Introduction
This article may very well initiate a controversy but it must be ascertained right in the beginning that this has never been intended. Islamic banking and finance (IBF) has made some valuable progress in the last five decades, and it is indeed an achievement that a humble start has become a significant phenomenon in more than 20 countries of the world. Size of the global Islamic financial services stood at US$2.431 trillion at the end of 2017, with an annual growth rate of around 6%1 . In other countries, although IBF exists but it has yet to make a mark. It has also attracted attention of global players in financial markets, with the likes of HSBC, Standard Chartered, Citibank, UBS, BNP Paribas, and many more. Admittedly, many of these institutions have revised their IBF strategies and their initial excitement towards the industry has receded. However, this has allowed full-fledged Islamic banks, like Dubai Islamic Bank (DIB), Kuwait Finance House (KFH) and Al Rajhi Bank, to strengthen their positions in the growing markets of IBF. Conglomerates of Islamic financial institutions are fast developing to become multilateral organisations. There is growing recognition of IBF in the multilateral institutions like the World Bank and International Monetary Fund.
In academia, Islamic economics has got marginalised but there is a growing focus on IBF. There are regular conferences, seminars and workshops with an exclusive focus on Islamic economics, banking and finance (IEBF).
Academicians continue to make valuable contributions to what may come under the rubric of IEBF.
Despite impressive growth and significant market shares in a number of countries, IBF has failed to impress government agenda in terms of poverty alleviation, financial inclusion, gender balances, employment creation and support for industry and innovation. It has also yet to enter public policy debates in addressing a socio-economic problem faced by the countries wherein it has otherwise assumed significance and prominence.
Main Hypotheses
This article focuses on the future of IBF.
The question arises if the future is path dependent. If it is, then there are three possible scenarios for future of Islamic banking and finance.
1. It will continue to grow to eventually become indistinguishable from the conventional interest-based banking and finance.
2. It will continue to develop itself to become completely independent of conventional interest-based banking and finance.
3. It continues the way it is being developed and nothing happens.
In this path-dependency framework, there is no other possibility. Other possibilities may arise out of a paradigm shift that may come into existence because of a completely new and path-independent event. We shall come to this possibility later, but first let us analyse the above three path-dependent outcomes.
Number one is the most probable, and unfortunately this will be the gloomiest future of IBF. Number two is the least likely. Number threeis possible only in the medium to long run, giving rise to the ultimate outcome, i.e., the first outcome, in the very long run.
Scenario Number One
To understand it, let us look at the practice of Islamic banking and finance. No one can deny the fact that Islamic banking and finance is different from its conventional counterpart in the process only, with exactly the same ultimate outcomes and objectives. Islamic banks are merely money managers, with at best facilitating trades, and contrary to the claims, not traders. Admittedly, the existing banking regulations do not allow Islamic banks to operate as traders. But, then this is a completely different story. No one compelled Islamic banks to be in bed with banks. This is a deliberate choice rather than a compulsion.
Because Islamic banks are banks, they operate and behave as such. They offer credit for home purchases, for buying and selling of cars, and they offer credit cards to cater for liquidity needs of households and individuals. For businesses, they offer credit in the form of trade finance and in some cases for working capital. In a wider context, Islamic financial institutions are involved in issuing Islamic bonds named as sukuk to borrow or lend, named as financing.
All Islamic financial products are priced as credit facilities. Because they are credit facilities, and not trading activities, they are benchmarked to a loan contract. Here comes the role of LIBOR, SIBOR, KLIBOR and KIBOR. At present, Islamic financial products are benchmarked to an interestbased index, with the distinction that Islamic financial products differ in the process only, with an ultimate outcome similar to an interest based loan contract. This was acceptable, if the transactions were real trades. However, Islamic banks merely finance trades; they are not traders. The regulators do not deem them traders. Islamic banks themselves ask tax authorities to deem their
transactions mere financing, and not trading, to negotiate tax neutrality. When we look into the contracts like murabaha, istisna’, salam and even ijara, they are structured in such a way that there are provisions for rebate on early payments and penalties on late payments and defaults, making these contracts nothing more than loan contracts.
These are just a few of many examples that leadone to conclude that in future Islamic banking and finance will become indistinguishable from the interest-based conventional banking and finance. This is the most likely future of Islamic banking and finance, if it continues to grow the way it has grown in the last fifty years.
Scenario Number Two
IBF can become a completely independent financial system if reforms are endogenised. There are some early indicators of this trend in countries like Malaysia. Malaysian Islamic banks started with only one product, that is of bai al-‘ina or what they called as bai’ bithaman ‘aajil or BBA. This controversial contract was systematically and gradually routed out to be replaced by a less controversial contract of tawarruq. Most recently, the central bank of the country, Bank Negara Malaysia (BNM), has introduced the concept of value-based intermediation to ensure that Islamic banks and financial institutions offer a distinct value proposition to their customers and clients. There is no doubt that a number of malpractices in IBF have been taken out as a result of great emphasis on Shari’a governance and assurance. The effectiveness of industry bodies like Islamic Financial Services Board (IFSB) and Accounting & Auditing Organisation for Islamic Financial Institutions (AAOIFI) is on a rise. The regulatory bodies are increasingly becoming aware of IBFspecific needs and requirements and are trying to develop frameworks for strengthening of Islamic financial institutions to ensure their stability and sustainability.
Furthermore, there are a number of countries (e.g., the GCC countries, Malaysia, Brunei and Bangladesh, etc.) where Islamic banking is about one-fourth of national banking sectors, or more, and one should expect that the influence of Islamic banking and finance in these countries will increase in future. This must create monopolistic competitive markets wherein Islamic and conventional banks will compete with each other, trying to win business from each other. With the increase in share of Islamic banking and finance in such markets, more authentic and distinctly different Islamic financial products may emerge. This is the least probable scenario though.
The reason behind this pessimistic view is the institutionalisation of practices like tawarruq and commodity murabaha. The latest development (or anti-development if one may say so) in this respect is the allowance of commodity murabaha even in countries like Pakistan.
Scenario Number Three
Growth in IBF has been phenomenal in the first decade of the current century. However, in the last three to four years, there has been a visible slowdown in the growth, with only 6% annual growth in 2017. The current size of the global Islamic financial services industry stands at US$2.431 trillion. There have been revised downward estimates for the size of the industry in the next 5 years. This means that potential of Islamic banking and finance to replace conventional banking and finance even in the key markets is rather limited. Saudi Arabia is an exception, where Islamic banking and finance is at least as much as its conventional counterpart in terms of the size. In all other markets, Islamic banking and finance will struggle to match with its conventional peer.
The quantitative comparison, however, should not be the major concern for the industry stakeholders. The real challenge is of qualitative nature. The conventionalisation of Islamic banking and finance is more rapid than Islamisation of conventional banking and finance, as Islamic banking and finance is becoming more conventional with every new development. There is now a strong movement in favour of changing the nomenclature to remove or limit the Islamic tag. In the medium to long-run (next 15 to 25 years), IBF will continue to grow the way it hasdeveloped so far. This will in the very long-run mean no distinctly different Islamic banking and finance.
This is indeed a pessimistic view of IBF. This whole process that started with a promise will collapse into a mere technicality. The prohibition of interest will in fact become a technical requirement, without any real benefits. That is what we have already admitted when we accept benchmarking of Islamic financial products with reference to an interest-based index. Benchmarking of Islamic financial products with reference to LIBOR, SIBOR, KLIBOR and KIBOR is nothing more than accepting efficiency of interest in pricing and resource allocation. Different stakeholders, especially Shari’a scholars, challenge the critics of Islamic banking and finance to suggest a more suitable benchmark than interest rates.
Outside banking, Islamic asset management provides a good opportunity for development of Islamic finance. In the context of Pakistan, mudaraba sector has a huge potential to develop Islamic finance as a viable alternative to conventional finance. However, despite the intial success of mudaraba companies and mudarabas, this sector has not been developed to its full potential.
It will certainly be an incomplete picture of the future of Islamic finance, if one stops here. The phrase used in the last sentence is Islamic finance, and not Islamic banking and finance, deliberately, because Islamic finance has a very different future than Islamic banking.
It is almost certain that a new Islamic financial institution will emerge in future, which will not price credit, and which will not be involved in trading of credit, either in the form of loans or credit embedded in financial arrangements woven around trades. This institution will accept the fact that the prohibition of interest implies no purchase and sale of credit. Credit would be provided for free, if it effectively means transfer of money now in exchange of money in future. In this framework, credit will fetch a price only if a trading institution has sold something on deferred payment basis. This means that this future institution will not be a bank (i.e., it will not be a deposit-taking institution), rather it will be a genuine trading establishment.
If one takes a more radical view, a charitable organisation will emerge, which will offer free credit to individuals, families and even businesses. It will be run with the help of charitable contributions and endowments to offer completely interest-free loans to anyone who would need it for consumption or business. It will become completely sustainable in a period of 15 to 25 years, when a full generation of beneficiaries becomes net contributors rather than mere recipients of credit. That will be the actual realisation of the prohibition of interest. That model will ensure no one inflicting injustice and not itself being subject to any injustice.
One may argue that such institutions are already in existence in various countries of the world. Perhaps they are not entirely wrong in their observation. However, one would like to see such institutions emerging as what may be called Foundations. Foundations and not banks! These Foundations may have their own endowments or awqaf, or maybe organised as profit-oriented establishments. Fauji Foundation in Pakistan provides a good example, although it is not being proposed that Foundations should emulate what Fauji Foundation does.
There is perhaps a better example in the form of Islamic Relief. The Islamic Relief Worldwide (IRF)is a charitable organization, with operations in more than 30 countries of the world. Although it is primarily a relief organization but it has of late started offering microcredit to the poor, particularly women.
As mentioned earlier, mudaraba model in Pakistan was perhaps the best opportunity to develop a new model of profit-oriented Islamic finance but even this is fast becoming a lost opportunity. This still has a potential to become a viable alternative model of financial intermediation, if it is further developed as a non-bank financial institution based on participation in capital and sharing of risk and reward. The emergence of FinTech and crowdfunding should help in democratising the model, as at present the only entry point for participation in mudaraba business is through stock market and Participation Term Certificates, based on musharaka.
The mudaraba model may very well be deemed as a double-helix model of Islamic finance. It was a better structure than the sukuk that stole the limelight from it. It was in fact an embryonic form of Exchange Traded Funds (ETFs) that came into prominence about 10 years back, almost 35 years after the first mudaraba was set up in Karachi. Mudarabas in Pakistan could also have been developed into full-fledged Islamic investment banks, but again nothing much was done to evolve this into a credible alternative system of financial intermediation.
If all the existing such businesses are studied, assessed and analysed to found a new model of Islamic finance, that could be one example of what was referred earlier as a completely path-independent event to introduce a new, genuinely authentic model of Islamic finance. That, one should hope, will be the future of Islamic finance.
