Conceptually, Islamic Banking broadly connotes as a banking which is in consonance with the ethos and value system of Islam and is being governed by the principles of Islamic Shariah and under the regulatory regime of the State Bank of Pakistan.
Riba means excess, increase or addition. According to Shariah terminology, it implies any excess compensation without due consideration (consideration does not include time as value of money). Islamic viewpoint is very clear that money does not make money itself and it has no intrinsic value, but it can be used as an effective tool if it involves transfer, activity or sale of permitted commodity. The nature of interest is such that it is calculated on a daily basis and keeps on increasing for the whole period of non-payment.
The transformation of Islamic financial system from a conventional system/interest-based system has a long chequered history of enforcement. However, various circulars issued by the Banking Control Department of the State Bank of Pakistan on the subject of elimination of "RIBA" from the banking system including circular BCD circular No. 13 dated 20.06.1984 and BCD Circular No. 32 dated 26.11.1984. The circular 13 recognized certain permissible modes of financing. In exercise of the powers vested under the Banking Companies Ordinance, 1962, the State Bank of Pakistan is pleased to direct that as from the 1st January 1985, interest, wherever charged by a banking company/development finance institution in any of the items of bank charges, shall be replaced by a non-interest mode considered appropriate by it. Moreover, overdue/penal interest or markup on markup shall not be charged by a banking company/DFI as from as from that date..." Presently the word finance has also been defined in the Financial Institutions (Recovery of Finances) Ordinance, 2001, which inter alia, includes Musharikah, murabaha, mussawana, istisnah, or modaraba certificate and term finance certificate, etc.
Skiekh Mahmud Ahmed in his book 'Man and Money' writes that one way of way of winning acceptability of interest was to emphasize the common elements if any between profit and interest, rent and interest or hire and interest. This was done to attract legitimacy to interest by confusing it with other categories. In order to further compound the ratio, the difference in the high and low rates of interest was used as a ruse to substantiate this viewpoint. It is misleading to presume that it is only the high, excessive and exorbitant rate of interest which is harmful financially, socially and religiously, while fair rate of interest was something fully justifiable on economic grounds and the concept of 'loan sharks' as mentioned in the Greek literature is not applicable in modern society is absolutely wrong. Skiekh Mahmud Ahmed further held that interest based economy leads to such insurmountable economic problems like unemployment, inflation, fiscal deficit, deficit financing and business fluctuation.
Even the institutionalized credit needs to develop a mechanism and/or framework in line with the principle of Islamic Shariah and cannot adopt any mode of financing other than as permitted by Islam, whether it be consumptional loan or commercial loan. The gestation period of introduction of Islamic mode of financing has to be completed as early as possible. We may broadly categorized Islamic financing as follows:
1. Murabaha
Briefly we can understand that Murabaha is particular brand of sale where the seller expressly mentions the cost of the sold commodity he has incurred, and sells it to another person by adding some profit. Most preferred way of Murabaha is that the financier himself purchases commodity but due to non applicability of the concept they can also hire agent for purchasing commodity on their behalf. It can easily be concluded that Murabaha is not a loan that bears interest but it is practiced as a sale of commodity by adding some agreed profit whose payment can be made in some future date.
2. Ijara
Another form of Islamic mode of financing is Ijara which simply means to give something on rent. Ijara has two different types namely
(a) If a person provides services and wage is given as compensation in this sense employer is called Mustajir and the employee is called Ajir.
(b) The other type is regarding the usufruct of assets and properties. So Ijara means to transfer the usufruct of a particular property to another person in exchange for rent claimed from him. According to the jurisprudence of Islam, it is compulsory for the validity if contract that the physical ownership is a sine qua non condition for the seller. But it has two exceptions based on some defined conditions.
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Conventional Financing Murabaha
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1. Qarz based contract 1.A sale transaction
2.Bank does not assume the ownership 2. The ownership and risk of the asset are
and risk of the assets borne by the Bank
3.charges penalty in the case of payment 3.No penalty can be charged in the case of
late payment
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Conventional Leasing Ijarah
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1. The asset to be leased is not 1. The asset to be leased is
owned by the Bank. owned by the Bank.
2. The Bank is not responsible 2.The Bank bears all the risk
for any loss to the asset. of loss of asset if such loss is
not caused by the negligence
of the customer.
3 Rent is charged and No rent can be charged and
demanded prior to delivery of demanded prior to the
the asset. delivery of the asset.
4. The conventional lease 4. Since, Ijarah is a binding
agreements give unilateral right agreement therefore, neither
to the bank to terminate the party can terminate it without
Lease Agreement without any mutual consent unless if
reason. there is a breach of contract
by either party.
5. Penalty on late payment is 5. Penalty on late payment
charged. cannot be charged.
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3. Salam
The terminology of Salam has been defined as a "sale where by the seller undertakes to supply some specific goods to the buyer at a future date in exchange of an advanced price."
The Holy Prophet (PBUH) allowed salam on the following circumstances that full payment should be made from the end of buyer because salam is allowed with keeping in mind the unavailability of finance of the seller like farmer. So salaam is beneficial for both the parties, seller enjoys advance payment unlike buyer take the benefit of price lower than the spot rate.
4. Istisna (Pre-production sale)
Similarly Istisna is kind of a sale where a commodity is transacted before it comes into existence. The important point in the case of Istisna is that the manufacturer uses its own material for production otherwise the contract will be of Ijara rather than Istisna. The distinguishing features are that in Istisna manufacturing of the commodity is necessary. In Salam full price is paid in advance but in Istisna there is no such condition and last but not least the delivery time is an important factor in Salam and not of Istisna.
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Istisna Salam
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1.The subject matter must be an The subject matter may be
item which need s to be any thing which may or
manufactured may not need
manufacturing.
2. The price does not necessarily 2. The price has to be paid
need to be paid in full in in full in advance.
advance. It is not necessary to
pay the full price even at
delivery either. It can be deferred
to any time according to the
agreement of the parties. The
payment may also be made in
installments
3. The time of delivery does not 3. The time of delivery is an
have to be fixed. essential part of the
contract.
4.The Contract can be cancelled 4. The contract cannot be
before the manufacturer starts cancelled unilaterally.
the work.
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5. Modaraba
Modaraba is a special kind of partnership where one partner gives money to another for investing in a commercial enterprise. The investment comes from the first partner who is called Rabul Mall and the management is extensively done by Modarib, Rabul Mall may specify a specific business and Modaraba have to do that business. Islam has not specified the percentage of profit it depends upon the parties to mutually consent and the ratio of profit, however, it is strictly prohibited to allocate any lump sum amount for any party. There is another kind of sale known as Musawamah which connotes that a bargaining sale without disclosing or referring to what the cost price is. However, when the cost price is disclosed to the client, it is called "Murabah". A simple Murabah is one where there is cash payment ie., payment is made at the time of sale. Murabah Muajjal is one on deferred payment basis. Payment is made after a few days of sale.
6. Musharikah
The literary meaning of Musharikah is "sharing". The root of the term "Musharikah" in Arabic comes from the word "Shirkah" which means "being a partner". Under Islamic jurisprudence, Musharikah means "a joint enterprise formed for conducting some business in which all partners share the profit according to a specific ratio while the loss is shared according to the ratio of the contribution."
It can be divided into two kinds.
(i) Sharikat ul Milk:
It refers to combined ownership of the property by two or more parties, it has two ways.
a. At the option of parties, such as jointly purchase of equipment
b. It comes automatically for example heir's ownership of property after the death of concerned person.
(ii) Sharikat ul Aqd:
It means partnership by natural contract. It has further three sub divisions:
(i). Sharikat ul amwal (Partnership in capital)
Where all the partners invest some capital into a commercial enterprise.
(ii). Sharikat ul Aamal (Partnership in Services)
Where all the partners jointly undertake to undertake to render some services for their customers and the fee charged from them is distributed among them according to agreed ratio. For example, if two persons agree to undertake tailoring services for their customers on the condition that the wages so earned will go earned to a joint pool which shall be distributed between them irrespective of the size of the work each partner has actually done, this partnership will be a shirat-ul-a'mal which is also called Shirat-ul-taqabbul or shirkat-us-sanai or Shirkat-ul-abdan.
(iii). Sharikat ul wajoo (Partnership in Goodwill)
The word wujooh has its root in the Arabic word wajahat meaning goodwill. They purchase commodities on deferred price, by getting favourable credit terms because of their goodwill and sell goods at spot. The profit so earned is distributed between them at an agreed ratio.
We can explain some rules of Musharikah on over all basis as under:
1. All the valid conditions of sale should be present in the Musharikah for its validity.
2. Investment comes from all parties.
3. Percentage of profit should be determined when contract is made.
4. Lump sum amount is not allowed.
5. According to Imam Malik and Shafi, profit is shared according to the percentage of investment. According to Imam Ahmed profit sharing ratio can be different from investment. Imam Hanifah made a coordination between both the points. According to him, if the partner will remain sleeping throughout the contract, the profit should not exceed from its investment.
6. On the point of loss all the Islamic jurists are given one view that loss will be distributed according to the share of investment.
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Interest Based Financing Musharakah
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A fixed rate of return on a loan Musharakah does not
advanced by the financier is envisage a fixed rate of
predetermined irrespective of the return. The return is based on
profit earned or loss suffered by the actual profit earned by
the debtor. the joint venture.
The financier cannot suffer loss. The financier can suffer loss,
if the joint venture fails to
produce fruits.
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Understanding Diminishing Musharikah
According to this concept, a financier and his client participate either in the joint ownership of a property or an equipment, or a joint commercial enterprise. The share of the financier is further divided into a number of units and it is understood that the client will purchase the units of the share of the financier one by one periodically, thus increasing his own share until all the units of the financier are purchased by the client so as to make him the sole owner of the property, or commercial enterprise, as the case may be.
> In Diminishing Musharikah, the financer and the client participate either in joint ownership of a property or an equipment or in a joint commercial enterprise.
> The share of the financer will be divided into a number of units.
* The client will purchase these units one by one periodically until he is the sole owner of the property.
* The arrangement allows the financier to claim rent according to his proportion of ownership in the property and at the same time allows him periodically return of a part of his principal through purchases of the units of his share.
Forms/kinds of diminishing Musharikah
1. Joint ownership of the Bank and Customer
2. Customer as a lessee uses the share of the Bank.
3. Redemption of the share of the Bank by the Customer.
Mode of fixed Asset Financing
Diminishing Musharikah is commonly used for the purpose of financing of fixed assets by various Islamic banks.
* House Financing
* Car financing
* Plant and machinery financing
* All other fixed asset
Basic structure
> The customer approaches the Bank with the request for project/machinery/house financing.
> The Bank enters into Musharikah (Joint Ownership) agreement with the customer and both of them pay their respective shares to the seller of the Asset
> Client promises to purchase Bank's share (units) over the term of transaction with the help of undertaking to purchase.
> Customer pays rent for the use of banks share in the property.
* Client purchases the units every month via a separate offer & acceptance every month and will eventually become the owner of the property.
* Ownership of the asset is gradually transferred to the customer upon payment of asset price (with the help of a sale transaction between bank and customer) at the end of each period.
Shariah principles
To create joint ownership in property is called sharikat ul Milk and is expressly allowed by all schools of Islamic jurisprudence.
> All Muslim jurists agree on the permissibility of the financer leasing his share in property to client and charging him rent, ie., permissibility of leasing one's share to his partner.
> Promise of client to purchase units of share of financer is necessary
* The transactions cannot be combined in a single arrangements and they have to be executed independently.
D.M illustration
> Customers request financing for a fixed Asset Costing Rs 3 million
> Islamic bank agrees to provide financing up to 90% of the cost.
> Joint ownership Agreement is executed between the Bank and the customer.
* Bank will purchase 90% share in the Asset by paying Rs 270 million to the supplier.
* Customer pays its share of Rs 30 million. Bank's share is divided into five units.
* Customer agrees to buy out Bank's share (units) on yearly basis and the understanding is executed by the customer.
* Customer pays the rent for the usage of the Bank's units.
* Rental reduces after the purchase of each unit by the customer.
* After five years ownership of the Asset is completely transferred to the customer.
Diminishing Musharikah for carrying on business:
A wants to purchase a taxi to use it for offering transport services to passengers and to earn income through fares recovered from them, but he is short of funds. B agrees to participate in the purchase of the taxi, therefore both of them purchase a taxi jointly. 80% of the price is paid by B and 20 % is paid by A. After the taxi is purchased, it is employed to provide transport to the passengers whereby the net income of Rs 1000 is earned on daily basis. Since B has 80% share in the taxi, it is agreed that 80% of the fare will be given to him and the rest of 20% will be retained by 'A' who has a 20% share in the taxi. It means that Rs 800 is earned by 'B' and Rs 200 by 'A' on daily.
At the same time the share of 'B' is further divided into eight units. After three months 'A' purchases one unit from the share of 'B'. Consequently, the share of 'B' is reduced to 70% and share of 'A' is increased to 30% meaning thereby that as from the date 'A' will be entitled to Rs 300 from the daily income of the taxi and 'B' will earn Rs 700. This process will go on until after the expiry o two years, the whole taxi will be owned by 'A' and 'B' will take back his original investment along with income distributed to him as aforesaid.
General misconception:
It is a hard reality that every kind of financing is treated as riba, despite the fact that it may fall under the permissible mode of financing. Even in the case of M. Aslam Khaki vs. Muhammad Hashim reported as PLD2000 SC 225 (Aslam Khaki case) at page 467 have recognized Mudarabah and Musharikah such transactions of partnership different from loan transaction. However, the people at large is not satisfied with the kind of treatment meted out to them by the Financial Institution and the record of financing in the form of Statement of Account being maintained by the Banks.vi It is relevant to mention here that the case of M. Aslam Khaki was reviewed and was remanded back to Shriat Court to cover further aspects of the matter and the instant matter is still sub judice for hearing of the matter.vii
Business Risk: In musharikah Financing, the bank is sharing the business risk with the customer since the return in Musharikah financing is dependent on the actual performance of the business. The bank should make a feasibility study of the business of the customer and should prudently evaluate all the risks of any business before making Musharikah financing decisions, since exposure of bank is on the business performance and not on the customer, unless and until fraud and negligence is established on the part of the customer.
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Islamic Banks (IB) Conventional Banks (CB)
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At the conceptual & Socio-
religious level
1.IB are not money lending 1. Conventional interest based
institutes but they work as a banks CB are in the business
trading/investment house. of lending & borrowing
money based on interest.
2. IB work under the socio- 2. In CB, we see no such
religious guidelines that prohibit restrictions. Interest is the
charging and paying interest and backbone of this system and
avoid all impressible speculative transactions are
transactions like gambling, common.
speculation etc.
3. IB do not permit financing to 3. In CB all type of industries
industries that can cause harm to are financed. Only businesses
the society such as alcohol and deemed illegal by the law of
tobacco. the land are not given loans.
4. IB business model is based 4. Generally CB do not
on trade, thus IB need to actively involve in trade and business
participate in trade and as they act only as money
production process and lenders.
activities.
5. IB have a Shariah governing 5. In CB no such framework
framework in terms of Shariah is present. CB treat money as
Advisor and/or Shariah a commodity and lent it
Supervisory Board which against interest as its
approves the transactions and compensation. In CB, almost
product in the light of the all the financing and deposit
Shariah rulings. IB recognize side products are loan based.
loan as non-commercial and
exclude it from the domain of
commercial transactions.
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Section 25 (2), Banking Companies Ordinance, 1962 empowers the State Bank of Pakistan to give certain directions to the banking companies, including a direction about the rates of interest, charges or markup to be applied on advances or prohibiting the giving of loans to any borrower on the basis of interest. The way 'mark-up' is applied at present is nothing but Riba, hence prohibited. But at the same time the concept of a real sale, based on mark-up is not impermissible in its origin, subject to certain conditions. The major condition for the permissibility of a markup transaction is that it should not be charged on lending or advancing money. It must be based on the genuine sale of a commodity with all its substantive consequences. But Section 9 of the Banking Ordinance prohibits a bank from a trading. It is provided in section 9 that " Except as authorized under section 7, no banking company shall directly or indirectly deal in the buying or selling or bartering of goods or engaged in any trade or buy, sell or barter goods for others, otherwise than in connection with bills of exchange received for collection or negotiation." When the word 'markup' used in section 25 is read in juxtaposition with section 9, it is certainly repugnant to the injunctions of Islam, because a valid mark-up transaction cannot be imagined without a genuine sale effected by the bank. Therefore, the provision of markup and the provision of section 9 cannot stand together. Either of the two must be struck down. The matter has been remanded to the Federal Shariat Court for determination afresh and the matter is still sub judice before the Federal Shariat Court.
(The views expressed in this article are not necessarily those of the newspaper)
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