Comments on “An Inquiry into Alternative Models of Islamic Banking”

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  • Comments on “An Inquiry into Alternative Models of Islamic Banking” by Iqbal Anjum

    (Dr. Asad Zaman)

    This article is published in “Advances in Islamic Economics and Finance” Volume 1 , Proceedings of 6th International Conference on Islamic Economics and Finance.


    The author has performed a valuable service by giving a historical review of alternative models of Islamic Banking. Because of the very broad scope of the paper, many of the arguments are sketchy and there are a very large number of facts listed without much cohesion and integration. More detailed comments are as follows:

    1. The Rationale for Islamic Universal Banking
    Because the paper is thick, and the language otiose, it is very hard to follow the main line of the argument presented by the author. Therefore it will be useful to summarize it as follows:
    Paragraph by paragraph summary:
    1.    Islam requires purging evils of interest from modern current banking system while retaining its beneficial features.
    2.    Conventional European banking system was based on the financial necessity and benefits of intermediation by providing surplus money available with savers to those who want to do productive investments.
    3.    This refers to evolution and specialization in USA Banking following political   and economic   necessities   of the post-Depression   era – however, it is too general, and does not fit will with the previous paragraph.
    4.    Western   banking   was   introduced   during   colonization,   and   these institutions remained in Muslim countries following decolonization.
    5.    Thus   the   challenge   for  Muslim   countries   is   to   transform   these institutions into those which are compatible with Shari’ah, retain the benefits of transferring money from savers to investors, but do not have the disadvantages of the Western institutions. The only disadvantage mentioned here is the frequent financial crises associated with banking in the West.
    6.    It is stated that these developments will bring about empowerment of humanity and development, and must be done at the level of the Ummah rather than on a national basis.
    7.    Due to lack of cohesion at the level of the Ummah, Muslim public has been trapped into buying into Western institutions and using the dollar as their base currency. This prevents us from having an independent monetary policy and also makes us very vulnerable to various types of economic warfare which could be waged against us.
    8.    In view of these concerns, Islamic economists have developed models of banking which will be more humanitarian and development oriented, as well as giving us financial freedom. These models have provided the basis for the launch of innovative experiments in Islamic banking.

    The above is a cogent and cohesive argument. However it could be made much shorter. Also, this section requires more references and greater precision in reasoning. That would create a greater impact on the audience, and also be easier to follow and understand.

    2.  Evolution of the Theoretical Models of Islamic Banking
    This section is very much in need of subsections. Furthermore it is very unbalanced in its presentation. MNS models is presented in excruciating detail, most of which is unnecessary. Some other models are presented so briefly that it is not clear what their essential features are. All models should be given a roughly equal and brief treatment and much more time should be spend on comparisons and contrasts between them.
    1. The first paragraph states that M.N. Siddiqui presented the first model of Islamic banking. Since then, several models have been presented. The author proposes to introduce, comprehensively understand, compare and contrast these alternative models. In the remaining section, the author presents an exhaustive analysis, replete with details of each of the proposals he discusses. However, there is little comparison or contrast. Furthermore, there is no distinction made between the main features of the alternative systems and how they compare with conventional. Apparently trivial details of no significance from the broader macro perspective are elaborated at length. This section needs to be substantially revised and condensed to focus on the main features of the alternative system (leaving out technical details which do not affect these features). After the main features are highlighted, it would be possible to compare and contrast them with each other, and also to asses them against conventional banking.

    2.  The first proposal to be discussed in M. N. Siddiqui’s (MNS) proposal. From pages 8 – 20, the MNS proposal is explained in excruciating detail. Many of these details seem to be of no relevance at all to the main theme of the paper. If we are trying to compare and contrast the major features of alternative banking systems, then we cannot focus too much on the micro details of the transactions. Issues relating to how shareholders in the ownership of banks must have quarterly accounting, and similar detail, is irrelevant to the macro performance of the system. Only those details of relevance to the macro performance of the Islamic banking system and how it compares to conventional banking and to alternative proposals should be mentioned.

    3. After 12 pages of details of MNS banking proposal, the paper transits without any warning or subsection heading to the CII (Council of Islamic Ideology) proposal for Islamic banking. Again, the proposal is discussed in great detail.
    However the discussion is couched in language used by CII, without explanations of the technical terms, or any comparisons or contrast to the previous MNS
    proposal. In fact the two are radically different approaches to Islamic Banking and the differences and the reasons for these would be very worthwhile to study. Six pages are devoted to details of the CII proposal; again many of these details seem to be of no relevance to the big picture or the theme of the paper. These should be eliminated, to focus on the major issues.
    One of the major issues is the following. The MNS model was a purely theoretical model. At the time, there did not seem to be enough political space to actually implement Islamic Banking. Therefore the model assumed that we have a free hand to create a system according to our own specifications. In contrast, the CII model is constructed with a view to implementation, in the expectation that the economy is due to be Islamized. This is why it deals much more with details of how implementation is to be carried out in many different types of transactions which actually occur. It also recognizes the need for compromise with existing practise, since Islamization cannot occur overnight. This can account for many of the differences between the two models.

    4. Jarhi’s (1980) model for Islamic banking is presented next, with help of figures and diagrams from Jarhi’s papers. This is a 100% reserve banking system, which differentiates it clearly from the previous two. Since this is currently not practiced anywhere, it is not at all clear whether or not it would be functional. What would the strengths and weaknesses of such a system be, relative to both conventional banking and relative to alternative models for Islamic banking? We do not know and the author does not comment on this issue.

    5. Ansari’s (1983) model is presented next. This model is substantially different from the previous ones because it focuses on the social context, and specifically builds communities with shared interests and common goals into the picture. Thus it is quite different from the earlier models which are purely economic, take social structures as given and do not attempt to take these into account. There are some analogies to the communes and communal living created in Israel, and the economic aspects of this model would be worth comparing and contrasting with the economic experiences of these communes.

    6. Chapra’s model focuses more on the Muslim agents in economy than the others. He assumes that motivated Muslims will have a different money demand function, since they will avoid luxuries and conspicuous consumption.   His monetary model focuses on the Islamic aspects, such as basic needs fulfilment, providing employment opportunities for the poor, etc.
    7. HIE Blueprint is discussed next. This is similar to the C1I proposal, in the sense that it is meant for immediate implementation, and therefore does not propose radical changes in either social structure, nature of banking institutions, or the character of the people in the society. Instead, it concentrates on making the minimal changes necessary to achieve an Islamic system in a practisal and feasible way.

    8. Jarhi & Iqbal (2001) present another model of universal Islamic banking. While some details are given, it is not clear how this model differs from the CII or HIE proposals.

    9. Khan (2002) presents a monetary model for an Islamic economy. It appears that the main purpose of this model is to show that price stability and growth can be achieved by the Central Bank within the constraints posed by Islamic banking. Again, there is no clarity on similarities and differences between Khan’s model and others.

    10. Hassan et. al. (2003) model Islamic banks as un-leveraged interest free financial   intermediaries   working   under   Shari’ah.   Their   model   emphasizes corporate   governance   and   interactions   between   7   categories   of  mutually functionally integrated stakeholders. It is not clear the extent to which this model is compatible with, similar to, or different from any of the other models presented. It appears to be focused on different aspects of the same Islamic model as some of those described earlier.
    11. Finally, Anjum (2004) present his own model. This is the most idealistic of all the models, in that it assumes a united Ummat, which operates with consensus according to full Islamic principles. In this ideal world, there is only one Islamic currency which has replaced the dollar, and numerous institutions of a purely Islamic nature have emerged. It is envisaged that the Khilafat has been reestablished so that the Ummat is united under one leader.

    In summary, this is a very valuable overview of a large amount of literature on Islamic Banking.

    3.  Retrospective on Applied Models of Islamic Banking
    The previous section dealt with theoretical models of Islamic Banking. In Section 4, Anjum Iqbal presents a summary of applied experience with Islamic Institutions. He presents a chronological list of Islamic institutions, and then proposes to take a detailed look at 10 of them. We give a brief summary of the 10 institutions examined.
    1.    Data showing the excellent financial performance of “Tabung Haji,” a Malaysian savings institution, is presented in some detail. What would be of more relevance to the present papers theme is details of how this institution works. Which of the 11 theoretical models described earlier does it correspond to? What accounts for its success – which types of Islamic transactions does it engage in? There is a general suspicion that Islamic banks perform essential the same
    operation as conventional ones, but re-label their transactions. This would not seem to be the case with Tabung Haji, but some evidence for this would be useful. In particular, one could compare the performance of Tabung  Haji  with  other conventional banks in Malaysia.
    2.    Mit Ghamr Bank of Egypt is mentioned in one paragraph. Again it is unclear what the range of operations was and how it was structured to avoid
    interest – which of the several possible theoretical routes described in the models of section 3 was taken by it.
    3.    IDB is a special purpose institution, not exactly a bank. It finances development projects on an Islamic basis, and also serves as an equivalent of the
    IMF for the Islamic World.
    4.    Islamic Bank of Bangladesh. This is described at some length, and the Islamic modes of operation used by it are also described.  There are many
    encouraging features of this report, including its engagement in welfare activities, in stark contrast to conventional banking. Some discussion of its relation to the theoretical models, as well as comparison/contrasts with other successful Islamic institutions such as Tabung Haji would have been welcome.
    5.    Amanah Mutual Funds are not really a bank, but rather a mutual fund in the USA which trades in common stock of firms classified as Islamically pennissible by a Shari’ah board. The issue of the extent to which this is permissible, and how it falls into the categories of Islamic banking described earlier would be worth examining in greater detail.
    6.    Ansar Cooperative Housing Corporation. This Canadian corporation provides an innovative alternative to conventional mortgage financing. This is one element of banking operation and worth examining in some detail as many alternatives have been proposed and some are in fact operational. In a paper of this
    length, I believe this could be profitably omitted, since this is not a bank per se. At least, no information is presented on whether or not it functions as an alternative to a conventional bank. A detailed examination of conventional mortgages, Islamic alternatives, and their relative merits would be full length paper in and of itself.
    7. Islamic Investment Bank Limited (IIBL). Operations of IIBL are described briefly and then it is mentioned that it has gone bankrupt in the wake of a financial
    scam. If this topic is to opened, then one needs to discuss the potential for financial scams within and Islamic framework, and mechanisms required to minimize this risk. Alternatively, this example could be omitted from the list of successfully functioning Islamic banks. Obviously, it is not the goal of the author to present all Islamic financial institutions, rather only a selection from them. In this case, would it not be better to focus on successful ones as the ones to learn from and emulate?
    8. Bank Muamlat (Indonesia). This bank is described in detail over 4 pages. Apparently it is a large, modern, fully functional Islamic bank which offers a
    complete range of conventional services. If such a bank exists, what is the need of the other models? It would appear that the Islamic alternative has already been
    found and is working well and efficiently. All we need to do is to imitate an existing successful model. To fully evaluate this issue, we need more details on
    whether or not there are any controversies about Shari’a h compliance of operations of this bank, and what obstacles exist in implementing the same banking model in other Islamic countries.
    9.  Abu Dhabi Islamic Bank. Again this seems quite similar to the previous case, and raised similar questions.
    10. Bank Shari’ah Mandiri: Five pages are devoted to this bank, which again appears to be a fully functional modern Islamic bank. If such a bank exists, do we
    need to do more work on Islamic banking? It would appear that solutions have already been found and are only in need of implementation. The questions which
    arise here are the same as those raised earlier. In particular, the interface with conventional banks and the interest based world financial system is a source of
    concern; complete insulation is not possible and some transactions run the risk of being counter to Shari’a h.

    4.   A Comparative Systemic Critique of the Alternative Models of Islamic Banking
    While there is a tremendous wealth of information in the rest of the paper, this section is the heart of the paper, with it comparisons of alternative models of Islamic Banking. Unfortunately, while the paper is replete with trivial details of some of the models which do not pertain to the larger issues under discussion, some of the key terms which need to be understood for making comparisons in this section are not defined. A two-tier muddrabah is the basis for all Islamic banking, but it is not explained here. It is said that Islamic models are constructed on the basis of either Anglo-Saxon fractional reserve type banking or the German/Swiss/Japanese type, with the exception of the 100% reserve model of

    Jarhi. However what these types are and how they compare with each other with respect to stability, efficiency of financial intermediation, conformity to Islamic requirements, etc. Are not mentioned.
    Anjum says that all theoretical models have explicit built in linkages with human development goals. However, some of the models described appear to be purely technical and these links are not described in the summary.

    The fourth paragraph states that “implementation of the narrowest nationalism-based models of the Islamic banking, by ignoring the humane universal dimensions of the Islamic banking system, has been very costly for the masses of the individual Muslim states in terms of colossal welfare losses.” I don’t think this has been adequately documented – at least, it is not clear that a real feasible alternative exists. The idea of a Muslim Dinar, while attractive, has certain clear cut drawbacks related to the theory of optimal currency areas.

    Two paragraphs are devoted to a critique of the MNS model, summarized via a comment by Yousri. Yousri’s comment refers to banking practise and not the MNS model, which has not actually been implemented anywhere. Critique of current practise would be much more useful. Of interest is the issue of how well the critique applies to the two or three successful large Islamic Banks cited. Also, completely missing from this paper is any coverage of Iran and Sudan. In particular, it is often claimed that the only genuine Islamic Banking experience has occurred in the Sudan.

    The last two paragraphs claim a watershed role for the CII model. This claim is important and interesting. It would be very worthwhile if some historical evidence or documentation to show this was available. As it stands, it is mere assertion.
    5.  Policy Recommendations
    The policy recommendations here seem idealized and optimistic. It is not explained whether lack of confidence of the masses is valid and the major bank operations are in fact Shan ‘ah tricks, or whether banks are sincere, but the masses have a misconception. Furthermore, the forces aligned against a genuine change towards Islamic system are also not given proper consideration.

    6.  Conclusion
    Overall, this is a very rich, detailed and valuable paper, which makes a substantial contribution to the literature of Islamic economics. Further work along the lines indicated in my comments should allow us to make progress in evaluating relative merits of the various options available in the literature and arriving at useful directions to pursue for the future of Islamic Banking.

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