03: True Islamic Banking is in a Cooperative Bank

By Dr. Rosana Gulzar Mohd

If you could reform Islamic Banks, how would it be? We would have to think along the lines of PLS since as described earlier, it is among the main tenets of Islamic Banking. PLS, if well-implemented, can result in higher financial equality and stability, thereby improving the economy. But experience shows that not everyone tells the truth so banks have been swindled. The solution perhaps lies in Germany, where for almost 200 years, cooperative banks have thrived. The way they focus on people as opposed to profits stands in stark contrast to our Islamic banks. This means funding projects that benefit the community and sharing profits with customers since they are also owners of the banks. This ownership structure has also kept non-repayments low.

Closer to home, the idea comes together even better in Indonesia, where for almost three decades, Islamic cooperative banks, performing commercial microfinance functions, have existed alongside Islamic social banks, which collect and disburse zakat, charity and waqf. Now a prominent scholar, Dr. Ascarya is calling for their integration to produce true Islamic banks. Indeed it is highly exciting since the proposed financial institution promises to take care of most of the Muslim ummah’s financial needs. And in conducting true Islamic Banking, it holds the promise of lifting millions out of poverty, thereby improving financial equality as well as growth and stability in the economy. The idea, which is embedded in Indonesia’s Islamic Economic and Financial architecture (2019-2024), may just be the right kick-start for President Joko Widodo as he begins his second term in office.

In a world dominated by commercial banks, Europe’s little known cooperative banks may actually be the ones that offer lessons for the reform of ‘Islamic’ banks. They were not created for the super wealthies of the world, the global corporates nor governments. They began at a time of great famine in 1848 when grief-stricken farmers and small business owners in Germany had no access to borrowings except through loan sharks that charged over 30% interest per annum. Moved, the founders of the cooperative banks decided to mobilise the collective power of the people to form a bank that they would jointly own and that would serve them. Two hundred years later, there are almost 1,000 cooperative banks in Germany with about 11% market share (by assets).

What makes these banks remarkable is how they have been able to use a PLS type of financing to foster start-ups so the less endowed or disadvantaged can earn decent livings. The conducive environment begins with the ownership structure where because owners are also depositors and borrowers, in essence, they are pooling their resources to support the economic endeavours of their members (another name for ‘owners’ since cooperative banks are organised like clubs) (See table below). And because the members’ dividends for their stakes in the bank depend on its aggregate profit, owners are incentivised to ensure loans are disbursed only to creditworthy borrowers and that due diligence is done to spot sustainable businesses for financing. These features have not only helped the less able in their community gain financing but have also made the German financial system more stable.

As with most things in life however, the path is not always smooth. Since the 2008 crisis, this model of banking has been under pressure from tightening regulations meant to curb the flagrant ways of commercial banks, the entrance of fintech companies and low or negative interest rates. Sub-zero rates threaten to upturn the norms in banking where customers expect reward for their deposits. Their loyalty may thus be at stake if cooperative banks start charging for deposits. As dire as these challenges may seem however, cooperative banks have survived for almost two centuries so more perhaps, can be said about their ability to adapt and thrive while remaining true to their community-oriented goals.

If we are convinced that cooperative banking is the way to go for (genuine) Islamic banking, the good news is that there isa working example right here close to home! Indonesia is an interesting case because for the longest time, its share of ‘Islamic’ commercial banking assets has been at 5%. Some call it the 5% trap but for me, it is a blessing. Commercial banks are the wrong place to be for genuine Islamic banking so I would be delighted even if this percentage nose-dives. Since Pak Jokowi took over, there seems to be new life breathed into the Islamic finance sector. There are now masterplans for Indonesian Islamic Economic and Financial architecture 2019-2024.

What is really interesting is that the way the Indonesians are developing their Islamic Finance industry seems very different from the GCC and Malaysia. Indonesia is learning (and learning well) from their mistakes. While those markets took the easy way out and mimicked riba finance, Indonesia is deliberating on how to build a more shariah-authentic finance that caters, not only to the large-scale (read: profitable) transactions in investment banking and capital markets, but also the masses. Here is how it can differentiate itself from the debris of fallen or ghost institutions in Islamic finance.

Indonesia has a large, mostly Muslimpopulation that is seven times more than Malaysia and Singapore combined. For almost three decades, Indonesia has had Baitul Maal (BM) and Baitut Tamwil (BT), which are Islamic social and commercial finance institutions. BMs handle zakat, waqf and charity while BTs are Islamic cooperative banks that issue microfinancing through profit- and loss-sharing contracts (PLS) as well as (genuine) murabaha. Together, they make up the BMTs, of which there are now around 4,500 in Indonesia.

The BTs practice what seems like more genuine Islamic banking because they support the community’s economic endeavours through (genuine) PLS, coupled with skills training and technical assistance. Indeed earlier attempts at PLS show that the people are grateful for this type of wholesome support as opposed to the arms-length financing disbursed by commercial banks. Past attempts also show that PLS-type of financings can lead to fraud or non-repayments. Dr. Ascarya explains that in the case of BMTs, these are mitigated through a pick-up service for individual financings and a group lending joint responsibility for group financings.

To maximise their synergies, Dr. Ascarya has called for the closer integration of BMs with BTs. A unification would for example, grant the BTs access to social finance funds such as zakat and waqf which can act as their long-term capital. This has multiple benefits. Firstly, it can reduce the BTs’ funding mismatch where liabilities (deposits) are mainly in small amounts and over the short-term while assets (financings) are in much larger amounts and over the longer-term. Secondly, it can reduce the BTs’ reliance on costly financings from Islamic banks, thereby lowering their cost of funds. Thirdly, the cash injection can reduce the BTs’ credit crunch during high demand seasons such as Ramadhan and at the start of school years.

Broadly, Dr. Ascarya is also calling for the integration of Islamic commercial with social financing toproduce wholesome Islamic banks. The marriage, according to him, will overcome weaknesses that each banking institution suffers as a result of being apart from the other. Current Islamic banks can for example, find the solution to their perennial funding mismatch problem in the zakat and waqf funds. They can in turn help the BMTs who suffer from a lack of management, human resource and IT skills.

Indonesia is indeed among the few countries with conducive regulations for such an integration. Its Islamic Banking Act No. 21 of 2008 not only allows Islamic Banks to conduct commercial finance but also explicitly support their social function through a baitul maal that manages zakat, waqf, infaq and sadaqah. This makes perfect sense if we want to unleash the full potential of Islamic finance. Indonesia’s Ministry of Cooperatives and SMEs also allows BMTs to jointly conduct Islamic commercial and social finance. The problem however with Indonesia has been deliverability. Let’s hope this time it will be different since President Jokowi himself is overseeing the national Islamic finance committee and the industry seems guided by sincere brains. I look forward to contributing since coincidentally, I am headed to Jakarta for an Islamic Economics and Finance conference. Exciting times indeed.