Class Lecture (Chapter-8)

Islamic Financial System (Fin-5402)

Program: MBA (Regular + Executive)
Course instructor: Basharat Hossain
Department of Business Administration (DBA)
International Islamic University Chittagong (IIUC)

Central Banking in Islamic Framework

The central bank has the sole authority to issue money (currency) and the responsibility to
regulate the banking system in order to secure the value of money and realize the other
objectives of monetary policy. Money serves as the medium of exchange and the commonly
accepted means of payment, and as such as a measure of value. Excessive fluctuations in the
value of money lead to economic distortions and causes social inequities. Inflation gives
windfall gains to the rich and the business people but causes hardship to the fixed and low-
income groups by eroding their purchasing power. Worse still, deflation often deprives the
latter of their employment and means of livelihood. The phenomena of inflation and deflation
are characteristic of the financial system based on the institution of interest, which is
prohibited in Islam
Objectives of monetary policy in Islam

Consistent with the Islamic ideals of social justice, equity, fairness and balance, there are
three major objectives of monetary policy in an Islamic economy, which discards interest.
These objectives are:

1. Stability in the value of money;

2. Economic well-being with full employment and optimum rate of economic growth;
and
3. Distributive justice

Stability in the Value of Money:

In an Islamic economy it is almost mandatory on the central bank to preserve the value of
money. Thus the central bank should allow expansion of money supply to the extent it is
justified by a possible contribution to growth in real balances. The stability in the value of
money should be accorded high priority because of the unequivocal stress of Islam on
honesty and fairness in all human dealings, and because of the negative impact of inflation on
socio-economic justice and general welfare. But, rather than absolute, this objective would
mean relative stability in the general price level. Absolute price stability is neither feasible
nor desirable as it may conflict with the optimum growth and full employment objective of
the monetary policy

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 1
Economic Growth and Employment:

While inflation is incompatible with the goals of an Islamic economy, prolonged recession
and unemployment that cause human sufferings are also unacceptable. Monetary policy has,
therefore, to aim at a high rate of economic growth with full employment and utilization of
productive resources. However, maximization of economic growth per se and at all costs is
not the objective of monetary policy in an Islamic economy. Material prosperity is to be
attained within the framework of Islamic values. It should not be attained through the
production of essential and morally - questionable goods and services. It should not lead to an
excessive and overly-rapid use of Allah-given resources at the expense of future generations,
and it should not be harmful to present or future generations by degenerating the moral and
physical environment. Environmental degeneration with degradation and depletion of land,
water and forest resources and serious air and water pollution are already matters of great
concern around the world. Hence the concept of “sustainable development", which means
meeting the needs of the present generation without compromising the needs of future
generations. Economic development and sound environmental management are
complementary aspects of the same agenda. Without adequate environmental protection,
development will be undermined; without development, environmental protection will fail

Distributive Justice

Monetary policy should be used actively to promote the goal of distributive justice and
prevent concentration of wealth and economic power in an Islamic economy. However, too
much concern with distributive justice in formulating and implementing monetary policy may
adversely affect its overall efficiency and effectiveness in attaining the other goals of
monetary policy. e.g. growth, employment and development. Reduction in income
inequalities and necessary redistribution should be an important policy objective of an
Islamic state and hence the domain, mainly, of its fiscal policy

Functions of the Central Bank

Pivot of the Islamic banking System: The central bank should be the pivot of the Islamic
Banking System, because only through its conscientious and creative efforts and eternal
vigilance can the Islamic money and banking system function properly and achieve its
objectives. It should be an autonomous government institution responsible for the realization
of the socio-economic goals of the Islamic economy in the sphere of money and banking.

Issue of Currency: Like all central banks, the central bank in an Islamic economy should be
responsible for the issue of currency and, in coordination with the government, for its internal
and external stability. It should act as banker to the government and the member banks. It
should make arrangements for clearance and settlement of checks and for transfers, and
should act as the lender of last resort. It should guide, supervise and regulate the commercial
banks, the non-bank and specialized financial institutions, without unduly affecting their

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 2
autonomy. Unlike the conventional central bank, it should also bear the responsibility of
preventing the concentration of wealth and power through the financial institutions.

Stabilization of the Value of Money: Stabilization of the real value of money should be an
important function of the central bank in order to realize the healthy sustainable growth of the
Islamic economy and to ensure socio-economic justice. For this purpose, it would have to
keep a close watch on money supply, to ensure that the growth in money is not out of step
with that in real output. This does not imply that the money supply is the only variable
influencing prices. All it implies is that the money supply matters, and that without its proper
regulation one of the important instruments for realizing the economic goals of Islam will
have been blunted.

Implementation of Monetary Policy: The central bank should be the primary institution
responsible for implementing the country's monetary policy. For this purpose, it should use
the instruments and methods that are not in conflict with the teachings of the Islamic Shariah.
Further, since the central bank cannot realize the goal of monetary stability without
cooperation from the government, a harmonious fiscal - budgetary policy would be
indispensable.

Promotion, Regulation and Supervision: The central bank will also have to play a positive
role in the promotion, regulation and supervision of all financial institutions with the
objective of helping them and making them healthy and strong. For this purpose it may have
to review all existing laws and amend or reconstitute them in the light of Islamic teachings.
The reformed banking legislation should reflect the different needs of the Islamic financial
system.

Ensure health and Development of Public Interest: The central bank should not confine its
regulatory role merely to the commercial banks. Its vigilance and assistance must envelop all
other financial institutions to ensure their health and development and to safeguard the public
interest. If some other government agencies are responsible for promoting and regulating
non-bank financial and auxiliary institutions, then there should be proper coordination
between the Central bank and other regulatory authorities to bring on harmony in their
promotional and regulatory functions.

Lender of the Last Resort: As in conventional banking, the Islamic central bank would also
have to act as the lender of last resort to ensure sufficient liquidity and to sustain the banks in
case of liquidity or solvency crisis. Its ingenuity would be reflected in the way it handled
crisis situations without bailing out bank management and yet safeguarding the interest of
depositors and equity-holders who are not a part of the management. Temporary
accommodation from the central bank provides the borrowing bank with a brief respite and
enables it to survive until remedial measures are enforced and become effective. This is
necessary for maintaining confidence in the banking system.

Financial Assistance by the Central Banks: The central bank, to help any Islamic bank tide
over its temporary liquidity problem, may provide general accommodation in the form
of Mudaraba deposit on which the Islamic bank may pay profit at the rate declared on such
deposits.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
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The central bank may also provide refinance to Islamic banks against finance provided by
them for purposes, projects or sectors specified by the central bank. Such refinance may be
provided under Mudaraba, Musharakaor any other Islamic mode of finance.

Current Account and Clearing House Facility: Islamic banks may be allowed to maintain
current accounts with the central bank and to participate in the bank's clearing house
operations. If the current account is occasionally overdrawn, the central bank may provide
this facility without any charge. Alternatively, such facility may be extended on the basis of
sharing of the profits of the bank.
Regulation and Supervision of Islamic Banks: Islamic banks may be subjected to
regulations and controls by the Central bank in respect of (a) permission to establish banks
and to open new branches; (b) minimum share capital; (c) the terms governing the
constitution of Boards of Directors and appointment of Chief Executives and auditors; (d)
tariffs for banking services; (e) measures regulating foreign exchange transactions; (f)
submission of periodical statements and operational data to the central bank and (g)
Compliance with the working hours.

Inspection of Islamic Banks: Islamic banks may be subjected to periodic inspection by the
central bank to ensure their operational soundness. The central bank personnel may be
adequately trained in Shariah-based operations of Islamic Banks. Detailed guidelines for
inspection of the Islamic banks should be prepared and set by the central bank, as it should
carry out research and training of personnel.

Bank supervision and inspection would be more important in an Islamic system. Unlike the
examination of conventional banks, it may be necessary to ensure that, in addition to proper
documentation, the projects financed dare sound. To examine all projects financed by the
banks would be difficult. It should, however, be possible to examine a random sample of
projects financed to ensure that banks do not indulge in financing speculative or unduly risky
ventures. Supervision should not be concerned solely with individual banks. It should acquire
an operational importance and should aim at promoting the efficiency and stability of the
whole financial system, by means of action directed towards both the system itself and
individual components, without interfering in moral operational decisions. Moreover,
supervision presupposes adequate disclosure and accurate information, and proper auditing.
The central bank should play an important role in determining the requirements for this
purpose. It should try to strengthen internal controls and issue policy guidelines, and monitor
the quality of assets and operations. It should reform the concepts and procedures of auditing
to ensure soundness and honesty.

Sources of monetary expansion

To ensure that growth of money supply is adequate and not excessive, it would be necessary
and important to monitor carefully all three of the major sources of monetary expansion. The
two domestic sources are: i) Financing of government fiscal/budgetary deficits by borrowing
from the Central bank; and ii) Expansion of deposits through commercial bank
credit creation. The third source of monetary growth is external and is monetization of a
balance of payments surplus.

i) Fiscal Deficits - Fiscal deficits can be, and have been, an important source of excessive
monetary expansion. Attempts by the government to extract real resources at a faster rate
Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,
International Islamic University Chittagong, Bangladesh
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than is sustainable at a stable price level could lead to continually rising fiscal deficits and
accelerated increases in money supply, thus contributing to an inflationary spiral. This has
tended to shift a disproportionate burden of the fight against inflation onto the monetary
policy. According to one important study, "the greater the dependence of the public sector on
the banking system, the harder it is for the central bank to pursue a consistent monetary
policy". Hence for the monetary policy to be effective, there must be coordination between
monetary and fiscal policies for the realization of national goals. This under scores the need
for a realistic and non-inflationary fiscal policy in a Muslim country. This does not
necessarily rule out fiscal deficits but imposes the constraint that deficits be allowed only to
the extent necessary to achieve sustainable long-run growth and broad-based well-being
within the framework of stable prices.

The need to eliminate unproductive and wasteful spending is a religious imperative for all
Muslims. It is particularly important for governments because they use resources provided by
the people as a trust, and using these wastefully or unproductively is a breach of this trust.
The limited resources must be used efficiently and effectively with the acute consciousness of
accountability to Allah. It requires a careful review of the entire expenditure program in the
light of Islamic teachings.

After all the wasteful and unnecessary spending has been eliminated, the balance of
government spending may be divided into three parts:

1. normal recurring expenditures

2. project expenditures
3. emergency expenditures

All normal, recurring government expenditures, including outlays on projects not amenable
to profit-and-loss sharing arrangements, must be financed by tax revenues. The non-
availability of debt financing for such purposes should prove to be a hidden blessing and help
introduce the needed discipline in government spending. The government may undertake
projects, which are amenable to equity financing, where this is necessary in the public
interest, but the financing should be obtained by selling shares to financial institutions and the
public. A commercially oriented pricing system should be adopted without a general
subsidy. All subsidies needed for the poor and lower middle class families should be
arranged from Zakat revenues, donations or Qard Hasan. Equity financing and commercial
pricing should help eliminate some of the unnecessary and unproductive or prestigious
projects that governments sometimes undertake to satisfy vested interests. Emergency
expenses or unavoidable deficits, which cannot be financed by either of the two ways may be
financed by borrowing from the banking system within a non-inflationary framework and to a
limited extent.

ii) Commercial Bank Credit Creation: Commercial bank deposits constitute a significant
part of money supply. These deposits may, for the sake of analysis, be divided into two parts

'primary deposits', which provide the banking system with the base money (cash-in-tills plus
deposits with the central bank); and

'derivative deposits' which, in a proportional reserve system, represent money created by

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 5
commercial banks in the process of credit expansion and constitute a major source of
monetary expansion.

Since derivative deposits lead to an increase in money supply in the same manner as currency
issued by the government or the central bank, and since this expansion, just like government
deficits, has the potential of being inflationary in the absence of an offsetting growth in
output, the expansion in derivative deposits must be regulated if the desired monetary growth
is to be achieved. This could be accomplished by regulating the availability of base money to
the commercial banks.

iii) Balance of Payments Surplus: Only a few Muslim countries have enjoyed a balance of
payments surplus in recent years, while most of them have experienced deficits. In the few
that did have a surplus, the surplus did not originate in the private sector and did not lead to
an automatic expansion in money supply. It did so only to the extent government monetised
the surplus by spending it domestically and the private sector balance of payments deficit did
not offset this adequately. In the Muslim countries that have a balance of payment deficit, it is
unhealthy monetary expansion along with public and private sector conspicuous consumption
that generate the balance of payments disequilibrium through current account deficits and
underground capital outflows. These cannot be removed without socio-economic reform at a
deeper level and healthy monetary and fiscal policies in the light of Islamic teachings.

REGULATION AND CONTROL OF COMMERCIAL BANKS IN AN ISLAMIC

BANKING SYSTEM

In the early 1980s, some countries decided to switch from interest based commercial banking
to Islamic banking. The Law of Usury Free Banking was passed in Iran in 1983 and the
necessary institutional framework was created by early 1984. The process of Islamization of
the banking sector in Pakistan started earlier but remained gradual and partial as, in the
beginning, only some specialized credit institutions in the public sector were asked to reorient
their activities along Islamic lines. In 1981, all commercial banks in Pakistan were permitted
to accept deposits on the basis of Profit and Loss Sharing (PLS). In July 1985, Pakistani
banks were instructed not to accept any interest bearing deposits and to convert all deposits
into PLS deposits. In Sudan, all commercial banks were prohibited to operate on the basis of
interest on 10 December, 1984.

The purpose of this chapter is to examine the instruments of monetary control and monetary
management which these countries adopted after changing to an Islamic banking system.
These instruments will be different from what they were in the interest based system, and
they will also differ from the instruments used in those countries in which Islamic banks and
interest based banks exist side by side.

In a country where all commercial banks operate along Islamic lines on a noninterest basis,
the question of the control and regulation of the commercial banking system, becomes
basically a question of the evolution and implementation of monetary policy in an interest
free environment. It is a case closest to theoretical formulations of Islamic banking in which

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 6
it is assumed that all commercial banks in the system are operating on interest free basis. At a
practical level, a legal framework is provided to conduct monetary policy in an Islamic
framework.
Thus, there are theoretical and empirical reasons for the study of these cases. However, the
intention here is not to study monetary policy as such which requires an analysis of goals,
instruments and effects in an integrated framework. The purpose here is confined to a close
examination of the instruments used for the control of Islamic commercial banks which can
later be contrasted with the instruments used for Islamic banks functioning in a mixed
environment in which the legal framework has not been especially designed for the
requirements of Islamic banking.

REGULATION AND CONTROL OF COMMERCIAL BANKS IN IRAN/

HOW AN ISLAMIC CENTRAL BANK DETERMINES/FIXES THE PROFIT

RANGE FOR COMMERCIAL BANKS IN AN ISLAMIC ECONOMY?

The legal framework for the functioning of the Islamic banking system in Iran is provided by
the Law for Usury (interest) Free Banking 1983 which was ratified by the Islamic
Consultative Assembly (Iranian Parliament) and approved by the Council of Protectors.
While in Pakistan, the existing rules and regulations were legislated and modified, usually by
executive orders to suit the requirements of Islamic banking, in Iran, completely new laws
were enforced. Thus, banking institutions in Iran were completely overhauled after the
Islamic Revolution of 1979. The law outlines the objectives and duties of the banking system,
and the methods of the mobilization of its resources and provides for central bank and the
conduct of its monetary policy.

The central Bank of Iran is called Bunk Markazi Jomhouri Islami Iran (BMJII), i.e. the
Central Bank of the Islamic Republic of Iran. According to Article 21 of the Law of Usury
Free Banking, the BMJII is not authorized to engage in banking operations which involve
usury (interest). Similarly, commercial banks are also not supposed to indulge in such
activities among themselves. The BMJII is empowered by Articles 19 and 20 of the Law to
supervise monetary and banking activities by using the following instruments:

i. “Fixing a minimum and/or maximum ratio of profit for commercial banks in their
joint venture and Mudarabah activities. These ratios may vary for different fields
of activities.

ii. Designation of various fields for investment and partnership within the framework
of the approved economic policies, and the fixing of a minimum prospective rate
of profit for the various investment and partnership projects; the minimum
prospective rate of profit may vary with respect to different branches of activity.

iii. Fixing a minimum and maximum margin of profit, as a proportion to the cost
price of the goods transacted, for banks in instalment and hire purchase
transactions.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 7
 iv. Determination of the types and the minimum and maximum amounts of
commissions for banking services, provided that they do not exceed the expense
of service rendered and the fees charged for putting to use the deposits received by
the banks.

v. Determination of the types, amounts, minimum and maximum bonuses to

different kind of deposits.

vi. Determination of the minimum and maximum ratio in joint venture, Mudarabah,
investment, hire purchase, instalments transactions, buying and selling on credit,
forward deals, Muzara'ah, Musaqat, Joa'alah, and Qard Hasan for banks or any
thereof with respect to various fields of activity; also fixing the maximum facility
that can be granted to each customer."

[Article 20 of the Law for Usury Free Banking.)

REGULATION AND CONTROL OF ISLAMIC BANKS IN A MIXED

ENVIRONMENT/ECONOMY:

In many Muslim countries today, a large part of the money market is controlled by interest
based banks. However, in the last decade, a few Islamic banks have appeared and are
increasingly claiming a growing share of the money market. During the past fifteen years or
so, Islamic banks have been established in Egypt, Jordan, Malaysia, Bangladesh, Qatar,
Bahrain, Kuwait, U.A.E., and in some European countries.

Several of these countries (Malaysia, Qatar, Kuwait, and U.A.E.,) have only one Islamic bank
while others (Bangladesh, Egypt and Jordan) have two or more Islamic banks. The presence
of Islamic banks in these Countries has raised the following question : How should Islamic
banks be controlled and regulated in a mixed environment which consists of traditional
interest based banks and Islamic banks? The question is being debated among Islamic
bankers, central bankers and economists although not much documentation exists on the
subject.

Islamic banks insist that they should not be subjected to the same controls as interest based
banks because their financing techniques are much different than those of traditional banks.
Interest based banks, it is argued by Islamic banks, advance their funds on the basis of loans,
thus creating credit and adding to the money supply. Hence, any attempt by the central bank
to keep the credit creating activities of these banks in check, seems to be justified. However,
Islamic banks point out that their own financing activities are not in the nature of loans but
take the form of investment. Hence, any control on them is not desirable. Some arguments
which have been pressed by the Islamic banks in this connection are listed below:

a. It is argued that reserve requirement should be enforced only on demand deposits. The
imposition of reserve requirements on investment deposits hampers the investment
activity of Islamic banks and deprives them of the opportunity to earn profit on the
reserved portion of investment deposits.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
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 b. It is also argued that the financing activities of Islamic banks such as, Murabahah,
Musharakah and Mudarabah, are not loan making activities. They resemble
investment more than they do lending. Hence, they should not be subjected to the
same controls which are devised to control credit.

In contrast to these views, the central banks of most of these countries treat Islamic banks in
the same way as traditional interest based banks. Their main argument is that so far Islamic
banks finance their activities using the deposits of the general public, they create credit and at
least in this respect there is no substantial difference between the operations of traditional
banks and Islamic banks. Hence, their activities are to be regulated in the same way as the
activities of traditional interest based banks.

As Siddiqi has pointed out, the truth probably lies somewhere in the middle of these two
extreme positions [Siddiqi,1989.] An important point to keep in mind is that credit (or
additional money supply) is not created by any bank ( traditional or Islamic) in isolation. It is
the commercial banking system as a whole which creates credit. In a traditional system, the
advance made by one commercial bank does not leave the banking system. It comes back to
other commercial banks in the form of new deposits and other receipts. The presence of
Islamic banks does not alter this fact in any way. The advances made by Islamic banks, either
in the form of Murabahah, or letters of credit or any other form, are also not likely to leave
the banking system. They will come back to either the same Islamic bank, or to another
Islamic bank, if there are more than one, or they may even go to other non – Islamic
commercial banks.

However, there is some merit in the argument that the financing operations of Islamic banks
are different from the financing operations of interest based banks. The monetary authorities
should consider the fact that Islamic banks cannot convert their financial assets into liquid
assets with the same ease as interest based banks which keep a large portion their total assets
in interest bearing financial papers.

Hence, in order to remain liquid, Islamic banks have to keep a large portion of their assets in
the form of cash on hand. In other words, the cash - asset ratio of Islamic banks is usually
higher than that of traditional interest based commercial banks. This means that the capability
of Islamic banks to create credit is lower because of their inability to invest in short term
financial assets and the absence of an Islamic financial papers market.

Furthermore, Islamic banks provide finance through Musharakah and Mudarabah. Unlike
interest based banks, they also participate in real investment. Hence, there is a case for
evolving and adopting new methods of credit control for Islamic banks in a mixed
environment.

CONFLICTS BETWEEN CENTRAL BANKS AND ISLAMIC BANKS:

Regulation and control of Islamic banks in the mixed environment where Islamic banks and
interest based banks function side by side presents a mare challenging situation. Experience
has shown that in most cases central banks, subject Islamic banks to the same controls,
conditions and regulations which they apply to the interest based banks. So far as these

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 9
instruments of credit control are free of interest, no objection can be advanced against them at
least on Islamic grounds.

However, there are certain cases in which there seems to a conflict between central banks and
Islamic banks. Some of these include:

a. Islamic banks keep their deposits with the central bank. The central bank pays interest
to commercial banks but Islamic banks have to forego this income.

b. The central bank functions as lender of the last resort. However, this loan, should the
need arise for it, is granted on the basis of interest. There have not been many cases in
which Islamic banks have had to face a liquidity problem. However, a case occurred
in Egypt in which an Islamic bank approached the central bank for additional cash to
face a run on the bank. It is reported that the central bank was not willing to lend the
required amount free of interest. Consequently, the bank had to borrow from the
central bank on interest obtaining a Fatawa from its religious board on the plea of
need (Darurah) .

c. In countries, where the central bank conducts open market operations, Islamic banks
are not able to participate in these operations because of the interest based nature of
the securities bought and sold. Thus, Islamic banks are constrained by the fact that
financial assets which could be liquidated quickly are unavailable.

d. It has been noticed in some countries that central bank authorities do not comprehend
the nature of Islamic financing techniques. This is particularly true in the case of
Mudarabah and Musharakah financing whose nature is entirely different from interest
based debt financing. In debt financing, the granting of a loan is a one-time activity,
no matter what the size of the loan. But Mudarabah and Musharakah are ongoing
activities and the participation of Islamic banks has to last as long as the project
remains in operation. It was pointed out by an Islamic bank that the concerned central
bank insists on separate approval for different stages of the same Musharakah
operation. This kind of situation results because there is little appreciation of the
techniques of financing used by Islamic banks.

SUGGESTIONS FOR ISLAMIC BANKS:

In light of the above, the following suggestions could be made for a healthier relationship
between Islamic banks and central banks:

a. It may be observed that Islamic banks, at present, control a very small portion of the
total money market in mixed environment countries. At best this share is around 10
percent of the market. If Islamic banks are established in these countries and they
claim a substantial share of the money market, the central banks in these countries
will be compelled to take notice of Islamic banking. Then it may be hoped that central
banks would resort to those techniques of regulation and control which would be
more conducive to Islamic banking.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 10
 b. Islamic banks may persuade their respective central banks to offer them some
facilities in lieu of interest free deposits they maintain with central banks. One
particular facility may be the provision of interest free loans from central banks to
Islamic banks in time of need. It can be argued that as Islamic banks do not receive
interest on the deposits which they keep with the central bank, the central bank should
return the favor by providing loans on an interest free basis (Qard Hasan) whenever
the central bank has to function as a lender of the last resort to Islamic banks.

c. Central banks in those countries where the entire banking system has been
reorganized along Islamic lines, may experiment with open market operations bearing
non-interest based financial papers. These may be in the form of Participation
Certificates, Investment Certificates, Muqaradah Bonds, etc. This will go a long way
towards developing secondary market for Islamic banks and providing Islamic banks
with financial assets which they will be able to liquidate quickly when necessary.

Central banking in the Islamic framework and the regulation and control of Islamic banks in a
mixed environment also deserve more attention from researchers.

General Principles for Financial Consumer Protection of an

Islamic Central bank

Saudi Arabian Monetary Agency (SAMA), the central bank of the Kingdom of Saudi Arabia,
was established in 1372H (1952). It has been entrusted with performing many functions
pursuant to several laws and regulations.

Consumer Rights:

In future planned enhancements of the consumer protection website, we will be including

content for finance companies and insurance companies .

In these pages, SAMA wishes to:

- make consumers aware about the new SAMA ‘Consumer Protection Department’
- inform consumers about the banking regulatory environment
- disseminate information about the banking market and the banks that are licensed to
operate in it
- Offer the opportunity to address banking-related complaints through the submission of
an online complaint form

Consumer rights when dealing with banks are set out in the ‘General Principles for Financial
Consumer Protection’ and are based on the general principles developed by the Organisation
for Economic Co-operation and Development (OECD) in 2011. They are:

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
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 General Principles for Financial Consumer Protection

Princi Ground Details

ples
1 Equitable Banks should deal fairly and honestly with consumers at all stages of their
and fair relationship, so that it is an integral part of the culture of a bank. Care should
treatment also be made and special attention given to older people and those with
special needs of both sexes.

2 Disclosure Banks should update information about products and services provided to
and consumers, so that they are clear and concise, easy to understand,
transparen accurate, not misleading, and can easily access this information without
cy unnecessary inconvenience, especially the key terms and features.

3 Financial Banks should develop programmes and appropriate mechanisms to help

education existing and future consumers develop the knowledge, skills and confidence
and to appropriately understand risks, including financial risks and opportunities,
awareness make informed choices, know where to go for assistance when they need it.

4 Behaviour Banks should work in a professional manner for the benefit of clients
and work during their relationship, where a bank is primarily responsible for the
ethic protection of the financial interests of the client.

5 Protection Banks should protect and monitor consumer deposits and savings and
against other similar financial assets through the development of control systems
fraud with a high level of efficiency and effectiveness to reduce fraud,
embezzlement or misuse.

6 Protection Consumers’ financial and personal information should be protected through

of privacy appropriate control and protection mechanisms. These mechanisms should
define the purposes for which the data may be collected, processed, held, used
and disclosed (especially to third parties).

7 Complaint Consumers should have access to adequate complaints handling mechanisms

s handling that are accessible, affordable, independent, fair, accountable, timely and
efficient and based on SAMA rules.

8 Competiti Consumers should be able to search, compare and where appropriate, switch
on between products, services and providers easily and clearly at a reasonable
cost.

9 Third Banks and their authorized agents should have as an objective, to work in the
parties best interest of their consumers and be responsible for upholding financial
consumer protection. Banks should also be responsible and accountable for
the actions of their authorized agents.

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International Islamic University Chittagong, Bangladesh
Page 12
10 Conflict Banks must have a written policy on conflict of interest, and ensure that
of interest this policy will help to detect potential conflicts of interest. When the
possibility of a conflict of interest arises between the bank and the third party,
this should be disclosed to the consumer.

Difference between conventional and Islamic Central bank

Islamic Central bank always control money demand for unproductive, haram and harmful
expenditures
(Please derive from functions and objectives)

Reference:

1. IBBL website: [Link]

2. A text book of Islamic banking by Islamic Economics Research Bureau ,Bangladesh
3. Regulation and supervision of Islamic banks, M. Umer Chapra and Tariqullah Khan
4. Website of SAMA: Saudi Arabian Monetary Agency (SAMA)
5. Website of Central Bank of Iran

Attention!
All class lectures are available at:

[Link]

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
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