KULLIYAH OF ISLAMIC BANKING AND FINANCE

IBF 7141

Islamic Banking Products and Operations

SECTION: 1

SEMESTER 2, 2021/2022

Assignment/Assessment

Topic:

“Discuss and deliberate on the Value Propositions of Islamic Banking”

PREPARED FOR:

Madam ZARIAH BINTI ABU SAMAH samah

Introduction
As we know the first Islamic bank was introduced in 1960. In Malaysia, Bank Islam was the first one and
incorporated as a company under the company act 1965. Since that time the Islamic banking system has
experienced major transformation and growth specially … This growing Islamic financial system has been
inspired by Muslim consumer who wants to get alternative financing and investment products that are
compliant with their religious beliefs (Oseni et al., 2012). Operating with the shariah principles known as
Islamic rules transection make the Islamic banks grow faster because one of the basic principles in Islamic
finance is the sharing profit and loss, and the prohibition of (Riba) interest. Furthermore, the Islamic banks
have introduced many alternative products such as (Mudarabah) profit sharing, (Wadiah) safekeeping,
(Musharakah) joint venture, (Murabaha) cost-plus, and (Ijarah) leasing. Although Muslims and non-Muslims
understand how socially responsible investment works, many of them are unaware of parallels between
socially responsible investing and Shariah-compliant investing. When you look at socially responsible
screens, the companies who are producing Alcohol, weapons, and tobacco are excluded firms that operate in
unethical industries. While Islamic screening product excludes those producing alcohol, tobacco, weapons,
and gambling (Ahmed, 2010). So, both screens are looking at one simple principle which is creating profit and
preventing harm. To conclude, my main objective for this is to study the various value proposition of Islamic
banks has.
Reduced impact of harmful products and activities is one of Islamic banks' primary value propositions as I
mentioned in the introduction. As we know business operations such as selling alcohol and weapons are
considered haram in Islam (forbidden). On the other hand, Islamic banks support business, which is useful and
when it comes to investing, they follow ethical and moral principles. (Alam et al., 2017) stated companies
which are involved in completely unacceptable (haram) activities, such as the company’s manufacturing,
selling, or offering of liquors, haram meat like pork, or involved in immoral services like gambling, discos,
prostitution, night club, pornography, pubs, etc. Shariah does not permit any Muslims to invest in these
companies or the companies where the core income is based on these activities. Because Islamic banks do not
go only to profit but also focus to follow ethical and moral principles which Allah recommend us. And in
general, Islamic finance goes to the bottom line which is creating benefits and preventing harm. To reduce
uncertainty and adverse selection problems, Islamic banks have a significant advantage over conventional
banks in terms of the characteristics mentioned above, particularly productivity and freedom from unethical
investments, Al-Gharar (excessive uncertainty) and Al-Darar (harmful in contracts), and so on (El-Galfy &
Khiyar, 2012).

The next value proposition which Islamic banks have is assisting financial inclusion. When you look at most
Muslim countries are the poorest countries around the world ((Obaidullah and Khan 2008), and one of the
reasons that Muslim society does not benefit from financial services (conventional banks) is either due to the
economic reason or religious matters. For example, many Muslim people are against charging interest because
of The religious prohibition on it. Karim et al (2008) study found the following:

Estimate that 72% of people living in the Muslim world do not use formal financial services and that
from 20% to more than 40% would not use conventional microfinance because it involves paying
interest. Thus, increasing access to financial services in all segments of the population in these
countries would require Shari'ah-compliant financing.

And I believe Islamic banks have the ability to contribute positively to financial inclusion and fulfill the gap
that needs to be filled. According to Ahmed (2004), Islamic banks are more likely to provide microfinance.
He is using an example of the Rural Development Scheme (the microfinance program of Islamic Bank
Bangladesh Limited) to support his idea and says that Islamic banks are more efficient in providing
microfinance than much contemporary microfinance. But nowadays Islamic banks who provide microfinance
is increasing and we can take as an example of Bank Kerjasama Rakyat Malaysia (Bank Rakyat) in Malaysia,
is one of the corporate banks in Malaysia that provides various services including investment, financing small
& medium business, commercial financing, financial planning and also, offers microfinance in the form of
Islamic pawning services under the ArRahnu program through all of its branches and specialized ArRahnu
centers (Ahmed 2013). One of the suggestions to expand financial inclusion by Islamic banks is to use
information and communication technology to reduce operating expenses and increase the sustainability of
microfinance institutions because there are African countries who succeed after they introduce mobile
technology to provide certain financial services (Demirguc-Kunt and Klapper 2013 and Fengler 2012).
Continuing this growth will contribute to financial inclusion among the Muslim society and will have courage
every Muslim can get financing home and invest such Islamic banks. We can take an example, Al Baraka
Islamic Bank (AIB) is a retail Islamic bank that is licensed by Bahrain's Central Bank and registered with the
Bahraini Ministry of Industry, Commerce, and Tourism. Al Baraka believes that Islamic finance's ethical
values are a force for good. As the world's largest Islamic banking network, they recognize their obligation to
revitalize their communities and are committed to creating new jobs, assisting small businesses, developing
affordable housing, funding high-quality education and healthcare, financing sustainable energy projects, and
embracing diversity and inclusion. They are advancing these aims through their flagship initiative Al Baraka
Goals (2016-2020), which has committed US$822 million to seven of the United Nations' Global Goals for
Sustainable Development. Al Baraka is also commemorating the year 2019 by signing a global Memorandum
of Understanding with the United Nations Environment Program (UNEP). They look forward to working with
UNEP to direct private capital toward environmental projects in their network nations. Additionally, they
committed an additional US$ 197 million in finance for two years to sustainable and clean energy initiatives
(2019-2020). This was in addition to our earlier contribution of US$635 million, increasing our total
commitment to Al Baraka Goals to US$822 million (2016-2020). They expect that their combined efforts will
contribute to carbon reduction initiatives in the nations in which they operate. In addition to the Al Baraka
Goals, they contributed US$3.4 billion to Al Baraka's other sustainability and social responsibility programs
in 2019. Al Baraka's experience taught him that promoting sustainable development is not only beneficial but
also makes perfect sense in terms of future growth. Additionally, they invite other banks and financial
organizations to participate in the initiative.

The second value proposition which Islamic banks have is the principle of Social/financial justice. In the field
of Islamic finance, the underlying Shariah rules and ethical principles governing the operation of Islamic
financial institutions, in which the ultimate objective is to promote socio-economic justice and overall human
well-being, have also been recognized as a promising tool to address the vulnerability of the poor, reducing
inequality, enhance financial inclusion and promote sustainable development within the Muslim economies
(Ahmed et al., 2015). Human to human relations, which come under mu'amalat, which encompasses both
public and private matters in order to produce an ideal, peaceful, and fair society, is one of the key themes of
justice dealt with exhaustively in the Qur'an. The horizontal equity pillar of Islamic development clarifies
equality, corporation, and welfare rights in such a fair society (Naqvi, 1994). In Islam prohibiting the interest
(Riba) is one of the core causes of financial injustice among the society. Iqbal and Mirakhor (2007) mentioned
that there are two dimensions when it comes to the prohibition of “Riba”, is One is to encourage more risk-
sharing arrangements for commercial activity, while the other is to regard lending as a charitable act. On the
other hand, Islamic banks provide a loan with no interest (Qard Hassan), as the study of (Khan 1987)
explained adding a risk-free asset to a wealth owner's portfolio improves their pleasure. So, the choice of the
borrower depends needy of his fund and the credibility regarding repayment of the loan. This will improve the
overall well-being of society and disallows individuals’ self-interest.
The other value proposition which Islamic banks have is the stability of the investments. According to (Lewis,
2013) stated that in the time of financial crises, the banks in Golf Corporation Council were more stable and
growing than the conventional banks and there is a rapidly annual growth rate which is 25% in the GCC
region & and 20% worldwide. According to (Alqahtani & Mayes, 2018), even in the terms of assets Islamic
banks are growing twice than conventional banks and estimated about US$ 2.8 trillion in 2015. One of the
reasons is the use of (PLS) contracts in Islamic banking because it supports the premise that Islamic
institutions should be more stable. And also, (Alqahtani & Mayes, 2018) suggests that Islamic banks must
have better quality asset because of two reasons, the first one is profit and loss sharing (PLS) because Islamic
banks normally do not need collateral from the businessman to minimize the credit risk and the second reason
is since the debt selling is forbidden in the Islamic law, so the bank cannot easily shift the risk to a third party
or sell after the loan issued for debt base contracts. As a consequence of these two restrictions, the bank bears
some of the risk associated with transactions and is thus motivated to perform a careful evaluation of risk and
reduce unnecessary expansions of the value and volume of transactions (Ahmed, 2009; Chapra, 2009). Some
authors assert that only small Islamic banks are capable of promoting stability (Abedifar et al., 2013;
Alqahtani & Mayes, 2018; Cihak & Hesse, 2010). Also, according to (Tekdogan & Atasoy, 2021) supports
that Islamic banks contribute to financial stability more than the conventional one because of two ways, one is
the nature of the Islamic banks, they tend to hold access to cash compared to the conventional and the second
is in the shock period time the Islamic banks borrowing requirement dramatically will reduce because they
have surplus reserves so, this will result fall in interbank borrowing between Islamic banks.

The other value proposition which Islamic banks have is poverty alleviation. When you look the conventional
banks, only rich people can have access to the financial market because they have the ability to repay the
money, guarantees, and collateral. But in the case of Islamic banks, their basis of the fund is profit and loss
sharing. For those who are not rich but have the essential skills such as knowing how to run the business,
engineers have a better chance to acquire the fund. Asyraf Wajdi Dusuki (2008), based on his survey findings,
recommended the following:

Islamic financial institutions must not only focus on maximizing profit, but they should also play a
vital role in addressing or solving socio-economic issues such as poverty reduction and improvements
in important aspects of human welfare (like education, research, and development studies, illiteracy,
reducing child mortality, youth insecurity, and restlessness, etc.) by efficiently channelling financial
resources towards productive opportunities, hence enhancing production, investment and trade
activities.

Because of the objective of Shariah, the system of Islamic banking has a positive contribution to fulfilling the
socioeconomic and alleviating poverty. So, the Islamic banking system can employ a variety of financial tools
in conjunction with other access mechanisms like zakah, charity, and waqf to encourage underprivileged
people to start businesses, and also, to alleviate the poverty line. The author Wajid, his findings suggested that
Islamic banks need to focus on demand-oriented financial services drives them to innovate more
institutionally and via programs, particularly in terms of product differentiation, operational efficiency, and
outreach (Wajdi Dusuki, 2008). So, if the Islamic banks have better financing this will lead to having more
economic benefits for poor customers and, as a result, a stronger social effect. For example, one of the best
products is Profit-sharing (Sukuk), this will enable you to own the share of the enterprise, in the case of
enterprise succeed you will just pay a set percentage of his or her earnings. The other product which is my
opinion is Musharakah mutanaqisah. This is called the indirect method of investment, usually, the bank
applies in mortgage financing. Throughout the partnership, the bank’s ownership of the business venture
decreases. For example, if the bank provided home financing under Musharakah Mutanaqisah and owns the
home %100, along the period of the partnership, the client of the bank every month will contribute to that
endeavor by donating a part of their profits to the bank.

Conclusion

As I have discussed above there are many ways that Islamic banks have a value proposition, one of them is
reducing the impact of harmful products and activities. As Maqasid Al Shariah (objective of Shariah) is to
prevent harm and maximize the benefit and to establish equality people and to promote socio-economic justice
and overall human well-being. Because Islamic banks do not go only to profit but to follow ethical and moral
principles which Allah recommend us. Furthermore, above I have mentioned Islamic banks can contribute
positively to financial inclusion and fulfil the gap that needs to be filled. And also, Islamic banks have the
ability to eliminate the poverty because all people of the society have access to take loan is not as
conventional banks so rich people can have access to their financial market.
References

Demirgus-Kunt, Asli and Leora Klapper (2012), Measuring Financial Inclusion: The Global Findex Database, Policy

Research Working Paper 6025, The World Bank, Washington DC.

Ahmed, H., Mohieldin, M., Verbeek, J., & Aboulmagd, F. (2015). On the sustainable development goals and the role of

Islamic finance. The World Bank.

Naqvi, Syyed, Vali, R., Islam, economics, and society. London; New York; New York, NY, USA: Kegan Paul International ;

Distributed by Routledge, 1994

Khan, S. R. (1987). An Economic Analysis of a PLS Model for the Financial Sector. in Khan, M. and Mirakhor, A. (Ed.).

The Theoretical Studies in Islamic Banking and Finance. Texas, US: The Institute for Research and Islamic Studies.

Wajdi Dusuki, A. (2008). Banking for the poor: The role of Islamic banking in microfinance initiatives. Humanomics,

24(1), 49–66. https://doi.org/10.1108/08288660810851469