7/16/2017 ChallengesfacingIslamicbanksNewspaperDAWN.

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Challenges facing Islamic banks

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ISLAMICbankingindustryhasbeentryingforthelast
overtwodecadestoextenditsoutreachtobringitat
leasttothelevelofconventionalbanking.Butthe
absenceofShariahcompliantlegalframework
neededtomakeinterestfreebankingacceptable(and

createsoundfinancialinstitutions)isthemajor
snagbehinditslowpenetrationinthefinancial

market.

Itisthetimetotakestockofchallengesfacedbythe
Islamicbanksastheyneedanumberofsupportinginstitutions/arrangementsto
performfunctionswhicharebeingcarriedoutbyvariousfinancialinstitutionsin
theconventionalframework.Attemptsshouldbemadetomodifytheexisting
structuretoprovidebetterproductsandqualityservicewithintheambitof
Islamiclaws.

SomeofthemostimportantchallengesfacingtheIslamicbankingindustryare
identifiedasfollows.

LegalSupport:Islamiclawoffersitsownframeworkforexecutionofcommercial
andfinancialcontractsandtransactions.Nevertheless,commercialbankingand
companylawsappropriateforimplementationofIslamicbankingandfinancial
contractsdonotexist.Islamicbankingcontractsaretreatedasbuyingandselling
propertiesandhencearetaxedtwice.

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Thecommercial,bankingandcompanylawscontainprovisionsthatarenarrowly
definedandprohibitthescopeofIslamicbankingactivitieswithinconventional
limits.ItisnecessarythatspeciallawsfortheintroductionandpracticeofIslamic
bankingbeputinplace.ThelegalframeworkofIslamicbankingandfinances
mightincludethefollowing:

a.Islamicbankingcourts:ThedisputedcasesoftheIslamicbanksaresubjectto
thesamelegalsystemandaredealtwiththesamecourtandjudgeasthe
conventionalonewhilethenatureofthelegalsystemofIslamistotallydifferent.
Toensureaproper,speedyandsupportingIslamiclegalsystem,amendmentsin
existinglaws,whicharerepugnanttoinjunctionsofIslam,arerequiredto
promulgateShariahcompliantlawforresolutionofdisputesthroughspecial
courts.

b.Amendmentofexistinglaws:Islamicbankinghassomekindofresemblanceto
universalbanking,therefore,lawsandregulationshavetobeamended
accordinglytoaccommodatethisnewconceptsuchassections7(formsof

businessinwhichthebankingcompanycanengage)and9(prohibitionoftrade)
oftheBankingCompaniesOrdinance1962whileIslamicbanksarebigor
wholesaletradersinreality.

c.Islamicbankinglaw:IntheabsenceofIslamicbankinglaws,theenforcement
ofagreementsincourtsmayrequireextraeffortsandcosts.Therefore,banking
andcompanieslawsinseveralcountriesrequiresuitablemodificationsto
providealevelplayingfieldforIslamicbanks.Furthermore,international
acceptanceofIslamicfinancialcontractsrequiresthemtobeShariahcompatible
aswellasacceptableunderthemajorlegalregimessuchasCommonlawand
Civillawsystems.

d.Islamicbankingbalancesheet:Islamicbanksdonotshowassetsfinanced
throughIjara,Murabahetc.,onbalancesheetbecausesection7ofBanking
Ordinance1962doesnotallowabanktoownpropertyorassetwhichsection9
prohibitstoenterintoanykindoftrade.However,alltheassetsownedbyIslamic
banksbementionedintheirbalancesheets.

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e.Monthlypaymentagreement:Thehousingfinanceisexecutedonthebasisof
DiminishingMusharakabytheIslamicbanks.Underthismodethehouseis
jointlyownedbythebankandthecustomer.Thebankrentsoutitssharetothe
customeronIjarabasis.TheIslamicbankwhileexecutingIjarawiththe
partner/customer,usesthetermMonthlyPaymentAgreementinsteadofhaving
theIjaraagreementwiththecustomer.Itissonamedastosafeguardthebanks
interestincaseofrefusalbythecustomertopayrentals.Nolegalcoveris
providedtotheIslamicbanktoovercomethisrisk.

f.PLSdeposits:DepositsinIslamicbanksareusuallybasedonprincipleofprofit
andloss(MusharakaorMurabaha).Ifsomethinghappensandthebanksuffers
lossithastobetransferredtothedepositordirectly.

ThisfearoflossisthebiggestbarriertodepositmobilisationinIslamicbanks.In
somecases,itleadstowithdrawaloffunds.Thedepositorsshouldbeprovided
withsomekindofprotection..
Islamicprudentialregulations:SupervisionofIslamicbanksisequallyimportant.
Atpresent,lackofeffectiveprudentialregulationisoneoftheweaknessesofthe
Islamicbankingindustry.Forinstance,leasingprudentialregulationsareapplied
toIjarawherethenatureofbothisdifferent,suchastakingadvances.Thebank
istheownerinIjarasotakingadvanceswillrenderthecontractofIjarafor
conversionintoMusharakahwhereastherulesofIjaraareappliedtoit,whichis
illegal.AndsomeoftheIslamicbanksareusingthetermofsecurity,hence
makingtheIjaracontractnonShariahcompliantasusingthedepositedsum
undertheheadingofIjarasecurity(Rahn)isnothingbutRibawhichisstrictly
prohibitedbyIslam.

Moreover,Ijarafinancingissubjecttocompulsoryinsurancewhichisessentially
prohibited.

Risks:ThenatureofriskinIslamicbankingisdifferentfromthoseof
conventionalbankingandthereforesomespecialprudential,accountingand
auditingstandardsshouldbeappliedtothem.

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Benchmark:Takingtheconventionalinterestbasedbenchmarks(Kiboretc.,)as
thebaseofpricinganIslamicfinancialproductputsIslamicbanksatthemercy
oftheirconventionalpeers.Anegativeperceptioniscreatedamongtheclientele
thatthereisnoprudentdifferenceinIslamicbankproductsasthesearealso
usingthesameinterestbasedbenchmark.Themechanismforlongterm
financingcouldbedevisedonthebasisofprevailingrentingsystemadoptedby
theprivatelandlordswhilerentingtheirassets/propertiesetc.

Shariahbasedproduct:AllIslamicfinancialinstitutionsofferthesamebasic
products,(90percentMurabahaandIjarah)buttheproblemisthateach
institutionhasitsowngroupofIslamicscholarsontheShariahboardtoapprove
theproduct..Consequently,theverysameproductmayhavedifferentfeatures
andwillbesubjecttodifferentkindofrulesintheseinstitutions.

Lackofstandardfinancialcontractsandproductscanbeacauseofambiguity
andasourceofdisputeandcost.Inaddition,withoutacommonunderstanding
oncertainbasicfoundations,furtherdevelopmentofbankingproductsis

hindered.

NatureofIslamicbanking:IslamicbanksareofferingonlyMurabahaandIjarah
whileleavingthecoreanddifferencemakingIslamicfinancialinstrumentssuch
asMusharakahandMurabah.Itisnecessarytoenhanceandfacilitatethe
implementationofrealIslamicbankingactivitiesi.e.promotingrisksharing
throughequitytypefacilitiesontheassetsideandprofitsharinginvestment
accountsonthefundingside.

Lenderoflastresortfacility:Islamicbanksarereluctanttoenterintoalongterm
transactionsduethelackofavailabilityofliquidationthroughsecondarymarket.
Thereisliquiditysupportintheformoflenderoflastresortfacility.

Thereisnopropermechanismoftransparencyanddisclosuretothepublicin
ordertoensureconsumerprotectionasprovidedbyShariah.

Islamicfutureexchange:Inconventionalsystem,longtermfinanceisprovided
throughlongtermbondsandequities.Apartfromthegeneralpublic,themost
importantsourceoftheselongterminvestmentsareinvestmentbanks,mutual
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funds,insurancecompaniesandpensionfunds.Islamicbanksdonotdealwith
interestbearingbonds.Therefore,theirneedforequitymarketsismuchhigher.
Onthetopofit,themostoftheproductsinIslamicbanksarebasedongoodsand
commoditieswhilepricesandcurrencyratesgoupanddownfrequently,creating
abigriskforthembeingtradersinrealityespeciallyinthecaseofSalamand
Istisna'a.Tohedgetherisk,theyareinneedofderivativeproductsand
consequentlyofFutureExchanges.

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