Prospects of Islamic Banking
Bridges and Dr Simon Norton for their enlightening views on several issues. I dedicate my efforts to ‘Bhaijan’, who has always been the inspiration and my guide throughout my life. 4 Preface At present times, it would not be inappropriate to state that Muslims the world over face the dilemma that their religion, Islam, prohibits interest in stringent terms and aims at establishing an economy that is not only free from all forms and kinds of interest, but also from anything that bears any resemblance to it.
The modern economy is heavily based and reliant on interest and it is hard to envisage any set of economic relations where interest does not play a part, whether directly or indirectly. Resolving the above-mentioned contradiction seems to be a challenge that Muslim intellectuals, bankers, industrialists, businessmen, policy-makers and ordinary consumers face. In a nutshell, this monograph seeks to provide an analysis of the workings and practices of Islamic banking industry and the products it offers; covering legal, political, social and economic issues as they relate to it.
Chapter 1 commences by providing a rationale to the Islamic banking and outlining its historical journey, and ends with a discussion on the riba and its prohibition in Islam. Chapter 2 deals with the modes of Islamic finance, which certainly requires a detailed study, as it is these products that form the cornerstone of the entire Islamic banking industry. Shariah precepts are also introduced at this stage (and are discussed throughout this monograph), as they aid the process of comprehension. This chapter would also serve to introduce a discussion on Islamic Project Finance, dealt within the following chapter.
Chapter 3 deals with Islamic Project Finance in practice, focussing on the legal and other economic issues as they relate to Shariah-Related Documentation, Construction and Lease Financing and Islamic Bonds. Chapter 4 consists of two case-studies, highlighting the Common law developments in Shariah law, as it relates to the Islamic banking industry. Two recent judgments (one from UK and another from Pakistan) are specifically perused, reflecting the stance that the judiciary in the two countries have adopted towards Islamic precepts, its interpretation and application.
Chapter 5 raises issues relating to structuring and offering of Shariah-Compliant investment products. In particular, focussing on the role of financial institutions, fund promoters and Shariah advisors. The chapter concludes by providing a comparative analysis on the legal issues linked to the marketing of Islamic investment products in different jurisdictions. Chapter 6 provides an insight to the regulatory and supervisory practices of Islamic banking in various countries.
Obstacles faced by the Islamic banking industry in their progress as regards their set up in interest-based banking jurisdictions is further addressed, which is supplemented by a case study on the regulatory issues of Islamic banks in India. 5 Chapter 7 is meant to be general, and briefly discusses the lessons that Conventional and Islamic banks can learn from each other, addressing issues such as the effect of technology transfer and the Bank-Client relationship, which would ultimately lead to the progress of one another. Chapter 8 concludes this monograph. It ascertains the merits of introducing Islamic banking globally.
Reforms and suggestions for the Islamic banks are also appended to this chapter, together with a few conclusive remarks on the subject. It is aspired that this work will be a positive contribution on the subject of Islamic banking and its practices. Suggestions and criticisms are solely intended to enhance the progress of this relatively nascent banking industry, which has undoubtedly shown major signs of progress. 6 Glossary of Arabic Terms This section explains some of the Arabic words and terms, most of them appearing in this study, whereas others might relate to them and would thus be of interest to the reader.
Allah is Arabic for God. Fatawa (singular. Fatwa) are legal decisions or opinions rendered by a qualified religious leader (mufti). Fiqh is Islamic Jurisprudence, the science of religious law, which is the interpretation of the sacred Law, Shariah. Gharar is uncertainty, speculation. Hadith (plural. ahadith) is the technical term for the source related to the Sunna; the sayings- and doings- of the Prophet Mohammed (pbuh), his traditions. Halal means permitted according to the Shariah. Haram means forbidden according to the Shariah. Jualah is the stipulated price (commission) for performing any service.
Maysir mean gambling, from a pre-Islamic game of hazard. Muslim is on who professes the faith of Islam or is born to a Muslim family. Qard Hasan is a benevolent loan (interest-free). Qiyas means analogical deduction. Quran is the Holy book, the revealed word of God, followed by all Muslims. Riba is literally excess or increase, and covers both interest and usury. Shariah is Islamic religious law derived from the Holy Quran and the Sunna Shirka (or Sharika) is a society or partnership. Surah is a chapter of the Holy Quran. Takaful refers to mutual support, which is the basis of the concept of insurance or solidarity among Muslims.
Umma means the community; the body of Muslims. Waqf is a trust or pious foundation. Zakat is a religious levy or almsgiving as required in the Holy Quran and is one of the Islam’s five pillars. (Courtesy: Lewis & Algaoud, Islamic Banking, Edward Elgar, 2001, Glossary, x, xi. ) 7 Chapter 1 Introduction and the Basis of Islamic Banking A. Rationale from an Islamic perspective It is argued by proponents of the Islamic banking that in today’s world, the economic system that is based on interest has resulted in concentrating the wealth in the hands of selected few, creating monopolies and further widening the gap between the affluent and the poor.
Islamic finance operates in compliance with the Shariah law. Islam is not anti-commerce (the Prophet Mohammad was himself a merchant). In contrast to the modern Western principles and philosophy, Islam encourages circulation of wealth and considers its role as vital to an economy. As Dr Usmani notes in his book, “just as clotting of blood paralyzes human body, concentration of wealth paralyzes economy. The fact that, today ten richest men in the world have more wealth than forty-eight poorest countries of the world is relied by the supporters of the Islamic banking as a testament to the fact that the current economical set up is unjust and has failed to distribute the wealth proportionately, thus leading to the downfall of humanity. 1 On considering the injunctions of the Holy Quran, it is apparent that the system of distribution of wealth laid down by Islam envisages three objects, namely: (a) The establishment of a practicable system of economy. (b)
Enabling every one to obtain, what is rightfully due to them. c) Eradicating the concentration of wealth. The traditional concept of Muslims that Islam is a unique way of life distinct from all other isms and ideologies extends to the economic life of the Muslims (Umma). In the process of reshaping the economy, the areas of money, banking and investment are regarded as extremely vital to the process of Islamisation of the economy. The Islamic emphasis on co-operation as the key concept in economic life has led to reliance on profit-sharing and participation as the alternative bases for banking and investments in the Islamic framework. The concept of Islamic banking is regarded as one of the few original and creative Islamic ideas that have been successfully tried in recent times. In the not too distant past, the entire banking system in all Muslim countries was designed on the Western banking model; the latter being inconsistent with Islamic law primarily due to the disapproval of Riba (i. e. interest) in Islam. In other words, the elimination of Riba 1 Meezan Bank’s Guide to Islamic Banking by Dr Muhammad Imran Ashraf Usmani, Preface, page 7, Darul-Ishaat, 2002. 2
Issues in Islamic Banking, Selected Papers by M. N. Siddiqi, page 9, Preface, 1983. 8 from financial transactions is the raison d’etre of Islamic Banking3. Attempts to avoid dealing in interest led to the introduction of a non-interest based banking system, commonly termed as “Islamic banking”. McDowall notes that Islamic banking not only provides services that are compliant in terms of the Muslim faith, but through the fundamental concept of profit and loss sharing with their customers, deliver a highly ethical proposition to Conventional banking. As Islamic banking offers services to its customers free from interest, any dealing or transaction that involves interest is seen as erroneous and thus forbidden.
Technically, riba refers to the addition in the principal amount of a loan, which the lender receives from the borrower. This deliberately simplified picture of the true complex state of affairs is something I shall return to in the following chapter in detail. B. History The Islamic financial system has a centuries-old history, as noted by Chapra and Khan (2000): From the very early stage in Islamic history, Muslims were able to establish a financial system without interest for mobilising resources to finance productive activities and consumer needs.
The system worked quite effectively during the heyday of Islamic civilisation and for centuries thereafter. ” However, over the centuries, the centre of economic gravity inclined towards the Western world, and the Western financial institutions (including banks) became dominant and the Islamic tradition remained dormant. 5 The Muslim society never approbated interest; throughout the thirteen enturies of its history prior to domination by imperialist powers, it managed its economy and carried on domestic and international trade without any involvement of interest. Profit – sharing and different kinds of participation arrangements served as adequate basis for savings and investment and considerable capital was mobilised for mining, shipbuilding, marine trade, textiles and other industries. 6 The issue of interest free banking regained the attention of Muslim intellectuals in the 1940’s and 1950’s. By this time, numerous local and national banks were established along the lines of interest-based foreign banks.
By this time, the government of Muslim countries, in particular, those who gained political independence, found themselves compelled to engage in international financial transactions using banking systems. The necessity for commercial banking was realised.