ISLAMIC BANKING – AN ALTERNATE APPROACH TO FINANCE BY MR. A.I. MARIKAR

FORTY FIRST MARHOOM DR. A.M.A. AZEEZ ORATION – 2014

Assalamu Alaikum Warahmathullahi  Wabarakathuhu

unnamedWe are gathered here today to pay tribute to a rare personality, a Visionary, an Erudite Scholar, an Educationist, a Senator and an Administrator par excellence. These words fall far short and are grossly inadequate to describe the profound contribution made by Dr. A.M.A. Azeez to Sri Lankan Muslim society .

Dr. Azeez was the Principal of Zahira College, Colombo when I was a student here in the late 1950s, and I vividly remember the Monday morning school assemblies he conducted, where he addressed the students, standing almost at the same place where I am standing now, he spoke with great dignity and aplomb. As a mature student listening to his enlightened discourses I and my contemporaries like S.H.M. Jameel, Khalid Farouk, Dr. Shukri, Macky Hashim, Dr. Neville Edirisinghe, Dr. Ameer Ali, K.M.H. Akbar and many more, were not just mesmerized by what he said but were humbled by his sheer presence. We walked back to our class rooms silently saying to ourselves “what a great man“.

I thank the Dr. A.M.A. Azeez Foundation for inviting me to deliver the Dr. Azeez Memorial Oration this year which is a great honour, especially to Ali Azeez who has been a close friend for over 45 years personally and professionally.

The topic of my talk today is Islamic Banking. This alternate approach to Banking is sweeping across human societies world-wide with the ferocity of a financial tsunami. Banking circles, Financial regulators and the world of business and finance started a serious dialogue on this emerging Banking initiative only during the last 25 years. NDB Bank launched Islamic Banking on 16th August 2014. Permit me to say, however,  that as a professional Banker and as a Muslim, I place the launch date of Islamic Finance   approximately 1450 years ago when two great personalities in history, Muhammed ibn Abdullah and Lady Kadija, may Allah’s mercy be on them both, prototyped the very first working model of a Mudaraba. At this  moment in history, Lady Kadija partnered with Muhammed Ibn Abdullah, may peace be upon them both, and they launched a unique business model, with Lady Kadija as Rab Al Maal investing money in a partnership business venture managed by the Mudarib, the experienced caravan trader, Muhammed ibn Abdullah, may peace be upon them both. The essential ingredients of Islamic Banking such as asset based finance, the use of expert fund managers (Mudarib), profit loss sharing, the fusion of capital and enterprise for profit generation, profit instead of interest being used as a pricing tool, have their genesis in this prototype business model. This business model has continued to be used unchanged for over 1450 years and remains as the bedrock principle of Islamic Banking even today.

At a global level, Islamic Banking is no longer an embryonic initiative. It has etched a very strong presence in the world of Banking and Finance spreading across many continents from the Americas to the Far East, from northern Europe to South Africa  and in many countries in between. The Gulf countries together with Malaysia took a lead role
in transforming the financial landscape by establishing strongly capitalized Islamic Banks in their respective regions. The Accounting and Auditing Organization for Islamic Financial Institutions in Bahrain, pioneered the setting up of the procedural framework for Islamic Banking by compiling very comprehensive accounting standards and process based Sharia Standards. These developments enabled Islamic banks to reach out to client needs globally.

Islamic Banking is big business world-wide. It has touched the USD one and a half trillion mark in incepted business and is reported to be growing at 20% annually. There are over 1,000 institutions world-wide offering Islamic finance and it has a strong presence in nearly all the major world financial centres.
 
Coopers estimate the global market capitalization of Islamic trade and finance at USD 21 trillion. To place this figure in perspective its worth pointing out that Global GDP is around USD 25 Trillion. The global market potential for Islamic finance is therefore of mega proportions.

In Sri Lanka we have been quite proactive in accepting, developing and launching Islamic Banking. The first stand alone Islamic financial institution made its debut in1997  with the setting up of Amana Investments Ltd. and the major milestones in the development of this industry were achieved rapidly within a space of less than 15 years.
 
The Banking Act was amended in 2005 as a result of which for the first time in the history of Banking in Sri Lanka, Islamic Banking was legalized and the Central Bank became responsible for the regulation of all Islamic Banks and Islamic Finance and Leasing companies. This led to the rapid proliferation of Islamic Banks in the country. Amana Bank was licensed in 2013 and  almost all the major conventional Banks set up Islamic Banking divisions during the last two years including Bank of Ceylon, Peoples Leasing Co., Commercial Bank, Hatton National Bank, NDB Bank, Seylan Bank and  MCB Bank. Many finance companies and leasing companies also set up Islamic Finance divisions. Lanka Orix Leasing Co. is a leading player in Islamic finance in the leasing sector.

The potential market size of Islamic Finance in the country is estimated at Rs. 250 Billion of which incepted business by all Islamic financial institutions is at around Rs. 50 Billion during 2014. These are impressive achievements and the growth surge continues.   

The journey of the Islamic banking initiative in Sri Lanka so far, has not been an easy one. The label ‘Islamic’ has led many Muslims and non Muslims to think that this is part of the revealed body of faith of the religion of Islam which should concern only the devout Muslim. This system of Sharia compliant Banking after all is based on Quranic law and Sharia compliant Banking they contend is an extension of Islamic religious law. They question both the need, the relevance and applicability of Sharia to modern day banking which is by and large based on Common law.

This misconception needs to be demystified. Sharia is an Arabic word lexically meaning road or pathway. It is a term used to denote a body of law which is used for the purpose of guiding human society and is essentially legal in nature and content. Broadly speaking  Sharia is classified into the five following compartments;


1. Sharia Ibadath
2. Sharia Kilafath
3. Sharia Imarath
4. Sharia Muasharat
5. Sharia Muamalath
 
From the perspective of religious dogma, hard core religion is found almost in its entirety in Sharia Ibadath. All the other areas of Sharia are focused on best practices for the survival and existence of a peaceful and healthy human society.

The rules of good governance, the rights and obligations of rulers are copiously detailed in Sharia Kilafath.

The rights of the governed, their obligations and their role in society are found in Sharia Imarath.

Rules regarding family matters, rights of children, marriage, divorce, inheritance etc. are specified in Sharia  Muasharat.

Matters concerning trade, finance and related matters such as contracts, debt, guarantees, pledge, trusts etc. are comprehensively covered in Sharia Muamalath.

What I wish to emphasize is that one fifth of Sharia is about Religious dogma and four fifths of Sharia is about rules for the well being of human society.

Sharia, therefore, is a body of law, it is about jurisprudence, it is therefore a legal system.

This leads me to the next misconception that many people have on the compatibility of Sharia with Common law, especially in the context of Islamic banking.

Historians who researched  the evolution and development of common law, hold the view that common law as we know, it had its origins in the 17th century in the writings of the eminent Dutch jurist Hugo Grotius (1583-1645). His book ‘The Laws of War and Peace’ which he released in 1625 is thought to be the foundation of modern law.  Hugo Grotius however never claimed to be the original author of all the legal principles propounded in his writings. These he said were the laws of mankind which evolved over time. Hugo Grotius drew inspiration from the vast bodies of law that pre-existed his time and extracted principles of law and gave them focused expression in his writings.

Hugo Grotius and other eminent jurists of his vintage were strongly influenced by laws that were practiced by early civilizations such as the laws of the Phoenicians (2000 BC); the laws of the Babylonians (500 BC) which saw its high watermark in the compilation of  Hamurabis code in 55 BC; the laws of the Mesopotamians (1500BC); the laws of the Romans and Greeks (1000 BC ) etc.

Hugo Grotius was also strongly influenced by another body of law, which to him was more state of the art, and this was Sharia. Sharia was propounded around 700 AD and unlike the laws of the earlier and older civilizations which were all of the era BC, Sharia was the only body of law belonging to the era AD.

In addition to that by the 17th century, Islamic jurists had researched extensively and had written copiously on a very wide spectrum of topics, which very strongly influenced Hugo Grotius and other 17th century Jurists. The compilers of modern law were so strongly influenced by Sharia that there is a large component of commonality between substance of Sharia and Common Law.

It would be appropriate at this stage to quote what an eminent non Muslim Jurist, Justice Weeramantry had to say about Sharia. Justice Weeramantry as you may know is a retired Supreme Court Judge, a Professor of Law at Monash University and a Vice President of the International Court of Justice in the Hague. An erudite scholar he has authored several books on Law and related subjects. In his Book ‘Islamic Jurisprudence’ he begins the first chapter  titled ‘Sharia’ with the following words,  Quote ‘Although the Islamic system of jurisprudence is one of the best developed and most adequate systems in the world, very little is known about it by western law students’ Unquote.

When we speak of Sharia based principles we are also talking about common law principles. Both bodies of law are identical in substance and the few differences that may appear to exist are on matters linked to ethics and transparency on which Sharia is uncompromisingly stringent.

Let me summarize what I said about Sharia. Sharia is not entirely a religious dogma, it is a body of law which has strongly influenced common law and in substance, common law and Sharia share a large area of commonality.

When we say that Islamic banking is Sharia compliant Banking, what we are really saying is that it is based on the same legal principles which govern modern day banking, but practiced within the contours of transparency, ethics, justice and fair play.

Let me now talk to you about Islamic Banking, but  before doing so it will be useful to state in summary what conventional banking is all about.

Conventional Banking is debt based Banking. The primary function of a conventional bank is to give loans to clients who then become debtors in law. The debtor has a legal obligation to repay the debt together with Interest and provide, if so requested by the creditor, adequate security for protecting the debt. When banks grant loans, the bank is the creditor and the borrower is the debtor.

On the side of deposit taking, when a customer deposits money in a current account, a savings account or a deposit account, the Customer is the legal creditor and the Bank is the legal debtor. The singular relationship that a conventional bank has with clients is therefore that of a debtor and creditor. Interest paid and received in conventional Banking is in the nature of rent or hire, that is paid for using money, arising from the principle accepted in conventional banking, that money has ‘Usufruct’.

Islamic Banking takes a very different route. It centres around the principle that money by itself has no Usufruct and therefore cannot generate a surplus. From an Islamic banking stand point, money can generate a surplus only, repeat only, if it is combined with Effort, Enterprise and Risk bearing. This was clearly demonstrated in the business model prototyped by Lady Kadija. Lady Kadija’s  capital was  combined with the ‘Effort’ and ‘Enterprise’ of Muhammed Ibn Abdullah (May peace be on them both) and both agreed to share profits and losses. This is the principle of the ‘Mudaraba’ which is also at the very foundation of Islamic banking.

Loss sharing by all transaction linked stake holders, is a non negotiable principle in Islamic banking and is the fundamental difference between Islamic Banking and conventional Banking.

In conventional banking, providers of capital (depositors) are not loss sharers and are legally entitled for the guaranteed repayment of capital together with interest. Operating losses are the total responsibility of the Bank.

Let us look at how Islamic Banks translate into modalities of Bank finance, the core formula of the fusion of Capital, effort, enterprise and the sharing of profits or losses in business. The Lady Kadija business model has shown us the simplicity of this approach. Business and trade as practiced by mankind from very ancient times were always based on the integrals of the Lady Kadija business model. Trade and business is all about combining Capital with Effort and Enterprise. The result of such an initiative at the end of the venture, is the generation of profit or loss which is shared by the entrepreneurs.

The financial re-engineering that Islamic Banks therefore have to undertake, is simply to use trade based platforms for the disbursement of money and to build into business processes, standard practices followed by traders and businessmen. Some of the universally used business/trading platforms are:

1. Trade, which is Buying and Selling.
2. Partnership business including and venture capital. 
3. Leasing.
4. Project finance  including agriculture finance.
5. Etc.

An Islamic Murabaha is the platform used to facilitate the buying  and selling needs of traders, Musharaka is partnership finance, Ijara is Sharia compliant leasing, Salam and Istisna are very versatile platforms for financing start up projects and for providing agriculture finance.

 The range of products in Islamic Banking is endless. The potential for re-engineering modalities of Islamic finance is wide and unlimited. Limitations in human ingenuity is what actually determines the horizons of Islamic financial product development.

Another attribute of Islamic Banking which differentiates it from Conventional Banking, is the asset based nature of each and every transaction. Sharia injunctions require that financial transactions be accompanied by an underlying productive activity. Islamic banking is asset based financing and is therefore trade based, this means that such an approach must have an asset at its core and it must be the sole rationale for the transaction. The asset must be tangible and must be useful to human society. By extension therefore, Islamic Banks define their role as funds managers entrusted with the task of garnering surplus unutilized public funds and channeling it to useful commercial activities for the betterment of human society.   

A conventional Bank has debt at its epicentre, instead of an asset. The main focus of a conventional Bank is to disburse loans and to recover them and to levy interest for hiring out money.                                                       

Let me illustrate this difference with an excellent example. We have all heard about “Derivatives”, which many of us think is a high end Financial instrument marketed by Banks and financial institutions. It is projected as a state of the art and proudly proclaimed as a universally accepted panacea for many of our financial woes. A derivative as the name implies, is an instrument ‘derived ‘ from another  transaction, and is therefore not a stand alone commercial deal. It is a parasitic instrument totally lacking any tangible substance. The market hype created by the vendors of this instrument has been so powerful, that its market presence today is in the region of USD 600 Trillion. This financial behemoth obviously has no asset base or any commercial use for the simple reason that Global GDP by comparison is only a miniscule USD 25 Trillion. The USD 600 Trillion in derivatives represents nothing on planet earth. Derivatives are essentially speculative and the word that we commonly use for describing such activity is ‘Gambling’.

Islamic Jurists have declared derivatives a Haram investment. In addition to the total absence of an asset base, derivatives also suffer from other multiple Sharia  prohibitions such as Maisir (gambling) and Garrar (uncertainty).
                                                                                                                                                                                                                                                                                                                                                                  The dangers of using financial instruments which do not have an asset base, especially those which are speculative in nature, such as derivatives, were clearly shown in the recent global financial market melt down. It demonstrated very cruelly that asset less toxic instruments can bring about the collapse not only of giants in Banking and Insurance such as Bear Stearns, Lehman Brothers, Freddie Mac and Fannie Mae, Merrill Lynch, AIG, Washington Mutual and many more, but can ruin the economies of countries and bring them to the brink of insolvency. Portugal, Ireland, Greece, Spain and Iceland are some of the countries that had to go Cap in Hand to outside financial institutions to beg for financial mercy.

Asset based Banking on the other hand provides stability to financial institutions and  to Nations even at times when financial shock waves threaten to crush everything as it makes landfall.

During the financial melt down in 2008, Islamic Financial institutions remained resilient. According to the Dow Jones Islamic Market financial index, which measures the performance of around 70 Sharia compliant stock markets around the world, the index lost just 2.7% in September 2008, whilst at this time conventional stock markets witnessed a 20% drop in value, with Wall Street crumbling into meltdown.

During the Asian financial crisis of 1997 the Islamic financial system performed better than its conventional counterpart and witnessed a growth spurt after the crisis, with large segments of the population migrating to Islamic banking because of its relative stability. . 

Islamic banking also carries the label ‘Ethical Banking’. The Intrinsic nature of Sharia compliance in financial dealings requires banks to follow principles which define what is true, fair, just, and uphold the spirit of ethical benevolence in business and corporate responsibilities. Priority is given to the well being of society.     .

If we look at Banks, Financial Institutions and Businesses anywhere in the world, we find that the profit motive is the crux of their business philosophy and the goal of their mission. Success or failure, the quality of performance of businesses are measured by only one yard stick, and that is the size of profits they make. The only condition that they observe is to be on the right side of the law whilst being on this profit maximization journey. Ethical considerations do not really mean a thing. 
  
Let me give you an example. Tobacco based businesses are some of the most profitable enterprises in the world today. They record extremely high profits year after year, enjoy very strong and impressive cash flows and are ranked ‘Blue chip’ among the ‘Blue chips’. By most rating standards, they use the vast amounts of cash at their disposal to build big and flashy offices in order to impress Banks and the movers and shakers in the  Business world. Banks in turn invest heavily to impress cash cows like tobacco businesses. The interest of the two dovetail because both are in pursuit of the same goal, namely profits, which tobacco companies make in abundance. While this symbiotic love affair blooms, we also learn from the small print in news papers that millions of people die every year from tobacco related diseases, millions are in hospitals dying of tobacco related illnesses, and medical researchers are repeatedly saying very unequivocally that the tobacco use kill humans. Governments know about the dangers of this addictive drug but remain silent because of the huge tax collections they make from tobacco sales. Human life, in short, is sacrificed at the altar of money. Ethical considerations are jettisoned in the race for profit maximization.

Islamic Banks are ethically driven because they do not entertain or support businesses  whose core activity is harmful to human beings or to society. They believe that business engagements that generate profits must be from ethically supportable sources. Islamic banks therefore do not deal with Tobacco companies, Alcohol companies, Casinos, Lotteries, prohibited food processing companies and speculative financial instruments such as Derivatives. These businesses generate huge profits but from an Islamic banking perspective they must remain outside the scope of their business for ethical reasons.

Another aspect of ethics is Transparency, Justice and Fair Play that Islamic Banks are required to practice in their dealings with customers. The message of Islamic Finance is very clear. Money can be earned and must be earned, but in a manner that conforms to the principles of Sincerity, Justice and Fairness as deeply inscribed in Sharia.

As a final observation, if we try and read the proverbial crystal ball and look into the future to assess where Islamic banking is likely to be in 25 years from today. My guesstimate is that it will be a financial heavy weight in all global financial centres, strongly impacting corporate business and the lives of mankind world-wide. The only down side, that I see retarding its growth will be us Muslims. We have demonstrated apathy, in fact total apathy towards a system of finance which follows the injunctions of the Quran and Sunna. Let us look at the statistics. Total bank loans and advances taken by all Muslims in Sri Lanka is currently estimated at Rs. 250 Billion, but the  business incepted by all Islamic banks today stands at a measly Rs 50 Billion. Even globally, Coopers estimate the market capitalization of Islamic Trade and businesses at USD 21 Trillion, but Incepted business by all Islamic financial institutions world-wide is only USD 1.5 Trillion. Is this a sign that Muslims of today who proclaim that they are the privileged torch bearers of a magnificent religion, have lost their bearings and with it their Imaan?
 
I would like to end my talk by sharing with you a very interesting discussion I had with a local senior Banker. We were invited as consultants to assist this big private bank to set up an Islamic Banking unit. Prior to our visit they conducted a survey and asked the large number of Muslim customers who they were banking with just two questions. The first question was whether they knew anything of Islamic modes of finance and the other question was whether they would like to migrate to the Islamic division of the Bank if one was set up.

To the first question nearly all who responded, pleaded ignorance.

To the next question the response was as follows;

25% were seemingly die-hard Islamists, who unequivocally confirmed their strong support to the initiative.

Another 25% said that if the pricing was about the same, they would consider Migrating. .  
The balance 50 % said that the Islamic banking initiative was not a critical issue to them  and that conventional Banking was a perfect comfort zone, from which they had no desire to move.

This is the apathy that I just highlighted.

Thank you for giving me your time.       
 
Ma As Salaam.


About the Speaker

Mr. A.I. Marikar hails from Negombo and had his education at Maris Stella College, Negombo and Zahira College, Colombo during the Azeez era.

He graduated from the University of Ceylon in 1965 and is an Associate of the Chartered Institute of Bankers in London.

He commenced his banking career at Grindlays Bank, Colombo and left in 1979 to join the Saudi British Bank in Saudi Arabia where he held senior positions. He returned in 1989 and held high posts at Emirates Bank, Middle East Bank and Muslim Commercial Bank.

In 1997 when Amana Investments Limited was inaugurated as the pioneering Islamic financial institution in Sri Lanka, Mr. Marikar joined them as the first Managing Director.
He contributed a great deal to this organization and left their services in 2004.

As an authority on Islamic Banking, he contributed a great deal in formulating the course of studies in Islamic Finance and Banking, when the Faculty of Islamic Studies and Arabic was established at the South Eastern University of Sri Lanka. He is a visiting lecturer

Mr. Marikar’s advice as a Consultant in Islamic Banking was sought after by many banks and finance companies who have introduced such facilities.

 

 

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