Do Islamic banks need to earn extra profits?

Abstract

PurposeThis paper aims to draw upon existing debate over “financial sector rent” (bank rent) to analyze the current pattern of financing of Bangladeshi and Indonesian Islamic banks during the period of 2011 and 2015.Design/methodology/approachThe empirical evidence through a comparative approach of analyzing the performance of Islamic banks with that of conventional banks in respective countries – two of the largest countries where majority of the population are Muslims – is drawn to demonstrate the objective.FindingsWhile Islamic banks in Bangladesh are primarily concentrating on the murabaha (mark-up contract) mode of financing, some transactions under musharaka (partnership/equity-based contract) are observed in the Indonesian Islamic banking sector. This anomaly in Indonesia can be explained by the nature of their musharaka financing which is not of the purely “participatory” financing type. As a result, we can observe the quasi-murabaha syndrome in Indonesian Islamic banking sector. The concentration of asset-based financing including consumers’ financing (hire purchase) in the credit portfolio gives Islamic banks relatively higher Islamic bank rent opportunity for protecting their “franchise value” as Sharīʿah-compliant (Islamic law-compliant) lenders. However, Indonesian Islamic banks share a still infant Islamic banking market, and enjoy less rent opportunity under a severe competition with conventional banks.Research limitations/implicationsThe bank rent approach suggests that the syndrome observed both in Bangladesh and Indonesia can be ironically justifiable. Moreover, the mode of profit-and-loss sharing provides, in practice, an idea of the difficulty in managing the participatory financing embedded with high credit risk. Under this scenario, it is necessary for Islamic scholars and the regulatory authority to design an appropriate financial architecture, enabling Islamic banks to avail the benefit from a wider variety of Sharīʿah-based Islamic financing.Originality/valueThis paper expands the newly emerged concept of “Islamic bank rent” to make sense of the murabaha syndrome in Bangladesh and the quasi-murabaha syndrome in Indonesia. This approach also contributes to clarifying the unique risk and cost to be compensated with the spreads that Islamic banks are expected to earn.