Interaction with conventional system
Most Islamic banks operate within certain environments and communities that encompass both conventional and Islamic banking systems. However, they can neither borrow from, nor invest any money in the conventional banks on interest basis. Nevertheless, it is inconceivable for Islamic banks to operate in a total isolation of conventional banks on the basis of the prohibition of interest in Islam. Apart from types of business relationship involving interest, there is much scope for co-operation between the two, especially in correspondence services and foreign trade financing. In fact, the volume of trade between Muslim countries and the rest of the world is such that conventional and Islamic banks are forced by circumstance to establish correspondent relationships. And as foreign banks were reluctant to offer interest free correspondent banking, especially in the early days of Islamic banking, Islamic banks had to be more innovative to secure the correspondent banking services from conventional banks on mutually agreed terms which do not involve the payment or receipt of interest.
Arrangements are made between Islamic banks and their correspondent banks to open interest-free operating accounts and use them for importing commodities from another country when there is no Islamic bank in the exporting country or when the supplier wants to open an account at a certain bank. Foreign banks accepted dealings with Islamic banks on the basis of agreements made by a simple exchange of letters giving the Islamic bank facilities up to an agreed ceiling without charging interest in case of overdrawn. In return, the Islamic bank agreed to keep a reasonable amount of cash in their accounts and cover any debit as soon as possible. The Islamic bank should not delay the transfer of the value of documentary credits to a correspondent bank abroad, to save the latter from being charged interest; and should try to correct a debit balance in their accounts with the foreign bank as soon as possible.
The correspondent banks does not charge any interest on temporary debit / overdrawn balances of Islamic banks, in exchange for a right to use the credit balances of Islamic banks profitably without paying any compensation. And as partial security on adding its confirmation, the foreign bank debits the Islamic bank with a certain cash margin. The Islamic banks has to keep a sufficient balance in the correspondent bank's account to cover the cash margin of the letters of credit and not the whole value of these letters.
Arrangements are made between Islamic banks and their correspondent banks to open interest-free operating accounts and use them for importing commodities from another country when there is no Islamic bank in the exporting country or when the supplier wants to open an account at a certain bank. Foreign banks accepted dealings with Islamic banks on the basis of agreements made by a simple exchange of letters giving the Islamic bank facilities up to an agreed ceiling without charging interest in case of overdrawn. In return, the Islamic bank agreed to keep a reasonable amount of cash in their accounts and cover any debit as soon as possible. The Islamic bank should not delay the transfer of the value of documentary credits to a correspondent bank abroad, to save the latter from being charged interest; and should try to correct a debit balance in their accounts with the foreign bank as soon as possible.
The correspondent banks does not charge any interest on temporary debit / overdrawn balances of Islamic banks, in exchange for a right to use the credit balances of Islamic banks profitably without paying any compensation. And as partial security on adding its confirmation, the foreign bank debits the Islamic bank with a certain cash margin. The Islamic banks has to keep a sufficient balance in the correspondent bank's account to cover the cash margin of the letters of credit and not the whole value of these letters.
Cooperation
Islamic banks are now an integral part of the banking system, not only in Islamic countries but also in the West. They operate parallel to conventional banks both within the banking system of their own countries and in respect of international financial and business operations. Therefore, conventional and Islamic banks are forced by circumstance to establish correspondent relationships. They started co-operating on ordinary correspondent banking services, such as confirming, advising and negotiating letters of credit; progressively, the scope of relationship between the two integrated other areas such as correspondence services, foreign trade financing, co-financing of projects and lines of leasing and exchange of business information. This is driving innovation in product-lines, with a view to integrating Islamic and conventional finance. However, Islamic bank can neither borrow from, nor invest any money in the conventional banks on interest basis. Still that temporary interest-free placing of funds, with each other is unavoidable if an adequate supply of liquidity is to be ensured as long as conventional banks must ensure that the Islamic bank deposits are 'ring-fenced' to ensure there is no 'contamination' by interest deposits on the inter-bank markets.
Forms of cooperation conventional and Islamic banks could be at different levels to take advantage of the vast amount of skills and knowledge of the conventional banking sector; it is also a viable economic proposition for conventional banks. Islamic banks should participate with conventional banks in training programmes for their personnel; they should also become familiar with conventional banking practices, to be able to inform the conventional banking personnel about Islamic methods and such mutual knowledge will pave the way for smooth co-operation later. In addition, the exchange of funds between Islamic and conventional banks without involving interest may take the different forms. Islamic banks accept funds from conventional banks on the basis of Mudarabah in the form of an investment account with a return calculated according to the yield of the investment pool. Financial co-operation can also take place on the basis of Musharakah, leasing, lines of leasing, and hire purchase. Joint equity participation is possible to the extent that the conventional bank is willing to share the risk. The scope of co-operation between Islamic and conventional financial institutions can also include correspondent banking services, documentary credits providing also foreign trade financing and co-financing of projects. Correspondent banking services provided by Islamic banks can range from handling payment and other transaction services as well as various trade credit facilities including trade execution. Islamic banks also provide services and facilities to conventional banks that do not have a local presence such as advising and confirming letters of credit, negotiating trade documents including accepting Bills of Exchange, etc. The exchange of business information could also be very useful. Islamic banks, being, by their nature, more involved in monitoring of their client's businesses than their conventional counterparts, are in a position to provide the latter with reliable information about the study of projects and the track records of individuals and companies.
Forms of cooperation conventional and Islamic banks could be at different levels to take advantage of the vast amount of skills and knowledge of the conventional banking sector; it is also a viable economic proposition for conventional banks. Islamic banks should participate with conventional banks in training programmes for their personnel; they should also become familiar with conventional banking practices, to be able to inform the conventional banking personnel about Islamic methods and such mutual knowledge will pave the way for smooth co-operation later. In addition, the exchange of funds between Islamic and conventional banks without involving interest may take the different forms. Islamic banks accept funds from conventional banks on the basis of Mudarabah in the form of an investment account with a return calculated according to the yield of the investment pool. Financial co-operation can also take place on the basis of Musharakah, leasing, lines of leasing, and hire purchase. Joint equity participation is possible to the extent that the conventional bank is willing to share the risk. The scope of co-operation between Islamic and conventional financial institutions can also include correspondent banking services, documentary credits providing also foreign trade financing and co-financing of projects. Correspondent banking services provided by Islamic banks can range from handling payment and other transaction services as well as various trade credit facilities including trade execution. Islamic banks also provide services and facilities to conventional banks that do not have a local presence such as advising and confirming letters of credit, negotiating trade documents including accepting Bills of Exchange, etc. The exchange of business information could also be very useful. Islamic banks, being, by their nature, more involved in monitoring of their client's businesses than their conventional counterparts, are in a position to provide the latter with reliable information about the study of projects and the track records of individuals and companies.
