By Youssef Aboul-Naja, Islamic Corporation for the Development of the Private Sector (ICD)
To the common individual, Islamic banks are nothing more than ‘normal’ conventional banks that do not deal with interest (usury); all the while refraining from non-Shari’a compliant investments. Though partially correct, yet at a fundamental level, Islamic banks differ drastically from that of its conventional counterpart. The differences stem mainly from Islam’s view on wealth; and the ensuing responsibilities pertaining to its circulation and management. But considering the ‘fiat currency syndrome’ that has taken hold of most economies, the superficial similarities between Islamic and conventional banks became further harmonised; giving the impression that they are two side of the same coin.
That being said, in order to propose a roadmap for bringing current Islamic banks closer to the original essence of the Islamic finance spirit, one needs to first go back in time to look at how Islamic banks came about. Islamic finance, at least as a concept, has existed for a very long time. Yet its adoption throughout the ages has been on a continuously declining trajectory to eventually reaching a nearly nonexistent level. At the same time, the rise of sophisticated conventional finance tools; coupled with human greed, accelerated and reaffirmed the people’s decision of not engaging with the Islamic finance variant. This stance remained the status quo up until the early 1960s, when the Malaysian Tabung Haji (a government fund to assist Malaysian pilgrims to travel to Makkah) and the Egyptian Mit Ghamr Savings bank (the first interest-free saving bank in modern times) were both established.
TO BRIDGE THE GAP
Based on the success of these two social experiments, other Islamic financial channels mainly banks, started cropping up across the Muslim world. But these banks where taking grassroots in an Islamically barren financial ecosystem. As such, the strict adherence to the ‘spirit’ of Islamic finance of placing higher emphasis on equity-type transactions became not feasible. So Islamic banks started mirroring their conventional counterparts by providing debt-based, Shari’a-compliant facilities; which alleviated the issue of incurring higher risks usually associated with equity-based transactions. This new modus operandi of the Islamic banks provided a glimpse on the potential of what this underdeveloped industry has to offer; eventually giving way to the reformation stage of the modern Islamic finance industry.
During this stage, industry stakeholders were scrambling to take control of this dormant giant; with the aim of harnessing the industry’s full potential. As such, Islamic banks began engineering products akin to conventional solutions; to bridge the knowledge gap at the client level. Governments also introduced Islamic banking laws to legitimise and govern the practice. Shari’a scholars, especially the ones verse in financial matters, became highly sought after talents. Thus, barren no more was this Islamic financial ecosystem. With time, complementary Islamic finance industries started cropping around the Islamic banking sector, given this ecosystem further depth and maturity. Yet, to date, the lion’s share, in terms of Islamic assets, remains with Islamic banks.
DIVERGE FROM THE TRUE SPIRIT
According to the ‘State of the Global Islamic Economy 2016/17’ report prepared by Thomson Reuters, Dubai Islamic Economy Development Centre, and DinarStandard; the global Islamic finance assets rose by 10.5% reach US$2.004 trillion in 2015; 72% or US$1.451 trillion of which are Islamic banking assets. Though this percentage is comprehendible in some ways, given that the industry initially grew out of Islamic banks, many cite how the industry continues to diverge from the true ‘spirit’ of Islamic finance in providing higher emphasis on debt-based transactions opposed to equity-like, risk sharing, modes. This divergence may be explained by two main issues faced by Islamic banks: (1) Lack of sufficient, investment-grade, Islamic channels; and (2) Stringent regulations governing the banking sector.
It is the latter that pushes banks towards debt-based transactions and further exaggerating the former issue. This creates an Islamic finance culture primed at focusing on debt-transactions; mainly carried out via Islamic banking channels. The aforementioned report continues to project that the Global Islamic finance assets will grow to US$3.461 trillion by 2020; 78% or $2.716 trillion to which will be Islamic banking assets.
This debt-based transactional drive by Islamic banks is not necessarily a bad thing. It is this very drive that allowed for a superstardom industry growth. But the often used argument that “you need to start somewhere [anywhere] to attain size and recognition, even though you may be moving away from the true spirit of Islamic Finance”, is slowly becoming invalid. The industry has already sprouted roots and is alive and growing. The scales may eventually tip one day against the favor of the industry, in that it will be too large then to introduce any change; point in case, the difficultly it took to kick start the current modern Islamic finance industry in the first place.
WHERE THE ROADMAP BEGINS
This brings us to the proposed roadmap that should be adopted by the Islamic finance industry as a whole. It can be summed up with simply: the need to place more emphasis on Islamic non-banking financial institutions (NBFIs). The mandate of such institutions, the likes of ijara and mortgage companies, is to invest in the real economy; i.e. in real physical assets. Considering that these NBFIs are usually bounded by less regulation and have higher risk appetite, they are able to extend financing to Small-and-Medium-Enterprises (SMEs) that banks tend to shy away from.
Additionally, their operational modes call for providing risk-sharing type of financing. A parallel industry would eventually also crop up, aimed at servicing these NBFIs and their client base. With time, these NBFIs would eventually allow for a yet deeper Islamically-tuned finance ecosystem, which will magnify the pool of available Islamic investment channels for Islamic banks to tap into. As such, NBFIs would act as the catalyst for Islamic banks in reconnecting with the intended Islamic finance spirit. To date, if we club the total assets of the takaful/reTakaful (Islamic insurance) and Islamic funds with that of the Islamic NBFI industry, their combined asset base only account for 10.5% of the total Islamic finance assets; amounting to a mere US$210 billion.
The logic of ‘a-thousand-mile-journey-starts-with-the-first-step’, which the Islamic finance industry adopted in its banking sector should be reused to fine-tune the industry’s offering. It will definitely take time and coordinated efforts to continue upholding the equity-conscious merits of the Islamic finance industry. For countries looking to introduce Islamic finance within its conventional-based economy, they are urged to explore developing a foundation of Islamic channels, made possible with NBFIs, prior to establishing Islamic banks. Given that Islamic banks have, even at a conceptual level, a ‘spiritual’ mandate, that while coupled with higher level of regulation, places such institutions at a more ‘evolved’ level; when compared to NBFIs. Thus, taking a ‘shortcut’ with establishing a country’s Islamic finance industry by jumping immediately in the deep-end, i.e. Islamic banks, would result eventually in mandate anomalies.
There is an old adage which says, “There are no shortcuts in evolution”. The Islamic finance industry has gained enough magnitude to be poised for the next big step. The talent is there, the ingenuity is there, the groundwork foundation is complete, and turbulent times seem to be upon the conventional finance space. The stage is set to take on the next leap forward by moving the industry towards a grander risk-sharing manner.