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Thursday January 17, 2013

Value of Islamic financing

WHILE Malaysia has become an internationally renowned centre for Islamic finance, the general public appear to have a very limited (if not flawed) understanding of it.

Most non-Muslims (and some Muslims) appear to be under the impression that there are only some terminology differences between the two, the main one being interest rate being termed as profit rate in Islamic finance.

Such a shallow understanding overlooks the fact that Islamic finance emphasises justice in financial transactions. Justice is a highly-regarded value in Islam.

The prohibition of interest in Islamic finance (IF) is due to it being viewed as an unjust practice. This is because, among others, the party providing the capital (financing) is able to enjoy a fixed return irres­pective whether the venture financed fails or succeeds.

However, it must be highlighted that most financing done by Islamic financial institutions (IFIs) currently are not based on profit-sharing modes of financing but sales-based transactions. This is mainly because the risk involved in equity-based financing is deemed to be too high for the risk appetite of financial institutions.

A sale or trade-based transaction with the profit factor included may appear very similar to a conventional lending transaction. However, a trade involves an underlying asset and changing of ownership of the asset, and impacts the real economy.

The conventional finance system being motivated purely by profit, and also greed at times, allows finance to exist for its own sake and in isolation of real economic activity and can lead to situations like economic bubbles and related financial problems.

For the individual customer taking financing, while the cost (in terms of finance pricing) may be the same between IFIs and conventional banks, many features and practices of IFIs are fairer to the customer due to the underlying value of justice in Islamic finance.

For instance in IF, the penalty for late payment is about 1% compared with about 8% charged by conventional banks.

Further, because the penalty is only to deter customers from delaying payment and not to profit from the customer’s hardship, the penalty fees collected are used by the IFIs for charitable purposes.

There is also greater transparency when dealing with IFIs compared with conventional banks where, for instance, the selling price of a financial transaction states clearly how much the financing will cost to a customer during the tenure of the financing and enables the customer to make a more informed decision whether to take up the financing.

In a conventional transaction, customers are sometimes not fully aware of the terms and conditions.

I myself being formerly employed by a conventional bank have seen this happen.

Terms like minimum prescribed rate and penalty rate, clauses that were previously stated clearly in the Letter of Offer, were subsequently put under the attachment (which is in a smaller font than the Letter of Offer).

Often, this was done purely on advice of sales personnel so that they (the sales personnel) do not have to go through the difficult clauses with customers and therefore have a higher chance of closing the sale.

The customers are usually told that the terms and conditions in the attachment are standard clauses applied by all banks, and the customers are left to decipher the terms and conditions which are in fine print on their own.

Such practices are less likely to happen in IFIs because they are not purely motivated by profit but values of justice and transparency. Further, if you were to encounter any unfair terms, an IFI is more likely to consider removing the unjust term because the value of justice overrides the pursuit of profit.

In comparison, conventional banks are usually not willing to accommodate a legitimate request, until of course you report to Bank Negara or blow up the issue in the media.

There may be a fear among non- Muslims that practising Islamic banking means they become Muslims. Islamic banking is not about propagating the religion of Islam, but about providing an alternative form of banking which is based on the universal value of justice, and should thus be viewed positively.

Islamic banking can be likened to eating a halal burger, which may taste like a normal burger. However, if we know that it is more nutritional and better than a normal burger, aren’t we better off opting for the halal burger?

At the very least, our choice of opting for Islamic finance will result in conventional banks being forced to adopt fairer banking practices if they want to retain customers.

VIJAYANTHRAN RAJANTHRAN
Cheras, Selangor

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