PART 1: (Islamic Banking in Islam) RIBA AND INTEREST
Question No. 1).
What is Islamic Banking?
Answer: Islamic
banking is defined as banking system which is in consonance with the spirit,
ethos and value system of Islam and governed by the principles laid down by
Islamic Shariah. Interest free banking is a narrow concept denoting a number of
banking instruments or operations which avoid interest. Islamic banking, the
more general term, is based not only to avoid interest-based transactions
prohibited in Islamic Shariah but also to avoid unethical and un-social
practices. In practical sense, Islamic Banking is the transformation of
conventional money lending into transactions based on tangible assets and real
services. The model of Islamic banking system leads towards the achievement of
a system which helps achieve economic prosperity.
Question No. 2). What is the philosophy of Islamic banking?
Answer: The
philosophy of Islamic banking takes the lead from Islamic Shariah. According to
Islamic Shariah, Islamic banking cannot deal in transactions involving
interest/riba (an increase stipulated or sought over the principal of a loan or
debt). Further, they cannot deal in the transactions having the element of
Gharar 1 or Maiser2. Moreover, they
cannot deal in any transaction, the subject matter of which is invalid (haram
in the eyes of Islam). Islamic banks focus on generating returns through
investment tools which are Shariah compliant as well. Islamic Shariah links the
gain on capital with its performance. Operating within the ambit of Shariah,
the operations of Islamic banking are based on sharing the risk which may arise
through trading and investment activities using contracts of various Islamic
modes of finance.
1
Excessive
level of uncertainty or ambiguity created due to the lack of information or
control in a contract. 2 Game
of Chance
The prohibition of a risk free return and
permission of trading, as enshrined in the Verse 2:275 of the Holy Quran, makes
the financial activities asset-backed in an Islamic set-up with ability to
cause ‘value addition’.
Question No.3) What is Meant By
Riba?
Answer: The word "Riba" means excess,
increase or addition, which correctly interpreted according to Shariah
terminology, implies any excess compensation without due consideration
(consideration does not include time value of money). This definition of Riba
is derived from the Quran and is unanimously accepted by all Islamic scholars. 3
The meaning of Riba has been
clarified in the following verses of Quran (Surah Al Baqarah 2:278-9)
"O those who believe; fear Allah and give up
what still remains of the Riba if you are believers. But if you do not do so,
then be warned of war from Allah and His Messenger. If you repent even now, you
have the right of the return of your principal; neither will you do wrong nor
will you be wronged."
Question No.4) What is
interest? Is there any difference between interest and
Riba?
Answer: The origination of term interest dates
back to 17th century with the emergence of banking system at
global level. Interest means giving and/or taking of any excess amount in
exchange of a loan or on debt. Hence, it carries the same meaning/value as that
of Riba as defined in the previous question. Further, it is narrated that “the
loan that draws interest is Riba”.4
3
Dr.
Muhammad Imran Ashraf Usmani (2002), Meezan Bank’s Guide to Islamic banking,
Darul Ishaat, Karachi, Pakistan, p 45
4
Dr.
Muhammad Imran Ashraf Usmani (2002), Meezan Bank’s Guide to Isalmic banking,
Darul Ishaat, Karachi, Pakistan, p 48
There is consensus among the
Muslim scholars of all the fiqhs that interest is Riba in all its forms
and manifestations. 5
Question No. 5) What are the
different kinds of Riba?
Answer: There are two kinds of Riba:
1.
Riba-An-Nasiyah/Riba-Al-Quran
2.
Riba-Al-Fadl
1. Riba An Nasiyah/Riba Al-Quran:
In the Holy Quran, Allah (SWT) says in Sura Al-Baqarah (2-279):
“ …..And if you repent, yours is your principal”
It is reported by Harith ibe
Abi Usamah in his Musnad that Sayyidna Ali Radi-Allahu Anhu reportedly referred
that the Holy Prophet said:
"Every loan that derives a benefit (to the lender) is riba"6.
Example of Riba-al-Nasiyah/Interest: If Mr. A
lends Rs.100 to Mr. B (a borrower) with a condition that Mr. B shall return him
Rs.110 after one month. In this case, the extra amount of Rs. 10 is Riba or
Interest.
2. Riba-al-Fadl:
Abu Said al Khudri Radi-Allahu
anhu narrated that Holy Prophet (Peace be upon him) said:
5 Dr.
Muhammad Imran Ashraf Usmani (2002), Meezanbank’s Guide to Islamic Banking”
Darul Ishaat, Karachi,
Pakistan, p 45”
6 Al-Syuti, Al-Jame’ al-Saghir V.2, P.94
"Gold for gold, silver for silver, wheat for
wheat, barley for barley, dates for dates and salt for salt, like for like,
payment made hand by hand. If anyone gives more or asks for more, he has dealt
in riba. The receiver and giver are equally guilty" 7
Based on aforesaid definition, it may be noted
that economically speaking it would be irrational to exchange one kilogram of
wheat with one and a half kilogram of wheat in a spot exchange. Therefore, some
fuqaha have pointed out that Riba-al-Fadl has been prohibited because if it was
left un-prohibited it could be used as a subterfuge for getting
Riba-al-Nasiyah. Of the six commodities specified in the hadith, two (gold and
silver) unmistakably represent commodity money used at that time. One of the
basic characteristics of gold and silver is that they are monetary commodities.
As a matter of fact, each of the six commodities mentioned in the hadith has
been used as a medium of exchange at some time or the other.
During the dark ages, only the first form (Riba
An Nasiyah) was considered to be Riba. However, the Holy Prophet (peace be upon
him) also classified the second form (Riba-al-Fadl) also as Riba8.
Question No. 6).
What are the
revelations/verses in Holy
Quran regarding
prohibition of Riba/interest?
Answer: There are
four sets of
revelations about Riba
which were revealed
on
different occasions.
1. First Revelation: In Surah-Ar-Rum, verse 39 ,
dealing in riba has been discouraged in the following words:
"And whatever riba you
give so that it may increase in the wealth of the people, it does not increase
with Allah." [Surah Ar-Rum 30:39]
2. Second Revelation: Muslims
have been informed about the practice of taking riba by Jews in Surah An-Nisaa:
"And because of their
charging riba while they were prohibited from it." [Surah An-Nisaa 4-161]
3. Third Revelation:
Riba/Interest has been abolished in the third verse of Surah Al-i-'Imran. The
prohibition of riba is laid down in the following words:
Islamic Banking in Islam
"O those who believe do
not eat up riba doubled and redoubled." [Surah Al-e-Imran 3- 130]
4. Fourth Revelation: In the fourth revelation,
Riba has categorically been prohibited in all its forms. The following set of
verses is found in the Surah Al-Baqarah, verse 275-281 in the following words:
"Those who take interest will not stand but
as stands whom the demon has driven crazy by his touch. That is because they
have said: 'Trading is but like riba'. And Allah has permitted trading and
prohibited riba. So, whoever receives an advice from his Lord and stops, he is
allowed what has passed, and his matter is up to Allah. And the ones who revert
back, those are the people of Fire. There they remain for ever. Allah destroys
riba and nourishes charities. And Allah does not like any sinful disbeliever.
Surely those who believe and do good deeds, establish Salah and pay Zakah, have
their reward with their Lord, and there is no fear for them, nor shall they
grieve. O
those who believe, fear Allah and give up what
still remains of the riba if you are believers. But if you do not, then listen
to the declaration of war from Allah and His Messenger. And if you repent,
yours is your principal. Neither you wrong, nor be wronged. And if there be one
in misery, then deferment till ease. And that you leave it as alms is far
better for you, if you really know. And be fearful of a day when you shall be
returned to Allah, then everybody shall be paid, in full, what he has earned.
And they shall not be wronged." [Surah Al-Baqarah 2:275-281]
Question No. 7) What are the
sayings/Ahadith9 about
Riba/Interest?
Answer: According to Islamic jurists and
scholars, there are around 40 different Ahadith on the subject of riba and its
prohibition from Holy Prophet (peace be upon him).
Few of these are as follows:
1.
From Hazrat Jabir (May Allah be pleased with him): The Prophet, cursed
the receiver and the payer of interest, the one who records it and the two
witnesses to the transaction and said: "They are all alike [in
guilt]." 10
2.
Jabir ibn Abdallah (May Allah be pleased with him), giving a report on
the Prophets Farewell Pilgrimage, said: The Prophet addressed the people and
said "All of the riba of Jahiliyyah is annulled. The first riba that I
annul is our riba, that accruing to Abbas ibn Abd al-Muttalib (the Prophet’s
uncle); it is being cancelled completely."11
9 Hadith
means a saying, action or sanction by the Prophet.
10
Narrated
in
Muslim, Kitab al-Musaqat, Bab lani akili al-riba
wa mukilihi; also in Tirmidhi and Musnad Ahmad.
11 Narrated in Muslim, Kitab al-Hajj, Bab Hajjati al-Nabi.
3.
From Hazrat Abdallah ibn Hanzalah (May Allah be pleased with him): The
Prophet, said: "A dirham of riba which a man receives knowingly is worse
than committing adultery thirty-six times"12
4.
Bayhaqi has also reported the above hadith in Shuab al-iman with the
addition that "Hell befits him whose flesh has been nourished by the
unlawful."
5.
From Hazrat Abu Hurayrah (May Allah be pleased with him): The Prophet
said: "On the night of Ascension I came upon people whose stomachs were
like houses with snakes visible from the outside. I asked Gabriel who they
were. He replied that they were people who had received interest."13
6.
From Hazrat Abu Hurayrah (May Allah be pleased with him): The Prophet
said: "Riba has seventy segments, the least serious being equivalent to a
man committing adultery with his own mother."14
7.
From Hazrat Abu Hurayrah (May Allah be pleased with him): The Prophet
said: "There will certainly come a time for mankind when everyone will
take riba and if he does not do so, its dust will reach him."15
8.
From Hazrat Abu Hurayrah (May Allah be pleased with him): The Prophet
said: "God would be justified in not allowing four persons to enter
paradise or to taste its blessings: he who drinks habitually, he who takes
riba, he who usurps an orphans property without right, and he who is undutiful
to his parents."16
12
Narrated
in
Mishkat al-Masabih, Kitab al-Buyu, Bab al-riba,
on the authority of Ahmad and Daraqutni
13 Narrated in Ibn Majah, Kitab al-Tijarat, Bab al-taghlizi fi al-riba; also in
Musnad Ahmad
14 Narrated in Ibn Majah.
15 Narrated in Abu Dawud, Kitab al-Buyu, Bab fi ijtinabi al-shubuhat; also in Ibn
Majah.
16 Mustadrak al-Hakim,
Kitab al-Buyu.
Question No.8) Are there any
injunctions against Riba/usury in religious texts
other than Holy Quran?
Answer: The following
references against the prohibition of Riba/usury are drawn from the old
testament of the bible17:
Deuteronomy 23:19: "Thou
shall not lend upon usury to thy brother; usury of money, usury of victuals,
usury of anything that is lent upon usury."
Psalms 15:1, 2, 5: "Lord, who shall abide in
thy tabernacle? Who shall dwell in thy holy hill? He that walketh uprightly,
and worketh righteousness and speaketh the truth in his heart. He that putteth
not out of his money to usury, nor taketh reward against the innocent."
Proverbs 28:8: "He that by
usury and unjust gain increaseth his substance, he shall gather it for him that
will pity the poor."
Nehemiah 5:7: "Then I consulted with myself,
and I rebuked the nobles, and rules and said unto them, Ye exact usury, every
one of his brother. And I set a great assembly against them."
Ezekiel 18:8.9: "He that hath not given
forth upon usury, neither hath taken any increase, that hath withdrawn his hand
from iniguity, hath executed true judgment between man and man, hath walked in
my statues, and hath kept my judgments, to deal truly; he is just. He shall
surely live, said the Lord God."
Ezekiel 22:12: "In thee have they taken
gifts to shed blood; thou hast taken usury and increase, and though hast
greedily gained of thy neighbors by extortion, and hast forgotten me, said the
Lord God."
In these excerpts of the Bible the word usury is
used in the sense of any amount claimed by the creditor over and above the
principal advanced by him to the debtor. The word riba used in the Holy Qur'an
carries the same meaning because the verse of Surah An-Nisaa (4-161) explicitly
mentions that riba was prohibited for the Jews also18.
17 Justice Maulana Muhammad Taqi Usmani (May 2005), The Historical
Judgment on Interest,
delivered in the Supreme Court of Pakistan,
Idaratul – Ma’arif, Karachi-14 – Pakistan , p 31-32
18 ibid
Question No. 9) Does
interest/Riba is related only to consumption loans or it
applies to commercial loans also?
Answer: The interest is prohibited whether it is
consumption loan (loan for meeting day to day human needs) or commercial loan
(loan for business purpose). There are quite a number of ahadith which clarify
that in the days of Holy prophet, people not only borrowed for consumption
purposes but also for productive purposes. A few of the ahadith are given as
follows for reference:
(i)
Ibn Saad has reported Hazrat Umar ( Radi-Allahu anhu), wanted to send
a trade caravan to Syriya. He borrowed four thousand dirhams from Sayyidna
Abdurrahman ibn Awaf, Radi-Allahu anhu for this purpose.19
(ii)
Ibn Jarrir has reported that Hind, daughter of Utbah and wife of Abu
Sufyan borrowed four thousand dirhams from Sayyidna Umar, Radi-Allahu anhu, for
the purpose of her trade. She invested this money in purchasing goods and
selling them in the market of the tribe of Kalb.20
This is an ample testimony that the commercial
loan was in practice when Quranic verses on Riba were revealed and the term
Riba covers not only consumption loan but also the commercial loan.
Question No.10) Does
the prohibition of
Riba apply equally
to the loans
obtained from or extended to Muslims as well as
non-Muslims?
Answer: With respect to the receipt and payment
of interest, there is no distinction between Muslims and non-Muslims or between
individuals and states because interest is prohibited not only in Islamic
scriptures but also in other religious scriptures of the world as given in
Question No. 8 above. Therefore, prohibitions of interest apply to Muslims as
well as to non-Muslims.
19 Ibn Saad, Al-Tabqat al-Kubra, Beirut,
V.3, P.278
20 Al-Tabari, Tarikh-al-Umam V.3, P.87,
Events of the year 23 A.H.
Question No.
11). What is the difference between conventional
banking and
Islamic banking?
Answer: The
following are the
main differential points
between conventional
banking and Islamic
banking.
Sr.
|
CONVENTIONAL
BANKING
|
|
ISLAMIC
BANKING
|
|
|
|
No.
|
|
|
|
|
|
|
|
|
|
|
|
|
1
|
Money is
a commodity besides
|
Money is not
a commodity though
it is
|
|
medium of exchange
and store of
|
used as a medium of exchange and store
|
|
value.
Therefore, it can be sold at a
|
of
value. Therefore, it cannot be sold
at
|
|
price higher than its face value and
|
a price higher
than its face
value or
|
|
it can also be rented out.
|
|
|
|
rented
out.
|
|
|
|
|
|
|
|
2
|
Time value
is the basis for charging
|
Profit on trade
of goods or
charging on
|
|
interest on capital.
|
|
|
|
|
providing service is the basis for earning
|
|
|
|
|
|
|
|
|
profit.
|
|
|
|
|
|
|
|
3
|
Interest
is charged even in case the
|
Islamic bank
operates on the
basis of
|
|
organization
suffers losses by using
|
profit and
|
loss sharing.
|
In
case, the
|
|
bank’s funds. Therefore,
it is not
|
businessman has suffered
losses, the
|
|
based on profit and loss sharing.
|
|
bank will share these losses based on the
|
|
|
|
|
|
|
|
|
mode of
finance used (Mudarabah,
|
|
|
|
|
|
|
|
|
Musharakah).
|
|
|
|
|
|
|
|
|
|
4
|
While
|
disbursing
|
cash
|
finance,
|
The execution of
agreements for the
|
|
running finance or working capital
|
exchange
of goods &
services is a
must,
|
|
finance,
|
no
|
agreement
|
for
|
while
disbursing funds under Murabaha,
|
|
exchange of goods
& services is
|
Salam & Istisna contracts.
|
|
|
|
made.
|
|
|
|
|
|
|
|
|
|
|
|
5
|
Conventional
banks use money as a
|
Islamic
banking tends to create link with
|
|
commodity
|
which
|
leads
|
to
|
the
real sectors of
the economic system
|
|
inflation.
|
|
|
|
|
|
by using trade
related activities.
|
Since,
|
|
|
|
|
|
|
|
|
the money is linked with the real assets
|
|
|
|
|
|
|
|
|
therefore
|
therefore
|
it
|
contributes
|
|
|
|
|
|
|
|
|
directly in the economic development.
|
Question No.
12): What are the basic principles of
Islamic banking?
Answer: There are at least six basic principles
which are taken into consideration while executing any Islamic banking
transaction. These principles differentiate a financial transaction from a
Riba/interest based transaction to an Islamic banking transaction.
1.
Sanctity
of contract: Before executing any Islamic banking transaction, the counter
parties have to satisfy whether the transaction is halal (valid) in the eyes of
Islamic Shariah. This means that Islamic bank’s transaction must not be invalid
or voidable. An invalid contract is a contract, which by virtue of its nature
is invalid according to Shariah rulings. Whereas a voidable contract is a
contract, which by nature is valid, but some invalid components are inserted in
the valid contract. Unless these invalid components are eliminated from the valid
contract, the contract will remain voidable.
2.
Risk
sharing: Islamic jurists have drawn two principles from the saying of prophet
Muhammad (SAW). These are “Alkhiraj Biddamaan 21 ” and “Alghunun Bilghurum22”.
Both the principles have similar meanings that no profit can be earned from an
asset or a capital unless ownership risks have been taken by the earner of that
profit. Thus in every Islamic banking transaction, the Islamic financial
institution and/or its deposit holder take(s) the risk of ownership of the
tangible asset, real services or capital before earning any profit there from.
3. No Riba/interest: Islamic banks cannot involve in
riba/interest related transactions. They cannot lend money to earn additional
amount on it. However as stated in point No. 2 above, it earns profit by taking
risk of tangible assets, real services or capital and passes on this
profit/loss to its deposit holders who also take the risk of their capital.
4. Economic purpose/activity: Every Islamic banking
transaction has certain economic purpose/activity. Further, Islamic banking
transactions are backed by tangible asset or real service.
5.
Fairness:
Islamic banking inculcates fairness through its operations. Transactions based
on dubious terms and conditions cannot become part of Islamic banking. All the
terms and conditions embedded in the transactions are properly disclosed in the
contract/agreement.
6.
No
invalid subject matter: While executing an Islamic banking transaction, it is
ensured that no invalid subject matter or activity is financed by the Islamic
financial transaction. Some subject matter or activities may be allowed by the
law of the land but if the same are not allowed by Shariah, these can not be
financed by an Islamic bank.
21 Gain accompanies liability for loss
22 Earning profit is legitimized only by
risk-sharing and engaging in economic activity.
Question No. 13) What is meant
by Shariah/Islamic Law?
Answer: Shariah lexically means a way or path. In
Islam Shariah refers to the divine guidance and laws given by the Holy Quran,
the Hadith (sayings) of the Prophet Muhammad (Peace Be Upon Him) and
supplemented by the juristic interpretations by Islamic scholars. Shariah
embodies all aspects of the Islamic faith, including beliefs and practices.
Islamic Shariah or the divine law of Islam is derived from the following four
sources:
1.
The Holy
Quran
2.
The Sunnah
of the Holy Prophet (Peace Be Upon Him)
3.
Ijma’
(consensus of the Ummah)
4.
Qiyas
(Anology)
Question No. 14): The end result of Islamic Banking and Conventional
Banking
is the same. Why do they appear similar?
Answer: The validity of a transaction does not
depend on the end result but rather the process and activities executed and the
sequence thereof in reaching the end. If a transaction is done according to the
rules of Islamic Shariah it is halal even if the end result of the product may
look similar to conventional banking product.
For example a normal McDonalds burger in USA and
Pakistan may look similar, smell similar and taste similar but the former is
haram and the later is halal due to its compliance of Islamic guidelines of
slaughtering animals.
Similarly, if a person is feeling hungry, he may
steal a piece of bread and eat or alternatively buy a piece of bread to eat.
The apparent end result would be same but one is permissible in Shariah and the
other is not allowed.
The same is also true for Islamic and
conventional banking. Therefore, it can be concluded that it is the underlying
transaction that makes something “Halal” (allowed) or “Haram” (prohibited) and
not the result itself. Apparently, Islamic banks
may look similar to conventional banks, however
the contracts and product structures used by Islamic banks are quite different
from that of the conventional bank. In the verse 2:275 of the Holy Quran, Allah
the Almighty has responded to the apparent similarity between trade and
interest by resolutely informing that he has permitted trade and prohibited
Riba (though they may look similar to someone).
Question No. 15) If Islamic banks do not invest
in interest based activities then
how do they generate profit to pay to their customers?
Answer: The Islamic bank uses its funds in
various trade, investment and service related Shariah compliant activities and
earns profit thereupon. The profit earned from such activities is passed on to
the depositors according to the agreed terms.
Question No. 16). Are not
Islamic banks just paying interest and dressing it as
profit on trade and investments?
Answer: No, Islamic banks accept the deposits
either on profit and loss sharing basis or on Qard basis. These deposits are
deployed in financing, trading or investment activities by using the Shariah
compliant modes of finance. The profit so earned by the bank is passed on to
the depositors according to the pre-agreed ratio which, therefore, cannot be
termed as interest.
Question No. 17): Islamic banks use interest base
system (KIBOR) as a Bench Mark while determining profit; how Islamic banking
can be said to be Islamic?
Answer: Islamic banks should ideally have their
own benchmark system for determination of profit. Since, the industry is in its
initial stage of development, it is using the available benchmark for the
banking industry. It is expected that once it is grown to a sizable level, it
would have its own benchmark. However, using Interest Rate benchmark for
determining the profit of any permissible transaction does not render the
transaction as invalid or haram. It is the nature/mechanism of the transaction
that determines its validity or otherwise.
For example Mr. A and Mr. B are
two neighbors. Mr. A sells liquor which is totally prohibited in Islam whereas
Mr. B, being a practicing Muslim dislikes the business of
Mr. A and starts the business of soft drinks. Mr.
A wants his business to earn as much profit as Mr. A earns through trading in
liquor. Therefore he decides that he will charge the same rate of profit from
his customers as Mr. A charges over the sale of liquor. Thus he has tied up his
rate of profit with the rate used by Mr. A in his prohibited business.
One may say that Mr. B uses an undesirable
benchmark in determining the rate of profit, but obviously no one can say that
the profit charged by him is haram because he has used the rate of profit of
the business of liquor only as a benchmark.
The same is true for Islamic banks, it is most
desirable and preferable that Islamic banks develop their own benchmark
however; in the absence of any such alternative, interest rate related
benchmark can be used.
Question No. 18) Is Islamic
banking meant only for Muslims?
Answer: The teachings of Islam are not confined
to Muslims, rather these equally address the non-Muslims due to their universal
nature. The basis of Islamic banks is laid down on ethical values and socially
responsible system. The values like justice, mutual help, fee consent and
honesty on the part of the parties to a contract, avoiding fraud,
misrepresentation and misstatement of facts and negation of injustice or
exploitation form the basic principles of Islamic banking. Therefore, the
principles of Islamic banking lead the economic system to achieve the common
good and economic prosperity. On this premise, Islamic banking becomes a viable
option for everyone irrespective of their religion.
PART 2: ISLAMIC MODES OF FINANCE
Question No.19) What are the major modes of Islamic banking and
finance?
Answer: The following are the modes of finance which
are or three categories:
1) Participatory modes of Finance
a) Mudarabah
b)
Musharakah
2)
Non
Participatory modes of Finance
a) Murabaha
b)
Musawamah
c) Salam
d)
Istisna
e) Ijarah
f) Ijarah wa Iqtina (Ijarah Muntahiyyah Bittamleek)
3)
Sub
contracts
a) Wakalah
b) Kafalah
c)
Rahn
Question No. 20). What is
Mudarabah?
Answer: A form of partnership where one party provides the funds while
the other
party provides expertise. The people who bring in
money are called "Rab-ul-Maal" while the management and work is an
exclusive responsibility of the "Mudarib". The profit sharing ratio
is determined at the time of entering into the Mudarabah agreement whereas in
case of loss it is borne by the Rab-ul-Mal only. In case of
Islamic banks, the depositors are called Rabb-ul-Maal and the bank is
called Mudarib.
There are two types of Mudarabah:
1.
Al-Mudarabah Al-Muqayyada: Rab-ul-Maalmal who, in case of Islamic
bank, is depositor specifies a particular business or a particular place for
the mudarib (bank), in which case he shall invest the money. This is called
Al-Mudarabah Al-Muqayyadah (restricted Mudarabah).
2.
Al-Mudarabah Al-Mutlaqah: In case where Rab-ul-maal (depositor) gives
full freedom to the Mudarib (bank) to undertake whatever business he deems fit,
this is called Al-Mudarabah Al-Mutlaqah (unrestricted Mudarabah).
It is necessary for the validity of Mudarabah
that the parties agree on a certain formula of sharing the actual profit right
at the beginning of the contract. The Shariah has prescribed no particular
proportion of profit sharing rather it has been left to the mutual consent of
the parties.
For the deposit management, Islamic banks create
different pools of investment keeping in view the risk and maturity profile of
the depositors. The deposits of the customers are placed in these pools and
profit therefrom is distributed between the bank and the depositors as per
weightages assigned at the time of agreement.
Mudarabah agreement cannot allow a lump sum
amount of profit for any party nor can it determine the share of any party at a
specific rate tied up with the capital. For example, if the capital is
Rs.100,000/-, parties cannot agree on a condition that Rs.10,000 out of the
profit shall be the share of the Mudarib nor can they say that profit
equivalent to 20% of the capital shall be given to Rab-ul-Maal. However they
can agree that 40% of the actual profit shall go to the Mudarib and 60% to the
Rab-ul-Maal or vice versa.
Question No. 21) What is
Musharakah?
Answer: Musharakah means a relationship
established under a contract by the mutual consent of the parties for sharing
of profits and losses in the joint business. Under Islamic banking, it is an
agreement under which the Islamic bank provides funds which are mixed with the
funds of the business enterprise and others. All providers of capital are
entitled to participate in management but not necessarily required to do so.
The profit is distributed among the partners in pre-agreed ratios, while the
loss is borne by each partner strictly in proportion to respective capital
contributions. The following are the rules with regard to profit and loss
sharing in Musharakah:
1.
The profit sharing ratio for each partner must be determined in proportion to
the actual profit accrued to the business and not in proportion to the capital
invested by him. For example, if it is agreed between them that 'A' will get
10% of his investment, the contract is not valid.
2. It is not allowed to fix a lump sum amount for
anyone of the partners or any rate of profit tied up with his investment.
Therefore if 'A' & 'B' enter into a partnership and it is agreed between
them that 'A' shall be given Rs.10,000/- per month as his share in the profit
and the rest will go to 'B', the partnership is invalid.
3. If both partners agree that each will get
percentage of profit based on his capital percentage, whether both work or not,
it is allowed.
4. It is also allowed that if an investor is
working, his profit share could be higher than his capital contribution
irrespective of whether the other partner is working or not. For instance, if
'A' & 'B' have invested Rs.1000/- each in a business and it is agreed that
only 'A' will work and will get two third of the profit while 'B' will get one
third. Similarly if the condition of work is also imposed on 'B' in the
agreement, then also the proportion of profit for 'A' can be more than his
investment.
5. If a partner has put an express condition in the
agreement that he will not work for the Musharakah and will remain a sleeping
partner throughout the term of Musharakah, then his share of profit cannot be
more than the ratio of his investment.
6. It is allowed that if a partner is not working,
his share of profit can be established at a rate lower than his capital share.
7. If both are working partners, the share of profit
can differ from the ratio of investment. For example, Mr. A and Mr. B both have
invested Rs.1000/- each. However, Mr. A gets one third of the total profit and
Bakar will get two third, this is allowed.
8. If only a few partners are active and others are
only sleeping partners, then the share in the profit of the active partner
could be fixed at higher than his ratio of investment eg. 'A' & 'B' put in
Rs.100 each and it is agreed that only 'A' will work, then 'A' can take more
than 50% of the profit as his share. The excess he receives over his investment
will be compensation for his services
The following are the Basic rules of distribution of Loss in case of
Musharakah:
All scholars are unanimous on
the principle of loss sharing in Shariah based on the saying of Syedna Ali ibn
Talib that is as follows:
"Loss is distributed
exactly according to the ratio of investment and the profit is divided
according to the agreement of the partners."
Therefore the loss is always subject to the ratio
of investment. For example, if Mr. A has invested 40% of the capital and Mr. B
has invested 60%, they must suffer the loss in the same ratio, not more, not
less. Any condition contrary to this principle shall render the contract
invalid.
Question No. 22) What is Murabaha?
Answer: Murabaha is
one of the
most common modes
used by Islamic
Banks. It
refers to a sale where the seller discloses the cost of the commodity
and amount of
profit charged. Therefore,
Murabaha is not a loan given on interest rather it is a sale of a commodity at
profit.
The mechanism of Murabaha is that the bank
purchases the commodity as per requisition of the client and sells him on
cost-plus-profit basis. Under this arrangement, the bank is bound to disclose
cost and profit margin to the client. Therefore, the bank, rather than
advancing money to a borrower, buys the goods from a third party and sells
those goods to the customer on profit.
A question may be raised that selling goods on
profit (under Murabaha) and charging interest on the loan (as per the practice
of conventional banks) appears to be one of the same things and also produces
the same results. The answer to this query is that there is a clear difference
between the mechanism/structure of the product. The basic difference lies in
the contract being used. Murabaha is a sale contract whereas the conventional
finance overdraft facility is an interest based lending agreement and
transaction. In case of Murabaha, the bank sells an asset and charges profit
which is a trade activity declared halal (valid) in the Islamic Shariah.
Whereas giving loan and charging interest thereupon is pure interest-based
transaction declared haram (prohibited) by Islamic Shariah.
Question No. 23) What are the
basic rules of a valid Murabaha transaction?
Answer: The following are the rules governing a Murabaha transaction:
1. The subject matter of sale must exist at the time
of the sale. Thus anything that may not exist at the time of sale cannot be sold
and its non-existence makes the contract void.
2. The subject matter should be in the ownership,
either actual or constructive, of the seller at the time of sale. If he sells
something that he has not acquired himself then the sale becomes void.
3. The subject matter of sale must be in physical or
constructive possession of the seller when he sells it to another person.
Constructive
possession means a
situation where the possessor has not taken physical delivery of the commodity
yet it has come into his control and all rights and liabilities of the
commodity are passed on to him including the risk of its destruction.
4. The sale must be instant and absolute. Thus a
sale attributed to a future date or a sale contingent on a future event is void.
For example, 'A' tells
'B' on 1st
January 2008 that he will sell his car on 1st February 2008 to
'B', the sale is void because it is attributed to a future date.
5. The subject matter should be a property having
value. Thus goods having no value cannot be sold or purchased.
6. The subject matter of sale should not be a thing
used for an un-Islamic purpose.
7. The subject matter of sale must be specifically
known and identified to the buyer. For Example, 'A' owner of an apartment says
to 'B' that he will sell an apartment to 'B'. Now the sale is void because the
apartment to be sold is not specifically mentioned or identified to the buyer.
8. The delivery of the sold commodity to the buyer
must be certain and should not depend on a contingency or chance.
9. The certainty of price is a necessary condition
for the validity of the sale. If the price is uncertain, the sale is void.
10. The sale must be unconditional. A conditional
sale is invalid unless the condition is recognized as a part of the transaction
according to the usage of trade.
Question No. 24). What is Murabaha used for in Islamic banks?
Answer: Murabaha is
typically used to
facilitate the short-term
financing
requirements of the customer.
The following are the uses of Murabaha:
- Purchase
of raw material, goods and merchandise of all kinds and description
- Purchase
of equipments
- Import
of goods and merchandise
- Export
financing (pre-shipment)
- Other
financing of working capital nature
Presently, the majority of
financing extended by Islamic banks is based upon Murabaha.
Question No. 25). What is Bai Muajjal?
Answer: Bai' Muajjal is the Arabic equivalent of
"sale on deferred payment basis". The deferred payment becomes a debt
payable by the buyer in lump sum or in installments as may be agreed between
the two parties. In Bai' Muajjal, all those items can be sold on deferred
payment basis which come under the definition of tangible goods where quality
does not make a difference but the intrinsic value does. Those assets do not
come under definition of capital where quality can be compensated for by the price
and Shariah scholars have an 'ijmah' (consensus) that demanding a high price in
deferred payment in such a case is permissible. The following are the
conditions of a valid Bai’ Muajjal:
1.
The price to be paid must be agreed and fixed at the time of the deal.
It may include any amount of profit agreed between the parties.
2.
Complete/total possession of the object in question must be given to
the buyer, while the deferred price is to be treated as a debt due from him.
3.
Once the price is fixed, it cannot be decreased in case of earlier
payment nor can it be increased in case of default.
4.
In order to secure the payment of price, the seller may ask the buyer
to furnish a security either in the form of mortgage or in the form of any
other item.
5.
If the commodity is sold on installments, the seller may put a
condition on the buyer that if he fails to pay any installment on its due date,
the remaining installments will become due immediately.
Question No. 26). What is Musawamah?
Answer: Musawamah is a general and regular kind
of sale in which price of the commodity to be traded is bargained between
seller and the buyer without any reference to the price paid or cost incurred
by the former. Thus, it is different from Murabaha in respect of pricing formula.
Unlike Murabaha, seller in Musawamah is
not obliged to reveal his cost. Both the parties
negotiate on the price. All other conditions relevant to Murabaha are valid for
Musawamah as well. Musawamah can be used where the seller is not in a position
to ascertain precisely the costs of commodities that he is offering to sell.
Question No. 27)
What is Ijarah?
Answer: Ijarah refers to transferring the
usufruct of an asset but not its ownership. Under Islamic banking, the bank
transfers the usufruct to another person for an agreed period at an agreed
consideration. The asset under Ijarah should be valuable, non-perishable,
non-consumable identified and quantified. All those things which do not
maintain their corpus during their use cannot become the subject matter of
Ijarah, for instance money, wheet etc.
Question No. 28): What are the
salient features of Ijarah transaction?
Answer: The customer approaches the bank and
expresses his desire for a particular asset/property. The bank acquires that
asset as per undertaking of the customer to acquire the said asset on Ijarah
basis. The bank leases (transfers the use of the asset) it to the customer for
an agreed period of time and against an agreed amount of rentals. An Ijarah
agreement, signed between the bank and the customer, stipulates all the relevant
conditions with regard to the transaction. According to this agreement the bank
is Lessor and the customer is Lessee. During the Ijarah period, the corpus of
the leased property remains in the ownership of the bank and only its usufruct
is transferred to the lessee. The following main points are considered in the
Ijarah transaction:
1.
As the corpus of the leased asset remains in the ownership of the
Islamic bank, all the liabilities emerging from the ownership shall be borne by
the bank. It is necessary for a valid lease that the leased asset is fully
identified by the parties.
2.
The lessee (customer) cannot use the leased asset for any purpose
other than the purpose specified in the lease agreement. However, if no such
purpose is specified in the agreement, the lessee can use it for whatever
legitimate purpose it is used in the normal course.
3.
The lessee is liable to compensate the lessor (bank) for any harm to
the leased asset caused by any misuse or willful negligence. The leased asset
shall remain in the risk of the bank throughout the lease period in the sense
that any harm or loss caused by the factors beyond the control of the lessee
shall be borne by the lessor.
4.
A property jointly owned by two or more persons can be leased out and
the rental shall be distributed between all joint owners according to the
proportion of their respective shares in the property. A joint owner of a
property can lease his proportionate share only to his co-sharer and not to any
other person.
5.
The rental must be determined at the time of contract for the whole
period of lease. It is permissible that different amounts of rent are fixed for
different phases during the lease period, provided that the amount of rent for each
phase is specifically agreed upon at the time of executing a lease. If the rent
for a subsequent phase of the lease period has not been determined or has been
left at the option of the lessor, the lease is not valid.
6.
The determination of rental with regard to the aggregate cost incurred
in the purchase of the asset by the lessor, as normally done in financial
leases, is not against the rules of Shariah, if both parties agree to it,
provided that all other conditions of a valid lease prescribed by the Shariah
are fully adhered to.
7.
The lessor cannot increase the rent unilaterally, and any agreement to
this effect is void.
8.
The lease period shall commence from the date on which the leased
asset has been delivered to the lessee.
9. If the leased asset has totally lost the function
for which it was leased, the contract will stand terminated.
10. The rentals can be used on or benchmarked with
some Index as well. In this case the ceiling and floor rentals would
specifically be mentioned in the agreement for validity of lease.
11. At the end of the lease period, the ownership of
the property may be transferred to the lessee against a nominal price through a
separate sale deed to be executed after the expiry of the lease.
Question No. 29)
What is the
difference between conventional
mortgage
financing and Islamic Mortgage financing?
Answer: There are several key
differences between conventional mortgage finance and Islamic mortgage finance.
Under conventional mortgage, in order to purchase
a property the customer borrows money and repays it with an additional amount
over a period of time. The additional amount is the amount of interest which is
against the Shariah rulings of Islam. Under Islamic mortgage finance facility,
Islamic bank shares with the customer in purchasing his desired property.
Accordingly, the customer and the bank become the joint owners of the property
in proportion to their share in purchasing the property. In order to own and
use the entire property, the customer purchases the share of bank’s property
over a period of time and also pays the rent for using the bank’s share of the
property. Over a period of time, the customer manages to purchase the entire
share of bank in the property. Ultimately, the customer becomes the sole owner.
Further, in case of Islamic mortgage finance, the
rent will be charged after the lessee has taken delivery of the property and it
is in workable/usable condition. Rent cannot be charged from the day the price
was paid to acquire the property/asset. If the supplier has delayed the
delivery after receiving the full price, the lessee should not be liable for
the rent of the period of delay. In case of conventional mortgage finance,
normally the lease rentals starts from the date the bank make payment for
purchasing the property/asset.
Question No. 30): The rental amount under Ijarah
transaction is normally linked to interest based benchmark like LIBOR or KIBOR.
Is not it an interest based financing?
Answer: The difference between
an interest based financing and a valid lease does not lie in the amount to be
paid to the lessor. The basic difference is that in the case of
lslamic Ijarah, the ownership and title in the asset/property
rest with the lessor who assumes the full risk of the corpus of the leased
asset. If the asset is destroyed during the lease period, the lessor will
suffer the loss. Similarly, if the leased asset looses its usufruct without any
misuse or negligence on the part of the lessee, the lessor cannot claim the
rent, while in the case of an interest-based financing, the financier is
entitled to receive interest, even if the debtor did not at all benefit from
the money borrowed. So far as this basic difference is maintained, (i.e. the
lessor assumes the risk of the leased asset) the transaction cannot be
categorized as an interest-bearing transaction, even though the amount of rent
claimed from the lessee may be equal to the rate of interest.
Therefore, the use of the rate of interest merely
as a benchmark does not render the Ijara contract invalid as an interest-based
transaction. It is, however, advisable at all times to avoid using interest
even as a benchmark so that an Islamic transaction is totally distinguished
from an un-Islamic one, having no resemblance of interest whatsoever.
Question No. 31): Interest rates are subject to
unknown variations and linking the amount of rent with interest rate will
create uncertainty (Gharar) impermissible in Shariah. How would the Ijarah
contract remain valid under this scenario?
Answer: It is one of the basic requirements of
Shariah that the parties to the contract must exactly know its considerations.
Under Ijarah agreement, amount of rent is one of the prime considerations of
the agreement. So far as the parties are agreed with mutual consent upon a
well-defined benchmark which would serve as a criterion for determining the
rent, and whatever amount is determined, based on such benchmark, will be
acceptable to both parties, therefore, there should not be any dispute.
However, in order to save the parties from
unforeseen losses due to the either way movement in the interest rate, the
scholars have advised that there should be a floor and cap for the amount of
rentals stipulated in the contract in case variable benchmarks is taken to
determine the rental amount.
Question No.32). What is Ijarah-Wal-Iqtina?
Answer: It is allowed in Shariah that the lessor
signs a separate promise, (but not an agreement or contract) to gift the leased
asset to the lessee at the end of the lease period, subject to his payment of
all amounts of rent. There can also be a unilateral promise by the lessee to
purchase the asset at the end of the Ijarah period. Alternatively, there may be
an undertaking by the bank to sell the asset to the lessee at the end of the
Ijarah period. However, Ijarah agreement should not be dependent either on the
promise by the lessee (to purchase) or the undertaking by the bank (to sell).
This arrangement is called 'Ijarah wa iqtina and it has been allowed by a vast
majority of contemporary scholars and is widely used by the Islamic banks23.
However, the validity of this arrangement is subject to two basic
conditions:
1. The agreement of Ijarah should not have the
clause regarding the lessor’s promise to gift or sell the leased property to
the lessee at the end of the Ijarah period. Therefore, there should be a
separate document stipulating this promise by the lessor.
b) The promise should be unilateral and binding
on the promisor only. It should not be a bilateral promise binding on both
parties because in this case it will be a full contract becoming effective on a
future date, which is not allowed in the case of sale or gift.
Question No. 33) What is Bai Salam?
Answer: Salam means a contract in which advance
payment is made for goods to be delivered at a future date. The seller
undertakes to supply some specific goods to the buyer at a future date in
exchange of an advance price fully paid at the time of contract. It is
necessary that the quality of the commodity intended to be purchased is fully
specified leaving no ambiguity leading to dispute. Bai Salam covers almost
everything which is capable of being definitely described as to quantity,
quality and workmanship. For Islamic banks, this product is ideal for
agriculture financing, however, this can also be used to finance the working
capital needs of the customers.
23
Dr.
Muhammad Imran Ashraf Usmani, Meezanbank’s Guide to Islamic Banking, Darul
Ishaat, 2002, p 161
The permissibility of Salam is
an exception to the general rule that prohibits forward sale.
Bai-Salam has been permitted by the Holy Prophet
(PBUH) himself, without any difference of opinion among the early or the
contemporary jurists, notwithstanding the general principle of Shariah that the
sale of a commodity which is not in the possession of the seller is not
permitted. Upon migration from Makkah, the Prophet (PBUH) came to Madinah,
where the people used to pay in advance the price of fruit or dates to be
delivered over one, two or three years. However, such sale was carried out
without specifying the quality, measure or weight of the commodity or the time
of delivery. The holy Prophet (PBUH) ordained: “Whoever pays money in advance
for fruit to be delivered later should pay it for a known quality, specified
measure and weight (of dates or fruit) of course along with the price and time
of delivery”24
The Salam transaction is subject to the strict conditions as follows:
1.
It is necessary for the validity of Salam that the buyer pays the
price in full to the seller at the time of affecting the sale. In the absence
of full payment, it will be tantamount to sale of a debt against a debt, which
is expressly prohibited by the Holy Prophet (PBUH). Moreover the basic
rationale for allowing Salam is to facilitate the "instant need" of
the seller. If it is not paid in full, the basic purpose will not be achieved.
2.
Only those goods can be sold through a Salam contract in which the
quantity and quality can be exactly specified e.g. precious stones cannot be
sold on the basis of Salam because each stone differ in quality, size, weight
and their exact specification is not possible.
3.
Salam cannot be affected on a particular commodity or on a product of
a particular field or farm e.g. Supply of wheat of a particular field or the
fruit of a particular tree
24
The
hadith reported by Imam Bukhari, Muslim and others, See AAOIFI, 2004 -5a,
p.171. For the legal status and permission of
Salam as a special case, see zuhayli, 2003, 1, p. 256
since there is a possibility that the crop is destroyed before
delivery and given such
possibility, the delivery remains uncertain.
4. All details in respect to quality of goods sold
must be expressly specified leaving no ambiguity, which may lead to a dispute.
5. It is necessary that the quantity of the
commodity is agreed upon in absolute terms. It should be measured or weighed in
its usual measure only, meaning what is normally weighed cannot be quantified
and vice versa.
6.
The exact
date and place of delivery must be specified in the contract.
7.
Salam cannot
be affected in respect of things, which must be delivered at spot.
Question No. 34) What is Istisna?
Answer: It is a specific kind of a Bai (sale)
where the sale of the commodity is transacted before the commodity comes into
existence. The legality of Istisna is accepted by the Shariah scholars because
it does not contain any prohibition, As far as the financing mode, it has been
legalized on the basis of the principles of Istihsan (public interest)25.
Istisna is an agreement culminating in a sale at
an agreed price whereby the purchaser places an order to manufacture, assemble
or construct (or cause so to do) anything to be delivered at a future date. It
becomes an obligation of the manufacturer or the builder (as the case may be)
to deliver the asset of agreed specifications at the agreed period of time. As
the sale is executed at the time of entering into the Istisna contract, the
contracting parties need not renew an exchange of offer and acceptance after
the subject matter is prepared. Istisna can be used for providing the facility
of financing the manufacture or construction of houses, plants, projects and
building of bridges, roads and highways etc. After giving prior notice, either
party can cancel the
25 Islamic Fiqh Council of the OIC,
Resolutions No. 65(3/7), pp. 137, 138; AAOIFI, 2004-5a, p.191.
contract before the
manufacturing party has begun its work. Once the work starts, the contract
cannot be cancelled unilaterally.
Question No. 35) What is the
difference between Istisna and Ijarah?
Answer: Under Istisna, the manufacturer either
uses his own material or he arranges for the material himself whereas under
Ijara the material is provided by the customer and the manufacturer uses only
his labour and skill meaning that his services will be hired for a specified
fee paid to him. Further, under Istisna the purchaser has the right to reject
the goods after inspection if these are not according to the specifications
agreed at the time of contract whereas under Ijara this right of inspection does
not exist.
Question No. 36): What is the difference between Istisna and
Salam?
Answer: The following are the
main differences between Istisna' and Salam:
1.
In case of Istisna, the subject on which transaction of Istisna'
transaction is based is always a thing which needs
manufacturing/assembling/processing etc., whereas in case of Salam, the subject
matter can be a thing that does not necessarily need manufacturing etc.
2.
The price in Istisna' does not necessarily need to be paid in full in
advance. It is not even necessary to pay the full price at delivery. It can be
deferred to any time according to the agreement of the parties. The payment may
also be made in installments. In case of Salam, the price has to be paid in
full in advance.
3. The time of delivery does not have to be
necessarily fixed in Istisna' whereas in case of Salam the time of delivery is
an essential part of the sale.
4.
Istisna contract can be cancelled before the manufacturer starts the
work. Salam contract cannot be cancelled unilaterally.
Question No. 37) Is it
permissible for an Islamic bank to impose penalty in
case receivables are delayed?
Answer: In Islamic law it is permissible to
penalize a debtor who is financially sound but willfully delays payment of debt
without any genuine reason. Such act of the debtor is unjust as the Prophet
(PBUH) has said,
"A rich debtor who delays payment of debt commits Zulm".
A heavy non-performing portfolio and default on the
part of clients is a serious problem confronting the financial institutions all
over the world including Pakistan. This problem may be a threat to the success
of Islamic banking system if not properly addressed. If clients do not honour
their commitments in respect of timely payment of a debt created in installment
sale, Murabaha, leasing or do not pay banks’ share of profit in participatory
modes or do not deliver goods at stipulated time in Salam and Istisna, it could
cause irreparable loss to the system. The banks, financial institutions,
depositors and ultimately the economy will have to suffer its consequences. The
jurists allow punishment (T´azir) to such borrower in the form of fine. In view
of the severity of the problem, Islamic Fiqh Academy of the OIC and Shariat
Appellate Bench of the Supreme Court of Pakistan have approved the provision of
penalty clause in the contractual agreements. This would also help in
maintaining a credit discipline in the banking and act as a deterrent against
debts becoming bad or unrealizable. However, the penalty proceeds would be used
for charity as penalty cannot become source of income for the bank in any
manner.
Question No. 38) Can Islamic
banks claim compensation or liquidated damages on account of late payment/default
by the clients?
Answer: The contemporary Shariah scholars have
evolved a consensus that banks are authorized to impose late fees on the
delinquent. However, the proceeds of such penalty are to be used for charity
purposes. It is the court or any recognized alternative independent dispute
resolution body which can allocate any part of the penalty as liquidated
damages/solatium for the banks.
Liquidated damages can be given to banks in case
of default on the part of banks’ clients provided it is based on actual
financial loss. The court or a recognized adjudicating forum may reasonably
adjust the amount of compensation. The actual financial loss cannot be the loss
in terms of conventional opportunity cost. It has to be proved by the bankers
themselves to the satisfaction of the court or any arbitrator.
Question No. 39) Islamic bank’s
financing is sometime costlier than that of the conventional banking. Why is it
so?
Answer: Islamic banking is in its early stage and
is in the process of strengthening its base in the economies having
conventional banking rooted deeply in the current interest-dominated system.
The volume of business captured by the conventional banking system gives it an
edge over Islamic banking in terms of cost due to its ability of having
achieved economies of scale. The conventional banks can avail the economies of
scale due to their wide network and huge volume of business which the Islamic
banking, in its nascent stage cannot avail given the present volume of their
business. Further, Islamic banking has to maintain some additional
documentation which adds to the cost of its operations. While Islamic banking
may appear to be marginally costlier at this stage, the incremental cost is not
prohibitive in relation to the benefits.
Question No. 40) Does discounting of bills is allowed under Islamic
Shariah?
Answer: A promissory note or a bill of exchange
represents a debt payable by the debtor to the holder. This debt cannot be
transferred to anybody except at its face value. Discounting of bill or a Note
or a Cheque, therefore, involves interest. In an Islamic financial market, the
papers representing money or debt cannot be traded (except at face value).
However, the papers representing holder’s ownership in tangible assets, like
shares, lease certificates, Musharkah certificates, etc. can be traded due to
the underlying assets they represent. Islamic banks have various modes of
finance through which the business needs of the customer can be satisfied
without discounting the bill.
A majority of Islamic Shariah scholars do not
allow Salam in gold, silver, currencies or monetary units, although a few
jurists have allowed it. As such, a few Islamic banks have been using Salam in
currencies as an alternative to bill discounting26.
26 Muhammad Ayub, Understanding Islamic
Finance, 1807 WILEY 2007, p 245
PART 3: PRACTICAL ASPECT OF ISLAMIC BANKING
Question No. 41) If the Islamic
banks do not lend money on interest then what modes of financing can be used
for the following:
A) Trade and industrial finance
B) Financing the budget deficit
C)
Acquiring
foreign loans
Answer: As a matter of principle, all the
financial transactions between the parties are lawful in the eyes of Islamic
Shariah as long as they do not violate Islamic principles. Islamic Shariah
provides several interest-free modes of finance that can be used to satisfy
various business needs of the customer. These modes can be clubbed into two
broad categories.
The first category may include modes of advancing
funds on a profit-and-loss-sharing basis. Examples of profit and loss sharing
category are Mudarabah, Musharakah and participation in the equity capital of
companies. The second category may include the modes of finance which are used
for the purchase/hire of goods (including assets) and services on a fixed
return basis. Examples of this type are Murabaha, Istisna, Salam and Ijarah.
Therefore the financial needs can easily be met
through interest-free legitimate modes of finance. These can be used to finance
the trade, industry or a budget deficit through domestic or foreign sources.
The following would further elaborate in detail.
A) Modes for financing trade and industry:
Murabaha, Musawama, Ijarah and salam are
particularly suitable for trade while istisna is especially suitable for
manufacturing or construction industry. Further, the trade and industry needs
financing for the purchase of raw materials, inventories (stock in trade) and
fixed assets as well as to meet some working capital requirements. Murabaha can
be used for the financing of all purchases of raw materials and inventory. For
the procurement of fixed assets including plant and machinery, buildings etc.
either Dinimishing Musharaka or Ijarah can be more feasible. Funds for
continuing/recurrent expenses can be obtained by the advance sale of final products
of the company using Salam or Istisna and even Musharika in appropriate
circumstances.
B) Modes for financing a budget deficit:
It is noted that in an Islamic state, all the
efforts should be made to avoid the budget deficit. However, in case of
unavoidable circumstances, the budget deficit may be kept to the possible
minimum limit. Sometimes the budget deficits are seen as a result of either
extravagant (and/or unproductive) expenditure or insufficient and/or
inefficient effort to generate tax revenue due to political, economical reasons
or otherwise. There is a need to win public confidence about these needs and to
create transparency in government expenditure. There is also a need to prevent
the leakage of revenue generating streams for the Government. This can serve
better in keeping budget deficits to a minimum level. In case of unavoidable
deficits, government-owned enterprises can obtain finance by way of Mudarabah,
Musharakah or Sukuk certificates, just like private companies do.
C). An alternative to foreign loans
Seeking Islamic solution to
foreign borrowing, arrangements could be made to attract foreign as well as
domestic funds through the following two ways:
i. The issue of certificates
Musharakah (partnership) or Ijara certificates
can be issued to finance the projects of the Government. Such certificates can
be denominated in foreign as well as domestic currencies and they would carry a
predetermined basis for sharing the profits earned through the respective
projects. The certificates issued can be restricted to a particular project or
earmarked to a group of projects.
ii. The establishment of funds
Funds can be created to finance the economic
activities of public and private enterprises on equity, partnership, and Ijarah
basis. These funds can attract funds through the issue of shares and
certificates of various values and maturities and in domestic as well as
foreign currencies. These can be established either to finance a certain sector
(for example agriculture, industry and infrastructure), a particular industry
(for example textiles, household durables, etc.), or a conglomerate of
projects.
Question No. 42)
If banking were
to be based
on interest-free transactions,
how would it work in practice?
Answer: Islamic bank like other banks is an
institution whose main business is to mobilize funds from savers and use these
funds to finance the economic activities of businessmen/entrepreneurs. While a
conventional bank uses the rate of interest for both obtaining funds from
savers and lending these funds to businessmen, an Islamic bank performs these
functions using various financial modes which are compatible with the Shariah.
For mobilizing resources, it uses either the contract of Mudarabah or Wakalah
with the fund owners. Under the first contract, the net income of the bank is
shared between fund user (Mudarib) and fund providers (Rabul Maal) according to
a predetermined profit sharing formula. In the case of loss, the same is shared
by fund providers in proportion to the capital contributions. As far as the
nature of investment deposits are concerned, these could be either general
investment deposits or specific investment accounts in which deposits are made
for investment in particular projects. In addition, there are current accounts
that are in the nature of an interest-free loan to the bank. The bank
guarantees the principle in case of current accounts but pays no profit on such
accounts.
Under the wakalah contract, clients give funds to
the bank that serves as their investment manager. The bank charges a
predetermined fee for its managerial services. The profit or loss is passed on
to the fund providers after deducting such a fee.
On the assets side, the bank uses a number of
financial instruments none of which involves interest. A wide variety of such
modes of financing is available as discussed before.
Question No. 43) Do We Really
Need Islamic Banks?
Answer: The question may be
divided into following two parts for proper understanding:
1.
Do we need
bank?
2.
If yes, why
it should be on the basis of Islamic Shariah.
i.
Do we need
bank?
In order to assess the need of the bank, we need
to look at the functions it performs. In any society, be it a secular or Islamic
one, the main function of the bank is to mobilize funds from the surplus units
and allocate these to the shortfall units or to the units having budget
constraints. This function is performed through the process of financial
intermediation in the financial markets where banks are the most important
operators. Financial intermediation enhances the efficiency of the
saving/investment process by eliminating the mismatches inherent in the
requirements and availability of financial resources of savers and
entrepreneurs in an economy.
Normally the surplus units/savers are the small
households or individuals who save relatively small amounts whereas the
entrepreneurs are firms which often need relatively large amounts of funds.
Financial intermediation removes this size mismatch by collecting the small
savings and packaging them to suit the needs of entrepreneurs. In addition,
entrepreneurs may require funds for periods relatively longer than would suit
individual savers. Intermediaries resolve this mismatch of maturity and
liquidity preferences again by pooling small funds. Moreover, the risk appetite
of savers and entrepreneurs are also different. It is often considered that
small savers are risk averse and prefer safer placements whereas entrepreneurs
may wish to deploy funds even in risky projects. The role of the intermediary
again becomes crucial. They can substantially reduce their own risks through
the different techniques of proper risk assessment and risk management.
Furthermore, small savers cannot efficiently gather information about
opportunities to place their funds.
Financial intermediaries are in
a much better position to collect such information which is crucial for making
a successful placement of funds.
The role and functions of banks outlined above
are indeed highly useful and socially desirable. Hence, we reach to the point
where the banks become the need of any economy.
ii. Why the bank should
be on the basis of Islamic Shariah?
Commercial banks normally operate on lending
basis. They may not be unduly much bothered about the use of funds as long as
the borrower pays back the loan regularly. This does not ensure that the amount
advanced to the borrower was used for the productive or unproductive purpose. Thus
the impact of commercial banking on economic development, therefore, may remain
below potential. Whereas, Islamic bank provides finance which has a greater
focus on the productive use. Islamic banks’ financing targets both the equity
as well as the working capital needs of enterprises. It is expected that its
impact on economic development will be more pronounced. The avoidance of
interest by Islamic banking is an additional plus. It is mentioned that
allocating financial resources on a productive basis is more efficient than
their allocation on a purely lending basis. It has also been argued that the
whole banking system would be more stable and less liable to suffer from
financial crises. A monetary system based on riba is also unjust as it allows
savers and banks to get away with interest (guaranteed fixed rate of return on
their loans) without bearing a fair part of the risks faced by entrepreneurs.
Question No. 44) Is Islamic
Banking Viable?
Answer: Islamic banking is still in the stage of
evolution. No one disputes that there is a definite desire amongst Muslim
savers to invest their savings in the venues which are permitted by the
Shariah. Nevertheless, they must be provided with halal returns on their
investments. Islamic scholars and practical bankers took up this challenge and
have made commendable progress in the last few decades in providing a number of
such instruments. However, the concepts of Islamic banking and finance are
still in their early stages of development and Islamic banking is an evolving
reality for continuously testing and refining those concepts.
Islamic banking and financial institutions have
now spread across several Muslim countries as well as non-Muslim countries.
Various components of the Islamic financial system are now available in
different parts of the world in varying depth and quality. A detailed and
integrated system of Islamic banking and finance is gradually evolving.
Theoretical arguments and models developed by Islamic economists and the
successful practice of hundreds of institutions in heterogeneous conditions
both testify to the viability of Islamic banking as Islamic banking model
provides a complete banking solution to all the business needs of the customers
while remaining with the boundaries of Shariah. The average growth rate of
assets in Islamic banks over the past twenty years has been around fifteen
percent per annum. Islamic banking institutions have come of age now and are
realizing a high degree of success in respect of market penetration. This is
considered remarkable in view of the fact that the markets in which these
Islamic banks were established have had highly developed and well-established
commercial banks as their competitors.
Another manifestation of the success of Islamic
banking is the fact that many conventional banks have also started using
Islamic banking techniques in the conduct of their business, particularly in
dealing either with Muslim clients or in predominant Muslim regions.
Question No. 45)
How does Islamic
banking fare vis-à-vis
conventional
banking?
Answer: The approach of Islamic banking to
satisfy the business needs of the customers is entirely different from that of
the approach adopted by conventional banking. Basically Islamic banking
satisfies the business needs of the entrepreneurs by the following two modes:
1.
Profit and
Loss sharing modes
2.
Debt creating modes (financing the purchase of commodities on credit
with a mark-up)
On the other hand conventional banking satisfies
the business needs of the entrepreneurs by charging fixed interest which raises
several questions. Although the results of operations of an enterprise in which
such loans are to be invested are by no means certain, yet, guaranteeing in advance,
a fixed return on a loan without taking into consideration the actual results
of the operations of the borrowing enterprise puts all business risks on the
entrepreneur/borrower.
The Islamic banking philosophy is not based on
interest because according to Islam, interest is haram and a curse in society.
Islamic banking focuses on the common good, encourages highest ethics such as
universal brotherhood, collective welfare and prosperity, social welfare and
justice. On the other hand, interest based system accumulates money around
handful of people and it results inevitably in creating monopolies, opening
doors for selfishness, greed, injustice and oppression.
Further, the allocation of financial resources on
the basis of profit-and-loss sharing gives maximum weight to the profitability
of the investment whereas an interest-based allocation gives it to credit
worthiness. It is expected that the allocation made on the basis of
profitability would be more efficient than that made on the basis of interest.
Moreover, a system based on profit sharing would
be more stable compared to the one based on a fixed interest rate on capital.
In the latter, the bank is obliged to pay a fixed return on its obligations
regardless of their fate, should the economic conditions deteriorate. In the
former, the return paid on the bank's obligations depends directly on the
returns of its portfolio of assets. Consequently, the cost of capital would
adjust itself automatically to suit changes in production and in other business
conditions. Furthermore, any shock which might befall the obligations' side of
the balance sheet would be automatically absorbed. This flexibility not only
prevents the failure of the enterprises seeking funds but also ensures the
existence of a necessary harmony between the firm's cash flow and its repayment
obligations. This is the main element which enables the financial system to
work smoothly. Since bank assets are created in response to investment
opportunities in the real sector of the economy, the real
factors related to the
production of goods and services (in contrast with the financial factors)
become the prime movers of the rates of return to the financial sector.
The transformation of an interest-based system
into profit sharing system helps in the achievement of economic growth which
results in increasing the supply of venture or risk capital and consequently
encourages new project owners to enter the realm of production as a result of
more participation in the risk-taking.
Question No.46) How can Islamic banking institutions avoid money
laundering
and such kind of other illegal/illegitimate activities?
Answer: In the post –9/11 global scenario anti
money laundering measures by regulatory authorities of banking and finance have
gained extraordinary importance. It is pertinent to indicate in this regard
that Islamic banks, by their nature, are less likely to engage in money
laundering and other illegal activities. They cannot undertake activities which
are detrimental to society, because to ensure the adherence of moral values, it
has to go through an exhaustive test of Shariah compliance. Islamic banks are
not allowed to invest in narcotics, casinos, nightclubs, breweries etc. This
requires that the clients of Islamic banking must have business which should be
socially beneficial for the society, creating real wealth and adding value to
the economy rather than making paper transactions. Therefore, a more stringent
‘Know Your Customer’ (KYC) policy is an in-built requirement for an Islamic
bank.
Islamic modes of financing and deposit-taking
discourage questionable or undisclosed means of wealth which form the basis of
money-laundering operations. Islamic financing modes are used to finance
specific physical assets like machinery, inventory and equipment etc. Further,
the role of Islamic banks is not limited to a passive financier concerned only
with timely interest payments and loan recovery. Islamic bank is a partner in
trade and has to concern itself with the nature of business and profitability
position of its clients. To avoid the loss and reputational risk, the Islamic
banks have to be extra vigilant about their clientele. As such, Islamic banks
are less likely to engage in illegal activities such as money laundering and
financing of terrorism than conventional banks.
However, the existence of rogue elements cannot
be ruled out in any type of organization. Keeping this in view, Pakistan has
adopted a strategy by adopting uniform international standards to ensure fair
play by all kinds of banks and financial institutions including Islamic banks.
After reviewing its existing systems and procedures, it has developed a
multiple-track strategy in its financial war on terrorism and money laundering.
It has also put in place stringent regulations in order to effectively curb
money laundering. The ‘Know Your Customer’ (KYC) regulation has been sharpened
to provide more detailed guidelines to banks/DFI’s for due diligence in respect
of customers. All banks are required to properly investigate transactions which
are out of character with the normal operation of the account involving heavy
deposits/withdrawals/transfers.
PART 4: AN ECONOMY-WIDE
APPLICATION OF ISLAMIC BANKING AND FINANCE
Question No.47) Can a Muslim country transform
its economy according to the principles Islamic finance in a successful manner?
What are the prerequisites for success?
Answer: The conventional banking still holds sway
over the overwhelming part of the banking operations internationally. However,
over the last thirty years, some of the Muslim countries have started Islamic
banking which is running parallel to the conventional banking system. Islamic
banking is yielding a reasonable success as evident by its growth (around 15%)
annually. The current success of Islamic banking and finance has been
accomplished despite the unavailability of an ideal legal and institutional set
up which is imperative to support the operation of these banks. There is no
doubt that once an appropriate institutional infrastructure is completed, their
degree of success will be even greater. Provision of enabling framework which
may include compatible national and banking laws, rules and regulations, tax
regime, accounting system and relevant disclosures etc. are the prerequisites
of Islamic financial system,
Question No. 48) In cases all interest-based
transactions are abolished from the economy, what would be the economic
implications on national and international levels?
Answer: In case all interest
based transactions are abolished from the economy, the implications at the
national and international level may be visualized as follows:
A. Implications at the national
level:
The following will be the implications at the national level.
i. Adopting the operating method of Islamic banking:
The economic consequences of eliminating interest
at the national level could be anticipated on the basis of considering the
nature of the business operations of Islamic banks. As previously pointed out,
Islamic banks can undertake financing through partnership modes as well as
sales-based modes involving fixed returns. Therefore, Islamic banking offers a
wider scope of operations where it can follow up and monitor more closely the
activities and performance of the enterprises it finances. It can employ
various monitoring techniques and procedures including sitting on boards of
directors to obtain information in its capacity as partner who has a stake in
the capital of those companies. Economists believe that Islamic banks face
fewer risks than purely commercial ones regardless of whether the national
economy is undergoing a period of economic recession or upswing. Hence, the
greater the ability of Islamic banks to employ the monitoring techniques the
less amenable they become to moral hazards. This gives Islamic banking an edge
in profitability over commercial banks.
Islamic banking has valuable opportunity of using
proper mix of financial modes. They can choose the proper mix of partnership
and fixed-return modes that would afford them more effective monitoring at
lower costs. For this reason, they can become relatively more profitable as
well as efficient and as a result the national economy as a whole would gain.
ii. Resource allocation on
production bases
The most important aspect characterizing Islamic
financing at the macro economic level is its unique method of financial
resource allocation. The allocation of financial resources in a conventional
economy revolves around the rate of interest and where the credit worthiness of
the borrower is the main criterion for lending funds. In an interest-free
economy, financial resources are allocated on the basis of production and
commercial criteria. This implies that under Islamic finance, the vital factor
of obtaining the financing facilities is the ultimate results of the enterprise
whose operations are being financed whereas the credit worthiness is the
secondary factor. Resource allocation on the basis of production and commercial
criteria is more oriented towards growth and development wherein the financial
sector remains in harmony with economic fundamentals.
Islamic finance modes are of two types:
partnership and markup. Once an agent obtains finance of the second type, he
ends up owing a loan to the finance provider. Nonetheless, an Islamic banking
system does not face problems associated with debt accumulation because the
debt generated is used to finance real transactions i.e. the purchase of real
commodities and assets. In addition, the markup is set once and it is not
cumulative. Furthermore, the debt is not marketable, as it is sellable only at
face value. This makes debt renewal or accumulation much more difficult. In
this context, it is inconceivable that Islamic financing could generate debts
to the extent that their volume would exceed the volume of the commercial and
production activities financed. Furthermore, the bulk of debts in a
conventional economy, mostly government debt, would be replaced in an Islamic
economy by financing through Islamic modes. There is no room for a large volume
of transactions in debt instruments (bonds) as appears in conventional
economies, where the volume of such transactions reaches multiples of GDP. Unlike
a capitalist economy, the Islamic economy is not heavily leveraged. Thus, such
an economy would be well protected against shocks resulting from debts.
iii. Relative stability of the banking system
Conventional banks hold assets
resulting from personal and business finance which can generally be riskier
than their liabilities to their depositors. The conventional
banking system would therefore face some measure
of instability especially during the downturn of the business cycle or generally
during periods of low aggregate demand. At such time, higher rates of business
failures and bankruptcy could bring the average rate of return on banks'
investments below the average rate of interest they have to pay on time
deposits. This exposes banks themselves to business failures. By contrast,
Islamic banks guarantee only demand deposits and shares the risks with
investment depositors. An Islamic bank may not generally be expected to incur
losses, even at times of low levels of aggregate demand, because of its wider
scope of activities. When the rates of return on its investments decline, so
does the rate of return paid out to the depositors. The possibility of business
failure faced by Islamic banking is therefore lesser as compared to its conventional
counterpart. We can, therefore, conclude that Islamic banking is more stable
which in turn gives an added measure of stability to the domestic economy.
B) Advantages of Islamic Financing at the International Level
The present age of globalization has witnessed
the narrowing/eliminating the gaps of communication. Further, the market
disclosures are also getting enhanced which would expose the economies to the
influences of external factors that pass through trade as well as capital flow
channels. A single country cannot place trade controls without consulting the
World Trade Organization (WTO). After repeated international financial crises,
especially that which befell the South East Asian countries, economists found
themselves compelled to reconsider their preference for free capital flows,
especially short-term. We cannot also ignore the fact that such flows are
associated with interest-based financing, where debt becomes marketable and
free moving.
In a conventional economy, debt financing comes
in a pyramid-shaped chain, where foreign banks lend local banks, which in turn
lend individuals and local enterprises. Most of this lending is on short-term
basis. Once foreign banks face a problem, they recall their loans from local
banks, which in turn recall their loans from domestic borrowers. Thus the
pyramid of debts starts to collapse and a financial crisis ensues.
An Islamic economy would receive external capital
flows using only Islamic modes of finance. Whether based on partnership or
markup, those flows would be contractual and are neither marketable nor
recallable on notice. We can, therefore, imagine that those who wish to provide
external capital flows to an Islamic economy would have to wait until the maturity
dates of their debts before withdrawal. Those interested in providing external
funds on a partnership basis would have to abide by the partnership contracts.
Therefore, Islamic financial system is not prone to those risks which the
conventional banking system is exposed to.
Question No. 49) A large number of Muslim
countries depend heavily on foreign loans from other countries as well as from
international financial institutions like the World Bank and the IMF. If
interest is totally abolished from the economy of a Muslim country, how can it
deal with foreign countries and foreign financial institutions?
Answer: This question has three
parts as follows:
a.
How to deal
with current debts
b.
Economic
effects of borrowing
c.
Alternatives
to borrowing
Each of these three dimensions is discussed as follows:
a) Dealing with current debts
To begin with it should be noted that the shift
to the Islamic economic system does not mean the outstanding debt under
conventional system would not be settled. It is a basic principle of the
Shariah that Muslims should fully honour their contracts/promises. Therefore,
the principal and interest amounts of such debts that had risen from past
contracts and obligations should be settled regardless of whether they were contracted
with domestic or foreign parties.
Should a country find it
difficult to secure the liquidity required to settle all its outstanding debts,
it could resort to one of the following courses of action:
The outstanding debts of developing countries
facing economic difficulties are usually offered in markets at prices less than
their nominal value. The amount of discount given varies with the economic
conditions of each indebted country. It is therefore possible to negotiate directly
with creditors swapping debts with equity participation and at the same time
achieve some discount.
Meanwhile, governments of developing countries
usually have a large public sector, which could be privatized in the course of
a comprehensive structural adjustment program. Part of the proceeds obtained
from selling some of its public enterprises can be used in purchasing foreign
debt at a discount. In addition, debt can be swapped for equity in public
enterprises within the desired limits of keeping the majority holding of key
enterprises in the hands of nationals.
b) The harmful effects of
borrowing
Having said that all outstanding debt must be
settled, Muslim governments should strictly avoid future borrowing on the basis
of interest. In this regard, the global debt crisis can be recalled that
started during 1982 which was accompanied by the inability of developing
countries to settle their debts. The crisis continued until 1990 when the
developing countries returned quickly to borrowing. The debt problem rose again
in 1997 in the Asian countries and it was accompanied this time with a crisis
in the foreign exchange market. This renewed heated discussions among
economists. Some suspected that those crises indicated that a number of developing
countries had fallen victim to the greed of some creditors on the one hand and
to the unsound economic policies of these countries on the other.
Generally, leveraged economies face the open
economy dilemma under which the countries that allow free capital movements
have to choose between independent monetary policies and fixed exchange rates.
Nonetheless, South East Asian countries
fixed their exchange rates, while attempting to
have independent monetary policies. What compounded their problem was the fact
that heavily leveraged economies inevitably face two problems. The first is
that business borrowers face disproportionately high risks (in relation to the
size of equity) during periods of slow economic activities as debts have to be
repaid regardless of business conditions. This scenario increases the rate of
business failures. Secondly, expectations in the debt market are non-segmental,
implying that when debts in one part of the market (a sector or a whole
country) become non-performing, pessimistic expectations would not be
restricted to that segment as it will spread all over. This phenomenon of
contagion is basically due to the fact that conventional debt is marketable. It
exposes heavily indebted economies to business problems. The problem is
compounded when the debt is short-term and when lenders of a group of countries
are the same. It has become evident from the last debt crisis that South East
Asian countries allowed excessive borrowing that was predominantly short-term. As
shown above, there are reasons that would make foreign capital flows a source
of instability resulting from the herding effect. It would, therefore, be wise
to steer away from borrowing as much as possible and to use Islamic modes of
financing instead.
c) Alternatives to foreign
borrowing
What could an Islamic country do to benefit from
foreign financial resources? The key to answering this question lies in the
innovative utilization of financial markets to attract foreign capital. Such
innovative utilization should be made alongside a dialogue with foreign
financing institutions to familiarize them with the advantages of using the
Islamic modes of finance. Those modes directly finance the purchase of real
assets and commodities in contrast with conventional lending which provides
enterprises with general funds which could be used on bureaucratic expansion or
inefficient conglomeration. The use of foreign funds through Islamic modes
would have a direct impact on economic activities, thereby impacting economic
development in a more efficient and effective manner. If Muslim countries can
put their houses in order, there is no reason why they cannot attract some of
these funds.
In this context,
the following methods
may be considered
for attracting foreign
capital:
i.
The issue of
Islamic financial instruments in foreign currencies.
ii.
The design
of special funds to cater to the needs of specific projects and sectors.
Examples could be:
An infrastructure
fund for use in financing roads, transport projects, building of airports and
seaports, power stations etc.;
An Ijarah fund;
A trade financing fund;
An
agricultural investment fund; An industrial investment fund
A
housing investment financing fund, and A fund for financing a specific project
d) When is it permissible to borrow?
It must first be noted that borrowing as such is
not prohibited by the Shariah. Borrowing is acceptable if the debtor has the
means and resources to pay back. When Islamic modes of finance are used, even
if they are debt-based, there is a possibility of the debtor being able to
service the debt. However, question arises as “Should a country resort to
interest based borrowing if it is not succeeding in satisfying financial
requirements for meeting the "needs" of the society? The answer to
this question is based on the general Islamic juridical rule providing that,
"Necessity renders legitimate that which is originally illegitimate".
The doctrine of darurah (necessity) allows temporary suspension of normal law
in case of dire need. Since this doctrine can often be misused, a word of
caution is in order.
The doctrine of necessity is meant to be used in
dire cases as it is a rule to handle emergencies. Even in emergencies, it does
not provide an automatic and unrestricted suspension of the law. First of all,
it has to be determined that situation has arisen where the doctrine can be
invoked. While in individual cases, it is the individual
conscience which will determine this whereas in
case of public application, a ruling must be given by Shariah scholars after
consulting with the experts of the concerned field. Secondly, the suspension of
the normal law is not absolute as there are limits and conditions to be
observed. The Quranic text providing for the doctrine, itself lays down two
basic conditions: the user must accept the sanctity of the original law
(implying a return to it as soon as possible) and in the meanwhile use the
exception to the minimum possible extent. The application of the principle of
necessity to foreign borrowing should be left to the discretion of the `ulama'
in each country to decide after their full and accurate understanding of the
country's real conditions. Interest-based foreign borrowing can only be
resorted to in cases of compelling need for development purposes, which amounts
to "necessity" as determined by the `ulama'. Even when such
permission is granted, feasibility studies in respect of the projects to be
financed by way of foreign borrowing should be undertaken, scrupulously
reviewed and evaluated. Borrowing should be made to the extent of such
necessity only and accompanied by a plan and schedule for repayment from the
returns of the project to be financed.
Question No. 50). Can Islamic banks play any role in economic
development of
the Country?
Answer: While functioning within the Shariah
framework, Islamic banks can perform a crucial task of resource mobilization
and efficient allocation using either profit sharing (Musharaka and Mudaraba)
or trading & Ijarah based categories of Islamic modes of financing. Profit
sharing modes can be used for short, medium and long-term project financing,
import financing, pre-shipment export financing and working capital financing
transactions. In order to ensure maximum role of Islamic finance in the
development of economy it would be necessary to create an environment which may
induce financiers to earmark more funds for Musharakah/Mudarabah based
financing.
The non-PLS techniques, as acceptable in the
Islamic Shariah, not only complement the PLS modes but also provide flexibility
of choice to meet the needs of different sectors of the society based on their
risk profile. Trade-based techniques like Murabaha with lesser risk and better
liquidity options have several advantages vis-à-
vis other techniques but may not be as fruitful
in reducing income inequalities and generation of capital goods as
participatory techniques would do. Ijarah related financing which requires
Islamic banks to purchase and maintain the assets and afterwards dispose them
off according to Shariah rules, require the banks to engage in activities
beyond financial intermediation.
Salam has a vast potential in
financing the productive activities in crucial sectors, particularly
agriculture, agro-based industries and the rural economy as a whole. It
provides incentive to enhance production as the seller would spare no effort in
producing, at least the quantity needed for settlement of the loan taken by him
as advance price of the goods. Salam can also lead to creating a stable
commodities market especially the seasonal commodities and therefore to
stabilize their prices. It would enable savers to direct their savings to
investment outlets without waiting. This would help them to invest their
surplus funds till the harvesting time of agricultural products or the time
when they actually need industrial goods and without being forced to spend
their savings on consumption.
On the basis of the above it can be said that
supply and demand of capital would continue in an interest-free scenario with
additional benefit of greater supply of risk-based capital alongwith more
efficient allocation of resources and active role of banks and financial
institutions as required in asset based Islamic theory of finance. Islamic
banks can not only survive without interest but also could be helpful in
achieving the objective of development with distributive justice by increasing
the supply of risk capital in the economy, facilitating capital formation,
growth of fixed assets and real sector business activities.
Banks might engage in fund and portfolio
management through a number of asset management and Ijarah and trading companies.
Such companies/entities can exist in the economy on their own or can be an
integral part of some big companies or subsidiaries. They can manage Investors
Schemes to mobilize resources on Mudarabah basis and to some extent on agency
basis and use the funds so collected on Murabaha, Ijarah or equity
participation basis. Subsidiaries can be created for specific
sectors/operations which would enter into genuine trade and Ijarah
transactions. Low-risk ‘Funds’ based on short-term Murabaha and Ijarah operations
of the banks in
both local as well as foreign currencies would be
best suited for risk-averse savers who cannot afford possible losses in PLS
based investments. Under equity based funds, banks can offer a type of equity
exposure through specified investment accounts where they may identify possible
investment opportunities from existing or new business clients and invite
account-holder to subscribe. Instead of sharing in the bank’s profit, the
investors would share the profits of the enterprise in which funds are placed
with the bank taking a management fee for its work.
Small and medium enterprises (SME) sector has a
great potential for expanding production capacity and self-employment
opportunities. Enhancing the role of financial sector in development of SME
sub-sector could mitigate the serious problems of unemployment and low level of
exports.
Keeping in view the above, it
can safely be said that Islamic banking has a great potential of playing an
effective role in the development of the country.
Bibliography
1.
Dr. Muhammad Imran Ashraf Usmani (2002), Meezan Bank’s Guide to
Islamic banking, Darul Ishaat, Karachi, Pakistan.
2.
Justice (Retd) Muhammad Taqi Usmani (May 2005), The Historical
Judgment on Interest delivered in Supreme Court of Pakistan
3.
Muhammad
Ayub, 1807 WILEY 2007, John Willey & Sons, Ltd.
4.
Islamic
Development Bank, Islamic Research And Training Institute, Islamic Banking:
Answers To Some Frequently Asked Questions, Mabid Ali Al-Jarhi And Munawar
Iqbal, Occasional Paper No.4, 1422h, 2001
All content provided on this blog is for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information.
