Islamic Banking and Finance: Role and Relevance in a Recessionist Economy (Part 2)

The growth of Islamic Banking and Finance as a new discipline, particularly in the context of the global economic recession that is in force today, has been, to say the least, quite remarkable. Presented hereunder is the second installment of the text of an interview conducted by a research group from the Indian Institute of Management, Bangalore, (IIMB) with BIJU ABDUL QADIR, Executive Editor of YOUNG MUSLIM DIGEST, on the implications of this growing interest in Islamic Banking and Finance for a recession-hit economy such as the one in place now.

IIMB: What do you think is the level of consumer awareness? Is the awareness high among Muslim population?

BAQ: As mentioned earlier, the current global financial crisis has awakened most users of conventional banking to the risks they had been running without even being aware of the same. While research into Islamic banking and finance dates back from the early 1970s, it is in their search for alternatives amidst today’s global crisis that a new level of consumer awareness with regard to Islamic Banking and Finance has been attained to on the international scene.

It is interesting here to see how the Indian subcontinent, of all other places, has been leading from the forefront not only in providing Islamic Banking solutions today, but also in research into Islamic economics and banking right from the initial stages. The 70s and 80s were times of great ferment in Muslim intellectual circles at least as far as Islamic Economics and Finance was concerned. Indeed, some of most internationally renowned names in this subject have been those of people like Dr. Fazlurehman Faridi, Dr. Muhammad Najathullah Siddiqui, Dr. Muhammad Umer Chapra, and Mahmud Ahmad among others. As such, the awareness at the level of the Muslim intellectuals of the subcontinent has been quite acute, indeed. While this need not always translate into a high level of public awareness also, it is a sufficient indicator that in forward states of the country like Kerala, public awareness too has been on a high in recent times. The establishment of the Cochin-based Alternative Investments and Credits Ltd (AICL) as an interest-free financial venture registered under the RBI as a Non-Banking Financial Institution (NBFI) with a starting capital of five crore rupees several years ago was a landmark event in the state. The good performance of the AICL which runs on the Islamic Profit-Loss Sharing (PLS) basis must surely have influenced, and encouraged, the government in that state to start an Islamic bank of its own as announced recently. The great public support and investment garnered by the AICL over the years is also an indicator of the level of public awareness of this institution in Kerala.

Again, on the international academic front, universities in the West have been quick to grasp the possibilities of Islamic Finance. If projections at some of these are to be believed, 2009 will see new courses and postgraduate qualifications in Islamic finance springing up throughout the UK and elsewhere in Europe, reflecting the fact that it has become one of the fastest-growing sectors of the global banking industry. In the UK, interest in the sector also reflects the government’s commitment to promoting Britain as an Islamic finance centre. The UK already leads Europe in the number of Islamic finance training courses it offers, from entry to postgraduate level, and in 2006 saw the launch of the Islamic Finance Qualification, a joint initiative between a Lebanese business school and the Securities and Investment Institute.

In late 2008, the UK Treasury published a paper setting out the government’s aim to make London Europe’s gateway to international Islamic finance. This was a clear acknowledgement that the industry was still young and therefore not yet experiencing skills shortages, but predicted that it soon would be. In turn, universities have responded enthusiastically. NewcastleUniversity is offering an M.Sc in finance and law with Islamic finance from its next academic year. HenleyBusinessSchool at the University of Reading has been offering M.Sc in investment banking and Islamic finance, with students spending the second part of the year in Kuala Lumpur. The University of Bangor in Wales has also been running its Islamic finance MA and M.Sc for a year and is considering introducing a new MBA in the subject, while the first students to take an Islamic finance option as part of an executive MBA offered in Dubai by CassBusinessSchool will have graduated this summer. Durham, which has been offering postgraduate research degrees in Islamic finance for some time, is now introducing an M.A. and M.Sc. (the M.Sc. is more quantitative), to respond to demand. Elsewhere in Europe, the ReimsManagementSchool is offering a new specialist course in Islamic banking and finance for students on its masters in management programme, taught in English. Student demand is driving the subject as much as any urging from governments. According to Rodney Wilson, founder and director of the Islamic finance programme at Durham, it is coming mainly from south-east Asia, particularly Malaysia, and the Middle East, although there is plenty of interest from the UK as well. Joanna Gray, professor of financial regulation at NewcastleLawSchool, says she is keen that their new degree course is not just seen as something for Muslims. She believes that it is for anyone interested in a fast-developing industry that in the UK has been quite busy in the past few years to accommodate forms of investment in finance that are Shariah-compliant.

IIMB: Considering the large infrastructure projects are currently under development, do you think Islamic Banking (through product features of Istisna’a) can help?

BAQ: An important characteristic of the Islamic resurgence in our time is the coming-of-age of Islamic banking. Istisna’ – like other Islamic commercial contracts such as Mudarabah, Musharakah, and Murabahah – can play an important role in the Islamic banking system, especially when the major parts of goods in a commercial transaction are manufactured goods. The flexible legal nature of Istisna’ and its secure aspect of investment greatly contributes to this facility.

The term Istisna’ as derived from the word Sana’a literally means ‘making, manufacturing, or constructing something.’ It is also defined as a contract with a manufacturer to make something. As a contract, Istisna’ must fulfill the requirement of a valid contract i.e., the capacity of the contracting parties, offer and acceptance, and the subject-matter should be a valuable thing. Besides these general conditions, there are some specific requirements for the contract of Istisna’ itself. Thus, the object should be exactly determined in essence and quality, the object should be a known item for the parties involved, the time of delivery – whether long or short – must be fixed so that related disputes are avoided, the material should be provided by the maker and not the buyer, and the place of delivery must be specified if transportation expenses are involved. It is also pertinent to note that it is not a condition in a Istisna’ contract to advance the payment, though it is permissible to do so, or to defer it, or make the payment in installments. Also, it is not a condition that the seller should himself make the commodity. He can fulfill his obligation by bringing a commodity with an exact prescribed description although manufactured by a third person. Lastly, that the seller be an expert in manufacturing, it is not a condition

If implemented properly, Istisna’ can play a crucial role in the development of the economy since it promotes demand for manufacturing goods; finances economic activities, contributes to the stabilization of prices of manufactured goods, promotes industrial and technological advancement and makes use of all possibilities within the economy. With the manufacturing sector representing the foundation of contemporary economies, Istisna‘s role in increasing the demand for manufactured goods can prove vital. Since there is no pre-condition in Istisna’ that the price should be paid in advance, various bargains can be finalized with the price being paid in the future or through installments. As an aside, an increase in demand has quite a few positive economic implications through expansion of economic activities, opening new areas of competitiveness, creation of new jobs and expansion of the market.

Furthermore, if the buyer possesses the money during the conclusion of the contract and pays in advance, the manufacturer will benefit from this payment to finance the process of production or other investment projects. Moreover, it will finance the expenses of manufacturing and stabilize the process of production. Moreover, the contract between the buyer and the seller before the production of the commodity will be based on sound calculations. The buyer would be aware that what he pays is commensurate to the right price. The manufacturer on his side wants the market to continue its progress in a stable manner to guarantee a regular demand for his merchandise. Thus, the agreed price will be based on solid estimates, which will contribute to the prevalence of a market price, which reflects the realities of supply and demand.

In addition, based on the production and trade of manufactured goods, and in particular the need to take the utmost care in the selection of the manufacturer, Istisna’ increases competition and specialization in the manufacturing field which will, in turn, boost technological advancement in this area: a factor which is not available in other modes of investment. Finally, a seller in an Istisna’ transaction need not supply the necessary services for the manufacturing of the goods by himself. This makes it possible for financial institutions, like Islamic banks, to be the seller in Istisna’ contracts. Therefore, it is inevitable for a financial institution that assumes the role of a seller in Istisna’ transactions to relate the Istisna’ contract to a third party that will be able to provide the necessary services for manufacturing the goods. Furthermore, it is necessary sometimes to have a consultant or supervisor to monitor the effective progress of the production. Thus, Istisna’ allows the involvement of many parties in the production which will contribute to the reduction of unemployment.

Istisna’ is applicable to the various industries as long as they can be monitored by measurement and specifications and which could be manufactured or constructed at any stage of the process of production. Thus, it can be used in the food processing, drying, or canning industries or beverage manufacturing. The Istisna’ contract is applicable also in high technology industries such as aircraft industries, locomotives, ships, cars, electronics and machines produced in big factories and workshops. It can also be used to finance intangible assets, such as electricity and gas. In addition, Istisna’ could be used as an international mode of investment (especially among Muslims countries) in pre-shipment financing of the acquisition of capital goods in projects for which no other suitable mode of financing is available. The Islamic development bank, for instance, has so far used installment sale and leasing mostly for financing finished goods. Working capital needed for the production of such goods falls outside the ambit of the Islamic Development Bank (IDB) financing.