“Gotong Royong” Bank?

To the uninitiated, the term “gotong-royong” means cooperation in Bahasa Malaysia. It is a concept where the community may come together to assist its community members without expectation of returns. In Malaysia, this is a community event to achieve a certain purpose for example a village wedding.

But how about having a “gotong-royong” Bank? Ms Rozana Gulzar, who contributed an earlier article on this site, made this interesting proposition that while the current Islamic Finance system set-up based on the conventional banking model is working sufficiently, a different model of banking may provide a closer structure espoused under the Maqasid of Shariah (Objectives of Shariah). A more inclusive and less profit driven model? It may provide a refreshing alternative to the existing financial system. Maybe not as a full 100% replacement of the existing models (where it caters for a large scope of requirements) but to complement and complete the Islamic Banking financial infrastructure.

Read about what she wrote below, as well as her earlier writings on this site.


DOWNLOAD : Cooperative Banking as the Solution for Islamic Banking Woes (pdf)

Excerpt from Rosana’s being cooperative:

While there are some differences in the models of cooperative banks in various regions of the world, a basic common feature is that they are owned by members, who in turn tend to be their depositors and borrowers. That’s mutuality built right into the system. This form of ownership then sets the tone for a business model that is more Islamic than ‘Islamic’ commercial banks. For example, because cooperative banks are owned by members who may be their borrowers, profit maximisation is not the main objective. Their raison d’être is in fact to charge reasonable enough rates so that those who cannot get financing from blood-sucking commercial banks can do so through the cooperative banks. And yes, they are not Islamic in form but I think they are more Islamic in spirit.

Bankers of cooperative banks are also known to have close relationships with their customers. A Turkish German once told me that his neighbourhood banker would come regularly for tea. When he notices a child in the household is old enough for a bank account of his own, the banker will ask the parents if he should indeed open one for him. Germany by the way is home to the largest network of cooperative and savings banks in the world. This close relationship has important implications. One it answers a call by some quarters for a move towards relationship-based banking as opposed to the transactions-based frenzy that characterises commercial banking and has been blamed for the crises. Secondly, it addresses a key issue that has been plaguing Islamic finance since its modern birth: How to implement profit and loss sharing (PLS) contracts such as musharakah and mudarabah which are at the heart of an ideal Islamic financial system when early attempts failed due to moral hazard and adverse selection issues.


Additionally, she makes a call to academia to rise to the occasion of re-looking the existing model and having more research to support the building of the new model. She throws the challenge that the road is still long and hard and only the ones who are able to persevere will make a difference.


DOWNLOAD : Islamic Finance Academia – We Can Do Better (pdf)

Excerpt from Rosana’s war cry to Academia:

Firstly, we need to address the controversies. Islamic finance is suffering from a dichotomy between theory and practice. What is taught in schools is a world away from what is being practiced. While ‘Islamic’ bankers keep an almost sole focus on producing the best ROE for shareholders, at the obvious expense of social welfare, Islamic finance professors go on and on about the ideals that shape this form of finance, oblivious to the divergence in practice. It is thus not surprising that the ‘solutions’ they come up with have no semblance to reality. I keep thinking, ‘We are not yet in jannah so how will this work in the real world?’

To come up with better solutions, I think we need to first face facts. Don’t gloss over them. I would prefer an honest (and mature) discussion of how we have gone wrong in Islamic finance and how to address them. This obviously needs rigor in thought and analysis. And critical thinking. Just because someone is from the IMF or World Bank does not mean he knows what he is saying or his intentions are purer than pure. We still need to evaluate the rigor of his arguments. On the other end, those who do not understand Islamic finance need to keep silent. The problem in Islamic finance is that we have many talking heads who really sound like empty vessels. And you know what they say about empty vessels right? (They make the most noise).


I like to make the same challenge to my staff as well; 90% of the practices we see today are derived from decisions, opinion and fatwa made in mid 1990s and has been taken as Urf (custom) and not challenged anymore… but we should re-look at some of them (especially with standing controversies) and see if current regulations and Shariah Advisory Council resolutions and product thinking and market development can offer a better solution. Doesn’t Islamic Banking allow for intelligent discussion to always evolve into something better? Just because it has now become Urf, it does not mean there is no better solution and be happy with the status quo. There’s always room for improvements to this 30 year old industry.

The purpose of this website is to encourage constructive discussions and perhaps find a better solution to the existing ones. Let’s have your views on these topics. Have a read of Rosana’s writing and I know she appreciates honest feedback on her work. Do spend that time reading, and your comments may perhaps resonate in someone’s mind and change the world.

To go to Rosana’s page, click here.

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The Difference Between Islamic Banking Financing and Conventional Banking Loans

I know the title of this post is a mouthful, but I am insisting on the title. Simply because today I came across another round of bashing by individuals on Islamic Banking. Again, the contention is that Islamic Banking is no different from conventional banking; worse still it is claimed that Islamic Banking is more detrimental than conventional banking. How can this be? I watched the video and aghast by the level of ignorance to the nature of Islamic Banking. And gauging from the response by the rest of the audience, it seems that the audience themselves knows no better.

It seems that a lot of individuals are still unconvinced about Islamic Banking. Furthermore, the impression that it is worst-off than conventional banking needs to be addressed. Islamic Banking, while on the surface is still banking, but it is built on a totally different foundation. There are significant difference which is brought about by a single requirement; Shariah-compliance.

THE STRUCTURE 

The basic difference between Islamic Banking and conventional banking is the structure of how the Bank is set up. For a conventional banking, the purpose of set up is to collect deposit and to give loans. This is the shareholders understanding of what it should be. 2 very distinct function ie Collect Deposit and Give Loans, and the arrangement is managed by a Treasury function which tries to balance the returns to shareholders’ funds.

Conventional Banking Structure (Diff)

But what is Islamic Structure then? In essence, how an Islamic Bank is supposed to be set up is based on the theory of “Sources and Application of Funds”. There should be a single flow between the deposits and the financing / investment use of funds; this means there is no distinct function. It is a single function where customer deposits or investment pool is used to fund financing portfolio or deploy into investment instruments, from which returns are derived and recognise. Once the returns are determined, these returns are “shared” between the Bank and the customers (deposit/investment). This “Profit Loss Sharing” structure demands a different way of managing the Bank, although not all Islamic Banks are able to successfully pull this off 100% (especially when the Islamic Banks are still under the parentage of a conventional bank).

Islamic Banking Structure (Diff)

In my personal view, the structure of an Islamic Bank is most suited if it is built around the Mudharabah structure. It fits perfectly on how the Bank is to be managed. It should be the backbone of any Islamic Banks, where the set-up is linked end to end resulting in sharing of actual returns arising from a Shariah-compliant financing/investment activity.

Finally, the processes in an Islamic Bank and conventional Bank are also different, simply due to the structure of which it has been set up. There is a broader requirement for oversight and research required to ensure the Islamic products and services meets Shariah requirements. A lot more layers to comply with, a lot more details needed.

Islamic Banking Diff (Structure)

THE SHARIAH COMMITTEE

Shariah Committee is the most important difference between an Islamic Banking business and conventional Banks. It provides an oversight accountability in ensuring that all the operations of an Islamic Bank is consistent with the rules of Shariah.

Shariah Committee (Diff)

There is a huge layer of governance surrounding an Islamic Banking proposition. Whatever features that it offers, it goes through regulatory oversight by the Shariah Advisory Council of BNM, and stricter scrutiny  by the Shariah Committee whom are not under the jurisdiction of the Bank but reports directly to the Board of Directors. The decisions (or “fatwa”) given by the Shariah Committee will be held solely by the committee themselves, therefore there is a huge responsibility for them. The Shariah Committee must ensure their decisions have taken into account all requirements of justice, customer protection, compliance to Sharia, interpretation to customary civil practices as well as practicality of implementation. In short, decisions must be clear, defensible and without any doubt to its validity.

SUSTAINABLE MAQASID OF SHARIA

In Islamic Banking, matters really are determined by intentions. And the intention is to ensure the Maqasid (Objectives) of Shariah are met.

Maqasid

These Objectives are a key consideration in setting up an Islamic Banking operation. But it does not mean the operation of Islamic Banking and the deployment of its funds are for charitable purposes. It is still a business that needs to be sustained by investing in Sharia-compliant economic activities, therefore it is misleading to assume Islamic Banking is a holistic endeavor that “should not charge interest” or merely to “provide assistance to the ummah”. There are costs for running an Islamic Banking business, and as far as possible it should be at par to the costs of running a conventional banking business. Returns on Shareholder capital is also important to ensure that capital is continued to be invested into Islamic Banking for it to grow. With growth comes the ability to continue supporting the ummah. The key word is sustainable banking. You cannot grow or even survive if you are not competitive.

THE PRODUCT & CONTRACTUAL RELATIONSHIP

Designing and launching an Islamic product is not easy. The amount of work that needs to be done in relation to the fundamental difference between an Islamic Bank and conventional Bank. The fundamental difference is the totally different outlook on what happens after entering a contract. The contract between a customer and a conventional bank is simple; a loan where interest is charged upon over a period of time.

Key Diff - Product (Example)

But look at an Islamic contract. It is much more complex structure, but once determined, it really makes total sense. The contract defines the relationship, the relationship defines the responsibilities and subject matter, the subject matter defines the sequencing and ownership requirements for the use in an economic transaction, the transaction defines the rewards and returns on the completion of the contractual obligation. Cause and effect, risks and compensating return, action and rewards.

What usually confounds practitioners (whom are not well versed in Islamic Banking contracts) are the level of detail. Some may consider the issues discussed in an Islamic Banking forum as “petty” but others expressed amazement in the level on consideration undertaken during discussions. For example, an Islamic Banking forum would discuss the nature of loan (Qard) and responsibilities of Qard, conditions of Qard, transferability of Qard, conclusion of a Qard Aqad (offer and acceptance), dissolution of Qard and implications of Qard when attached to other Islamic contract. This level of discussion is missing from the conventional banking space where in their view is that a loan is an amount given to customer where it is to be repaid back with interest.

OVERALL SUMMARY OF DIFFERENCES

There really are differences between Islamic Banking and conventional banking, and there are some of us trying very hard to make a difference in the compulsion towards Riba’. As a summary, below are some quick differences I have compiled from my earlier days in the industry on the differences between the models.

Difference 1

Difference 2

Difference 3

Difference 4

DNA OF ISLAMIC BANKS

For me, the main difference between Islamic Banking and conventional banking is that the concept of justice to customer is not regulatory driven; it is conceptually driven by the idea of Islamic Banking itself. A lot of conventional banking practices are developed to maximize returns while minimizing risk, and risk-transference is a key consideration for conventional banks. Regulators have to be vigilant in ensuring conventional banking toe the line to protect customer’s interests.

Islamic Banking, in its DNA is intended more than just being profitable. It is meant to be providing service to support the activities of the ummah (Muamalat) defined within Shariah-compliant transactions. There are specific rules that must be followed; breach of these rules means the penalties are non-negotiable i.e. whatever returns gained from these breaches must be given to charity. Care and consideration is a must. Justice and fairplay is always important in a decision by Shariah Committee. Release of customers burden is a priority.

AVOIDING FITNAH

Many customers still lack knowledge of what Islamic Banking is all about. They collate biased and misleading information from truncated and unverified sources on the internet, facebook postings that intends to be malicious rather than presenting the true picture, and comments by individuals who make generalized comments on their experience which may well be isolated cases due to misinformation, misunderstanding or just plain ignorance to the fact. And yet these comments are sensationalized, made viral and deemed to be the absolute truth without further exploration or verification.

Cut and paste seems to be the easy way forward. Yet people forget the discipline that is practiced by the companions of the Prophet; you must verify the information by determining it all the way to the source of the information, up to naming the individuals who made the first comments, and deciding whether the individuals are trustworthy and of good standing. This discipline is lost in this world of over-abundance of unverified information in the social media where direct accountability is undetermined, and it has become increasingly difficult to separate untruth from fact.

I had always advised friends and critics alike to be careful of what they “recommend” when dealing with Islamic Banking due to the huge responsibility of such recommendations. If they are ready to criticise Islamic Banking as “same as conventional” or “open to back-door riba” without full understanding of what it really is, they should be ready to take responsibility for that. If their basis of stating as such is based on “viral whastsapp message” or “comments by third party islamic practitioners” or “explaination by insiders in the industry” or “commentary by blogs”, I do appreciate if we as practitioners can be provided with these “sources” for us to verify its accuracy. Many times I find the comments are based on partial information, taken out of context, outdated writings or information as well as just being malicious without proper basis or discussion. Some are not even Shariah related or relevant to Islamic Banking practices, just operational and processes defects.

Do think of the implications: Should a person make such comments that “Don’t take Islamic Banking products because it is not really Islamic and there is a lot of trickery to it”, and the person listening to that comment thinks “Owh then there is no difference between Islamic product and conventional riba banks’ product” and proceeded to take Riba-based loan products, the implication is that the person who made the comment had directly influenced another person, in my view, in making a wrong and sinful decision. Will that person be responsible for this act of “pushing another Muslim into taking Riba products”? It is a heavy burden to take, not just immediate but in the hereafter. So be careful when a person makes that comment.

And to imagine what will happen when the person who took the Riba product commented to another person (and another) that someone commented that “there is no difference between Islamic Banking and Riba Banking…” . It will become a tree with a massive root, grown by the single seed of the original “defective” comment by the first person.

MashaAllah

Hopefully those doubtful questions on Islamic Banking should be directed to Islamic scholars, Islamic banking practitioners or relevant academicians with stature, knowledge and qualifications before the ummah believes and spread untruth that will, in the end, become a disservice to the religion of Islam by spreading “fitnah”.

ISLAMIC BANKING IS EVOLVING

Evolution

Granted, Islamic Banking is a 30 year old structure, with many building blocks are still in progress. But it has not stopped evolving to existing times as and when new regulations and Shariah decisions comes into discussion. It is not perfect yet, but practitioners are aware of the difficulties of meeting all the requirements without enhancements and considerations to practicality. There is a misguided assumption that academia are aware of all the shortfall of Islamic Banking practices and the industry had turned a blind eye to these. Nothing can be further than the truth. Islamic bankers, Shariah Committees and BNM are well aware of all of the issues raised by academia as well as other practitioners, with the benefit of global awareness as well. In truth, practitioners know more of the issues they faced on a day-to-day basis, as compared to academia where some of the issues had already been resolved by the industry but not made known to academia.

Criticisms are always welcome, but ideally it should be constructive on how to improve. It is a heavy responsibility to ensure the differences between Islamic Banking (based on Shariah) and conventional banking (based on lending) are managed diligently. It is an on-going evolution that I am confident one day will reach its apex. Ideas are welcome and proposed solutions considered in earnest. And as I have always said to my product team; If you’re not part of the solution, then you are part of the problem. So, let’s be the solution that we had always wanted.

Wallahualam

My earlier postings on similar conversation:

  1. Consequence for Choosing Islamic Banking
  2. Shariah Banking in Malaysia
  3. Conversations on Islamic Banking in Malaysia
  4. Choosing the Right Options

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