Islamic Banking and Finance - Essay Example

Islamic finance Despite the upheavals and mayhem that exists between the Islamic world and the United Kingdom, as peculiar as it may seem, it is wise to say that Islamic banking and finance has found its way in the United Kingdom. Islamic finance is the basis of Islamic banking system. Laying its foundation on the rules and principles of Sharia, commonly known as the Islamic law, this offers Islamic finance its very unique and competent features. As much as Islamic Banking has its challenge and opportunity, many western bankers have sort to involve themselves in this growing business (Maria, 2011). Their guiding principles and rules state that Allah owns everything in this world and that man has only been rendered permission to use it. In the United Kingdom, London has emerged itself to be the core ad centre of Islamic banking. In the United Kingdom, a decade ago, the business was perceived to be in its infancy this being the reason as to why its extent is limited (Rodney, 2000). A decade later, Islamic banking and finance has prevailed in the United Kingdom due to its unique characteristics. One of the most distinct characteristics that have made Islamic banking and finance business to grow is the fact that Islamic banking does not offer interests, which is commonly referred to as riba in the Islamic world. The reward for money deposited as perceived is done by not charging or paying interest. As a way of curbing the loss and profits occurred, Islamic banking use the technique of sharing both the profit and loss occurred. This is commonly known as mudarabhah, which in lay man’s term means profit sharing. In cases that involve mortgage buying, the bank itself buys the mortgage from the seller then giving it to the buyer making profits thus allowing the buyer to pay the money in installments. The mortgage is registered under the buyers name from the start to avoid any suspicions. This kind of arrangement is known as Murabah. The entrepreneur feature of the Islamic banking and finance is another characteristic that has made this type of banking to stand out. Putting its focus not only on financial expansion but on also physical expansion of economic services and production, this has made many western bankers to use the Islamic banking and finance services. Trade financing and equity financing have led the way for the Islamic banks. No wonder the growing trend of people enjoying their banking services. The United Kingdom being one of the worlds’ most sophisticated and complicated banking and financial systems, this has helped the Islamic banking and finance to prevail. The main reason as to why Islamic banking and finance has prevailed more in London than in any other cities of the world is due to the fact that London is much closer to Middle East than any other cities. In fact, London is estimated to have hosted the world’s largest Islam’s in all the cities of the world (Anwar, 1995). In the center of London, the Arab community is ranked among the most affluent Arabs in the world. To add on to that, Arabs restaurants and hotels exists in London center to cater for the Arabs that visit the city every now and then. There has been an increasing number of doctors, engineers, and students in the United Kingdom. London emerges to be the leading market in the world for foreign currency exchange, dollar being the popular currency trade. In the recent years, the retail level banking in the United Kingdom has gone down. This is due to the introduction of the Banking Act of 1987, which allowed external banking to exist. The big four banking players dominance namely Barclays, Lloyd, NatWest and the Midland bank, the latter being the only one that has managed to secure its market share. Evolving from a small niche bank in the Middle East in the last four decades, Islamic Banking and finance have grown in to a dynamic, profitable, and resilient competitor to all major banks in the United Kingdom. By the end of 2008, Islamic banks are estimated to be over $850 billion and estimated to grow by about 15% annually. According to Maria, the Islamic financial industry is estimated to be over $1 trillion (2011). If the past performances are a thing to go by, in another decade, then we will be about to witness the system doubling in size. Some institutions posted a total return of equity for over 40 percent. The global financial crisis that emerged in 2007 was the first major challenge for the Islamic banking and finance. A decade ago before the financial crisis sprang up; exceptional returns were experienced by the sharia-compliant financial system. Almost every two years assets were doubling and the net income also doubling annually. During the millennium year and 2007, the figures posted by the conventional Islamic institutions were quite remarkable. If we put the time frame in to consideration and the Islamic financials evolution system, then the Islamic banking and finance department had done quite an impressive job. The global financial crisis hit the economy very hard making it difficult and challenging both the opportunities and foundation for a rapid growth for the Islamic banking and finance community. The aftermath of the crisis created challenges that can be subdivided in to two groups. Firstly, the impact the global financial crisis had on the financial sector and the effects, which occurred after the financial crisis on the real economy. Looking at the effects the global financial crisis had on the Islamic banking and finance, then it is safe to say that the next decade has a lot of growing opportunities. A look at the 2007 global financial crisis shows that the Islamic banking system was favored by the crisis. According to Hassan and Lewis, Conventional banks were outdone by Islamic banks in performance terms in matters related to its credit, asset, and profitability growth (2009). In the year 2008, the profit of the conventional banks went down by 35 percent compared to the Islamic banks which when down by an estimate of less than 10 percent. According to Ayub, Islamic banks are perceived to have maintained their credit growth quite strongly compared to the way in which the neighbors the conventional banks were doing (2009). This is a suggestion that in the nearby decade, if there is to be a reoccurrence of a global financial crisis, then the Islamic banking and finance sector will stand out. The system has proved to have great potential for a further market-share expansion. The system has also shown that through the available credit, the system can have a possible contribution to the market stability. Between the period of 2007 and 2009, the same trend reoccurred on the assets side. The assets side was less affected by deleveraging and rose up by an average of more than double compared to the conventional banks. Since the global financial crisis has proved to be an ongoing occurrence, the results, which are provisional are supported by the characteristics of the Islamic banking system. The current decade proves to have a lot in store for the Islamic banking and finance system in terms of assets and credit growth.   In addition, another reason why the Islamic banking and finance sector will prevail through the continuous global economic system is due to the fact that the Islamic banks usually strike a balance between oversight and flexibility. It is estimated that the credit crunch will not happen to the Islamic institutions due to the proponents of the Islamic banking systems. Based on the partnership between the clients and the banks, these systems will succeed topping up with the social commitment within the Islamic banking and finance (Chapra, 2009). Although the Islamic banking system has posed to succeed within the decade, there are certain challenges that face it. First and foremost, due to the fact that the Islamic banking and finance industry has not yet boomed all that much in the United Kingdom and also the fact that majority of the tourists in the capital city London mainly use the conventional banks, this can pose as a threat. The Islamic banking and finance system operate in an economy that has been manipulated and is well driven by interest. The central bank governs the banking sectors’ financial economy. The central bank operates in such a manner that its regulations and policies are designed for conventional commercial banks. This means that the central bank only acts as a lender in the last resort. Unfortunate for the Islamic banks, they do not get to enjoy these privileges. In addition to that, the operational procedures for the conventional banks and Islamic banks are very different. If a liquidity gap happens to arise, the non compatibility results usually prevents the central bank from giving support or controlling the Islamic banking and finance system. These are among the challenges that will continue to challenge the Islamic banking and finance system in the United Kingdom. The Islamic banking and finance system usually management liquidity through the lack of or limitation of practical instruments. This is also because there is a small number of people participating on the finance market. The sharia principles and rules have banned down majority of the conventional liquidity tools. This makes the Islamic banking and finance system to experience higher liquidity ratios in comparison to the conventional banks. However, there a lot of facts that can still weaken the potential of the Islamic banking and finance system and also affect its reputation. These facts include that the Islamic banking and financial systems lack contract standardization. They also lack the instruments to go against the currency’s volatility. The issue of the industry also lacking a lot of professional on the supervision and industry level also contributes to a major down fall (Cechetti, 2008). Besides that, there is also the challenge of the Islamic banking and finance system facing the same risks that the contemporary conventional financial systems are facing. This is due to the fact that the Islamic finance and banking industry also work under the secular system, which the conventional banking institutions operate from. For instance, the Islamic banking and finance system does not operate genuinely in risk sharing because they lack proper regulation. This means that the clients of the Islamic banking and finance system usually face the same consequences as their counterparts, the clients of the conventional banking system who operate on interest. The cycle that is evident in the United Kingdom economy, this is a sign that if the Islamic banks were to involve themselves in a money creation system, then they are likely to suffer the same fate (Adrian & Shin, 2008). The fact that the wealth inequality increases from one generation to another is usually resulted in this kind of system that the Islamic banking and finance system offer. Islamic banking and financial system usually suffer a lot of conflict in their risk sharing. This is because the conventional institutions usually prioritize the rich to the provision of the rich. Besides that clients’ risk is usually taken away from the banker because the conventional banks lending system is usually collateral. If the Islamic banking and financial system wants to cut out the risk sharing, then they should concentrate on determining the banks liabilities by the performance of its assets (GoodHart, 2008). Most of the conventional banking systems have adopted quite complicated risk management system. The Islamic banking and finance system does not offer this kind of system or a diversified customer base. On the levels of liquidity and advantage, some banks pose quite different and less complicated activities. Considering the real economy, majority of the Islamic banks are likely to suffer from negative spillover effects although they have managed to overcome their current shortcomings. Their shortcomings in this case include their lack of a modern liquidity management system though they have managed to keep their legal infrastructure currently updated in line considering the pace at which the financial landscape is rapidly changing. The Great Depression of the 1930s seems to share many similarities with the current global crisis since 2007. Within capitalism, it seems that there many characteristics that have been inherited. The characteristics inherited seem to have caused the oil, credit crunch and food crisis that is happening now. The United Kingdom economy and all other economies that have imitated them seem to continue the plague. The fragility of capitalism and the market free economy has proved to be fatal due to the credit crunch. The demand for other alternatives seems to be growing in place because of the credit crunch falling out (Siddiqqi, 2009). Conclusion In the midst of the growing global economic crisis, Islamic banking and finance has proved to be with stand the crisis because it is here with a good cause that is to solve the credit crisis. The Islamic finance value is estimated to enjoy a phenomenal growth, with a global estimate value of approximately 1 trillion. Estimated at an average yearly growth of more than 15 percent, the Islamic banking and finance system has been rated among the fastest growing financial institutions in the global financial system. This has made many western bankers to turn their interest and much research in to the system. There is nothing like a perfect banking system so the Islamic banking and financing system should not consider itself resilience regardless of the fact that it has managed to survive through the current tough economic times. The effects and the impacts of the global economic crisis have also managed to have negative impacts on their lack of a proper risk sharing strategy. They also lack a proper liquidation management system. Additionally, the Islamic banking and financial systems lack contract standardization. They also lack the instruments to go against the currency’s volatility. The issue of the industry also lacking a lot of professional on the supervision and industry level also contributes to a major down fall. Despite the challenges that the Islamic banking and finance system face, it is evident that it has managed to secure itself a place in the United Kingdom. If the Islamic banking and finance system manages to work on its weaknesses, then there is no doubt that it will continue to prevail in the tough economic times of the United Kingdom. References Adrian, T, and Shin, H, S, 2008, Liquidity, Monetary Policy, and Financial Cycles. Federal Reserve Bank of United Kingdom, Current Issues in Economics and Finance. Ayub, M, 2009, Understanding Islamic finance. John Wiley and sons Limited. West Sussex, England. Cechetti, S, G, 2008, Sub-prime Series: Part 4: Does Well-Designed Monetary Policy Encourage Risk- Taking? in Andrew Felton and Carmen Reinhart, eds., The First Global Financial Crisis of the 21stCentury.Retrieved from 29th February 2012 ;www.voxeu.org/index.php?q=node/758. Chapra, M,U, 2009, “Global Islamic Financial Crisis, Can Islamic Finance Help?”, NewHorizon, January-March, 2009, Issue No.170, Retrieved on 29th February 2012http://www.newhorizonislamicbanking.com/index.cfm?section=archive&action=view&id=81 Goodhart, C, 2008, The Background to the 2007 Financial Crisis. International Economics and Economic Policy, 4(4), pp. 331-46. Hassan, K, M, & Lewis, K, M, 2007, A handbook for Islamic Banking. Edward Elgar Publishing Limited. Cheltenham, U.K Maria, C, F, 2011, Islamic Banking System: Threats and Opportunities. Retrieved on 29th February 2012 from http://www.worldpress.org/Mideast/3741.cfm Muhammad, A, 2000, Muslims in Britain in Syed Z. 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