Sharia banking provides universal alternative

Sharia banking provides universal alternative

Muhammad Akhyar Adnan, Yogyakarta

During four decades, the banking industry has been enlivened
by the emergence of new types of bank, known as Islamic or sharia
banks. These have been set up, not only in countries where
Muslims are in the majority like Indonesia, Malaysia, Egypt,
Saudi Arabia, Iran, Pakistan and so forth, but also where Muslims
constitute a minority, as in the United States, Britain, Russia
and Switzerland.

In Indonesia a sharia bank began to operate in the early
1990s, much later than its neighbor Malaysia, which started in
the 1980s.

The most important reason for establishing a sharia bank,
particularly in countries where Muslims account for the bulk of
their population, is simply that Islamic teachings prohibit the
practice of riba (usury), as stated frequently in the Koran.

But it is interesting to note that, the prohibition of riba
(such as bank interest) is not merely the monopoly of Islam, as
it is also clearly condemned by Christianity and Judaism. Even
the great philosophers like Plato and Socrates were against usury
because it led to unfair or unjust transactions.

There are, in essence, special types of transaction or
products/services a sharia bank can enter into. Among these are
the murabaha (trading transaction). For example, a customer who
wishes to buy a car (or any other commodity) can go to a sharia
bank. The bank will propose to the customer that it will buy the
car at a specified cost, but will sell it again to the customer
at an agreed margin or profit. Hence, instead of selling money as
a commodity, as practiced by conventional banks, the bank sells
the car at an agreed profit and payment procedure within a
certain period of time. This is one of the ways that conform to
sharia principles, by which a sharia bank earns its income.

Another product that might be offered by the sharia bank is a
partnership contract. The most common ones are the musharaka and
mudharaba.

The musharaka is broadly similar to what is known by the
conventional finance industry or Western practice as venture
capital. In this regard, two parties (a bank and a customer)
participate in a particular project by putting up capital and,
perhaps, skill. The profit and loss resulting from the project
will be shared proportionately by both parties.

Experience in many developed countries in Europe and the
United States has shown that many international corporations that
have now become giant companies were launched in collaboration
with venture capitalists. Bill Gates with his Microsoft Corp. is
perhaps one of the best examples of how a small firm can be
helped and finally transformed into a giant corporation through
the venture capital system or musharaka.

Unlike musharaka, in a mudharaba contract, one party will be
the capital supplier, and the other will act as the provider of
expertise and, at the same time, operate or manage the business.
The manager is known as the mudharib and the capital provider
sohibul maal. Again, the income generated by the project is
shared between the capital provider and project manager, based on
an agreed split. However, if normal losses (caused by honest
mistakes) are incurred, they will be borne by the capital owner,
while the manager will bear only nonfinancial losses, such as his
labor or managerial expertise. But any loss inflicted by the
manager's negligence is entirely his responsibility.

A sharia bank may also provide other fee-based services such
as hiwalah (money transfers), kafalah (financial guarantees),
wakalah (representation or deputyship), ijarah (leasing) and so
on.

These are some illustrations of the way a sharia bank earns
its revenue and income. It is also interesting to note that the
variety of products and services a sharia bank can offer is
basically much broader than what conventional banks can provide.
A sharia bank will share its income with its depositors on a
proportionate basis. Hence, the more profitable a bank, the
greater the income that accrues to depositors.

Unlike conventional banks, a sharia bank will not provide
fixed income or pre-determined interest revenue, meaning that a
sharia bank shares its risks with depositors and customers.

Within the organizational context a sharia bank should also
have a special, independent unit in charge of supervising the
bank and seeing to it that the bank always holds to the
principles of sharia.

This unit is called the Sharia Supervisory Board (SSB). While
the board of commissioners in a conventional bank is in charge of
ensuring that the bank fulfills prudential regulations and all
other rules imposed by the central bank on the banking industry,
the SSB oversees that a sharia bank's operations are fully in
compliance with sharia principles.

Given its role and responsibilities, the SSB must comprise
people who have both competence or knowledge about Islamic
teachings/rules on economic activities and skills in business
management and auditing.

Many have acknowledged that sharia banks are much stronger and
more flexible than conventional ones, particularly at times of
economic crisis, such as the one that hit Indonesia in 1997.
While most major conventional banks collapsed during the crisis,
none of the sharia banks went bankrupt. The reason is obvious --
sharia banks do not have the negative spread of their
conventional counterparts.

The growth of sharia banks, both in terms of individuals or
aggregates, is really remarkable. Sharia banks have so far
successfully attracted many depositors, not only from Muslims but
also the non-Muslim community.
They have also been very successful in efficiently allocating
their funds to the market. If the loan-to-deposit ratio (LDR) of
conventional banks in Indonesia now averages only about 40
percent, the finance-to-deposit ratio (FDR, the sharia bank
equivalent of LDR) averages about 80 percent, much closer to the
standard set by the central bank.

In recent years many conventional banks have expressed
interest or announced plans to open sharia bank branches (as
permitted and regulated by the central bank), or even to convert
themselves fully to the sharia bank model.

Despite some weaknesses, many depositors and customers have
testified they are fully satisfied with the performance of their
sharia banks, not only because they generate just and fair
transactions, but also rates of return that are mostly higher
than the interest provided by conventional banks.

The writer is a senior lecturer in the department of
accounting of the school of economics at Universitas Islam
Indonesia, Yogyakarta.