer and
sells it to them at an agreed marked up price, payment being generally
deferred. Also referred to as Bay’ Muajjal or Bay’ bi Thaman Aajil.
Musharika: Partnership;
all business partners supply capital and participate in management.
Salam: Payment
on the spot for goods to be delivered in the future with the price being agreed
now (e.g. paying now for wheat that is yet to be grown). This is similar to a commodity forward.
Shariah: Refers
to divine guidance as given by the Qur’an and the
example of Prophet Muhammad and embodies all aspects of the Islamic faith,
including beliefs and practices.
Urboon: Depositing
small fraction of price in a deal to be concluded in the future. It binds the seller to wait but allows the
buyer to back out of the deal, with the seller keeping the deposit.
Additional
Resources
For
more information on Islamic Banking and Finance, check out these sites:
www.islamicbankingnetwork.com
www.hifip.harvard.edu
www.siddiqi.com/mns/
www.halalco.com/economics.html
www.islampub.com/books/econom.html
www.islamic-finance.net
www.islamic-economics.com
Recommended
Towards a Just Monetary System
by M. Umer Chapra,
Islamic
Banking by
Mahmoud al-Gamal,
Islamic
Finance by Rodney Wilson,
Challenges
Facing Islamic Banking by Munawar Iqbal et al (eds),
Jeddah, Islamic Development Bank 1998
Islamic
Financial Instruments for Public Sector Resource Mobilization
Jeddah, IRTI, Islamic Development Bank, 1997
Development
and Problems of Islamic Banks, Jeddah, IRTI, Islamic
Development Bank, 1987
Muslim
Economic Thinking, by M.N. Siddiqi,
Contacts:
Dr. Mohammad N. Siddiqi, LARIBA Senior Visiting Scholar
Center for Near
Eastern Studies
(310)
825-1181
mnsiddiqi@hotmail.com or www.siddiqi.com/mns
Dr. Yahia Abdul-Rahman, Founder of
American Finance House LARIBA
(626) 449-4401
yarahman@email.msn.com
or www.lariba.com
Jonathan
Friedlander, Assistant Director of Center for Near Eastern Studies
(310) 825-1181
jfriedlander@isop.ucla.edu
Parisa Sekandari, President of Muslim Business
Student Association (MBSA)
(310) 963-0979
psekanda@anderson.ucla.edu
Question and Answer
IS
NOT MURABAHA FINANCING LIKE INTEREST-BASED LENDING?
No, there are at least 4 differences:
A. With
conventional banking, the borrower gets cash from the lender which, in
principle, can be used for any purpose.
Instances abound of individuals and nations borrowing for one purpose
and using the money for other (non-productive) purposes. Not so in Murabaha; the customer gets goods,
not cash.
B.
Come time for repayment, a regular loan can
be rolled over with the customer paying interest for the extended time (often
at a rate higher than the initial). This
is not possible in Murabaha. What the
customer owes is a price agreed to in the beginning, which can not be increased
because of delay in payment.
C.
The rate of interest has become a
policy-determined variable. But the rate
of mark-up in Murabaha is determined by the demand and supply of goods and
services like all other prices. Murabaha
financing is therefore more compatible with free market economy.
D. At
the macro level, Murabaha keeps the financing tied to real economic activity
conducted through acquisition of goods and services, which is not the case with
debt financing. Debt-financing
contributes to higher inflation, and the availability of huge quantities of
debt instruments in the market opens the door for speculative games that do not
contribute to the real economy.
WHY DO THE SERVICES OF ISLAMIC FINANCIAL INSTITUTIONS COST MORE THAN THOSE OF THE CONVENTIONAL ONES?
This may not be the case for all services.
Checking accounts in Islamic banks perform at par with any other bank. It could be true regarding home financing,
financing of consumer-durables or opening a LC, etc. I think the reason lies in the much smaller
size of these institutions as compared to others, which makes them incur higher
unit overhead costs. This phenomenon
may, therefore, prove to be transient.
It could, even in the short run, be compensated by the greater trust
these institutions evoke in their communities as well as their ethical approach
to investment, etc.
WHAT ARE THE BENEFITS OF THE ISLAMIC FINANCIAL INSTITUTIONS TO THE SOCIETY?
It is widely acknowledged that the availability of
Shariah-compatible banks has increased banking habit in the Muslim
community. Islamic investment companies,
mutual funds, and insurance companies have brought out some hoarded wealth,
encouraged people to save more and helped Muslim entrepreneurs. The Islamic Development Bank is promoting
trade and technical cooperation between Muslim countries. At the community level, the Islamic financial
movement has provided the community with yet another cause to rally around,
with the unique advantage that this activity brings them closer to the rest of
humanity as it is open to all. Islamic
financial institutions are the most modern face of contemporary Islam, a face
with which every human being can empathize because of the promise of much
needed reforms it bears.