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Recent
years have brought an increasing flow of
empirical studies of Islamic banking.
The earliest systematic empirical work
was undertaken by Khan (l983). His
observations covered Islamic banks
operating in Sudan, United Arab
Emirates, Kuwait, Bahrain, Jordan, and
Egypt. Khan's study showed that these
banks had little difficulty in devising
practices in conformity with Shariah. He
identified two types of investment
accounts: one where the depositor
authorized the banks to invest the money
in any project and the other where the
depositor had a say in the choice of
project to be financed. On the asset
side, the banks under investigation had
been resorting to mudaraba, musharaka
and murabaha modes. Khan's study
reported profit rates ranging from 9 to
20 per cent which were competitive with
conventional banks in the corresponding
areas. The rates of return to depositors
varied between 8 and l5 per cent, which
were quite comparable with the rates of
return offered by conventional banks.
Khan's
study revealed that Islamic banks had a
preference for trade finance and real
estate investments. The study also
revealed a strong preference for quick
returns, which is understandable in view
of the fact that these newly established
institutions were anxious to report
positive results even in the early years
of operation. Nienhaus (1988) suggests
that the relative profitability of
Islamic banks, especially in the Middle
East in recent years, was to a large
extent due to the property (real estate)
boom. He has cited cases of heavy losses
which came with the crash of the
property sector.
The
IMF study referred to earlier by Iqbal
and Mirakhor (l987) also contains
extremely interesting empirical
observations, although these are
confined to the experience of Iran and
Pakistan, both of which have attempted
to islamize the entire banking system on
a comprehensive basis. Iran switched to
Islamic banking in August l983 with a
three-year transition period. The
Iranian system allows banks to accept
current and savings deposits without
having to pay any return, but it permits
the banks to offer incentives such as
variable prizes or bonuses in cash or
kind on these deposits. Term deposits
(both short-term and long-term) earn a
rate of return based on the bank's
profits and on the deposit maturity. No
empirical evidence is as yet available
on the interesting question as to
whether interest or a profit-share
provides the more effective incentive to
depositors for the mobilization of
private saving. Where Islamic and
conventional banks exist side by side,
central bank control of bank interest
rates is liable to be circumvented by
shifts of funds to the Islamic banks.
Iqbal
and Mirakhor have noted that the
conversion to Islamic modes has been
much slower on the asset than on the
deposit side. It appears that the
Islamic banking system in Iran was able
to use less than half of its resources
for credit to the private sector, mostly
in the form of short-term facilities,
i.e., commercial and trade transactions.
The slower pace of conversion on the
asset side was attributed by the authors
to the inadequate supply of personnel
trained in long-term financing. The
authors, however, found no evidence to
show that the effectiveness of monetary
policy in Iran, broadly speaking, was
altered by the conversion.
The
Pakistani experience differs from the
Iranian one in that Pakistan had opted
for a gradual islamization process which
began in l979. In the first phase, which
ended on l January l985, domestic banks
operated both interest- free and
interest-based 'windows'. In the second
phase of the transformation process, the
banking system was geared to operate all
transactions on the basis of no
interest, the only exceptions being
foreign currency deposits, foreign loans
and government debts. The Pakistani
model took care to ensure that the new
modes of financing did not upset the
basic functioning and structure of the
banking system. This and the gradual
pace of transition, according to the
authors, made it easier for the
Pakistani banks to adapt to the new
system. The rate of return on
profit-and-loss sharing (PLS) deposits
appears not only to have been in general
higher than the interest rate before
islamization but also to have varied
between banks, the differential
indicating the degree of competition in
the banking industry. The authors noted
that the PLS system and the new modes of
financing had accorded considerable
flexibility to banks and their clients.
Once again the study concluded that the
effectiveness of monetary policy in
Pakistan was not impaired by the
changeover.
The
IMF study, however, expressed
considerable uneasiness about the
concentration of bank assets on
short-term trade credits rather than on
long-term financing. This the authors
found undesirable, not only because it
is inconsistent with the intentions of
the new system, but also because the
heavy concentration on a few assets
might increase risks and destabilize the
asset portfolios. The study also drew
attention to the difficulty experienced
in both Iran and Pakistan in financing
budget deficits under a non-interest
system and underscored the urgent need
to devise suitable interest-free
instruments. Iran has, however, decreed
that government borrowing on the basis
of a fixed rate of return from the
nationalized banking system would not
amount to interest and would hence be
permissible. The official
rationalization is that, since all banks
are nationalized, interest rates and
payments among banks will cancel out in
the consolidated accounts. (This, of
course, abstracts from the banks'
business with non-bank customers.) There
are also some small case studies of
Islamic banks operating in Bangladesh (Huq
l986), Egypt (Mohammad l986), Malaysia (Halim
l988b), Pakistan (Khan l986), and Sudan
(Salama l988b). These studies reveal
interesting similarities and
differences. The current accounts in all
cases are operated on the principles of
al-wadiah. Savings deposits, too, are
accepted on the basis of al-wadiah, but
'gifts' to depositors are given entirely
at the discretion of the Islamic banks
on the minimum balance, so that the
depositors also share in profits.
Investment deposits are invariably based
on the mudaraba principle, but there are
considerable variations. Thus, for
example, the Islamic Bank of Bangladesh
has been offering PLS Deposit Accounts,
PLS Special Notice Deposit Accounts, and
PLS Term Deposit Accounts, while Bank
Islam Malaysia has been operating two
kinds of investment deposits, one for
the general public and the other for
institutional clients.
The
studies also show that the
profit-sharing ratios and the modes of
payment vary from place to place and
from time to time. Thus, for example,
profits are provisionally declared on a
monthly basis in Malaysia, on a
quarterly basis in Egypt, on a
half-yearly basis in Bangladesh and
Pakistan, and on an annual basis in
Sudan.
A
striking common feature of all these
banks is that even their investment
deposits are mostly short-term,
reflecting the depositors' preference
for assets in as liquid a form as
possible. Even in Malaysia, where
investment deposits have accounted for a
much larger proportion of the total, the
bulk of them were made for a period of
less than two years. By contrast, in
Sudan most of the deposits have
consisted of current and savings
deposits, apparently because of the
ceiling imposed by the Sudanese monetary
authorities on investment deposits which
in turn was influenced by limited
investment opportunities in the domestic
economy. There are also interesting
variations in the pattern of resource
utilization by the Islamic banks. For
example, musharaka has been far more
important than murabaha as an investment
mode in Sudan, while the reverse has
been the case in Malaysia. On the
average, however, murabaha, bai'muajjal
and ijara, rather than musharaka
represent the most commonly used modes
of financing. The case studies also show
that the structure of the clientele has
been skewed in favor of the more
affluent segment of society, no doubt
because the banks are located mainly in
metropolitan centres with small branch
networks.
The
two main problems identified by the case
studies are the absence of suitable
non-interest-based financial instruments
for money and capital market
transactions and the high rate of
borrower delinquency. The former problem
has been partially redressed by Islamic
banks resorting to mutual inter-bank
arrangements and central bank
cooperation, as mentioned earlier. The
Bank Islam Malaysia, for instance, has
been placing its excess liquidity with
the central bank which usually exercises
its discretionary powers to give some
returns. The delinquency problem appears
to be real and serious. Murabaha
payments have often been held up because
late payments cannot be penalized, in
contrast to the interest system in which
delayed payments would automatically
mean increased interest payments. To
overcome this problem, the Pakistani
banks have resorted to what is called
'mark-down' which is the opposite of
'mark-up' (i.e., the profit margin in
the cost-plus approach of murabaha
transactions). 'Mark-down' amounts to
giving rebates as an incentive for early
payments. But the legitimacy of this
'mark-down' practice is questionable on
Shariah grounds, since it is time- based
and therefore smacks of interest.
In
the Southeast Asian context, two recent
studies on the Bank Islam Malaysia by
Man (l988) and the Philippine Amanah
Bank by Mastura (l988) deserve special
mention. The Malaysian experience in
Islamic banking has been encouraging.
Man's study shows that the average
return to depositors has been quite
competitive with that offered by
conventional banks. By the end of l986,
after three years of operation, the bank
had a network of fourteen branches.
However, 90 per cent of its deposits had
maturities of two years or less, and
non-Muslim depositors accounted for only
2 per cent of the total. Man is
particularly critical of the fact that
the mudaraba and musharaka modes of
operation, which are considered most
meaningful by Islamic scholars,
accounted for a very small proportion of
the total investment portfolio, while
bai'muajjal and ijara formed the bulk of
the total. It is evident from Mastura's
analysis that the Philippine Amanah Bank
is, strictly speaking, not an Islamic
bank, as interest-based operations
continue to coexist with Islamic modes
of financing. Thus, the PAB has been
operating both interest and Islamic
'windows' for deposits. Mastura's study
has produced evidence to show that the
PAB has been concentrating on murabaha
transactions, paying hardly any
attention to the mudaraba and musharaka
means of financing. The PAB has also
been adopting unorthodox approaches in
dealing with excess liquidity by making
use of interest- bearing treasury bills.
Nonetheless, the PAB has also been
invoking some Islamic modes in several
major investment activities. Mastura has
made special references to the qirad
principle adopted by the PAB in the Kilu-sang
Kabuhayan at Kaunlaran (KKK) movement
launched under Marcos and to the ijara
financing for the acquisition of farm
implements and supplies in the Quedon
food production program undertaken by
the present regime. So far no reference
has been made to Indonesia, the largest
Muslim country in the world, with
Muslims accounting for 90 per cent of a
population of some 165 million. The
explanation is that a substantial
proportion, especially in Java, are
arguably nominal Muslims. Indonesians by
and large subscribe to the Pancasila
ideology which is essentially secular in
character. The present regime seems to
associate Islamic banking with Islamic
fundamentalism to which the regime is
not at all sympathetic. Besides, the
intellectual tradition in Indonesia in
modern times has not been conducive to
the idea of interest-free banking. There
were several well respected Indonesian
intellectuals including Hatta (the
former Vice President) who had argued
that riba prohibited in Islam was not
the same as interest charged or offered
by modern commercial banks, although
Islamic jurists in Indonesia hold the
opposite view. The Muslim public seems
somewhat indifferent to all this. This,
however, does not mean that there are no
interest-free financial institutions
operating in Indonesia. One form of
traditional interest-free borrowing is
the still widely prevalent form of
informal rural credit known as ijon
(green) because the loan is secured on
the standing crop as described by
Partadireja (1974). Another is the
arisan system practiced among consumers
and small craftsmen and traders. In this
system, each member contributes
regularly a certain sum and obtains
interest-free loans from the pool by
drawing lots. The chances of an Islamic
bank being established in Indonesia seem
at present remote (cf. Rahardjo 1988).
Finally,
in the most recent contribution to the
growing Islamic banking literature,
Nien-haus (l988) concludes that Islamic
banking is viable at the microeconomic
level but dismisses the proponents'
ideological claims for superiority of
Islamic banking as 'unfounded'. Nienhaus
points out that there are some failure
stories. Examples cited include the
Kuwait Finance House which had its
fingers burned by investing heavily in
the Kuwaiti real estate and construction
sector in l984, and the Islamic Bank
International of Denmark which suffered
heavy losses in l985 and l986 to the
tune of more than 30 per cent of its
paid-up capital. But then, as Nienhaus
himself has noted, the quoted troubles
of individual banks had specific causes
and it would be inappropriate to draw
general conclusions from particular
cases. Nienhaus notes that the high
growth rates of the initial years have
been falling off, but he rejects the
thesis that the Islamic banks have
reached their 'limits of growth' after
filling a market gap. The falling growth
rates might well be due to the bigger
base values, and the growth performance
of Islamic banks has been relatively
better in most cases than that of
conventional banks in recent years.
According
to Nienhaus, the market shares of many
Islamic banks have increased over time,
notwithstanding the deceleration in the
growth of deposits. The only exception
was the Faisal Islamic Bank of Sudan
(FIBS) whose market share had shrunk
from l5 per cent in l982 to 7 per cent
in l986, but Nien-haus claims that the
market shares lost by FIBS were won not
by conventional banks but by newer
Islamic banks in Sudan. Short-term trade
financing has clearly been dominant in
most Islamic banks regardless of size.
This is contrary to the expectation that
the Islamic banks would be active mainly
in the field of corporate financing on a
participation basis. Nien-haus
attributes this not only to insufficient
supply by the banks but also to weak
demand by entrepreneurs who may prefer
fixed interest cost to sharing their
profits
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