Can Banks Ever Truly Be Ethical?

Khairul Nisa Ismail, CEO Sedania As Salam Capital

We often don’t think about how present banks are in our lives. When we were children, parents set up a children’s savings account for us to use when we’re adults. Without thinking, we transition to opening our own accounts to get our salaries and then rely on banks to loan us money for houses or cars. 

It’s difficult to imagine that just two generations ago, our grandparents kept their life savings in secret places at home which you only discovered after their passing. Hence, it may be difficult to believe that today, many people prefer to do the same, over-trusting their life savings with a bank.

Knowing what I know, it’s hard to blame them.

Putting things very simply, banks serve two main functions: they hold our money and they participate in lending or borrowing. The first problem with this setup? Banks charge higher interest when they lend versus when they borrow; so you’re technically at higher risk when you borrow for your car or house than they are when they’re trying to make a profit. 

Can something be ethical if it’s unfair at such a basic level? 

Most of us have this understanding that our money is safe in the bank and will be put to good use via prudent investment. But do any of us actually know what happens to our money when deposited into a bank? 

When we are unaware, we can’t object if, for example, an unscrupulous bank uses our deposits for risky business investments or if they go into buying stocks in shady companies. 

Even if you wanted this information, it’s not accessible to the regular person, hidden behind company policy, intimidating walls of jargon and a probably banking degree. 

Hence, I don’t think people truly understand the risks they’re taking.

Banks Are a Business, and Businesses Can Fail

Let’s look at one scenario: what happens when a bank loses more money than it makes? 

Unlike any other business, there’s too much at stake—too many regular people who depend on the bank with all of their life’s savings.

Historically, this is when a government will bail it out. Now, most financial experts will instantly think about the 2008 financial crisis bailout—but did you know that something similar happened in Malaysia much earlier?

In 1999, Bank Negara stripped control from a family-owned local bank, which was one of the top banks in Malaysia at the time. Some turbulent financial times meant that more than 20% of the bank's loans have turned bad, and it invested into the wrong industries. Scared customers at the time then attempted to withdraw billions worth of cash from the bank, so the central bank came to the rescue. Bank Negara proceeded to “recapitalise” the company to help balance its risk to capital ratio. 

Think about all of that hard-earned money that you’ve paid for taxes, hoping that it could build infrastructure, or help the poor. Now your taxes are instead going to help businessmen get out of bad business decisions, simply because they hold too many fates in their hands. 

All of this is enough for us to wonder—should banks be allowed to continue making money out of thin air on the backs of debt?

If we could rebuild our economy from scratch, maybe we could build a fairer system. Unfortunately, that’s just not feasible anymore. Too much is at stake for us to overhaul now. 

But maybe Malaysia has the next best thing in the market already. 

Islamic Financing—Not Just for Muslims

Image from Nawaiwaqt

When we talk about Islamic financing, it’s easy to think of it as a service targeted to Muslims, but it is more than that. Islamic banking is at its core, is socially-responsible finance. 

Much of its unique systems exist to stop anyone from making money out of money. 

Islamic finance principles specifically ban participation in ambiguous and uncertain transactions, and it sees agreements with excessive uncertainty (gharar) or speculation (maysir) invalid.

Contracts have to avoid ambiguities and faults, or they’re seen as invalid. 

Interests are seen as unjust. Banks with Islamic banking principles at its core cannot charge lower earners with higher interest rates as a reflection of their potential to default, so there is more equality in its access.

Banks also can’t earn money off debt, because profit earned through dealing money (or papers representing them) are seen as interest, and thus barred. 

Basically, Islam doesn’t recognise that money has any built-in value. Therefore, Shariah-based financing insists on asset-backed trading; where funds can only be made based on trade involving actual, physical goods you can touch, or services rendered. 

Shariah-based banking also forbids gambling, which effectively removes some of the riskiest investments from a bank’s options—like derivatives, futures or swaps. Speculation is a similar beast, so investments have to be made from deposits instead of any borrowed money from wholesale markets. 

Islamic banking products and investments are more ethical because they are designed to share profits and losses with everyone involved. It is also more ethical in its transparency, as customers are told from the start that their investments will only yield returns if the contract is profitable. This, more than a conventional bank, helps educate customers about the risks they're taking—and subsequently demand that banks reduce risky investment practices.

The problem with Islamic finance right now is how young it is. 

Islamic financial institutions can’t always mitigate risks as well as conventional institutions can, simply because it’s less developed. For example, the safety of asset-backed financing will break down if there’s a possibility of overlap on the assets used. How can a financial institution confirm that the same commodity is only sold to one buyer? 

Sedania As-Sidq has utilised a system that tokenises our assets to help the process somewhat, but there needs to be an industry-wide framework designed and Shariah audited. 

Islamic financing is growing quickly, more than just Malaysia. Islamic finance is projected to be worth US$3.2 trillion by 2020, so it is no surprise that Bank Negara has set a target for Islamic finance to form 40% of total banking assets by the same timeline. Between technologies like artificial intelligence and big data, the relatively young Islamic finance industry may be in the perfect position to take advantage of these advancements to put its growth into turbo-drive—and prove that ethics can, in fact, be profitable.

To know more about As-Sidq, click here