The Role Of Center Bbanks

Introduction:

Islamic banks are based on certain principles, which distinguish them from the other banks; the most important of these principles is the prohibition on the taking of interest. Other principles that are core to Islamic banking include the doctrine of risk sharing, participatory business, bar on speculation, bar on exploitation, and protection of property rights. Due to the application of these principles from an ethical and religious standpoint in the functioning of the Islamic banks, it can be surmised that Islamic banks are different from other banks. Islamic banks are also characterised by a different governance model, where the Sharia governance system is applied to them. There are four such models that can be identified by the practices of different countries. Iran follows a model in which the Board of Advisors supervise Islamic banks in all Shariah matters. Some countries follow a model that sees the use of an internal Sharia supervisory committee and a supreme Sharia authority. The supreme committee is not required to follow the central bank. Another model is to create an internal Sharia committee and a central Sharia committee along with the supreme Sharia authority; this is followed in Malaysia. The model followed in Saudi Arabia is different with there being an internal Sharia committee but no central Sharia authority. The question being explored in this dissertation relates to the relationship between Islamic banks and the central banks and to what extent do central banks play a supervisory role in credit control. To answer this question, the case study of Saudi Arabia is undertaken.

Research problem

The relationship between the central banks and Islamic banks has become one of the interesting areas of discussion in the context of Islamic banking where there is also a central bank that may play a role in regulating some of the functions of the Islamic banks, including credit control. However, how Islamic banks are regulated in the area of credit control by central banks may not be necessarily similar to how other banks are regulated in the same context. The research problem is related to extent of control that central bank can exercise for credit control purposes in Islamic banks. .

Research aims and objectives

The aims of this research include, to provide an overview of the Islamic banking system including its theoretical and philosophical foundations; to compare the differences between Islamic and conventional banks in context of the possibility of subjecting both systems to the same rules as in dual banking systems with regard to credit control and supervision of the central banks; to analyse the effect of the legal and the regulatory system on the behaviour of Islamic banks in terms of their adherence to rules on credit control; and to explore the ways .

M Ben Arab and A Elmelki, ‘Managing Risks and Liquidity in an Interest Free Banking Framework: The case of the Islamic Banks’ (2008) 3(9) International Journal of Business and Management 80.

2 Ibid.

3 M Hassan and M Lewis, Handbook of Islamic Banking (Cheltenham: Edward Elgar 2007).

4 S Kunhibava, ‘Islamic Banking in Malaysia’ (2012) 40(1-2) Int'l J. Legal Info 196.

5 Ibid.

6 Ibid.

The aims of this research include, to provide an overview of the Islamic banking system including its theoretical and philosophical foundations; to compare the differences between Islamic and conventional banks in context of the possibility of subjecting both systems to the same rules as in dual banking systems with regard to credit control and supervision of the central banks; to analyse the effect of the legal and the regulatory system on the behaviour of Islamic banks in terms of their adherence to rules on credit control; and to explore the ways in which central bank in Saudi Arabia does exercise such control over the Islamic banks in the country. The objective of this research is to provide a better analysis and understanding on the relationship between central banks and Islamic banks in context of credit control.

Justification for choice of jurisdictions

This research focuses on a single jurisdiction of Saudi Arabia. Saudi Arabia being an Islamic country, makes its laws as per the Sharia. The banking law and regulatory mechanism is also informed by the Sharia. Saudi Arabia also has a central bank, which makes it possible to explore the relationship between this bank and the Islamic banks in the country in the context of how former exercises credit control over the latter. This makes Saudi Arabia a relevant jurisdiction for exploring the regulatory relationship between central banks and Islamic banks. .

Literature review

A number of scholars have researched Islamic banks. The existing research on Islamic banks indicates that modern Islamic banks have only developed in the last five decades or so. The development of Islamic banks in general can be said to have passed through three phases: in the first phase, there was theoretical development based on the concepts in Sharia; in the second phase, there was a trial period; and in the third phase, Islamic banks came to be recognised as established institutions. The first phase, where theoretical development of Islamic banks took place can be linked back to the scholarship developed in the 1940s through to 1960s, at which time, there was a theoretical idea of what Islamic Banks could look like. Malaysia was the first country to establish Islamic Banks and the next country to do so was Pakistan. In some countries, Islamic Banks were created in the nature of government banks. For example, the Islamic Development Bank (IDB) was established in the Kingdom of Saudi Arabia as an inter-governmental bank in 1975. .

Previous literature also provides insight into the relationship between central banks and Islamic banks. The relevant area of discussion in the context of credit control is the central banks’ function of monetary policy making, especially after the financial crisis of 2007-08. Monetary policy relates to the process of controlling and supervising the quantities and usage of money and credit in circulation; this would also include borrowing by the government. Central banks aim to control the demand for money for the purpose of maintaining price stability for which the central bank raises or lowers its interest rate target to encourage or reduce lending. Through this method, the central banks are able to keep interest rates and inflation at targeted levels by synchronising supply of money through banking operations and demands for money. In order to achieve the objectives of monetary policy, the central banks also create restrictions on interest rates, credit and lending. This is significant to the area of research in this thesis because the role of central banks in controlling credit in Islamic banks is being considered here. However, the question is as to how far this role of central banks is witnessed vis a vis credit control functions of Islamic banks. It may be stated here that while performing the function of the implementation of monetary policy, a central bank in Islamic countries like Saudi Arabia can only use instruments that do not violate the prohibition of Sharia, particularly in the bar on interest (riba), which means that the instruments of monetary control that depend on interest from the authorities’ inventory cannot be applied in the context of Islamic banks. Thus, there may be a different policy applied to other banks while Islamic Banks are treated differently. In Saudi Arabia, the monetary policy of Saudi Arabian Monetary Agency (SAMA) is not permitted use of tools that are in conflict with Sharia. SAMA is barred from using the re-discount facility while it can use selective credit controls such as credit ceilings, cash margins, terms and conditions of customer transactions. Importantly, with respect to credit control, certain kinds of loans are not permitted.

Research methodology

The research methodology applied in this research is doctrinal with interdisciplinary aspects as there are also technical and economic issues of Islamic banking that are involved in this study. The study involves different approaches, including descriptive, analytical, critical, and comparative, for analysis of the available primary and secondary data to answer the research question on the relationship between Islamic banks and central banks in context of the latter’s role in monetary policy and credit control over the former. )

Study rationale

There is lack of research and literature on the relationship between Islamic banks and central banks in Saudi Arabia, which can bring more attention to how the latter can reasonably discharge their functions in maintaining monetary policy by credit control over the former. There is a need to propose a balanced mechanism by which the relationship can be managed while also complying with the Sharia. This is necessary because some credit control supervision is needed so as to maintain the financial health of the economy and the banks.

Outline of chapters

1 Emergence and features of Islamic banks

• Origin of Islamic banking in Saudi Arabia
• Conceptual framework of Islamic banks
• Core principles of Islamic banking system

2 Central banks and monetary policy

• Emergence of central banks
• Responsibilities and functions of central banks in the modern banking system
• Monetary Policy and credit control
• The central bank in Saudi Arabia

3. Banking and credit in the Islamic context

• The concept of money in Islamic law as compared with other systems
• The notion of credit in Islamic law
• Financing in Islamic banking
• Risk management in Islamic banks and financial institutions

Relationship between central bank and Islamic banks

• Proposal for the balanced relationship between the central bank and the Islamic banks in Saudi Arabia (based on the analysis of the data in previous chapters)

Conclusions and recommendations

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