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Riba has always been an important issue for Muslims of all eras. The reason for this is the severe warnings given in the Qura'n against this institution. There is no disagreement on the unlawfulness of any transaction that involves riba.
However, there is a significant controversy revolving the issue of commercial interest as it has been practised for several centuries all over the world. The majority of the Muslim religious scholars as well as so-called Islamic economists put both usury and interest under the definition of riba and call for establishment of a banking and financial system that avoids this institution.
Elimination of nba has been the hall mark of Islamic financial theorists and at least a stated goal of the practitioners. Also, almost all proponents of the proposed Islamic financial system refuse to distinguish between usury and interest (or between consumption and commercial loans) and put both of them under nba.
To eliminate the institution of interest, Islamic financial experts have come up with a number of Islamic financial instruments and have sought approval of the same by Islamic religious scholars. Many of these new instruments are modern version of old modes of transactions that were approved by some Islamic jurists and used by Muslims during the past centuries.
The majority of the ordinary Muslims who lack in-depth knowledge of Islamic injunctions on these issues are confused. They read the verdicts of the ulema condemning interest based transactions but they do not find a single Muslim country which has developed a workable alternative banking and financial system. They are further puzzled when they observe that the most widely used transactions by so-called Islamic banks are not very different from the institution of interest.
They find it particularly confusing that, for example, an interest based loan at 8 to 18% is not permissible but a bai muajjal (deferred payment) transaction involving an effective or implicit interest rate exceeding 50% is made permissible. Many of them, therefore, leave this matter to the government and the ulema to work out a solution and, carry on with their day to day business under the prevailing system based on interest.
In Pakistan where technically all banks were supposed to switch to Islamic banking, the only change that happened was in name, not in substance --- interest was given the name of mark up and everything remained the same. At present, with the exception of Meezan bank in the private sector, no other bank even claims to be working on the Islamic principles. The State Bank of Pakistan has a Department that is responsible for the gradual implementation of Islamic banking system.
However, it is obvious that there is no will and desire on the part of the key relevant members of the Government to make any serious effort. The same was true for all previous Governments. The question today we arte looking at is whether there is a need for an Islamic alternative, and if so, what are the prospects and what is the best way to have a significant movement towards the establishment of a viable Islamic banking and financial system? We would like to answer these questions in the following sections of this paper.
Islamic scholars emphasise that nba (usury and/or interest), gharar (uncertain or unclear elements in business contracts) and mysir (transactions similar to gambling) should be avoided in trade and financial dealings.
They also emphasise that trade or financial dealings of forbidden goods and services (such as pork, pornography, gambling) should be avoided. As some aspects of the existing banking and financial system are repugnant to the teachings of Islam; Islamic banks, Islamic insurance Takaful companies and other financial institutions are being established all over the Muslim world to provide alternatives to the adherents of Islam.
The main difference between the two banking systems is that Islamic banks are supposed to work without the institution of interest. Rather than charging a predetermined fixed rate of interest to those who want to use banks' funds for trade, commerce and production, Islamic banks are ideally required to have a profit and loss sharing arrangement with them. In principle, the depositors have two choices. They can keep all or part of their money in an Islamic bank in a no risk account.
The bank will keep this money as safe deposit and guarantee the principal amount (Some Muslim economists suggest that Islamic banks should not use these deposits for investment ie, a 100% reserve requirement for such accounts). Alternatively, depositors can choose to put all or part of their money in investment accounts. Islamic banks will use the proceedings of these accounts to make investments in trade and production. The profits made by Islamic banks are then shared with depositors. To avoid gharar, the details of profit and loss sharing arrangements are completely and clearly known to all parties in advance.
According to Islamic teachings, all parties directly or indirectly involved in a business should share the risk of the business. The bank's shareholders combine their equity funds with those of their depositors and provide these funds to the ultimate users: traders and producers. Islamic sense of social justice requires that all parties of this business arrangement should share the benefits as well as the risks of these investments.
Conventional banks have to guarantee the principal and accrued interest by law, whereas Islamic banks will violate their very basic principles if they give such guarantee (to their investment deposit holders). In principle, Islamic banks are not supposed to ask for collateral.
In order to avoid risk, the integrity, capability/competence of the potential user of banks' funds (or the entrepreneurs) and the viability of the trade or business proposal are given much more importance in comparison to conventional banks. Banks being equity provider of a business would be given the right to inspect all financial accounts of the business. This is normally not the case when conventional banks provide loans on interest.
A number of conventional commercial banks all over the world go bankrupt every year due to bad loans or bad economic condition or both. To be competitive, Islamic banks have to be prudent and efficient. However, even when banks are working prudently, they could still face insolvency due to an overall downturn in the economy.
The whole idea of Islamic banking is to let the negative consequences of a genuine downturn be absorbed by all parties: depositors, banks and traders/producers. The depositors may get a lower than normal return in some years. In extreme cases, a negative return is also a possibility. However, one should also keep in mind that when most businesses would realise better returns, Islamic banks and their depositors should also receive higher than normal returns.
(The writer is Vice President, FPCCI.)

Copyright Business Recorder, 2007

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