True riba-free Islamic banking

The motivation to provide interest- (riba) free financial services is derived from the desire of Muslim communities living in the modern age. The general perception of most of the critics is that there is hardly any difference between conventional and prevalent Islamic banking.

The structure, operation and financial information disclosure of an Islamic bank, support this observation.

Some basic principles, if followed, in their true spirit might help in changing this perception. This article sheds some light on the history of Islamic finance in the Muslim world and suggests how to practice Rabb-ul-Mal and Mudarib relationship, while contemplating Islamic finance arrangement.

Before deliberation on basic principles, one must need to know how banking was introduced in the Muslim regions. While reading the history of banking in Islamic regions, it transpires that first Ottoman Bank was established in 1856 in Istanbul.

Known from 1863 to 1925 as the Imperial Ottoman Bank and correspondingly referred to by its French acronym BIO, was a bank that played major role in the Ottoman Empire’s financial history. By early twentieth century, it was the dominant bank in the Ottoman Empire and one of the largest in the world

The Ottomans saw military expansion, with more emphasis on manufacturing and industry in the WEALTH-POWER-WEALTH equation. Moving towards capitalistic economics comprising expanding industries and markets they continued along the trajectory of territorial expansion, traditional monopolies, buildings and agriculture. It can safely be concluded that the Empire’s Islamic scholars embraced the capitalistic economics.

What exactly is WEALTH-POWER-WEALTH equation? From the fifteenth century, a combination of economic, political and religious factors had brought a situation of instability that attributed to the weakening of the Islamic civilization.

The West, on the other hand, was making progress and banking, a main component of capitalism system, was adopted by all countries including the Islamic countries.

Universal acceptance of the gold standard during the last quarter of nineteenth century (1870-1914) almost ended the bimetallic monetary system.

During that period, colonized Muslim territories were tied to their master’s currency system, i.e., linked to the British Sterling gold-based money. Islamic state dependencies also had been under the British Crown for centuries.

The British currency policy of the dependencies stated that, the legal tender in all of them was gold, silver and copper coinage of the United Kingdom.

Dominance of West in terms of WEALTH-POWER-WEALTH equation and industrialization implies that thought process of development and implementation of Islamic Modes of Finance had been to fit in the skeleton of complex banking structure.

It means efforts were made to Islamise capitalism, on no choice basis, owing to supremacy of West—“Jiski Lathi Uski Bhans”, the meaning of this Urdu language proverb is that “whoever has the power, or means of controlling others are the ones who get to rule those people that they are controlling” or, in other words, “might is right.”

Before analysing the structure, definition of three important modes of Islamic Finance need to be comprehended. According to Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI):

Murabaha is an Arabic word that means, “gaining profit”. It is a financing method used in Islamic finance in place of loans. It is also known as cost-plus financing because it includes a profit mark-up in transactions instead of interest.

Mudaraba is a financing transaction where an Islamic bank provides funds and the funds are used in a Mudaraba, which is also known as “trustee finance” or a passive partnership contract.

A Mudaraba contract usually involves two parties: the Rabb-ul-Mal, or investor, who provides capital, and the Mudarib, or working partner, who contributes skills and labour.

Musharakah is a product similar to Mudaraba, but with some key differences. Musharakah is a partnership where capital owners contribute equity to others in exchange for sharing profits and losses.

There being no other alternative, Islamic modes of finance introduced by adopting modern Conventional Banking Skeleton: conventional banking fundamentals built on tripartite dealing relationship i.e., Depositor, Bank and Entrepreneur, as opposed to the most preferred mode of Islamic finance i.e., Mudaraba and Musharakah, which deal with two party relationship i.e. Rabb-ul-Mal and Mudarib. Magda Ismail Abdel Mohsin brilliantly explains the tripartite relationship in “THE PRACTICE OF ISLAMIC BANKING SYSTEM IN S HYPERLINK “https://beautyofwaqf.wordpress.com/wp-content/uploads/2011/12/82.pdf”U HYPERLINK “https://beautyofwaqf.wordpress.com/wp-content/uploads/2011/12/82.pdf”DAN” [Journal of Economic Cooperation [26:4 (2005) 27-50].

Structure of the Sudanese Islamic Banking (SIB) System: Extract from the Journal of Economic Cooperation [26:4 (2005) 27-50]:

The structure of the SIB is similar to the one that was presented in 1963 by the Egyptian economist Ahmad El-Najjar. The main idea of this new Sudanese Islamic Banking structure is to incorporate the classical Mudaraba into a modern complex system in order to create an interest free banking system (Çizakça, 1996, pp. 195-198).

Islamic banks function in reality with hundreds or thousands of investors and entrepreneurs. This is a two-tier partnership with three main groups: the depositors/investors Rabb-ul-Mal, the Islamic bank and the entrepreneurs (with whom the Islamic bank signs a partnership contract and to whom it provides finance).

First, on the liability side, the Islamic banks collect all the funds from their investors. They then have to utilise those funds by financing the entrepreneurs. Here, it is worth mentioning that the Islamic banks have a double personality.

In the first phase, they function as a Mudarib to whom the investors entrust their savings, and in the second, they themselves assume the role of a major investor financing a multitude of entrepreneurs.

Hence, the characteristic of the Islamic banking changes at this point from Mudarib to Rabb-ul-Mal, once it has signed partnership contracts with those entrepreneurs.“ In this case, the bank acts as the principal Rabb-ul-Mal and the client as a Mudarib.

Whatever form of partnership is used, the profit of each entrepreneur is shared according to the stipulations of the contract signed with the bank. The bank’s share of profits from all the ventures is then pooled in a reserve. This profit pool is shared between the bank and the holders of the so-called investment accounts.

The only difference between the structure of the Islamic banks in Sudan and the one which had been presented by El-Najjar is that according to El-Najjar, only Mudaraba or Musharakah should be applied to medium and long-term finance in the second phase (Çizakça, 1996, pp. 195-198, 203).

In contrast, in Sudan, as in other Muslim countries, they include Murabaha too. We believe that if the Islamic banks continued to resort to Mudaraba or Musharakah partnerships as suggested by El-Najjar, their function would be similar to Venture Capital Companies which are very successful in developed countries.

It is thus to be appreciated that the transaction’s substance (spirit) is more important over form (skeleton). In other words, it is actually the nature and structure of transaction (undertaken) that makes it permissible or impermissible according to injunctions of Islam.

If transaction is Shariah compliant then it is permissible and if not Shariah compliant or there are doubts in being Shariah compliant then such transaction is impermissible and against Islam.

In today’s world clubbing of resources of public at large and bank’s shareholders pool based on Mudaraba and Musharakah should be the transaction’s substance. That would eliminate the bank’s dual personality once as Mudarib and then Rabb-ul-Mal.

If we carefully read Mudaraba definition, the efforts to carry out business or trade (as another participant to Mudaraba) are made by entrepreneur and not by Islamic Bank as Mudarib, rather deploying resources together as partner of depositors.

As mentioned earlier, banking is a main component of capitalism that was adopted by all countries, including the Islamic countries.

The tripartite financial arrangement seems to negate the spirit of both Mudaraba and Musharakah which, in order to apply, depositor’s money and bank’s capital could be grouped as Rabb-ul-Mal and entrepreneur Mudarib, respectively.

In case of comingling of Islamic Bank equity with depositors’ fund in a pool, Net Income/Loss of Pool is allocated between Islamic Bank’s equity and the depositors’ fund in proportion to their respective share in pool. It clearly categorises Islamic Bank parallel to depositors.

The dual personality role is, hence, nullified when the question of distribution arises, that shows Islamic Bank is not putting efforts as second part to the Mudaraba Islamic Financing rather the entrepreneur.

Islamic Banks, according to definition of Mudaraba should be treated as Rabb-ul-Mal for all practical purposes parallel to depositors.

In other words, “pool of depositors and Islamic bank commingling their equity” to be considered as first party investing/providing money and entrepreneur as second party putting efforts and labour; to fulfil the essence of Mudaraba financing definition. This would ensure the spirit of trade which is permissible.

In view of above observations, emphasis should be on following the trade practices hence the most preferred mode of Islamic Finance i.e., Mudaraba and Musharakah to be made basis, i.e., resource pool comprising Islamic Bank’s equity and depositors’ money.

Present disclosure of mark-up earned and profit paid to depositors in Financial Information of Islamic Banks is an apparent and ample example of portraying conventional banking skeleton.

Financial Information Disclosures, therefore, need to be changed to give a true and fair view of divisible pool for distribution between depositors and shareholders collectively called (Rabb-ul-Mal).

Main objective of establishing Islamic Banking System is to invest the funds entrusted to them through profit and loss sharing partnerships, avoiding any kind of dealing with interest (riba), which is strictly forbidden in Holy Quran and Sunnah.

To some extent, the existing Islamic banking system has succeeded in minimising riba by resorting to Murabaha, Mudaraba, Musharakah, etc. One can hope that by giving preference to Mudaraba and Musharakah and decreasing the use of Murabaha, Islamic banks can manage to desist from interest totally thus becoming as successful as venture capital companies in financing, and distinguishable from conventional banking—the main component of capitalism dominating the world economy, in the wake of West’s supremacy over WEALTH-POWER-WEALTH equation.

Copyright Business Recorder, 2024