Banking On Faith

Islamic banking is becoming increasingly popular in Asia. More financial institutions are offering Islamic banking services to their customers. Consider this, Islamic banking car loans in Malaysia grew by almost 20 percent in the 12 months to May this year. In Indonesia, the number of bank branches offering Islamic financial services has nearly tripled in the last five years.

Asia is not alone in seeing huge growth in Islamic banking. According to Moody’s, worldwide demand for Islamic financial products is expected to surpass $1 trillion in value this year. While the Arab Gulf region still dominates this industry, Asia is catching up quickly.

According to Bloomberg, the region made up 68 percent of the nearly $8 billion of Islamic bonds or sukuk sold globally this year. Malaysia has emerged as Asia’s leading Islamic financial centre, being the world’s biggest issuer of Islamic bonds. Islamic banking in Malaysia has a 20 percent market share, compared with 35 percent in the Gulf States.

What is Islamic Banking?

Islamic banking has two edges to it. It’s banking specifically catered for Muslims who need banking facilities but want to ensure that the tenets of their faith are maintained.

It can also be viewed as ethical banking – a fiscal option that has been available to customers in the West for some time. Ethical banking, among other things, keeps away from investments in some of the arms areas or the defence industry. Islamic banking has similar value sets.

Islamic banking differs from conventional banking in that it is based on Shariah law. A central theme of Shariah law is the prohibition of charging or paying interest. Badlisyah Abdul Ghani, Executive Director and Chief Executive Officer of CIMB Islamic Bank Berhad, one of Asia’s most established banks providing Islamic financial services, explains, “The reason for the difference is predominantly because conventional banking involves the act of charging money on money through a lender-borrower relationship or an IOU relationship known as Riba, while Islamic banking does not.” Banks also don’t profit from late payment penalties – if they charge penalties, these have to be donated to charity.

All Islamic financial institutions have Shariah Committees made up of academicians and Shariah experts in Islamic banking and finance. Muslims are encouraged to save, borrow or invest according to the guiding principles of Islam, but there are no restrictions on who can participate.

Islamic Banking Products

There are several products and services available under the Islamic banking umbrella, ranging from bank deposits to credit cards, investment and insurance. Here are some of the most popular:

Mortgages and Car Financing Typically, the bank enters into a Murahaba or Ijarah financing contract. In a Murahaba financing contract, the bank will buy the item in question (property or vehicle) from a vendor that the customer is dealing with, then sell it to the customer at an agreed marked-up price. This price is payable in instalments. In an Ijarah financing contract, the bank will buy the item from the vendor, then lease it to the customer for a period of time with an option for the customer to buy the goods at the end. The lease rental is payable on a periodic basis, upfront or at maturity, depending on the agreement.

Investment Funds Islamic funds only invest in companies that engage in moral economic activity, similar to socially responsible funds (SRF). Islamic fund management aspires towards a different asset allocation using investment criteria that is based on Shariah law. In general, they are not allowed to invest in companies whose businesses include alcohol, tobacco, gambling and pornography. On top of that, these funds can’t buy shares in companies that deal with pork or conventional finance (i.e. firms that charge and pay interest such as banks and insurance companies).

Leong Sze Hian, past President of the Society of Financial Service Professionals, advises that Islamic funds aren’t risk-free. “Do not assume Islamic means lower risk because it could end up being higher risk if you don’t understand the exposure of the funds.” He says basing your entire portfolio on Islamic funds would not give you enough diversification.

Bank Deposits Banks take deposits under various products. There is the Mudharabah deposit where the banks enter into a joint venture with the depositor and share the profit generated. Also, there is the Wadiah deposit where the banks may give you a hibah (gift) instead of paying you interest.

Takaful (Islamic Insurance) Under this form of insurance, a group of people mutually share loss or damage with one another by contributing to a fund that is managed by a takaful operator. In this sense, the risk is shared with the group or community.

Compared with conventional banking, Islamic finance has a risk-sharing intermediation structure and transparency is a codified requirement in some financial transactions. There are no hidden costs in Islamic banking, says Badlisyah, so for the customer, what you see is what you get.

Furthermore, he adds, you enjoy the same rights and protections as under conventional banking. “What is important to note is that both industries are equally regulated by the same banking regulator and the rights of the customers are equally protected.”

Both local and foreign players are active in this region’s Islamic banking sector, with Malaysia having one of the most competitive landscapes.

Local banks, such as CIMB Islamic Bank, compete with the Islamic banking arms of global financial institutions like HSBC Amanah and Standard Chartered Saadiq. While Malaysia may have the most developed Islamic banking sector in the region, its neighbours Singapore and Indonesia are trying to encourage more development in the industry.

Indonesia plans to give small and medium-sized companies more access to Islamic lending, as well as increase tax incentives for Islamic banking services. Although it has the world’s biggest population of Muslims, Indonesia has come late to Islamic banking. Authorities there recognise that and are working to improve the regulatory and legal framework. It’s all part of the country’s plan to establish a dual banking system – conventional and Islamic – to help cushion the effects of an economic or financial crisis.