Don’t break up the big banks. Give Islamic banking a try.
Recently appointed Minneapolis Federal Reserve President Neel Kashkari stunned the banking industry after a recent speech in which he advocated breaking up “too big to fail” banks. In remarks at the Brookings Institution in mid-February, Kashkari said the “biggest banks are still too big to fail and continue to pose a significant, ongoing risk to our economy.”
One solution he proposes is to break up large banks into smaller, less influential entities. He also suggests turning the large banks into public utilities by forcing them to hold so much capital that they are almost guaranteed to remain solvent. The goal seems to be greater access to capital with less risk of a financial collapse like we saw in 2008-09.
While these ideas have merit, Kashkari didn’t mention one option that could arguably result in the greatest social good: Islamic banking. If he’s interested in a banking system that works for everyone and an alternative that can co-exist within our current regulatory regime alongside cooperatives like credit unions, it’s an idea worth considering.
The public perception of the finance industry in general is that it only exists to benefit the rich. Islamic banking requires financial institutions to have an awareness of and shared responsibility for the poor in society, as well as the standard aspects of a business. In its ideal form, Islamic banking is an ethical banking system that operates not only to earn income for owners of capital but also to help the general public.
Here’s a quick primer: although Islamic commercial banks have many products similar to those offered by conventional banks, the two entities differ conceptually. One key difference is that conventional banks earn their money by charging interest and fees for services, while Islamic banks earn their money through profit-and-loss sharing, trading, leasing, charging for fees for services rendered, and using other contracts of exchange.
You can also think of Islamic banks as public benefit corporations, a designation that is gaining popularity as an alternative business structure in the U.S.: each bank takes part in socially responsible activities by setting aside a certain amount of money from its total funding sources to serve the community in which it operates. One example of the better banking behavior common among Islamic banks is interest-free loans to those who otherwise couldn’t afford financing.
Today, Islamic banks are also often involved in programs that help people from all walks of life in areas like education programming, health care services, and microfinance grants. The primary focus of Islamic banking is to make money in a way that maintains social justice.
By creating an environment that allows Islamic banking to flourish, authorities would also acknowledge that for some people–not exclusively Muslims, by the way–traditional banking and investment products don’t fit the bill. Such products violate a code of conduct by which many people strive to live.
And Islamic banking should not be perceived as some sort of threat. Financiers should be lauded if they take steps to actively foster its growth. A financial industry that welcomes Islamic banking is one that seeks to improve itself by providing alternatives to different (often unsatisfied or “unbanked”) types of people.
How might an Islamic banking system work in conjunction with conventional banks? It may surprise you to know that the two have coexisted in more than 50 countries for many years.
Some of those countries have a dual financial system (e.g., Turkey and Malaysia), practicing both conventional and Islamic finance. In many more countries (e.g., the United Kingdom and Singapore), Islamic banks operate under conventional bank legal frameworks, but the regulations they must follow differ from regulations that apply to conventional banks.
(International conventional banks like Citibank, HSBC, and UBS operate Islamic banking windows, too, but these hardly suffice as alternatives to accomplish the goals Kashkari has outlined.)
If Kashkari needs a real-life, closer-to-home example of a government working to promote Islamic banking practices for the public good, he need look no further than the Federal Reserve Bank of Minneapolis’ own backyard. Since 2006, the city of Minneapolis has loaned more than $1 million to Muslim business owners through a program that complies with Islamic financial principles.
As reported by The Atlantic in 2014, the Neighborhood Development Center in St. Paul created the first nonprofit model of Islamic financing in 2001, inspired by the handful of banks and financial companies in the U.S. that currently provide mortgages and loans that follow Islamic banking practices. According to the article, Minneapolis had made 64 loans worth $1.2 million.
Those involved with the project point to the Islamic banking model as the reason commerce has returned to long-neglected neighborhoods like the dilapidated area of Lake Street. “Once a bustling commercial corridor in the early 1900s,” the article says, “shops on Lake Street began closing as consumers moved to the suburbs.” Thanks to the city’s outreach to entrepreneurs in search of Islamic financing, more than 20 businesses are open again.
Although it’s a nice slogan, “breaking up the big banks” isn’t a realistic policy prescription. As evidenced by his time administering the government’s bank bailout fund, Kashkari has a history of thinking outside the box to deal with a crisis. If serious about banking reform, he would do well to consider Islamic alternatives as part of the solution.
Besides, what’s the difference between a “too big to fail” multinational bank and smaller carbon copies of the same bank, only with fewer assets at each institution? A banking model that encourages longer-term investment, community involvement, and benefit for the real economy is worth looking at.
Joshua Brockwell is Investment Communications Director at Azzad Asset Management, a socially responsible registered investment advisor located in Falls Church, Virginia. Although Azzad is an investment company and not an Islamic bank, the firm regularly invests in Islamic banking products to earn a competitive, socially responsible return for clients.
Opinions expressed are those of the author or fund manager, are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security and should not be considered investment advice.
Fund holdings and sector allocations are subject to change and are not a recommendation to buy or sell any security. Click here for Azzad Ethical Fund current top 10 holdings.
Past performance does not guarantee future results.
The Azzad Ethical Fund is non-diversified and may invest a larger percentage of its assets in fewer companies exposing it to more volatility and/or market risk than diversified funds. The Fund may not achieve its objective and/or could lose money on your investment in the Fund. Stock markets and investments in individual stocks can decline significantly in response to issuer, market, economic, political, regulatory, geographical, and other conditions. Investments in mid-cap companies can be more volatile than investments in larger companies. Investments in growth companies can be more sensitive to the company’s earnings and more volatile than the stock market in general. Because the portfolio may invest substantial amount of its asset in issuers located in a single country or in a limited number of countries, it may be more volatile that a portfolio that is more geographically diversified. See the prospectus for more details about risks.
Investments in smaller and medium sized companies involve additional risks such as limited liquidity and greater volatility. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower rated and non-rated securities present a great risk of loss to principal and interest than higher rated securities.
The Azzad Wise Capital Fund is non-diversified with a high concentration of securities in the financial sector which can expose the Fund to more volatility and/or market risk than diversified funds. The Fund may not achieve its objective and/or could lose money on your investment in the Fund. The Fund mainly invests in securities issues by foreign entities which expose the Fund to country specific risks such as market, economic, political, regulatory, geographical, and other risks. The Fund intends to invest in certain instruments that may be illiquid. As a result, if the Fund receives large amount of redemptions, the Fund may be forced to sell such illiquid investments at a significant loss to be able to meet such redemption requests. See the prospectus for more details about risks.