The case for separate Act for Islamic banking

Islamic banking, which shuns interest in its operational mode, has gained popularity all over the world. Though this banking has its root in Islamic religious faith that prohibits interest in any form, it can be adopted, and in fact, has already been adopted by most other banks in the country.

Nowhere is it written in modern economics that banking cannot be done without interest. Interest is a price for borrowing and lending. The banks pay this price to the people who deposit their money with the banks and ask this price, i.e., interest at a higher margin from the persons who want to use the same. The difference between these two prices or interests is the gain for the banks. Banks do the business with other peoples' money, and as such, they have to pay a price for this money which they in turn realise from the borrowers of this money. Interest rates remain fixed, but no always, it all depends on the agreements the banks sign with the concerned parties. However, be it fixed or flexible, it has little relation with the profit or loss of the business of the borrowers. Interest all over the world is, to some extent, a collateral backed price, i.e. the borrower is to provide some sort of guarantee or collateral against the money he borrows from the banks or other types of financial intermediaries. This is asked by the banks, lest the borrower fails to pay back the borrowed money. In this way, banks feel secure, but the borrower is on his own in respect of his business's profit or loss, the bank does not accept any part of the liability of the borrower's business loss. The risk of doing business by borrowing money absolutely lies with the borrower himself, the banker only waits for the money he had lent to return to the bank.

This type of banking is an age-old practice, and is in existence since the time people came to learn that there was a scope of making money by lending the same to those who needed it. Interest-based banking is still dominant in the world and it will remain so unless the major global banks seriously think of an alternative mode of banking.

In the eighties of the last century, some Islamic scholars took the bold step of setting up a different kind of banking which, instead of interest payment, was based on the principle of profit-loss sharing. That is, this type of banking shares both profit and loss of the business for which the money was borrowed from the bank. In the same way, Islamic banking pays a variable profit or no profit at all to the depositors. The banks act as the intermediaries in passing over both profits and losses to the depositors. The depositors also know they are to receive no fixed return or anything called interest, they are to accept a part of the profit from the businesses financed by their money through Islamic banking.

In a competitive economy, though these two variables -- profit from the deposits with the Islamic banking and interest from the same with the traditional banking-- should converge at the same rate or close to the same rate, the differentiating point is that in the former the risk is also shared by the depositors.

Islamic banking has over the years expanded its base from one country to another where Islam is the predominant religion. It has become hugely popular with people of Islamic faith. As for others, it is also popular because in some cases, they receive better return than the interest. Many non-Muslim scholars also promoted the idea of Islamic banking because they think the system is more equitable and also stable. Nowhere in the world, Islamic baking needed recapitalisation by the state, and failures in businesses funded by such banking were minimal.

Some countries, which adopted Islamic banking alongside the conventional banking already enacted separate laws to regulate this banking. In Bangladesh this type of law is still absent, though one-fourth of the country's banking market has already come under such banking.

Islamic banking is finding difficulty in doing business in inter-bank money market and also in buying and selling of interest-bearing Treasury bills and Bonds from the central bank. Islamic banks are now being deprived of the profit from holding the financial instruments they are to hold under the present regulation. In such a situation, what the Bangladesh Bank could have done is to use Islamic banks' money separately for investment purposes and then pass over a part of the profit received from such investment to the Islamic banks. But using Islamic banks' money for investment purpose by the Bangladesh Bank will not be easy, in the absence of a defined Act. Also, Islamic banks cannot do any business in the inter-bank money market unless such market offers an option of profit-loss sharing. Here, too, a regulation based on a separate law is needed. For issuance of 'Sukuk'-- the Islamic bond, the law is more urgent.

Bangladesh has eight full pledged Islamic banks and few more are also trying to go Islamic. Besides, as many as fifteen conventional banks, including those belonging to the government have separate Islamic banking windows. Some new banks want to go Islamic because they think there is a demand for such banking with the people. Also, they do not want to see that the NPLs (Non-Performing Loans) pile up every year at a higher level under the traditional banking system. Not a single Islamic bank in Bangladesh is sunk in bad debt. If other countries having Islamic banks can enact separate Acts for such banking, Bangladesh also can do the same. The present Company Act could have included a separate chapter for the purpose. Anyway, the economy needs a separate Act for Islamic banking.

The writer is Professor of Economics University of Dhaka.

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