Islamic banks predominate in Muslim countries, and their market share of the global banking market is now 14 per cent.
What characterises these banks is the fact that they adhere to certain economic rules that are part of the Islamic Sharia law. Business based on interest is forbidden, and aggressive risk taking and creation of credit against credit are not allowed. Sabur Mollah, Associate Professor of Finance at SBS, explains how business is done.
“Islamic banking is about partnership and mutual funding based on profit-loss sharing. The entrepreneur and the bank both invest money in the business and become partners. They share the profit, and if there is a loss they will share that too. The loss sharing is one of the advantages of Islamic banking, but there are also drawbacks. For example, access to Islamic banking systems is difficult for poor people, even though Islamic banks have adopted micro financing on a limited scale. However, you cannot borrow from Islamic banks if you do not have equity participation,” Sabur says.
The partnership-idea works both ways in Islamic banks. Customers do not receive interest when they put their savings into a bank account. Instead they share any profit the bank may make.
Multi-layer governance system
Sabur’s main research field is corporate governance in banks, and recently he has compared governance in Islamic banks with governance in conventional banks. Islamic banks have two levels of governance: a regular board and a board called the Sharia board. The latter monitors the regular board to ensure that the bank follows the Islamic regulations. Sabur and a colleague in Australia have studied empirical data from a large number of banks, most of them operating in Muslim countries, to see whether this affects the banks’ performance or not.
“We found that the additional level of governance – the Sharia board − improves the performance of Islamic banks. We also found that it is important for the Sharia board to be a supervisory board and not only an advisory board.
Not allowed to speculate
Islamic banking is an alternative way of doing business, and Sabur suggests that conventional banks might benefit from learning more about it. In western countries with large Muslim populations some of the regular banks are now trying out new ways of meeting their customer’s demands.
“In the United Kingdom some conventional banks, for example HSBC, Lloyds and Barclays, are opening a small Islamic window to serve their Muslim customers. There they will do business together without interest,” says Sabur.
One reason behind the increasing curiosity for this type of banking is the fact that they did a lot better than conventional banks during the financial crisis. Since they share their customers’ losses they are more likely to be cautious and selective when investing. And when the crash in the American housing market – the subprime credit crisis − spread to conventional banks over the world, it didn’t affect Islamic banks as much.
“Islamic banks only do business based on real assets, like a shop or a factory, and they cannot buy liabilities. They are not allowed to take risks based on artificially created assets, like the securitisation of debt instruments. Academics generally believe that the prohibition of securitisation of debt helped Islamic banks survive the global financial crisis,” Sabur says.
Supervisory boards for financial stability
Sabur suggest that conventional banks could establish a mechanism similar to a supervisory board − a function that would keep an eye on ethical factors and what is best for society, and not only on stockholder interests.
“Stockholders always want the bank to take higher risks in order to make more money, but the taxpayers will have to pay for the bailout if the bank fails. You need to have some kind of regulation to keep the financial system healthy, otherwise we will experience a new financial crisis every ten years. It would serve the public interest for conventional banks to have some type of committee that can tell the board of directors what they can and cannot do.”