problems and prospects of islamic banking
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8/6/2019 Problems and Prospects of Islamic Banking
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Problems and prospects of Islamic banking
Banking is an important financial intermediary and vital institution in the economic
structure of any country. The basic services a bank provides include receiving, collecting,
transferring, paying, exchanging, lending, investing, or safeguarding money for its customers.
However, an important question that agitates the minds of those who think on Islamic banking,
whether proponents or critics, is the feasibility of it in Nigeria (which operates on interest free
basis). Islamic banking has the same purpose as conventional banking except it operates
principally on sharing of profit and loss, and the prohibition of riba (interest). Amongst the
common concepts used in Islamic banking are profit sharing (Mudarabah), safekeeping
(Wadi¶ah), joint ventures (Musharakah), cost plus (Murabahah) and leasing (Ijarah).
Islamic banks lend their money to companies by issuing floating rate loans. The floating rate is
pegged to the company¶s individual¶s rate of return. Thus, the bank¶s profit on the loan is equal
to a certain percentage of the company¶s profits. Once the principal amount of the loan is repaid,
the profit sharing arrangement is concluded. So that both profit and risk are shared. Such
participatory arrangements between capital and labour reflect the view that the borrower must
not bear all the risk/cost of a failure, resulting in a balanced distribution of income and not
allowing lender to monopolize the economy. Islamic banking is also restricted to Islamic
acceptable deals, which excludes those involving alcohol, pork, gambling, etc. Thus ethical
investing is the only acceptable form of investment and moral purchasing is encouraged.
The banking system currently operating in Nigeria is the conventional one. It is interest-based
banking system. The whole credit system is built upon the institution of interest. Under thesystem, the borrower is obliged to pay a predetermined rate of interest on the amount borrowed
even though he may have incurred losses. The relationship between the bank and its client is,
therefore, that of creditor and debtor, this had led to so many economic and social evils among
other things.
From the foregoing, it is obvious that the detrimental effects of interest (applicable to
conventional banking) are evident as interest was originally forbidden by all major religions of
the world (Islam, Christianity and Judaism in particular). Even the non-Muslim scholars,
economists and bankers acknowledge that Islamic banking has made a place for itself in the
whole world of finance. The Vatican has put forward the idea that ³the principles of Islamicfinance may represent a possible cure for ailing markets´. (Lorenzo Totaro (2009) ³Vatican says
Islamic finance may help western banks in crisis´. http:/www.bloomberg.com)
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Similarly, the provision of interest can be regarded as exploitation. Islamic banking is a
system that has its rules and regulations and the only system that is performed entirely free of
interest. The establishment and application of Islamic banking particularly in Nigeria, is the best
way to curb these socio-economic maladies in our system.
The main objectives of the banking system are removal of injustice, bringing in the optimal level
of social welfare and ensuring justice in the lives of individuals and the society at large, through
the concept of unity, brotherhood and social justice. It discourages and prohibits all forms of
exploitation, extravagance, hoarding etc.
The main goal of the Islamic economic system is social justice and equality. It tries to be fair to
one and all. It helps in promoting individual enterprise and also controls the economic system in
a fair and equal manner. In the Islamic financial system, the financial institutions (banks) become
a partner in business. The utilization of the funds from the institution by a business house or an
enterprise is on a profit and loss sharing basis. Gains from the business as well as losses earneddue to the business are shared proportionately by the institutions and the enterprise.
But this does not mean that the investments by financial institutions are speculative. Before
investing money, a thorough investigation is carried out on the risk factors associated with the
business. Feasibility study of the project and necessary risk management principles are rightly
undertaken to undermine the effect of loss. Investing in Islamic banks may provide more profit
and less risk because the financial institution has its own interest as it acts as a partner.
There are several factors inhibiting the full implementation of Islamic banking in Nigeria. The
legal factor is there, the political factor, the social factor and even the economic factor. When welook at the legal factor, we can see that the banking decree in Nigeria does not allow the
establishment of any bank with a religious name but a compromise has been reached that you can
open an interest free banking.
There is some significant difference between Islamic banking and interest free banking. Interest
free banking is without interest but the mode of operation or the institutions it may use in its
operation may not necessarily be Islamic. For example Bank PHB, Finbank, StanbicIBTC and
other micro-finance banks such as Integrated Microfinance Bank, Kada Microfinance Bank, etc
have these windows (which non-Muslims do patronize effectively); you can transact interest free
if you like but that does not mean the bank will not transact with other non Islamic institutions
like brewery and other things.
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So a bank can be interest-free, but its instruments might not be Islamic. It doesn¶t deal
directly with interest but the instruments on the people it gives loans may have some elements of
un-Islamic practice. A pure Islamic banking is the one that does not deal with interest as well as
its instruments, purely Islamic. They will not invest in gambling, brewery and any kind of trade
that is un-Islamic. (Hence the need by the CBN to perfect the legal framework that will allow its
full operational system).
Today, Islamic banks are operating worldwide and their impact on financial market is clearly
visible. This progress is an indication of the viability and dynamism of the system.
As Dr. Abbas Mirakhor of IMF has said ³those who believed that banks and financial system
could not operate in a modern economy without reliance on an interest-rate mechanism must
have been surprised at the progress of Islamic banking´. Islamic bankers have accepted the
challenges and are trying to develop innovative financial instruments to meet the need of modern
financial markets. They are tapping their enormous resources and are trying to develop
investment outlets, viable secondary markets and other instruments. Some progress has already been made in this direction.
Islamic banking will make the bank and customers more committed to the management of assets
(loans) on the one hand and interest free deposits for investments by the bank on the other. By so
doing, they will woo investors in the sector. So also the equity and justice in profit sharing will
provide enabling environment for investors to commit their resources.
There are teeming individuals and corporate persons that abhor interest (both muslims and non
muslims). So with its non-interest elements, deposits could be generated from the investing
public. Other potentials such as mortgages, trade and other infrastructure will be realized. Islamic banking will avoid speculations and impact better on the real economy. It will also create
employment by funding the real sector and employing hundreds of thousands of people. The
system will provide good profit and prudent practice and there are expectations that the practice
will annihilate the interest being charged by conventional banking.
Through Islamic banking system, there would be provision of a full range of non-interest local
and foreign currency trade and transaction processing services, collection and payment services,
deposit products and loans to target customers. There would also be a strong balance sheet as a
mark of commitment to high standards of banking practices and safety of depositors¶ funds
(because the whole system is mutually based on trust).
Based on the above explanations given, it would be clear that Islamic banking system will fully
sanitize the banking sector and also reduce the socio-economic problems bedeviling the sector in
Nigeria. There have undoubtedly been fluctuations in the profitability of Islamic banks and
occasional losses in the world, but the general picture is one with steady growth and stability.
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The benefits of Islamic banking in a growing economy like Nigeria cannot be over-emphasized.
In line with the Federal Government¶s desire for a single digit interest rate to spur socio-
economic growth, nothing can be more apt than establishing a non-interest financial institution.
Islamic banking will also contribute significantly to the overall development of the country by
developing micro credit schemes aimed at improving the overall communities, thereby
drastically reducing unemployment rates. There are also ample opportunities to attract Foreign
Direct Investments (FDI) into the country.