Are Islamic banks automatically ethical?

Almost all of the literature on Islamic finance, and the marketing material of Islamic banks, emphasises its ethical nature. Attending a conference in September led me to ask what makes a bank ethical.

I chose this as the topic for my October column in the magazine Islamic Finance News. You can read it below.

What makes a bank ethical?

In September, I enjoyed attending the London Islamic Finance Forum organised by Islamic Finance News. It provided a good update on current developments in the industry, as well as being a venue for meeting old friends!

The presentation I found most interesting was “What is Value-Based Intermediation and how does it fit with Islamic Banking and Finance?” given by David Korslund, Senior Economist, Global Alliance for Banking on Values (GABV). Subsequently, I spent some time learning more about GABV from their website, as I had not come across the organisation before.

GABV describes itself as a global network of “banks, banking cooperatives and credit unions, microfinance institutions and community development banks.”

Its mission is “to use finance to deliver sustainable economic, social and environmental development, with a focus on helping individuals fulfil their potential and build stronger communities.” The organisation was founded in 2009 (which was of course during the depths of the global financial crisis which followed the bankruptcy of Lehman Brothers in September 2008) and now has 54 member institutions whose total assets are reported as being approximately USD $163 billion.

What struck me was the relatively small number of members and the tiny size of the total assets of the members.

Given the size of the banking industry worldwide, it is clear that even banks well below the size of the international giants have not been interested in joining. For example, the only UK member reported is Ecology Building Society which had total assets reported in its most recent accounts of only £178 million.

The GABV should be a natural organisation for Islamic banks to join. Indeed, the only Malaysian member is an Islamic bank, Bank Muamalat Malaysia Berhad. However, where are the other Malaysian Islamic banks? Similarly, the GABV website report only one member in the whole of the Middle East and North Africa, namely Bank of Palestine, which appears to be a conventional bank. None of the UK Islamic banks is a member either.

When you look at the marketing literature of Islamic banks, most of them appear to operate on the presumption that because they are Islamic, and therefore do not charge interest, they are automatically ethical.

In my view, individuals clearly need finance for major purchases such as houses and cars, with repayment being over an extended period and the financier making some kind of charge for the credit, whether as interest, or as mark-up on a murabaha transaction, or as rent on a diminishing musharaka transaction.

Conversely, I detest conventional banks encouraging people to borrow money to go on holiday or to otherwise live beyond their means.

I carried out a little test by looking at the websites of one Islamic bank in the GCC and one in Malaysia, focusing on their personal finance offerings. Quite properly, both offered finance for the purchase of houses and cars.

However, both also offered credit cards. While the way that an Islamic credit card charges the customer for credit differs from the mechanism of a conventional credit card, there is no meaningful difference in the economics. In both cases, unless the full balance is cleared monthly (relatively uncommon), the credit card is a tool for individuals to live beyond their means to their detriment, and for the bank to profit from the customer’s desire to spend more than he or she earns.