• BSP support for Islamic banking is long overdue

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    Ben D. Kritz

    Ben D. Kritz

    It was encouraging to hear the news earlier last week that the Bangko Sentral ng Pilipinas (BSP) intends to amend its charter to permit the growth of Islamic banking in the Philippines. The initiative is meritorious enough that we should overlook the not-so-subtle political timing of the announcement, and the fact that the Philippines is at least decade behind its regional neighbors in realizing the economic potential of a system that caters to the financial needs of businesses and individuals who adhere to the principles of Shari’ah.

    The idea of “Islamic banking” unavoidably causes some skepticism among consumers and businesspeople accustomed to conventional finance systems, but if one can overlook the obvious religious overtones, the financial principles established by Shari’ah law have a certain practical logic to them. There are five fundamental requirements that Shari’ah-compliant finance must follow. First, the collecting of interest, or riba, is prohibited. The theological basis of the concept is that riba serves as an insurance against the lender’s risk, making the risk relationship between lender and borrower unequal; this is not allowed, because it is up to Allah to grant whether a venture should be successful or not—in other words, one who does not take a risk does not deserve a reward of profit.

    Second, investments must be in ethical products, and avoid those which are haram (prohibited), such as gambling businesses, alcohol, prohibited foods such as pork, weapons and other things considered immoral by Islam. Third, investments must be in “real” products, or be trade-related. For example, a Western financial invention like a credit default swap or mortgage-backed-security would not be acceptable in Islamic finance. The idea behind this principle is that money is simply a medium of exchange and not something with an inherent value; without an underlying product for the money to represent, the money has no definable worth. The fourth principle is avoidance of gharar (excessive risk). This is related to both the provisions against investing in that which is haram, since excessive risk is like gambling, and the prohibition of riba in the sense that any profit to the lender comes to him without his own effort in either case; winning a gamble is simply chance, and collecting riba is a guarantee against fair risk. Finally, one of the most important principles is that a part of the profits must be paid as zakat (charity).

    The real benefits of Islamic banking are perhaps best seen at the level of the MFI or rural/community bank. Because Shari’ah is a moral and ethical framework that is intended to embrace the Muslim’s entire life, small institutions as a matter of necessity tend to adopt a more holistic approach in providing support for individuals’ and businesses’ productive activities, and these institutions enjoy a credibility advantage within their communities to mobilize excess resources in informal economies. Some typical Islamic financial products offered in MFI/community banking settings are:

    • Bai Salam–A forward sale agreement for a commodity (in practice, usually a farmer’s future harvest).

    • Bai Muajjal–The opposite of bai salam, involving the immediate sale of a commodity with payments being deferred.

    • Wadiah–A “safekeeping” deposit, roughly equivalent to a conventional savings account. The bank is liable to the depositor for the full amount of the deposit, but retains any profit (or loss) from it. In a bit of a work-around of the rules to make wadiah accounts more like conventional accounts, some banks will pay discretionary “gifts” to depositors that approximate the interest that would be earned on a conventional account.

    • Mudarabah–A profit-sharing deposit; depositors are entitled to a share of the profits earned by the bank on a deposit, but—again, in accordance with the concept of risk-sharing—the principal amount of the deposit is not guaranteed.

    While Islamic finance in what could be considered its “classical” or most “religiously accurate” form, which prioritizes social utility over financial profit, works well within the scope of MFIs and community banks, it faces a number of challenges to operating in the larger commercial banking sector. In order to be competitive, some Islamic banks have resorted to interpreting the principles set forth by Shari’ah in ways that are potentially contentious. For example, the orthodox definition of riba is interest in all its forms, but it can apparently be taken to mean simply “usury”; on that basis, some Islamic banks pay deposit interest that is virtually indistinguishable from that paid on a conventional deposit account, save for its being defined as a form of “profit-sharing.” The definition of what constitutes a “real” product is sometimes interpreted rather broadly as well, and has led to the development of somewhat controversial secondary financial products such as the sukuk murabaha, which is the sale of rights to receivables, or a form of bond.

    The main objective of the BSP’s plan to amend its charter—for which it has not, unfortunately, provided any sort of timeframe, making the initiative more an aspiration than an actual goal at this point—is to allow Islamic banks access to BSP credit facilities, and so far nothing has been offered in terms of how actual bank regulation may have to be modified to effectively manage an Islamic banking system. Obviously, there is a great deal of work left to do, but the fact that the BSP, better late than never it might be said, is stepping forward on Islamic banking is a welcome development.

    benkritz@outlook.com

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    1 Comment

    1. Rodolfo L. Gorospe on

      Islamic Banking should be encouraged in the Philippines ’cause it encourages profit sharing.