Introduction
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.a
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 qar Day 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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