The first argument which is generally heard against Islamic banking is that there is NO difference between the conventional banking and Islamic banking and this is merely a change of name. The second argument is that even in Islamic banking, the most common products being used eg Murabaha, Musawwama, Salam, Istisna and Ijara Muntahia Bittamleek are on fixed return basis.
Answers to these observations have already been discussed in the preceding paragraphs. However, we should just recall the fact that unless we can distinguish an Islamic bank from a conventional bank, it would be difficult for any of us to rely on the same.
Particularly, it is observed that they try to make sure that their product is similar to the conventional products in all respects, even if for that purpose they have to incorporate a few provisions in these products which are not considered to be good or a few of them are considered Makrooh.
In addition, their endeavors are focused towards minimisation of their risk through every possible option and accordingly, the essence of Islamic finance which is based on risk taking is killed.
The third question is generally raised on the honesty and integrity of Islamic financial institutions. This question, which is asked the most times, is that these Banks are using the name of Islam to earn a few bucks more as compared to the conventional banks.
This question has two sides. The first one is on the financing side, where these Banks charge higher than the charges of a conventional bank. In other words, internal rate of return on Islamic financial products is higher than the conventional products.
A justification of this argument is that since the Islamic financial institutions are subject to the commodity risk and the price risk, in addition to the conventional risks that a bank faces, they are justified in their demand.
In addition, particularly in case of Ijara Muntahia Bittamleek, since the risk and reward of the asset rests with them for the whole tenure of lease, which inter-alia includes payment of insurance premiums, they may be justified in charging a higher rental.
Nevertheless, financial experts have generally felt that even if these factors are considered, the pricing by these Banks is on the higher side. On the contrary, it is observed that on the deposit sides they pay less as compared to the conventional banks. In addition, it is generally observed that the expected rates, as well as, the actual rates of return offered by these financial institutions are fairly equivalent to the rates being offered by conventional financial institutions.
In a profit and loss based model, it is agreeable that they assign weightage to different types of deposits in a manner that the total return on investment and financing pools is allocated amongst various depositors and the Bank (working as a partner).
Nevertheless, the question that a participant of a lecture asked me was very distressing for me, as well as, most of the supporters of the Islamic finance in general.
He asked the reason as to why the return to depositors of these banks averages out to be 2 percent per annum - which is slightly less than or fairly equivalent to the rates being offered by the conventional banks, whereas their return on capital employed, which is attributable to the shareholders is around 20 percent per annum.
The fourth question is the acceptability of insurance under conventional mode. A number of practising Muslims and jurists are of the view that unless the option of Takaful is available, the Islamic financial institutions should not opt for conventional insurance which is impermissible. Instead, options for internal Takaful fund or any other similar option shall be used.
However, we all hope that such question shall stand resolved in near future once the rules for Takaful companies are finalised by the SECP and these are operational in the country.
The fifth argument is about the marketing approach being used by these financial institutions, which adversely effects the public reliance on this mode. People raising such question have two grounds for the same. The first one is the general marketing approach being applied by a few Islamic financial institutions which include advertisement and other publicity materials including involvement of women and employment of women for Islamic banking business without Hijab or even appropriate attire (as defined by Shariah).
Although a few modern and liberal Muslims will not like this objection at all, nevertheless, it should be kept in mind that a common man cannot understand "Islamic" banking while he feels that other factors of business are not really Islamic.
Another similar objection is the marketing strategy in which sometimes it is felt that false statements are made for promotional purposes. An example of the same is the claim by a leading Islamic bank that all its day to day activities are monitored by its Shariah Advisor.
Just imagine, if it is humanly possible, that a part time Shariah Advisor can look after all day to day activities of a full-fledged bank with a number of branches even located at other cities. Another example is the claim by an Islamic mutual fund that it is the first one of its kind in the country, whereas another fund was operating in the country for around one year earlier to subscription for such mutual fund.
The sixth argument is of key significance from the perspective of the overall control environment of these banks with regard to the applicability of Shariah principles. You would note that most of these institutions have hired the conventional bankers and generally no or very little consideration is awarded to ensure that they are well conversant with the Shariah requirements with regard to the modes of finance being used by these Banks.
Consequently, a number of non-compliances of such requirements have been discussed on various forums. Since the objective of this article is just to highlight the issues, these are not being discussed in detail. Anyway, I have myself met a few Islamic bankers at various occasions who were not fully conversant with the basic principles of Shariah compliant products that they were marketing.
The seventh question with which I can't personally agree is regarding the appointment of Shariah Boards and Shariah Advisors. People have largely noted and discussed at various forums that the major contribution in this field in Pakistan is limited to a very small group of jurists most of whom relate to a single family and their pupils.
Besides this, another question is also being raised that generally the honorariums, consultancy fee and other benefits being offered to such jurists by the Islamic financial institutions in Pakistan, as well as, abroad are quite high and this may jeopardise their independence.
I personally along with most of the people conversant with the business and operations of Islamic finance do not agree with this observations because the contribution of these people to the industry as a whole is remarkable and they deserve even more than that based on their contribution and efforts in the promotion of this industry.
The general concept that a Maulvi should be paid the minimum at which he can live, is not something justifiable. If you are getting benefits from their efforts, their knowledge and skills, then they should be justifiably rewarded.
However, we all agree that it is the right time that contributions from jurist from other schools of thought should necessarily be provided opportunities to enter into the field. For this purpose, it would be a good idea that a jurist should not be allowed to hold more than one remunerative position as a Shariah Advisor or member of a Shariah Board.
However, honorary/advisory members may hold upto three positions in all. This will ensure that fresh blood gets a route to enter into the field which will eventually improve the overall Shariah compliance in the field, as well as, will help these institutions to innovate fresh products.
This organisation has been established by a number of Islamic financial institutions operating throughout the world and is based at Bahrain. AAOIFI has established an Accounting and Auditing Standards Board, as well as, a Shariah Board. These Boards have, to date, performed a commendable job by issuing accounting, governance, auditing and Shariah standards for Islamic financial institutions.
Since these Boards have been established by choosing the experts of the fields from throughout the Islamic world, their works, are considered to be a consensus of the experts from the field and hence these work may be used for standardisation of practices of Islamic finance and banking throughout the world.
In Pakistan, the Institute of Chartered Accountants of Pakistan has issued draft Islamic accounting standards for Ijara and Murabaha which are under finalisation phases. However, these drafts do not contain enough details regarding standardisation of transactions. On the other hand, the State Bank has issued essentials for Islamic banking and financial products and a bunch of model agreements.
A very useful book has also been published by the State Bank on the topic of Islamic finance. Nevertheless, these are just guidelines and not a mean of standardisation of practices. As a part of its efforts, the State Bank has established a Islamic Banking Department, duly supported by an independent Shariah Advisory Board comprising of Shariah jurist, lawyer and account members.
Nevertheless, without going into further details it is pertinent to mention that as evident from its name, it is just an advisory board and accordingly, advises when and only when such advises are sought.
In contrast, SECP has not yet demonstrated any concrete initiative for promotion of Islamic finance in country. As an example, the matter of establishment of Takaful companies in Pakistan is pending finalisation of rules on the part of SECP.
Similarly, there is no monitoring of Islamic financial institutions that come under its umbrella, including, Islamic mutual funds, Modarabas, Housing finance companies etc, as well as, the Islamic financial products issued eg Musharaka TFCs issued by Sitara Energy.
From the above details, it is established that a great deal is outstanding on the part of our regulators, as well as, the lawmakers to ensure that a conducive environment for promotion of Islamic finance is made available in the country, particularly including the standardisation in order to build public reliance on these products and institutions. However, from the old times a Shariah Board for Modarabas was operating or rather not-operating.
In view of the same, it may be recommended that the State Bank and the SECP shall join forces to form an independent authoritative Shariah Monitoring Board for Islamic financial institutions and Islamic financial products.
In our humble opinion, such Board shall besides advising on matters, as and when its advises are sought, also establish an independent and effective monitoring framework for Islamic financial institutions. Besides this, its functions shall include setting standards of operations for these institutions based on Islamic Shariah.
For that purpose it is advisable that in addition to the members of the State Bank's Shariah Advisory Board and the members of the Supervisory Board for Modarabas, a few executive, full-time working members of such Board shall be appointed.
These members shall also be taken from bankers, accountants, lawyers and most importantly from Shariah jurists. Islamic banking department of SBP and SECP shall support such Board in development of rules and regulations for Islamic financial institutions, particularly ensuring standardisation and consistency in the practices of Islamic financial institutions and their maximum compliance with the requirements of Islamic Shariah.
However, unless such standards are developed, which shall obviously take some time, the State Bank and the SECP may decide to adopt Shariah Standards issued by AAOIFI as a regulatory framework for Islamic financial institutions. Even after, these standards will provide a solid base for further strengthening the standardisation process.
My personal experiences have proved, which I am sure that a number of readers will second, that the Shariah compliance cannot be ensured merely on the basis of approval of products by the Shariah Supervisory Boards and the Shariah Advisors.
Presently the framework of Shariah compliance assurance in Pakistan may be divided in three different types of assurance as follows:
1. The first option which is being used by a leading Islamic commercial bank is the Shariah compliance review report of the Bank's own Shariah Supervisory Board or the Shariah Advisor. This option is although considered an effort to ensure Shariah compliance; the same cannot be construed to fulfil the need in this respect because of three basic weaknesses being discussed as follows:
The first weakness is that the Shariah jurists who are sitting on the Board or are appointed as Shariah Advisors generally have no or a very little knowledge about the principles of finance, accounting and auditing, and more importantly, of the operations of the financial institutions.
Consequently, their compliance review generally remains limited to the extent of assurance of the legal form of transactions ie vetting of agreements etc. On the contrary, the operational matters, which include the substance of the transaction might remain unattended because it is not the core competence of these respectable jurists.
Besides this, generally the management do not wish to bring each and every matter in the attention of the Board or the Advisor; The second weakness is independence of the person performing the assurance function. Although we don't have any doubt on the personal independence and integrity of these respectable jurists, they would themselves appreciate that the work performed under one's guidance should always be counter checked by an independent person.
Particularly, keeping in view the human tendency of errors, it cannot be advised that the person supervising and monitoring the transactions is also entrusted to recheck the same; and
The third issue is of time and skilled staff. Generally those on the Shariah Boards and on the seat of Shariah Advisors are busy guys. They are generally serving a number of Boards and educational institutions and are involved in a number of social and religious activities.
In addition, they do not have any skilled staff hired for the purpose of assisting them in the assurance work. Consequently, you can easily imagine that it is humanly not possible for a single person to perform a comprehensive Shariah compliance audit of the operations of a full-fledged Islamic financial institution which may even have a number of branches.
2. The second option being used by two Islamic mutual funds in the country is Shariah compliance audit by the external auditors of the Islamic financial institutions. In such option, the external auditor is also assigned with the task of performing Shariah compliance audit with a scope defined in advance.
This may be considered to be a viable option for independent assurance of compliance with the Shariah terms. However, such system has two basic weakness being discussed as follows:
-- Since the external auditor is also entrusted with the task of performing the Shariah compliance audit, his expertise in Islamic finance is not ensured. You would appreciate that if the auditor is not equipped with the necessary skills and knowledge, the output of the assignment might not be as good as may be expected from an experience auditor; and
-- Since the scope of the audit is pre-defined and the matter of permissibility of a transaction is generally subject to the opinions and perspectives of the Shariah Supervisory Board or the Shariah Advisor, the independence of the exercise, to some extent, remains in jeopardy.
3. The third option is being exercised by the State Bank in form of Shariah compliance Inspection of Islamic commercial banks. This is a very good option, as it is independent and authoritative in nature. Nevertheless, since the results of such inspections are considered to be confined to the management of the Bank and the State Bank, the benefits of such exercises cannot be forwarded to the general public.
Moreover, such exercise is limited to the Islamic commercial banks and the Islamic banking branches of conventional commercial banks and consequently other financial institutions that are governed by the SECP including Islamic mutual funds, Modarabas, Takaful companies, Housing finance companies, Investment finance companies and leasing companies shall remain out of ambit of such exercise.
In view of the same, it is proposed that a framework for Shariah compliance audits of Islamic financial institutions shall be introduced. In this framework, a common panel shall be approved by the State Bank and the SECP amongst reputable firms of chartered accountants, having experience, knowledge and skills in Islamic banking and finance. All the Islamic financial institutions operating in the country shall be required to get a Shariah compliance audit performed.
In the absence of relevant expertise in the country, in the beginning phase, the existing external auditors may also be allowed to perform such audit, if they are amongst the approved panel of Shariah compliance auditors as approved by the State Bank and the SECP. However, in the later phases these duties may be allocated to different auditors in order to improve the independence in performance of their duties.
It is, anyway, pertinent to note that the scope of such audit needs to be assigned by the regulators ie the State Bank and the SECP. Due consideration shall be given to the nature of each financial institution and accordingly different scope of work may be assigned for Shariah compliance audits of various Islamic financial institutions. However, in the absence of initiative from the regulators, an association of Islamic financial institutions may, with the help of respectable jurists, define such scope.
(Concluded)