Perception of Islamic financial system: its obstacles in application, and its market.

Maniam, Balasundram ; Bexley, James B. ; James, Joe F. 等

ABSTRACT

It is often misunderstood that the Islamic financial system involves only the absence of interest and only applies to those who practice the Islamic faith. Although the paying or receiving of interest is strictly forbidden to the many million practicing Muslims all over the world, this system can be an alternative to the existing method for everyone. Further, the concept of Islamic finance involves more than zero interest. There are other principles such as prohibition of guaranteed earning, transactions to comply with a set of Islamic laws known as Shari'a, and the emphasis on the element of business risk.

The central theme of this paper is (1) to provide an overview of the theoretical concept of Islamic finance, (2) to discuss the various instruments available in Islamic finance, the obstacles involved in its application, and its growing market trend, and (3) to analyze the perception of Islamic financial system in the U.S.

INTRODUCTION

The conventional banking and financial institutions exist today based entirely on the concept of interest-bearing instruments. It is hard to imagine that there is an alternative to the interest-bearing financial system. This alternative method is commonly known as Islamic finance because of its deep roots in the Islamic religion. The objective of this study is to understand the basic concept of Islamic finance, to have an overview knowledge of the various instruments available, and to determine whether or not this interest-free economy is a viable alternative to the conventional financial system.

The Islamic financial system is based upon the sharing of profit and loss, rather than on the payment of interest. Although the system does not allow for the payment or receiving of interest, there are a wide variety of instruments allowed that investors can choose from depending on his or her risk tolerance. The main idea behind the Islamic financial system is more than generating wealth. It is a financial system intended to promote economic growth while maintaining the morals of the communities.

Although the method of interest-free economy has not been very well known by the general public, there is an emergence in the understanding and application of this concept by the Muslim communities as well as the traditional financial institutions. This is partly due to the growing interest by the Muslims for options that do not involve interest to satisfy their religious obligations. Further, the Western financial institutions are taking a closer look at this system not only to reach the niche market but because there is money to be made.

The objective of this paper is three fold: (1) to provide an overview of the theoretical concept of Islamic finance, (2) to discuss the various instruments available in Islamic finance, the obstacles involved in its application, and its growing market trend, and (3) to analyze the perception of IFS in the U.S. he next section reviews the literature, followed by the various financial instruments within this system, its obstacles in application, its potential market, and finally the conclusion.

LITERATURE REVIEW

The subject of a zero interest based economic system has been around for over 1400 years yet only in the past two decades has there been studies and writing on the subject within the scope of the modern finance industry. Not only is the application of the Islamic financial system growing, but also, the academic writings and studies are also increasing. There are many misconceptions about the Islamic financial system and studies such as Zineldin (1990), Al-Omar and Abdel-Haq (1996), Khan (1987), and Saeed (1996) are truly instrumental in establishing the principles and the definition of various Arabic terms that can cause much confusion because of multiple meanings.

After the basic knowledge about the concept is set, the next step is to see how the theory is put into practice. In this regard, there are several studies that specifically analyze practicing Islamic institutions via case studies. Some of these studies include Kazarian (1993), Wilson (1990), and El-Ashker (1987). Kazarian specifically compares the Islamic banking versus conventional banking as practiced in Egypt. These three studies provided financial comparison that is useful in establishing the viability of the Islamic system. Due to the scope of this paper, detail comparison of financial information has to be deferred. Others such as Ali (1992), Iqbal (1997), Freeland (1998), De Belder and Hassan (1993), Drexhage (1998), Iqbal and Mirakhor (1999), Kahf (1999), and Hamwi and Aylward (1999) have addressed various aspects of Islamic finance and the success of the Islamic system in this new millennium.

CONCEPTS AND OBSTACLES IN APPLICATION

The Islamic financial system is complicated and rooted in a deep religious belief. Therefore, to understand the concept, one must first understand and appreciate the basic principle of the religion. Islamic financial history is traced back to the religion of Islam that began over 1400 years ago. The Muslims' lives are bound by the Islamic laws known as the Shari'a. According to El-Ashker (1987), the sources of the Shari'a are The Holy Qur'an, the Traditions known as Sunnah which are the practices and saying of the Prophet Muhammad, and the Jurisprudence composes of religious scholars from the various schools of opinion.

The Islamic financial system is shaped by the Qur'an strict forbidden of riba. As Al-Omar and Abdel-Haq (1996) defines, Riba as "an excess or increase". Technically meaning an increase which is a loan transaction or exchange for a commodity accrued to the owner (lender) without giving an equivalent counter-value or recompense ('iwad) in return to the other party; every increase which is without an 'iwad or equal value" (p. XVI). Riba has often been interpreted as being synonymous with interest. However, some schools of thought define riba to include not only interest but also speculation, unlawful capital gains, monopoly, hoarding, and absentee rents. Riba is stated explicitly in the Qur'an thus not open for interpretation. The paying or receiving of interest or dealing with interest-bearing instruments is strictly prohibited to the Muslims. As Iqbal (1997) states, "describing the Islamic financial system simply as 'interest-free' does not provide a true picture of the system as a whole. Undoubtedly, prohibiting the receipt and payment of interest is the nucleus of the system, but it is supported by other principles of Islamic doctrine advocating risk sharing, individuals' rights and duties, property rights, and the sanctity of contracts" (p.42). The definition of riba consequently determines the prescribed structure of Islamic banking and also the permissible banking instruments. One key element of Islamic finance is the requirement of an element of risk normally associated with doing business. However, one must keep in mind that risk in business sharing is allowed whereas risk in the form of gambling or mere speculation is prohibited by Islamic Law. The main idea is that investors should spend their effort searching for projects that are sound, that adhere to the Shari'a, and share in the success or failure of the project. The objective is that investments should provide a stimulus to the economy and encourage entrepreneurs to maximize their efforts. The profit or losses should be shared by all parties involved and earnings may not be guaranteed or predetermined.

In addition, Islamic financial system restricts investments in certain business sectors whose products are forbidden by the Shari'a such as alcohol, pornography, or gambling to name a few. This limitation also extends to those with questionable moral values that may not have been directly stated in the Islamic laws such as tobacco industries, anything that may harm the environment, or genetic experiments such as cloning. The latter is open for various interpretations depending on the various schools of thought. The need to clarify certain aspects of the laws resulted in the involvement of the religious council known as the Shari'a Board. The Board is an advisory board which acts as Islamic legal counsel in certifying the compliance of activities with Islamic principles. These restrictions are not unlike the idea of Socially Responsible Investments now available among the Western conventional financial institutions.

In short, there is more to the Islamic financical system than the absence of interest. In addition, the system also restricts any activities that do not comply with the Shari'a, and there needs to be an element of business risk involved by the participating parties. Within these parameters there are many investment products currently available that are permissible under Islamic laws.

FINANCIAL INSTRUMENTS

One of the key concepts in the Islamic financial system is the idea of profit and loss sharing. The techniques allowed in the Islamic financial system can be classed in two broad classes; profit and loss sharing or equity-like contracts and mark-up or debt like contracts. According to Hamwi and Aylward (1999), the equity-like contracts consist of Musharaka (partnership), and Mudaraba (trust financing). The debt-like products are composed of Murabaha (cost-plus financing), Ijara (leasing), and Istisna (progressive payment).

Musharaka (Partnership)

First, Musharaka is a joint venture agreement whereby money is the main investment. The institution funds the working capital requirements of an entrepreneur. Both parties bear any losses incurred or share in the profits according to the previously agreed terms. Therefore, this instrument is also known as the profit sharing or partnership. This product is similar to the modern concept of a partnership. There are two schools of thought among the Muslim scholars; limited and unlimited partnership.

Khan's (1987) showed that one school's emphasis is on the equality of the partners in personal and financial status and thus in the contribution to the partnership. Liability is unlimited, and the partnership is based on the principle of mutual agency; each partner being an agent of his colleague's action. Therefore, each partner is fully liable for the actions and commitments of the other in financial matters. Dissolution of the partnership could result from either the death of any partner or by consensus agreement amongst the involved parties. Another view is a more restricted form of partnership. In this form, the equality of the partners is not mandatory. Also, the mutual agency extends only to those commodities and areas of trade agreed upon. Liability is strictly limited according to each partner's contribution to the total investment.

Under the Musharaka the share in the profit and the duration of the joint venture are agreed upon in advance. Loss is shared in proportion to the contribution of each party to the capital, unless the individual is proven to be the cause of loss due to negligence or willful action. The research shows that this form of Islamic financial instrument is similar to the conventional partnership business organization. The difference is under the Islamic financial system, the partnership can be between a bank and individuals; whereas in the conventional financial system, banks are not allowed to be a partner in this type of contract.

Mudaraba (Trust Financing)

Another type of equity-like instrument is known as Mudaraba, or trust financing. Mudaraba requires two parties; the beneficial owner(s) and the managing trustee. The institution may act as a trustee with the responsibility of investing funds provided by the client. Alternatively, the institution may act as the owner providing the funds to the client. The ratio of distribution of profit is agreed on by both parties prior to any undertaking of business. According to Khan (1987), the key to this particular instrument is that the profit sharing must be proportional and cannot be a guaranteed return. The profit may not be predetermined or specified for either party. Instead, the parties involved are to share profits in accordance with an agreed upon formula. The contract is legally terminated when the investor receives his principal after profit is shared.

Another key element of this instrument is the investor is not liable for losses beyond the capital he has contributed, and the trustee does not share in the financial losses except for the loss of his time and efforts. However, it is important to point out that the agent is liable for a proven loss resulting from his negligence. Sometimes, the agent is obliged to repay the original sum of capital to the owner in case of negligence.

The study done by Zineldin (1990) indicates that the Mudaraba certificates can be issued as nominal or bearer. These can mature at a fixed date, at a fixed interval after issue, or at call. These certificates entitle the holder to share in the profits of the investment activities being undertaken by the company. This aspect of issuing certificates makes the Mudaraba instrument similar to the conventional stock market. Shares are issued in form of certificates, the certificates are transferable, and the holders of the certificates entitled to a portion of the profit or loss of his capital if the project fails. Similar to stock, neither the return of the principal nor profit is guaranteed to the holder. The main difference is that the project certificate issued must comply to the Shari'a.

Although trading stock is permissible from an Islamic viewpoint, a transferable contract would lead to riba if it allows capital gains from speculative activity. In other words, the buying or selling of stock resulted in riba, is forbidden, when an attempt is made to acquire a return by manipulation of a market rather than by contribution to real production. As Khan (1987) pointed out in his book, "it is due to the possibilities of earnings via manipulation that some scholars have urged the elimination of the stock market, despite the impact it may have on the mobilization and allocation of funds" (p.67).

Also according to Khan (1987), a way around this speculation issue has been attempted by the Islamic Investment Company of the Gulf. The experiment was to state the value of the certificate at regular intervals based on the actual progress of the project. The value of the certificate at a given time reflects the principal plus or minus the profit or loss incurred, which is added as a dividend or subtracted as a penalty. Exchange would be transacted on the basis of this value. This procedure prevents the face value of a certificate from differing from its market value, but it does cater to individual needs for liquidity.

This solution does not entirely resolve the problem of speculation. A premium will arise on certificates which represent the better performing companies. Similarly, liquidity may remain an illusion for certificates of poorly performing companies. In the end, the solution for manipulation and other stock market abuse may require careful regulation similar to the conventional stock market. For now, the wide prevalence of manipulation necessitates fine discrimination to distinguish between acceptable and non-acceptable from the viewpoint of the Islamic principles.

Hence, there are two Islamic financial instruments which are based on the idea of profit sharing such as Musharaka or partnership, and Mudaraba or trust financing. Next, the focus will be on debt-based products.

Murabaha (Cost-Plus Profit)

The first debt-like form of Islamic financial instrument is known as Murabaha. Although this type of contract is not based directly on any text of the Qur'an or the Sunnah, it has been allowed in Islamic Law by the Jurists. Ali (1992) defines it as a "contract in which a client wishing to purchase equipment or goods requests the Islamic financial institution to purchase these items on his behalf then sell them to him at cost plus a reasonable profit. Capital and profit are due and payable on terms agreed between the parties" (p.33). It is important to clarify that only a legitimate profit in addition to the actual price is considered lawful under Islamic laws. Any excessive addition because of deferred payments is not allowed since it would become a payment based on the value of money over time which is the same as interest. Hence, this concept is sometime known as cost-plus financing or sale with stated profit. Per Josh (1997), this method is the most familiar substitute for conventional interest-based finance, most commonly used in trade and commodity finance.

According to Saeed (1996), the basic features of a Murabaha contract consist of four key features. First, the buyer should have full knowledge of all related costs and the original price of the commodity, and the profit margin should be defined as a percentage of the total price plus costs. The costs can include but not be limited to a fee covering handling charges, transaction costs, or risk premium. Second, the subject of the sale should be goods or commodities and not money. Third, the subject of sale should be in the possession of the seller and owned by him and he should be capable of delivering it to the buyer. Finally, the payment is deferred with specific terms clearly stated in the contract.

This form of financial instrument is very popular because of the element of predetermined earnings. In fact, Saeed's (1996) research shows that "Islamic banks in general have been using Murabaha as their major method of financing, constituting approximately seventy-five percent of their assets. This percentage is roughly true for many Islamic banks as well as Islamic banking systems in Pakistan and Iran. As early as 1984, in Pakistan, Murabaha-type financing amounted to approximately eighty-seven percent of total financing in the investment of PLS (profit and loss sharing) deposits" (p. 77). Yet this very point of predetermined and guaranteed earnings have caused controversy among the Muslims and critics of Islamic financing. Some Muslims and critics take the view that Murabaha is not legitimate Islamic trade. Zineldin (1990) stated that there are some who feel that the fact that Murabaha enables a buyer to finance his purchase with deferred payment, as against accepting a mark-up on the market price of the commodity, means that the financier earns a profit without bearing any risk hence falls under riba.

Saeed (1996) also points out that financing a venture on the basis of Murabaha to be repaid at a particular point in time does not differ greatly from financing a venture on the basis of fixed interest. In both cases, it is a debt, and the cost of financing, whether it is called interest or profit, is fixed, and the time allowed for repayment is also fixed. The most significant difference should be in the case where the debtor fails to repay the debt at the specified time. The loan at interest would generally incur an extra interest penalty if the loan is not paid upon maturity, whether the debtor was able to pay or not. In the case of Islamic finance, the debtor should be given time for repayment if he is unable to pay. However, in practice, Islamic institutions, with support of the Religious Supervisory Boards, have narrowed the meaning to close the potential loophole for debtors who might be remiss in paying their debts despite being able to do so. To address this loophole, the Religious Boards allowed for 'fine' to be incorporated in the contract, Al-Omar and Abdel-Haq (1996). The Islamic institutions use the name 'fine' whereas the traditional bank refers to it as 'interest'.

From an economic point of view, there is no substantial difference between mark-up and interest. The main difference between the two is a legal one based on religious theories; the basis for interest is loan contracts while the mark-up is founded on the sale contract. In economic terms, financing on the basis of mark-up in price has no significant economic merit over the interest-based system, except in the name. There is a genuine fear among the Islamic circles that if interest is largely substituted by mark-up, it would represent a change just in name rather than in substance. Therefore, some scholars are pushing for the exclusion of this instrument altogether (Saeed, 1996) However, for now, this form is allowed and is binding among the practicing Islamic financial institutions.

Ijara (Leasing)

The second debt-based instruments available in Islamic finance is the leasing concept. There are two forms of leasing concept known as Ijara, which is similar to conventional leasing, and lease to purchase option known as Ijara wa Iktina. First, with Ijara, the institution owns the equipment, buildings, or other facilities as requested by a client for the purpose of leasing to the same client on a previously agreed rental contract. Leasing is common in the conventional financial system as long-term financing. In the past, it is generally associated with real estate such as land and buildings. However, today, it is possible to lease virtually any kind of fixed asset.

There is no effective difference between the Islamic and conventional operation of the leasing concept. However to be acceptable in an Islamic framework, the leasing contract must meet certain conditions as discussed by Al-Omar and Abdel-Haq (1996). First, the service that the asset is supposed to provide and for which it is being rented should be definitely and clearly known to both parties. Further, its usage must comply to the Islamic laws. Second, the asset remains in the ownership of the lessor who is responsible for its maintenance so that it continues to give the service for which it was rented. Third, the leasing contract is terminated when the asset ceases to give the service for which it was rented. If the asset becomes damaged during the period of the contract, the contract will remain valid. Fourth, the price of an asset that may be sold to the lessee at the expiration of the contract cannot be pre-determined. It can be determined only at the time of the expiration of the contract.

Another form of leasing is the lease to buy option which has been used for major asset financing. Under the lease purchase, the financial institution agrees to buy the equipment, buildings, or what ever is requested by the client. Then the assets are rented to the client based on negotiated terms agreed upon. In return, the client is to make incremental payments into an investment account that will contribute toward the purchase of the asset. Any profits accumulated in this account are for the benefit of the client and to be applied toward the purchase price. The client thus becomes the owner of the financed equipment and the contract with the financial institution ends.

According to Saeed (1996), some Muslims feel that this method is similar to the cost-plus financing concept called Murabaha, discussed earlier. Therefore, it also includes all the arguments of whether or not this form of instrument is allowed under Islamic laws. Similarly, this leasing concept is currently permissible and binding by the various Islamic institutions and by the Religious Supervisory Boards. As Iqbal (1997) pointed out, leasing accounts for about 10 percent of Islamic financial transactions.

Istisna (Progressive Payment)

Another form of debt-like instrument which is relatively new is what is known as Istisna. According to Hamwi and Aylward (1999), this type of investment is "a contract for acquisition of goods by specification or order, where the price is paid progressively in accordance with the progress of a job completion. This is utilized, for example, for purchases of houses to be constructed where payments made to the developer or builder are according to the stage of work completed" (p.409). This is very similar to the conventional make to order where the seller receives payment based on the progress of the project. Therefore, the seller bears the risk of completing the project. As mentioned, this is still a very new product in Islamic finance.

Qard Hasan (Humanitarian Loan)

This is not an investment for investor to make return. Rather it is viewed as a good deed which the reward will be earned from God. As Al-Omar and Abdel-Haq (1996) pointed out, this is a pure loan transaction in which the client obtains cash from individuals or institutions to be returned at a stipulated future date, absolutely free of interest. The borrower has the right to reward the lender for the loan by paying any amount above the amount of the loan even though he does not have to. Also, the return of the principal is not guaranteed and usually not expected by the lender. This does not excuse the borrower from paying his debt. Under Islamic laws, the borrower is obligated to honor his contract and repay the debt if he is able to. If he encounters difficulty, he should return the debt at a later date when it is not a burden for him to do so. This is sometimes known as a good will loan, and is usually extended to the poor who need it for basic living. It is not known how widely this loan is applied in practice.

THE OBSTACLES IN APPLICATION

Although the concept of Islamic financing existed for over 1400 years, it is still in an early stage of development in order to compete with the conventional system. During the research, there is a common theme among the various sources regarding the challenges encountered in implementing the theoretical concept. Iqbal and Mirakhor (1999) suggest that "these challenges can be classified in two groups; (a) financial engineering challenges to apply principles of Islamic finance for further innovation and (b) challenges to make operation of the system more efficient, stable, and well integrated with international capital markets" (p.397).

First, one of the major problem with Islamic investment instruments is the lack of liquidity and safety. This is in part due to lack of understanding and partly due to the nature of the instrument. According to Iqbal (1997), the secondary market for Islamic products is very shallow and illiquid, and money markets are almost non-existent. So far, the Islamic instruments available are mostly short and medium-term; products need to be developed to handle extreme short-term such as overnight deposits by banks, and long term investments needed for economic development. In addition, there is a need for risk-management tools to provide clients with instruments to hedge against the high volatility in currency and commodities markets. Further, the market currently lacks the alternative option for public debt financing. Iqbal and Mirakhor (1999) stated that "financial engineering in Islamic finance will have to focus on the development of products that foster market integration and attract investors and entrepreneurs to the risk-return characteristics of the product instead of whether it is Islamic or not" (p.398). In the end, the majority of the public will be drawn to the products because of the potential earning more so than because of their religious choice.

Second, the operational challenges need to be addressed for the movement to grow. Another obstacle is the lack of standard interpretation on various instruments by the various jurists. Currently, there is much confusion regarding which transactions are allowed and which are not because of the different rulings by various religious boards. Currently, each Islamic institution elects their own religious board consisting of religious scholars from the various schools of opinion. Therefore, a transaction may be considered Islamic at one institution and may not be at another, hence causing confusion and incompatibility. It is very important to have a unified Shari'a council whose decision is binding for all practicing Islamic institutions. This will eliminate confusion and inconsistency thus promoting interaction with other conventional financial institutions.

Also, the lack of accounting principles and stardards is a serious limitation. Similar to the conventional financial system, well-defined principles and standards are crucial for information disclosure, building investor's confidence, for monitoring, and surveillance as Iqbal (1997) pointed out in his study. It is not possible to use the conventional accounting principles and apply it to the Islamic financial concepts because the framework for the two systems is too different.

Further, the Islamic financial movement lacks the technical staffs who are familiar with the system and have adequate knowledge to enhance the implementation of the moral and social values of the system. Currently, the majority of the staff in the Islamic institutions are made up of either one extreme or the other, thus limiting the growth of the system. Most of the staff working in Islamic institutions come from conventional banks and are familiar only with the conventional approach. These employees lack the knowledge of Islamic laws which limits their ability to convey the laws to customers or conventional bankers. On the other extreme, there are those who are well versed in the Shari'a but are very limited in mechanics of the financial industry. There is a desperate need for committed Islamic financiers as well as a training program specifically in Islamic finance.

In summary, there are various obstacles which limit the growth of the Islamic financial system as a competitive financial alternative to the traditional financial system. As discussed, these challenges are lack of liquidity for the instruments, more products for extreme short-term and long-term maturity, a lack of religious council's ruling, a lack of standard accounting methods, and lack of trained professionals in the field. However, despite the challenges, the market for Islamic finance is growing.

THE MARKET

Currently, the Islamic financial system is mostly practiced in countries with "Islamic" governments. Even then most Muslim countries have conventional banking as the main system, and the Islamic institutions exist alongside it. Examples include Malaysia, Egypt, Saudi Arabia, Jordan, and many other Middle East countries. Only three countries so far solely utilize the Islamic financial system, and they are Iran, Pakistan, and Sudan. According to Iqbal's study (1997), the industry has been growing at a rate of more than 15% annually for the past five years. Iqbal's study also suggests that the market's annual turnover was estimated to be $70 billion in 1997 compared to $5 billion in 1985, and is projected to be over $100 billion by the turn of the century.

The growth of Islamic finance is a reflection of the "Islamization" movement within the Muslims communities where Muslims are returning to teaching of The Qur'an. As such, the demand for ethically acceptable financial mechanisms is increasing. According to Josh (1997), there are 8 million to 10 million Muslim residents in the United States alone who are seeking Islamic financial tools. This presents a huge niche market that has yet to be explored. In addition, the industry is growing not only among the Muslim communities but among western financiers as well.

Following are some examples to illustrate the growing trend of the Islamic financial system being utilized by both Muslims and non-Muslims. A very high profile example is the Hub Power Project in Pakistan. This is a $1.6 billion project which began in 1985 by the Pakistani government as an initiative to encourage private participation in power generation (Hamwi & Aylward, 1999). As Hamwi and Aylward (1999) point out, the importance about this project from the Islamic financing standpoint is that it is the first project financing "featuring an Islamic mark-up based limited recourse facility and the first project to receive mobilization finance in the form of an Istisna facility" (p.417).

Another indication that the concept is extending into to the conventional financial institutions is set by Citibank. According to Drexhage (1998), Citibank is the first conventional international bank to set up an Islamic institution called CitiIslamic Investment Bank in 1996 located in Bahrain, Saudi Arabia. In addition, Josh (1997) indicated that multinational companies such as General Motors, IBM, and Xerox have raised money through a U.S. based Islamic leasing fund set up the United Bank of Kuwait. Also, oil giants such as Enron and Shell have used Islamic banks to finance their activities in the Arabian Gulf and Malaysia.

PERCEPTION OF ISLAMIC FINANCIAL SYSTEMS IN THE U.S.

As of the end of 1996, there are about 166 of Islamic financial institutions in 34 countries according to Timwell (1998). Table I provides financial highlights based on 1996 results which are helpful in comprehending the scale of the overall market. In summary, most of the existing Islamic institutions are currently in the Middle East and South East Asia. There is a huge potential for expansion in Europe and North America.

Even though there is a market for Islamic financial instruments and the trend is growing, this study also seeks to analyze the perception of the Islamic financial system in the U.S. Hence a brief survey was conducted to gather this information. The survey has two sections, first to gather the reaction and perception to an Islamic financial system, and second, to gather the demographics of those surveyed. (The survey is available from authors upon request.)

Only 102 out of 150 surveys are usable, which represents about sixty eight percent of the total survey conducted. Table II represents the demographic information of those surveyed and Table III shows the summary results of the alternative payment perception.

A typical person responded to the survey is a twenty-three year old, single, white, and Christian male. The survey results indicate that sixty percent of the respondents do not see the Islamic financial system as a viable system for use in the U.S. and only about eighteen percent see an Islamic financial system as good or better then the conventional systems used in the U.S. By the same token, only thirty seven percent of the respondents said that they would use an Islamic financial type system in the U.S. Partial explanation for the disappointing results is that the respondents are not very familiar with the Islamic financial system and its innovative concepts nor its application. Though it is very difficult to prove using these results, the author of this study wonders about a possible racial bias. The summary result also shows that about ninety two percent of the respondents were Christian, whereas there is no single Muslim respondent in the survey. It should be noted that before the survey was conducted, respondents were told to look at the Islamic financial system strictly from a financial standpoint. It would be interesting to compare these results with a different group.

Table II shows that the other results support the notion that the respondents do not support the Islamic financial type system and they do not understand the system very well. For instance, on the question of progressive payment (see question three in the survey), only forty nine percent of those surveyed said that they would accept this alternative payment method where payments are made to the supplier according to the stage of completion. This notion is very similar to the conventional financial type system, yet many of the respondents did not support this notion. The results on the other alternative payment method are similar except for the humanitarian loan. Only in this alternative method, fifty percent of the respondents either (strongly) accept the notion that money is loaned without stated interest rate and that the borrower determines how much interest he can pay in the future.

Therefore, in summary the results indicate that the respondents do not perceive the Islamic financial systems very well. They either do not understand this alternative system or they are biased against it because of the religious connotation attached to it.

SUMMARY AND CONCLUSIONS

Islamic finance is not only a technique but a whole economic system of finance. The system framework is based on the Islamic faith thus the name. The key elements to this system are the prohibition of interest, the compliance with the Islamic laws, and the prohibition of a guaranteed or a predetermined earning.

Within the guidelines of the Shari'a, there are a variety of investment options allowed in both equity-based and debt-based instruments. The profit sharing products are Musharaka also known as a partnership, and Mudaraba known as trust financing. In addition, the debt-like instruments are Murabaha which is cost-plus profit; Ijara similar to leasing; and Istisna also called progressive payment method. In addition to the equity and debt-like products, there is a humanitarian loan known as Qard Hassan which does not result in any return.

As with any industry struggling to establish itself, Islamic finance faces a number of obstacles in its development. These challenges are a lack of liquidity in the instruments, a lack of standard interpretations by the religious boards, a lack of standard accounting principles, and a lack of technical staff. However, despite the challenges, the market continues on an upward trend. The paper also points to examples such as the Hub Power Project in Pakistan, and Citibank's commitment in Bahrain to show that Western financial institutions are getting involved as well.

The survey results indicate that those surveyed did not perceive the system very well and further study is warranted to make any additional conclusions. Also this study should be repeated where the respondents are more balanced in terms of ethnicity in order to get a true picture.

In conclusion, Islamic finance is a legitimate financial system with various instruments to meet the guiding principles. The system is not limited to Muslims only, it is open to anyone who is looking for an alternative to the interest based system. There is a huge potential market for Islamic finance to thrive, and it is believed that it will compete alongside the existing conventional system in the near future. Its success will be mainly due to the fact it is a profitable system and not so much due to its religious philosophy.

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Temple, P. (1992). Islamic banking: Principles as well as roots, Accountancy, 46-47.

Timewell, S. (1998). A market in the making, The Banker, 57-61.

Wilson, R. (1990). Islamic Financial Markets, New York: Routledge.

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Balasundram Maniam, Sam Houston State University

James B. Bexley, Sam Houston State University

Joe F. James, Sam Houston State University

Table I: Financial Highlights of Islamic Banks and Financial
Institutions in 1996 (in $ million)

Region No. of Capital Total Assets
 Banks

South Asia 50 (31%) 962 (13%) 45,201 (33%)
Africa 35 (21) 213 (3%) 1,951 (1%)
South East Asia 30 (18%) 136 (2%) 3,801 (3%)
Middle East 24 (14%) 4,060 (56%) 67,142 (49%)
Gulf Corp. Council 19 (11%) 1,344 (18%) 18,084 (13%)
Europe and U.S. 8 (5%) 559 (8%) 952 (1%)
Total 166 7,271 137,131

Region Deposits Reserves Net Profit

South Asia 27,042 (27%) 1,849 (325) 350 (21%)
Africa 603 (1%) 418 (7%) 39 (2%)
South East Asia 1,572 (2%) 1944 (34%) 184 (11%)
Middle East 54,288 (53%) 347 (6%) 373 (22%)
Gulf Corp. Council 16,494 (16%) 1,095 (19%) 686 (41%)
Europe and U.S. 1,164 (1%) 93 (2%) 53 (3%)
Total 101,163 5,746 1,685

Source: Timwell (1998)

Table II: Demographics Summary

Marital Single: 74 (72.6%) Married: 20 (19.6%)
Status

Age (years) 25 and < 26 to 30

 66 (64.7%) 30 (29.4%)

Gender Female: 46 (45.1%)

Ethnicity Blacks: 18 (17.7%) White: 74 (72.6%)

Religiouse Christian: 94 (92.2%) Islam: 0
Affliation 0%

Marital Divorced: 8 (7.84%) Widow(ed): 0
Status 0%

Age (years) 31 to 35 36 and >

 0 (0%) 8 (7.84)

Gender Male: 56 (54.9%)

Ethnicity Hispanic: 8 (7.8%) Others: 2 (1.9%)

Religiouse Others *: 6 (5.88%) None **: 2 (1.96)
Affliation

Note: * Include Buddhist, Hindu, Jewish, and others (except Islam)
** Atheist

Table III: Perception on the Alternative Payment Method
(in percentages)

 1 2 3 4 5

Sharing of Profit 11.76% 15.69% 50.98% 15.69% 5.88%
Trust Financing 9.80% 15.69% 39.22% 25.49% 9.80%
Progressive Payment 5.88% 13.73% 31.37% 31.37% 17.65%
Cost plus profit concept 7.84% 11.76% 41.18% 29.41% 9.80%
Humanitarian Loan 19.61% 15.69% 13.73% 29.41% 21.57%
Leasing 9.80% 19.61% 52.94% 7.84% 9.80%
IFS--viable system 31.37% 27.45% 21.57% 15.69% 3.92%
IFS--a good system 25.49% 31.37% 25.49% 11.76% 5.88%

Note: Scale of 1 through 5, where 1 means strongly unacceptable,
and 5 means strongly acceptable.