Islamic Banking: Interest-free and halal
In an interview with Capital Ideas, Svetlana Babenkova, PhD, Senior Researcher at the Center for Arab and Islamic Studies at the Institute of Oriental Studies of the Russian Academy of Sciences, Certified Specialist in Islamic Finance (PCIF INCEIF), member of the Russian Council on Islamic Finance, tells what Islamic banking is.
Today in Russia people are increasingly talking about Islamic banking. In mid-July, the chairman of the State Duma Committee on the Financial Market, Anatoly Aksakov, said that Islamic banking is planned to be introduced in the country in the autumn, with the help of partner financing organizations.
Since Russia has practically no experience of its own in this area, to begin with, tell us about the most intriguing principle of Islamic banking. According to the Christian Holy Scriptures, Christ drove the moneylenders out of the temple; Islamic banking also rejects the charging of interest. How, in this case, does a bank remain a commercial structure, creating and living off profits?
For clarity, let’s take a specific example: you want to buy, for example, a plasma TV. If you go to a traditional bank, you take a consumer loan, say 100 thousand rubles; then in some “M-Video” you buy the item, and later pay back the loan to the bank.
In a similar situation, an Islamic bank buys a TV on your behalf, and you buy it from them – but at a markup. If the TV costs, say, 100 thousand rubles, then the bank sells it to you for 150 or 200 thousand. Then you pay this to the bank. Of course the contract spells out what brand of TV, say “Philips” or “Samsung,” what diagonal, the color of the panel, and so on.
Or let’s take the cooperation of an Islamic bank in the creation or development of a business. For example, you intend to open your own bakery. The bank in this case participates in the authorized capital of your enterprise, where the division of profit and loss is stipulated, and also takes on all the risks – becoming your partner. Everything depends on the contract, which is the most important tool in any Islamic transaction.
Islamic banking rules out the use of derivatives, and prohibits operations with futures, swaps and any types of intangible products. What are the reasons for this? Is it for practical, or for ideological and ethical reasons?
It is for ideological and ethical reasons. Business must be halal, allowed by Sharia. A bank works only with real assets: for example, investments in capital housing or road construction projects.
Actually, I know from my own experience that the only country with 100% Islamic banking is Iran. Even in the countries of the Persian Gulf – in the United Arab Emirates, in Qatar and Bahrain, as well as in Iraq – traditional banks also function. One of the reasons is the slow turnover of funds in Islamic banking. Borrowed funds in this case are always expensive, and there are problems with liquidity.
If the borrower, the client, goes bankrupt, for example – the Islamic bank does not have the right to demand the return of the debt or credit, since the bank is a co-investor and accordingly, shares all the risks. Can this be equated with principles of venture financing?
I happened to attend a meeting where bankers and borrowers in Bahrain were addressing bankruptcies caused by the coronavirus pandemic. Business is built on the Quran, but nowhere in the Quran describes the force majeure caused by Covid. Bankruptcy was not the result of mistakes in business management, but a natural disaster: diseases and pestilence due to the epidemic. Banks were asked to “understand and forgive,” at least for private individuals. And for legal entities, to allow for delays in the distribution of profits – that they in any case do not have or have not received in full.
The principle of “musharakah” applied in Islamic banking indicates joint financing. Starting from the era of caravan trade, there were several merchants in the business at once: one acquired goods, another purchased them onward, the third provided logistics, the fourth already sold to the final client. But as the number of participants in a project or transaction increases, accordingly risks and conflicts of interest arise. In Islamic banking, are all participants absolutely equal when resolving disputes, or does someone have a controlling stake?
First of all, you need to look at the contract, which defines the roles and responsibilities of the parties. Naturally, a larger investor has a weightier voice in resolving disputes. But at the same time, do not forget that Islamic banking is organically created in the traditions of Islam and is based on the provisions of Sharia – guided above all by the principles of justice.
Since the bank in its activities complies with the norms of Sharia, do the religious beliefs of the client matter? Can, for example, an Orthodox citizen of the Russian Federation use the services of an Islamic bank?
This is the favorite question on all forums. The answer is yes. The main thing is that the client complies with the rules of Sharia transactions, so the money is invested only in permitted projects and/or products. You cannot use funds, for example, for the construction of a casino or a brothel, or for the purchase of pork or pork products. The money should go exclusively to good deeds.
What pitfalls should be taken into account when implementing Islamic banking?
As a person who has worked for 15 years in a financial supervisory authority inspecting banks, I should pay attention to one thing that many overlook. Islamic banking requires the creation of a Sharia committee for bank supervision. It is necessary to recruit specialists for this structure who understand Sharia as well as they understand banking.
What advantages will the Russian financial sector receive from the appearance of Islamic banks?
This is a tough question. Nowhere have I seen a detailed analysis assessing the economic effect. Yes, this would be a certain diversification. But what will be the contribution of Islamic banking to increasing the stability of the financial system as a whole? Suppose five Islamic banks open – will they make it possible to overcome the crisis phenomena of the current period? Again, there is no answer yet to the question: how wide will the clientele of such banks be? In the regions, a trend is noticeable: weak banks do not survive the competition, and are absorbed by larger ones.
Can we consider that this innovation fits seamlessly into the “turn to the East” taking place – no longer only in words, but in deeds?
There is some truth to this supposition. In the program of the Central Bank “The Financial Market: New tasks in contemporary conditions,” the fourth point indeed talks about Islamic banking in the context of the application of new instruments of economic development.