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.


  1. Jct: If interest-free piggy banking dependent on finding scarce cash to lend out is beneficial, imagine how beneficial interest-free casino banking creating its own currency will be?

  2. I am afraid in the context of Islamic banking any kind of gambling is prohibited :-).

  3. Profit sharing is a nice concept but am afraid whether the shared profit is used for the good cause!! Will wait for your paper...
    - Suhas

  4. Thanks suhas, a valid concern but the concern would also be there if interest is earned instead. As a concept islamic banking is sound. Also these banks also do not lend to haram (as they call it) businesses like liquour, porn, etc that might be against the greater good in the society.

  5. Hi Prashanth,

    Not sure if these banks differ that much from the traditional ones. Much of the time the contracts are structured as leases, etc, but in reality they are economically the same as traditional banking loans. I can assure you that most of the investors in these products think of them as interchangeable with traditional loans. The true "profit-sharing" aspect is usually naam-ke-vastey. Depends on the bank and the Sharia board as well- its incredibly fragmented, and whats acceptable to one scholar may not be to another.

  6. Hi Shamir,
    Thanks for the post. Firstly sorry for the delayed response. Completely agree, economically it is just an adaptation of traditional banking, just structured differently. However there are some underlying rules like a it is based on underlying asset (not on derived secondary assets), kind of industry (mostly they participate in infrastructure projects), etc that govern the banking practice.