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Bright Future of Islamic Banking
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The concept of Islamic Banking and its inherent benefits, seem to be catching
on globally. Many countries are now following in the footsteps of Malaysia in
instituting financial products and services that offer certainty and
transparency.
Basically, Islamic banking refrains from the practice of usury and unfair
banking penalties such as “interest upon interest”. It focuses on an equitable
sharing of profits between the bank and the customer or depositor.
The United Kingdom and several other European countries, as well our closest
neighbour Singapore, have ventured into Islamic banking. And they all aspire to
be an Islamic Banking hub.
In Malaysia, the government’s efforts in positioning the country as an
international Islamic financial hub have shown much progress. This is seen in
the high growth rate of Islamic-based assets and liabilities of the banking
sector of the past few years.
Other initiatives include the liberalisation of the Islamic banking sector with
the granting of Islamic banking licences to major foreign Islamic financial
institutions and the launch of the International Currency Business Unit (ICBU)
with a 10-year tax break. These steps further prove that Malaysia is keen to
expand its master plan in the growth of the Islamic banking sector.
Most local banks have already set up full-fledged Islamic subsidiaries and a
foreign bank has also obtained approval for similar establishments. It is
expected that some other foreign banks will follow suit.
The recent approval by Bank Negara Malaysia for the setting-up of a
full-fledged Investment Bank under the ICBU platform marks another milestone
for Malaysia.
The Islamic banking system can attain significant growth if the value
proposition is better understood.
Any misconception about Islamic banking, once eliminated, will certainly
encourage more customers to switch from existing conventional banking practices
to Islamic banking.
Perhaps, the true value propositions have not been highlighted by financial
institutions with full-fledged Islamic banks, fearing that such a move may
“cannibalise” their existing conventional banking business.
One of the main misconceptions (although Islamic banking has been introduced in
Malaysia since 1983) is that Islamic banking is exclusively for Muslims. With
the affixing of an “i” to Islamic products rather than applying the Arabic
contract name, we hope that this change will make the product acceptable to
non-Muslims.
Islamic banking products and services address the requirements of all,
regardless of race and religious belief. For Muslims, it will fulfill their
religious obligations where they must refrain from taking usury (or interest).
For non-Muslims, it provides viable alternatives to their conventional banking
products.
Comparatively, conventional banking is predominantly driven by a floating
interest rate system, as opposed to Islamic banking which subscribes to fixed
or a hybrid of fixed and variable profit-rate mechanism. Thus, Islamic banking
promotes certainty, clarity and predictability in its financial transactions.
In addition, Islamic banking also offers profit-sharing contracts. Customers,
particularly the depositors (or investors in the true sense of risk and reward
arrangement), can enjoy higher returns (at an agreed profit-sharing ratio) from
profits generated from the bank’s investment in financing and other ventures.
This measure is in contrast with the conventional banking model where profits
generated from the bank’s business is not shared but predetermined on placement
of the deposits.
Technically, in a rising deposit rate trend, depositors who place funds under a
long tenure, conventional fixed deposits will lose out while depositors of
Islamic deposits will continue to enjoy uptrend movement of the profit rates
(irrespective of their placement tenure) which normally is benchmarked against
the “interest rate trend” due to competition.
Nevertheless, two important differences between conventional fixed deposit and
Islamic fixed deposit that most customers are not aware are: (a) profit rate
for longer tenure placement is generally higher than the shorter tenure to
ensure principle of fairness is applied; (b) there is no penalty for premature
withdrawal.
With regards to Islamic financing products, the pricing is determined as a
fixed selling price which incorporates and pre-determines the profit levels
that the Islamic bank will charge for the whole financing tenure. This will
enable the customers (or the borrower as termed under conventional banking) to
better manage their cash flow, unlike conventional banking loans where the
interest rate is on a floating basis.
The 1997 financial crisis taught us a great lesson where floating interest rate
pricing caused hardship to both businesses and consumers alike. On top of that,
the “interest upon interest” or compounded method used by conventional banks is
strictly prohibited under Islamic banking.
Late charges on overdue instalment is normally charge as a deterrent and
whatever income derived from late charges are given to charity. (Late charges
are part of the bank’s income under conventional banking.)
A series of articles on the value proposition of Islamic banking on various
products and services offered by Islamic banks will be published to help
consumers and business entities understand better and appreciate what Islamic
banks can offer and the benefits associated with Islamic banking.
This article is brought to you, courtesy of Asian Finance Bank (AFB). AFB is
the latest, full-fledged Islamic bank to operate in Malaysia. Backed by a
consortium of some of the most prominent names in the Middle East, Malaysia
shall serve as AFB’s regional hub, as it expands into neighbouring countries
and other parts of the region.
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