Conventional banking is
unacceptable to Islam for many reasons, not just because interest is a part and
parcel of its operations. IF banking was the ambitious response of many Muslims
to the challenge which Islamic rejection of conventional banking had
necessitated. Since the response was concerned primarily with the elimination of
interest in the legal sense, it has failed to remove the real evils of banking
in the reformed versions of commercial banks they have created. The objective of
elimination of interest has also been achieved, at best, only partially.
It has been said that Muslims
have no alternatives other than the interest-free banking they have already
presented to fill the void which the withdrawal of conventional banking will
create. This claim is incorrect at least insofar as the theoretical presentation
of models is concerned. Alternative proposals can be found, among others, in the
writings of Rabooy; Ahmad, S. M.; Ghamidi, Javed Ahmad; and Khan, Muhammad Akram.
These proposals are substantially different from what has already become
well-known as the model of Islamic banking. All these writers find themselves in
disagreement with the popular version of IFBs and believe that radical changes
are essential to bring the financial system of modern Muslim economies into
conformity with Islamic teachings. There are other writers who believe that
adequate reforms in the conventional banking structure will enable Muslims to
get rid not only of interest but all or most of the flaws of banking.
In this article some of these
proposals are critically examined. It begins with a look at the Time Multiple
Counter Loan mechanism presented by Shaikh Mahmud Ahmad to replace interest as
the basis of bank lending. Banks are very much an integral part of this
proposal. Then, it takes up the recommendations of Muhammad Akram Khan to reform
IFBs so as to bring them closer to Islamic teachings. Although banks do still
find a place in the considerably reformed model, their role is a much changed
one.
Time Multiple Counter Loan (TMCL)
Shaikh Mahmud Ahmad (d. 1989),
the proposer of the concept of TMCL, was also one of the earliest proponents of
the popular IFB model. His book Economics of Islam: A Comparative Study which
was first published in 1947 contained a full chapter on Islamic banking. That
chapter does not contain any mention of TMCL but proposes that borrowers, banks,
and depositors should agree to share the results of businesses on a PLS basis --
a concept that was the cornerstone of the theoretical model of IF banking.
However, later he strongly opposed that proposal. The concept of TMCL was
presented for the first time by the author in October, 1960 in thaqafat, an Urdu
language journal of the Institute of Islamic Culture, Lahore. Later, he
presented his ideas to the Panel of Economists and Bankers which was constituted
by the Council of Islamic Ideology of Pakistan in 1977 to propose ways to
actualise the objective of IF banking in Pakistan. Although the author himself
was a member of the panel, his proposal was not accepted nor did his note of
dissent appear along with the report of the panel. He published that note later
in an Urdu book in 1986 (Ahmad, S.M. 1986, 7-8). The proposal was reproduced in
an English book later in 1989. The author has claimed that TMCL is ‘the only
concept available so far with whose help it is possible to introduce
interest-free banking’.
The Model
The TMCL model is based on the
basic premise that in a loan arrangement not only is the amount of loan
important but equally the duration for which it is lent. Thus, if the amount of
any loan is multiplied by the period for which it is extended, the result would
be a unit -- loan value (LV) -- which will be the measure of deprivation of the
lender as well as the measure of gain of the borrower. Thus an amount of £1000
for one year, for instance, has the same loan value as £100 for ten years i.e.
1000 LVs. In fact, there could be a large number of combinations whereby
different amounts of a currency could be multiplied by appropriate units of time
period to give the same loan value.
Ahmad has proposed that borrowers
should exchange equivalent loans with such combinations of amount and duration
that the bank receives only a fraction of the amount it pays to the borrower,
but receives it for such a multiple of time that, as a result, equivalent loan
values are exchanged. The suitable fractions of loan and time for which loans
are to be given should be decided by a government as a part of its monetary
policy, keeping in view the exigencies of a given situation.
Apart from the claim of
eliminating interest from banks by exchanging loans of equivalent loan value,
the proposer does not envisage any other substantial changes in the way banks
function. He has not only supported the idea of requiring collateral security
from borrowers but has suggested that a collateral of 110 per cent of the value
of the loan should be demanded for all loans. In fact, he believes that the
collateral margin can go higher than 110 per cent but should not be lowered to
less than 100 percent. The author has admitted that in his model "loans cannot
be advanced to people who possess neither the requisite collateral nor the
requisite counter-loan", and has pre-empted his response to such possible
criticism which he believes is likely to originate from socialists by
emphasising that "this is a model for a viable and profitable interest-free
banking system and lays no claim to be regarded as a substitute for charity
houses".
The author believes that there
can be no objections raised against his proposal from the point of view of
Islamic law (sharee‘ah) and that his model holds the promise of
institutionalising qarDay Hasan. The exchange of equivalent time multiple
counter loans, to him, is in the true spirit of the message of this verse of
Qur'an: "Is there any reward for good other than good?" (Qur'an, 55:60).
Comments and Objections
The concept of counter loans has
been presented by some other scholars as well, the difference being that these
others propose that the borrower should, after returning the principal to the
bank, deposit the same amount with the bank for exactly the same duration as the
period of his loan. Indeed, there can be no objection against this type of
counter loan of equal loan value except for the fact that no remedy for erosion
in the value of loan has been suggested in it. As regards the counter loans of
equal loan values suggested by Shaikh Mahmud Ahmad, there are some other
objections as well.
Whereas the concept of TMCL is
based on the premise that money ought to have time value, the Islamic
prohibition of riba requires that money should not be allowed to have any time
value at all. Consequently the TMCL proposal is contributing to resurrect
exactly the same evil which Qur'an wants to see condemned to extinction.
There could be no objection to
lending interest-free loans to individuals provided such lending is not
accompanied by a condition of counter lending. When a counter loan of smaller
value is presented by the borrower for a longer duration, it creates the problem
of uncertain business results for both the parties in the duration of loan. The
proposer of the idea believes that the parties exchanging counter loans will
exchange, in reality, equivalent possibilities of earning profits; whether they
will actually do so will depend on the quality of their respective productive
efforts. The proposer has, in fact, committed a crucial error in assuming that.
In reality, differences in people's achievements are usually attributable to two
factors.
The first is that people differ
in their ability. The second is that although circumstances may appear similar,
they are actually not, and there is some stochastic external influence which
produces the diversity of outcomes. The essential distinction between these two
is that in the first case people's accomplishments are consistent over time,
whereas in the second they are unrelated. If achievements in business were based
on the first factor alone, there would not have been much justification in
prohibiting interest, as investors could have given their funds to borrowers on
the condition of fixed return knowing full well that they would earn a certain
percentage of profit even after paying them interest. Since it is not known
beforehand whether a business will flourish in a certain period of time or not,
demanding fixed returns on capital is considered to be an immoral arrangement by
Islam.
The proposal of exchanging loans of differing values and durations, therefore,
far from being equivalent and fair, will turn out to be, in many cases, highly
unfair. If the spirit behind the prohibition of riba is to be followed, then the
proposal of TMCL cannot be considered acceptable to Islam.
Even if the question of uncertain
business circumstances is overlooked for the sake of argument, the prospects of
achieving justice for both parties in the proposal by exchanging counter loans
of equivalent loan values will be frustrated by the constantly changing value of
currency. In an inflationary period -- which is a rule rather than an exception
in the modern times -- the party that receives a smaller amount for a longer
duration will clearly be the loser since the real loan value of the money it
will have over that period will be less than the real loan value of the money it
will lend to the other party.
Moreover, as mentioned earlier,
the TMCL proposal envisages that borrowers will be required to advance a
collateral of a value which is 110 percent of the loan and this value should in
no case be less than 100 percent of a loan. In Islam security as a condition of
loan is allowed only in circumstances when writing a contract in the presence of
witnesses is not possible. The TMCL proposal which lays down the condition of
demanding security from all borrowers cannot, ipso facto, be acceptable to
Islam.
Furthermore, the proposer of TMCL
model concedes that the elimination of interest envisaged in his model is not
intended to provide fair opportunities to all members of society. In his model,
as in the case of commercial banks, funds cannot be presented to the poor at
all; to the less rich too, the opportunity of getting loans as large as the rich
is non-existent. For the one who, owing to his lack of affluence, cannot get
loans from his proposed model of banks, Ahmad proposes that he should "seek a
job, work hard at it, save necessary means of securing a loan, and then let him
have the satisfaction of becoming his own boss [by getting a bank loan]. Till
that happens, he has to content himself with a job which the market is prepared
to offer to him". The fact is that any arrangement which provides additional
wealth to the already wealthy by disregarding the deprived sections of a society
is just the opposite of what Qur'an has desired in an Islamic society.
The view of the proposer that his
proposal of TMCL is approved by Qur'an is also unacceptable. His suggestion, for
instance, that his proposed counter loans belong to the category of qarDay Hasan
is based on an incorrect understanding of the term. The term qarDay Hasan has
been used in Qur'an for spending to please Allah without expecting any worldly
gains in return. Similarly unacceptable is his claim that his idea of exchanging
equivalent loan values is supported by the following Qur'anic verse: "Is there
any reward for good other than good?" (Qur'an, 55:60). If the context of the
verse is considered to construe its meanings, then it is suggesting that Allah
Almighty, after describing some of the blessings His faithful believers will get
in the life hereafter, is informing the reader about the reason why they will
get them. To do that, He has posed the question as to why He should not reward
goodness for goodness? In other words He is asking the reader how he thinks it
was possible for Allah not to reward the righteous. Clearly, the verse cannot be
understood to support a scheme of exchanging loans whereby the parties are
prompted by their respective self-interests.
Agency
Services by Commercial Banks
Muhammad
Akram Khan (b. 1945) has proposed for commercial banks a new role along with his
other proposals for elimination of interest from the Pakistani economy. Although
the role of commercial banks is substantially changed in his proposal, the
institution itself is retained, allowing it to carry on its traditional
functions in a different, restricted way. These recommendations are preceded by
the author's analysis of the various long-term financing instruments used in
Pakistan after the so-called Islamisation of banking in Pakistan. His conclusion
is that the attempt at Islamisation of banking in Pakistan has failed, as most
of the financing arrangements are still based on interest, although various
terms are used to camouflage their interest-bearing nature. On account of that
reason, he has presented his proposals which, if implemented, will, in his
opinion, make the process genuinely Islamic.
The Proposal
The recommendations of the author
are divided into two main parts. In the first part he has proposed Islamic
instruments for long-term finance. In the next one, he has described the
institutions which he believes are necessary to make his proposed instruments
effective.
The author proposes that
interest-free economy should have common stock as a popular mode of financing.
He also pleads for revival of the scheme of Participatory Term Certificates (PTC),
which were tried and abandoned in Pakistan, to replace interest-bearing
debentures. These certificates were issued by business enterprises to financial
intermediaries which financed those business organisations on the basis of those
certificates for a definite duration. The author proposes that these
certificates should not have any pre-determined return nor should they be
allowed to be redeemed before due date. The certificates, moreover, should be
tradable on the stock exchange. He has also proposed that mudaraba certificates
(MCs) should continue to be patronised in Pakistan. These certificates are not
different from common stock except that their sponsors are required to be a
company registered under the Modaraba Companies and Modaraba (Floatation and
Control) Ordinance 1980. This condition implies that only those businesses are
allowed to float modarabas which are sound and whose business plan prospectus is
approved by a Religious Board appointed for the purpose. Moreover, if 90 percent
of the pre-tax profits for a year of the modaraba are distributed to their
certificate holders, no income tax is required to be paid by the modaraba. The
modaraba certificate holder is also exempt from tax on profits from modaraba.
Likewise, Khan has proposed Leasing Certificates (LC), a new instrument, for
leasing business. These certificates are to be issued by the companies needing
assets on lease to banks or specialised financial intermediaries who would
invest savers' funds specifically entrusted with them for investing in leasing
business. The financial intermediaries would act as agents of savers and would
be entitled to a fixed commission paid once for each service. All profits or
losses will be passed on to the leasing certificate holders who will assume all
risks as lessors. The certificates will be tradable on the stock exchange.
Similarly he has also proposed other instruments like Instalment Sales
Certificates (ISC) and Mutual Funds Certificates. All these schemes involve
banks and/or specialised financial intermediaries in such a way that savers are
required to deposit funds with these institutions knowing full well that their
funds are going to be invested in a specified form of business on the basis of
profit and loss sharing. Financial intermediaries are to act as agents of savers
and the certificates are required to be tradable on the stock exchange.
In the second main part of the
presentation, the proposal mentions the institutions which are necessary in the
opinion of the proposer to actualise the scheme. Apart from other institutions,
the author has proposed new roles for commercial banks and investment banks.
The model of commercial bank
proposed by him gives the institution the right to accept current accounts from
depositors who will pay a fee for receiving the service of safe custody of their
funds. The banks will provide short-term, interest-free loans to their
depositors from these funds whereby the limit and period of loans would depend
on the average balance held by a client throughout the year. Moreover, banks can
invest a part of the funds from current accounts in safe investments provided
they feel confident about their liquidity. Since they will invest these funds at
their own risk, banks will be entitled to the entire profits and liable for any
losses incurred.
Apart from rendering other
secondary banking services not involving interest, commercial banks will provide
agency services to various types of savers for investing in the real sector.
They will supervise and monitor operations of various businesses on behalf of
savers and earn service charges for doing that. The implication of these
suggestions is that banks will not be allowed to earn interest or profit by
lending these funds to businesses at their own discretion without involving
savers, as happens now. The only exception will be in the case of current
accounts, where they will have limited opportunity to use funds at their own
risk and will retain all profits.
Besides commercial banks, the
author proposes that a large number of investment banks be opened as well. These
banks will collect household and corporate savings and act as agents or trustees
to invest them in the real sector in consideration for agency fees. The only
difference between these and commercial banks appears to be that the latter
would receive current accounts and render the secondary banking services not
involving interest like chequeing, remitting of funds, foreign exchange
arbitrage, brokerage etc. The investment banks, on the contrary, would
concentrate on investing funds in the real sector on behalf of savers.
Muhammad Akram Khan's scheme for
elimination of interest from the Pakistani economy is not restricted to the
proposals I have mentioned above. However, they constitute the more important
part of his suggestions and, moreover, are directly relevant to this study.
Rabooy's proposal of creating an
institution which he calls Islamic Intermediary Investment Company (IIIC) is not
very different. He has proposed this institution because he too believes that
the Western conventional banking system cannot possibly be adapted to make it
Islamically acceptable. The IIIC he has proposed would link savers and
entrepreneurs and would manage and control the financial affairs of their
businesses. He suggests that IIIC be allowed to accept only one sort of account
which could be traded and transferred among individuals and corporations like
shares. The funds of this account should be invested in profit and loss sharing
investments and the proceeds distributed amongst account holders, IIIC itself
getting charges for its services.
Comments and Objections
Financial Instruments
As regards Khan's proposal of
introducing interest-free financial instruments, little can be said in
disagreement, apart from the condition of limited liability associated with
shares. Indeed, it seems perfectly legitimate to have common stocks and similar
instruments which give the bearers of certificates a right to participate in the
ownership of businesses proportionate to the value of their shares. There is
nothing wrong in allowing shareholders to sell their shares in a secondary
market if they wish, just as partners in a partnership firm should be allowed to
sell their interest in the firm to another party provided the other parties
agree to the arrangement. In the case of common stock of joint stock companies
free trading of shares by the shareholders is allowed by other shareholders by
implication. Moreover, shareholders participate in profits and losses of the
business too in that when the company is doing good business they receive
dividends as well as, on many occasions, a higher value in the stock market; if
the business runs into losses, they do not receive any dividends and the value
of their shares goes down.
The shareholders are able to
participate in the affairs of the business not only through their voting right
but they can also indirectly influence the management by the potential threat of
selling the shares in the stock market and bringing down the stock prices,
thereby putting pressure on the business management.
As regards the limited liability
of shares, the condition is unacceptable to the Islamic teachings which expect
owners of businesses to take absolute responsibility of the loan they take in
case of default. In the case of joint stock companies that requirement would
entail that shareholders ought to be responsible to the creditors for all the
loans taken by the company even beyond the face value of their shares,
proportionate to their respective share holdings. In the context of Islamic
teachings, however, that condition would not alarm the shareholders, since, in
that context, borrowing by businesses, if any, would be far more limited.
Moreover, the increased responsibility is likely to make shareholders more
involved in the affairs of the business of their companies, which will be a
welcome development.
The proposal of the author to
introduce redeemable stocks -- Participatory Term Certificates (PTC) -- is also
unacceptable. One of the objections against the popular IFB model is that they
have confused the distinction between debt and equity. Whereas interest is the
return a lender gets on debt, legitimate profits are earned by owners of a
business who have invested an amount in a business and bear the risk of losses.
When an investment is temporary i.e. not intended to stretch over the lifetime
of the project and yet participates in the returns of the project, it seems to
be neither debt nor equity. Such arrangements can at best be described as
doubtful if not completely forbidden.
The reason why temporary
participation needs to be condemned is that it creates a debt-like situation
whereby the owners and management are under pressure to return the amount apart
from what they have already given as profits. On the contrary, the creditors
will not be fully interested in the project because of their temporary
participation. In a truly Islamic economy such temporary arrangements would only
serve to create riba-like situation which would serve the interests of those
rentiers only who would not like to take full responsibility of a business
project. After all why should not investors participate fully in a project with
the intention of staying with it over its lifetime? The sort of security which
temporary investments seek to provide to capital is the very opposite of the
objective of the Islamic teachings which expect capital to take most of the
risk. If investors are in need of liquidating their share in the business at
some later stage, they should be allowed to do so at their own risk.
Banks
Khan's proposal to reduce the
function of banks to agency services for savers is based on the true spirit of
Islamic teachings. Indeed, most flaws of banking emerge from the fact that they
are entrusted with huge funds by savers to be used almost at will. Whereas banks
wield tremendous economic power, savers are kept completely in the dark about
the whereabouts of their funds. By confining the role of banks to that of agents
of investors, the author has attempted to remedy the problem from the right
place. Indeed, if savers are given full responsibility to choose their preferred
business and invest their money, banks would lose all the unreasonable advantage
they enjoy today. In fact, in that case banks would completely change their role
and would, perhaps, have to be called by a different name. Although Rabooy's
model prevents the financial institution from getting a share from the profits
of savers' funds, yet it allows the institution considerable, if not total,
liberty to invest available funds within Islamic limits. That liberty would
confer upon the institution a financial power which is the cause of many evils
if improperly used. I, therefore, propose that these institutions should not be
given the right to invest funds at will.
The proposal of Muhammad Akram
Khan makes a significant concession to commercial banks when it allows them to
use funds at their disposal from current accounts at their own risk with all
returns to be retained by them. If the author is keen to restrict the powers of
banks, however, the concession is not appropriate. Indeed the proposer has
suggested measures to restrict the financial liberty of the banks by suggesting
strict supervision by the central bank to ensure that banks' investments are
safe and by suggesting that banks should not be allowed to invest beyond the
limit of their own equity capital. If these measures are strictly implemented,
it will only restrict the evil instead of completely eliminating it. The ability
of banks to use savers' funds at their disposal wherever they choose to is the
root cause of many evils of banking.
Perhaps the author fears that if
even that 'limited' right of banks to use savers' funds is withdrawn, then no
real incentive would be left for these institutions to carry on doing business.
That fear is perfectly justified. A theorist should, however, look for the best
solutions to remedy the problems at hand rather than look for lesser evils. If
banks do not solve the problem of economic injustice in an Islamic society, they
should be wrapped up instead of being allowed to continue to do whatever limited
damage they can.
The proposal of the author that
commercial banks should provide interest-free loans to depositors in a way that
the duration and volume of loans should be based on the average annual balance
held by the borrower is also unacceptable to the spirit of Islamic teachings of
economic justice. If depositors have sufficient funds, they should use their own
funds to satisfy their needs. If they want funds in addition, they should either
exploit their own contacts for the purpose or involve other parties in PLS
contracts. They have no right to get funds belonging to others and that too in
proportion to their relative wealth. Few things can be more unacceptable to
Islam than the suggestion that the privileged sections of the society should be
helped to get more privileges simply because they are rich. Moreover, providing
any incentive to a creditor is similar to riba according to sunnah of the
prophet.
In conclusion, it could be said
that whereas Muhammad Akram Khan's proposal does contain many useful
suggestions, there are still some objectionable aspects of the traditional
financial system retained which do not fit into the ideals of Islamic economic
teachings.
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