Islamic Banking in Jordan

The subject of Islamic finance has received increasing attention in recent years, both from Moslem scholars and from those in the West with an interest in Islamic affairs. Much of the writing is of a theoretical nature, however, and it is only recently that the results of empirical investigations have started to appear. This paper is intended as a modest contribution to this empirical literature.

There are several reasons why the Jordanian experience is of special interest, and why it is worth examining in some detail.

1. Jordan, despite its small size, is one of the most developed Islamic countries, where the majority of the population use banks. The kingdom’s gross national product per capita of $2,000 understates its level of development, as Jordan has perhaps the best educated and qualified population in the entire Islamic world.

2. The economy is very open, with international transactions of considerable importance, reflecting Jordan’s geographical position, market size, and economic structure. Much banking business therefore involves trade finance, and the handling of remittances, which are still of considerable importance for the Jordanian economy, despite the oil recession in the Gulf.

3. The banking laws are liberal, with the major banks being privately owned. Foreign banks are permitted to operate, although most business is handled by domestically-owned banks. There is much competition in the financial sector, involving both the banks themselves and money changers who handle a large portion of remittance transactions and business involving the West Bank where Jordanian banks no longer operate.¹

4. Islamic banking is well established in Jordan, with the Jordan Islamic Bank for Finance and Investment founded in 1978, and operating since September 1979. It has a more extensive branch network than any other national Islamic bank. There is also an Islamic Investment House in Amman, which has built up a significant investment portfolio while working in accordance with the Sharia’s financial principles.

5. There has been little written about Islamic banking in Jordan, despite the seven years of experience with modern Islamic finance.²

Jordan’s current financial position

The Jordanian economy has been remarkably resilient for over three decades, despite the traumatic experiences of the Israeli occupation of the West Bank in 1967, the Civil war in 1970, the difficult relations with Syria, and the spillover effects from the Gulf War involving Iraq, Jordan’s major trading partner. Growth rates have been high often averaging over 10 per cent per annum, well above those of neighbouring state such as Syria and Iraq. The government’s policy of encouraging private initiative and enterprise seems to have paid off, with a flourishing small business sector, and a diversified range of light consumer-orientated industries which serve both Jordan and Iraq.

The economy’s main weakness has always been the trade imbalance, however, with export receipts covering only 20 to 30 per cent of import payments. Until recently this was not a problem as the foreign exchange gap was covered by remittances and aid inflows from abroad, initially from Britain and the United States, but in recent years mainly from Saudi Arabia and the Gulf. With the oil recession in the Gulf, aid inflows have fallen sharply. Those from Kuwait in 1985 fell to a quarter of the previous year’s level, and in the case of Saudi Arabia, the major donor, the decline exceeded 50 percent. Early indications suggested aid disbursements were even lower in 1986, as aid to Iraq was being given priority over assistance to Jordan, given the former’s critical situation because of the Gulf War.

At the same time remittances are falling sharply, the value declining by over one quarter in 1985. Although remittances in 1986 were better than expected, prospects are poor. The demand for foreign labour has declined sharply in the Gulf, partly reflecting the completion of labour-intensive infrastructural projects, but also as a result of the fall in investment caused by the fall in oil revenues. Even if the oil situation improves, it seems unlikely that there will be any substantial recruitment of new workers from Jordan, as the pressures are now great to indigenise employment in the Gulf, especially as some of the states flow face a problem of youth unemployment. Even those Jordanian passport holders working in administration and teaching are finding their services are no longer required when contracts come up for renewal.

The Jordanian banking scene

It is important to be aware of these disturbing economic trends when assessing the prospects for banking in Jordan, including those for the Islamic banks. The future growth of the economy and banking business will inevitably be affected by developments in the international oil market, even though Jordan itself is not an exporter of oil. Much will also depend on the outcome of the Gulf War, given Iraq’s significance as a market for Jordan. In view of Jordan’s ability to overcome the gravest of the crises in the past however, it would be unwise to take too gloomy a view of the future.

Jordan’s educated citizens have a remarkable aptitude to seize whatever opportunities arise, and to ensure that profitable business results. The demise of Beirut as a banking centre, for example, helped Amman, as a number of international banks made the Jordanian capital their centre for Middle Eastern and Arab operations, given the stable political environment, and the liberal economic climate. Similarly, the state control of virtually all economic activity in Syria and Iraq, including the nationalised banking sector, has helped Jordan attract capital and enterprise from these states which could not flourish under tightly regulated conditions.

Jordan is the home of one major international bank, the Arab Bank, and eight primarily local banks which serve the domestic market. Although in terms of paid-up capital the Arab Bank is four times larger than any other Jordanian bank, this merely effects the size of the international operations of this essentially Palestinian institution. Domestically the Jordan National Bank is more significant in terms of deposits and lending, and other institutions such as the Cairo Amman Bank, the Jordan Kuwait Bank and the Petra Bank do almost as much business.³

Riba transactions in Jordan⁴

In the mid-1970s almost half the bank deposits with the commercial banks were in demand or current accounts on which zero or minimal interest was paid. By 1985, however, this proportion has fallen to below one-quarter, reflecting the increased competition for deposits in the banking sector. Most deposits are now in the form of term deposits for a fixed period or savings deposits which also earn interest. Non-residents, mainly Jordanian expatriates working in the Gulf, seem particularly keen to maintain interest-earning deposits, as only 15 per cent held demand deposits in 1985. This may reflect their lesser need for transactions balances, as they return to Jordan relatively infrequently.⁵

As far as asset deployment is concerned, the commercial banks advance almost half their funds in the form of loans on which interest is payable, some through overdraft facilities, but an increasing amount through structured term lending. Around 10 percent of bank assets are held in interest-earning government bills and bonds, and around 15 per cent are held in foreign assets, again mainly interest-yielding securities. Less than 2 per cent of all commercial bank advances are in the form of direct investment.

Around one-quarter of commercial bank advances are in the form of trade finance, mostly credits to cover imports, although some are for purely domestic commerce. A similar proportion of commercial bank advances are for construction finance, although this proportion has been falling, reflecting the recession in the construction industry, which has affected even domestic house building and home extensions. Personal lending has increased in significance, however, and now accounts for over one-tenth of all commercial bank credit.

Although interest transactions are the prevalent form of bank business in Jordan, rates remain relatively low, reflecting the kingdom’s modest rate of inflation, and the stability of the Jordanian dinar. Interest rates on savings and time deposits are in the 4-8.5 per cent range, depending on the deposit terms, and borrowers are seldom charged more than 10 per cent. The authorities have been concerned to keep interest rates down in order to curtail business overheads, although this has been largely through exhortations rather than by direct regulation via monetary policy.⁶ Nevertheless this policy seems to have worked, and relations between the commercial bank and the central bank are close, the latter being able to exercise effective control, while at the same time ensuring that sound banking standards are adhered to.

Origins of Islamic banking in Jordan

The Central Bank acted in an accommodating way to the introduction of Islamic banking into the kingdom, and responded positively to the initial suggestions which were made concerning this type of banking. While not wishing to see the banking system Islamised, the authorities were sensitive to the wishes of those who wanted Islamic financial services, and it was recognised that many believers were unhappy with the kind of banking facilities offered by the riba commercial banks. It was therefore thought that provision should be made for a plural system, which would accommodate both riba and halal financial transactions, the latter being the only type permissible under the Shani’a religious law. Accordingly, Law No. 13 of 1978 was drafted, published in the Official Gazette No 2733 of 1 April. It was this law that provided for the establishment of the Jordan Islamic Bank for Finance and Investment.

In framing this legislation the Finance Ministry sought the advice of Shani’a legal experts, as well as the Central Bank staff concerned with bank regulation. The initiative for the law, however, came as a result of an approach made to the Jordanian authorities by Sheikh Saleh Kamel of the Al Baraka Group, with backing from within Saudi Arabia. The law defines the type of deposits which the bank can receive, and the forms of advances which it is permitted to make under the Shari’a law. The functions, objectives, management structures and capital provisions are all set out under the establishment law.

Several types of deposit are permitted. Trust deposits are like current account deposits which earn no return, but which are repayable in full by the bank on demand. Joint investment accounts can be opened by individuals or businesses who wish to share in the bank’s profits (or losses). The return on these deposits is not guaranteed, as such a guarantee would contravene Islamic law. Indeed there may be a zero return, as section 22(a) of the establishment law indicates, but in practice this has never happened. There are three kinds of joint investment accounts: savings accounts, notice accounts and fixed accounts. Money can be withdrawn from savings accounts subject to 10 days’ advance notice. The depositor gets a 50 per cent profit share, however, on his or her balance. Notice accounts, as their name implies, are subject to a longer minimum notice of withdrawal, three months, but depositors get a 70 per cent profit share on their balances. With fixed accounts depositors get a 90 per cent profit share, but funds are illiquid in the short term, the minimum deposit period being a year.

The Jordan Islamic Bank also provides specific investment accounts for clients seeking to invest in particular projects, with the bank acting as the client’s agent or investment manager. The bank shares in any profits from the investment, but is not liable to participate in any losses. This type of service provides a model for Islamic fund management, and represents a successful innovation in the Islamic financial field by the Jordanian bank. The bank may also provide muqaradah bonds,⁸ which maintain their face value, but entitle the holder to a share of the profits on the funds in which the money raised through the bond issues have been utilised. Such bonds have not yet been issued, but the provision of such a facility under the establishment law gives the bank increased flexibility.

The law provides for advances to be made by the bank on the mudarabah⁹ profit sharing principle, as well as through decreasing participation. The bank is also entitled to a profit share under the latter scheme, but the bank’s share of the project gradually diminishes over time. Short term finance for trade purposes can be advanced through re-purchasing schemes, as is the case with other Islamic banks.

Capital structure of the Jordan Islamic Bank

The authorised share capital of the Jordan Islamic Bank was JD 4 million,¹⁰ with shareholdings restricted to a maximum of 5 per cent of the total capital under Law No. 13 of 1978. The initial paid-up capital was JD 1 million, most of which was raised by public subscription, apart from the funds invested by the founder owners. Each year until 1983 a further JD 1 million was paid up until the whole authorised capital was subscribed. The founder subscribers were entitled to increase their participation in line with their initial subscriptions each year until 1983, but not all did so. By December 1980 only JD 273 was unsettled, but by 1981 this had risen to JD 168,492, representing almost 17 per cent of that year’s settlements. The position improved the following year, however, as only JD 56,983 was left unsubscribed out of the fourth capital issue. All of these shares were readily taken up by new purchasers who were keen to become owner participants in the bank because of its increasingly favourable reputation.

In 1985 some amendments to the bank’s establishment law were made when the bank’s permanent Law No. 62 was passed. The major change provided for an increase in the bank’s authorised capital to JD 6 million, a decision which was ratified by the General Assembly of the Bank at a meeting on 21 December 1985. All the bank’s shareholders are entitled to attend the General Assembly. This decision was taken partly as a result of the development of the bank’s business, and the need to have an adequate capital base. In addition, however, the Central Bank of Jordan issued new regulations requiring the minimum capital of all Jordanian Banks to be JD 5 mil1ion. During the first half of 1986 the new authorised capital was duly paid up, most being subscribed by the existing shareholders. Under Jordanian law existing shareholders are given the first option of purchase when the company’s capital is increased, and they have 15 days to exercise their right. Most chose to do so, as the bank’s shares had steadily increased in value, and proved a sound investment. The shareholders were confident in the management, and there was a ready market for existing shares. The number of shareholders of course varies, but the majority are private rather than institutional investors. The management estimated that there were over 5,000 shareholders in 1986, with the average nominal holding therefore being JD 1,200 although the shares themselves were worth twice this amount.

Sheikh Saleh Kamel of Saudi Arabia is Chairman of the Board of Directors, but his holding in the Bank is below JD 250,000. The Al Baraka Investment and Development Company has a similar shareholding, it being a Jordanian company which is wholly owned by the Al Baraka international group. Over 95 per cent of the capital is Jordanian owned. The bank is not a member of the International Association of Islamic Banks, which tends to be dominated by Prince Mohammed bin Faisal’s Islamic banks. Like other Al Baraka associates, the bank prefers to remain independent of this grouping, although in its overseas business it will deal with other Islamic Banks, including the Faisal Islamic Banks, in preference to secular commercial banks. All the bank’s operations are fully in accordance with the Shari’a law, and Sheikh Abdul Hamid Essayeh, a respected Jordanian religious authority, acts as the Shari’a consultant,

Share values

Shares in the Jordan Islamic Bank have been actively traded since the creation of the company in 1979. Dealings in bank shares account for around 70 per cent of transactions in the Amman Financial Market, an exchange which has become the second most important in the Arab Middle East after Cairo in terms of the value of transactions.

Kuwait

used to be the leading market in the region, but dealings remain depressed following the Souk A1-Manakh debacle in 1982. The volume of dealings in shares in the Jordan Islamic Bank peaked in 1980 and 1981 as Table 1 shows, but since then the amount of trading has fallen. In 1980 it was the second most traded company on the Amman Financial Market after the Jordan and Gulf Bank, but more recently dealings have declined. The initial high volume of transactions partly reflected the enormous amount of interest in this new type of financial institution by market participants. Shareholders today tend to regard their holdings as long term, however, rather than tradeable instruments which can be sold to realise capital gains.

Table 7.1 Equity position of the Jordan Islamic Bank

	Value of shares traded (JD thousands)	Numbers of shares traded (thousands)	Average share price1 (JD)	Yield2 (%)
1979	542	503	1.078	0.0
1980	4059	2757	1.472	0.0
1981	3886	2732	1.423	3.51
1982	6402	2517	2.544	3.14
1983	7261	2310	3.143	2.54
1984	6693	2015	3.322	2.71
1985	826	308	2.678	3.36
19863	186	82	2.268	ND4

Notes:

1 Nominal value is JD 1,000

2 Calculated on the basis of shareholders dividend in relation to the actual average share

price

3 January to June

4 ND — not declared

Sources: Jordan Islamic Bank 1979—85; Central Bank of Jordan 1986

There is a willingness to hold on to the shares even when their value declines as shareholders feel themselves committed to the bank. As a capital asset the shares have done relatively well in any case. As Figure 1 shows, share prices in the Jordan Islamic Bank have consistently outperformed the index for all banks, as well as the

Amman

financial market index for all shares. Prices rose more than twice the general share index over the 1979-86 period and although bank shares did better than those for manufacturing and distributive trades, the value of shares in the Jordan Islamic Bank increased by almost 50 per cent more than banks on average. It was only during the 1980-81 period that the shares in the Jordan Islamic Bank performed less adequately, but this reflected the uncertainties of the early settling-down period. Nevertheless during this period the overwhelming majority of founder shareholders willingly subscribed to the increases in paid up capital as already indicated.

Deposit growth

The Jordan Islamic Bank started from a modest deposit base as might be expected for a new and novel kind of financial institution. Jordanians tend to be conservative, especially in financial matters, and preferred to adopt a “wait and see” approach before depositing their own funds. The initial publicity that surrounded the opening of the new bank brought only a limited public response, and most of the initial depositors were the bank’s own investors. The management was content to have a slow build up of business initially, as it would not have been easy to employ profitably a sudden surge in deposits in any case. Advertising was rejected as a means of attracting clients, instead the management’s policy was that the bank’s reputation could best be spread by word of mouth from existing satisfied customers to their relatives and friends.

Source:Central Bank of Jordan, monthly statistical bulletin and Amman Financial Market

It would, of course, have been easy to expand deposits rapidly by targeting a few affluent customers and larger businesses which could have deposited substantial sums. In Jordan there are several thousand such people, some of whom are extremely devout in their religious observance. Management’s aim, however, was to establish a wide deposit base by attracting as many customers of modest means as possible. This inevitably meant more administrative effort, and raised bank overheads. The advantage of such a policy was that the deposit base would be more stable than if some affluent customer decided to withdraw all his funds at once. One year after opening, by the end of 1980, there were around 5,000 depositors, and by 1986 the number had grown to 65,000.¹¹ The average size of deposit is under JD 2,000, and some clients have deposits of JD 200 or less. The size of deposits has tended to fall over the time despite the aggregate growth, a trend which the management is pleased to see. The aim is to make the institution a people’s bank for the community of believers.¹² The major means of expanding the deposit base was by establishing a branch network throughout Jordan. There are now 13 branches of the bank, from Irbid in the north to Aqaba in the south. Five of the branches are in Amman, where over one third of Jordan’s population is concentrated, including most of its more affluent citizens. The spread of branches in the region may have contributed the decline in the average value of deposits, but it means the bank is regarded as a truly national institution. Further branches are planned including Mafraq in the north, Salt, high above the Jordan Valley, and possibly Azraq in the east. Jordan is of course a limited market, and the geographical possibilities are soon exhausted, but the management plan is to open a new branch each year, at least for the next five years. The bank has no ambitions outside Jordan, being an essentially national institution.¹³

Types of deposit

Figure 2 illustrates the growth of deposits since the Jordan Islamic Bank’s inception. Initially trust accounts were the most popular, these being current accounts on which cheques can be drawn, as already indicated. The management was keen at the start to encourage such transactions accounts which earned no return, until the bank could build up an investment portfolio. Since 1980, however, joint investment accounts have become more significant, and it is this type of account which has come to dominate in terms of deposits. The percentage of total deposits accounted for by joint investment accounts rose from 54 per cent in 1980 to almost 62 per cent in 1983, and over 70 per cent by 1986. Of the various types of joint investment account offered, the fixed term account has proved the most popular, as it earns the highest return, 90 per cent of the declared profit proportion. Over 90 per cent of the joint investment deposits are of this type.

From the bank’s point of view this dominance of fixed term accounts means a secure deposit base. At least a year’s notice must be given for funds to be withdrawn, and in practice the amount under notice is extremely low. The bank can therefore back projects on a long-term basis, secure in the knowledge that most of its funding is also long term. There is little need to worry about unanticipated calls for funds, as in the case of riba commercial banks. Depositors know, however, that if an unexpected need arises, and there are unforeseen expenses such as hospital bills to be paid, then the bank will provide help. The bank maintains a Qird Hasan,¹⁴ or social purpose fund, to help the needy. A total of 595 loans was granted from this fund on an interest-free basis in 1985, these being worth JD 238,321. The bank has started to accept Qird Hasan deposits which must be specifically used to alleviate social hardship. In 1985 a total of JD 14,628 was deposited by 68 customers on this charitable basis.

Figure 2: J.I.B. DEPOSIT GROWTH

The management is keen to attract specified investment accounts, which as Figure 2 shows have grown steadily since 1983. By 1986 these accounted for over 10 per cent of deposits, and the management’s objective is to increase these accounts to over one- fifth of deposits by 1990. With this type of deposit, funds are invested in specified investment projects which the depositor requests, and the rate of return directly depends on the particular project being funded, rather than the bank’s overall profit. The depositor has therefore a greater degree of choice, but he bears the risk, and makes the gain (or loss).¹⁵ The bank’s role is to provide financial management for the project. It ensures that the funds are properly used, and that the interests of the investor are protected. The bank is therefore an investment services manager, bringing the parties in need of funds in touch with those with surplus funds.

Many customers maintain more than one type of deposit, running a trust account for their transactions’ needs, while at the same time placing longer-term funds in joint or specified investment accounts. Some of these long-term accounts are precautionary balances, to cover items such as medical expenses, although in Jordan, given the emphasis on education, many of the balances are to cover future school and university fees. This is a major expenditure item for most middle-class households, but through savings, the cost can be met over a longer period of time. Needs can be reasonably, well anticipated in advance with educational fees, and for this purpose a joint investment account with a fixed one year notice provides the ideal investment vehicle.

Role of Jordan Islamic Rank compared to other banks

The extent to which Islamic banks contribute to the institutionalisation of savings, has long been debated. It is through this process that a positive contribution to development can be made by matching savings with investment needs. Funds are employed in a systematic fashion using some form of rate of return criterion, thereby ensuring a more optimal use of resources. A major contribution to this process is made if Islamic banks encourage those who were not previously in the banking habit to use their services. Many Moslems were hesitant to use riba-based financial institutions, but Islamic banks provide them with a halal¹⁶ system of finance, to which there is no religious objection. Indeed, for believers, dealing with such institutions is preferable to personal hoarding, which like riba transactions, is condemned in the Quran.

The Jordan Islamic Bank seems to have attracted several thousand customers who were not previously in the banking habit, although the exact number cannot be assessed precisely, as clients are not asked such questions when they open accounts. It seems likely that many trust (current) account holders are in this position, a quarter of the total Some may have used riba banks in the past, and then closed their accounts when the Jordan Islamic Bank opened, but this probably only applies in a small minority of cases Bank customer loyalty is as significant in Jordan as elsewhere. Few with trust accounts with the Jordan Islamic Bank maintain current accounts with other banks, however, as the holding of multiple accounts which earn no return is extremely wasteful.

Many clients of the Jordan Islamic Bank who maintain only joint investment accounts also have current accounts with other banks. This applies especially in the case of business customers. The accounts with the Jordan Islamic Bank are viewed as long-term investments, whereas the other accounts are transactions balances. For individuals this is less likely to be the case, and they may not need current accounts. Jordan remains, like other Arab countries, an essentially cash-based society as far as personal transactions are concerned, with cheques and credit cards¹⁷ used much less than in the West. In these circumstances banks are regarded as primarily savings institutions. Even foreign exchange transactions, apart from those for large amounts or letters of credit seldom go through the banking system. Money changers handle most foreign exchange deals, including remittances, which were very important, and continue to have some significance for the Jordanian economy.

The Jordan Islamic Bank has probably not contributed as much to the spread of banking as some of the Islamic banks in the Gulf, simply because most Jordanian with significant means already banked prior to its establishment. The bank has made a more significant contribution to the spread of banking in the provincial centres where it established branches, rather than in Amman, which was financially more sophisticated. Overall it would seem most appropriate to suggest that the Jordan Islamic Bank has tended to complement the activities of the riba banks rather than be a substitute for them, but this reflects the Jordanian financial environment, rather than any shortcomings in the bank itself.

The Jordan Islamic Bank is continuing to expand its deposits rapidly, however, in spite of the recession which Jordan is experiencing. Table 2 shows recent deposit growth, which has been extremely rapid, especially for joint investment accounts. These are growing much more rapidly than trust accounts, perhaps reflecting the fact that the new customers being attracted are lower income earners who do not require chequing and other similar facilities. The bank seems to be doing better than riba-based banks in terms of deposit growth, particularly with regard to time deposits, No comparison was possible for specified investment accounts, as other Jordanian banks do not offer such deposit facilities.

Table 2: Recent Trends in Deposit Growth in the Jordan Islamic Bank for Finance and Investment

Accounts	Trust accounts	Joint investment accounts	Specified investment account
Deposit value (JD)
Dec 1984	22,297,948	60,570,798	6,610,710
June 1985	24,696,330	68,977,848	9,895,949
Dec 1985	23,745,917	79,118,479	10,703,701
June 1986	24,876,300	90,400,921	13,228,938
Deposit growth (%)
Dec 1984-Dec 1985	6.51(-10.2)2	30.61 (15.0)2	61.9
June1985-June 1986	0.71 (0.5)2	31.01 (9.8)2	33.7
Deposit shares (%)
Dec 1984	24.9	67.7	7.4
June 1986	19.4	70.3	10.3

Notes: ¹Refers to demand deposits in all commercial banks.

²Refers to time deposits in all commercial banks.

Sources: Jordan Islamic Bank for Finance and Investment, Seventh Annual Report, 1985, and Balance Sheet, June 1986. Central Bank of Jordan Monthly Statistical Bulletin, June 1986.

Asset deployment

Most of the Jordan Islamic Bank’s funds are placed in Islamic investments on a profit basis. Figure 3 shows the growth of the bank’s assets, with almost JD80 million invested on an Islamic basis by 1986, and over JD 45 million in cash holdings. Initially cash holdings predominated, as Islamic investments take time to 21 but by 1980 Islamic investments were already more significant. The proportion of bank assets accounted for by Islamic investments amounted to over 54 per cent by 1983, and by 1986 this figure had risen to almost 56 per cent out of a total asset portfolio exceeding JD 142 million. These Islamic investments mostly consist of 1 advances to business clients on the profit sharing principle. About 20 per cent are trade credits provided through the purchase of goods on behalf of clients, who re-purchase the goods when they in turn have arranged sales.

This figure also includes leasing arrangements on the ijara¹⁸ Islamic principle. The leasing is for a specified period, at the end of which the client will make a final payment and take over the ownership of the goods in question.

The relatively high holdings of cash by the bank should be noted. In 1983 this proportion was 26 per cent, and in 198 the figure had risen to almost 32 per cent. This refers partly to cash in hand, but it also includes deposits with other commercial banks and the Central Bank of Jordan. These inter-bank deposits are placed on a no interest earning basis. The high level of cash reserves partly reflects the conservative policy of the bank’s management, and the desire to maintain adequate liquidity. Cash holdings are higher than the management would like, however, partly reflecting the recession in the Jordanian economy, and the lack of investment opportunities in the present climate. A proportion of around one-quarter is considered optimum, but the management does not wish to make high risk advances, and views the additional cash as a welcome hedge during this period of business uncertainty.

Islamic community finance

The specified investments identified separately in Figure 3 are also, of course, undertaken on an Islamic basis, and the essential principle involved is mudarabah or profit sharing. These investments, nevertheless, have to be distinguished from the more general type of Islamic investments already discussed, which take the form of portfolio investment in the sense that the Jordan Islamic Bank has only a minority stake in the enterprises it is supporting. With specified investments the bank itself is the instigator of the investment, and wholly owns and controls the projects involved. This can therefore be regarded as direct investment. The major instance of this type of investment is the Al-Rawdah housing project in north Amman. In 1981 the bank acquired a plot of 40 donnoms¹⁹ opposite to the Al Rai daily newspaper offices in the north of Amman for housing development for middle income citizens, and a larger plot the same year in the south of the capital near Jabal Al-Hashimi. This was for a comprehensive housing scheme for low-income citizens.

Work was started on the smaller plot in north Amman first, with the preliminary study completed within a few months of the plot being acquired. Construction started in October 1983. A commercial centre containing a supermarket and other shops is being built together with 30 villas and seven residential buildings containing 213 apartments. A mosque, community hall, and school are being constructed. Work is almost complete, and the first occupants should start to move in during 1987. Disbursements have accounted for almost 87.4 per cent of the funds invested in the specified investment accounts by 1986, the remaining sum being accounted for by the land purchase at Jabal Al-Hashimi for the low-income housing scheme. Some of the investors are hoping to live in this new Islamic community themselves, which will be a very attractive residential suburb of Amman. This ambitious project has taken up much of the bank’s efforts in the last few years, but once the villas and apartments are occupied, returns will start to come in, and the bank plans to go ahead with the development of the Jabal Al-Hashimi site as well as other specific projects.

As Table 3 shows, the assets accounted for by specific investments continue to grow rapidly reflecting these housing developments. If specific investment funds from depositors continue to grow as rapidly as recently then a corresponding build-up of the bank’s specific investment will occur. The Jordan Islamic Bank will be well placed to undertake further large direct investments in housing and other fields, and the experience learnt from the Al-Rawdah scheme should be invaluable.

Table 3: Assets of the Jordan Islamic Bank for Finance and Investment

	Cash	General Investment	Specific investment	Fixed assets
Asset Value (JD)
Dec 1984	27,555,017	63,013,403	5,636,284	3,842,930
June 1985	33,442,402	66,404,051	4,111,218	4,472,492
Dec 1985	38,855,419	71,013,906	10,107,048	4,865,563
June 1986	45,362,485	79,650,758	12,279,117	4,969,438
Asset growth (%)
Dec1984-Dec1985	41.0	12.7	79.3	26.6
June1985-June1986	35.6	19.9	34.8	11.1
Asset Shares (%)*
Dec 1984	27.0	61.7	5.5	3.8
June 1986	31.2	54.8	8.5	34.0

Note: Does not add to 100 per cent as other assets such as securities, non-interest yielding bills, etc., excluded.

Sources: As Table 1.

General investment policy

Figure 4 shows the distribution of funds by the Jordan Islamic Bank. This refers to the allocation of the Islamic investment funds already discussed, rather than the specified investments which have been in housing to date as indicated in the previous section. Most of the bank’s lending has been to industry, mainly small manufacturing establishments producing plastics, soaps; medicines and other products which are sold mostly in the local market and in neighbouring Arab countries such as Iraq. The bank has been much more involved in industrial lending than other Jordanian banks, as many of its depositors are those involved in manufacturing. It is hoped to increase investment exposure in manufacturing, as this sector has been more buoyant than most, despite the recession and payments difficulties with Iraq.

Advances for trade are second in importance as Figure 4 shows, much of this being on a resale basis as already discussed. This type of advance is more liquid than industrial investments which tend to be long term, the period for trade advances typically being one year or less, and often as short as three months. Jordan’s imports are being curtailed because of balance of payments difficulties, and the bank’s management expects that trade finance, which usually covers imports, will at best

Figure 4: DISTRIBUTION OF FUNDS BY J.I.B.

1984 Total Lending = J.D. 63 million

1985 Total Lending = J.D. 71million

Source : Jordan Islamic Bank Data Base

maintain its share in the years ahead. Lending for real estate acquisition has continued to increase. With real-estate values depressed, the bank’s view is that this is a good to invest, as property will appreciate once the economy moves out of recession. This seems a reasonable judgment, as prices are no longer falling, and the expectation is for a market improvement. It was only financial institutions which invested in real estate speculation at the height of the boom in the 1970s that got into difficulties over asset valuations when the boom ended. The Jordan Islamic Bank avoids speculative investment however, as this would be against the institution’s principles. Rather the ephasis is on aiding believers to acquire property at reasonable prices for their own long-term use, and that of other believers.

Investment in transport undertakings declined over the 1984-85 period in relative terms as Figure 4 shows, largely reflecting the difficulties in Iraq’s trade which most of the transportation companies are involved in. The future demand for this type of advance is difficult to predict, as much depends on Iraq’s position in the Gulf War. The bank would like to invest more in agricultural projects, but the kingdom’s agriculture is experiencing marketing difficulties after the rapid expansion of production in the Jordan Valley in the 1970s. Saudi Arabia has a surplus of its own heavily subsidised wheat production, and some of the other Gulf states are producing tomatoes and other produce at great expense in greenhouse units. The advances to individuals are mainly to professionals such as doctors and dentists, for the purchase of equipment. The bank hopes to advance more to this type of client, as they are extremely reliable, and know exactly how to use their advances usefully.

Returns on investment

The revenue which the Jordan Islamic Bank earns on its investments compares favourably with the earnings of other financial institutions. Figure 5 shows the returns since 1980, which are expressed in money values. The decline over the 1982-84 period merely reflects the drop in the rate of inflation, and in real terms the return is higher. Inflation has declined from over 7 per cent in the early 1980s to under 4 per cent per annum. This means a real rate of return of 31/2 per cent over the 1984-85 period, which is quite adequate by Jordanian standards. Higher returns can of course be earned by more risky investments, but the bank’s management tends to be prudent in its asset deployment policy, as already indicated. Furthermore the bank is keen to back socially-constructive projects, rather than ventures of dubious national value to Jordan.

Figure 5 also shows the margin for risk which the bank sets aside in case of default by those funded. In practice the calls on these reserves are very limited, as the bank’s clients, being committed Moslems, are honest in their business dealings, and are fully aware of their responsibilities towards the bank and its depositors. The bank has perhaps the best clientele in Jordan in terms of the customers to whom it makes advances. Nevertheless, in business, problems often arise which are unforeseeable, as this is the nature of any investment undertaking. Therefore the bank likes to adopt a

Figure 5: RETURNS ON ISLAMIC INVESTMENTS AND RISK PROVISION %

safety first approach, and allow an adequate margin of funds to cover any contingencies that might arise. With the favourable repayments record, and good return on investment, it has been possible to establish a large contingency fund for investment risk, which stood at over JD 3 million in 1986. A specific portion of the bank’s cash assets is earmarked for this fund.

Distribution of profits

Figure 6 shows the profits which have been distributed to investors. These are, of course, determined by the bank’s own investment returns. They compare favourably with the interest paid by riba-based commercial banks, the returns being consistently above the rate of inflation. The return has been calculated on the basis of 90 per cent of the declared dividend, the rate earned by those holding fixed term joint investment accounts, which, as already indicated, accounts for the overwhelming proportion of investment deposits.

This return is above the interest which most of those holding time deposits with the riba-based banks earn. Only those who deposit very large amounts with the Jordanian commercial banks can earn higher returns. The Central Bank of Jordan until 1982 set a minimum rate which riba-based banks paid to those with time and savings deposits. Following concern that this was raising interest rates for borrowers, the Central Bank decided to set a maximum rather than a minimum rate. Both rates are shown in Figure 6 for the respective time period for which they applied by the long dashed lines above and below the profit return on Islamic investments. The dotted lines indicate the actual maximum and minimum which the commercial banks paid during periods when these were not enforceable by statutory limits. Overall, it seems that investors with the Jordan Islamic Bank have fared well, and the bank has been able to reward them adequately while still maintaining a cautious investment strategy.

Figure 6: PROFITS FOR DISTR TO JOINT INVESTMENT ACCOUNT HOLDERS COMPARED TO INTEREST PAYMENTS BY RIBA BANKS

Staffing issues

The Jordan Islamic Bank recruited most of its initial senior staff from other Jordanian banks and the financial services sector, as the emphasis was on the hiring of competent and experienced personnel. There was little need to recruit abroad given the wealth of banking talent within Jordan, some of whom were enthusiastic about the new type of financial institution as it meant they could pursue a banking career which was in harmony with their religious beliefs. Most had university degrees as well as the professional banking qualifications.

Further down the seniority ladder, school leavers were recruited for clerical and other tasks, and the bank developed its own training programme. Within the bank’s new headquarters building in the Shmeisani district of Amman there are a lecture room and teaching facilities. Specialist courses are provided for the bank’s staff on Islamic banking practices and techniques. Employees have also been sent to the Banking Institute of the Central Bank of Jordan for training. The bank has also co-operated with local educational institutions including the University of Jordan, and has offered trarneeships in Islamic banking to a number of economics and business studies students, some of whom have subsequently been taken on by the bank. Scholarships in Islamic finance are also offered to outstanding students, which are tenable at the University of Jordan on a sandwich course principle combining academic study with practical training. Recruitment is generally presenting no problems, with many more applicants than jobs at all levels. Jordan with its well educated workforce now faces the problem of graduate unemployment. The bank is therefore giving priority to graduate recruitment, although, of course, given its small size, it can only hire a limited number of graduates each year from Jordanian universities.

The Islamic investment house

The encouraging success of the Jordan Islamic Bank contrasts with that of the kingdom’s other major Islamic financial institution, the Islamic Investment House. This institution was founded on 10 September 1981 with an authorised capital of JD4 million, the same amount as the Jordan Islamic Bank.²¹ It received its permit to operate from the Central Bank of Jordan on 28 December 1981. Very comprehensive regulations were drawn up for the working of the institution, even more detailed in fact than those for the Jordan Islamic Bank. The institution was partly founded as a result of a Kuwaiti initiative, with Mr.Tukhaim Fahd Al-Tukhaim as chairman. Most of the directors were Jordanian however, including Mr Khairy Ayyoub Al Hammoury, the Vice-Chairman and General Manager. Sheikh Motlaq Al-Mohtaseb, a prominent Jordanian religious authority, was appointed as the Shari’a advisor.

The aims of the institution were similar to those of the Jordan Islamic Bank, as it was intended to provide financial services for both investors and those in need of funds on a riba-free basis. From the start, however, the institution was regarded as a vehicle for those with substantial funds to invest, rather than an ordinary deposit bank. As its name suggested, it was primarily an investment house, although the use of the word house in the title was partly be some Moslems object to any reference to banks.²²

The Jordan Investment House did not establish a branch network, however although it offered similar types of accounts to the Jordan Islamic Bank, including demand deposits, and three kinds of joint investment deposit. Initially in 1982 only demand deposits were accepted, and JD 729,971 was deposited. By 1983 when joint investment deposits started to be accepted, demand deposits fell to JD 633,251, as some investors switched to profit-earning deposits. Notice deposits proved the most popular as with the Jordan Islamic Bank, these accounting for around 90 per cent of the JD 1.5 million in joint investment accounts in 1983.By 1984 this figure had grown to over JD 5.5 million, including JD 628,000 deposited in foreign currency. This represented about 9 per cent of the amount invested in the Jordan Islamic Bank.

Investment policy

The Islamic Investment House pursued an active investment policy with the limited funds it had at its disposal. The investments undertaken were imaginative, and at first sight seemed sound projects to back. A 30 per cent stake was acquired in the ship Farah which carries passengers, cars and trucks from Aqaba to other Red Sea ports including Jeddah in Saudi Arabia, and more recently Nueiba in Egypt. Advances were also given to house purchasers, who repaid by instalments over a 10-year period. Over 150 advances were given for such purchases. The Islamic Investment House also financed the building of villas in the Zayy and Al-Ghour areas of Amman for rental. In 1983 an agreement was signed between the Islamic Investment House and the Tukhaim International Exchange Company of Kuwait for the House to manage the latter company in return for a share of its profits. This company was also controlled by the Islamic Finance House’s chairman, Mr Tukhaim Fahd A1-Tukhaim. The purpose of the agreement was to facilitate money transfers between Kuwait and Jordan. The House also invested in Jordanian industrial companies, including the Jordan Steel Industries Company and the Vegetable Processing and Preservative Company. In addition a plot of 1,500 donnoms was acquired for market gardening through greenhouse cultivation of vegetables, and it was planned to use part of the plot for a dairy farm, and another part for lamb fattening.

All these ambitious projects were supervised by the Islamic Investment House’s small staff of 1.5 in 1982, and 35 by 1983-84. A very high proportion of the House’s deposits was invested, only 22.7 per cent of assets being liquid cash or bank deposits in 1982. The following year this proportion declined to 11 per cent, although in 1984 there was a slight increase to 13.7 per cent. This left only a small margin to meet unexpected withdrawals by depositors. These were less than half the proportion of cash reserves held by the much more prudent management of the Jordan Islamic Bank. Clearly with hindsight it appears the Islamic Investment House was not adequately covered to meet unforeseen contingencies.

The financial crisis

The worsening recession in the Jordanian economy and the neighbouring Arab states had disastrous consequences for the Islamic Investment House. Problems started to appear in 1983, but the House was committed to the projects it was backing, and did not want to let its clients down. The real estate ventures were particularly unfortunate, as there were problems letting the villas in Zayy and Al-Ghour, as the market became depressed, and there were few newcomers seeking this type of rather expensive rented accommodation. Many of those who had been given advances for house purchase were unable to repay the instalments to the House, as their incomes had fallen with the recession, and a large proportion was dependent on income from the Gulf.

The fall in remittances with the oil recession and the dismissal of Jordanian workers in Saudi Arabia and the Gulf affected the business of the Tukhaim International Exchange Company, whose profits were sharply reduced. Furthermore the recession even affected the profitability of the ship Farah which had fewer passengers and vehicles to carry. In spite of these setbacks, the Islamic Investment House tried to maintain a high return to depositors, as the management realised that funds might be withdrawn if the rates did not stay competitive with those offered by the Jordan

Table 4: Returns to Deposits with the Islamic Investment House and Jordan Islamic Bank

Islamic Investment House and Jordan Islamic Bank

	Islamic Investment House		Jordan Islamic Bank
	1983	1984	1983	1984
Investment deposits	5.4	5.5	2.7	2.8
Notice deposits	6.3	6.5	3.8	4.0
Fixed deposits	8.1	8.3	4.9	5.1

Sources: Islamic Investment House Second and Third Annual Reports, 1983 and 1984, Amman and Jordan Islamic Bank Fifth and Sixth Annual Reports, Amman, 1983 and 1984.

Islamic Bank. Profits paid out were as shown in Table 4 for 1983 and 1984. These were in fact higher than those for the Jordan Islamic Bank, being over 60 per cent greater for the one-year fixed deposits in which most account holders invested. Those investing with the Islamic Investment House may have expected a higher return however, as placing money with a small institution always implies a greater risk.

With low profits on its investments, and the need to pay out high returns to its account holdings, the Islamic Investment House got into serious difficulties in 1984. A rumour spread that it could no longer meet withdrawals by depositors, although this was unfounded. Nevertheless, the value of its shares started to decline rapidly, and the Central Bank of Jordan feared that the situation might become critical if it did not step in.²³ Share dealings in the Islamic Investment House were suspended, and the House was prohibited from taking further deposits. The value of existing deposits was guaranteed by the Central Bank, but no dividend was paid out for 1985, and none was expected for 1986. The institution has, in practice, become a closed fund, although depositors will be able to get their funds back in instalments if they wish. Most are holding on, however, as the Islamic Investment House hopes to pay dividends again in the future when the economic situation improves.

Investors cannot complain too much, as the Islamic Investment House had tried to honour its commitments, and they have not lost their deposits. Rather, all they have forgone are the dividend receipts. Their deposits were placed on a profit-sharing basis, however, and with no profits, there can be no gain. This must be a lesson for the investors, but the principle of sharing in hardship as well as in good fortune is, after all, an important tenet of the Moslem religion.

Despite the setbacks which the Islamic Investment House has experienced, the Jordanian experience of Islamic banking has been on the whole one of success, with the Jordan Islamic Bank emerging as a major domestic financial institution. It now ranks sixth in terms of the value of assets as far as Jordanian banks are concerned, and it is the second fastest growing Jordanian bank after the Bank of Jordan and the Gulf. It accounts for over 5 per cent of the total assets of the Jordanian banking system.²⁴

The Jordan Islamic Bank has also been successful in encouraging many believers to use its services as a riba-free bank rather than hoarding. It ranks fifth in Jordan in terms of deposits, and its deposits are growing at a more rapid rate than any other major Jordanian bank. Its financial caution has proved justified given the experience of the Islamic Investment House. The Jordan Islamic Bank ranks seventh out of 18 major Jordanian financial institutions in its holding of liquid assets as a proportion of deposits, a position which the management intends to maintain. Yet it was the eleventh most profitable institution in gross (pre-tax) terms, and ninth in terms of net profit in relation to paid-up dividend. This ratio was a reasonable 16.6 per cent. All this augurs well for the future of Islamic banking in Jordan, which after seven years is already well established and prospering. Jordan is likely to maintain a plural banking system, with riba and halal institutions existing side by side, but the experience of the Jordan Islamic Bank shows that this type of bank can function effectively, serve its clients well, and compete in the market with the other institutions while strictly 5 to Islamic principles.