Introduction
Islamic banking has been growing in popularity in MENA countries as a way of complying with Islamic principles. According to Mervyn and Algaoud (83), there has been pressure among the financial institutions to be compliant with some of the Islamic principles in their operational strategies. Shariah law prohibits charging of interests on loans given by any financial institution or individual. Interest charged on loans forms the basis of trade in the capital market. Financial institutions get their profits from the interests earned on the loans they extend to their customers. It is, therefore, unfortunate that this law prohibits the main source of income that these institutions have. This has made it difficult for this industry to develop in many of the Gulf Corporation Council countries. The Shariah law dictates the nature of the business that would qualify for a loan under Islamic principles. The law prohibits giving out loans to business units that sell products classified as sinful among Muslims. For this reason, a business unit selling pork, or such related products may not qualify for a loan under this law.
The micro, small and medium enterprises (MSMEs) have suffered out of this financial outfit because the capital market in GCC considers them undesirable market segments or inconsequential groups that may not have any positive impact on the industry. This has led to a huge deficit in between the supply and demand of capital. This research will explore specific features within Islamic banking that impede the free flow of capital. It will also make a close comparison between the conventional banking system and the Islamic banking system to help bring out the differences that exist.
Research and Analysis
Recent research has revealed that there is a massive disparity between the supply and demand for loans in GCC/MENA that is closely associated with the application of Islamic banking principles. MSMEs are struggling to find enough resources to fund their activities because most of the banks are unwilling to offer them a loan. The few who accept to deal with these small enterprises have policies that are so unfriendly that most of these firms prefer not to go for loans. It is important to analyze the supply side of the loans and how it matches the demand in order to understand what could be bringing the disparity.
Conventional Banking Ecosystem
The ecosystem surrounding financial products and services provided by conventional banks has been regarded as the most attractive both to the suppliers and customers of loans. A number of factors make this banking ecosystem attractive to both sides of demand and supply. Conventional banks operate under a strict legal framework that guides the relationship between the lender and the borrower. These laws clearly specify the role of the two entities and how the loaned amounts and the accumulated interests can be recovered by the lenders. This makes the lenders feel secure, making them more willing to offer loans to small and medium enterprises (Maurer 78). The system also specifies that all the savings made by individuals in fixed deposit accounts earn some form of interest. This encourages people to make savings, increasing the amount of supply for loans that can be extended to small and medium enterprises. Because of the clear legal framework in this ecosystem, financial institutions have flexible conditions for people who may want to take loans from them. Although they still ask for collaterals, most of them are currently willing to extend the loan of soft collaterals that can easily be affordable to small business operators. According to Schoon (39), despite the attractiveness of this ecosystem, it is increasingly becoming rare in most of the GCC/MENA countries where Islamic banking is taking great shape. This means that the numbers of conventional banks that can offer loans to MSMEs in these countries are limited. This is one of the main reasons why there is a huge imbalance between the supply and demand for loans.
Islamic Banking
Features within Islamic banking that impede the free flow of capital
It was important to determine some of the specific features within Islamic banking that impede the free flow of capital among the MENA countries. At this point, it would be necessary to clarify that the countries under focus in this investigative research include Egypt, Libya, Tunisia, Morocco, and Yemen (Ahmad and Ahmad 28). It was necessary to conduct background research that would define the context and main policy questions that make it difficult for the MSMEs to have easy access to loans from financial institutions that practice Islamic banking. In order to get the needed data on this topic, the research relied on the existing research, especially scholarly journals and books that have been published on this topic. These secondary sources of data are important because they take a shorter period to gather. This research also found primary sources of data to be valuable when developing conclusions for the research. In this regard, the researcher conducted targeted surveys and direct interviews with key stakeholders and other market participants using open-ended questionnaires. These individuals were considered to have some knowledge of the specific challenges faced by the stakeholders in our area of research. Both primary and secondary data were integrated during the analysis instead of analyzing them separately. This was so because of the limited nature of the research. The findings from the two sources of data have been discussed below.
Lack of a common legal framework
The capital market requires a strong legal framework that defines all transactional activities that the players engage in during their normal operations. According to El and Mohamod (32), the capital market has numerous risks that can only be mitigated by strict laws that would govern the relationship between the banks and their clients. Islamic banking lacks a common legal framework that would define such a relationship. This is one of the main features of Islamic banking that has been viewed as a reason that lowers the chances of MSMEs getting loans. Instead of a common legal framework, it has common guidance that is not entrenched in the law. It is not easy to follow up on some of these issues when they are only based on common guidance. Unlike the conventional banking system where banks can follow their defaulters based on clear legal structures, this is not the case when dealing with Islamic banking (Venardos 112).
An interview conducted with Islamic bank officials confirmed that the lack of a legal framework has made it difficult for these financial institutions to follow up on some of the defaulters. For this reason, the capital market has very stringent rules that must be followed by those who are planning to get any financial aid from them. The banks are forced to ask for strict collaterals in order to protect themselves from defaults. This has been the main reason why small and medium-sized enterprises are unable to access these funds. Most of the customers lack the ability to present such strict collaterals as title deeds for land or logbooks for vehicles. As Kettell (95) observes this has forced most of the MSMEs out of the capital market. The results obtained from the questionnaires sent to some of the MSME players revealed that they were unable to access the loans they needed because of the strict collaterals that were demanded by the financial institutions. This has serious impacts on the progress of their business because they are forced to get an alternative source of funding from the government, family members, or friends.
Differences in product offerings
In conventional banking, there is a clear structure of products that can be offered in the banking institutions. There are different categories of loans that can be offered such as personal loans, auto loans, mortgage loans, or investment bank loans. These products are universal in all of the conventional banks. There are specific requirements that must be met by the customers who plan to take such loans, and the structure of paying back such loans is always clear. However, this is not the case with Islamic banking. Most of the product offerings have differences that make it difficult to understand how to approach them. Given that most of these institutions lack a legal framework, they are forced to develop some internal regulations based on their internal needs. The regulations given in one bank would vary a lot from those given by another. This makes it complex for the MSMEs to access loans from them.
Transactions costs associated with structuring Islamic financial products
The transactional cost associated with structuring Islamic financial products is another reason that has been cited as a cause of the inability of the MSMEs to access the capital market in GCC countries. Many Islamic banks prefer trading with governments or other large corporations that they are certain may not disappear once they get the loans they need. However, they are wary of individuals or small businesses that can easily relocate or be unable to pay when the time comes. According to those who were interviewed, most of the small and medium-sized firms are forced to avoid loans from Islamic banks because the transaction costs are just too high.
Disparities between supply and demand of funds offered by banks
According to Ahmed (52), there is a huge disparity between the supply and demand of funds offered by Islamic financial institutions. Given the fact that these institutions do not offer interests to those who deposit their money with them, many people have not realized the benefits of keeping their money in the banks. This means that these institutions have little cash to offer to those who are interested in borrowing from them. The conditions that have to be met by the borrowers make it impossible for them to go for these loans. It has created a scenario where funds offered by these institutions are out of reach for many small business people.
Syndicated Capital Ecosystem
According to Ariff and Iqbal (74), some of the MSMEs have come to embrace a syndicated capital ecosystem to finance their businesses. These are financial products that circumvent financial intermediation through banks (Abdul-Rahman 67). Private equity capital, charitable giving, and crowd-funding are some of the most common forms of the syndicated capital ecosystem. They are always based on mutual trust and the relationship between the supplier and the recipients. However, it is important to note that funds that can be obtained from this ecosystem are not only limited but also unreliable. The dissemination of funds from this ecosystem cannot support the MSMEs in their daily operations.
The Commissioned Report
As mentioned before, besides collecting primary data from players such as the bank officials and MSMEs, there was a special report that was commissioned to collect data from experts in the legal sector, consulting firms, and academic partners to help develop policies to correct some of the problems identified above. They had a number of policies, regulations, rules, and mechanisms that need to be implemented by the GCC/MENA countries. The most important issue raised by these experts was that the number of conventional banks should be increased in order to meet the demand of the MSMEs in these countries. The government should also consider lifting laws and regulations that may restrict the flow of funds from the syndicated capital ecosystem. Finally, these experts were in agreement that it is time for the Islamic banks to review some of their restrictive policies because they may cripple this industry that has become very competitive.
Policy Briefs
Based on the findings from the commissioned report, the researcher developed policy briefs that should be observed to ensure that MSMEs in the GCC/MENA countries have access to capital that can help in their growth.
- It is recommended that the number of conventional banks should be increased in these countries. This will not only address the identified challenges in this industry but also create job opportunities for people in the region.
- The Islamic banking system needs to readjust its policies in order to make their loans more flexible for the MSMEs.
- The governments in this region should promote the development of non-financial institutions to act as alternative sources of funding for the MSMEs.
- The government should find a way of enabling MSMEs to mobilize capital in order to achieve a blended return in GCC/MENA.
Works Cited
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Ahmad, Abu, and Faruq Ahmad. Developments in Islamic Banking Practice: The Experience of Bangladesh. New York: Dissertation Com, 2010. Print.
Ahmed, Habib. Product Development in Islamic Banks. Edinburgh: Edinburgh University Press, 2011. Print.
Ariff, Mohamed, and Munawar Iqbal. The Foundations of Islamic Banking: Theory, Practice and Education. Cheltenham: Edward Elgar Pub, 2011. Print.
El, Tiby, Amr Mohamod. Islamic Banking: How to Manage Risk and Improve Profitability. Hoboken: Wiley, 2011. Print.
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Maurer, Bill. Mutual Life, Limited: Islamic Banking, Alternative Currencies, Lateral Reason. Princeton: Princeton University Press, 2008. Print.
Mervyn, Lewis, and Latifa Algaoud. Islamic Banking. Cheltenham: Elgar, 2001. Print.
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Venardos, Angelo. Current Issues in Islamic Banking and Finance: Resilience and Stability in the Present System. Singapore: World Scientific, 2010. Print.