- Need to overcome hindrances for the true growth of Islamic banking, financing
Islamic Banking and Finance practices are running and growing at a rapid pace and have been proven viable financial systems before the conventional economic and banking system. The present-day Islamic banking practices are Shariah compliant as these are being governed and supervised by eminent Shariah scholars throughout the world but the socio-economic objectives could not be achieved with these practices.
What was the objective to start Islamic finance? The objective was to start a financial system that could lead to an Islamic socio-economic welfare system. The reason for transforming the banking and finance system was that this sector is the engine of the present-day economic vehicle of society. There was no objective to merely establish the Islamic banking system but to affect the overall socio-economic structure.
At this point in time when Islamic financial practices have gained suitable momentum and growth, we must consider the achievement of Islamic socio-economic goals and objectives which can only be achieved through the serious and effective implementation of the partnership modes i.e. Mudaraba and Musharaka but this is the fact that there are serious hindrances in this respect.
Despite the fact that Mudaraba and Musharaka are the ideal modes of transaction, the practices of Mudaraba and Musharaka exist in the Islamic financial industry in a very limited manner as compared to other prevalent modes like Murabaha, Ijarah, Diminishing Musharaka, Salam and Istisna etc.
The mode of Mudaraba is being used for the liability side of the bank but not for the asset side and the mode of Musharaka is being used on the asset side as Diminishing Musharaka on Shirkat ul Milk basis and Running Musharaka on Shirkat ul Aqd basis. There is a need for Shirkat ul Aqd transactions on the asset side of Islamic banks. It is evident that the transactions of Running Musharaka are prevalent in Islamic banks but unfortunately, these transactions do not show the real essence of Musharaka transactions and these transactions face very much criticism.
If the partnership modes i.e. Mudaraba and Musharaka would be implemented and practiced in an ideal manner, both parties share the profit with a certain ratio. In this respect, no cost of funds or cost of financing is involved. In this case, both parties will bear their own risk and earn their own reward according to a certain pre-agreed ratio. Consequently, the cost of a fund or cost of financing that is paid to conventional or Islamic banks would be eliminated and the burden of this additional cost upon the final consumer would be abolished.
At present, it is a fact that the practices of Mudaraba and Musharaka on the financing side are not very easy due to various factors. There is less risk factors in the prevalent modes of Murabaha, Ijarah, Diminishing Musharaka, Salam and Istisna’ etc. Therefore, Islamic banks do not consider partnership modes.
The prevalent modes in Islamic banks are sale and rental-based modes which give fixed income for the banks but on the contrary, the ideal partnership transactions have investment risks which may cause loss and less profit as compared to speculated profit for the bank which may disturb the regular profit distribution to the depositors. The banks may face misrepresentation risk by the customers. Many firms make fictitious income statements to deceit the taxation authorities. These firms may also provide wrong information to the banks.
To mitigate these risks and to go forward with confidence in this respect, Islamic financial institutions should enter into Mudaraba and Musharaka transactions after proper scrutiny and transparency in the valuation and accounting procedures of a certain customer. In this regard, the independent audit reports must be periodically checked. The Islamic financial institutions must watch the business situation of the customer and may devise an exit plan at the beginning of the contract in case of non-performance of the business as compared to the desired results. In Musharaka, the Islamic financial institutions may monitor the business but in Mudaraba, it must be ensured that the customer is experienced and has the knowledge and the business is being run smoothly.
Some measures must be taken by the government and regulatory authorities as well which may include, but are not limited to:
- Monetary management, in the present era, is controlled mainly through discount rate policy. To abolish this system, there is a need to promote the Islamic banking and finance system with a special focus on the practice of participatory modes due to which monetary management through interest-based benchmark may be abolished.
- When the bank will be entered into a partnership with the customer, the status of the bank-customer partnership must be defined according to law.
- For the promotion of partnership within society, there is a need to provide economic, taxation and business incentives to businesses and Islamic Banks.
- There is a need to equip employees of Islamic banks with sufficient knowledge of the modes of Mudaraba and Musharaka in order to develop products and services and to operate the transactions in the best possible manner. Besides this, awareness campaigns and sessions must also be conducted for the customers.
It is evident that the practices of Mudaraba and Musharaka are crucial for attaining the objective of Islamic banking in a true sense. Although there are many hindrances and risks in this respect due to conventional economic and banking systems and other socio-economic circumstances, there is a need for proper coordination and collaboration of Islamic financial institutions and regulatory authorities in order to take serious steps and long-term effective strategy for the ideal practice of Mudaraba and Musharaka.
No doubt, the practices of Mudaraba and Musharaka can lead to the implementation of the Islamic socio-economic welfare system and bring harmony and equality to society.
The Author is a Team Leader-Training & Development Unit, Shariah Compliance Department, National Bank of Pakistan