Morality and Ideology in Lending and Credit - Research Proposal Example

Morality and Ideology in lending and credit Introduction: There are some significant differences between the Saudi and U.K. banking systems in the areas of lending and credit. The banking model in Saudi Arabia prevents the collection or paying of interest, since it is considered to be forbidden. In the wake of the recent financial crisis, where the stock markets collapsed as a result of the mass default on the repayment of mortgages in the USA, the U.K. banking system and concomitant lending and credit criteria have been under increased scrutiny and stricter regulations have been introduced. This study proposes to examine the differences in the banking systems in terms of lending and credit and the underlying ethics of the financial principles and practices utilised in these systems. On the basis of this, it is proposed to undertake a detailed study of the morality in lending law based upon empirical data collected on the banking systems in Saudi Arabia and the U.K. The research question for this study is: Do Saudi banking systems promote greater morality and utility in lending and credit under the Muslim ideology as opposed to U.K. banking law? In order to address this research question, it is proposed to undertake a detailed examination of the lending and credit systems in both Saudi Arabia as well as the U.K by looking into how effective the respective systems have been in terms of encouraging and fostering repayment. The notable feature about Saudi banking systems is the fact that charging interest is forbidden because it is considered to be against Muslim law, hence ethical issues may play a salient role. In view of the financial crisis that erupted in recent years, where the morality and ethics of lending decisions were questioned, it might be of interest to assess whether the ethical element inherent in Islamic banking law practices in countries such as Saudi Arabia could influence lending and credit positively. This is the reason for choosing this particular topic for the study. Literature Review History of banking: Banks are financial intermediaries that accept deposits and channel those deposits into lending activities. Modern banking commenced in the middle ages in northern Italy, where Jewish banking developed because the Christians considered it as usury to charge interest. During the medieval ages, three different kinds of banking systems developed, such as the pawnbrokers, moneychangers who also accepted deposits and commercial lending banks (Seims, no date). This was followed by the emergence of paper money and in the year 1844, bank notes became the official legal tender in England. In the present times, banking laws have been harmonised to a considerable extent with several instruments being developed by the League of Nations and the United Nations Commission on International Trade law in regard to bills of exchanges, promissory notes, credit transfers, stand-by letters of credit and assignment of receivables (Seims, no date). The recent financial crisis and corporate scandals such as Enron have dispelled the deregulation which existed previously and given rise to stricter financial regulation of money markets (Von Hagen and Ho, 2007). Deregulation of the banking system has been blamed for the speculative activities of the stock markets and the unrestricted use and issue of credit, which led to the financial crisis (Money morning, 2009). The impact of the crisis was especially acute in the UK, with a call for reforms as indicated below in the discussion of the UK banking system. Banking systems in UK and Saudi Arabia: In the U.K., the banking system is dominated by four large banking conglomerates, Royal Bank of Scotland, HBOS, Barclays, and HSBC. The financial crisis of 2007 also affected the regulatory system in the UK, producing a tightening up of banking operations (Gola and Roselli, 2009). In March of 2009, the Financial Services Authority in the UK put forward proposals which were geared towards the overhaul of the banking system and its governing rules, especially in regulating lending criteria and clamping down on the unrestricted use of credit, in order to prevent a recurrence of the financial crisis (BBC News, 2009). Saudi Arabia has emerged as a major financial force on the world monetary scene, due to the sharp rise in production prices as well as the higher prices of oil, which have produced a considerable rise in the fiscal and external payments positions (Hitti and Abed, 1974). This was not always the case, during the mid 1950s, its oil revenues grew only moderately in relation to its growing expenditures, as a result of which foreign exchange reserves were depleted. The Government intervened with strong stabilization measures which eliminated the fiscal deficits and produced a substantial improvement in the external payments position (Pollard and Samers, 2007). Until 1952, the kingdom of Saudi Arabia had no central bank or monetary authority until the SAMA was established. The Saudi Arabian banking system is governed by the SAMA, i.e, the Saudi Arabian Monetary Agency, which is an autonomous, governmental agency that functions as the custodian of Saudi currency, i.e, the riyal (Meyer Reumann, 1995). This agency has also taken up fiscal functions and now regulates the banking system and lending criteria. The banking system in Saudi Arabia is conditioned by Islamic law that does not allow for the collection of interest. According to Islamic law, the collection of money from money, such as by way of charging interest, is not permitted because that is considered to be an unlawful way of earning money; rather it is only through legitimate trade and investment in assets that money should be generated. (www.islamicmortages.co.uk). Since all forms of interest are forbidden under sharia law, the Islamic finance model, as used in Saudi Arabia, focuses on risk sharing. Under this model, an Islamic bank is viewed as a two tier silent partnership. As a result, deposits made into the bank and seeking some return in the form of interest, would be viewed as silent partnership investments in the bank’s portfolio. The investments made by the banks in terms of lending out this money in the forms of loans and investments are considered to be silent partnership investments in other business ventures (El Gamal, No date). This risk sharing model is thus the cornerstone of Islamic banking, because the collection of riba or interest is considered to be haraam or forbidden under Islamic laws. In a recent report, a Russian author has stated that the Islamic banking system could have prevented the banking collapse because (a) it bans the interest rate and the interest rate is the foundation for the development of wealth and the source of trouble (b) the Islamic economy is not based on collecting as much profit as possible (c) Islam dictates that individuals should not buy something they can’t afford, which if applied to the Western banking system could have prevented the housing mortgage crisis (www.digitaljournal.com). These ethical issues highlight the apparent absence of greed that exists in the Islamic system, which, it could be argued, might well have prevented the financial collapse, since the crisis occurred on account of the underlying greed of banks and lending institutions which wanted to capitalize on the existing market demands and profit from speculative lending activity. Methodology: Doctrinal or library based research is generally the most common methodology used in legal research, because this forms the basis upon which the answers to legal questions are sought. Applying this method, specific enquiries are made and based upon extensive background library readings, the underlying legal issues are unpacked and analysed. Based upon this, the researcher determines the relevant rules and applies them to the research question. The historical research method however relies upon examining case precedents which have been set out by the courts in earlier cases that have dealt with similar or related topics. Applying the historical research method could have a higher level of relevance in the context of UK banking law, because case precedents are the primary source for establishing the necessary legal rules and practices. This method was taken into consideration, but its relevance and applicability in Saudi Arabia was limited, because there is a dearth of Saudi law which can be applied. Hence, the library based method offers greater scope in the context of this particular research study. Legal rules are also applied differently in the UK and Saudi Arabia. In the U.K., there is a reliance on case precedents in the application of the law. In some areas of law such as tort, it is case precedent which has established the relevant rules, for example the duty of care as specified in the case of Donaghue v Stevenson1. In Saudi Arabia however, cultural and religious factors have played a much more significant role. The fact that interest cannot be charged is directly related to the religious underpinnings of the Islamic faith and the cultural elements, which have come to view banking in the context of silent partnership investments rather than as lending with interest. As a result, they cannot be viewed in the same manner and the methodology in this study would need to also take into account the religious and cultural factors influencing lending and credit behaviour in Saudi Arabia. A primarily library based investigative research method supplemented by empirical data on lending and credit in the two countries therefore appears to be best suited for this particular study. The topic which is proposed to be examined in the study is the morality, utility and ideology of lending law in Saudi Arabia which follows Islamic principles as compared to western countries and the study proposed is primarily an empirical one. In order to carry out this comparison, it is proposed to collect empirical data on lending and loan repayment rates over a 25 year period in both Saudi Arabia and the UK. The proposed methodology is primarily quantitative because it will be based upon financial data collected from various banks over the time period specified above. However, it may be borne in mind that since financial data is generally confidential, there may be some difficulties associated in collection of the data. It is quite likely that managers at banks may be reluctant to disclose information and data pertaining to customer loans and their repayment history. They could also be held guilty of breaching laws pertaining to the data protection act in operation especially within the UK. In order to provide for this eventuality, it is also proposed to carry out an additional quantitative study using other empirical data that may be easily available. It is proposed to collect information on interest rates periodically set by the Central banks in both countries – Saudi Arabia and the UK – from time to time. This data will be collected in the form of a database, which will then be used as a basis to assess the changes which have taken place in lending rates over several years. On this basis, it would be possible to assess how likely borrowers of loans utilizing such interest rates would have been to repay them. In the case of Saudi Arabia, it might be necessary to approach banks to find out what the prevailing interest rates have been for the silent partnership deals. On the basis of the results, it should be possible to determine which system would have been more useful in terms of ensuring repayment, with a supplementary analysis of which system would have been more moral and ethical in terms of its use. The analysis of such empirical data would then provide enough information to make a collective analysis of which system is likely to be the better one on an overall basis. References: * Aldrick, Philip, 2010. “MPs call for radical reform of UK banking system, The Telegraph, march 28, 2010; http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/7533133/MPs-call-for-radical-reform-of-UK-banking-system.html * El Gamal, Mahmoud, No Date. “Islamic Finance”, http://www.jhfc.duke.edu/disc/events/documents/IslamicFinance.pdf * Forsloff, Carol, 2009. “Could Islamic finance model have prevented banking collapse?” Digital Journal, http://www.digitaljournal.com/article/273515 * Gola, Carlo and Roselli, Alessandro, 2009. “The UK Banking System and its regulatory and supervisory framework” Palgrave Macmillan * Hitti, Said H and Abed, George T, 1974. “The economy and finances of Saudi Arabia” Staff Papers International Monetary Fund 21(2): 247-306 * Meyer-Reumann, Rolf, 1995. “The banking system in Saudi Arabia” Arab Law Quarterly, 10(3): 207-237 * Money Morning, 2009. “How deregulation fuelled the financial crisis”, The Market Oracle, January 13, 2009; http://www.marketoracle.co.uk/Article8210.html * Pollard, Jane and Samers, Michael, 2007. “Islamic banking and finance: Post colonial political economy” Transactions of the Institute of British Geographers, 32(3):313-330 * Seims, Mathais M. “Banking law in Europe: Past, present and future” * “Shake-up plans for the UK bank system”, http://news.bbc.co.uk/1/hi/business/7950355.stm * Trochim, William, 2001. “The Research Methods Knowledge base” (2nd Edn) Atomic Dog Publishing Von Hagen, Jurgen and Ho, Tai-Kuang, 2007. “Money market pressure and the determinants of banking crisis” Journal of Money, Credit and Banking 39(5): 1037-1066 * Wilkinson, David and Birmingham, Peter, 2003. “Using research instruments: A Guide for researchers” Routledge Read More