Islamic Banking
Islamic banking refers to a system of banking which is consistent with Shari'ah principles and guided by Islamic Economics. Islamic law prohibits usury, the collection and payment of interest (Riba’), and trading in financial risk (which is seen as a form of gambling). In addition, Islamic law prohibits investing in businesses that are considered haram in Islamic ethical code (such as businesses that deal in alcohol, pornography or pork). Shari’ah-compliant institution cannot charge or pay interest on any transaction.
The risk and reward characteristics of Islamic banks are unique due to the nature of profit and loss sharing arrangements. Islamic banks treat depositors as investors distributing profits or losses from ventures according to shared risk taken by the parties. As the foundation of Islamic banking is based on ownership in tangible assets and debt free instruments, this set-up creates a compelling incentive for the bank, the depositor, and the business entity to leave no stone unturned in order to make every investment as highly profitable as possible which is in their mutual benefit and which in turn benefits the whole economic society.
Islamic Banking, if comprehensively implemented in its original form, can be an ethical solution for preventing future financial crises, due to its reliance on mostly tangible asset backed transactions, avoidance of sub-prime securities and financial leverage from hybrid products, derivatives and associated creative accounting practices. Investors in Islamic investments have an implicit right of information on the use of their funds and the nature and performance of underlying assets. The comfort level of investors through this transparent guarantee on the proper utilization of their funds is a clear advantage in Islamic Banking. Scholars at the Anderson Graduate School of Management, University of California, have pointed out that, "Islamic finance will be less prone to inflation and less vulnerable to gambling-like speculation, both of which are fuelled by the presence of huge quantities of debt instruments and derivatives”.
Islamic banking stimulates real sectors in the economy, performs the critical function of mobilizing savings, and intermediates them for investment to generate growth and alleviate poverty. To the extent the poor and low income groups are able to participate and benefit from the fruits of economic growth these excluded classes would then have little incentive to indulge in creating disorder, violence and terrorism. Therefore, the discouragement of economic exclusion, poverty, and social vulnerability will lead to reduction in violence and terrorism as a result of Islamic Banking.
Social investment and Green Funds are based on promotion of socially and environment friendly businesses. Islamic finance does not allow financing the anti-social and unethical businesses such as gambling, alcoholic liquor, and nightclubs. In this respect, it is clearly ahead of the recent surge in ethical finance and socially responsible finance. Islamic financial institutions, because of their active involvement and knowledge of the nature of businesses of their clients, are in a better position to detect and prevent the channeling of depositors' money for financing highly risky anti-social activities. The financing it provides is mostly asset-based, whereby the Islamic bank knows the actual utilization of funds due to the very nature of its structured modes of finance.
The global market for Islamic banking services continues to expand and the sector has perhaps the best potential for growth of any sector in international finance today. Products that are compliant with Shari’ah law are gaining wider understanding and acceptance and are making their way into the mainstream of financial products. The Islamic Finance industry with the help of leading bankers, product development managers, lawyers, regulators and investors are contributing to product structure innovations and expanding the market both in terms of breadth and depth of product offerings.
UAE Islamic Banking Sector
Until recently UAE has had 22 local banks, 27 foreign banks, two specialized banks and 65 representative offices of other foreign banks. Islamic banks have become an increasingly important part of the UAE banking system and have increased their share of total bank assets, from 8.8% at the end of 2002 to 13.4% at end of the first quarter of 2008 (as per newspaper reports). The significance of Islamic banking was further underlined as major banks formed Islamic banking windows or converted into Islamic banks, like EBI formed Emirates Islamic Bank by converting its subsidiary, Middle East Bank. New Islamic banks launched were Noor Islamic Bank in 2007 and Al-Hilal bank and Ajman bank in 2008 and other recent conversions included Dubai Bank and National Bank of Sharjah (now SIB).
The UAE Central Bank treats Islamic banks under Federal Law No. 6 of Islamic Banks and Financial Institutions 1985. The law sets requirements for Islamic banks and allows them to provide finance using Islamic modes of finance which often involve purchase and sale/lease of goods and assets as well as establishing subsidiaries or taking equity in existing firms. In addition, Islamic banks’ financial operations are not subject to double taxation. Beyond this, the Central Bank takes a neutral position on Islamic finance and allows competition between Islamic and conventional finance activities. Industry estimates have shown that market share of Islamic finance in the UAE could reach 50% by the year 2020.
Anti money laundering and Shari’ah Audit
In this world where caution and concerns about possible risks arising from money-laundering and terrorist financing have become acute, Islamic banks by explicitly prohibiting proceeds from activities such as gambling, prostitution, night clubs, drug trafficking provide adequate safeguards. These are the main channels used for money laundering, terrorism financing, and organized crime. Islamic financial institutions enjoy a head start in mitigating these risks. Unlike conventional banks, which rely on documentary evidence and usually have impersonal, arms-length, passive relationships with the majority of their clients, Islamic banks have more stringent 'know-your-customer' requirements.
Islamic banks are engaged in a quasi-partnership profit-loss sharing framework and therefore have to know their clients, their businesses, as well as, their sources and uses of funding in order to satisfy themselves about the authenticity and legitimacy of their counterparties. Thus, they are in a much better position to detect, prevent, and disengage quickly from suspicious transactions. In addition to normal audits, Islamic banks have to conduct Shari’ah review of their transactions for ensuring Shari’ah compliance. This review will catch any funds mobilized or used for 'Haram' (prohibited) activities. Moving forward, this unique feature of Islamic finance can help institutions in prevention of money laundering.
(References: Various online information sources)
ADCB and Islamic Finance
ADCB started to make serious strides into the realm of Islamic Finance in early 2008 and has now established a firm presence in the Islamic Finance market space providing consumer, corporate and investment banking products and services within the framework of Islamic Shari’ah under its proprietary brand of ADCB Meethaq.
For further information on Islamic Banking at ADCB, please click here
