Finance

Santander Bank

Table of Contents1.0INTRODUCTION......................................................................................................................................3

2.0 The Capital Markets...............................................................................................................................3

2.1Significance Of capital markets...............................................................................................................5

2.2Capital Markets and associated Risks.....................................................................................................5

3.The rise of Islamic capital markets...........................................................................................................5

4.0Concerns for the Islamic capital market.................................................................................................6

4.1Transactional Cost Factors......................................................................................................................6

4.2 Regulatory bodies..................................................................................................................................6

4.3The product basket Limitations..............................................................................................................6

4.4Compliance with rules............................................................................................................................7

4.5 The Clash with Investment Banking.......................................................................................................7

4.6 Development of Trained professionals..................................................................................................7

4.7 Awareness of investors for growth and development...........................................................................8

4.8Need for spread of knowledge...............................................................................................................8

5.0 The correlation between the Islamic Finance, global recession and instability.....................................8

5.1Introduction............................................................................................................................................8

5.2The prime causes of global economic downfall and recession...............................................................8

5.3. The Islamic Financial System................................................................................................................9

6.0Conclusion............................................................................................................................................12

1.0INTRODUCTIONIslam happens to be one of the oldest, profound and most widespread of all the religions of

the world. It is one of those religions which has enlightened and touched upon all the various

spheres of human life be it social or cultural, economic or political. Islam literally means, to

submit oneself to the will of the almighty. Islam preaches that in order to lead a complete and

peaceful life one should lead life according to His Divine Laws .It centers on the basic idea

of monotheism and regards Allah (God) as the supreme power and man is his representative

on earth. Quran was his final message to mankind that was mediated by the enlightened soul

of Prophet Muhammad and it took him 23 years. The holy Quran is regarded as the purest

form of God’s word unlike most other religious scriptures.

The Sharia Law laid down in Quran bans the use of conventional Interest and regards it as a

sin. Islam believes in Zakah or almsgiving which is in direct contradiction to the rest of the

world financial concept. Therefore the dire need to build a market the foundations and

principles of which would lay deep into conventional Islamic principle and show the world

the right path and do away with the ways of Haram(forbidden).The focus is thus on debt

financing rather than equity financing. Islam thus introduced the Sukuk market or the bond

market in general terminology. Islam does not object creation of capital markets when they

are in accordance with the principles laid down in the Sharia Law. There is an Islamic

organization known as Accounting and auditing organization for Islamic financial institutions

(AAFOI) which has laid down the principle for trding of sukuk ,they have to owned only by

sukuk holders ,and this ownership would be in the form of real assets(Ahmed et al .2011).

Quran considers this as legitimate and vouches that God has never forbidden trade and

business but there should not be any indulgence in the Riba (Interest ) or

Gharar(Uncertainty).

2.0 The Capital Markets

The basic market structure which provides which bridges the investors to deal in long tern

equity backed or debt backed securities is known as capital markets. The saver here by

entering into long term investments facilitates in funding other governments, entrepreneurs,

banks or other companies to use them and in turn they return some saver profits. It may be

comparable to bond markets in case of conventional banking or Sukuk markets when it

comes to Islamic banking as opined by Dusuki(2008). Issue of these Sukuks is potent enough

in proving ample opportunities to the British Muslims and may help in metamorphosing

London into one of the leading centers of world finance according to an article published by

HM treasury in the United Kingdom.

2.1Significance Of capital marketsThe capital markets and mode of business is a mutual symbiosis between business houses,

banks, various financial institutions and common people as well to together work as

machinery which will help grow not only organizations but also nations and in turn generate

some return on their money, as money has always a time value attached to it according to

Cizaka(2013) .These markets facilitate in the mass scale privatization of various

organizations.

2.2Capital Markets and associated RisksThe conventional banking system has many risks of various kinds associated with it .The

banks offer various kinds of loans and that too in huge amounts to its prospective customers,

especially the banks of USA. The premier interest of the financial institutions was profit

maximization. But this resulted in weakening the asset side of the balance sheet and the

liability side kept piling up .Bad debts and Non performing assets were on an ever increasing

surge (Banaji,2007).This slowly and steadily contributed to worldwide economic crunch and

a debt crisis which led to the worldwide economic recession. But with the kind of strong

principles in which the Islamic capital markets are based on and technically since they have

an equity based debt structure the risk is much less .

3.The rise of Islamic capital markets.

Since its inception in the year 1998 Islamic financial markets have steadily grown. Their

foundation principles which prohibit any kind of doubtful transactions, contracts based on

interest generation, and non-Islamic revenue generation have helped the most. They gained

world attention during the period of 2001-2003.the recession hit global market in 2007

provided it the much needed breakthrough and world economists started supporting the cause

(Ibrahim and Rahaman,2005).

4.0Concerns for the Islamic capital marketThe Islamic financial systems are still on the growing phase and have lot of obstacles to

overcome. Since there is already a much used conventional banking and financing system so

there is urgent need that the masses change their general outlook and culture towards the

same .The growth of the Islamic financial organizations and capital markets are not of

uniform nature across the globe. The non –Islamic countries which are slowly introducing the

Islamic way of banking are doing so but on a micro level and with small business houses as

opined by Harris and Warde(2010).. The economic powerhouses on the other hand suffer

from lack of proper institutionalization .It has been revealed by the World bank(2006),that

only 21 of the 57 Islamic countries have a structured stock market .again there different

system from conventional banking system stands contradictory with established institutes

like GAAP and IAS.

4.1Transactional Cost FactorsThe developing Islamic capital market is plagued by tax issues such as Double stamp duty,

real property gains .income tax .Moreover there is a marked cost difference in the securities

issued by the Islamic capital market and conventional capital markets.

4.2 Regulatory bodies According to Hasan (2010) there are great differences of opinions among the 30 various

Sharia boards, which happen to be the regulatory and supreme authority on Islamic Banking

and Financial institutions .The Sharia laws as it is stand very much contradictory to the

standard banking regulatory authorities. This is one of the major hurdles in establishing a

sound Islamic capital market.

4.3The product basket LimitationsAll the Islamic banking and financial instruments need to be approved by the sharia

board .Most of the products cannot be liquidated easily and too add to that there are not

enough different product options available. This is one of the major area of concerns that

needs to be looked into.

4.4Compliance with rulesThere are discrepancies which arise to due to the distinguishing feature of Islamic banking

from conventional banking which is its compliance to the Sharia laws. This results in

considerable delay, as any Islamic capital market product would have to be first verified by

their in house board. Then the central sharia board has to clear the same. What complicates

things even further is that different sharia boards opine differently about the same product

says Khan(2000).While some strictly adhere to the laws which are laid ,there are a few others

who have undergone a change in their attitudes and believe in some of the modern principles.

so there is a significant lack of adequate structure and standardization of all various kinds of

products.

4.5 The Clash with Investment Banking

The general and natural tendency of Islamic banking is that refutes innovation, the Riba or

interest principle and it more concerned towards retail rather than customer banking. But

investment banking on the other hand is creative, innovative rapidly evolving and provide

great money making opportunities to all. This is in direct clash with the foundation principles

of the Islamic system of finance.

4.6 Development of Trained professionalsThere is a considerable lack of professional who are trained and knowledgeable about all the

minute details of Islamic finance. This does not help to the cause and there is therefore very

slow development when it comes to diversification of products .to bring about the necessary

changes trained professionals are required, who have sound knowledge of economics as well

as the sharia laws (Obaidullah,1996).

4.7 Awareness of investors for growth and developmentThe investors are wary about the Islamic concept of banking and finance. There is no proper

campaigning from the banks to draw investors or convince them to invest to their cause. This

lack in communication between the investors and the Islamic banks needs to be worked to

improve the situation. Without them understanding the concept in a crystal clear manner

there would always considerable difficulty in the investments pouring in.

4.8Need for spread of knowledge There are no proper information channels which the customers and general public may access so

that they can take informed decisions .Database building more access to Islamic banking

products is the need of the hour. A lot of investors believe in proper statistical analysis so that

they can do their researching which would aid them in the benchmarking of products.

5.0 The correlation between the Islamic Finance, global recession and instability

5.1IntroductionThe economic disturbances and collapse of the banking system of the west had brought in the

global economic crisis in 2007.The excess debt and leveraging which was given by the various

banks of the world was mainly due to the removal of the trade and tariff barriers internationally.

The nature of transactions carried out by the banks, mainly the uncontrolled selling to third

parties brought about the downfall..The deals were made in papers which were hardly of any

economic value.

5.2The prime causes of global economic downfall and recessionAfter a insightful study of the causes of global recession, the economists derived that debt and

leveraging are the main causes of financial volatility in the current system along with the

following defoliating factors:

There have been excessive levels of risk and debt floating in the market along with

comprehensive deregulation of various monetary and fiscal instruments. Shadow banking

operations were also done by many organizations. Insufficient supervision by managers and

officials was another major reasons which needs to be considered. Superfluous low interest rates

the shortcomings and inefficiency of credit rating agencies and fraudulent activities were on the

surge.The practices of mark-to-market bookkeeping. Again the existence of too many of the sub-

prime borrowers in the USA also affected and contributed significantly to the downfall.

According to Sole (2007) The failure of one system effected the other financial systems as a

chain reaction. To add to all this was excessive printing of money in trillions supplied to meet

the financial needs which resulted in higher inflation. Lastly approving various mortgages

without proper evaluations increased the debts and also contributed significantly in bringing

about the downfall.

5.3. The Islamic Financial SystemThere is a need of a procedure that could prevent the excessive debt and risk shifting, and would

work in favour of risk sharing and equity financing. This is Islamic financial system unlike the

traditional procedure which favours excessive risk and debt for increased profits. The Islamic

banking system daunts borrowing and encourages risk sharing, resulting in decreasing the asset-

liability gap. The Islamic financial arrangement is based on asset backed financing and risk

sharing between the banks and the customers. This system has two great advantages:

It asserts the inflation rate to the minimum irreducible

It maintains the compatibility between the investor and the entrepreneur

Islam, according to Holy Quran, does not permit, exchanging money for money, interest (Riba);

rather it supports an alternative of shared exchange, allowing both the participants of the contract

to share marketing risks, production, and transportation. Allah has mentioned at different places

in Quran the prohibition of receiving and giving of Interest (Riba) (Al-Roun Chapter 30, Verse

39; Al-Nisa Chapter 4, Verse 160-162; Al-Imran Chapter Chapter 3, Verse 130-136; Al-Baqarah

Chapter 2, Verse 275-277; Al-Baqarah Chapter 2, Verse 278- 281).

Controlled “asset-linked” securities are the oppose part of debt in Islamic Financing. The

fundamental difference between the conservative securities and Islamic securities is the transfer

of ownership to the investor. Undiluted commitment to the larger benefit of society, socio-

economic justice, and justice are some of the vital values on which Islamic finance works.

Firstly, Islamic finance is against the unjust wealth allocation that is caused by the interest. This

will help in reducing the debt. Secondly, Islamic finance does not allow pointless risk to be taken

and therefore avoids any undesirable loss to the society.

5.4 Impact of the Islamic financial System even during recession

Kuwait Qatar Saudi arabia

UAE Malaysia Indonesia0

20

40

60

80

100

120

140

20082009

Figure 1 World Islamic banking Competitiveness Report

A scrutiny in the underlying causes would reveal the reason for this stunning exceptional

performance.

To begin with, the Islamic banking system is very strongly regulated with the Sharia System.

They cannot by any means overwhelm these laws. Instead of printing billions and trillions of

money in the form of paper to restore the balance of economy and attain equilibrium, the Islamic

financial system is majorly based on asset financing. The conventional banking policy led to

increasing rates of inflation, causing excess liquidity by printing and increasing the global debts

by leaps and bounds.

The Islamic finance by its moral policing keeps a necessary check on the society. It forbids and

prevents investment into activities which are non Islamic in nature like high risk investments of

various kinds, any form of gambling and also in activities which have a high interest rate

associated with it. This helps in prevention of excess debts as opined by Wilson(2000).

To prevent any form of disparity between two the concerned parties Islamic finance prohibits

and is against any deal which has any form of predetermined interest rates attached to it. This

kind of interest rate generally widens the societal economic misbalances between the poor and

the rich. Predetermined interest rate generating projects generally create wealth without being

directly involved to any good real economic activities. If due to political or economic causes the

interest rage surges the tenure for the loan payment automatically increases and in the end the

customer has to pay much more, and the feeling of oppression and injustice crops up and causes

various problems in the society.

Entrepreneurship forms the core of Islamic finance. The idea behind Islamic finance is to

promote activities that will enhance trade and commerce. Trading helps in attaining the much

needed equilibrium that is missing from the society. This virtually shields the Islamic financing

organization from potential economic threats and the negativities of excess globalization. The

essence of the philosophy of Quran is charity, and if charitable there would be no dearth and will

have the blessings of Allah.

The greatest benefit of Islamic finance according to Ibrahim and Rahman (2005) lies in the

unique concept they have laid in sharing of the profit or loss. The Islamic finance contracts have

two clauses embedded in them known as Musharakah and Mudarabah. In accordance with these

clauses both the parties entering into a contract have to share their profit or loss whichever they

incur according to the terms and conditions set .In accordance withYudistira(2004)This

facilitates in reducing the burden of a loss and debt considerably ,is more humanitarian and

philosophical in nature The business ethics which Islamic finance has brought in is unheard of

and exemplary in nature. More and more economists and social scientists are vouching for better,

attitude, behavior and societal responsibility from the main stream banking industry. With the

abolition of the Riba ,or the very concept of interests in banking, Islamic finance is leaps and

bounds ahead in the ethical necessities demanded from the banking and financial sector. They

also have a concept known as Ibn Majah, according to which is any Muslim or anyone following

Islam sells any kind of defective item without any knowledge of the other person ,the forfeiting

seller would be under the grudge of Allah .Thus the Quran with its Sharia which has been laid

down for the Muslim society ensures that it has to remain as fair and sensible possible along

with the much needed philanthropic angle to go with it. Even the non Muslim community are

finding Islamic banking to be more humanitarian these days and are influenced by the truth that

there is much less burden here than the conventional form of banking opines

Lastly the Islamic banking strongly believes and focuses in the upbringing and development of

the society rather than become unjust and deadly system of money maximizing instruments in

the brutal hands of global economical forces. They do not believe in profit maximization which

is the premier aim of conventional banking across all corners of the world (Sole,2007). The very

concept of profit sharing eliminates the threat of excessive loss and is of immense philanthropic

value. It also grows a sense of responsibility from within ion the minds of the people and ensures

enhanced discipline and better morality among the ge4neral masses, poor and rich alike.

Therefore, it would be fair and sensible to claim that each and every financial activity that

complies with the Sharia’s rules and guidelines is a socially responsible activity.

6.0ConclusionWhy and what exactly engineered in bringing about the global economic crisis and recession is a

debate that has stirred the best economic minds in the recent times. Though they could not single

out any single factor, what most of the equivocally agreed to is the fact of excessive profit

maximization .to attain this excessive sanctions of loans By lowering interest rates to lure more

and more customers, the US sub prime mortgages, debt based financing model and the basic

flaws that are inherent in conventional banking can all be held responsible and guilty as opined

by Mills and Presley (2007)

Contrary to this is Islamic finance regarding which experts are of the opinion that it is still in its

nascent stage and is yet to bloom totally and attain its full potential. The economic scholars of

the Islamic system of finance have yet not been able to fully grasp the underlying potential of the

banking system that remains unearthed. It can safely be said that the global economy would be

relatively much safer and the future chances of another great recession may be avoided if one

follows the principles of Islamic banking and financial structure. One of the prime reasons of

development of the Islamic Capital market may be attributed to this according to.The abolition of

Riba(Interest) and the strict regulations that are integral to the Islamic banking system is both

unorthodox and tough follow (Khan,2000). No religion ever is easy to follow and when religion

forms the base of economy it would be harder, since people are used to following their

incredulous easy ways and discrepancies, scams are common place occurrences. This printing

causes surplus liquidity and eventually granting more loans, and hence causative to global debt.

Islamic banking and financing is a new concept which opens up a new horizon of opportunities

and yet is considerably immune to global economy. If it is followed properly with strict

governance and adherence which is integral to it would create a much more stable and healthy

economy and yet usher prosperity into the global economy. However what is requires is patience

and time , both of which are found wanting in the modern day context and public. Due to its

strict adherence to the Sharia principles, global recession may be averted. Forbidding the unfair

practices and passing them as law gives it the much needed edge to thrive in this tough global

scenario. Its instruments provide the necessary edge and sharpness to fend off all the

malpractices.

The necessary improvements that are required, the sea of opportunities have all been identified in

this research. Emphasis is given to the various good practices that have been brought forth by the

Islamic banking, of which Santander bank is an integral part of. The bank believes in the laws of

Sharia and adheres to the principles laid by the governing body of Sharia extensively without fail

with immense respect for the Holy Quran. Also if this rate of interest is, somehow, increased

during the term, this will increase the loan payment and hence the term and the paying party will

end up paying more which amounts to domination and injustice to the society. To accept, follow

and introduce an entirely new system and format of banking is not a very easy thing to do

practically. The slow growth & maturity is the resultant of a entirely new concept of banking

which is entirely asset based. The onus is thus on the regulatory and governing bodies to promote

Islamic banking as it brings in a very noble and humanitarian approach to banking and thereby

sets it apart from any other contenders. The regulatory boards also need to unite and act as one

single entity to all laws and references, which shall give in the final verdict on any matter or any

discrepancy .a much needed laying down of laws which all the common people will know is thus

the need of the hour. There are few countries where the system of Islamic banking is very good

like Malaysia, Pakistan and the Middle East with Australia fast following taking the cue from

these nations.

References:

Ahmed, R., Karim, A. and Archer, S. (2011) Islamic Finance: The Regulatory Challenge, 4th ed.

New York: John Wiley & Sons

Banaji, J. (2007) "Islam, the Mediterranean and the rise of capitalism", Historical Materialism 15

(1), pp. 47–74,

Choong, B. S. and Liu, M-H. (2009) “Islamic Banking: Interest-Free or Interest Based?”

Available from: http://ssrn.com/abstract=868567. [Accessed 26th July 2013]

Cizakca, M. (2013) Islamic Capitalism and Finance: Origins, Evolution and the Future, London:

Edward Elgar Publishing Ltd

Dusuki, A. (2008) What Does Islam Say About Corporate Social Responsibility. Review of

Islamic Economics, 12(1), 5 – 28

Ebrahim, M. S. and Rahman, S. (2005) ‘On the Pareto-optimality of conventional futures over

Islamic: implications for emerging Muslim economies’, Journal of Economic Behaviour and

Organisation, 56 (2), 273–95.

Harris, J and Warde, F. (2010) "Islamic Finance In The Global Economy". Edinburgh:

Edinburgh University Press.

Hasan, Z. (2006) Sustainable Development From Islamic Perspective: Meaning, Implications

and Policy Concerns. J.KAU: Islamic Econ., 19(1), 3 – 18

Hassan, M. K. (2008) Textbook on Islamic Banking. 4th ed. Dhaka: Islamic Economic Research

Bureau.

Khan, T. (2000) ‘Islamic quasi equity (debt) instruments and the challenges of balance sheet

hedging: an exploratory analysis’, Islamic Economic Studies, 7 (1), 1–32

Mills, P. and Presley, J. (2007) Islamic Finance: Theory and Practice. 5th ed. London:

Macmillan.

Muljawan, D. and Hall, M. J. B. (2004) ‘A capital adequacy framework for Islamic banks: the

need to reconcile depositors’ risk-aversion with managers’ risk-taking’, Applied Financial

Economics, 14 (6), 429–41.

Obaidullah, M. (1996) ‘Anatomy of Istijrar: a product of Islamic financial engineering’, Journal

of Objective Studies, 8 (2), 37–51.

Sole, J. (2007) “Introducing Islamic Banks into Conventional Banking Systems,” IMF Working

Paper 07/175

Wilson, R. (2000), ‘Challenges and opportunities for Islamic banking in the west: the United

Kingdom experience’, Islamic Economic Studies, 7 (1 & 2), 35–59.

Yudistira, D. (2004) 'Efficiency in Islamic Banking: an empirical analysis of eighteen banks',

Islamic Economic Studies, 12(1), pp.1–19