30 March 2009

Nigeria: Islamic Banking and Finance

editorial

The recently mooted idea of an Islamic finance system may be a welcome alternative to the age-old traditional Anglo-Saxon financial practices.

The credit crunch occasioned by the economic meltdown and the need to lever up with bailouts have created the need for a new approach to finance and banking. The Islamic financial system has been mentioned in this regard.

Although it is modelled on its interest-based counterpart in that both systems share the same material goals and adopt same institutional structures and so the products promoted by the Islamic finance industry are often seen as undistinguishable, there are sufficient differences to make for a viable alternative to orthodox banking practices.

Ordinarily, interest-based lending secured by collateral sufficiently absolves bankers from their clients' risks, which usually leads to conflict of interests. Oftentimes, the banker who endorses the loan deal has already collected his bonus and retired by the time the deal goes bad. This could scarcely be the case should the requirement of Shari'ah be implemented, where commercial banks would be required to share the profits as well as the losses of their clients, whether on business investments or home purchases. In such circumstances, banks would be more careful when choosing which deals to finance. This risk-sharing finance eliminates conflicts and ensures greater stability in economic activity, since there would be no sub-prime crises where the value of a bank's liability is determined by the performance of its assets.

Incidentally, risk-sharing techniques are not prevalent in modern finance practice. The reverse is usually the case. Both entrepreneurs and bankers actually increase risk, then insulate themselves from it, all in the bid to increase return on capital. If, as an example, the entrepreneur borrows from a bank at 5 per cent interest and then invests in a business that makes 20 per cent profit, he takes away 75 kobo in profit for every naira invested. Logically, he is encouraged to borrow heavily and grow his business operations. This results in a situation where a few large organisations become dominant players on the business landscape. Yet, when he is heavily indebted, a moderate rise in interest rates combined with a moderate fall in revenue can erode his entire profit margin.

Interest-based finance also biases the availability of funds in favour of those who are already rich. Individuals with great ideas but have no collateral, that is, the poor people, often fail to attract finance under the system. This increases the yawning gap between the rich and the poor from one generation to another. Under the practice of tawarruq, however, Islamic banks are allowed to provide their clients with interest-bearing loans in all but name, through a good combination of commodity trades.

One of the factors that engender market volatility is the facility that exists for buying shares on deferred payment terms, or for selling in deferred delivery terms. Price swings as large numbers of sellers and buyers appear in the market. Under Shari'ah, however, ownership of a share is a pre-requisite for its sale, such that there can only be one seller for each share at any particular time. Again, Shari'ah also restricts the use of margin trading and forward trading. This means that one or both counter values (shares or cash) must be exchanged in full on the spot when trading shares.

About the most powerful destabilising factor in modern markets is the issue of money creation by the banking system. For more than three hundred years in the western world, the creation of money out of nothing by central banks and lending it into circulation has caused age-long succession of inflationary trends, as such newly created monies that are spent on assets such as property and shares make their prices rise, naturally.

To address these, Muslim thinkers, such as Mahathir Mohamad, have canvassed for the use of gold and silver as legal tender as against the use of "representative" forms of money such as paper and economic data. Under such metal monetary system, gold and silver, unlike 'representative' money cannot be created out of nothing, and so no organisation has the power to create money without cost, which becomes an important guarantee of stability in a monetary system. The law of trust and the prohibition of interest are the two Islamic regulations that work to prevent money creation by the banking system.

Islamic finance experts, Haitham al-Haddad and Tarek el-Diwany have criticised the deviation from the norms of Islamic finance as the only reason it may not be offering alternative banking and finance practices that are much needed for these times.

Here in Nigeria, there had been facilities like the Small and Medium Income Enterprises (SMIEs) loans which had been put in place as an interest-free facility meant to bridge the yawning gap of wealth inequality between the poor and the super-rich. The scheme hardly achieved its set objectives as it was criticised for circulating only in Lagos and just amongst the few. This may be another opportunity to address what the SMIE failed to do.

Again, we are not unmindful of the religious coloration of our people's faith. The law regulating the practice of banking and finance in Nigeria does not allow the use of religious nomenclature in banking operations. This may be enough to allay the fears of individuals who might think that the Islamic banking and finance is a covert or subtle way of transforming Nigeria, a secular, nay, multi-religious State, into an Islamic State. The fact that the Bible itself discountenances usury is enough reason for all and sundry to embrace a banking system that would alleviate the problems of our people.

It is important that Islamic banking and finance be considered on the basis of its own merits and demerits, rather than seeing it from the viewpoint of religious divides. Practitioners and promoters of the ideals should also go the extra mile to enlighten their prospective customers and clients that it has nothing to do with furthering the cause of one religion over another, nor the promotion of terrorism.

The fact that Islamic finance is largely unorthodox is enough ground to believe that its jurisdictional challenges may not be as broad as the orthodox. To move it from its geographical territories to other lands must therefore be done within the context of adaptability.

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