The dilemma over Islamic banking

Islamic banking industry is a small portion of the entire conventional finance industry, which is currently growing exponentially at a rate of 15 per cent, according to Thomson Reuters Islamic Finance Database. In fact, Islamic banking is a model where depositors are supposed to invest their money in a partnership contract basis provided that the profit and loss would be shared based on their contractual outcomes. Needless to say, it is a business contract. This kind of banking will not be affected by the liquidity crisis, which has recently been the hot topic in the media, as the capital is locked for a certain period of time. Surprisingly, this is not the real scenario as the partnership contract yields uncertain outcomes.

Inversely, when we come to the asset side, banks are supposed to invest money in the products or project, which are exempt from the prohibition of Islamic jurisdiction. As usual, banks can have either a substantial profit or the other way round. Thus, there is a prevalence of rate of return risk that is not accepted by the Islamic banks as they have to maintain depositors in the liability side by giving a stable rate of return. To safeguard their own standing, banks prefer to have a project or investment where the rate of return is fixed or pegged at a certain rate of return or sometimes variable rate of return by maintaining a shield. Unfortunately, due to this reason, Islamic banks are deemed as the other side of the same coin, that is, mainstream banking.

There are a good number of full-fledged Islamic banks in Bangladesh. Although there are some issues, Islamic banking in the country is still doing relatively well compared to international Islamic banks. However, one of the widespread notions is that an Islamic bank is not Islamic if it deals with fixed rate mechanism (alternatively known as interest or riba). There is no other issue apart from this. A big question that remains unanswered: who will invest their money by getting into a partnership contract to accept outcomes related with ideal Islamic Banking?

No depositors will welcome this proposal. Even entrepreneurs with a prospective project are unwilling to take financing from banks, based on partnership contracts. Therefore, the most likely stance is that the bank itself should come out with its own money to maintain depositors and be known as fully Islamic. This is an irrational notion as the bank is just an agent authorised by the financial authority to act like a bridge between the borrower and the person lending. It is ultimately upon the stakeholders of the banks especially the account holders. They would need to be willing to be in partnership contracts with banks, if they want to keep their money in a true Islamic bank.

There are other factors as well including difference in accounting methods, regulatory guideline, and legal system. It should be understood that Islamic banks, or so-called participatory banks, are passing through a fragmentation phase. Soon there will be a coordination phase followed by consolidation phase. These phases are faced by almost all major industries. In the end, it all depends on the depositor and investor.

Md. Hakim Ali, a Research Associate at Taylor's University Flagship Project, is doing Ph.D at the same institution and he is also a member of the Chartered Institute of Islamic Finance Professionals (CIIFP), Malaysia.

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