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Salman Ahmed Shaikh
For recognition as a distinct field in economic inquiry, any school has to have a distinction in methodology, offer positive explanation of an economic phenomenon or propose policy suggestions on recurrent and important economic issues. For these factors, the discipline also has to have a sound and coherent theoretical base.
Islamic principles and philosophy of social system are part of Islamic doctrine. Islamic economics is part of Islamic social system. It is not a distinct field of economic inquiry because it has a distinct paradigm of its own which is based on Islamic worldview. Its methodological base is also different with Quran and teachings of Holy Prophet Muhammad (pbuh) as the guiding sources of knowledge.
Islamic economics can admit micro foundations as description of human behavior in economic way of life; however, the systems, institutions and policy making offered by Islamic economics cannot take human behavior as a rule, but only as a guide. Islamic economics cannot be just description of animalistic pursuit of materialism. Whenever Islamic principles guide choices, the emphasis is not on choosing the specific actions and leaving no other choice for the agent. The reason of that guidance is to create the boundary of permissible ethical and social choices that avoid harming self-interest in both short run and long run for self and for the society.
Most of the description of human economic behavior in mainstream economics is trivial at best. Mankiw once wrote in a widely used textbook in principles level economics course ‘people react to incentives, rest is commentary’. Islamic economics cannot confine itself to commentary on material pursuits alone. In mainstream economics, the important issues of equity, welfare, equitable distribution and institutions that can ensure these are at the periphery rather than at the centre.
That is where; Islamic economics has something distinctive to offer. Islam as a comprehensive doctrine not only offers basis of a credible social contract and institutions that address issues of welfare and equity effectively, but it also defines the purpose of human existence which gives meaning to the creation.
Salman Ahmed Shaikh
In this article, we present financial analysis we performed on full-fledged Islamic banks in Pakistan including Meezan Bank Limited (MBL), Bank Islami (BI), Dubai Islamic Bank (DIB), Burj Islamic bank and Bank Al-Barakah. The period of analysis is 2007-12. We discuss the recent trends in Islamic banking by analyzing the various important financial ratios we computed for these 5 Islamic banks over the last 6 years period.
Low Finance to Deposit Ratio
Finance to deposit ratio for most banks has declined during 2007-12. The possible reasons for that include:
a) Rise in markup rates.
b) High cost of doing business, energy crisis, security crisis etc.
c) Lack of product alternatives to provide distress financing other than for purchase of assets. The demand for such financing is more prominent in a recessionary period.
High Deposits to Total Assets Ratio
Islamic banks have effectively mobilized deposits and deposit to total assets ratio has steadily increased during the period 2007-12. Though, we defer the empirical analysis of determinants of growth in deposits for the next section, but, here several possible reasons can be highlighted for strong deposit growth and mobilization.
a) Deposit mobilization has much less contractual frictions than creating a Shari’ah compliant financing asset. In providing finance, it is important that finance is provided for genuine purchase of an asset whose ownership, possession and risk has to be borne by bank so as to be able to earn any sale premium or rents for the use of asset.
b) When people become aware of Islamic banking and accept its status as Islamic, most people would start using Islamic banking services first by opening bank accounts than by obtaining finance.
c) It is easier for a customer to switch from conventional bank deposit to Islamic bank deposit than to convert a conventional debt based liability to Islamic financing product.
d) Islamic banks have remained solvent and liquid and hence during and after consumer-financing bust, people have placed more faith in Islamic banks for parking their surplus funds.
Declining NPL to Financing Ratio Post Crisis (2010 Onwards)
NPL to finance ratio has increased during the consumer-financing bust, but comparatively, Islamic banks have lower NPLs and cleaner balance sheets as compared to conventional banks. After 2010, the ratio is decreasing for all banks in the sample. Possible reasons include:
a) Islamic banks do not provide risky financing, i.e. unsecured loans.
b) Financing is always provided for the purchase of an asset whose ownership belongs to bank.
c) Since Islamic banks can not earn profit on late payments, they only provide financing to sound clients than creating subprime assets.
Expense to Net Markup Margin Ratio
This ratio shows that Islamic banks have not achieved scale efficiency yet, but the ratio is declining for some banks and stabilizing for some other banks showing a possible reversal. Hike in this ratio could be attributed to:
b) Scale inefficiency.
c) Diseconomies of scale and scope. Each financing contract requires thorough documentation and ascertainment of genuine purchase of an asset.
d) Lack of room to provide every type of loan, like credit cards, running finance, personal finance, travel finance, education finance, health finance etc.
Net Markup Margin to Finance Ratio
This ratio does not present a unique picture or trend. This ratio depends on:
a) Movements in benchmark rate. Rise in benchmark rate will increase this ratio.
b) Any changes in average maturity of financing assets. Increase in average maturity of financing given a normal yield curve will also increase this ratio.
Rising Net Income to Financing Ratio
Most banks had been in losses in their initial years of establishment. This is understandable given the heavy capital expenditure required to set up a bank. Secondly, being a small part of the overall market along with increase in number of players in the banking sector of Pakistan during 90s and 2000s, Islamic banks at the moment cannot use price skimming to break even quickly. However, all banks taken in the sample currently are now in profits.
Declining Capital to Finance Ratio
Islamic banks are solvent and have reasonable capital adequacy ratio. With increased penetration and awareness, they are able to park liquidity into financing assets more efficiently than before which is reflected by the decline in this ratio. Market leader during this period has had consistency in this ratio which reflects that there is first mover advantage and dominant firm advantage in the industry.
Improving Net Income to Total Assets Ratio
Most banks had been in losses in their initial years of establishment. However, all banks in the sample currently are now in profits. The top two banks have had much stable path for this ratio during the period as compared to new entrants.
Declining Net Markup Margin to Total Assets Ratio
Fluctuation in benchmark rate, slight rise in NPLs and low ADR has resulted in decline of this ratio in recent years.
Salman Ahmed Shaikh
In this article, we briefly analyze the logical arguments that are usually presented in the defense of interest as a price of money capital in loans.
Interest is the price of risk
It is not correct to say that lending money involves a risk. Because the lender gets interest in any condition, whereas businesses after taking operational risk either earn profit or incur a loss. In any entrepreneurial investment, the investment has to go through the entire process of a business activity that involves risk taking at each stage and any compensation on investment is strictly dependent upon the outcome of the entrepreneurial activity. Time value of money is the problem for the investor to avoid keeping his money idle and to avoid forgoing the use of money that may bring positive value to his investment. However, it does not mean that the investor can demand an arbitrary increase (or is given as the case may be) as the cost of using money without taking the entrepreneurial risk.
Share in the profit of the borrower
Interest is not a share in the profit of the borrower because if money is borrowed for fulfilling needs rather than for conducting business, then, there is no question of a profit. But, even if money is lent for commercial purposes, then, how one can determine that the enterprise will be profitable let alone determining the level of profits. Businesses earn profits and incur losses, but why the investor doesn’t share in the losses and what sort of an effort he has put in to demand a share in profits that is fixed and confirmed irrespective of the profitability of the business.
Interest is a rent on money
Those things on which rent is charged are used and given back in the same existing condition like homes, cars etc, while money and other consumption goods are consumed. When we borrow money, we consume it and regenerate it. When the money is consumed, the borrower has to regenerate it and the lender without taking any risk is entitled to receive the consumed money with the interest. Can we borrow apples or mangoes on rent? We can borrow hammer but not the nails based on the above classification.