Questioning economic value of Islamic banks
Many industry observers assert that all Islamic banking products in essence are replicas of conventional banking products, be they Islamic deposits or financing products based on leasing or trade-based contracts.
A replica, however, by its very nature and definition is inferior to the original, and should sell for a significantly lower price. Islamic banking products are certainly not replicas in this sense, as in most cases they happen to be more expensive than their conventional counterparts.
While structures of these products fulfill basic Shariah requirements, they are not novel in their economic profiles. Islamic banking faces cynicism from those who expect it to be different from conventional banking not merely in terms of adherence to Shariah principles but also in terms of its socio-economic implications.
Because of limited economic value addition by Islamic banks and financial institution and relative dearness of Islamic financial products, Islamic banking and finance has emerged as an elitist phenomenon. It is therefore not a co-incidence that it is more popular in the countries where Muslims have higher per-capita income and wealth. Within other countries, Islamic banking and finance is serving the relatively affluent segments of the society.
It is only fair to accept that Islamic banks have retained basic features of conventional banks that are no more than money managers. Islamic banks on the other hand should have been structured as trading houses, which has to date been not the case, as they by and large do not get involved in trading. They merely finance trading activities of their clients, with the help of contracts like Morabaha and salam.
As such their returns are based on financing and not trading. As financiers, the managers of Islamic banks think like financiers and not traders. If an Islamic banker thinks like a financier, acts like a financier, prices his products like a financier, and penalises defaulters like a financier, then he is involved in tapping. Such an Islamic banker is a tapper. If an Islamic bank is involved in tapping, it does not add economic value to conventional banking. Tapping, in other words, is nothing but meeting basic Shariah requirements without adding any economic value.
In tapping-based Islamic banking and finance, the prohibition of interest is merely a Shariah technicality, without a substance. In this context, Islamic banking is a little more than a sub-set of conventional banking and definitely not an alternative.
As long as Islamic banks remain involved in money management, they will do nothing more than tapping. For Islamic banks to add real value to the societies and communi- ties they serve they will have to add broader socio-economic services to their product offerings. Many critics would argue that Islamic banking as a phrase is a contradiction in terms. According to this argument, Islamic financial doctrines can best be implemented outside a banking context. It is argued that a charity or donation-based model better suits Islamic financing. It is proposed that an Islamic financing model could be based on a for-profit-philanthropy (FPP) model.
An FPP branch could be deemed successful if it has improved levels of employment, education and earnings, and by doing do so has enriched the lifestyle in its catchment. With the increased use of FinTech in financial services, it is not only possible but is also expected to drive businesses in future.
There have been some interesting initiatives that could have been developed into viable improvements to conventional banking, if not fullfledged Islamic alternatives. The ini- tial thinking behind Modaraba companies in Pakistan was a model for developing an alternative to conventional banking but that initiative received little strategic attention by the subsequent policymakers.
The Securities and Exchange Commission of Pakistan (SECP) remained indifferent to the recently exposed Modaraba scandal in Pakistan, giving a bad name to an otherwise sound business model.
Modaraba Companies, which still operate in Pakistan, nevertheless target relatively sophisticated investors in the society. The proposed FPP-based model could be used to bring masses and financial excluded segments of the society into banking and finance. In Pakistan, there is no harm in using existing banks (conventional as well as Islamic) for basic banking needs (like current accounts and safe custody), as banks are not heavily involved in financing any way. Islamic finance should reposition outside the banking sector where there is scope as nearly two-thirds of bankable population is still outside the banking sector.
The share of Islamic banking is expected to grow to 20% by 2020.
If banker Taqi Usman was not on Bank payroll then he would have told Islamic banks that the right way to conduct themselves is to investment their cash in the businesses that they want to share profit and loss through the stock exchange. Once they buy shares or part of a business then the Islamic banks are in effect not simply loaning money to business in guise of Islamic sounding nomenclature, which in function mimic conventional interest based banking.
They are adding value by marketing themselves to religious people. The author may have heard of a little known electronics company called Apple that makes money through marketing phones and other electronics that are actually manufactured by contractors in China. No one says that Apple is not adding economic value.