Introducing Islamic Banking in Conventional Banking system

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islamic 351 banks 108 banking 96 financial 95 conventional 82 institutions 73 finance 54 shariah 42 instruments 37 countries 36 products 35 systems 33 deposit 27 funds 27 investment 27 regulatory 27 government 26 deposits 23 international 23 liquidity 23

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introducing islamic banks into conventional banking systems juan solea abstract over the last decade islamic banking has experienced global growth rates of percent per annum and has been moving into an increasing number of conventional financial systems at such a rapid pace that islamic financial institutions are present today in over countries

the paper is structured as follows section ii discusses some preliminaries with which the authorities should be familiar before introducing islamic banks section iii explains the different phases in the development of islamic banking section iv discusses the role that the supervisory authority should play in this process section v explains the different elements that are needed to build a supporting islamic financial infrastructure finally section vi concludes
besides the well known quran admonishment against riba interest gharar and maisir contractual uncertainty and gambling and haram industries prohibited industries such as those related to pork products pornography or alcoholic beverages there are other principles that must be observed by practitioners and supervisors in order to comply with islamic jurisprudence

this initial step is essential for the future operations of the institution as it will help minimize shariah risk which is the risk that the terms agreed in a contract do not effectively comply with islamic jurisprudence and thus are not valid under islamic law
this section reviews four areas of paramount importance that practitioners and supervisors need to appreciate in order for islamic banking to be successfully introduced into a conventional system i compliance with the shariah ii segregation of islamic and conventional funds iii accounting standards iv legal and regulatory adaptations and v transparency and awareness campaigns

an important effort towards achieving international consistency was the creation of two multilateral institutions i the accounting and auditing organization for islamic financial institutions aaoifi which issues internationally recognized shariah standards on accounting auditing and governance issues and ii the islamic financial services board ifsb which issues standards for the effective supervision and regulation of islamic financial institutions

in this regard a consensus has not emerged and therefore the cross country experience has been varied the options range from a minimal alterations approach such as in the united kingdom where all deposit taking institutions are required to comply with broadly the same set of regulations but with some minor requirements for institutions offering islamic productsa see section iv
among other important goals the ifsb aims to i promote disseminate and harmonize best practice in the regulation and supervision of islamic financial institutions ii promote coordination among the relevant standard setting institutions worldwide and iii enhance initiatives to develop instruments for risk management in islamic institutions

furthermore the pursuit of international consistency would not only ease the task of supervising internationally active institutions but it would also ultimately favor the regulated institutions as islamic transactions would become better understood and thus more attractive for muslim and non muslim investors across the world

introducing islamic banks into conventional banking systems disclosure transparency and awareness campaigns the speed and degree of success with which islamic banking will emerge in conventional systems will largely depend on whether potential depositors and investors are well informed about the opportunities and risks at hand and on whether islamic banking is perceived as a transparent and well regulated activity
this section reviews three broad stages an initial stage where selected islamic products are offered a second stage where full fledged islamic banks are allowed to operate and a third stage where non bank islamic financial institutions develop and expand the range of islamic financial products available

at the inception of the islamic window the products typically offered are safekeeping deposits on the liability side of the bank and islamic trade finance products for small and medium companies on the asset side of the bank
in many countries this interest responds to the banks desire to offer services to a growing muslim population but it is also motivated by the wish to tap the growing pool of international investors attracted to shariah compliant products

although it does not seem to be a widespread concern within the industry it must be mentioned that some shariah scholars have raised concerns regarding the legitimacy see financial times of friday december in the case of islamic windows the treasury department of the parent bank is typically in charge of managing the liquidity requirements of the bank as a whole which poses the threat of mixing conventional and islamic funds
becoming a full fledged islamic bank once a conventional bank has operated an islamic window for some time and has gathered a sizeable customer base for its islamic activities it may decide to establish an islamic subsidiary or even fully convert into a full fledged islamic bank

this policy was adopted in order to allow the cbk to develop enough capacity and proficiency to supervise this new segment of the banking system and to initially let the infant islamic banks develop in a somewhat protected environment see imf
introducing non bank islamic financial institutions and instruments as full fledged islamic banks increase their operations and it is clear that there is a segment of the population interested in these products other financial institutions and products may appear in the market

nonetheless from the standpoint of islamic jurisprudence the use and trading of some conventional derivatives such as currency and interest rate swaps or options is see for instance sole prospects and challenges for developing corporate bond and sukuk markets in kuwait forthcoming
that is the insured party pays the insurer for an object ie the monetary compensation in case of an accident that she may never receive ie if the accident never takes place

similarly sudan pursued the full islamization of its financial system with the promulgation of the banking law which aimed at eliminating interest from banking as well as from all government for example bai salam contracts or the recently developed in pakistan istijrar contracts
numerous scholars have pointed out that these derivatives should be viewed with reticence because they may easily involve excessive uncertainty gharar may encourage speculative behavior maisir or may involve the trading of debts

while most of the financial institutions since the signature of the comprehensive peace agreement in january between the government of sudan and the sudan people s liberation movement splm conventional banks have been allowed to operate in this country
starting with a few very specialized islamic institutions the malaysian financial system has evolved to become a well functioning and internationally integrated mixed financial system in which conventional and islamic financial institutions work alongside each other

third stage some conventional banks fully convert to islamic banks after a certain period of operating islamic windows some conventional banks accumulated a sufficient critical mass of islamic customers to make viable a full conversion of the bank into an islamic institution

the role of the supervisory authorities the role to be played by the regulatory authority in systems with emerging islamic banks is two fold on the one hand there is the traditional prudential supervision aspect but there is also a vital developmental role that is equally important
given that islamic banks can pass a substantial part of the investments losses onto depositors banks could potentially be induced to undertake riskier projects than if they had to guarantee all deposits as in conventional banks

the solution reached was that the ibb would always offer its customers a choice between investment accounts with a non guaranteed principal due to religious considerations and fully guaranteed see the ifsb s guidelines capital adequacy standards for institutions other than insurance institutions offering only islamic financial services and guiding principles of risk management for institutions other than insurance institutions offering only islamic financial services

box the emergence of bahrain as an islamic financial center while it is true that the kingdom of bahrain partly owes its success to a number of external circumstances that gave it a leading advantage the bahraini authorities also undertook prompt and resolute actions to maximize and materialize this advantage
bahrain took advantage of this situation as well as of its favorable geographical location and of its relatively educated population to start developing its own financial services industry

journal of islamic economics banking and finance the location for the headquarters of important organizations such as the accounting and auditing organization for islamic financial institutions aaoifi the international islamic rating agency iira the international islamic financial market iifm and the islamic liquidity management center ilmc among others
particularly in low income countries where there is typically a lack of public trust in the banking system a well designed deposit takaful would encourage participation in the banking system and help reduce the fraction of the population that is under banked

on the other hand if most deposits are mudarabah deposits then not including them under the coverage would limit the impact of the dt in increasing the stability of and the public s confidence in the banking system
introducing islamic banks into conventional banking systems regarding the design of the dt it is important to recall that insurance as it is understood in conventional finance is not permitted in islam see footnote

this section will briefly discuss some of the existing islamic government instruments with the intention of providing the reader with a general sense of how these securities are used in practice for monetary operations
for a number of years however islamic banks in conventional systems have operated with no access to tradable short term treasury instruments with which to channel excess funds to other islamic banks

the intention was to replace some of the sovereign s conventional borrowing with islamic instruments so that i islamic banks would face a level playing field vis a vis traditional banks in terms of investment opportunities and ii the authorities could engage islamic banks in the conduct of monetary policy
two types of certificates allow the sudanese government to raise financing at different maturities government investment certificates which are based on a pool of ijara salam and murabaha instruments are used to raise long term financing government musharaka certificates based on equity partnerships have maturities of one year

journal of islamic economics banking and finance price of the future sale determines the return of the sukuk while the initial spot payment from the islamic banks to the central bank constitutes the liquidity withdrawal
note however that the potential issuance size of this security will be somewhat capped by the value of the central bank s assets thus effectively limiting the amount of liquidity that can be drained from the market via this instrument

immediately after the islamic banks make a payment to the central bank equal to the value of the spot sale of the commodities
this is indeed a trend that is likely to carry on as oil exporting nations continue to accumulate wealth gcc and south east asian islamic financial markets develop further and companies in western nations keep on competing to attract international investors

journal of islamic economics banking and finance finally it should be emphasized again that fortunately a number of multilateral institutions have been recently created in order to provide assistance to governments in the matters discussed above and to issue standards and best practice guidelines for this industry
in addition the authorities should engage in dialogue with the local interlocutors of this industry in order to promote an open and fluid exchange of information and ideas

sole juan forthcoming prospects and challenges for developing bond and sukuk markets in kuwait international journal of islamic and middle eastern finance and management
david marston and ghiath shabsigh monetary operations and government debt management under islamic banking imf working paper wp washington international monetary fund

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AlHuda Material\islamic banking

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islamic banks banking financial finance investment conventional institutions funds risk financing deposits assets services management international countries equity profit products

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Number of Pages

26

Published Date

2009-02-19 06:11:31

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Introducing Islamic Banking in Conventional Banking system

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