Islamic modes of financing

Before introduction of Islamic modes of financing in banks and DFIs, a Task Force of Bankers from all the five nationalised commercial banks was formed by the defunct Pakistan Banking Council 20 years back for chalking out the system of financing free of interest. I was selected as a member of the task force by Pakistan Banking Council to represent the Allied Bank. It was an uphill and a challenging task. There were apprehensions and difficulties in accomplishing the assignment. Different modes of financing were devised by the task force and approved. The commercial banks have chosen since then "mark-up system" (substitute for interest) for bulk of their financing. The huge stuck-up loans and frauds speak themselves both about the attitude of borrowers and bankers. It was, therefore, not easy to replace interest with profit.
The substitute for switching from mark-up/interest to profit/loss sharing is Musharakah which is not practicable due to the impaired moral value, control, undependable attitude of the borrowers etc. It is otherwise an ideal mode of financing. If we examine other modes of financing, namely leasing, Hire Purchase, Bai-Muajjal, Murabaha etc, it is revealed that the mode of recovering profit is so devised that minimum percentage of yield (spread/profit) on the amount invested is pre-determined (in-built) and received by the lenders.
In the conscious/subconscious of lender, he has in mind the rate of return (spread/profit) on investment he would get. He accordingly varies his sale price/charges/rental. In all these there is an element of predetermined return on funds lent.
Since then, financial experts have been harping on the introduction of Islamic modes of financing. The Supreme Court in the judgement ordered introducing interest-free banking on the pattern/conditions devised by them after hearing a panel of socalled experts, with effect from June 2002. But the government being aware that it was a difficult task and not possible, preferred to refer the matter, to the Shariat Appellate Bench of the Apex Court in June 2002.
It was published in a newspaper in June 2002 that Shariat Appellate Bench was hearing, advocate Raza Kazim and another Counsel Syed Riaz-ul-Hassan Gillani, as representing the Federation respectively. Since then the matter is lying in cold storage.
THE MODES OF FINANCING ARE DISCUSSED HEREUNDER:
MURABAHA: Now, Islamic banks functioning world over and Islamic banking branches in Pakistan have adopted Murabaha for financing which is elaborated hereunder:
In Murabaha, the borrower first becomes the agent of the bank and purchases goods required by him on behalf of the bank and later on buys the goods from the bank at an enhanced price, the difference between purchase/sale price is the profit/return of the bank.
IT SHOULD BE NOTED:
(a) Sale price is not fixed at the market forces (demand/supply), but worked out as mentioned in the second para herein above (percentage of return on funds) and the borrower agrees because to him the cost of money is the same as in the case of conventional financing ie mark-up/interest.
(b) The borrower having acquired goods from funds given by the bank is free to use it in any manner having become owner of the goods. He can consume/sale/hypothecate/pledge the same.
(c) Islamic banking branches for their existence are persuading/alluring the customers to avail finance facility on Murabaha and the customers agree being convinced that profit to the banks (difference between sale/purchase price) would be equal to mark-up paid under conventional financing. The purchase/sale prices are determined as per conception discussed in the second para and a) hereinabove and in short what would be the percentage of return. Thus it is a camouflage which they call Islamic banking and for that Muftis have been appointed by each Bank.
(d) Another aspect is that the Murabaha mode cannot be applied on running finance (perpetual borrowing) which the borrowers, particularly industrialists, wholesalers, distributors, stockists and retailers (where there are numerous commodities at a time and quantity varies from day to day) require against hypothecation, hence they resort to conventional financing (mark-up). Murabaha adopted by the banks is a sort of loan for specific stock, stored at specific place and repayable in a specific period and sale price includes mark-up in the guise of profit. The mode, if fool-proof, should be such which can be applied on all running finance needed for purchase/against stocks/raw materials, spare etc particularly against hypothecation of stocks. Therefore, the same borrower raises funds from the same bank/other bank for his same business on mark-up basis as Murahaba (with pre-determined profit) is unworkable in their case.
MUSHARAKAH: This perfect Islamic mode of financing is not adopted for the reasons given in para 2 above. Otherwise based on profit/loss sharing (partnership concept) in proportion to capital invested by each party, the same is strictly according to Shariah as return (profit) on capital is not known and not predetermined as determined/known in the case of Murabaha and Ijarah where sale price/rental is fixed by the lender on the basis of minimum return he expects. But for various reasons Musharakah is not used for financing.
Let us examine income tax. It is obligatory for businessmen to share profit with the government by way of income tax as per laid down slabs. The amount of tax varies with the profit going up/down. Does the government get its due share? No The reason being that true profit is not declared from time immemorial.
How the banks can expect to get proportionate profit if they enter into Musharakah unless there is a proper recording, accounting, punitive action, proprietary audit, fear of Allah etc. How unfortunate that in an Islamic country we are helpless in introducing the perfect mode of financing Musharakah.
MODARABA: This is yet another mode where profit is equitably distributed amongst the investors. A person/company of repute need not approach the bank for financial requirement. They can float perpetual or specific Modaraba to attract investors who in view of creditability of the Modarib (who will devote time/skill), nature of business, will be willing to participate in Modaraba.
This is the unique mode - the bank is eliminated - both for the entrepreneur (for raising funds) and investors for depositing funds. The net profit made is distributed amongst the Modaraba Certificate holders. If 90% of profit is distributed, no income tax is leviable.
The rate of return on deposits has reduced tremendously, making it difficult for pensioners, widows etc, to make both ends meet. If we have honest businessmen of high moral value, instead of borrowing from banks as at presently, they can resort to this mode and give succour to such segment of the society on the one hand and on the other earn blessing of Allah.
Floating of public limited companies listed on the stock exchange are another source to raise interest-free funds for the entrepreneur and Halal profit for depositors by way of dividend provided correct records are maintained and correct profits are declared. "------" But disappointingly and unfortunately in Islamic countries, we have no such dependable society, otherwise the benefit would accrue to the public at large.
IJARAH/LEASING: It is used but the basis to determine profit (rental) is as outlined in para 2 and hereinabove. Surprisingly one of the banks levies penalty as high as 2000 per month on defaulted amount by way of charity on the pretext that the same is deterrent for default. Was it ever in vogue in the Islamic Era when Riba was banned? Never.
Thus in the Islamic mode of financing penalty is astonishing whereas in conventional financing mark-up upon mark-up cannot be applied. Why default should occur if funds are lent prudently?
Further there is exploitation of the depositors on the one hand by paying very low return to them though high expenses by way of hefty salary/perks, rent etc are incurred on the other hand.
Realities have been highlighted in right earnest. Instead of beating about the bush and harping for the past 20 years on this subject, facts must be faced. In Saudi Arabia, where strict Shariah Law prevails, small profit is paid on deposits and service charge is levied on the borrowers.
Keeping in view the above shortcomings, IJMA as permissible in Islam can be held duly participated by religious scholars, bankers and economists from all Islamic countries to resolve the issue.
Thus, the Government of Pakistan would also be relieved of the pressure to implement interest-free banking as envisaged in the Supreme Court ruling (which inter alia also eliminates mark-up system) which they are avoiding for various reasons and as discussed above.
It would not be out of place to mention that under the doctrine of necessity/circumstances the Saudi government since the last Haj constructed a wide wall and relaxed timings for stoning Satans (Rami), a great change in this important Arkan since Haj was made compulsory and rituals were in vogue since then.