Banking without Interest – Challenges ahead

Kwan Kin Sum explores the challenges for the Islamic finance industry




Islamic finance has gone through an exceptional growth over the last decade registering an average annual growth of about 15% worldwide. It continues to grow as the popularity of Islamic finance among Muslims and awareness among non-Muslims in this alternative financing increases. This unprecedented interest in Islamic finance globally can be attributed to the influence of religious faith among the Muslims, the quest for better returns by financial intermediaries and renewed interest from the Western society.


Nevertheless, the growth has been achieved under an increasingly challenging and dynamic environment brought about by financial globalization. This article highlights several of the many issues confronting Islamic finance that need to be addressed successfully to bring Islamic finance to greater heights.





Human capital is the most important resource for any service industry.  Due to the immense growth of Islamic finance, there is constant pressure for the industry to develop a pool of qualified manpower. Islamic finance practitioners need to comprehend not only basic financing skills but also appreciate Islamic values and concepts, core prohibitions, and the distinction between legitimate profits and illegitimate gains in form and in substance from the sharia perspective.


A pre-requisite to the aforesaid understanding is a profound comprehension of the objectives and philosophies of the sharia and Islamic principles guided predominantly by the Quran, Sunnah, Ijma and Qiyas and the subsequent interpretations of such principles by Islamic scholars. These are not issues that can be understood overnight. There must be proper programs and education backed by institutional support with adequate funding.


Islamic commercial transactions require the input of sharia scholars with respect to product-structure, usually within a short turnaround time so as to avoid losing the opportunity to close a transaction. The services of scholars are therefore highly demanded. Product innovation can only progress in parallel with an increase in qualified sharia scholars and competent talents.


An area where qualified manpower is necessary is in musharakah ventures where the bank is one of the capital providers. Musharakah ventures usually require long term commitments. As a result, the bank has to commit funds and must have a pool of qualified employees on a long term basis. These employees must be competent in Islamic finance and be able to provide the assistance required by the co-partners to ensure the success of the ventures. The employees must have, amongst others, the requisite skills in profit and loss analysis, management of the particular business sector, an appreciation of associated risks and the requisite knowledge to ensure that the transactions are sharia compliant.


Due to the lack of qualified personnel, products based on the principles of musharakah and mudarabah are therefore low on the priority list of most Islamic banks in Malaysia.  This explains why banks currently rely more on bai bithamin ajil (BBA), murabahah, musharakah mutanaqisah or diminishing musharakah products. Growth in Islamic finance can be inhibited if Islamic banks continue to focus on such products alone.




Product innovation and creativity with competitive rates are key drivers to capturing market share and competing at the global level. Islamic financial institutions need to grow in size and introduce new sharia compliant products to increase the range of Islamic financial products and services. Public awareness and acceptance of this alternative financing are crucial for the industry to sustain growth. Otherwise, there will be an exodus back to conventional products.


To stave-off competition from conventional finance, Islamic products must be on par with, if not better than, conventional finance in terms of diversity, cost effectiveness and ability to meet the risk and return requirements of investors whilst remaining sharia compliant. It will not suffice to mimic conventional products and label them as ‘Islamic’ in form alone. Mere adaptations will render Islamic products second rate at best.


The lack of derivatives and an organized secondary market for dealing with Islamic instruments are creating liquidity problems for the Islamic capital market. A vital development of capital markets, not just Islamic capital markets, lies in the creation of a secondary trading platform for their instruments so that investors are offered the option and flexibility in managing their investment portfolios. Without an effective secondary market where financial instruments are easily tradable, an early exit may be difficult or costly for an investor.


Islamic financial instruments are faced with pricing difficulties given that they cannot be associated with interest. The continuous practice of benchmarking against inter-bank offered rates will only fortify the common perception that Islamic financing is conventional in substance. Hence there is a need for the industry to come up with its own indicator which is sharia compliant. Islamic products ought to be truly Islamic and benchmarked against an Islamic indicator.


On the positive side, the development of the Islamic bonds or sukuk has given investors an alternative form of investment. It represents one of the most promising innovations in Islamic finance. Although the size of the market is modest by global standards, the sukuk market has experienced phenomenal growth in recent years due to the rise of infrastructure projects in the Gulf region and the need to seek funding for large corporate exercises from investors in the Gulf States and other Islamic countries who require the products to be sharia compliant.




IT in conventional banking is very much entrenched when compared to Islamic banks. There is still a lot for Islamic banks to do in this area. It is often said that IT has become one of the key differentiators among competitors. With the latest IT solutions, the potential to introduce new Islamic products and services can be enhanced and banks can have a better platform to manage transactions, risks, costs and therefore decision-making.


One of the key challenges to IT development in Islamic finance is the ability of the solution to meet the sharia requirements. Banks have to be careful while embarking on any IT systems to ensure sharia compliance particularly with systems which are customized.


Needless to add, specialized talents are required to operate sophisticated IT systems, from front desk to back-room operations. Islamic banks must be prepared to invest in such human resource. Alternatively they may consider outsourcing. It is important to ensure that vendors of IT systems and outsourcing service providers understand sharia requirements.


Greater connectivity through internet banking and other online delivery channels will help promote and create public awareness of Islamic finance as a whole.




After the demise of the Prophet, there was no further revelation for humankind. Thereafter, the sharia developed through the process of Ijma and Qiyas undertaken by scholars based on the Quran and Sunnah. This in turn led to the emergence of various schools of jurisprudence.


Consequently, differences in interpretations of the sharia arose over time and some of these schools have ceased to exist, leaving behind four main schools comprising the schools of Hanbalis, Malikis, Shafi’is and Hanafis that have found particular favour in certain jurisdictions, hence explaining the geographical concentration of believers observed today.


The differences of interpretation of the sharia by the different schools have led to the subject of harmonization in sharia interpretation. Some say the divergence is necessary and unavoidable given the views of each school or mazhab is peculiar to the circumstances, culture, politics, economy, social belief and religious background of a particular country. What is appropriate for one country may not be suitable for another. In addition, the views of one school are not binding on another school.


A lack of uniformity in the principles applied and consistency in practice give rise to uncertainty. Whilst the Hadith is no doubt a comprehensive collection of principles, there is no single text agreed by all four schools. Therefore, one of the great challenges to Islamic finance is to develop a set of principles agreed by all the schools for Islamic finance purposes.


Mere product innovation without harmonization of sharia interpretation will not suffice. Differing sharia views, or worse, opposing sharia interpretations can lead to legal uncertainties and affect investors’ confidence. Sharia incongruency makes it difficult for financial intermediaries to structure cross-border transactions or develop new products with global appeal. There is therefore an urgent need for a common understanding and acceptance of applicable sharia rules and standards to enable Islamic finance to become truly global in its reach.




The challenges highlighted above are in many respects unique to Islamic finance. The extent to which Islamic finance will displace conventional finance as the preferred mode of financing will depend on how well the industry copes with these challenges.



KWAN KIN SUM ( This e-mail address is being protected from spambots. You need JavaScript enabled to view it )



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