Monday, January 18, 2010

Views: Islamic Banking


I wanted to write the first blog of the year about a banking practice that is based on ethics. About 8 years back I had first heard about Islamic banking from Mr. Srinivasan, then the vice president at i-flex. He described Islamic banking as 'Allah gives and Allah takes', an interest free banking practice. For a long time it stayed in my mind as a funny cultural and unsustainable practice that was funded by the crazy oil rich Middle Eastern states. But, since my interactions with banks in Saudi Arabia, UAE and Bahrain, etc I started to better understand the underlying principles of Islamic banking. According to the holy Koran, the Shariah is what is acceptable to Islam. There are a set of Islamic values that are in general applicable to all practices of trade and also applied to the banking practices. Shariah prohibits interest or a time value for money. Money as such is not a marketable commodity, but an instrument that can be only put into productive use based on the values of shared risks and benefits. Therefore most Islamic banking products are structured on the concepts of trade with profit sharing agreements. These ethical values make so much sense today after the global meltdown where billions of dollars were pumped into unproductive assets in the secondary markets. Traditionally Islamic products mostly were consumed by the government sectors and Islamic businesses houses. But today the popularity of these products has been growing not only in the Middle Eastern countries but also in parts of south East Asia and Europe. There also are non Muslim retail consumers increasingly signing on to these products.

Most banking products have an equivalent Islamic banking counterpart across retail, commercial banking, trade finance etc. The products are structured based on the trade concepts of Mudharabah(profit sharing), Musharakah(joint venture), Murabaha(cost plus), Ijarah(leasing), ujr(fee), Kafalah (guarantee), Takaful(Islamic insurance) etc, etc. Every islamic bank is mandated to have a Shariah board that overseas the product management, product development and operations. The Shariah Board periodically reviews, reports and vets on the various pricing, product structures, revenues, etc. Globally there are only a handful of dedicated solutions for Islamic banking practices. Most Islamic banking software solutions are adapted applications at best. I am writing a paper on the challenges existing in these banks today and how technology solutions could help to address those.