Extent of Growth of IBF in IRAN - Research Proposal Example

Extent of Growth of IBF in IRAN (Insert Name) (Institution Affiliation) Research Question: To what extent IBF has registered growth in IRAN and what factors are important for growth [or no growth] there? Introduction Islamic banking is not banking in the traditional sense but an alternate to the interest- based banking. The Islamic banking and finance in Iran derives its guidance and inspiration from the Islam religious edicts and has to conduct its entire operations strictly in accordance with the Shariah laws directives. The Islamic finance system employs the concept of participation in investment, enterprise and utilizing the funds at risk on a basis of profit and loss sharing (Ahamad, 2012). Both the Islamic banks’ lending principles and lending policies have proven to be excellent tools for developing and creating entrepreneurs. This paper traces the extent in which the Islamic Banking and Finance has registered growth and explains in details the factors that have promoted this growth amid the tough times they are currently facing in the wake of economic sanctions posed against them and the uncertain future due to lack of unanimous rules in the domain of Islamic Banking and finance all over the world. This paper consists of five sections which includes a brief introduction, literature review, the research methodology used, detailed analysis and a conclusion that sums up all the key points about Islamic Banking and Finance. Literature review Islamic banking is not a new concept especially in the Muslim countries such as Iran and Pakistan. Currently, there are more than 300 institutions practising Islamic banking and finance in various parts of the world (Ashraf & Giashi, 2011). These institutions does not only operate in Muslim countries but has also gained a significant customer base in the non- Muslim countries. Iran has remained very active in the transformation of the financial and banking sectors to completely operate in accordance with the dictates of Shariah. During the past two decades, Islamic Banks in Iran have grown in number and size. Most of these banks are not profit and loss sharing but they are instead debt like in nature. The principle reason behind this is due to the fact that the Islamic law prohibits interest charging. Unlike other commercial banks that have received extensive government support during the period of oil boom, the Islamic banking and finance is a product of basically private initiative which is predominant in non- oil producing countries (Bunchuan, 2006). The Islamic banks offer services that are strictly consistent with the cultural behaviour and religious beliefs of the Muslim community and in accordance with the Shariah law which emphasize on a profit and loss sharing. The Islamic banking has been at the middle of numerous surveys, many public debates and extensive Islamic banking literature. In his article entitled “Islamic banking and monetary policy: experience of Iran (1982 – 2006)”, Hassani (2010) focuses on the core challenges and issues affecting the Islamic banking and finance in Iran. The growth of Islamic banking in Iran can be traced from back in 1979 revolution which sparked the Iranian government to play a key role converting the conventional banking into Islamic banking. Later in 1883, the Iran government passed the law of usury –free system of banking which forbid lending money at interest ((Bunchuan, 2006). The implementation of this law saw the increase in Islamic banking and consequently most banks were nationalised thus enabling the government to merge and reduce the number of banks. The reliance of the Islamic banking and finance system on the profit and loss sharing arrangements makes it akin to an equity based system which has relatively straightforward theoretical model (Hassani, 2010). This model makes the banks to systematically become partners with the borrower and accordingly share the returns of whatever is obtained from the funds that are borrowed. The banks do not provide any guarantee whatsoever on either nominal share values or the rate of return. Just like the conventional banking, the establishment of Islamic banking and finance serves as financial intermediary between the borrower and the depositor. The Islamic banking is however slightly more than a borrower depositor relationship since it is more of a partnership where the banks are basically entrusted to invest the depositors money and any profit generated thereof will be shared on an equity basis (Bunchuan, 2006). This notion of profit and loss sharing is different from the conventional banking which is interest based whereby the borrower is charged an interest on funds borrowed and the depositor gets some interest on the funds deposited. Over the past few years, the growing concerns about the ill effects of interest rates which are being charged especially on the borrowed funds has led to a significant decline in the traditional conventional banking. Consequently, many people have resorted to the Islamic banking due to the equity rates and profit sharing policies. The Iran Islamic banking system is well known around the globed. The Islamization process of the Iran banking system has gone through two major phases. The first phase took place between 1979 – 1982 when the banking system was re- organized and nationalised. However, the external and internal developments that accompanied this phase did not permit the policy makers to build enough plans to completely Islamize the banking sector. The second phase, which took place between 1982 and 1986, saw the passing of the usury free law (Ismayil, 2012). This law recognizes two distinct forms of partnership which includes legal partnership and civil partnership. The civil partnership is defined as the mixing of capital from partner or partners with capital from a bank on medium or short periods. The legal partnership, on the other hand, refers to a long duration joint venture. Research Methodology The main source of information in this research paper is the published papers and academic journals. For the past few years, extensive research has been conducted on the trend of Islamic banking in Iran. Some secondary sources include bank websites and archives which gives the factual figures and the issues facing the Islamic banking system in Iran. A number of Muslim scholars have investigated the issue of usury problem and attempted to solve it since the beginning of the twentieth century. Some of them include: Shahid Seyyed Mohammadbaqr, Shahid Motahhari, Iqbal, Arif, and Mohsen Khan among many others. Their work was used as a source of data in this research paper. Analysis The Iran banking system is being perceived as an effective and efficient tool in carrying out of the Islamic economic objectives which includes proper credit and money usage for the creation of a healthy, progressive and just economy, use of the financial tool for the creation and promotion of national objectives which involves poverty elimination and attainment of national self –sufficiency and finally, promotion of balance of payment and stability and preservation of national currency value. The table below shows the top 20 institutions by Shariah compliant assets. Table 1.1 (source: The Banker, 2010) Rank institution Country Shariah compliant assets $m 1 Bank melli Iran, Tehran Iran 35, 493. 32 2 Bank Saderat Iran, Tehran Iran 34, 840. 09 3 Takaful IBB Berhad Brunei 31, 535. 19 4 Al Rajhi Bank Saudi Arabia 28, 093. 12 5 Bank Mellat, Tehran Iran 25, 128. 62 6 AmIslamic Bank Berhad Malaysia 22, 263. 25 7 Kuwait finance House, safat Kuwait 18, 945. 38 8 Bank Tejarat, Tehran Iran 17, 544. 98 9 Dubai Islamic Bank, Dubai United Arab Emirates 14, 219. 78 10 Blom Bank Lebanon 13, 913. 53 11 Bank Sepah, Tehran Iran 10, 483. 10 12 Parisian Bank Iran 9, 881. 67 13 Abu Dhabi Islamic bank United Arab Emirates 9, 725. 12 14 HSBC Amanah United Kingdom 9, 725. 00 15 National commercial bank ltd. Jeddah Saudi Arabia 9, 175. 97 16 Bank Rakyat Malaysia 7, 784. 77 17 Al Baraka Banking Group Bahrain 7, 625. 83 18 Banque Saudi Fransi Saudi Arabia 7, 302. 54 19 May bank Malaysia 6, 290. 68 20 Samba financial group Saudi Arabia 5, 911. 88 As we can see from the table above, the Islamic banks in Iran tops the list and they also has the largest Shariah compliant asset base. This can be attributed on the fact that Muslim scholars especially in Iran have profound influence on the Islamic banking and finance and also the Iranian government have worked relentlessly to transform the entire internal financial system into Islamic. Furthermore, the Islamic banking in Iran have been embrace as a national policy concurrently with some of the conventional banking and finance systems that. The Islamic bank not only consists of financial institutions that are actively involved in Islamic banking but also other institutions that offer Islamic banking services through the Islamic banking scheme. Such institutions include: commercial banks, Islamic banks, Merchant banks, discount houses and the development financial institutions offering Islamic banking and financial services. Since the 1979 Islamic revolution, the financial system and economy of Iran have been functioning strictly in compliance with the dictates of Shariah. All the financial assets interest was replaced by a 4 percent maximum service charge and a profit ranging between 4 to 8 percent depending on the type of the economic activity. The usury- free law which was enacted in 1983 and fully implemented in 1984 set strict restrictions on charging of interest. Thus the interest on deposits converted to guarantee minimum profits and the participation certificates were used to substitute the interest bearing bonds. Since the early 1970s up to date, Iran has maintained good economic prospects. This is mainly due to high oil prices, inflow of funds post September 11 and the fact that Iran is a net international creditor with a healthy current account surplus and low debts. Prior to the year 2003, the task of supervising the interest free financial institutions was delegated to the police force and the interior Ministry. The Islamic banking has thus experience rapid growth in Iran due to the continued government support and the oil boom. However, lack of adequate or prudent supervision has led to exploitive trading and banking activities which comes at the expense of the deprived segments of the Iran general population. The Islamic banking law enacted by the Iran government in early 1980s gave the banks additional and more specific regulatory power (Zaher & Kabir 2001). For instance, the central bank of Iran was granted power to set the minimum rate of return in limited or regular partnerships in every sector. These rates eliminated the sub- par and marginal projects more effectively. The central bank could also influence the amount of credit allocated by the Islamic banks to various sectors through determination of the profit sharing ratios. Furthermore, the CBI could also regulate the allocation of credit financing to the traders through changing and regulation of the rates of service fee that was charged by banks on instalments sales, forward transactions and lease purchases (Pollard & Samers, 2007). All these factors greatly contributed to the significant growth of the Islamic banking sector in Iran since 1970s. The act of usury free banking has also greatly influenced the growth of Islamic banking in Iran due to the ratification of the banking operations. The table below shows the various methods of financing that was envisaged for each line of activity. The fact is that the performance of the Islamic banking has not been different from the western banking style. Table 1.2 Islamic mode of financing on Iran (1984 – 2006) (Source: central bank of Iran annual reports) year Ghalz al Mozarebeh Civil partnership Installment sale Legal partnership Debt purchase 1984 10.8 18.5 15.0 34.0 3.6 11.7 1985 10.8 15.9 13.2 32.6 7.3 10.1 Rate of change 0.0 -14.1 -13.5 366.7 -50.0 500.0 1986 11.6 15.5 13.9 35.7 6.6 6.4 Rate of change 7.4 7.4 21.9 0.0 -11.1 -25.0 1987 10.6 12.6 13.9 42.7 7.1 3.1 Rate of change -8.6 -8.6 0.0 28.6 0.0 -37.0 1988 9.7 11 11.7 47.1 7.1 1 Rate of change -8.5 -8.5 25.6 55.6 0.0 -23.5 1989 7.5 10.7 12.8 46.8 5.8 0.6 Rate of change -22.7 -22.7 36.7 82.1 -37.5 0.0 1990 5.7 10.2 14.5 49 4.6 0.3 Rate of change -24.0 -24.0 -20.9 29.4 -20.0 0.0 1991 4.2 9.7 17.8 47 4.8 0.1 Rate of change -26.3 -26.3 -5.7 6.1 75.0 0.0 1992 3.6 8.5 17.6 46.5 5.2 0.1 Rate of change -14.3 -14.3 34.0 -14.3 -28.6 46.2 1993 4.6 7.5 17.4 45 4.8 0.1 Rate of change 27.8 27.8 3.0 0.0 40.0 36.8 1994 4.4 7.3 18.1 45.8 3.6 0.1 Rate of change -4.3 -4.3 -10.1 10.0 14.3 -7.7 1995 4.7 6.8 19.4 45 2.7 0 Rate of change 6.8 6.8 -11.3 6.1 25.0 -29.2 1996 4.5 6.7 19.6 43.4 3.8 0 Rate of change -4.3 -4.3 -9.1 -5.7 10.0 64.7 1997 4.6 6.4 11.6 56 4.7 0 Rate of change 2.2 2.2 4.0 -75.8 -27.3 -10.7 1998 5.9 6 9.7 58 3.1 0 Rate of change 28.3 28.3 19.2 -12.5 -12.5 -28.0 1999 4.6 6.3 10.3 28.3 2.7 0 Rate of change -22.0 -22.0 8.1 21.4 -51.2 -14.3 2000 4.2 6.2 9.9 28.8 2.2 0 Rate of change -8.7 -8.7 4.5 -5.9 0.0 -20.0 2001 4.5 5.5 8.6 31.4 1.6 0 Rate of change 7.1 -11.3 7.1 0.0 16.7 -25.0 2002 7.2 5.7 6.4 33 1.3 0 Rate of change 60.0 3.6 -10.7 -12.5 57.1 -11.1 2003 5.8 6.2 6.7 35.5 1.6 0.1 Rate of change -19.4 8.8 -9.0 14.3 9.1 12.5 2004 4.7 6.2 7 36.9 2.4 0.1 Rate of change -19.0 0.0 -4.9 31.3 25.0 11.1 2005 4.4 6.9 7.5 33.6 2.5 0.1 Rate of change -6.4 11.3 -10.3 -19.0 60.0 0.0 2006 3.4 7.7 10.7 30.7 1.8 0.2 Conclusion The Islamic banking industry in Iran has shown tremendous growth potential. The country has completely transformed its banking and finance system to fully comply with the accepted Islamic principles. The banking and finance system of Iran is being perceived as a very effective tool in the pursuance of the national and the Islamic economic objectives. However, the banking sector has been plagued by slow growth due to the existence of a large portfolio of assets that are non- performing and also a narrow range of services and products. References Ahamad, S. (2012). Islamic Banking and Financial Systems: Future Strategies for Facing the Challenges Towards Market Leadership. Available at SSRN. Ashraf, D. S. H., & Giashi, M. A. A. (2011). Islamic Banking in Iran-Progress and challenges. Kuwait Chapter of Arabian Journal of Business and Managemet Review, 1(2), 31-44. Bunchuan, D. (2006), “Islamic Banking and Finance: Is It Complementing or Competing the Conventional banking”. 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