ISLAMIC FINANCE

In Depth Analysis of Islamic Banking and its Financial Products

In Depth Analysis of Islamic Banking and its Financial Products

Introduction

Given that the Islamic finance industry has branched into so many different areas, it is difficult to succinctly define the "financial needs" that Islamic finance is supposed to serve. In some ways, the financial needs are not any different from the "financial needs" that conventional finance, which can lead to (somewhat deserved) cynicism about how the industry works now and whether there is anything that can usefully be accomplished within the Islamic finance industry as it is constructed now (Pryor, 1985, pp.212). In order to start the thought process every financial institution should serve two sides as an intermediary, matching the excess funds on the one side with the need for funds on the other.

Islamic (retail) banks

Hold Excess Funds: Depositors, Investors

Need Funds: Individuals, Companies

Islamic (investment banks) banks

Hold Excess Funds: Investors

Need Funds: Companies, Governments

Islamic investments

Hold Excess Funds: Investors

Need Funds: Companies

Takaful

Hold Excess Funds: Individuals, Companies

Need Funds: Individuals, Companies (when need arises in the future)

In some ways these different functions are all inter-linked. Investment companies will invest in equity (and debt) of the Islamic banks and Takaful companies. Takaful companies will invest the premiums (donations) from policyholders in the Islamic investments. Islamic banks will provide financing to companies that also receive investments from other Islamic financial institutions. These financial needs are not unique to Muslims, and the institutions should not be viewed as specifically targeted towards Muslims, nor should they necessarily be viewed as mirror images of conventional financial institutions.

Discussion & Analysis

Microfinance institutions use daily journals from a sample of their customers or potential customers to determine how people actually use their money and how they engage with financial institutions to develop what financial needs are not being met currently by financial institutions (i.e. what are they using cash for that a financial intermediary could help them get a better outcome). While Islamic financial institutions are not flying blind in regards to their clients needs, it does appear that in some cases they are developing products that they can make money selling and then taking them to market and hoping that the supply will create a demand. In other cases, they see a need (e.g. a financial product not being offered by Islamic banks and developing their own Shari'ah-compliant version and bringing it to market).

The problem with these approach is that they take as their premise either that the products that they develop to be profitable (for the bank) have a natural market or that conventional banks are offering products that always suit the needs of consumers. Islamic banks start by trying to attract customers who either do not use banks or are with conventional banks (Sudin, 1995, pp.19). Similarly, microfinance institutions are trying to get the business of people who rely on cash for most of their transactions because they don't have access to banks.

The analogy is not perfect, but an Islamic bank that is developing new products would ...