Reward in the Afterlife as the Notion of Profit in Islamic Banking - Literature review Example

Research Paper Student’s Name Subject Professor University/Institution Location Date Islamic banking is banking activities which are consistent with Sharia principles that are practically applicable through Islamic economics development. Sharia principle prohibits a fixed, floating payment, or acceptation of specific fees or interest commonly known as usury/riba for loans. The banks are also regulated from investing in services or goods which are termed as contrary to the principles of Islam. This paper will analyze the determinants of profitability in Islamic Banking and Finance (Pollard & Samers 2007). It will further assess the reasons why Muslim consumers are driven to Islamic Banks products and services and the notion of afterlife reward. In addition the underlying promotional materials used by Islamic Banks to encourage consumers buy their products will be empirically discuses. Literature review As Ahmed (2011) observes, Islam practice has led to application of these principles and in 20th Century with formation of Islamic banks, the principles were to be applied by the private and semi-private institutions working within Muslim community. From the second half of the 20th century, there has been growth of interest-free banking which has attracted much attention. Pakistan and Egypt were on the spotlight for such development which sprang from political interest and emerging Muslim economists. Islamic Development Bank was started in 1975 as an intergovernmental bank. Subsequently other were established in Jordan, Egypt and Dubai and used to support and fund projects in member countries. Islamic Banks has steadily expanded bringing in a new financial landscape for Muslims. They are operating in more than 100 banks with an asset base exceeding $700 billion. The trend has been shaped by their flexibility as creditors and shareholders’ firms and provision of investment-banking services. National Islamic Council maintains that Islam is a practical way of life that teaches the good to the benefit of mankind regardless of the place, time and stages of development. Islam as a fitrah religion which is build o human nature and banking and financial activities have been viewed as having a place in modern society and including the Sharia principles into its practices. One of the principles known as Al Ta’awun emphasizes on mutual cooperation and assistance among the members of Islamic society for the good course. This is in line with Al Qur’an statement (QS 5:2): “And it is god to help one another, doing good and piety, and not helping in offense and sin.”Accordingly, the partners in banking business are contained from the practices of modern conventional banking. They cannot promote interest-based activities which are not for the benefit of weak partners. The belief that Allah will provide sustenance and offer guidance is a thriller to investing the funds without expecting interest. The second principle is based on avoiding Al Iktinaz or holding of money/fund. This requires the Islamic believers to let the money idle to rotate in transactions which benefit the public as Al Qur’an states: “Those who trust in Allah will not take other peoples’ or neighbor property through vanity, except by commerce which applies with the deals amongst them” (QS.An Nissa: 29). Every fund is set to be used for the greater good of entrepreneur in the same faith. The bank is an intermediate institution that brings both the investor and entrepreneur together. Being subject to Sharia law, it embodies a strong and enduring relationship which promotes trust, organizing and managing to avoid risks. The theoretical literature of Islamic finance is dominated by Profit Loss Sharing (PLS). PLS is a contractual agreement and arrangement between transacting parties. This allows them pool resources and invests in projects while sharing the profit and loss. However, Islamic economist argues for PLS based on major financing modes, the Mudaraba and Mushaaraka as desirable for Islamic context. Reward-sharing is equated with risk-sharing by the transacting parties. In practice of Islamic finance and banking, PLC features marginally and almost all Islamic banks, investment funds and investment companies offer trade and finance project on commissioned manufacturing or leasing bases. PLC however covers a very small percentage of world-wide Islamic banks. Furthermore for Islamic Development Bank, except for few small projects, it has not used Profit Loss Sharing in financial business. Discussion As Hassan & Bashir (2003) discusses, measures of performance involve an assessment of interaction between the environment, external activities and internal operations. There are financial ratios used to assess the internal performance through the analysis of accounting data. Financial ratios provide broader understanding of the financial condition of a bank. Operating efficiency has been another key element used as a primary factor to assess bank performance. These are calculated though contractual rates, loan charges and rates payment on deposits. Islamic banks calculate the rates of return which is generated from different non-interest activities of the bank. The various banking activities include the bank participation in the direct investment. Efficiency indicator in Islamic banking use revenues generated from mark-up (Murabaha), deferred sale (Bai Mu’jal) and rent-to-win (Ijara). The notion of profit is also derived from service charges minus the cost of carrying out those activities. There are some measures of performance used such as profit margin, returns on assets (ROE), non-interest margin (NIM). The net non-interest margin is the income accrued to the bank based on non-interest activities such as service charges, fees, direct investment and foreign exchange. NIM has grown in importance which has been a source of revenue for most conventional banks. There are fast growing non-interest income items such as ATM surcharges, sale of annuities and mutual funds fees and credit-card fees. Non-interest income has marked a lion share of operating income capturing the bank’s ability in reducing risk. As the bank reduces its non-loan activities and increases offering new services, NIM increases overtime. NIM has particularly been a critical factor for measuring Islamic Banks efficiency and profitability. BTP/TA (before-tax profit over total tax) measures bank’s profit margin. The bank income statement measure the sum of its non-interest income compared to total assets. BTP/TA reflects ability of the bank to offer a large set of financial services and choices at lower costs. This support the efficiency hypothesis as before-tax profit is compared to total assets. Alternatively, overall performance Islamic banking is measured by both ROE and ROA. Both measure those nontraditional services which promotes the ability of a bank to generate income. ROA on its hand reflect the profit earned through management ability in utilizing real investment resources and bank’s financial resources to generate profits. ROE reflect the effectiveness of bank management to use the shareholders funds. Islamic banks utilize this measure of performance to promote their profitability (Hassan & Bashir 2003). However, it takes the work of management to ensure that the measures are positive through balancing various external and internal activities. The critical undertaking of management is to reduce risky activities while at the same time being aggressive in promoting income generating activities (Sufian 2007). Islamic banks therefore play a role of receiving the funds from their customers then channel the funds to those customers in need. In the principle, there are five concepts which are set in operation including: Contract where all transactions use promise over promise, profit-sharing where the revenue of financing is divided based on contract between the bank and the customer. Financing targets concept limit the bank from distributing funding to business sectors opposed to Islamic law including beverages and foods and gambling business which are forbidden. Customers are partners in business and thus business in run on mutual need. Profit oriented and prosperity promotes continuity of Islamic banks as funds are drawn from operation revenue. There are core factors based on Islamic banking that can primarily be attributed to the reasons behind its customers consent to work in non-profit loss sharing institutions (Wilson & Grant 2013). According Ram (2008), Al Hadith and Al Qur’an concepts based on Sharia management promote planning which is in accordance to QS.59:18 and Al-Albani: 6. People ought to plan for the future if they trust Allah as he knows they deed. They also need to improve within and look for sustenance through taking what is lawful and leaving the forbidden. Actuating is a concept requiring cautiousness for Allah direction and sustenance, restriction for taking usury, fulfill transactions agreements and pursue for the virtue that promote mankind. Organizing based on the legacy of Nuh, Muhamad, Isa, Musa and Ibrahim to uphold goodness. There is also obligation to uphold the truth, justice anytime and anywhere. Further there are obligations of Mandated regarding field of muamalah and controlling where predetermined plan gear all the activities and particularly the banking activities. Every other principle is acceptable so long it does not interfere or go contrary to Sharia law and uphold the fiqih rules. As Rethel (2011) argues, apart from operating and functions based on Islamic Sharia, risk is shared between the investors and entrepreneur. This is mandate by upholding the good of mankind and offering help and sustenance to the others. Islamic banks however maximizes profit but in subject to Sharia restrictions. Modern Islamic banking has been dominated by services functions and as Zakat collection centre. This increase the income generating activities as transactions are carried across the functions. Profit develops through participation in business partnership which is very fundamental for Islamic banks. This is promoted by a complete understanding of their customers business. The banks gives due importance to public interest with the aim of ensuring growth with equity. As the system shares the profit and loss, they pay greater attention in developing project evaluations and appraisal and give a greater emphasis on project viability. The relationship between the bank and its clients is based on buyer, seller, investors, trader and partners. This is unlike the conventional banking which views its clients as creditors and debtors (Wilson & Grant 2013). The aspect of relation primarily may be a reason for long-lasting relationship which promotes loyalty of clients in support of banks activities. The ultimate push for the Muslim consumers toward the products and services which are offered by Islamic Banks may primarily be after life reward. However, the basic concept that guide in avoiding Al Iktinaz or holding of money/fund may apply to various context and stimulate investor interest in those services. Most services are suited according to the way of faith (Sharia) like Zakat. Every requirement of Sharia law has subsequent promise which is not only after death but also while on earth. Investing in Islamic banks is seen as total obedience to Allah, care for humankind and promotion of personal virtue. Islamic resurgence worldwide largely drives rapid drive to Islamic banks products and services (Mokhtar, Abdullah & Al-Habshi 2006). According to Khan (2010), the increase in asset which was at US $700 billion and growth rate at 15%p.a confirms the trend of investment. Islamic Banking and Finance (IBF) in key terms involves wider moral and ethical issues which overlook simple interest free transactions. As Islamic society is collectivist in nature, upholding the corporate responsibility based on faith is a virtue that everyone strives to be acquainted with and practice. The purpose is to promote greater economic justice and equity. IBF distinctly strengthen Islamic identity through provision of appropriate terminology in financial transactions which are readily available in Sharia (Chong & Liu 2009). As Hassan, Chachi & Latiff (2008) observes, to promote their products, Islamic banking focuses on customer-oriented services. There various ways which are used to promote Islamic bank including: television, radio, website, newspaper, magazine, billboards, leaflet, email, annual reports, seminars and community relations. At present, customers are increasingly more demanding and more mobile between the competing financial providers. Islamic banks strive for the best efficiency which apart from Islamic-based services, they further promote partnership where their client is more secure in case of dispatched loans. Islamic banks and specifically the customer-contact employees build strong customer relation through established advisers or officers. Both of these promotional methods are perceived by the clients as being Islamic. Islamic marketing ethics is based on justice and equity than on secular ethics. They are based on Qur’anic commandments without in further interpretation by marketing executives who suit individual desires. They are absolute in nature and emphasize value-maximization for the greater good of society than selfish pursuit for profit maximization. Commercial and banking activity is governed by principles of submission to Allah moral order, mercy and empathy to God’s creation where they refrain from doing harm or spread of unethical practices. There are however 5 Ps that guide the marketing ethics. They include product, promotion, price, people and place. Product promotion rules give no room to justify cover up, deceptive promotional behavior and false testimony (al-Qur’an, 43:19). They therefore avoid misleading and false advertising, reject high pressure manipulations and misleading sales tactics and avoid those sales promotions which use manipulation or deception. Promotional techniques regulate any sexual, emotional, fear and such unethical appeals (Hassan, Chachi & Latiff 2008). References Ahmed, S 2011, Islamic banking and finance: A review essay. Journal of Monetary Economics, 24(1), 157-167. Chong, B S & Liu, M.-H, 2009, Islamic banking: Interest-free or interest-based? PacificBasin Finance Journal, 17(1), p.125-144. Hassan, A, Chachi, A & Latiff, S A 2008, Islamic marketing ethics and its impact on customer satisfaction in the Islamic banking industry. Islamic Economics Journal, 21(1), 23-40. Hassan, M K & Bashir, A H M 2003, Determinants of Islamic banking profitability. In th ERF Annual Conference (Vol. 16). Khan, F., 2010, How “Islamic” is Islamic Banking? Journal of Economic Behavior & Organization, 76(3), p.805-820. Mokhtar, H S A, Abdullah, N & Al-Habshi, S M 2006, Efficiency of Islamic banking in Malaysia: A stochastic frontier approach. Journal of Economic Cooperation, 27(2), 37-70. Pollard, J & Samers, M 2007, Islamic banking and finance: postcolonial political economy and the decentring of economic geography. Transactions of the Institute of British Geographers, 32(3), 313-330. Ram, V, 2008, Islamic Finance: The Enforcers. Forbescom. Rethel, L, 2011, Whose legitimacy? Islamic finance and the global financial order. Review of International Political Economy, 18(1), p.75-98. Sufian, F 2007, The efficiency of Islamic banking industry: A non-parametric analysis with nondiscretionary input variable. Islamic Economic Studies, 14(1-2), 53-78. Wilson, J A & Grant, J 2013, Islamic marketing–a challenger to the classical marketing canon?. Journal of Islamic Marketing, 4(1), 7-21. Read More