ISLAMIC BANKING: IS IT REALLY “ISLAMIC”?

By: Omar Mustafa Ansari & Faizan Ahmed Memon

Is it really Islamic? …. In this era of development and growth in Islamic finance and
banking, this is a question being raised at every forum by various quarters. All those who
raise this question, are undoubtedly well-wishers of Islam, Islamic economic system and
Muslim Ummah. Accordingly, while we celebrate the achievements of Islamic banking on one
hand, we should not be ignoring the issues and objections being raised by such quarters in
order to ensure that we lay the foundations of this industry on strong, straight and
acceptable-to-all footings.

Objectives Of Islamic Banking

Before discussing various objections raised on the present day Islamic banking, we
should first try to understand the objectives of Islamic banking, which are as follows:

1. To provide Shariah compliant and prudent banking opportunities; hence providing an

opportunity to Muslims to do their banking transactions – a Halal way: In other words,
this is just an effort to avoid Riba and other prohibited elements from commercial and
banking transactions, in order to ensure that we do “Nothing-Haram”; and

2. Achieving the goals and objectives of an Islamic economic system.

We all can agree that, given the circumstances, the Islamic banking industry is making
all efforts to ensure the first objective, while the second objective, although no-less
important, is not the prime objective of current-day Islamic banking.

History Of Islamic Banking

Modern banking system was introduced in Muslim countries at a time when they were
politically and economically slave to the western world. The main banks of the western world
established their branches and subsidiaries in the Muslim countries and territories to fulfill
requirements of foreign business. The Muslim community generally avoided the foreign banks
for religious reasons but with the passage of time, it became more and more difficult to
engage in trade and other activities without making use of commercial banks. Even then, a
large number of Muslims, confined their involvement to transaction activities such as current
account or hundred percent cash margin letter of credits. Borrowings from commercial banks
or placement the access funds and saving accounts were strictly avoided by practicing
Muslims in order to keep away from dealing in interest which is prohibited by Islam.

With the passage of time, however, due to increase in cross-border transactions and
other socio-economic forces demanding more involvement in national economic and financial
activities, avoiding the interaction with the banks became impossible. Local banks were
established in Muslim countries (including the names like Muslim Commercial Bank) on the
same lines as the interest-based foreign banks and they began to expand within the country
bringing the banking system to more and more people. Governments, businesses and
individuals began to transact business with the banks, with or without liking it. This state of
affairs drew the attention and concern of Muslim intellectuals which gave emergence to the
contemporary Islamic banking. By the midst of the last century, many Muslim countries
started their efforts to adopt the Islamic economic and banking systems. Many scholars,
economist and experienced bankers came with different solutions to initiate the Islamic
banking. Those experiences paved the route for modern Islamic banking.

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 Nowadays Islamic financial institutions (IFIs) are spread all over the world including
European countries and the United States. In particular these have their significant presence
in Pakistan, Saudi Arabia, Bahrain, United Arab Emirates, other GCC countries, Malaysia,
Sudan and Iran.

Who Raise The Questions?

Islamic banking is a weak industry…. In respect of resources, in respect of knowledge-

bases, in respect of trained-knowledgeable-sincere human resources, in respect of availability
of commercial options, in respect of state support, as well as, society support, in respect of
sincerity of stake-holders and WHAT NOT. With such adverse footings, unfortunately, it really
has certain weaknesses which are not only targeted by the enemies, but, are more severally
and forcefully attacked by the FRIENDS. As a consequence, the Islamic banking and finance is
facing disagreements from various quarters including certain “revolutionary” Islamic
movements, certain “rigid” and “hard-core” religious scholars, and “idealistic” and “utopian”
Islamic economists (without any disrespect to them all).

Can Banking Ever Be Really Islamic?

The first question is raised mostly by those who either do not have any knowledge
about banking, or those who have the courage to evaluate the banking systems from its
evolution to its objectives. They feel that the banking per-se is against the very basic
concepts of Islam. They feel that just like the fact that there can not be any “Halal pork” or
“Islamic prostitution”, there can be no “Halal banking”. This viewpoint is supported by the
fact that, particularly in Pakistan, we have already faced a complete disaster in the name of
interest-free banking and so-called IFIs particularly including Modarabas.

The argument, as to whether Islamic banking is really Islamic, has two different facets.
The first one is that whatever is being performed in the name of Islamic banking is apparently
quite similar to the operations of a conventional financial institution hence creates doubts in
people’s mind, as to on what grounds we can call it Islamic? So they feel that it is merely a
change in name and documents and in fact, it is nothing different from conventional banking.
The second facet of this question is more important and deals with the socio-economic
factors associated with the overall Islamic financial system. Due to significance of these
objections, we will discuss these two issues before looking for other arguments.

Merely A Change In Name And Documents

The most common and most discussed argument against contemporary Islamic
banking is that there is “NO DIFFERENCE AT ALL” between the conventional banking and
Islamic banking and this is merely a change of name and documents. The second argument,
which is in-fact a derivative of the first argument, is that even in Islamic banking, the most
common products being used e.g. Murabaha, Musawwama, Salam, Istisna, diminishing
Musharaka and Ijara Muntahia Bittamleek are on fixed return basis. Even the Musharaka and
Modaraba based products are engineered in a way that the profits are “virtually-fixed”.

One should realize the fact that unless we can distinguish an Islamic bank from a
conventional bank, it would be difficult for any of us to rely on the same. Particularly, it is
observed that they try to make sure that their product is similar to the conventional products
in all respects, even if for that purpose they have to incorporate a few provisions in these
products which are not considered to be good or a few of them are considered Makrooh. In
addition, their endeavors are focused towards minimization of their risk through every
possible option and accordingly, the essence of Islamic finance which is based on risk taking
is killed.

We can note that most IFIs market their products on the models very much similar to
those used by the conventional banks. As an example, an Ijara Muntahia Bittamleek
transaction introduced by an IFI might be very similar to a finance lease transaction offered

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by a conventional leasing company, except for a difference of Takaful / insurance cost which
in Islamic mode is to be borne by the lessee and accordingly, the same is built-in the rentals.

The basic reason behind this similarity is to ensure three objectives. The first one,
which is more important one, is to provide an “even playing ground” to the IFIs in order to
ensure their survival in the overall banking system. The second one, is that even by IFIs, it
has to be ensured that their shareholders and depositors get some return and preferably a
return equivalent to those of conventional banks. And the third reason is to avoid arbitrage
amongst Islamic and conventional financial systems which may be exploited by a few big-
guns to get the benefit of the pricing difference between the two parallel financial systems.
For such reason, time value of money concept is used for performance measurement and
pricing of financial products.

Most importantly, it should be kept in mind that in some areas Haram and Halal have
a very small difference. For an example, only saying the name of Allah Almighty on an animal
at the time of slaughter makes it Halal and permissible while by not saying that name we
make it Haram or by just a few words of acceptance in Nikah, in presence of a few persons, a
man and woman become Halal for each other. Similarly, if a transaction can be engineered in
a way that the same becomes Shariah compliant, then we should not conclude that the same
is Haram only due to its resemblance with the interest based financing.

It is also pertinent to note that since the Islamic financial services sector is in its
infancy phase, as compared to the conventional banking, we unfortunately have to follow the
conventional system in the pattern of financial products and are still not in a position to
invent absolutely new financial services. During the last few centuries, the conventional
banking system has well read the human needs and psychology and has invented a
considerable number of financial products and accordingly, it is not simple to just invent a
new financial tool just for the purpose of inventing one. For example, if they have running
finance and overdraft as a financing tool, we have invented an alternate to the same in form
of Istijrar with Murabaha or Musharaka based running finance model. Similarly, if they use
finance leases as a financing tool, we have converted the same in a Shariah compliant form
in form of Ijara Muntahia Bittamleek or in form of Diminishing Musharaka. These are only two
examples, but the tally is practically very high and for each interest based financial product
except for those explicitly Haram, more than one alternates have been engineered.

The objective of this discussion was just to emphasize that merely an amortization
schedule similar to the one offered by a conventional bank, is not a basis for declaring a Halal
product to be Haram. If just a pricing model or just the similarity of a cash-flow model makes
the transaction Haram, what you will say regarding a conventional loan offered at a price
much higher or much lower than the market prevailing rates for which the pricing model and
the cash-flow model are not similar to those generally applied in the industry. Does anybody
think that such dissimilarity will make it Halal? Accordingly, from Shariah principles it is
rightly concluded that it is the substance of a transaction what makes it Halal or Haram and
not a pricing model used to price the transaction or the cash-flow model used for the
payments and repayments in monetary terms.

Socio-Economic Effects Of Islamic Banking And Finance

Second most significant argument from such group, predominantly by certain Islamic
economists and certain Islamic revolutionary movements, is about the socio-economic factors
of Islamic banking. They feel that since Islamic banking is also based on profit motive and in
present form, it generally works on “virtually-fixed” return basis; hence the same cannot
attribute anything-positive towards the socio-economic changes that Islam desires. This is a
crucial question and, we believe that, every conscious Muslim will concur with the concerns of
those who raise the same, although the conclusions derived by different people might vary.

Nobody can argue that virtually-fixed return based banking, although being Shariah
compliant, is not what has been desired by Islam as a complete way of living. In addition, the
current-day Islamic banking is emphasizing more on consumer finance as compared to

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financing to SME sector, agricultural sector, and more importantly, on the micro-finance;
hence, it is not contributing enough towards the “just and equitable monetary system” that
Islam needs.

Having due regard for these arguments, may we remind you that that the Islamic
economic system is not something that can work in isolation of the geo-political and
legislative system, as well as, and more importantly the society’s behavior towards the
injunctions of Islamic Shariah in personal and collective matters. Accordingly, one can easily
imagine that in an economy whereby most of the businessmen are not honest in fairly
presenting the financial statements of their businesses, how difficult it is to introduce a profit
and loss sharing based financial solution. Similarly, in most of the cases payment of Zakat
and Sadaqat depends on the individual and particularly, in view of the gigantic volume of the
black economy in the country, what can be expected even if a good system for Zakat and
Ushr is introduced? It needs to be emphasized that only the change in banking system is not
a solution to the overall revolution of economic system unless other facets of Islamic
economic system, as well as, Islamic social system are not implemented simultaneously.
Accordingly, the complete transition of economy to an Islamic economic system can be
performed, when and only when, the overall consensus of the society is developed towards
practical application of Shariah in all the facets of human life, particularly including the
governmental, political and legislative structures.

Despite such an unsatisfactory and rather discouraging attitude of the society towards
application of Islamic Shariah, it should be noted that such a situation do not relieve a Muslim
from the applicability of Shariah principles, but rather increases his responsibilities in the way
that it becomes his duty not only to try to abide by all applicable Shariah requirements in his
personal capacity but also to put his endeavors towards improvement in such system.
Consequently, in case the Islamic banking, in your opinion, is not contributing enough
towards betterment of society, you cannot blame the same alone. The responsibilities of the
Muslim Ummah as a whole (or of the State) can not be expected to be borne by a single
sector only, which, at this point of time is in its infancy stages.

Is It Heela Banking?

This is a general discussion at various forums that contemporary Islamic banking is

based on Heelas. From Shariah perspective, a Heela is an option utilized to disobey the divine
guidance through engineering the circumstances and playing with the facts and intentions.
Having an insight into the industry, one can not disagree with this argument to certain
extent, as it has been observed in a number of cases that in-fact, certain transactions are
practically applied on this basis.

Having said that; this argument should, however, not be used to blame the entire
industry. We should acknowledge that the foundations of the industry have been built using
the pillars which are directly derived from the Holy Quran, Sunnah and Fiqh. It is worth-noting
that mostly, a Heela is applied in the “execution of a transaction” rather than “designing of a
transaction”. In other words, we can safely conclude that application of Heelas in Islamic
banking is not a weakness in the theories of Islamic banking, but actually is a matter of
misuse / misinterpretation of basic Shariah guidance in respect of various Shariah compliant
financial transactions.

Accordingly, it needs to be emphasized that in order to support the growth of Islamic

banking and finance on right footings, we need to strengthen the Shariah compliance
mechanism for the industry. In addition, in the longer run, we need to eliminate the Islamic
financial products which have the potential of misuse.

Use Of Interest-Rate As Benchmark; Is It Halal?

Critics, including scholars, as well as, economists, strongly condemn that most of IFIs
while providing financing by way of any of the “Halal” transactions, determine their profit rate

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on the basis of the current interest-rate benchmarks prevailing in the conventional money
market. Scholars are of the view that by applying these benchmarks, the Islamic banking
industry makes their transactions “similar” to interest-based transactions and as a
consequence, these transactions become doubtful from Shariah point-of-view. Economists
feel further issues and that and are of the view that this thing makes these financial
institutions a part of the prevailing capitalistic economic systems, hence this sort of
transactions are absolutely not desirable by Islam.

Here it would be worthwhile to have a look on the arguments by the Islamic banking
for better understanding of the pricing issue. They generally give examples like; suppose you
enter into a supermarket in UK and see that the pork, the beef and the Halal beef are all
being sold for GBP 2 per kg. Do you think that this similarity of price or the fact that these
products are being sold under the same roof renders the Halal beef as Haram? Or for
example; in the same superstore you note that they are using the same balance for weighing
these three types of meat. Do you think that using the same balance will render the Halal
beef, as Haram? If not, then we should better understand the principle that it is the substance
and legal form of the transaction that makes it Halal or Haram and not its pricing, rate or the
cash-flow model or the institution, or even the environment that offers such transaction.

This issue, however, needs to be addressed by the government, as well as, the market
players. A strong Islamic inter-bank market will InshaAllah provide us opportunities to develop
our own benchmarks for Islamic banking operations.

Dealing of Islamic Banks with Conventional Banks

Another strong argument against Islamic banking is against dealing with conventional
banks. These dealings are of two types i.e. sharing of services and commercial transactions.
As far as services are concerned, where the Islamic Banks are facilitating the foreign
businesses of their customer or helping out their customers to transfer the money from safe
channels. For these services, the remuneration or expense of Islamic banks is service charges
which are allowed by Shariah jurists, although they recommend that such interaction should
be avoided wherever IFIs are available.

The second argument which is much strong is regarding the commercial transactions
with conventional financial institutions. These transactions generally relate to the treasury
side of the Bank whereby either the IFIs place their excess liquidity with the conventional
banks or obtain financings from them to meet their own liquidity requirements. For placement
of funds with conventional banks most of Islamic banks in Pakistan are using the product of
Commodity Murabaha or they invest in certain “Halal assets” of the conventional financial
institutions. On the other hand, they normally obtain financings from the conventional banks
on the basis of profit and loss sharing, although the profit rates are once again “virtually-
fixed”.

Although, most of the Shariah scholars have allowed these transactions duly
considering the Shariah requirements, however, nobody can argue that it is a must to avoid
all such transactions. For this purpose, however, we need to strengthen the Islamic inter-bank
market and to provide further liquidity management options to the IFIs particularly, in form of
strong Shariah-compliant government securities and a stable capital market with plenty of
Halal investment options available. All dealings with conventional financial institutions should
remain limited to the necessities which reach the extremes of compulsion.

Cost Of Being A Muslim

Those who have bad memories of dealing with Islamic banks are in front-line of critics
with this remark. People feel that there are serious doubts on the honesty and integrity of
IFIs. They feel that these Banks are using the name of Islam to earn a few bucks more as
compared to the conventional banks or rather they are exploiting the faith of Muslims by
charging them, the “cost of being a Muslim”. On the financing side, they charge higher than
conventional banks. In other words, internal rate of return on Islamic financial products is

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higher than the conventional products. On the contrary, it is observed that on the deposit
sides they pay less as compared to the conventional banks. In addition, it is generally
observed that the expected rates, as well as, the actual rates of return offered by these
financial institutions are fairly equivalent to (generally slightly less than) the rates being
offered by conventional financial institutions.

A justification against the first argument is that since IFIs are subject to the
commodity risk, asset destruction and holding risks and the price risk, as well as their
relevant costs e.g. Takaful expenses, in addition to the risks and costs that a bank faces, they
are justified in their demand i.e. higher internal rate of return. Nevertheless, financial experts
have generally felt that even if these factors are considered, the pricing by these Banks is on
the higher side.

On the other side, in a profit and loss based model, it is agreeable that they assign
weightage to different types of deposits in a manner that the total return on investment and
financing pools is allocated amongst various depositors and the Bank (working as a partner).
Even then, it is generally noted that IFIs are paying less than the market.

We can only hope that in near future, with increasing competition in the Islamic
banking industry, this effect will minimize because of market-forces except to the extent of
pricing against actual additional risk elements.

Marketing Approach Of IFIs

Another valid argument is about the marketing approach being used by these financial
institutions, which adversely effects the public reliance on this mode. People raising
objections on the marketing approach of IFIs have two grounds for the same. The first one is
the general marketing approach being applied by the a few IFIs which include advertisement
and other publicity materials including involvement of women and traditional marketing and
advertisement styles for promotion of “Islamic” banking business.

Second ground is the marketing strategy in which sometimes it is felt that false
statements are made for promotional purposes. An example of the same is the claim by a
leading Islamic bank that all its day to day activities are monitored by its Shariah Advisor. Just
imagine, if it is humanly possible, that a part time Shariah Advisor can look after all day to
day activities of a full fledged bank with a number of branches even located at other cities.
Another example is the claim by an Islamic mutual fund that it is the first one of its kind in
the country, whereas another fund was operating in the country for around one year earlier to
subscription for such mutual fund.

They Don’t Look Like Islamic

Once you enter into a glittering branch or office of an IFI, generally you do not feel any
difference with a conventional bank. This issue is raised particularly by the blend of people
who feel that once they enter into such location, it should look like a sacred place instead of a
commercial office. You generally feel that they have over-spent on the furniture, interior-
decoration and publicity stuff, which apparently, is against the injunctions of Islam. This
impression is further strengthened when you see the overall environment, the dealing style of
personnel and most significantly, you feel (in most of the cases) that there are ladies working
for the organization without Hijab or even “appropriate attire” (in line with the dress-code of a
Muslim woman as defined by Shariah). Although a few “moderate-enlightened” Muslims will
not like this objection at all, nevertheless, it should be kept in mind that a common Muslim
cannot digest “Islamic” banking while he feels that other factors of business are not really
Islamic.

We can’t argue with these objections as these have due weightage in them and the
management of IFIs should take these objections seriously. However, we should keep in mind
that the prime objective of Islamic finance, is to ensure that “financial” matters are dealt with
in line with Islamic Shariah. In other words, environment does not make anything Haram.

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Needless to mention, from Shariah perspective, you can always buy a Halal product from a
store where everything else is Haram although the same needs to be avoided if other options
are available.

Islamic Bankers – Don’t Know Islamic Banking

This argument, once again, has key significance from the perspective of the overall
control environment of these banks with regard to the applicability of Shariah principles.
Particularly, it is astonishing when you deal with an Islamic banker, who knows very little
about Islamic banking, but unfortunately, this is not very uncommon. The prime cause behind
this issue is the fact that most of the IFIs have hired the conventional bankers and generally
no or very little consideration is awarded to ensure that they are well conversant with the
Shariah requirements with regard to the modes of finance being used by these Banks.
Similarly, the IFIs do not spend enough on their resource-building for Shariah compliance and
training of their staff, in comparison to what they spend for marketing.

Having experience of training “Islamic Bankers”, as well as, performing Shariah

compliance reviews, we may safely conclude that, this objection is not without substance.
This accordingly, is a strongest need that the IFIs should allocate more and more resources
for staff training and Shariah compliance.

Monopoly Of Shariah Advisors

Another objection is regarding the appointment of Shariah Boards and Shariah

Advisors. People have largely noted and discussed at various forums that the major
contribution in this field in Pakistan is limited to a very small group of jurists most of whom
relate to a single family and their pupils (a single religious university). Besides this, another
question is also being raised that generally the honorariums, consultancy fee and other
benefits being offered to such jurists by the IFIs in Pakistan, as well as, abroad are quite high
and this may jeopardize their independence. In addition, it is felt that they are the only ones
who are whole and sole responsible for Shariah compliance. They approve the products, they
review the transactions and in the end; they perform Shariah audit themselves, which is,
however, an indicative of a conflict of interest (without any doubt on their personal
independence and integrity).

Most of the people conversant with the business and operations of Islamic finance do
not agree with this observation, because the contribution of these people to the industry as a
whole is remarkable and they deserve even more than that based on their contribution and
efforts in the promotion of this industry. The general concept that a “Moulvi” should be paid
the minimum for his life, is not justifiable. If you are getting benefits from their efforts, their
knowledge and skills, then they should be justifiably rewarded.

Having said that, it is always agreeable that it is the right time that contributions from
jurist from other schools of thought should also be sought and they should necessarily be
provided opportunities to enter into the field. For this purpose, it is a good proposition from
the State Bank that a jurist should not be allowed to hold more than one remunerative
position as a Shariah Advisor or member of a Shariah Board. This will ensure that fresh blood
gets an option to enter into the field which will eventually improve the overall Shariah
compliance in the field, as well as, will help these institutions to innovate fresh products.

IFIs Use Conventional Insurance

A valid objection; can’t argue with that. It was a real issue that according to the legal
requirements, as well as, derived from real “compulsion”, the banks were required to obtain
insurance coverage from conventional insurance companies and this practice was allowed by
the Shariah Advisors to the extent of compulsion only. This situation, Alhamdolillah has
changed after introduction of Islamic mode of insurance (Takaful) in Pakistani market.

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 Unfortunately, there are a still IFIs who have not yet switched to Takaful while to-date
three Takaful companies and a family Takaful company have commenced operations in
Pakistan and now this lame excuse of compulsion can not be exercised anymore. Now it’s
high time that the State Bank and the Shariah Advisors should take strong steps to ensure
that no business is given by the IFIs to any conventional insurance company either in respect
of owned assets, or against assets held under security.

Should We Still Prefer Islamic Banking?

As a conclusion to this debate, we may say that we are required by our religion to
implement a complete Islamic way of living in our individual and collective lives and the
society and the government as well. The Islamic banking and financial system is a part of
such system and is not construed to be applicable in isolation while other laws and customs
repugnant to the Shariah requirements are still in force. However, for the sake of our own
benefits, in order to avoid interest by ourselves and providing interest-free opportunities to
our brothers and sisters in Islam, we should promote and support the Islamic banking and
finance in the country with all our possible efforts and endeavors. We should not try to pull
legs of an infant who is just trying to take his first step towards a long journey to go.
However, we should try to ensure that he commences his journey on the right way, with
strong footings.

Such Islamic banking, may not be termed as perfect, but can provide us with a shelter
from interest based transactions for the time being, and might support us in augmenting a
truly Islamic financial system, and more appropriately said, will serve as an experiment for
the time when we will really be in a position to the implement the complete Islamic way of
living in our beloved country.

May Allah Almighty bestow us his blessings and enable us to evolve a complete
system of life in accordance with the principles of life provided by the Holy Quran and the
Holy Prophet (SAAWS). May Allah accept our efforts and forgive us for our mistakes in this
field in our individual capacities, as well as, as a society.

About Omar & Faizan:

Omar is a Chartered Accountant by profession, and is presently working as Partner –

Islamic Financial Services Group with Ford Rhodes Sidat Hyder & Co. (A member firm of
Ernst & Young Global Limited). Omar enjoys vast experience in audit, Shariah compliance
and providing related services to Islamic finance industry in Pakistan. He is author of a Book
on Islamic finance namely “Managing Finances – A Shariah Compliant Way”.

Faizan holds experience in the field of Shariah audits and product development. In
past, he has worked with a leading Islamic bank as Shariah Coordinator and Shariah Auditor.
Presently, he is working with Ford Rhodes Sidat Hyder & Co. as Manager – Islamic Financial
Services.

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