Islamic Banking: Going Strong

When 22 countries of the Organization of Islamic Conference (OIC) joined together in 1395 A H - 1975 - to set up a development bank working on the principles of Shari’ah, many people were shaking their heads. How can a bank prosper without taking interest on its loans? Yet according to the Islamic Development Bank’s (IDB) latest report, for 1995-96, there are now 50 member countries. More are expected to join in the near future — from Africa, eastern Europe and former Soviet Central Asia.

The expansion in the size, quality and variety of services offered by the Bank has been equally impressive as has been the growing cooperation among the banks operating on similar principles. This has been achieved without, in any way, preventing cooperation between Islamic and conventional banking for development.

During 1995-96 the IDB approved 1,016.18 million Islamic Dinars (ID) corresponding to about 1.5 billion dollars, for a total of 184 operations, an increase of about 7% compared with the level attained the previous year. Of the total, ID 344.01 million went for project financing and technical assistance and ID 664.41 million was approved for finance trade operations, particularly imports of goods that are important for economic development in the member countries.

Development projects were approved for 32 countries and, as the report says, ‘a task force was established to look into the special needs of new member countries in the Common wealth of Independent States (CIS) and eastern Europe and to enhance opportunities for them to benefit from IDB financing. Operations were approved for Albania, Kazakhstan, Kyrgyzstan and Turkmenistan. The IDB also commenced operations in Mozambique, its newest member country’.

As for development sectors, the Bank committed 33% of its 1995/96 programme for public utilities, with emphasis on power transmission projects, particularly in the more developed member Countries. Other projects in this sector focused on improvement of living conditions in rural areas, including provision of clean drinking water, basic health services, primary education and integrated rural development, special attention being paid to the Least Developed Member Countries. The LDMC enjoy preferential treatment, including concessionary lending.

Transport and communications benefited from 20.4% of the total approval; 19% went for health and education; 18.6% for agriculture and agro-industry; and 8.2% for industry and mining.

The Islamic Development Bank has adopted a number of ways of financing the projects its supports such as leasing, instalment sale, lending and equity participation, or co-ownership of the project.

Loan financing: Accounting for 23% of the total in the year under review the mode is mainly intended for social and economic infrastructure projects and chiefly to help the LMDCs. The type of project benefiting from loan financing includes schools, water supplies, health centres, hospitals, rural electrification as well as roads, ports, airports, irrigation schemes and land development. Out of the total loan financing approved, 72% was to assist the LMDCs. The IDB charges a service fee of 2.5% maximum to cover part of administrative expenses. But LDMCs pay only 0.75 per cent.

Leasing: The medium-term financing involves the purchase on the part of the Bank and subsequent transfer to the beneficiary of the right of usage of equipment for a specific time period when the IDB retains ownership. Payments on the part of the beneficiary include a mark-up ranging from 6.5 to 7.5 per cent. Leasing accounted for the largest share of project financing in the year under review: 41% of the total.

Instalment sale: The main difference from leasing is that ownership of assets is transferred to the beneficiary on delivery, whereas in leasing the assets pass on to the lessee after the final lease payment is been made. The mode accounted for 35% of the project financing in the year concerned.

Equity participation: This is the least important of the four modes and has actually been decreasing as a proportion of the total, from 4% in 1994/95 to 0.6% in 1995/96.

Examples of project approval in the year under review include loans of ID 5.050 million for education and training in Burkina Faso and ID 4.800 million for rural water supply in Albania; leasing worth ED 11.240 million for power transmission in Bahrain; instalment sale for ID 7.450 million for an irrigation development in Algeria and an equity participation project of ID 1.670 million for an Islamic finance house in Turkey.

The IDB has been continuing and intensifying its cooperation and co- financing with development institutions active in the countries of IDB interest, particularly with Arab, or mostly Arab, financed development aid funds with which regular consultations take place. The institutions include the OPEC Fund for International Development, the Arab Bank for Development its Africa and Saudi and Kuwaiti Funds. There are also close partnership ties with Bretton Woods organizations, particularly with the World Bank.

‘The IDB, through its trade financing schemes which cover both import and export financing, aims not only to promote trade and cooperation among its member countries but also to stimulate growth in production and improvement in the balance of its member countries’ trade positions.’ This is how the Bank sums up its work in supporting international trade as a way of helping the development of Muslim countries.

The IDB’s role takes on added urgency because of the intensified activities of the World Trade Organisation and the recent moves to liberalize exchanges through the Uruguay Round. As the report points out, this presents fresh opportunities as well as challenges for member countries as the developed world is seeking to gain advantages at the expense of the weaker nations, many of whom are members of the IDB.

Again, the Bank has been helping its members to utilise trading opportunities for their development by offering three modes of support.

Import Trade Financing Operations:

ITFO was fist introduced its 1977 and was designed to finance imports of raw materials as well as intermediate and finished products by member countries. As the Bank explains: ‘The scheme also served as a vehicle for utilization of the bank’s liquid funds in a Shariah compatible way and has become an important source of income supplementing the Bank’s resource base in its other financial commitments.'

The Longer Term Trade Financing

Scheme: LTTFS was introduced in 1987 to finance exports of member countries’ goods that are not usually traded among them. The facility is designed to help increase the necessary imports from other member Countries.

The Islamic Banks’ Portfolio:

Launched in the same year, the IBP is the even more sophisticated facility. A joint venture of 20 Islamic banks, it is designed to promote trade among member countries by use of instalment sale, leasing and the so-called murabaha instrument. (It is a contract of sale between a buyer and a seller at a higher price than the original price at which the seller had bought the goods.)

As a financing technique it involves the purchase by the seller (financier) of certain goods needed by the buyer and their re-sale to the buyer on cost-plus basis. Both the profit in the form of a mark—up and the time of repayment are specified in the contract. The Bank operates in partnership with 19 other Islamic banks. In fact it is these banks which provide the finance, the IDB only acting as the mudarib, that is, providing management expertise. Profits, if any, are shared among he parties, but capital loss is borne by the partners supplying the capital.

Other schemes of technical support nature are addled to facilitate trade among member countries. Thus, The Trade Cooperation Programme has the objective of informing member countries of the existing and potential trade opportunities by holding workshops, seminars and trade exhibitions where member countries display their products and opportunities for trade among the member countries are highlighted. Poorer countries, including the LDMCs, may he assisted financially by the Bank to cover the cost of shipping the exhibits and in other ways.

Through seminars the Bank has been focusing important subjects related to trade promotion, such as the General Agreement on Tariffs anti Trade (GATT) and its successor, the World Trade Organisation and their impact on exports from member countries.

The recent Setting up of the Islamic Corporation for the Insurance of Investment and Export Credit (ICEC) signifies another major step in facilitating and expanding exports among the member countries.

Time share of IDB-promoted trade among member countries may be small compared to total intra—trade, but being concentrated on specific, strategic areas it is nevertheless significant. For example, the IDB has been successful in promoting trade for jute from Bangladesh, palm oil front Malaysia, exports of fertilizer front Jordan and Tunisia to other member countries and of communication and power cables from Saudi Arabia and turkey.

Trade among member countries is expected to grow further as their economies become healthier and their industrial and agricultural sectors expand.

Special attention is now being paid to the promotion of trade contacts with the new Muslim countries from the former USSR, such as Azerbaijan, Kazakhstan , Kyrgyzstan and Turkmenistan, which have all recently become members of the Islamic Development Bank.