Sunday, September 04, 2011

Revisiting the Islamicity of "Islamic" banking

The questions you have posed are very important.  It is a good change from the numerous incoherent e-mails received on the IBF Net.

Your questions are rephrased below:

One:"Is today's Islamic banking system structurally different from Conventional banking?"

Two:"Can it or Does it behave differently from Conventional banking system?"

Three:"In my observation today's  Islamic banking system is just a subset of conventional super system and it cannot be any different from conventional system in the long run, i.e. it has to converge."

To answer Question One:
I don't think we have conceptualized the architecture of the Islamic banking system.  Our eminent practitioners have rushed into it (without a thorough plan of action) to make money  - they have managed to convince our esteemed Ulema to give them fatwas to circumvent the Shariah on issues (involving borderline ribawi contracts) - please see a further explanation below.

To answer Questions Two and Three:
Let us consider the case of the classic Murabahah contract.
Why is it allowed in the Shari'ah?
Allah SWT says in His glorious book (ie., the Quran) that He SWT has forbidden riba but allowed trade (2:275).

It has taken me a long time to realize that Allah SWT in His wisdom allowed Murbahah as it enhances the demand for a product in the real sector of the economy.  There is a paper by an economist, which states that credit sales typically help in the absence of financial markets.  The pricing of it is contingent on the price elasticity of demand for the product.   We all know that in the time of the Prophet SAW the economy was bare subsistence and there was no financial markets (ribawi or ghair ribawi). 

Now let us take the same issue further to a banking Murabahah, which involves a sale of goods in the financial sector of the economy (instead of a real sector) [some of my colleagues would call it a fictitious sale constituting a "Shari'ah arbitrage"].

If you work in the financial sector, which is highly integrated in the current economy you are compelled to price the banking Murabahah using a ribawi index - there is no choice.  This is where I differ from the Shari'ah scholars who espouse using a ribawi index - the rationale behind employing this index is because arbitrage will force the two returns to converge.

The end result is very important - the current so called "Islamic" banking system is not all Islamic (see Feisel Khan's 2010 critical paper in the Journal of Economic Behavior and Organization distributed in this net earlier).

The end result illustrates that we have really not understood the issue of riba (especially riba an nasi'ah).  If we had understood it, we would never adopt the banking Murabahah [and for that matter the Tawaruq]. 

To answer Question Three:

If the Islamic bank operates in the real sector of the economy then we need not use a ribawi index.  This is the focus of my current work.  You can ask me for a paper (Insha-Allah in about three months time and if i am still alive and not incapacitated in any way (especially from the ridiculing incoherent colleagues) - I will provide it to you.


Professor Dr. Muhammed-Shahid Ebrahim
Chair in Islamic Banking and Finance
Bangor Business School
Bangor University
Hen Goleg
College Road
Bangor (North Wales)
Gwynedd LL57 2DG
United Kingdom

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