A review on article :

HOW ISLAMIC IS ISLAMIC BANKING?

By : Feisal Khan
Dept. of Economics, Hobart and William Smith Colleges, 300 Pulteney Street, Geneva, NY 14456, United States

2008

Reviewed by : GROUP 4

01 Introduction
02 Findings
03 Methodology
Conclusion
04
05 Recommendations

INTRODUCTION
1.Size of Islamic Banking Worldwide
Found in over 70 countries worldwide
Value of worlds Islamic Assets = US
$700 billion (2008)
Growth rate 15% p.a
2. Islamic Economics: Critics
IBF is merely a change of terminology or names

Why Islamic Banking and Finance?

1. General Principles
Economic activities in Islam ; free from riba, gharar and maysir
Engaging in trade is encourage, but profit must not be earned risk free

2. More practical perspective

El-Hawary (2004) defines IBF as a system that adheres to the following 4 principles
i. Risk sharing
ii. Materiality
iii. No exploitation
iv. No financing/ sinful activities

Then

How is IBF actually carried out

How interest free is its operations?

Main Form of Islamic Financing

PROFIT & LOSS SHARING

Equity financing/
Participatory form
Mudharabah
Musharakah

NON PROFIT & LOSS

SHARING

Debt Financing/
Non Participatory Form
-Murabaha (Cost Plus Sale)
-Ijarah
-Bai muajjal (deffered payment)
-Salam/ istisna
-Sukuk

 ISLAMIC BANKING IN THEORY

The equity nance is more preferable compare to
interest-based debt nance. WHY?

Prot-and-loss-sharing (PLS) is at the core

of Islamic Banking.
Non PLS is other alternative for Islamic Banking financing
and being referred as weak Islamic forms.

ISLAMIC BANKING IN PRACTICE

Non PLS such as Murabahah and Ijarah DOMINATE Islamic financial
transaction.
The predominance of interest-based nancing is still the norm in Islamic Banks,
the main difference being that now it is no longer explicitly identied as
interest-based nance and that the business is no longer dominated by nonMuslims

FINDINGS
WHY IS NON-PLS THE DOMINANT MODE OF FINANCING?
1. The prevalence of information asymmetry give risk on two problems.
ADVERSE SELECTION, know as an ex ante problem.
- When loan/ investment are made to/in a poor credit risk
MORAL HAZARD, named as an ex post problem.
When loaned/invested funds are misused or utilized in inappropriate ways
Low quality and quantity of financial information flow in IBFS most practicing
countries, make debt financing more desirable than equity financing.

 For example, in 2005 and 2006 tax evasion in Pakistan as being between 5.7% and 6.5% of
GDP. And underground economy as between 54.6% and 62.8% of GDP respectively.
Also in in Africa and the Middle East, 38% of firms surveyed did not report at least 30% of
their sales to government tax authorities.

2. Similarities between conventional and Islamic banks.

IBF product should be identical to the conventional product to be proven by
the banks regulators.
Hangover from the conventional banking industry. (works are from CB).
Sometimes the IBF institutions simply lie in their accounting and reports.
Sometimes they do not lie in their financial statements, but simply do not
highlight their conventional activities.

FINDINGS
HOW PARTICIPATORY IS PARTICIPATORY?
Avoiding true equity participation in home purchases.
Musharaka financing should be PLS since there is supposed to
be a direct equity stake taken by the financier, but this is frequently simply
misleading terminology.
For example, Islamic residential mortgage (declining musharaka).

profit.
benchmark.

REALITY PRACTICES
ISLAMIC BOND

SUKUK

Basic of Islamic bond.

A sukk (plural sukuk)
A generic term for an Islamic financial certificate
Usually with a variable rate of return tied to a commonly accepted market indicator
rate and must have an underlying real transaction basis to be Shariah compliant.
Typical Sukk :- a floater bond type of Asset Backed Security.
Maulana Justice M.Taqi Usmani.
Most sukk transactions mimicked conventional bonds too closely and so were
unIslamic.
Sukk al-Ijara a lease- revenue bond (tangibility and related income-stream)

Ownership or merely a secured loan?

ISLAMIC BOND

SUKUK

Fitch Rating, Standard and Poors and Moodys.

Fitchs policy not rate individual sukk issues separately but to
assign them the same Issuer Default Rating as the originator.
Malaysia Ulama.
Have shariah certified securitizing Islamic Private Debt
Securities(IPDS)
Scholars in Pakistan.
IPDS are not Shariah compliant since the underlying transaction is a
sale of debt and not a tangible asset.

HOW ISLAMIC IS ISLAMIC BANKING AND FINANCE?

01

Transaction mimic conventional- using current

market interest rates as pricing benchmarks

02

No meaningful underlying material transaction

No new asset is being finances/ no actual title transfer

03

The higher fees associated with Islamic mortgages

and investment funds for doing nothing.

04

The truthfulness that the funds will not be used

for sinful activities and rarely to ensure them.

METHODOLOGY

QUALITATIVE METHOD
Library research.
Reference to many books, articles, proceeding
papers, handouts and journals
Reliable sources from the internet - relevant
databases and websites

CONCLUSION

1. After three decades IBF still fail to provide truly Shariah compliant
vehicle violated by contemporary IBF practices
2. IBF fail on two counts:
Its overall efficiency compared to conventional banking
Its claim to offer better alternative for observant muslim

3. There is a lot of drawn back which need improvement, but the

efforts made until today are acknowledged and appreciated

RECOMMENDATIONS

1.To have separate standards instead of

operating under conventional standards
2.To ensure that profit maximizing is not
the goal, rather to secure the welfare of
the society


Monday | October 19th 2015 | ISF 3106 | Section 2