Islamic banking is in the early stage of its development. For years Islamic banks remained relatively small and offered very limited range of products to a narrow domestic client base.
It is only recently that they have been growing at the rate of 15% per annum - a rate much higher than the rate of growth of conventional banking industry keeping in view its earlier performance, it is now being argued that Islamic banking has the potential to capture a significant share of the world banking industry.
At this stage, major divergence between the ideology and practice of Islamic banking has taken place, which should be settled. The current thrust in Islamic banking system is to eliminate the interest from banking transactions. It has worked well in eliminating interest from all banking transactions.
Moreover, the system has not only proved its viability but also competitiveness. Notwithstanding this such a model is incapable of providing larger economic benefits to Muslim communities or reducing existing international financial injustices.
Theoretically speaking, Islamic banking is a branch of Islamic economics which is shaping up on the bedrock of Islamic ideology. As such, Islamic banking should reflect its main features ie equity and social justice. Under this ideology; Islamic bank acts as financier entrepreneur engaged in the generation of assets and expansion of output.
Larger part of its financing goes to the output sector trough profit sharing modes and small part is allocated to the trade sector. Accordingly, output and employment is increased while inflation is subdued. This kind of model has the capacity to offer productive solutions to contemporary problems thereby benefiting mankind as a whole. The preference of one approach over another depends on underlying framework on the basis of which a typical Islamic bank works.
Islamic banks are now a reality in both national and international financial markets. The significant role which Islamic banks are already playing in Muslim countries can be further expanded by pursuing well-designed strategy. In case of global market penetrations, Islamic banks have to face tough competition with conventional banks. For improving their competitiveness they follow strategy that focuses on improvement of operating mechanism, transparency arrangement and institutional building.
In what follows, presents a framework for Islamic finance. The third section addresses strategy to reach part of floating market. Section four discusses strategy in penetrating the market. Section five discusses product development in Islamic banks. Finally, section six concludes the paper.
A FRAMEWORK FOR ISLAMIC FINANCE: Islam wants to establish a balanced society through the mechanism of justice and benevolence. It requires everyone to discharge his obligations towards others. In this way rights of every one are protected. It exhorts the Muslims to go even further by showing benevolence to their brothers.
This is a general approach of Islam. The Islamic framework of finance therefore, consists of three institutions: Ukhuwah (brotherhood), Adl (justice), and Ihsan (benevolence). These institutions are based on the injunctions of the Quran and Hadith.
Islam unites all individuals in the bond of universal brotherhood as if they were members of single family. Each and every individual within this brotherhood is entitled to equal social status. This is summed up by one Hadith of the Holy Prophet (SAW): "Mankind is the family of Allah and the most beloved of them before Him is the one who is best to his family".
The main implication of brotherhood is co-operation and mutual help, a point stressed by the Quran:"...Help ye one another in righteousness and piety" and "The believers, men and women, are protectors, one of another". Some of the Ahadith bring out the significance of co-operation more explicitly: "A Muslim is the brother of another Muslim. He neither wrongs him nor leaves him without help, nor humiliates him"
Seen in this perspective, financier and clients are members of one brotherhood and, regardless of any group distinction, enjoy the same degree of respect, love, and social status. It rules out all such relationship in which financier acts from a position of power and strength and his/her client acts from the position of socially weak and needy persons. This motivation favourably affects demand and supply forces of the financial market. Both parties understand each others interest and through fair dealing focus on favourable synergies which facilitate greater use of risk-sharing modes of financing.
The institution of Adl (justice) plays a key role in realising the goal of social balance, for it provides legally enforceable measures specified in the contracts. Fulfilment of contract roots out all injustice and exploitation from society. Islamic Fiqh has developed a comprehensive code for making contracts, which regulate the role of both parties. contractual obligations between individuals are written out in the form of a contract, and Islamic law emphasizes that all contracts should be honoured in accordance with the terms of the particular contract in question. About the contractual obligations, Quran says 'And fulfil (every) engagement for every engagement will be inquired into (on the Day of Reckoning)". One Hadith says 'A man shall honour his contracts together with all binding conditions provided that the conditions are rightful and according to the code of Islam".
PRINCIPLES OF EXISTENCE OF CONTRACT:
P1: Existence of parties of the contract
P2: Existence of object of contract (and also its price, if in non-money)
P3: Existence of offer and acceptance
Principles of validity of contract:
P4: Free will of the parties; or no duress
P5: All forms of contracts are permissible except those thatare prohibited by Shari'a
P6: Any contract that works against the Maqasid of Shari'a is prohibited
P7: Free from Riba
P8: No Gharar
P9: Free from Khalabah, ie, deception; free from wager and all games of chance
P10: Free from Jahal, ie free from ignorance or uncertainty about the present
Principles more specific to financial contracts
P11: Al-khiraj Bi-Addaman, ie, right to benefits belongs to the one who shoulders the liability of consequences.
P12: Prohibition of sale of debt with debt
P13: Prohibition of combining two contracts in one such that one is conditional or contingent on the other
P14: Prohibition of combining two mutually inconsistent contracts in one contract
P15: Prohibition of element of Qimar or gambling in the contract
P16: A debt is not settled but only when paid or if forgiven by the creditor.
Adherence to the principles relating to financial contracts minimizes chances of fraud and deception.
Justice requires a fair allocation of the bank profits between all parties ie the depositors, borrowers, shareholders, and retain a portion for its growth. The current interest free banking system logically stands on these principles.
The institution of Ihsan essentially means foregoing one's rights for the sake of others, an act, which is considered to be a virtue of a higher order. Such a behaviour is quite consistent with the Islamic concept of rationality. The individual displaying Ihsan understands that Allah will compensate him/her for sacrifices, for the Quran asks: "Is there any reward for good other than good?" Islamic teachings call upon both financier and clients to be kind, honest, gentle, forgiving accommodating, and generous.
The client/entrepreneur is expected to be efficient, enterprising and honest by maintaining record and correctly reporting profit. Influenced by these high morals, the financier is induced to participate in Musharaka and Mudaraba--based financing.
The principles of Ihsan also induce him to share part of profit with the employees and setting aside funds for Qarz-e--Hasana. In fact Ihsan contains set of values that gives rise to professionalism, high ethical conduct and concept of trust the by-product of which is good governance.
In Islam, elements of good governance ie trust accountability, ethical conduct are our way of life not something that became fashionable only recently. Thus practicing attributes of Ihsan uplifts interest-free banking to the level of Islamic banking characterized by risk-sharing modes, financing of SMEs and Qarz-e-Hasana become popular features.
STRATEGY TO REACH PART OF FLOATING MARKET: A lot of concerted efforts are underway in reaching part of floating market of Islamic banking. The growing trend of globalisation has increased interbanks transactions and dependences and greater vigilance and supervision of financial institutions at the national and global level.
This calls for better risk management in Islamic banks, enabling them to reach global market. The global market penetration requires Islamic banks to adopt industry segmentation strategy for future growth of their customer base. Companies will benefit from increased transparency between banks and companies resulting in greater responsiveness and customized service. The customer will be benefiting most from banking specialisation. He will be getting quality products at lower price.
Banks will be able to better understand their customers, which will shorten the contract negotiation. Pricing for both fees and 'spread will decrease as banks become more equipped to understand customers.
On non-credit side, companies will benefit most from customized services and products that meet process requirements including specialised cash management technology, greater securitisation for accounts receivable and inventories and risk management activities. Banks provide these improved services by utilising industry knowledge and expertise.
Three things need to be developed. One, a set of common international accounting standard which is being addressed by AAOIFI. Two, standardised products and three, role of Shariah Board. It is not clear whether Shariah Board can veto decision of the management.
International bank lending to emerging markets has often more volatile than portfolio investment in equities and bonds because vast bank financing has taken the form of short term loan between banks not long term project financing. Approximately $14 billion are crossing borders on daily basis in search of high return investment.
A good part of this money is Muslim money some part of which can be attracted by Islamic banks. Another global business opportunity lies in the development of Iraq and Afghanistan. Muslim investors are pulling out billions of dollars from these countries. Conventional banks are struggling to bring back these funds by marketing Islamic products.
Moreover, billions of dollars are flowing for the reconstruction of these countries. The changing scenario presents a lucrative opportunity to the Islamic banks. But accessing global part of floating market needs a network of enabling institutions and some of them have already been put in place as discussed below.
INTERNATIONAL ISLAMIC FINANCIAL MARKET (IIFM):
IIFM WAS ESTABLISHED IN NOVEMBER 2001 WITH TWO MAJOR OBJECTIVES:
(1) to establish a more structured global financial market based on Shariah principles, and
(2) to enhance the co-operative framework among Islamic countries and financial institutions.
IIFM is a new institution designed to facilitate a cooperative framework among financial institutions dealing with Islamic finance. It is expected to boost the creation of Islamic financial products and meet liquidity requirement of the industry. Currently, substantial amount of funds from Islamic financial institutions are invested in conventional market through commodity Murabaha. The IIFM will go a long way to broaden the coverage and to ensure these funds are invested in Islamic financial system.
THREE FACTORS ARE IMPORTANT FOR THE SUCCESS OF IIFM: (i) large number of market players (ii) creation of a wide range of Islamic financial instruments (iii) availability of adequate liquidity. With these things put in place, the market will cater to the need of Islamic banks seeking international financing for their activities rather than domestic financing. In this way, Islamic banks will be enabled to do international business.
THE ISLAMIC FINANCIAL SERVICES BOARD (IFSB):
IFSB organisation is located in Malaysia. It was set up in 2000 for the purpose of harmonisation of standards for Islamic financial products and in promoting a level playing field and foster industry development. IFSB is preparing standard for identification of risks inherent in Islamic instruments of financing and methods of their management without violating Shariah principles.
Moreover, it is engaged in preparation of standard for capital adequacy calculations to which Islamic bank will comply. It also provides sound bases for more effective supervision of institutions offering such products and also improve the products for better risk management.
One of the major concerns of IFSB is to promote prudent, transparent, and robust development of Islamic financial services industry and markets by issuing new standards of adopting existing international standards consistent with Shariah principles.
IFSB also promotes co-operation among members in developing Islamic financial services industry.
COURTESY: Journal of Islamic Banking and Finance
Accounting And Auditing Organisation for Islamic Financial Institutions (AAOIFI)
AAOIFI was established in 1990 in Bahrain. Its main goal is to develop accounting, auditing, governance, and ethical thinking relating to the operation of Islamic financial institutions in the light of Shariah principles and their dissemination: It harmonises accounting policies and procedures adopted by Islamic banks through issuance of standards and their interpretation.
Moreover, it seeks to achieve conformity in the concept and application among Shariah advisory board of Islamic financial institutions.
It has been extremely successful in achieving its objectives, in 2001, the organisation has released sixteen financial accounting standards, four auditing standards, four governance standards and one code of ethics. AAOIFI has also been continuously working with international bodies involved in the development of standards and regulation of banks in order to create international recognition for its standards. It maintains contact with IMF, International Accounting Standard Board, and The Basel Committee.
4. A STRATEGY FOR MARKET PENETRATION:
Islamic marketplace is diverse and global. According to an estimate, these institutions are managing some $260 billion of assets. In addition, $200-$300 billion are being managed by Islamic windows and subsidiaries of international banks.
The sector is growing at and annual rate of 10%-15% despite all challenges of product development, financial engineering, Shariah interpretation, market linkages, globalisation and interface with the conventional banking. It is a rich area offering huge business potential to Islamic banks provided they can improve their competitiveness vis-à-vis conventional banks.
For instance, Islamic banking can be the first choice of 1.6 billion Muslims living across 56 countries with a combined GDP of $1 trillion and also for millions of Muslims living in secular countries.
Muslim families need house financing which means massive investment opportunities in this sector. In order to formulate accurate strategy for market penetration, it is essential to examine existing degree of market penetration and underlying modes of financing.
EXISTING TREND: Islamic banking is a relatively recent phenomenon. Only in l960s and 1970s first Islamic banks were established in Islamic world. They developed afterwards in numbers and in activities.
Now they are working as a viable institution. Both depositors and investors are showing more interest In these banks because they provide Halal earnings, which in many cases exceed interest earnings in inflationary environment. Accordingly, Islamic banks have succeeded in penetrating financial markets of the Muslim countries as reflected below:

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Country                       Market share
Malaysia      10% (and government wants to
                  raise it to 20% by 2010)
Kuwait                                 20%
Qatar                                  20%
Saudi Arabia                           15%
Sudan                                  30%
UAE, Jordan, Egypt                     10%
==========================================

ISLAMIC BANKING IN NON-MUSLIM COUNTRIES:
Fifteen non-Muslim countries including UK, US, Canada, Switzerland and Australia have Islamic banking institutions. They are using Islamic products to make business. Germany launched euro 100 million Sakuk last year. In UK where 18 lakh Muslims are living the demand for Islamic finance particularly the housing financing is increasing.
The fifth largest bank of UK Allied T.S.B. has started personal banking account on Shariah principles. Bank of England has waived 2% stamp duty on Islamic house financing.
In USA Ministry of Finance has hired the services of a Shariah scholar to advise them on Islamic financial matters. China is also interested in Islamic finance. New Zealand is interested in Islamic banking. In Thailand and Philippines, Islamic banks are operating. The interest in Islamic banking is growing in the entire East Asian region.
Examining the sale record of Islamic investment products, the list of marketed equity Fund include 104 Funds, managing total assets in excess of $5 billion in 2001. There were only 29 funds managing a little over $80 million in 1996. It demonstrates a surge in the popularity of Islamic funds within a short period.
Many factors have contributed in the flourishing of this sector among which lifting of base on equity investment by some of Shariah boards, consensus of Shariah scholars on stock screening criteria, Islamic awareness among the Muslim youth in the West and the creation of credible Islamic equity benchmarks by leading index providers such as Dow Jones and FT.
FUTURE TREND: Based on existing trend, Islamic banking industry is expected to gain momentum in medium to long run period. It is linked with degree of Islamicity of masses that activates the Muslim governments to speedily lay down the infrastructure of Islamic banking and capacity building. The contemporary resurgence in Muslim countries is a pointer towards a promising future of Islamic banking.
Sudan is a successful case in point where political support has been single most important factor. Other Muslim countries can replicate Sudanese experience. Given the political will, a well designed strategy is needed to improve the image and performance of Islamic banks for playing proactive role in the financial markets of Muslim countries.
ELEMENTS OF MARKET PENETRATION STRATEGY: Most important consideration has to be given to the fact that Islamic banks have to grow in a competitive environment of the private sector by preserving their identity as Islamic Institutions. At the risk of Irruption, it is stressed that customers must be satisfied about the Islamicity of business. In the following we discuss five elements of a market penetration strategy.
I) AWARENESS CAMPAIGN: Islamic banks can secure more business provided depositors and clients believe that their dealings with Islamic banks in beneficial for them. For this purpose effective publicity campaign is needed. So far, Islamic banks have earned business on the basis of emotional rather than rational factor, which means that dealing with Islamic banks is the only way to earn Halal income. Such clientele has almost been tapped.
New clientele will be looking both to Halal income and the rate of return that compares favourably with rate of interest of the secular banks. The theme of Islamic banks awareness campaign should combine both religious and profit oriented aspects. This means that Islamic bank can get you both profit and Barakah. The Barakah element may be properly stressed. Advertising companies may be employed to prepare effective advertising programmes. Similarly, the platform of Masjid can be used to educate and motivate masses for using services of Islamic banking. Effective media campaign should stress attractive features of the Islamic banking: simple procedures, risk sharing and potential of higher return in inflationary environment.
II) CONFIDENCE BUILDING: Confidence building is important for market penetration. The secular banks are making a lot of business by supplying Islamic banking services and they have convinced their clientele that they are doing it right. Citi Islamic Bank of Bahrain is a good example of it. The secret of its success lies in the better confidence, which it enjoys with the customers.
The confidence building means satisfying the depositors that their deposits are safe and available for withdrawal along with competitive return. To minimise the investment risks additionally, they should follow a "matching policy" in procurement of assets that match nature of liabilities. The prices of Islamic products should be competitive. Often they charge high price of the similar products relative to conventional banks.
III) TRANSPARENCY: A lot of doubts are prevailing regarding general activities, asset quality, or management policies of Islamic banks in the eyes of conventional banks and rating agencies. This barrier must be removed. Islamic banks should make their operating system, their products and risk involved in them more transparent.
At present, rating agencies are justifiably concerned with asset quality. For example, balance sheet shows total outstanding under each investment product heading, but lack the detail of the types of the counterpart with which the bank invested.
This shortcoming should be removed. Annual Reports of many Islamic banks do not show profit distribution formula between depositors and shareholders. Maintaining transparency is an integral part of Islamic finance. The Quran highlights the importance of transparency by providing step by step process that should be followed when carrying out transaction, highlighting the importance of record keeping to avoid injustice to parties involved and emphasising the need for accountability and transparency.
We are enjoined to "betray not the trust of Allah and the Apostle nor misappropriate knowingly things entrusted to you" (27 Sura Anfal). Also one Hadith says that each of us is a guardian and each guardian is a accountable to everything under his care.
IV) DEVELOPMENT OF PROCEDURES, NORMS AND STANDARDS: Islamic banks have made progress in capacity building by preparing procedure, norms and standards satisfying national and international requirement and Shariah compliance.
These developments have brought Islamic banks in a position to take entire deals onto their books without the need to syndicate. By so doing they will be making the process of negotiation simpler and reducing transaction cost. Further, they should adopt the standards of disclosure and risk management that are expected in the international market and to educate western borrowers in the use of Islamic finance.
V) INCREASING LIQUIDITY MANAGEMENT TOOLS: Because of their infancy, Islamic banks have limited liquidity management tools, which are inhibiting market penetration efforts. Liquidity management relates to the arrangement that provide access to determinate amount of cash as and when needed.
This is essentially an asset liability-gap management problem. A superficial study of the balance sheet of a typical Islamic bank will reveal that a part from shareholder's funds, their liabilities are predominantly short term or current account balance. Therefore, any investment in excess of shareholder's funds invested in assets with maturities beyond the very short term are considered to be mismatched.
It is precisely this element that has been the basis for the negative attitude that has persisted in the lower evaluation of the financial strength of Islamic banks and consequently lower rating by the international rating agencies.
The liquidity problem is not specific to Islamic banks. Conventional banks also suffer from it occasionally but they can handle it easily by borrowing from interbank money market.
The lack of Islamic Interbank market on the scale of similar sized conventional market disable Islamic banks to meet unexpected withdrawal from their depositors. Mostly, they handle it by keeping more liquid assets than would be in the case of conventional banks and they invest them in commodity Murabahas on the understanding that they can get liquidity when required through early cancellation at some cost. This is done through agency agreements or break clauses.
To effectively solve the problem progress has to be made both in term of development of institutions and of short liquid instruments. Without an efficient capital market, Islamic banks finance will not really grow. The market requires liquidity and price transparency to enhance secondary market. More co-operation amongst Islamic banks and between them and their conventional counterparts is desired.
Conventional banks usually hold government securities as a source of ready cash and also satisfy the demands of prudential balance sheet management, the regulation and rating agencies. The Islamic banks must create a viable and liquid market to provide alternative to debt markets and at the same time give effective cash management tools.
5. PRODUCT DEVELOPMENT: The term "product development" can be defined as the "internal process that a financial organisation adopts in order to create a financial product or service for delivery to its customers". This process differs with different banks depending upon such factors as the organisation's target customer, its experience and expertise, regulatory environment and other internal and external factors.
There is enormous scope of developing new products because at present there are about twenty Islamic products while there may be hundred such products. Traditional products need reformation to suit contemporary business environment in Shariah compliant framework. It is important to target right product to right customer. In the following reformation of some of the traditional products and a new product Sukuk are discussed.
MUDARABA: Historically, two-partner contract was found to be the most suitable and practical mode for mobilising funds to Islamic banks. But it had to be modified to allow for intermediation between large number of savers and users. A multiple partnership mudaraba contract was devised for this purpose where bank acts as capital user when receiving funds from savers and capital owner when financing business.
Pooled funds are invested through different modes in different projects for different time periods. Profit or loss for all projects is calculated annually. The unrestricted mudaraba contract stipulated no constraint on the use of capital.
The multiple-partnership contract reduced risk considerably relative to two-partner contract through diversification. Also central bank regulation towards normalisation of profits distributed annually further reduced the risk of loss to the depositors.
On financing side, Islamic banks made sparing use of it because of high risk. It is noticed that not more than 3 to 5% of investment is made through this mode by all banks.
To boost confidence of Islamic banks in multiple mudaraba contract a mechanism has to be developed.
THUS: (i) objective bases have to be used by the Islamic bank for evaluating credibility of the clients, (ii) projects have to be scientifically scrutinised, (iii) legal conditions based upon the feasibility study of the project for the sake of securing best possible use of finance at minimum risk have to be prescribed (iv) mudaraba fund shall not be delivered in one single payment as was the case in the past, (v) bank will enjoy full right to get periodical progress reports from the client to examine accuracy and transparency of their reports and to halt or stop flow of funds if terms are isolated,(vi) the Mudarib will undertake to return funds that he has received in case he has violated the contract.
It is also suggested that Mudaraba bonds for projects approved by the bank be issued for 3 to 5 year period. The bank will redeem them at the time of maturity and it will be revalued, taking into account market value of project and profit/loss made. Mudaraba bonds will open a new channel to finance long term projects.
MUSHARAKA: Musharaka is a flexible mode of financing. In establishing new companies, Islamic bank's equity participation can take the form of either permanent musharaka or diminishing musharaka. The later form has turned out to be beneficial for both the bank and the client.
It enhances the financing capacity of the bank since resources withdrawn from some companies can be employed in establishing other companies which facilitates economic expansion and growth. Diminishing musharaka contract is quite suitable for house financing and Islamic bank frequently resort to it in the housing sector.
Musharaka instrument can be further developed on three aspects. One is allowing issuance of preference stock to the shareholders, staff and labor holding shares of the company. Shariah's approval for this purpose can be obtained because conventional musharaka contract allows disproportionate distribution of profit to the partners. Preference shares will infuse greater interest from the bottom to the top in the company to work for higher return. Greater the proportion of shares held by the company employees the smaller will be the need to resort to 'efficiency wages'.
Secondly, conventional musharaka put restriction on the right of any partner to withdraw from conventional musharaka contract; Islamic bank equity participation is in joint stock companies with limited liability status. Therefore, old rule cannot be applied, and stockholders may be allowed to sell their shares in the market with some restriction to protect the right of shareholders.
The restriction is that whenever some partner wants to sell his share he/she must offer it first to the remaining shareholders and if they are not interested then he/she can sell in the market.
Thirdly, musharaka Sakuk, may be issued the holder of which will be owner of real asset of the company. As owners, the holders
will be responsible for the maintenance of capital assets. The return will be net after deducting maintenance cost. This instrument plays the dual role in financing capital investment of the firms and at the same time satisfies the clients who want stable and periodical return with security of the capital.
One of its good example is issuance of Musharaka Term Finance Certificate (MTFC) by Sitara group of Pakistan. The group got its debts equivalent of Rs 360 million transformed into MTFC which pays the financier a fixed rate profit and is redeemable after five years.
MURABAHA: Murabaha is originally a current sale contract which was transformed into a deferred payment sale contract. This transformation allowed Islamic bank to adopt it as a mode of financing trade on short and long term with limited risk to the bank which can further be reduced by keeping the object of Murabaha as collateral to the bank for the period of financing.
Because of simplicity and flexibility features, Islamic banks invariably extend 80% of their financing through this mode. However, it has been grossly misused by ignoring Shariah requirement.
It was found that manager after reaching agreement with the client on final price and terms of payment allowed him to withdraw cash needed for the purchase and do all the job himself. The manager took prevailing interest as a benchmark for fixing margin of buying and taking the goods into possession and then selling them on deferred payment basis.
It has been argued that buying and selling merchandise in Murabaha cannot be strictly accommodated in Islamic banking without violating Shariah or violating the financial intermediation to maintain the benefits of Murabaha finance, a new mechanism based on the distinction between trade and finance is needed. Trade aspect can be assigned by the bank to specialised trading companies.
Client will be directed by the bank to select the commodity from the store of trading company and bank purchases it by paying current price and delivering it to the customer and gain the mark-up in this transaction. The arrangement is Shariah compliant plus the client is saved from bank administration cost. Trading company may even give discount to the client.
It is also important that mark-up should be fixed on the basis of Bai Muajjal, in which deferred payment is based on estimation of the future market value of the commodity and Islamic bank should not be guided by the interest rate when negotiating their Muarbaha mark-up. The bank should hire marketing experts to rightly estimate the Murabaha market. Moreover, the collateral stress should not be exaggerated to offset the gains of Islamic finance.
IJARA: The conventional Ijara contract required involvement of the bank in multiple operations of purchasing, storing, and maintenance besides leasing. The calculation of long run net return of such operations requires every lessee to rent the real asset for whole of its useful life. More practical was, therefore, a new Ijara contract known as Ijara Was Iqtena, facilitating the lessee to purchase the leased asset by the end of leasing period. This form became very popular with Islamic bank.
The new contract is a mix up between leasing and ownership rights and responsibilities and made like hire and purchase contract. Solution to the problem lies in resorting to diminishing musharaka. There will be no difference in the size of finance advanced by the bank nor in the benefits accruing to the client. The Islamic bank can develop a proper leasing finance by issuing leasing Sakuks.
SALAM: This mode relies heavily on the technique of parallel Salam contract. But hedging through parallel Salam contract cannot be conducted in all cases. Islamic banks need the services of marketing companies to organize hedging and to avoid storing and marketing operation if and when actual delivering dates of first and second Salam are not same.
Islamic bank can practice Salam at lower cost in the global market. In export sector, the bank purchases home goods on Salam basis and enter into a parallel Salam contract undertaking the delivery of the same goods to importing firms in foreign countries. Same kind of arrangement can be made for the import sector.
ISTISNA: This mode can play a vital role in financing of the SMEs in particular who have little access to the credits of conventional banks. An improved procedure may consist of four steps in which bank acts as intermediary. First bank receives a request from the manufacturers to finance manufacturing of specific article demanded by a certain client.
Second, the bank will contact client, and third, the bank will examine position of both parties to execute the contract. Four, after agreeing to finance, the bank will arrange contracts with both parties. In the first contract, the bank undertakes to finance manufacturing operation and in the second contract, the buyer undertakes to pay a down payment in advance to the bank and remaining value to paid on delivery.
This arrangement is beneficial to both parties and risk involved can be minimised by gathering correct information on the manufactures and taking necessary steps in securing payment from the buyers. Islamic bank should established liaison with the manufacturers and firm needing equipments to expand scope of Istisna financing.
ISLAMIC SUKUK: One of the innovative products that has emerged during past three years is Sukuk. In addition to fixed rate Ijara and Salam Sakuks, floating rate Ijara Sukuk as well as pooled Sukuk by both corporate bodies and sovereigns has been issued in several countries.
They serve as medium to long run instruments of investment. They are bought by investors to be held rather traded. Therefore, they cannot provide short term and overnight liquidity to the Islamic bank - a giant problem facing the Islamic banks.
The present market size of Sukuk is estimated to be over 4 billion dollars growing at the rate of more than 90%. So far 40 issues of these Sukuks have been made each one oversubscribed. The largest issuance in the $750 million mandate awarded to Dubai Islamic Bank in June 2004 by the Department of Civil Aviation, UAE, to raise funding for the expansion of the Dubai International Airport.
The relatively low number of issues had inhibited overall liquidity in the markets. With the growing number of larger corporate issues being listed, however, Sukuk secondary markets can look forward to increased trading and activity.
The paper has examined the growth performance and future prospect of Islamic banking industry. It has been found that this industry has achieved considerable growth and expansion. From serving a narrow client base with limited Islamic products, it is now outreaching to global financial market. The paper argues that if proper market strategy in adopted then prospects of its future growth and global role are quite promising.
The paper begins by noting the characteristic feature of existing Islamic banking interest free banking which is operating on parallel lines with the conventional banking.
Though the interest has been eliminated from banking transactions but other features of Islamic banking, through which humanity could benefit more have not been realised.
While discussing the strategy to reach part of floating market the paper notes that enabling institutions have recently been put in place in the Muslim world. New products are being launched. Impact affects of this development will take some time.
In the current scenario, Islamic banks cannot adopt industry segmentation strategy. Within certain limitations, Islamic banks can divert smaller fraction of international financial flows toward them.
The paper presents a strategy for market penetration. The reality is that Islamic marketplace is diverse and global. For successfully enlarging their role in the national and international financial market, it has argued that Islamic banks implement five elements of this strategy.
The progress and competitiveness of Islamic banks will remain constrained without enlarging the scope of their products. This can be done by launching new products or reforming of existing products.
In this context it has called to our attention introduction of new instrument called Sakuk which is not only serving as an instrument of medium term investment but also mobilising funds for undertaking of sizeable projects which are of vital socio-economic importance for Muslim countries.-Courtesy: Journal of Islamic Banking & Finance
(The writer is Dean, School of Economis, International Islamic University, Islamabad.)