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It
is not possible to cover in this survey
all the publications which have appeared
on Islamic banking. There are numerous
publications in Arabic and Urdu which
have made significant contributions to
the theoretical discussion. A brief
description of these in English can be
found in the Appendix to Siddiqi's book
on Banking without Interest (Siddiqi
l983a). The early contributions on the
subject of Islamic banking were somewhat
casual in the sense that only passing
references were made to it in the
discussion of wider issues relating to
the Islamic economic system as a whole.
In other words, the early writers had
been simply thinking aloud rather than
presenting well-thought-out ideas. Thus,
for example, the book by Qureshi on
Islam and the Theory of Interest (Qureshi
l946) looked upon banking as a social
service that should be sponsored by the
government like public health and
education. Qureshi took this point of
view since the bank could neither pay
any interest to account holders nor
charge any interest on loans advanced.
Qureshi also spoke of partnerships
between banks and businessmen as a
possible alternative, sharing losses if
any. No mention was made of
profit-sharing.
Ahmad,
in Chapter VII of his book Economics of
Islam (Ahmad l952), envisaged the
establishment of Islamic banks on the
basis of a joint stock company with
limited liability. In his scheme, in
addition to current accounts, on which
no dividend or interest should be paid,
there was an account in which people
could deposit their capital on the basis
of partnership, with shareholders
receiving higher dividends than the
account holders from the profits made.
Like Qureshi, above, Ahmad also spoke of
possible partnership arrangements with
the businessmen who seek capital from
the banks. However, the partnership
principle was left undefined, nor was it
clear who would bear the loss if any. It
was suggested that banks should cash
bills of trade without charging
interest, using the current account
funds.
The
principle of mudaraba based on Shariah
was invoked systematically by Uzair
(l955). His principal contribution lay
in suggesting mudaraba as the main
premise for 'interestless banking'.
However, his argument that the bank
should not make any capital investment
with its own deposits rendered his
analysis somewhat impractical.
Al-Arabi
(l966) envisaged a banking system with
mudaraba as the main pivot. He was
actually advancing the idea of a
two-tier mudaraba which would enable the
bank to mobilize savings on a mudaraba
basis, allocating the funds so mobilized
also on a mudaraba basis. In other words
the bank would act as a mudarib in so
far as the depositors were concerned,
while the 'borrowers' would act as
mudaribs in so far as the bank was
concerned. In his scheme, the bank could
advance not only the capital procured
through deposits but also the capital of
its own shareholders. It is also of
interest to note that his position with
regard to the distribution of profits
and the responsibility for losses was
strictly in accordance with the
Shariah.6 Irshad (l964) also spoke of
mudaraba as the basis of Islamic
banking, but his concept of mudaraba was
quite different from the traditional one
in that he thought of capital and labour
(including entrepreneurship) as having
equal shares in output, thus sharing the
losses and profits equally. This
actually means that the owner of capital
and the entrepreneur have a fifty-fifty
share in the profit or loss as the case
may be, which runs counter to the Shariah position. Irshad envisaged two
kinds of deposit accounts. The first
sounded like current deposits in the
sense that it would be payable on
demand, but the money kept in this
deposit would be used for social welfare
projects, as the depositors would get
zero return. The second one amounted to
term deposits which would entitle the
depositors to a share in the profits at
the end of the year proportionately to
the size and duration of the deposits.
He recommended the setting up of a
Reserve Fund which would absorb all
losses so that no depositor would have
to bear any loss. According to Irshad,
all losses would be either recovered
from the Reserve Fund or borne by the
shareholders of the bank.
A
pioneering attempt at providing a fairly
detailed outline of Islamic banking was
made in Urdu by Siddiqi in l968. (The
English version was not published until
l983.) His Islamic banking model was
based on mudaraba and shirka
(partnership or musharaka as it is now
usually called). His model was
essentially one based on a two-tier
mudaraba financier-entrepreneur
relationship, but he took pains to
describe the mechanics of such
transactions in considerable detail with
numerous hypothetical and arithmetic
examples. He classified the operations
of an Islamic bank into three
categories: services based on fees,
commissions or other fixed charges;
financing on the basis of mudaraba and
partnership; and services provided free
of charge. His thesis was that such
interest-free banks could be a viable
alternative to interest-based
conventional banks.
The
issue of loans for consumption clearly
presents a problem, as there is no
profit to be shared. Siddiqi addressed
this problem, but he managed only to
scratch the surface. While recognizing
the need for such interest-free loans (qard
hasan), especially for meeting basic
needs, he seemed to think it was the
duty of the community and the State
(through its baitul mal or treasury) to
cater to those needs; the Islamic bank's
primary objective, like that of any
other business unit, is to earn profit.
He therefore tended to downplay the role
of Islamic banks in providing
consumption loans, but he suggested
limited overdraft facilities without
interest. He even considered a portion
of the fund being set aside for
consumption loans, repayment being
guaranteed by the State. He also
suggested that consumers buying durables
on credit would issue 'certificates of
sale' which could be encashed by the
seller at the bank for a fee. It was
then the seller not the buyer who would
be liable as far as the bank was
concerned. However, the principles of
murabaha and bai' muajjal were not
invoked.
Strangely,
Siddiqi favoured keeping the number of
shareholders to the minimum, without
advancing any strong reasons. This is
contrary to the general consensus which
now seems to have emerged with reference
to Islamic banks operating on a joint
stock company basis, a consensus which
incidentally is also in line with the
Islamic value attached to a broad equity
base as against heavy concentration of
equity and wealth. Ironically, Siddiqi
thought that interest-free banking could
operate successfully 'only in a country
where interest is legally prohibited and
any transaction based upon interest is
declared a punishable offense'
(l983b:l3). He also thought it important
to have Islamic laws enforced before
interest-free banking could operate
well. This view has not gained
acceptance, as demonstrated by the many
Islamic banks which operate profitably
in 'hostile' environments, as noted
earlier.
Chapra's
model of Islamic banking (Chapra l982),
like Siddiqi's, was based on the
mudaraba principle. His main concern,
however, centered on the role of
artificial purchasing power through
credit creation. He even suggested that
'seigniorage' resulting from it should
be transferred to the public exchequer,
for the sake of equity and justice. Al-Jarhi
(l983) went so far as to favor the
imposition of a l00 per cent reserve
requirement on commercial banks. Chapra
was also much concerned about the
concentration of economic power private
banks might enjoy in a system based on
equity financing. He therefore preferred
medium-sized banks which are neither so
large as to wield excessive power nor so
small as to be uneconomical. Chapra's
scheme also contained proposals for
loss-compensating reserves and
loss-absorbing insurance facilities. He
also spoke of non-bank financial
institutions, which specialize in
bringing financiers and entrepreneurs
together and act as investment trusts.
Mohsin
(l982) has presented a detailed and
elaborate framework of Islamic banking
in a modern setting. His model
incorporates the characteristics of
commercial, merchant, and development
banks, blending them in novel fashion.
It adds various non-banking services
such as trust business, factoring, real
estate, and consultancy, as though
interest-free banks could not survive by
banking business alone. Many of the
activities listed certainly go beyond
the realm of commercial banking and are
of so sophisticated and specialized a
nature that they may be thought
irrelevant to most Muslim countries at
their present stage of development.
Mohsin's model clearly was designed to
fit into a capitalist environment;
indeed he explicitly stated that riba-free
banks could coexist with interest-based
banks. The point that there is more to
Islamic banking than mere abolition of
interest was driven home strongly by
Chapra (l985). He envisaged Islamic
banks whose nature, outlook and
operations could be distinctly different
from those of conventional banks.
Besides the outlawing of riba, he
considered it essential that Islamic
banks should, since they handle public
funds, serve the public interest rather
than individual or group interests. In
other words, they should play a
social-welfare-oriented rather than a
profit-maximizing role. He conceived of
Islamic banks as a cross-breed of
commercial and merchant banks,
investment trusts and
investment-management institutions that
would offer a wide spectrum of services
to their customers. Unlike conventional
banks which depend heavily on the
'crutches of collateral and of
non-participation in risk' (p. l55),
Islamic banks would have to rely heavily
on project evaluation, especially for
equity-oriented financing. Thanks to the
profit-and-loss sharing nature of the
operations, bank-customer relations
would be much closer and more cordial
than is possible under conventional
banking. Finally, the problems of
liquidity shortage or surplus would have
to be handled differently in Islamic
banking, since the ban on interest rules
out resort to the money market and the
central bank. Chapra suggested
alternatives such as reciprocal
accommodation among banks without
interest payments and creation of a
common fund at the central bank into
which surpluses would flow and from
which shortages could be met without any
interest charges.
The
literature also discusses the question
of central banking in an Islamic
framework. The general opinion seems to
be that the basic functions of a modern
central bank are relevant also for an
Islamic monetary system, although the
mechanisms may have to be different.
Thus, for example, the bank rate
instrument cannot be used as it entails
interest. Uzair (l982) has suggested
adjustments in profit-sharing ratios as
a substitute for bank rate manipulations
by the central bank. Thus, credit can be
tightened by reducing the share accruing
to the businessmen and eased by
increasing it. Siddiqi (l982) has
suggested that variations in the
so-called 'refinance ratio' (which
refers to the central bank refinancing
of a part of the interest-free loans
provided by the commercial banks) would
influence the quantum of short-term
credit extended. Siddiqi has also
proposed a prescribed 'lending ratio'
(i.e., the proportion of demand deposits
that commercial banks are obliged to
lend out as interest-free loans) that
can be adjusted by the central bank
according to changing circumstances. In
this context, reference may also be made
to a proposal by Uzair (l982) that the
central bank should acquire an equity
stake in commercial banking by holding,
say, 25 per cent of the capital stock of
the commercial banks. The rationale
behind this proposal was that it would
give the central bank access to a
permanent source of income so that it
could effectively act as lender of last
resort. The discussion of central
banking in an Islamic context is
somewhat scanty, presumably because
Islamic central banking is viewed as too
far-fetched an idea, except in Iran and
Pakistan.
It
emerges from all this that Islamic
banking has three distinguishing
features: (a) it is interest-free, (b)
it is multi-purpose and not purely
commercial, and (c) it is strongly
equity-oriented. The literature contains
hardly any serious criticism of the
interest-free character of the
operation, since this is taken for
granted, although concerns have been
expressed about the lack of adequate
interest-free instruments. There is a
near-consensus that Islamic banks can
function well without interest. A recent
International Monetary Fund study by
Iqbal and Mirakhor (l987) has found
Islamic banking to be a viable
proposition that can result in efficient
resource allocation. The study suggests
that banks in an Islamic system face
fewer solvency and liquidity risks than
their conventional counterparts. The
multi-purpose and extra-commercial
nature of the Islamic banking operation
does not seem to pose intractable
problems. The abolition of interest
makes it imperative for Islamic banks to
look for other instruments, which
renders operations outside the periphery
of commercial banking unavoidable. Such
operations may yield economies of scope.
But it is undeniable that the
multipurpose character of Islamic
banking poses serious practical
problems, especially in relation to the
skills needed to handle such diverse and
complex transactions (Iqbal and Mirakhor
l987).
The
stress on equity-oriented transactions
in Islamic banking, especially the
mudaraba mode, has been criticized. It
has been argued that the replacement of
pre-determined interest by uncertain
profits is not enough to render a
transaction Islamic, since profit can be
just as exploitative as interest is, if
it is 'excessive' (Naqvi l98l). Naqvi
has also pointed out that there is
nothing sacrosanct about the institution
of mudaraba in Islam. Naqvi maintains
that mudaraba is not based on the Qur'an
or the Hadith but was a custom of the
pre-Islamic Arabs. Historically,
mudaraba, he contends, enabled the aged,
women, and children with capital to
engage in trade through merchants for a
share in the profit, all losses being
borne by the owners of capital, and
therefore it cannot claim any sanctity.
The fact remains that the Prophet raised
no objection to mudaraba, so that it was
at least not considered un-Islamic.
The
distribution of profit in mudaraba
transactions presents practical
difficulties, especially where there are
multiple providers of capital, but these
difficulties are not regarded as
insurmountable. The Report of Pakistan's
Council of Islamic Ideology (CII l983)
has suggested that the respective
capital contributions of parties can be
converted to a common denominator by
multiplying the amounts provided with
the number of days during which each
component, such as the firm's own equity
capital, its current cash surplus and
suppliers' credit was actually deployed
in the business, i.e., on a daily
product basis. As for deposits, profits
(net of administrative expenses, taxes,
and appropriation for reserves) would be
divided between the shareholders of the
bank and the holders of deposits, again
on a daily product basis.
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