The activity of Islamic banking system

Small and medium enterprises (SME) sector has a great potential for expanding production capacity and self-employment opportunities in the country. Enhancing the role of financial sector in development of SME sub-sector could mitigate the serious problems of unemployment and low level of exports. The banks may introduce `SME Financing Funds' with various geographical locations. The corporate sector and the commercial banks may set up a network of such Funds under the aegis of SECP by establishing institutions under syndicate arrangements or otherwise. [14]

Future challenges for Islamic banking and finance

Financial Innovation in Critical Areas:

Progress of Islamic banking will depend on its ability to innovate in the following areas:

- Financial instruments yielding stable income flows for orphans, widows, pensioners and other weaker segments of the society

- Financial instruments for meeting government's financing needs

- Cover or security for financing, in particular Shari'ah-compliant alternatives for penalty on payment defaults

- Formulas for pricing of Islamic financial products

Competition:

Islamic banks should be ready to brace not only intra-industry competition but also inter-industry competition from interest-based banks. The latter are already offering Islamic financial products. The competition is likely to grow.

Effect of Islamic banking on economy and economic life

The following effects are anticipated:

-The real and financial sectors in the economy will be better integrated, as compared to what one finds in interest-based economies.

- Both what the governments do and the way in which they work, will change.

This will mainly stem from the fact that without tax revenues, governments may address only those needs for which an economic transaction--other than pure loan transaction--can be defined between the government and the financiers.

- Inter-bank money market and central banking will take new form. New matrix of Shari'ah-compliant divisible and tradable financial instruments and the Shari'ah parameters for contracts will give shape to this development.

While the above happens, the regulators will also have to ensure compliance with Basel requirements for international acceptability of Islamic banking. In cases of no conflict between the Shari'ah parameters and the Basel requirements, there would be no problem. However, where conflict arises, there will be need (1) to design Shari'ah-compatible ways for compliance with the Basel requirements and (2) to sell the same to the international regulators.

- Accounting and financial management may undergo major changes. This would happen because Islam has different position on ownership, rules for transactions and the financial instruments.

- Islamic banking will lead to better business ethics because banks will entertain only economically viable financing requests. Note that the said transformation shall take place even without prior moral uplift of the society for Islamic banking. Careful design of Islamic financial instruments will discourage unscrupulous behavior by fund-seekers. [15]

The Islamic Development Bank

The Islamic Development Bank, a specialized institution of the Organization of the Islamic Conference (OIC), is an international financing institution. Its purpose is to foster the economic development and social progress of Muslim countries and Muslim Communities in accordance with the principles of the Shari'ah and to bridge the gap between rich and poor member-countries.

The IDB is the first international financial institution to commit itself to conduct its activities in conformity with the Shari'ah. As a result, the prohibition of Riba in Islam and the implications thereof have motivated certain conceptual and operational features which distinguish the IDB from other international development banks and other institutions having similar purposes. The Bank is authorized to accept deposits and to mobilize financial resources only through Shari'ah compatible modes and is authorized to levy a service fee to cover its administrative expenses instead of working on the basis of interest. The major source of IDB's finance has been the capital subscriptions of its members. Repayment of existing lines of credit enabled to have additional funds to support the activities of the IDB after the initial capital injections. And as the bank is providing temporary assistance rather than making grants, the capital is revolving and replenishes itself.

One of the strategic objectives of IDB is to improve and enhance the level of intra trade among its member countries from the developing world. Therefore, the bank assists in the promotion of foreign trade among Muslim countries, by providing financial assistance to member countries and Muslim communities in non-member countries and by developing human capital.

The IDB also acts as a catalyst in these intra trade activities by participating in equity capital through investment in economic and social infrastructure projects and by granting loans for productive projects in the private and public sectors. Equity-financing and profit-sharing functions are the primary modes of operational financing and loan-financing adopted by the IDB.

Furthermore, one of IDB's missions is to undertake research to enable the economic, financial and banking activities in Muslim countries to conform to the Shari'ah and to develop Islamic finance as a competitive advantage. In fact, thanks to the role played by the IDB, the Islamic baking world has stepped up efforts to standardize regulation and supervision. The bank plays a key role in developing internationally acceptable standards and procedures and strengthening the sector's architecture in different countries. [16]

Operations and objectives

The purpose of the Islamic Development Bank since its foundation is to foster the economic development and social progress of member Muslim majority countries as well as Muslim communities in non-member countries individually as well as jointly in accordance with the principles of Shari'ah. This is what distinguishes the IDB from other regional and international developmental institution; in fact it is obliged by its own charter to follow the Shari'ah in all of its functions and operations. The Islamic prohibition of interest and the implications thereof have forced the IDB to have certain distinguishing conceptual and operational features. The IDB foresees different ways of financial involvement with its clientele from the ways of the conventional multinational development banks. The equity participation and profit sharing functions of the bank together with the Shari'ah implied restrictions on the powers of the Bank in so far as accepting deposits, raising funds and suitably investing funds not needed in its operations are concerned, are some of the major issues that the bank had to consider in its planning stages. Among activities undertaken by IDB there are participation in equity capital of productive projects, investment in economic and social infrastructure projects, the promotion of foreign trade, primarily in capital goods and acceptance of deposits or the raising of funds in any other manner.

Unlike other multilateral financial institutions, the IDB finances its operations through a number of modes of finance that are compatible with Shari'ah. Loan financing is mainly intended for social, economic and infrastructure projects that are unlikely to be revenue generating and have a long implementation phase. These include schools, water supplies, health centers, hospitals, rural electrification, roads, ports, airports, irrigation schemes and land development. In addition, the IDB participates in the share capital of new or existing enterprises, through equity participation, even though a ruling of the Islamic Fiqh Academy prohibits equity participation with companies that use interest-based financing, therefore, the IDB has taken initiatives to assist successful companies in utilizing alternative Shari'ah-compatible modes of financing in close collaboration with Islamic banks. Leasing is another mode of financing used by the IDB because it meets the objective of providing finance for development projects that are sufficiently remunerative to meet market criteria. Leasing involves the purchase and subsequent transfer of the right of usage of equipment to the beneficiary for a specific period of time, during which the IDB retains ownership of the asset. Application of mark-up rate is determined on the basis of sector as well as on rate of return of a project. Installment sale has also become a most significant mode of financing because of its operational flexibility.

Through this mode, IDB purchases equipment and machinery, reselling it to the beneficiary at a higher price. The main operational difference between this mode and lease financing is that ownership of the asset is transferred to the beneficiary on delivery in the case of installment sale. Besides, the purpose of the Longer Term Trade Financing Scheme is to promote the export of non-traditional goods among OIC member countries through the provision of necessary funds. The scheme has its own independent budget and resources. It is managed and operated under the supervision of the IDB. Moreover, IDB provides technical assistance to member countries for identification, preparation and implementation of projects as well as for institution building. Priority for technical assistance is given to LDMCs as well as regional projects. The assistance is extended in the form of a loan, grant or both. IDB also finances consultancy services to assist its own staff in project preparation and follow-up; it encourages the establishment of a Federation of Consultants from Islamic countries, and provides continuous support for the Federation's activities. Furthermore, the main window for providing funds to the private sector is the extension of lines of finance to National Development Financial Institutions (NDFIs) in member countries. This mechanism helps aims at assisting development in small and medium scale enterprises. Lines are utilized through equity participation, leasing and installment sale operations. New procedures have even been added to provide greater flexibility and incentives for the effective utilization of IDB lines by introducing free limits; higher remuneration for national development banks; two levels of upper and lower limits for financing sub-projects, depending on the nature of the national development bank; and shortening the period for processing sub-projects.

IDB has been successful in applying Islamic principles in the field of finance despite the fact that the benefits to the poorer Islamic countries have been limited. It plays a central role in the development of the Islamic financial sector globally through co-operations with central banks; with national development banks and financial institutions and with regional and international financial agencies. In fact, Regular meetings are held between the Governors of central banks and the representatives of OIC member countries to discuss ways and means of improving co-operation among the financial institutions of member countries. The IDB also expands co-operation with the national development banks of the member countries to grant lines of equity, lines of leasing and lines of installment sales to these banks so that they can advance finance to viable local projects. This provides the banks with hard currency and facilitates financing operations for the IDB. And the bank helps to promote a greater flow of resources to its member countries from other financial agencies, through its co-financing arrangements with regional and international financial institutions such as the OPEC Fund, the BADEA and the Arab Fund for Economic Aid and Social Development. [17]

Future challenges for Islamic banking and finance in the Republic of Kazakhstan

Based on the analysis of individual Islamic countries can be made a conclusion that the most optimal for borrowing and the introduction of Islamic system in Kazakhstan is an Iranian one. While in Russia and other CIS countries made attempts to open Islamic banks, Kazakhstan is the first among the post-soviet countries that introduced Islamic financing at the legislative level. On February 12, 2009 President of Kazakhstan Nursultan Nazarbayev signed the Law of RK "О внесении изменений и дополнений в некоторые законодательные акты Республики Казахстан по вопросам организации и деятельности исламских банков и исламского финансирования". The Act was amended a number of significant changes and additions to some legislative acts of the country (the Civil Code, Tax Code, the laws "On securities market" and "On Banks and Banking Activity in the Republic of Kazakhstan", "On state registration of immovable property and transactions with him, "" On Obligatory guarantee deposits placed in banks of the Republic of Kazakhstan "," On Investment Funds ", etc.).

However, despite all its advantages and all the progressive potential, the Act of February 12, 2009 did not meet all the requirements necessary for successful implementation and development of Islamic finance in our country. For example, experts believe that the Islamic financial services in Kazakhstan are not massive, but rather a "niche" product. Consequently, due to limited customer base will be more effective implementation of these products through so-called Islamic "windows" in the framework of the commercial bank. In accordance with the law or to create Islamic "windows", that is to work with Islamic financial instruments could only new bank set up according to Islamic principles. After some time it will be necessarily to be amended for the optimization of the law. And it may be necessary to amend the legislation to permit the opening of the Islamic "windows". For example, in January 2010, Kazakhstan has opened its first Islamic bank Al-Hilal. In 2009, created several non-bank financial institutions: brokerage company JSC «Fattah Finance», Consulting LLP «Kausar Consulting Kazakhstan», LLC «Akyl-Kenes Consulting" Ltd. «Islamic Financial Instruments», an investment fund AIFRI "Amana Islamic Foundation "Allied Insurance Company" Halal insurance "Takaful". Also was created non-profit organizations related to Islamic finance: Association of Legal Entities "Association of Islamic finance," the Islamic Center of funding, training, and business in Almaty, the Club for the development and promotion of Islamic insurance in Kazakhstan. [18]

CONCLUSION

Islamic banking and finance had its major beginnings in the year 1975 with the establishment of the Islamic Development Bank. Islamic banking has flourished in various countries since then with Malaysia, Indonesia, UAE, Pakistan and Saudi Arabia being in the forefront. Islamic banking has also recently done rather well in non-Muslim countries with the reported size of UK Islamic banking overtaking that of majority Muslim countries like Pakistan. Islamic banking assets are thought to be anywhere from 700 billion dollars to 900 billion dollars as of 2009. The credit crunch that has affected much of the western world has not taken its toll on the Islamic Banks, mainly because of the nature of the underlying transactions which admonish Riba and encourage instead a partnership based approach. The result is that the actual profit or loss is shared with the shareholders rather than an arbitrary number called Riba or “interest” which they have to come up with to please the investors regardless of the market situation. In this way, Islamic Banking also helps in depicting the true state of the economy.

The preceding discussion makes it clear that Islamic banking is not a negligible or merely temporary phenomenon. Islamic banks are here to stay and there are signs that they will continue to grow and expand. Even if one does not subscribe to the Islamic injunction against the institution of interest, one may find in Islamic banking some innovative ideas which could add more variety to the existing financial network.

One of the main selling points of Islamic banking, at least in theory, is that, unlike conventional banking, it is concerned about the viability of the project and the profitability of the operation but not the size of the collateral. Good projects which might be turned down by conventional banks for lack of collateral would be financed by Islamic banks on a profit-sharing basis. It is especially in this sense that Islamic banks can play a catalytic role in stimulating economic development. In many developing countries, of course, development banks are supposed to perform this function. Islamic banks are expected to be more enterprising than their conventional counterparts. In practice, however, Islamic banks have been concentrating on short-term trade finance which is the least risky.

Part of the explanation is that long-term financing requires expertise which is not always available. Another reason is that there are no backup institutional structures such as secondary capital markets for Islamic financial instruments. It is possible also that the tendency to concentrate on short-term financing reflects the early years of operation: it is easier to administer, less risky, and the returns are quicker. The banks may learn to pay more attention to equity financing as they grow older.

It is sometimes suggested that Islamic banks are rather complacent. They tend to behave as though they had a captive market in the Muslim masses that will come to them on religious grounds. This complacency seems more pronounced in countries with only one Islamic bank. Many Muslims find it more convenient to deal with conventional banks and have no qualms about shifting their deposits between Islamic banks and conventional ones depending on which bank offers a better return. This might suggest a case for more Islamic banks in those countries as it would force the banks to be more innovative and competitive. Another solution would be to allow the conventional banks to undertake equity financing and/or to operate Islamic 'counters' or 'windows', subject to strict compliance with the Shariah rules.

It is perhaps not too wild a proposition to suggest that there is a need for specialized Islamic financial institutions such as mudarababanks, murabaha banks and musharaka banks which would compete with one another to provide the best possible services.

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