The Islamic Banks and their Requirements - Essay Example

?Running head: Emerging and alternative financial markets Emerging and alternative financial markets Insert Insert Grade Insert Name April 4, 2011 1. Provisions of financial services in the UK The consumers are the central figure in any business deal and the various business organizations need to have provisions that attempt to protect the needs of the customers. A successful market is that which provides for the needs of the consumers and the citizens in general (Consumer Focus, 2010, p.2). Various regulatory procedures then needs to be instituted that advocates for these public needs. A desired regulatory mechanism has certain valued characteristics. Firstly, it should give a first priority to the needs of the consumer. It has to ensure that the consumers are provided with the best services in a given market as they necessarily dictate the success of every business organization (McVea, 2002, p.6). The mechanism should also ensure high degree of integrity and accountability. Some of the events that are witnessed in the economic study are those that follow certain cycles and need to be studied chronologically so that their adverse effects are not felt repeatedly. Others may not follow any definite patterns and corrective procedures need to be adopted whenever such events are recorded. The regulatory measures that are to be adopted in the financial services should be those that respond differently to each of the emerging situations as per the specific requirements of the situation (Consumer Focus, 2010, p.4). The regulatory approach that is to be adopted after a given financial crisis should be different from the previous approaches and it depends on the current situations that are experienced. A good regulatory procedure on financial services thus responds to the prevailing financial crisis and mitigates the occurrence of future crises (Consumer Focus, 2010, p.2).It should be aimed at developing a competitive market that attracts more investors and focuses solely on the needs of the customers. The anticipated market should be that which allows for the invention innovation by the investing organizations. There are various financial regulatory bodies in the United Kingdom. The main regulatory body is the Financial Services Authority and which provides various regulatory provisions (Great Britain, 2005, p.37; Jaffer, 2005, p.134). The problem that arises is then how to collect the divergent views of the regulatory agencies ad channel them towards the same statutory objective (Consumer Focus, 2010, p.5). The UK Financial Services has had various developments that are geared towards the regulating the provision of financial services in the region. The UK Financial Services Authority has put more emphasis on regulatory measures based on policies and principles. The authority issued a policy statement in July 2007 that was in line with the policy that it had developed the previous year in regard to the principles and rules that govern business conduct by various investment companies (London Update, 2007, p.1). The revised policy would ensure the implementation of the ‘the relevant provisions of the EU Markets in Financial Instruments Directive (MiFID) as well as non MiFID Conduct of Business Rules’ (London Update, 2007, p.1). The issue of corporate governance is another approach towards the regulation of the provision of financial services that have been applied in the UK. The investment companies in the UK need to learn and adopt a code of corporate governance in an attempt to comply with the rules and provisions given. The Association of Investment Companies (AIC) gave out a guide on Corporate Governance to its members in June 2007 that included both the AIC code and the UK combined code on Corporate Governance (London Update, 2007, p.1). Deceptive misstatements in the regular disclosure to the market have also been another issue in the UK financial sector. There have been various legal provisions that govern who are to be held responsible for such misstatement in the market. Section 90A of the UK Financial Services and Markets Act 2000 (FSMA) provides that the issuers of such fraudulent misstatements to the market bear the associated liabilities (London Update, 2007, p.1). The problem that has been observed with these legal provisions is that the aims of the government in establishing the provisions are never fully met. The implementation process is often influenced by the political differences between the different organizations and the desires of a particular regulatory body (Consumer Focus, 2010, p.5). To ensure accountability by the regulatory bodies, the government should intervene and issue regular statements on what it requires to be done by the regulators, as well as what shall be implemented by the government itself. HM Treasury gave a report in June 2007 that vested the liability of such misstatement on the investment companies that have issued the statement. The report also suggested that the rules on statutory liability should include those for corporate misstatement to the market. The report gave some further recommendations. Firstly, the regulatory agencies should ensure that ‘fraud is maintained as the standard of problem’ (London Update, 2007, p.2). The regulators should aim at protecting the consumers against all kinds of scams and malpractices in the financial market (Consumer Focus, 2010, p.2). It is also suggested that the legislative provisions should apply to all unplanned market disclosures and the announcements by the Regulatory Information Service. In fact, it is required that no such ad hoc announcements be made and that the regulatory agencies be permanently instituted with regular operational procedures (Consumer Focus, 2010, p.6). It is also required that the regulations provide for equal opportunities for both the buyers and sellers. The effects that such regulations have on the market competition should be considered through the inclusion of different stakeholders in the financial sector (Consumer Focus, 2010, p.13). Besides, there is a requirement that a liability be imposed for fraudulent delay in making statements to the RIS. It has been noted that even the FSA as a regulatory agency has not been keen in promoting accountability (Consumer Focus, 2010, p.15). It has been found not to reveal the financial institutions that are not abiding by the regulatory provisions. The private equity market has experienced certain risks owing to the conflicting interests of the participants in the market. The growth and development that have been seen in the private equity market have been reported to negatively impact on the regulatory procedure by the UK Financial Services Authority (London Update, 2007, p.2). The authority gave a report in June 2007 regarding the measures that would be taken in managing the risks that would be caused by the growing private equity market. It ascertained that the outlaid procedures would be very appropriate and effective in dealing with the risks. The authority had purposed to ‘tighten the regulatory reporting requirements for firms and… conduct a semi-annual survey every six months on banks’ exposures to leveraged buy-outs in which private equity funds had a stake’ (London Update, 2007, p.2). 2. Critical aspects of the Islamic Banking and Finance Islamic banking refers to the banking activities and procedures that follow the provisions of the Sharia laws of the Islamic religion. It is a kind of banking that is ‘recognized by both Muslims and non-Muslims as an ethical alternative, protecting against the worst excesses of leverage whilst reinstating values, such as trust, which have been lost in the conventional finance’ (Vernados, 2010, p.1). The banking system operates under the requirements of the Islamic traditions towards the economic development in a given region. This lack of interest makes the banking system different from the Western or Conventional banking system where the interest is the main item of operation. The Islamic banks operate on three basic guiding principles that actually depend on how humane our actions as individuals are. These are the principle of multifaceted ownership, the principle of economic freedom within a defined limit, and the principle of social justice (Okte, 2010, p.3).The interest, which they refer to as riba, needs not to feature anywhere in the commercial activities by the Muslims (Salah, 2010, p.3). The banking system enables the Muslim to carry out their economic activities in accordance with the Islamic faith (Malik et al, 2011, p.2). Consequently, the system has certain principles and practices that are not in line with the usual monetary and fiscal policies that govern a given economy. In effect, the banking system has had certain criticism and has not been able to flourish well in some regions where the religion is not very well established. It was observed to withstand financial crisis in Asia but this could be seen to be confined in a given region (Vernados, 2010. p.2). The system had to be evaluated in the subsequent crises that cover wide geographical regions with diverse religious cultural beliefs and practices. In the recent past, the Islamic banking and finance institutions have been struggling to have their operations similar to those carried out by conventional banking institutions. However, the application of the Sharia laws to the banking industry does not provide for a legal framework that enhances the bringing of these banks to the interest of many investors. The Sharia provision that no interest be charged on loans given to individuals and business organizations does not attract very many investors into the financial market (Karimi n.d, p.1). The banking systems need to be restructured in order to perform the functions of banking institutions that are performed by the conventional banking systems. The Islamic banking system is characterized by a number of weaknesses that need to be reviewed and that do enhance the operations of such banks in non-Islamic regions like the United Kingdom. Firstly, there is lack of conventional legal framework that governs the operations of the banking system. They usually do not obtain legal support due to lack of corresponding laws that are appropriate for the implementation of the Sharia provisions in certain parts. The Islamic law offers 'its own framework for the execution of the commercial and financial contracts and transactions' (Karimi n.d. p.1). As a result, there are no standard procedures for implementation of the banking and financial contracts by the Islamic banking institutions. The conventional commercial, banking, and company laws contain provisions that are not consistent with the required operations of the Islamic bank. This lack of a standardized legal framework is seen in to negatively impact on various levels of operations. The Islamic legal system is totally different from the conventional legal systems. However, in the events that there are certain legal disputes in the activities of the banks, the case is directed to the same judicial procedures just like the conventional cases. It is then suggested that the existing legal provisions be reviewed in order to accommodate the requirements of the Islamic law, a point that is not easy to be effected. This is not particularly attainable in a country with a legal framework that has been constituted based on the provisions of a different religion. The banking and company laws in the different countries are required to modify their procedures to contain the Islamic banks as well (Karimi, n.d, p.2). Besides, it is internationally required that before a financial contract is signed for an Islamic bank, the terms of the contracts should be consistent with both the Islamic law and the International monetary and fiscal policies. There are a number of features in the Islamic Banking and Finance that are not standard and cannot be applicable to conventional banking institutions. One of the main challenges of the Sharia law and its implication on the Islamic banking system is that it does not allow for the payment and receipt of interest fees on loans. It has been noted that the current financial crisis that hits most of the Asian countries is caused by the large banking institutions that underwrite loans from foreign brokers and securitize the loans. The Islamic banking and finance operates under the Sharia laws and does not allow for interests imposed on borrowed loans (Vernados, 2010. p.2). The Islamic baking institutions do not operate primarily as lenders; they tend to be engaged in a tangible commercial activity that deals with a direct asset. The ancient Islamic practices did not allow trade on goods and services but this has since been adopted as the alternative to the prohibited interests imposed on the loans borrowed by investors. The current Islamic finance has a direct connection to the real sector and consists in directly conducting trade and other investment operations (Vernados, 2010. p.2). It is argued that carrying out trade on goods is ethical enough since it involves the process of risk taking by the investors (Salah 2010, p.3). It is believed that this process of creating profit through risk taking is essential in promoting business ethics through ensuring equitable and fair business transactions. The Islamic banking system promotes direct ownership of real assets. According to the provisions of Sharia, it is unlawful for an investor to sell or lease goods and services that are not owned by the investor as is the case in the above securitization process. It requires a trade on real assets that are owned by the investors. The application of ‘speculative short selling’ is thus not part of the Islamic banking and finance (Vernados, 2010. p.3). There are other provisions by the Islamic banks that cannot be generalized to other conventional banking activities. The balance sheet in an Islamic banking system is not supposed to contain certain assets that are believed not to be owned directly by the banks. The assets that are financed by Ijara or Murabahah are not to be shown on the balance sheet (Karimi, n.d, p.2). Poor regulatory system is also seen in the case of housing finance by the Islamic banks. It is run based on the Diminishing Musharaka, whereby the banks and their customers jointly own the houses. There is no proper agreement between the bank and the customer who has rented the house. Instead, a kind of monthly payment agreement is made with no guarantee that the customer shall have to pay the rents. There are thus no legal provisions for managing such a risk by the Islamic banks (Karimi, n.d, p.2). Besides, the requirement of the Islamic banking system when dealing with profits and loss is that it throws much of the operational risks to the customers of the banks. In particular, the depositors in the Islamic banks are not under any protection, which often necessitates their withdrawal from operating with such institutions. The banks operate on the basis of profit and loss and any loss that is incurred is passed on directly onto the depositors The Sharia law that governs Islamic banking also prohibits gambling in financial transactions and this cannot be generalized to all the banking institutions. It has also been noted that the companies that deal in prohibited goods like alcohol or pornographic movies are not entitled to obtain capital from the Islamic banks. These are some of the prohibitions that are given by the Islamic law, but are enjoyed by the conventional banking institutions (Malik et al, 2011, p.2). In this way, the market of the institutions is narrowed down to those who deal in recommended products, and which may not be in line with what the current prevailing market conditions dictate. The provision can also not be adopted by the international organizations that monitor the market situations. There is also lack of standard financial contracts and products by the Islamic banks. The Islamic financial institutions have the same products but the kind of interpretation of the Sharia laws given by different scholars constituting the governing board results into different products featuring the financial markets (Karimi, n.d, p.3). This often results into a state of ambiguity and does not promote financial growth in the given region. There is also the problem of low availability of liquidation by the banks and this prevents them from entering into transaction deals that are likely to take long periods. The liquidity issue would remain to be a challenge to the Islamic banking system whenever such a bank is established amidst competing conventional banks (Malik, et al, 2011, p.2). The consumers are thus not protected effectively as per the requirements of the Islamic law. The inability of the banks to deal with long-term investors also poses other challenges. The banks do not deal in interest bonds and they are therefore forced to deal in more equity products. The banks are then faced with the problem of fluctuating prices of the goods that they deal in thereby increasing their operational risks (Karimi, n.d, p.3). However, despite the difficulties that the Islamic banking system faces in its establishment, the industry is gradually expanding its operations in the Western and has recorded a significant growth particularly in the United Kingdom in the recent years (Malik et al, 2011, p.3). There has been a significant growth in the Muslim society in the UK and an additional handsome figure of the Muslim visitors into the region annually and a significant growth in insurance products like takaful (Jaffer, 2005, p.134). The banks had been earlier on established in the Islamic nations like Egypt and Malaysia and their successes in these regions triggered the investors to extend to other nations like the UK that had an increasing population of Muslims. The first Islamic bank in the UK was Al-Baraka bank introduced in the early 1980s. It carried on relatively well but had to succumb later on to the stiff competition from the conventional banks and its limited capacity (Malik et al, 2011, p.3). Islamic banking has continued to grow in the UK. The recent conflicts that were witnessed between the US and the Arab countries led to the closure of such banks in the US and the establishment of new banks in the UK. The UK government responded by improving the poor regulations that had been a barrier to the growth of these banks. The Financial Services Authority currently recognizes the Islamic banks and their requirements (Malik et al, p.3). References Consumer Focus. 2010. A new approach to financial regulation: Judgement, focus, and stability. (Online). Available from: http://www.consumerfocus.org.uk/files/2009/06/Consumer-Focus-response-to-Treasury-inquiry-A-new-approach-to-financial-regulation-final.pdf [Accessed on April 4, 2011]. Great Britain: Department for constitutional affairs. 2005. The Future of Legal Services: Putting Consumers First. London: The Stationery Office. Jaffer, S., 2005. Islamic retail banking and finance: global challenges and opportunities. London: Euromoney Books. London Update. 2007. UK Financial Services Regulatory Developments (Online). Available from: http://www.kattenlaw.com/files/Publication/89104e00-4141-4209-be69-00bf53a7ddbe/Presentation/PublicationAttachment/e2304937-9aa4-46fe-af50-010159a869cc/UK%20Financial%20Services%20Regulatory%20Developments%20-%20July%202007.pdf [Accessed on April 4, 2011]. Karimi, A., n.d. Challenges facing Islamic banks. (Online). Available from: http://www.nzibo.com/IB2/Challenges.pdf [Accessed on April 4, 2011]. Malik, M. et al. 2011. An Analysis of Islamic Banking and Finance in West: From Lagging to Leading. Asian Social Science, Vol.7 No.1, Pp.179-185. (Online). Available from: http://web.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=4&hid=17&sid=d805398d-8ca2-498a-a942-33c4075900be%40sessionmgr4 [Accessed on April 4, 2011]. McVea, H., 2002. Predators and the public interest- the ‘Big Four’ and Multi-Disciplinary Practices. The Modern Law Review, Vol.65. No.6. (Online). Available from: http://web.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=6&hid=17&sid=d805398d-8ca2-498a-a942-33c4075900be%40sessionmgr4[Accessed on April 4, 2011]. Okte, M., 2010. Fundamentals of Islamic Economy and Finance: Theory and Practice. Electronic Journal of Social Sciences, Vol.9. Iss.1 pp180-2008. (Online). Available from: http://web.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=4&hid=17&sid=d805398d-8ca2-498a-a942-33c4075900be%40sessionmgr4 [Accessed on April 4, 2011]. Salah, O., 2010. Islamic finance: the impact of the AAOIFI Resolution on equity-based sukuk structures. Law and Financial Markets Review, Vol.4 Iss.4 pp507-517. (Online). Available from: http://web.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=4&hid=17&sid=d805398d-8ca2-498a-a942-33c4075900be%40sessionmgr4 [Accessed on April 4, 2011] Vernados, A., 2010. Current issues in Islamic banking and finance: resilience and stability in the present system. Singapore: World Scientific Publishing. Read More