Abstract
Islamic banking is making a debut in the world of 'Finanzkapital'. Despite being new in the world of finance and still hesitant to make bold claims, it is emerging slowly but steadily. The men who took upon themselves the task of piloting the Islamic mode of 'Finanzkapital' belong to the new generation of Muslims. Not only are they endowed with a strong Islamic faith but are also equipped with the necessary technical wherewithal to rise to this occasion. The one who first started the ball rolling in this direction was Dr. Ahmed El-Naggar, an Egyptian economist. Among others who joined him later, were the late King Faisal and his son Prince Muhammad. Tunku Abdul Rahman too played the pioneering role in the establishment of the Islamic Development Bank in Jeddah.
Although the superstructure of Islamic banking is still in the making and there are quite a large number of fundamental issues waiting to be resolved, the spirit to make this premier pas a success seems undaunted. While some Muslim countries have already set up Islamic banks, there are others where at least a part of the banking business has been Islamized. Pakistan is among those countries which have set up special counters for interest-free banking.
As Islamic economics is not only confined to mere 'finance', quite a large number of steps are also being taken to orientate the economic contours of these countries compatible with the basic tenets of Islam. Zakat and Ushr have already been introduced in Pakistan. In addition, serious efforts are under way to find new ways and means towards raising funds through taxation etc. for purpose of meeting both the budgetary and developmental outlays.
The World of Islam, today, finds itself in an enviable position. Not only is it now largely liberated from the colonial yoke, but is also endowed with the fabulous oil wealth. With a view to enable the Muslim countries to break their centuries-old economic stagnation, the present exercise into Islamic banking is destined to open up a new epoch of resurgent development and distributive justice. If this effort got crowned with success, not only will it benefit the Muslims, but will also usher in a new era of efficient and broad-based growth and development in the whole world.
Introduction
For centuries the Islamic economic doctrines have remained dormant and been unable to face the more aggressive and vested-interests specific socio-economic order inaugurated by the West. Whatever may have been the reasons for this fate behind the unsuccessful character of the Islamic economic order in the past, one thing that seems to be emerging on the international economic front is the fact that the world of Islam has in recent years started getting awakened from this (chronic) slumber. Apart from political awakening, some of the Muslim countries are today anxiously exploring prospects of liberating themselves from the economic order thrust upon them over the past few centuries by the more powerful Western countries. A special need for this change has been felt on account of the domination of the Western and Communist countries in the realm of economic activity. Banking and finance is one area where the Muslim countries feel inclined to do something fundamentally different. The reason behind this desire is the fact that unlike Western banking system which operates on the cardinal principle of 'interest', the Islamic economic doctrines abhor and forbid all those transactions which directly or indirectly deal with interest or riba, the terminus tecknicus used for this in the Holy Qur'an. One could judge the explicit and emphatic character of prohibition of riba from the following verse of the Holy Qur'an:
" Allah, permitteth trading and forbiddeth riba Allah hath blighteth riba and made Sadaqat fruitful. Allah loveth not the impious and guilty." (al-Qur'an, II : 275-276).
The above Qur'anic injunction was known to the Muslim community for all the past centuries and there were many a Muslim who, inspite of placing their funds with Western banks, did not accept interest which accrued on their deposit accounts, but none tried to establish banking and financing institutions compatible with the dictates and spirit of Islam. In some countries where Muslims ruled, the most convenient practice followed was to let the non-Muslims carry on banking and frequently even commerce and trading. One possible reason responsible for the successful development of banking and financing institutions by Western nations in the Muslims countries was perhaps again the alleged non-Islamic character of these institutions Nevertheless, it seems quite intriguing that despite the explicit verdict in the Holy Qur'an:
" O ye who believe, ... give up what remainetk (due to you) from ribs, if ye are (in truth) believers. And if ye do not, then be warned of war (against you) from Allah and His Messenger." (al-Qur'an, II: 278-279)
The Western banking and financing institutions were allowed to be set up in Muslim countries and there is ample evidence to prove that even Muslims themselves were not hesitant to establish interest-bound banks. There are also enough instances where Muslim countries became signatories to the establishment o? Interest-bound international institutions like the International Monetary Fund and the International Bank for Reconstruction and Development.
Despite the acceptance of Western banking institutions by the Muslim countries, the West does not seem to be inclined to allow the establishment of Islamic banks in their countries. This is evident from a recent effort made by leading members of the Muslim community in South Africa to set up an Islamic bank on the basis of equity and profit and loss sharing with a share capital of 2 million Rands. The government did not approve the application saying that: "The registration of an additional banking institution at this juncture would not be in the public interest."' Other Western countries are likely to adopt similar attitude because the establishment of Islamic banks based on the principle of profit and loss rather than interest would shake the very foundations of Western banking institutions.
The two banking institutions, one working on the basis of interest and the other on profit and loss, represent two different socio-economic orders. The difference, rather the cleavage between the two is of such a magnitude and quality that there are no prospects of any convergence between their goals. Both work for and aim at the realization of different goals. If some-how the ultimate result comes out to be not too divergent from each other, this is more incidental rather than inherent and innate.
Growth of Western Banking System
The Western banking system grew as it did historically was supposed to serve the interests of the powerful class of entrepreneurs, whether businessmen, industrialists or stock traders. The banks operated through the ingenious mechanism of dividing the society into savers and investors. Both these groups were assigned a certain role to play in the society. While the savers were encouraged to do a large part of the 'passive capital-formation', the investors were inspired to use initiative and enterprise to make the best use of this capital through investment activity. The result of this 'division of capital-saving and capital-investing' was that while the former class continued to remain condemned vegetating on paltry rewards, the latter class grew in wealth and stature day in and day out. Notwithstanding other factors which led to the emergence of capitalism in Europe, the role of banking institutions seems to have served as the principal agent responsible for having "triggered off this development. It is indeed a great irony of human history that people who saved capital were the least to benefit from it, while those who dexterously collected and used it through the mechanism of investment were the ones who profited the most. The way this system operates, enables the investors to appropriate the lion's share of the earned profit, while only the remainder falls to the lot of the savers. In some cases, as is the situation in Pakistan at present, the savers were condemned to have even a negative rate of return, while the intermediaries, namely, the banks and the final investors were the ones who made fortune on these savings.
Factors Hindering Growth of Islamic Banking
Many factors led to the non-emergence of banking institutions along with Islamic principles in the Muslim countries. One was the treatment of the doctrine of ribs more as a religious commandment rather than as an economic imperative. It was this approach which led to theological interpretation of concepts, such as, ribs and, in this way, economic rationality and egalitarian thrust inherent in Islamic principles were thrown overboard. The Muslim scholars unfortunately kept themselves so much immersed with religious obligations and the concomitant trivialities that the great Islamic concepts of economic utility and human welfare were never allowed to be transformed into gigantic institutions serving the greater cause and dynamic pursuits of the larger Ummah. It is, in fact, this non-enterprising spirit of the Muslim people which kept them down on the economic front for centuries, while other nations, although not well endowed in terms of great religious commandments, were quick to set up institutions on the basis of human institution, reflection and endeavor.
Max Weber also admits this phenomenon when he says that while the majority of the great ideas were born in the Orient, it was the Occident which transformed them into great institutions. Not only does this verdict apply to riba, it even holds true in the case of Zakat. While the concept of Zakat is fourteen hundred years old, the forerunners of the present 'welfare state' or 'social security system' are no more than two hundred years old. The latter development, it may be mentioned here, wasn't, however, all too natural.' ... it arose as a way to combat socialism by mitigating some of the most conspicuous excesses of capitalism and thus removing the mobilization basis of the Social Democrats. As against this, the Qur'an concepts, such as Zakat and Sadaqat, aimed at offsetting the inequalities inherent in human social and economic order, were taken more or less as rituals rather than as the necessary wherewithal for institutionalizing social justice and social security. Similarly the doctrine of riba was also not understood in its broader and deeper perspective, and, as a result, the great revolution that it was supposed to usher in on the socio-economic front was frustrated.
Many factors have given birth to the above situation. One of them, for instance, was the notion that theological doctrines and dogmas were anachronistic in nature. Perhaps there was some truth in this approach as far as it related to older religions like Christainty and Hinduism, but surely it wasn't applicable to Islam, a religion committed to progress and human emancipation. The tragedy that overtook the Muslim world was the time perspective. In the period during which the great banking institutions were established, the Muslim world had become the victim of intellectual decadence or it was forced to come under the influence or hegemony of non-Islamic nations. It is this era of decline which forced the Muslim world to submit itself to alien institutions arid, worse still, to antithetical intellectual concepts. Although many Muslim countries are now sovereign and active as far as the resurgence of Islam is concerned, there is no denying the fact that the century's old Western supremacy in the world of finance and trading is still far from being shaken.
Islamic Concepts under Scrutiny
The great concepts enunciated by Islam are at present passing through an era of intellectual scrutiny and inquiry. The task before the Muslim scholars is not simply to understand and interpret the Islamic doctrines in the light of the contemporary challenges, but also to prove the economic viability of these concepts. It is here where Islam must compete with other civilizations on an equal footing.
We come back once more to the role of interest-free banking in the process of socio - economic, development. As mentioned earlier, the Western banking system, although it has over the past successfully removed some of its earlier shortcomings, nevertheless it still continues to serve as a financial arm of the capitalist class. The savers who generally represent a large majority of the population in the Muslim countries are continually .deprived of their legitimate share in national income. Because of the manipulations through the discount rate and, the concomitant cartelization of banks in respect of their rates of interest offered on deposits, it is the saver who gets the least reward for his efforts. The largest chunk of the profit is taken away by the investor and the bank serving as the intermediary between the saver and the investor. Through this modus operandi, it is the saver who is generally placed in a position of unequal relationship with the investor. As experience has shown, it is the investor who gains the most and passes on only the residual gain to the saver. I am reminded of a German proverb which says 'A saver always finances his own decline'. In Pakistan this proverb seems to be quite valid because the large majority of savers generally get a negative return on their savings if calculated b y giving due weight to inflation. The banks play the role of deposit collectors in the rural areas and dump these funds into the urban centers. The result is just catastrophic. Not only are the rural people given an inadequate return on their savings, but are also deprived of the opportunities to use their 'own' capital for local development purposes. The capital which is moved to the urban centers also creates a situation where a scarce commodity like capital is made plentiful with the result that the pattern of development financed with capital turns out to be more capital-intensive with the concomitant consequences of more demand for imports and the built-in-need for more foreign aid. Such a strategy is, of course, a volte-face on the development front. Not only does it lead towards further sharpening of income distribution but also neglects the proper and fuller use of the local resource endowment. The economic principle of 'opportunity cost' is thus thrown overboard.
Side by side with lesser utilization of local resources, inequitable reward for the savers' capital, the present banking system also leads to greater propensity to consume and the accompanying lesser growth of investible funds. Because of the cartelization of banks in respect of fixed rates of interest offered on deposits, there also does not take place the required competition among the banks towards making optimum utilization of the capital resource. This too is a serious drawback in the existing working of the Western banking institutions.
Interest-Free Banking System
Unlike Western banking institutions the interest-free Islamic banks are endowed with certain inherent features which make them quite distinct. For instance, operate as they do largely on the basis of profit and loss sharing, the majority of their clients are not savers but holders of profit and loss accounts. In this way not only are the holders of PLS accounts enabled to get a much larger share of the investment-return, but are also psychologically converted from traditional savers into investors.
It may be mentioned here that unlike a traditional saver who generally saves to finance some expenditure in future, an investor generally thinks of not meeting a particular expenditure in future, but much more in terms of building reproductive assets and services for the purpose of future command over resources in a dynamic sense. The Islamic banks operating to fulfill the latter function contribute towards acceleration of investment activity along with the realization of other concomitant goals of better income distribution, higher efficiency of capital and lesser attraction for demonstrative expenditure. An investor's Weltanschauung is world apart from that of a traditional saver. The efficiency of capital increases under the Islamic banking system, because, unlike the payment of a predetermined rate of interest on deposits, the banks are now forced to work efficiently for considerations of attracting clients on the basis of the rate of profit already announced by them in recent years and in the light of their future profit projections. Under the existing interest-bound savings, the banks are obliged to pay a pre-determined rate of interest which is generally no more than a quarter of the actual rate of profit earned on an average unit of investment.
The Islamic banking system has also the advantage of promoting investment habits among the large majority of the people which in the longer perspective lead to lesser consumption and better distribution of income. There is also another advantage bound up with the Islamic banking system. It emerges as a result of the elimination of interest-bearing credit facilities offered to a businessman or a limited company. While under the Western banking system a limited company can meet its additional requirements of capital by obtaining a loan carrying a fixed rate of interest, the same company will, have to obtain funds on profit and loss-sharing basis under an Islamic banking system. The difference between the two is that while in the case of the former the company directors and shareholders pay the usual rate of interest, in the latter case, they will have to part with the larger part of the profit earned on the funds obtained from the bank under the PLS scheme. In the latter cast, it will not be the directors and shareholders of the company who will be able to appropriate the largest chunk of the profit earned on funds borrowed/ obtained from the bank, but it will be the original savers who by virtue of having opened their PLS accounts with the concerned bank will now become the legitimate recipients of the largest chunk of the profit earned by the company. The maximum that the bank can do in this case would be that it will retain a certain amount as management charge. The practice of the PLS scheme is going to have far reaching impact on the social structure of the population. ' Instead of the earlier capitalistic inequitable distribution of the profits earned on savings between the savers and the investors the Islamic banking system will enable the savers' community to receive a much larger share of the profit earned on their deposits. One must also mention here a special feature bound up with the issuance of credit under the Western banking system. This is that the borrowers of funds from the Western banking system can claim tax exemption on the amount of interest paid by them. In order to enable the Islamic (banks to compete with the Western banks, it would therefore be desirable either to withdraw the above tax-exemption or allow similar tax exemption on the basis of the 'profit' passed on by the investors to the savers through the intermediary banks. Prof. Dr. Rittershausen of the Cologne University told me and Ahmed El-Naggar in 1960-both of us were then doctoral students that the tax-exemption granted on the amount of interest paid by the borrowing firm was one of the cardinal privileges enjoyed by the entrepreneurial class under the capitalistic system.
Some Distinctive Features of the Islamic Banking System
It is clear from our above analysis that the Islamic banking system is far superior to the Western banking system. This is evident from the special features enjoyed by the Islamic banking system.
The Islamic banking system is committed to efficient utilization of 'capital'. Savers being PLS holders force the banks to compete with each other and look for attractive investment opportunities. This leads to higher efficiency of capital.
Under an Islamic banking system a large majority of the savers will switch over to PLS accounts, which will earn them better reward than is available under the Western banking system. This will also mean a better distribution of income.
The change from a traditional saver to an investor will reduce the propensity to consume and thereby contribute towards increasing the propensity to save/invest.
The shift from interest-bearing deposits to PLS will increase the share of the savers and reduce the 'unearned' income of the borrowers under the older system. This egalitarian character of 'investment management' will remove sharp income differentials between different income echelons.
The first experiment in interest-free banking was undertaken by Prof. Dr. Ahmad El-Naggar during the early sixties in the Nile Delta. This maiden attempt covered a large number of villages.4 After achieving success in the Nile Delta, Dr. El-Naggar moved to Saudi Arabia and started a campaign for the establishment of Islamic banks throughout the Muslim World. In this struggle he was fortunate to get the support of Prince Muhammad and his illustrious father King Faisal. With hard work and persistent endeavors Dr. El-Naggar was able to steer through many difficulties and saw his efforts crowned with success when the Islamic Development Bank was established in Jeddah in 1975. Over the past few years, he has been instrumental in the establishment of no less than a dozen Islamic banks spread over the wider canvas of the Muslim world. Countries at present having one or more Islamic banks are Egypt, Sudan, Jordan, Kuwait, Dubai, Bahrain and Sharjah. Malaysia and Mauritania have also recently set up one Islamic Bank each. The reports so far received from the Islamic banks reveal that the performance of these banks has been quite satisfactory and it is hoped that they will be able to offer a much better service and reward to their clients than the competing Western banks. Egypt is the leader on the Islamic banking front. A few years ago Dr. El-Naggar set up the International Institute of Islamic Banking and Economics, Lefkosa (Turkish Cyprus)/Cairo to cater for the intellectual and operational needs of the Islamic banks. This institute also offers training facilities to banks staff in Islamic banking. There also exists an International Association of Islamic Banks with headquarters in Cairo. This institution helps member Muslim countries towards the establishment of Islamic banks.
Islamic Banks : Both Efficient and Distributive
With the successful working of the Islamic banks, the Muslim world is again heading towards a new era of financial institutions and equitable socio-economic development. The results so far obtained from the experience of the few Islamic banks look quite baffling. Not only the new PLS accounts are improving the efficiency of capital, but are also contributing towards the betterment of the existing pattern of income distribution. Even the present high propensity to consume rampant among the Muslim peoples is expected to go down in the long run and in its place there will emerge an overall acceleration of investment. These are revolutionary changes, if properly handled they are sure in due course of time to overshadow older and more sophisticated Western banking institutions.
The Islamisation of the banking sector is likely to come of age in the next decade or two. The other thrust of the Muslim countries is likely to be on Zakat and other taxation measures. With proper planning and careful implementation, they too can play their role in changing the unequal relationship perpetrated on social groups. While doing all this, we must not lose sight of the fact that all these great doctrines of Islam are not rituals, they are in fact the foundation-pillars of an egalitarian and development-inducing order.
The Totality Thesis
Despite the too obvious superiority of the interest-free banking system over the Western banking system, there are Muslim scholars who, for some reason, are still feeling hesitant to come out openly for the abolition of interest. One observes this, for instance, from a study recently published in Pakistan. It says: "To think of abolishing riba without reference to the 'totality' of the Islamic economic system is to put the cart before the horse. In fact, there is a real danger that the abolition of riba and its replacement by the profit-sharing system will increase the level of economic exploitation of the poor by the rich, thereby negating the basic Islamic principle of al-'Adl wal Ihsan.
It seems that the authors have not understood the basic message of the Holy Qur'an and have tried in vain to underrate the issue by tying it up with the change in the totality of the Islamic economic system. The Islamic banking system as explained in this paper is not going to strengthen the forces of exploitation, as apprehended by the authors. On the contrary, the Islamic banking system will eradicate the existing exploitation by the investors/banks of the savers. Not only this, the Islamic banks will also improve the efficiency of capital and will inspire many a saver to become active investors. The process of Islamisation in the banking sector is sure to have positive spill over and trickle down impact on the broader social canvas resulting in more equitable distribution of income and quicker development. No doubt the 'totality thesis' has its own merit, but there is no reason why one should wait endlessly lor it and stop looking for partial solutions to set the ball of Islamization rolling in the Muslim countries. We know there are numerous excesses at present obtaining in the Muslim world, but aren't we forgetting that the gravest of all sins that a Muslim can commit is the dealing with riba-bound business. The Holy Qur'an says :
"Those who devour riba, shall rise up before God like men whom Satan has demented by his touch." (al-Quran, II : 275)
Beyond Theological Frontiers
In this exercise of Islamisation one will have to be quite careful in not letting himself be misled by the historical endowment of the Muslim civilization. The riba doctrine as well as several others must be interpreted in the light of the Qur'ari and the contemporary challenges. If, however, we let ourselves be dictated by interpretations of early scholars and jurists, the results might not always be much rewarding; our approach must be beyond theological frontiers and surely away from barren discourses. In this scientific era, it is time that we look at ribs strictly from the point of view of the Holy Qur'an and examine how it could serve as a new intellectual break-through on the economic and banking front. It is only through such an attitude of mind that we can clear a backlog of more than a millennium. The existing order needs to be corrected and the abolition of riba will be just one effective way of making a start. ***By: M.A. Hussein Mullick
Should we adopt islamic banking
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Originally Posted by Haakon
like that.
