Punch Q & A: What is this Islamic banking caper?
A News Ltd survey of Australian imams unearthed a renewed call for the recognition of sharia banking in Australia. At The Punch we weren’t really sure what that meant, so we asked expert in Islamic banking Dr Hussain Rammal, a lecturer in International Business at UniSA, to talk us through the basics.
What are the main differences between Islamic banking and Western banking?
The main difference is in the way the two systems deal with money. Under the Islamic economic system money is seen as a medium of exchange and has no intrinsic value. Therefore charging a higher rate of return (interest) on lend money does not sit well under the Islamic system. Islamic financial institutions use an asset-backed system where they purchase the assets on behalf of their customers and then use various financing agreements to on-sell the asset to their clients. These include profit-and-loss sharing, leasing and hire-purchase, and mark-up based agreements.
The Islamic financial system also prohibits transactions that may allow investors to benefit from speculative behaviour and bans investment in industries that are seen as harmful to the society (for example, ammunition manufacturing, and pornography). Many industry experts believe that the highly structured nature of the Islamic financial products controls for the speculative behaviour of investors and is one of the reasons why the Islamic banks have performed better during financial crises than their conventional/Western counterparts.
What are the benefits of Islamic banking (for individuals and for Australia)?
For members of the Muslim community in Australia who have in the past stayed away from dealing with conventional banks due to the interest-based transactions, the Islamic banks provide an opportunity to own a home or fund a business venture. Islamic banks also provide benevolent loans (known as qard-e-hasan) to the needy for payment of medical bills and other pressing needs.
At the national level, the establishment of Islamic banks will allow Australia to attract investment of petrodollars from the Middle East. A number of companies in the Middle East are seeking international ventures for investment and prefer to work through Islamic banks. This is one of the reasons the British government permitted the establishment of the Islamic Bank of Britain. Australia has been identified as a strong market for investment in a number of ventures including the Real Estate Investment Trusts (REITs). Setting up appropriate banking infrastructure will allow Australia to gain a much larger share of this $1 trillion global Islamic finance sector.
Are they purely based in Sharia law or are there other influences? Is it truly ‘Islamic’?
The interest-free financing system pre-dates the advent of Islam. Arab traders in the pre-Islam era used profit-and-loss sharing agreements to fund their business activities. The Qur’an prohibits the use of interest in financial transactions and to fulfil this requirement Islamic banking professionals have developed a number of financing options. The Islamic features of a financial product are verified by the bank’s resident religious scholar (Sharia advisor). While there can be minor differences in opinion on certain aspects of the financing products, on the whole the Sharia advisors agree that the current Islamic banking system is consistent with Islamic law.
Do you think the majority of Muslims would prefer Islamic banking?
The first commercial Islamic bank was established in the mid-1970s (Dubai Islamic Bank). So the commercial application of the system is relatively recent. Studies that have surveyed the Muslim population in Islamic and non-Islamic countries indicate that majority of Muslims in the retail banking sector would prefer Islamic banking products.
However, in practice the Muslim population has been slow in converting to the Islamic banking system. Part of the reason for this is the lack of knowledge about the Islamic banking system and inconsistencies in application by different banks. In countries like Malaysia and Pakistan, which are regarded as pioneers in the sector, the Islamic financial system represents only a small share of the overall banking market. This figure is expected to rise as more awareness about the system is being created through the print and electronic media.
What legislative or regulatory changes would be needed to allow Islamic banking in Australia?
In Australia there are a few institutions that offer Islamic financial products. However, due to the tax and regulatory requirements in Australia, these exist as co-operatives rather than banks. The main issue relates to tax treatment of assets. Since Islamic banks purchase the asset on behalf of their clients before on-selling it to them, they are burdened with paying taxes every time the asset changes hands. This can be expensive when dealing with home purchases as Islamic banks would be double taxed.
The Board of Taxation in Australia has been reviewing the tax treatment issue and released a discussion paper in October 2010. The board sought advice from industry experts on what potential changes could be made to accommodate the Islamic banking and finance sector in Australia. The final report has been submitted to the Assistant Treasurer and is yet to be released to the public.
People are concerned allowing Islamic banking would mean a foothold for other religious-based laws, do you agree this is a concern?
This fear is misplaced. Islamic Banks operate in a number of non-Muslim countries including Singapore, and the United Kingdom. The concern in Australia stems from a lack of understanding about the system, and ill-informed opinions about the funding activities of Islamic banks.
As a trillion-dollar industry it would be a folly to think that the Islamic banking system merely fulfils religious requirements. Islamic banks face the same level of scrutiny as other commercial banks and compete with Western banks for a share of the market. They are therefore no different to any organisation that targets a niche market opportunity.
People are obviously excited by the idea of ‘interest-free loans’, would non-Muslims be able to access such a product?
The Islamic financial products are available to anyone regardless of their beliefs. For example, in Malaysia many non-Muslims use Islamic financial products.
Is ‘interest free’ just a marketing term, as the bank still turns a profit through other mechanisms?
While the earning of interest is prohibited, Islamic banks are permitted to make a profit. But this profit has to be linked to risk. Islamic banks earn profits through profit and loss sharing agreements, charging mark-up, and rental income through the lease agreements. In all of these transactions there is risk that the venture may make a loss which the bank would have to bear. Unlike conventional/Western banks, Islamic banks cannot be guaranteed a fix interest return and their earnings are directly related to the risk.
The industry does face criticism that some of the products used by Islamic banks charge ‘interest’ under the guise of ‘profit’. This criticism is not just from people outside the industry but also from some who operate within it. The industry is still in its infancy and the establishment of regulatory agencies such as the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB) is an indicator that the industry is attempting to address these concerns.
Hussain Rammal is a lecturer in International Business at the University of South Australia. His research interests lie in the areas of Islamic banking and finance, trade in services, corporate governance and cross-cultural management.
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